Can A Landlord Recover Lease Incentives From A Tenant?

This issue has come before the courts in Australia a number of times over the last 10 years.  The Supreme Court of Queensland has once again held an obligation to repay a lease incentive to be a penalty.

Facts 

BMG SP Pty Ltd (BMG) as tenant, entered into a lease (Lease) with Swordfish Australia Sub TC Pty Ltd (Swordfish) as landlord in respect of premises at the Strathpine Centre, with the intention of operating a mini-golf business. 

The Lease stipulated that, before BMG commenced trading: 

• BMG was required to undertake various fitout, installation and construction works at the premises (Tenant Fitout Works); and
• Swordfish was required to undertake various structural, electrical, mechanical and installation works at the premises (Landlord Works). 

BMG and Swordfish also concurrently entered into an incentive deed (Incentive Deed), under which Swordfish agreed to provide BMG with certain incentives including a fitout contribution of $1,250,000, which was to be paid in four instalments (Fitout Contribution).

Due to various delays in the completion of the Landlord Works and the Tenant Fitout Works, BMG was unable to commence trading on the agreed commencement date. 

The Strathpine Centre was purchased by YFG Strathton Pty Ltd (YFG).  Swordfish assigned its interest in both the Lease and the Incentive Deed to YFG as the new landlord. 

At this stage, Swordfish had already paid BMG three instalments of the Fitout Contribution (totalling $1,000,000).  The final instalment was due to be paid 30 days after BMG opened for trade. 

The relationship between BMG and YFG deteriorated.  BMG refused to progress the Tenant Fitout Works until YFG agreed to vary the commencement date to a later date and make other concessions. 

YFG refused to agree to BMG’s demands without an assurance and evidence that the Tenant Fitout Works would be completed in a suitable timeframe.  BMG refused to provide such assurance and evidence until its demands were met.

YFG contended that BMG had repudiated the contract and gave BMG notice that the Lease was terminated.

YFG also demanded that BMG pay $993,607.29, being a proportion of the Fitout Contribution, calculated by reference to clawback provisions set out in the Incentive Deed and the Lease (Repayment Clauses).  The Repayment Clauses provided that, if the Lease was terminated due a default by BMG, then BMG was required to repay to FYG an amount calculated by reference to the amount of the Fitout Contribution provided to BMG.   

BMG denied that it repudiated the Lease and refused to repay the amount demanded by YFG.  BMG sought a declaration from the court that the Repayment Clauses were unenforceable as a penalty (as well as a declaration that YFG’s purported termination of the Lease was invalid and of no effect). 

Arguments 

BMG submitted that:

• the Repayment Clauses were a penalty, as they could not be construed as a genuine pre-estimate of YFG’s loss due to early termination of the Lease; and 
• the case was on all fours with GWC Property Group Pty Ltd v Higginson [2014] QSC 264 (GWC).  In GWC, the Court held that similar incentive clawback provisions relating to the landlord’s fitout contribution and rent and signage fee abatements, which were contained in an incentive deed and were triggered by the tenant’s breach of the lease, were unenforceable penalties.  You can read our previous article on GWC here.

YFG submitted that: 

• the Repayment Clauses did not amount to a penalty;
• because of the difficulties in quantifying what the future loss of the landlord might be at the time of entering into the Lease and Incentive Deed, the Repayment Clauses constituted a valid and genuine pre-estimate of loss would be suffered in the event of BMG’s default; and
• GWC was distinguishable from this case, as the clawback provisions in GWC provided for recovery of a fitout contribution and an amount in respect of rent abatement.  YFG argued that this distinction was relevant as:
  • a clawback of a fitout contribution alone is more readily considered as the withdrawal of a conditional indulgence rather than a penalty; and
  • the relevant provisions in GWC did not include the same kind of tenant acknowledgements which were included in the Repayment Clauses and, therefore, any repayment demanded under those clauses could not be out of all proportion to YFG’s interests.

Decision 

The Court held that the Repayment Clauses were unenforceable as a penalty and that the case was materially indistinguishable from GWC. 

Penal in nature

In order to determine whether a provision is penal in nature, the terms and inherent circumstances of the provision must be scrutinised. 

A penalty is in the nature of a punishment for non-observance of a contractual stipulation, and it imposes an additional or different liability upon breach of the contractual stipulation. 

A distinction must also be drawn between a penalty and a pre-estimate of liquidated damages.  A penalty is a payment of money that is in the nature of a threat or intimidation by the offending party, whereas liquidated damages are a genuine covenanted pre-estimate of damage. 

The Court held that: 

• similar to GWC, the Repayment Clauses imposed a secondary obligation upon BMG to pay an amount of money to YFG if the Lease was terminated for BMG’s default;
• the Fitout Contribution was not a conditional indulgence (despite BMG’s acknowledgements contained in the Repayment Clauses);  
• the Fitout Contribution was part of the consideration provided by YFG for BMG’s entry into the Lease.  Through the bargain contained in the Lease and the Incentive Deed, YFG obtained the benefit of the Lease, including the right to receive rent, outgoings and other amounts.  Had the Lease been performed according to its terms, that is what YFG would have been entitled to receive.  BMG would not have been required to repay any of the Fitout Contribution; and
• accordingly, the additional payment sought to be recovered by the Repayment Clauses was a penalty.

Extravagant or out of all proportion 

To properly characterise the Repayment Clauses as penalties, consideration also had to be given to whether the Repayment Clauses provided for a payment that was extravagant or out of all proportion to YFG’s legitimate interests.

YFG’s interest was in the commercial leasing of its premises.  Upon termination of the Lease due to BMG’s default, YFG would lose the benefit of the Lease and it would be entitled to recover damages for that loss.  However, if enforced, the Repayment Clauses would allow YFG to receive additional advantages that it would not have otherwise received.  The formula contained in the Repayment Clauses provided for a pro-rata recovery of the Fitout Contribution paid, which reduced over the lifetime of the Lease.  

Accordingly, the Repayment Clauses could not be a genuine pre-estimate of loss.  The only possible loss that related to the Repayment Clauses was the loss of the amount paid by YFG for the Fitout Contribution.

Conclusion

Ultimately, the Court held that the Repayment Clauses: 

• imposed a punishment for BMG’s default and did not operate to protect any legitimate interest of YFG; and  
• operated to secure the tenant’s compliance with its duties under the Lease by a payment stipulation that was extravagant and out of all proportion with YFG’s legitimate interest in the commercial leasing of its premises.  

Lavan comments

Landlords commonly provide incentives to tenants to enter into leases.  

Provisions that simply require a tenant to repay a portion of the incentive are not enforceable. 

That is not to say that an incentive is not recoverable from a tenant consequent upon a tenant’s breach under a lease.  However, the mechanisms to achieve that result will be much more complicated than a simple repayment of a portion of the incentive. 

* Acknowledgement: Sara Stikic, a lawyer in our Property and Leasing team, made a significant contribution in the preparation of this article.