Obligation to repay lease incentives held to be a penalty

Recent case

GWC Property Group Pty Ltd v Higginson & Ors [2014] QSC 264 (GWC)


Landlords often give incentives to tenants to enter into leases.

In GWC there were two documents, a lease and an incentive deed.

Pursuant to the incentive deed:

  • the landlord agreed to make a contribution to the tenant’s fit-out, grant a rent abatement, and grant a signage fee abatement; and
  • the tenant agreed to repay (on a pro rata basis) the fit-out incentive if the lease was terminated for any reason other than default by the landlord or if there was an unauthorised assignment or subletting.  It also provided for repayment of the whole of the rent abatement amount if the lease was terminated by reason of the tenant’s default.   

The tenant abandoned the premises.  The landlord accepted the tenant’s repudiation and terminated the lease.  The tenant went into liquidation and the landlord commenced proceedings against the guarantors under the repayment provisions in the incentive deed.

In this case the court found that before the lease and the incentive deed were signed the landlord was in the position that its potential tenant would contract only on the basis that it received abatements and a fit-out.  The clauses in question in the incentive deed did not restore the landlord to that pre-contractual position; they gave the landlord an advantage the landlord would never have had if the lease had uneventfully run its term.

To establish that they are penal, the defendants needed to show that the impugned clauses stipulated for repayments which were extravagant and unconscionable in comparison with the maximum loss that might be suffered on breach of contract. 

The test is an objective one not related to the parties’ states of mind. 

Matters are to be judged as at the time the contract was made. 

In the judge’s view, the repayment clauses did impose obligations which were substantially in excess of any genuine pre-estimate of damages.  In addition to contractual damages for breach of the lease, the landlord was entitled by the repayment clauses, to recover monies to which it would never have been entitled had the lease run its course.  In effect, it was entitled to recover as though the tenant had agreed to the rent and signage fees without any abatement, and as though it had not been necessary for the landlord to pay the fit-out incentive in order to complete the bargain with the tenant.  It is true that all three impugned clauses limit repayment to specified times, rather than require repayment for the whole period relevant to contractual damages.  Nonetheless, the repayment clauses meant that on termination the landlord was entitled to damages for breach of the bargain it had made, and substantial additional payments by reference to a bargain it had not made.

Evidence was provided that the fit-out contribution and rent abatement reflected market conditions.  That was the crux of this case.  Only with those substantial financial concessions did the landlord obtain the lease it did.  The landlord is entitled to damages for breach of the lease but it is not entitled to extra payments on the basis that the landlord might have obtained a higher price for its premises had the market conditions been better for the landlord.  The parties’ bargain was that the landlord would own the fit-out.  If the landlord has difficulty in re-letting the premises, that fact would be adequately reflected in its contractual damages.

The court found that the situation in which the landlord found itself was a result of its own commercial decisions.  There was compelling evidence in these circumstances that did not warrant any compensation being paid to the landlord under the incentive deed.  

Lavan Legal comment – penalty interest rates in leases

This case is a reminder to landlords to review their leasing documents for any provisions which may be construed as a penalty.

It may be that fit-out incentives could be structured as a loan that is only repayable on breach under the lease.  Whilst not entirely free from doubt, such a structure places the landlord in a better position to deal with the penalty argument.

We recommend, in particular, that landlords also review the rate of penalty interest on overdue amounts in their leases.

This is the rate of interest payable by the tenant on an amount outstanding from the day the money becomes due until it is paid to the landlord.

Is this amount so high that it may be considered a penalty and be unenforceable?

It may be prudent, for example, for landlords to consider amending the penalty interest rate to be expressed as a margin above the rate quoted by the landlord’s bank for loans not exceeding $100,000.00 rather than a fixed percentage.

Disclaimer – the information contained in this publication does not constitute legal advice and should not be relied upon as such. You should seek legal advice in relation to any particular matter you may have before relying or acting on this information. The Lavan team are here to assist.