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Australia – Recovery Of Lease Incentives Held To Be Penalties.

19 November, 2014

 

Legal News & Analysis – Asia Pacific – Australia – Construction & Real Estate

 

GWC Property Group Pty Ltd v Higginson & Ors [2014] QSC 264 (29 October 2014)

 
What You Need To Know

 

  • Provisions for recovery of commercial lease incentives that operate in the event of default by the tenant are liable to be penalties and may be set aside.

 
What You Need To Do

 

  • Consider and where necessary revise the drafting of provisions for recovery of lease incentives.

 
Introduction

 
The Queensland Supreme Court has recently held that provisions in a side deed for the landlord to recover lease incentives paid to the tenant, in the event of default by the tenant, were penalties and not enforceable.

 
While the decision is one of first instance and may be appealed, the judgment has important implications, as provisions of this nature are common in commercial leasing.

 
Facts

 
The plaintiff owned office premises in Bowen Hills which had been leased by its predecessor to a commercial tenant. The predecessor had entered into a Lease and an Incentive Deed with the tenant.

 
The Lease was for a term of seven years with three options, and included an annual signage fee. The first, second and third defendants provided a guarantee and indemnity under the Lease. Subsequently the plaintiff released the defendants from their guarantee, instead agreeing to take a bank bond for a fixed amount insatisfaction of the guarantors’ obligations.

 
The Incentive Deed was entered into on the same day as the Lease, and was also signed by the first, second and third defendants as guarantors.

 
The Incentive Deed provided for the landlord to:

 

  • provide a contribution to the Tenant’s fit-out;
  • grant a rent abatement for the first three years of the Lease; and
  • grant a signage fee abatement for the first three years of the Lease.

 
The Deed further provided for the recovery of those amounts, in the following circumstances:

 

  • Fit-out contribution clause: if the Lease was terminated for any reason apart from the expiry of the term or the Lessor’s default, then the Lessee would pay the Lessor an amount calculated as the proportion of the fit-out contribution referable to the balance of the lease term; and
  • Abatement clauses: if the Lessee terminated the Lease or the Lessor validly terminated the Lease consequent upon default of the Lessee, then the Lessor was entitled to recover the amount allowed by way of abatement.

 
The plaintiff’s predecessor in title paid the fit-out contribution and allowed the tenant the benefit of the rent abatement and signage fee abatement. The predecessor in title then sold the office to the plaintiff.

 
The tenant abandoned the premises in breach of the Lease and the plaintiff accepted the repudiation and terminated the Lease. The tenant went into liquidation.

 
The plaintiff commenced action against the first, second and third defendants for AUD 1.2m as guarantors under the Incentive Deed, being the total amount of the incentives liable to be repaid under the Incentive Deed. There was no claim against the tenant (being in liquidation), nor was any claim made under the guarantee in the Lease (given the bank bond arrangements referred to above).

 
The defendants applied for summary judgment in their favour, on the basis that the incentive recovery provisions were penalties.

 
Decision

 
Dalton J allowed the application and summarily dismissed the action, finding that the provisions the plaintiff was suing on were wholly penal.Her Honour naturally considered the leading High Court decision of Andrews v ANZ Banking Group Ltd(Andrews) but decided the case on the common law as it existed before Andrews.

 
Application Of The Penalty Doctrine

 
Dalton J held that the recovery provisions were capable of being penalties because:

 

  • The provisions for recovery of the rent and signage fee abatements operated only when there had been a breach of the Lease by the tenant, therefore were “plainly a sum to be paid in consequence of the breach“.3
  • The provision for recovery of the fit-out contribution operated on termination, whichcould occur for reasons other than breach by the tenant (eg, natural disasters). Even so,because in this case termination had been effected for breach by the tenant, the provision was capable of being a penalty.4

 
Her Honour noted that the High Court has restated the doctrine of penalties in Andrews, such that breach is no longer required. Rather, the doctrine will apply where the provision in question is collateral to a primary stipulation in favour of one party and imposes an additional detriment on the other party.5 Dalton J found it difficult to apply the High Court’s formulation to the facts before her, because she said it was difficult to identify or articulate the relevant primary stipulation.6 Her Honour suggested that the primary stipulation would have to be something to the effect that the Tenant not breach the lease in such a way as to repudiate it.7 Dalton J regarded this as “untidy“.8 However her Honour found that it was not necessary to apply the High Court’s description of the penalty doctrine as a rigid formula.9 Her Honour stated (with respect, correctly) that Andrews marks a return to a more flexible approach to penalties, and that it does not narrow the scope of the penalties doctrine.10

 
For these reasons, and given the difficulties in applying Andrews strictly, her Honour concluded that the case before her fitted within the older cases and principles, and therefore applied them when determining that the relevant clauses could be penalties.11

 

Dalton J rejected the plaintiff’s attempt to characterise the provisions as compensatory rather than punitive.12 Her Honour found that the event which led to the payments being due to the plaintiff was the termination of the Lease on breach by the tenant.13 Such provisions have always been susceptible to the doctrine.

 
Dalton J further rejected the plaintiff’s argument that the incentives should be construed as conditional on the tenant performing under the Lease.14 Her Honour emphasised that there was no clause which made the fit-out contribution or abatements conditional upon the timely payment of rent.15

 
Her Honour found that the bargain contained in the Lease and the Incentive Deed was that the tenant would enter into the agreement on the basis of the abated rent and signage fees and the fit-out contribution. She stated:

 

“The impugned clauses do not restore the landlord to that pre-contractual position; they give it an advantage which it would never have had if the lease had uneventfully run its term.”16

 
Her Honour read the Lease and the Incentive Deed together and rejected an argument by the plaintiff that the Incentive Deed should be looked at separately from the Lease.17 This again appears to be orthodox.

 
Genuine Pre-Estimate Of Damages

 
Having decided that the provisions were capable of being penalties, Dalton J turned to consider the question of the quantum of loss and damage. Her Honour held that the relevant clauses imposed obligations which were substantially in excess of any possible pre-estimate of damages.18 Accordingly, the clauses were penal in nature.

 
Her Honour noted that Andrews makes clear that a penal provision is not void but merely unenforceable to the extent that it exceeds compensation for the prejudice suffered by the failure of the primary stipulation.

 
In considering what the measure of compensation should be in the present case, her Honour concluded that it was no more or less than common law damages. Her Honour regarded this as established by AMEV-UDC,19 which had been expressly approved by the High Court in Andrews. Dalton J noted that difficult questions might arise in another case, where the triggering event was not in fact a breach of contract. Her Honour suggested that the High Court may in the future consider a new law for compensation in penalty cases, not based on common law principles, but noted “[t]hat time has not yet come“.20

 

Her Honour noted that in the present case there was no reason that common law damages would be an inadequate remedy, because the repayment clauses expressly preserved the plaintiff’s common law right to damages for breach of the Lease.21

 
While noting that the plaintiff may not in fact obtain full compensation, because the guarantee under the Lease had been released and a bank bond taken, Dalton J was of the view that this was due to a commercial decision of the plaintiff’s own doing. Dalton J held that given the plaintiff had previously had rights under the Lease for compensation, there would be no injustice done in not enforcing the penalty clauses.22

 
Summary Dismissal

 
In determining that this case warranted summary dismissal, Dalton J noted that matters should not be “finally determined in a summary way except in clear cases”.23 Her Honour considered it appropriate to summarily dismiss this case on the basis that there was no factual uncertainty as to the matters for determination. The matter had been fully argued by respected counsel on both sides of the bar table .24

 

End Notes:

 

1 GWC Property Group Pty Ltd v Higginson & Ors [2014] QSC 264 (GWC Property Group), at [51].

2 (2012) 247 CLR 205

3 Cooden Engineering Co Ltd v Stanford [1953] 1 QB 86, 96-97.


4 GWC Property Group, at [27]; applying the cases O’Dea v Allstates Leasing System (WA) Pty Ltd (1982-1983) 152 CLR 359, AMEV-UDCFinance Ltd v Austin (1986) 162 CLR 170; Cooden Engineering Co Ltd v Stanford [1953] 1 QB 86.


Clause [10] of Andrews.

6 GWC Property Group, at [37].

Ibid.
Ibid.
Ibid.
10 Ibid.
11 Ibid.
12 Ibid, at [28].
13 Ibid, at [32].
14 Ibid, at [28].
15 Ibid, at [6], [9], [34].
16 Ibid, at [36].
17 Ibid, at [34].

18 Ibid, at [39].

19 AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170.

20 GWC Property Group, at [48].

21 Ibid, at [49].
22 Ibid, at [51].
23 Ibid, at [3].
24 Ibid.

 

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Ashley Wharton, Partner, Ashurst
ashley.wharton@ashurst.com

 
Courtney McKay, Ashurst
courtney.mckay@ashurst.com

 

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