Lease incentives offered by landlords to tenants have significantly evolved in recent times. Since the onset of COVID-19, there has been a substantial decline in commercial tenancies for various reasons, leading to an increased need for landlords to lure and entice tenants into signing new leases or renewing for additional terms.
In our latest Property alert, we explain what a lease incentive is, the purpose of the clawback clause, and the implications for both landlord and tenants when negotiating a lease.
What are lease incentives?
Lease incentives are additional benefits offered by the landlord to attract or retain a tenant.
Lease incentives can come in many different shapes and forms. The most common types of incentives are:
1. Rent-free periods
This is where a landlord gives the tenants a period of non-payment of rent which ordinarily starts from the commencing date. The rationale is that it allows the tenant to offset moving costs or initial setup expenses.
2. Rent abatement
An abatement provides for a rent reduction for an agreed period which can be for a certain number of years or for the course of the term. It is beneficial to a tenant as it helps reduce operating expenditure for an organisation, which in turn would help increase profit figures.
It is also favourable to a landlord as opposed to a rent-free period as it means cash flow remains continuous and in the event the tenant defaults, the landlord would have at a minimum received a portion of the rent rather than no rent at all.
3. Fit-out contributions
This is where the landlord provides a cash contribution towards the tenant’s fit-out and is incentivising as the tenant has the opportunity to renovate the premises whilst also increasing the capital value of the premises.
A combination of one or more of these incentives may be offered for the one lease.
There are a few different options when documenting lease incentives. The most common methods of documentation involve an incentive deed, within the agreement to lease or within the lease itself.
Clawback clauses
Most lease incentives are offered on the basis that in the event of default or early termination, the landlord will be able to recover all or a portion of the incentive provided. Clawback clauses generally operate on a pro-rata basis.
For example, if a tenant terminates a lease after three years during a six-year term due to the tenant’s default, it would mean that only 50% of the term is complete. The clawback clause would ordinarily provide that the tenant repays the total incentive received by the tenant during the first three years.
The rationale behind these types of clawback clauses is often that the lease incentives are offered in exchange for the tenant occupying the premises for the full term, and by failing to complete the term the tenant hasn’t fulfilled their part of the agreement. Case law however has since cast doubt on this rationale as highlighted below.
GWC Property Group Pty Ltd v Higginson [2014]
In the matter of GWC Property Group Pty Ltd v Higginson [2014] QSC 264 (Qld), a lease and incentive deed was entered into between the parties in 2010. The incentive provided for a monetary contribution towards the tenant’s fit-out and rental abatement for the first three years of a seven-year term. The tenant abandoned the premises after three years and the landlord sued for the return of the incentives.
The case centred around the clawback provision which provided that the tenant would have to repay the landlord’s fit-out contribution and rent abatement if the lease was terminated during the initial term. Despite the clawback provision, the landlord was unsuccessful in recovering the incentive as it was determined that if the landlord recovered the incentives, it would have taken monies which it would have never been entitled, had the lease run its course.
The Court further stressed that granting the recovery of the incentives would essentially allow the landlord to profit from the deal and put them in a stronger position than if the lease had run its course. Essentially, it was not a genuine pre-estimate of damage and would be deemed unconscionable if the incentive was repaid. The landlord still maintained its rights for breach of contract.
Alamdo Holdings Pty Ltd v Croc’s Franchising Pty Ltd (No 2) [2023]
The reasoning in the Higginson case was followed and expanded on in several cases including Alamdo Holdings Pty Ltd v Croc’s Franchising Pty Ltd (No 2) [2023] NSWSC 60 which implemented a test in determining whether an incentive could be recovered.
The test provided for two limbs:
- Can the relevant clauses be characterised as a threat against Croc’s failing to comply with its obligations under the lease or as a punishment for permitting that circumstance to arise?
- Do the relevant clauses serve to guard the legitimate interests of Alamdo, are not out of proportion to such interests, and reflect a genuine pre-estimate of Alamdo’s damage?
The Court again decided that the clawback right specific to a fit-out contribution was unenforceable as the clawback clause went further than was necessary to protect the interests of the landlord and was therefore considered to be a penalty.
148 Brunswick Street Pty Ltd v Strategix Training Group Pty Ltd (No 2) [2011]
The case of 148 Brunswick Street Pty Ltd v Strategix Training Group Pty Ltd (No 2) [2011] QDC 212 (Qld) provides a rare instance when a landlord has been successful in recovering an incentive. In this case, the parties entered a deed of variation which provided the tenant with an early termination right in exchange for refunding the value of the incentives to the landlord.
The tenant elected to exercise their early termination right, following which the landlord commenced proceedings to recover the incentives. The landlord was successful as the provision was attached to the tenant’s right to terminate. Essentially, the opinion of the Court was that although it was a harsh commercial bargain, the tenant was receiving the benefit of terminating the lease early. Accordingly, the landlord was entitled to recover the paid incentive.
Conclusion
Considering the case law in respect to clawback provisions, it has proven difficult for landlords to recover lease incentives unless a similar situation as described in the Brunswick St case applies. Accordingly, it is important the risks of recovery and repayment are adequately and fully understood. It may be worthwhile considering more creative approaches to incentives, such as incentives by way of secured financing arrangements which appear to have more success in recovery as opposed to lease incentives.
The emerging area of lease incentives and the implications for both landlord and tenants are very important to consider when negotiating and drafting lease documents. Other important factors for consideration are the associated tax implications as well as whether any assignment of the incentive rights are held by tenant.
Contact us
If you are a landlord, tenant or agent negotiating the terms of a lease incentive or would like to consider how a lease incentive could impact you, please contact a member of our Property team.
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