Land­lords beware — Incen­tive claw-back pro­vi­sions deemed to be penal­ty clauses

In Brief

The recent Supreme Court of Queens­land deci­sion of GWC Prop­er­ty Group Pty Ltd v Hig­gin­son & Ors affirms the long-held but (until now) untest­ed fear that the ubiq­ui­tous claw-back pro­vi­sions which accom­pa­ny most incen­tive pro­vi­sions may very well con­sti­tute a penal­ty clause.

What is a penal­ty pro­vi­sion?

The mod­ern law of penal­ty pro­vi­sions was enun­ci­at­ed in the UK House of Lords’ deci­sion of Dun­lop Pneu­mat­ic Tyre Co v New Garage & Motor Co Ltd, where Lord Dunedin stat­ed that the fol­low­ing tests would deter­mine whether a clause is a penalty:

1. If a sum [recov­er­able] is extrav­a­gant or uncon­scionable in com­par­i­son with the great­est loss that could con­ceiv­ably be proved to have fol­lowed from the breach;
2. If a breach is a fail­ure to pay a sum of mon­ey and the impugned clause stip­u­lates an amount greater than that which ought to have been paid (oth­er than inter­est); and
3. Where a clause stip­u­lates a sum payable on the occur­rence of one or more events, some of which may occa­sion seri­ous dam­age, but oth­ers mere­ly tri­fling dam­age, there is a pre­sump­tion (but no more) that the clause is a penalty.

This test was affirmed in Aus­tralia in the High Court deci­sion of Ringrow Pty Ltd v BP Aust Pty Ltd where it was held by the Court that the law of penal­ties is attract­ed where ​“a con­tract stip­u­lates that on breach the con­tract-break­er will pay an agreed sum which exceeds what can be regard­ed as a gen­uine pre-esti­mate of the dam­age like­ly to be caused by the breach” (at 663).

Back­ground
GWC Prop­er­ty Group Pty Ltd (Land­lord) owned a prop­er­ty in Bowen Hills, Queens­land which was leased by its pre­de­ces­sor in title to Hynes Lawyers Pty Ltd (Ten­ant) for a term of 7 years with three option peri­ods. The Lease was entered into on 11 Novem­ber 2010 and was accom­pa­nied by an Incen­tive Deed which was recit­ed as being ​“intend­ed to sup­ple­ment the Lease”. It was not­ed that oth­er than con­fi­den­tial­i­ty pro­vi­sions, the Incen­tive Deed con­tained no sub­stan­tial pri­ma­ry oblig­a­tions of the Ten­ant but rather oblig­a­tions by which the Land­lord must allow the Ten­ant the agreed incentives.

The Ten­ant aban­doned the premis­es on 20 May 2013 in breach of the Lease. The Land­lord accept­ed the repu­di­a­tion of the Lease and ter­mi­nat­ed the Lease on 12 June 2013. The Ten­ant is now in liquidation.

The Ten­an­t’s oblig­a­tions under the Lease and Incen­tive Deed where guar­an­teed by the First, Sec­ond and Third defen­dants (Guar­an­tors). It appears how­ev­er, that the Guar­an­tors were released from their oblig­a­tions with respect to the Lease by the Land­lord who agreed to accept a bank bond in sat­is­fac­tion of secur­ing the Guar­an­tors’ oblig­a­tions under the Lease. The Guar­an­tor’s oblig­a­tions with respect to the Incen­tive Deed were not released and that is the basis on which the Land­lord sued the defen­dants, seek­ing $1.2 mil­lion as the amount of incen­tives which the Ten­ant received under the Incen­tive Deed.

Incen­tive Deed
The Incen­tive Deed pro­vid­ed for the following:

• fit-out con­tri­bu­tion;
• rental abate­ment; and
• sig­nage fee abatement.

The Incen­tive Deed also con­tained stan­dard claw-back pro­vi­sions with respect to the fit-out con­tri­bu­tion and rental abate­ment which, in sum­ma­ry provided:

(a) [with respect to the fit-out con­tri­bu­tion] if the Lease was ter­mi­nat­ed pri­or to the expi­ra­tion of the ini­tial term, the Ten­ant will pay the Land­lord a sum cal­cu­lat­ed by mul­ti­ply­ing the num­ber of days between the date the Lease is ter­mi­nat­ed and the expiry date by the amount of the con­tri­bu­tion, and divid­ed by the num­ber of days of the ini­tial term; and

(b) [with respect to the rental abate­ment] if the Land­lord ter­mi­nates the Lease due to the Ten­an­t’s default, the Land­lord has against the Ten­ant a liq­ui­dat­ed debt and the Ten­ant must pay the Rent Abate­ment Amount [as defined in the Incen­tive Deed] that has been abat­ed by the Tenant.

The mat­ter was brought before Her Hon­our Jus­tice Dal­ton by appli­ca­tion of the First, Sec­ond and Third Defen­dants for sum­ma­ry judgement.

Her Hon­our con­sid­ered point 1 of Lord Duned­in’s test above, noting:

• Before the Lease and Incen­tive Deed were signed, the Land­lord was in the posi­tion that the Ten­ant would only enter into the Lease and Incen­tive Deed on the basis it received the abate­ment and fit-out payment.
• By the bar­gain con­tained in the Lease and Incen­tive Deed, the Land­lord obtained abat­ed rent and fees in con­sid­er­a­tion for its lease of the premis­es, togeth­er with the fit-out payment.
• Had the Lease been per­formed accord­ing to its terms, the above is all the Land­lord was enti­tled to.
• The claw-back pro­vi­sions of the Incen­tive Deed sought to give the Land­lord an advan­tage that it would not have had if the Lease was per­formed accord­ing to its terms and thus, would not restore the Land­lord to the pre-con­trac­tu­al posi­tion by, in effect mak­ing the Land­lord enti­tled to recov­er as though the Ten­ant had agreed to the rent and sig­nage fees with­out any abatement.

In a some­what stern rebuke, Her Hon­our not­ed that the sit­u­a­tion in which the Land­lord found itself was a result of its own com­mer­cial deci­sions and stat­ed that the claw back pro­vi­sions where whol­ly penal in their oper­a­tion, pro­vid­ing for sig­nif­i­cant sums to be paid over and above dam­ages which would be payable to the Land­lord at Com­mon Law.

The appli­ca­tion was allowed for the First, Sec­ond and Third Defen­dants and the mat­ter dis­missed.

Does this affect you?
Until now, the appli­ca­tion of claw-back pro­vi­sions with respect to incen­tives had not been prop­er­ly test­ed. This deci­sion may pave the way for fur­ther chal­lenges to claw-back pro­vi­sions should a land­lord seek to rely on them over and above the com­mon law dam­ages avail­able in respect of a breach of a lease.

Going for­ward, care­ful con­sid­er­a­tion should be made when lease deals are incen­tivised, par­tic­u­lar­ly with front-end rent free peri­ods and a fit-out con­tri­bu­tion, so that any claw-back pro­vi­sions are not penal in nature.