The clawback of incentives and their enforceability remains a live issue with the courts treating clawback clauses as a penalty in certain circumstances. This was recently reinforced in Alamdo Holdings Pty Ltd v Croc’s Franchising Pty Ltd (No 2)  NSWSC 60 (Alamdo).
In the context of commercial leasing, consideration should be given to what would constitute a penalty versus a genuine pre-estimate of damage for the purposes of enabling a landlord to lawfully claw back a proportion of an incentive where a tenant is in breach of its leasing obligations.
Market for incentives
The vacancy rates in the Sydney commercial leasing market continue to increase with an average vacancy rate across premium to B Grade space at around 11.3% and many industries downsizing their CBD office space needs either because of business restructuring or space utilisation restructuring.
However with a limited pipeline and some project based pre-committed space withdrawals from current supply, the vacancy rate is expected to fall.
In the meantime, gross incentives are still running at around 35% and the issue of whether clawback of those incentives are enforceable remains an issue.
Landlords offer incentives as an inducement to prospective tenants to enter into leases, generally with the effect that the gross face rent exceeds the gross effective rent with some sources indicating at the present time by an average of around 35%, with the nett effect being that the landlord is effectively merely meeting the market.
Alamdo, under a lease and incentive deed arrangement, paid Croc’s $250,000 towards Croc’s fit out costs and Alamdo retained ownership of the fitout. Upon termination of the lease for Croc’s default, Alamdo was entitled to repayment (clawback) of a proportion of the incentive payment. Croc’s challenged the clawback provision on the basis it was a penalty.
In Alamdo, as in earlier cases, the Court was of the view that, in the circumstances of Alamdo (which are common), to allow a landlord to clawback the incentive paid by a tenant on a default by that tenant, would have the effect of providing to a landlord greater compensation than it would otherwise have been entitled had the lease run its course and the clawback provisions went further than was necessary to protect Alamdo’s legitimate interests. As such the clawback provisions were considered to be in the nature of a punishment.
Given the current view of the courts, the safest way of providing a lease incentive is to do so as an abatement of the face rent spread equally or otherwise proportionally over the term of the lease. Alternatively other more creative ways may need to be considered to secure the value of a front loaded incentive.
If you would like to discuss this article with us further, please contact Mike Ellis, Property Partner on (02) 9261 5900.