Incentives and clawback provisions in leases

Landlords may offer incentive/s to prospective tenants to encourage and attract them to sign a lease. Lease incentives may include rent-free periods, fit-out contributions or rent discounts and sometimes allow the tenant to elect which of these incentives or combination of incentives the contribution is to apply to.

It is common practice for the incentive clauses to include clawback provisions which require the tenant to repay the incentive to the landlord if the tenant has defaulted under the lease, or if the tenant assigns the lease prior to the expiry of the term (collectively known as ‘trigger events’).

Enforceability 

In recent years, landlords and tenants have litigated the clawback provision in incentive clauses to determine whether the tenant is obligated to repay the incentives if a trigger event occurs.

The courts have frequently referred to the decision made by the Queensland Supreme Court in GWC Property Group Pty Ltd v Higginson [2014] QSC 264 (‘GWC’) in determining whether the tenant’s obligation to repay the incentive was considered a penalty and unenforceable on the tenant instead of a mechanism to protect the landlord’s interests and rights.

The courts have found that if the tenant had breached its obligations under the lease, the landlord could recover contractual damages which would put the landlord in the position it would have been in if the lease had “run its course”. If the damages payable by the tenant are extravagant and unconscionable compared to the maximum loss suffered, the clawback provision is unenforceable. The judge in GWC concluded that the clawback provision was substantially more than any genuine pre-estimate of damages.

Recently in the NSW Court of Appeal Supreme Court decision of Alamdo Holdings Pty Ltd v Croc’s Franchising Pty Ltd (No 2) [2023], the judge decided that the clawback provision for a fit-out contribution “went further than is necessary to protect [the Landlord’s] legitimate interest” and therefore the right was considered a penalty and unenforceable. 

Going forward 

When negotiating leases, landlords should consider the risk of granting incentives to tenants for the duration of the lease term and consider the structure of the incentive arrangements in the event a trigger event happens under the lease. It is important that clawback provisions do not constitute a penalty rather a genuine pre-estimate of damages.

Furthermore, in light of the Unfair Contracts Terms Regime, it is likely that a clawback provision may expose the landlord to penalties under the regime as the courts have considered that the right to clawback is a penalty if unconscionable compared to the maximum loss suffered.

A landlord should take care when negotiating incentive arrangements. The structure of the incentive and clawback provisions in a lease could be drafted in a manner that would protect the legitimate interest of the landlord and represent the anticipated loss suffered as a result of a trigger event, not exceed that loss. For example, the incentive could be structured to spread across and be abated throughout the term of the lease to help mitigate risks associated with unenforceable repayment clauses.

For more information about how the recent decisions apply to your circumstances or how to structure your lease incentives, please contact our people.

Ron Zucker 0410 590 111

Eollyn Cortes 0478 727 395

Sagang Chung 0431 435 333

Julia Zou 0426 670 202