October 2023

Commercial leasing transactions are often accompanied by incentive clawback provisions, which have long been a staple in the landlord-tenant relationship. These provisions are intended to provide a safety net for landlords, ensuring they can recoup incentives provided if the lease agreement is terminated prematurely. However, recent legal developments have cast doubt on the effectiveness and enforceability of these clawback provisions. In this uncertain landscape, it may be time for landlords to consider alternative approaches.

Recent Case

In the recent case of Alamdo Holdings Pty Ltd v Croc’s Franchising Pty Ltd (No 2) [2023] NSWSC 60, Croc’s Franchising Pty Ltd (Tenant) failed to pay rent due under their lease with Alamdo Holdings Pty Ltd (Landlord) between March 2020 and December 2020, which subsequently led to the Landlord terminating the lease on 3 December 2020.

Following the termination of the lease, the Landlord sought to recover a portion of the incentive contribution provided for the Tenant’s fitout, which was challenged by the Tenant who argued that the clawback provisions were a penalty.

The Court ultimately held that the clawback provision was unenforceable on the basis that it was punitive and allowing the Landlord to clawback the incentive from the Tenant would provide them with excessive compensation, surpassing what they would have received if the lease had run its course. This interpretation was also influenced by the fact that the Landlord retained ownership of the fitout, which is what the incentive amount was applied to by the Tenant. As a result, the clawback provisions were viewed in this case as a form of punishment.

Exploring Alternatives

Given the recent uncertainty surrounding clawback provisions, landlords may want to explore alternative approaches.

1. Secured Financing Arrangements: Landlords could opt for secured financing arrangements for tenant-installed fitouts using the landlord’s contribution. This alternative may allow landlords to recover a portion of their contribution if the lease is terminated due to the tenant’s default. However, it comes with the risk of unenforceability since it represents a new and untested approach. Additionally, landlords may forfeit tax benefits since they will not retain ownership of the installed fit-out.
2. Rental Abatement Incentives: Landlords can provide incentives in the form of rental abatements evenly spread throughout the lease term. This approach can mitigate risks associated with unenforceability and improve cash flow. However, it may not be the preference of tenants, and may not align with the commercial needs of all parties involved.

In Conclusion

The legal landscape surrounding incentive clawback provisions in commercial leasing remains uncertain. Recent cases have demonstrated however that it is abundantly clear that landlords can no longer take the enforceability of incentives for granted in the event of lease termination.

Given this uncertainty, landlords may want to consider alternative approaches to ensure they can protect their interests whilst maintaining positive tenant relationships. There is no one-size-fits-all solution, and landlords must carefully weigh the pros and cons of alternative strategies based on the unique circumstances of each lease agreement.

It is abundantly clear that landlords can no longer take the enforceability of incentives for granted in the event of lease termination. Flexibility and adaptability are key, allowing landlords to navigate this complex and ever-evolving legal landscape while preserving their financial interests.

Background

With the introduction of the Treasury Laws Amendment (More Competition, Better Prices) Act 2022 (the Act) it brought with it a raft of changes to Australia’s unfair contract terms (UCT) regime under the Competition and Consumer Act 2010 (CCA).

What is a UCT?

Whether a term is considered unfair will depend on the specific circumstances. However, the test for “unfairness” under the CCA is:

Terms which may be considered unfair include:

• terms that allow one party (but not the other) to avoid or limit their responsibilities under the contract;
• terms that allow one party (but not the other) to end the contract;
• terms that penalise one party (but not the other) for breaching or ending the contract; and
• terms that allow one party (but not the other) to change the terms of the contract

What are the changes?

The changes brought about by the introduction of the Act include:

• prohibiting the proposal of, use of, application of, or reliance on, unfair contract terms in a standard form consumer or small business contract;
• introducing new substantial penalties for UCT’s in such contracts, being maximum penalties of:
  • for businesses – the greater of $50million, 3 x the value reasonably attributable to the benefit from the UCT or 30% of adjusted turnover of your business for the breach period; and
  • for individuals – $2.5million;
• clarifying the court’s powers and the factors the court must consider when determining whether a contract is a standard form contract;
• expanding the definition of small business and increasing the contract value threshold – note, only one of the parties to a standard form contract has to have fewer than 100 employees or less than $10million in annual turnover for the UCT regime to apply;
• clarification of Commonwealth, state or territory laws that are excluded from the UCT regime; and
• new categories of contracts which are excluded from the operation of the UCT regime.

Importantly, the previous position on UCTs was that if a Court found a term unfair then that term would be deemed void and unenforceable. Moving forward, a party could face a pecuniary penalty in addition to the term being deemed void and unenforceable.

Will the changes apply to my contract?

The changes introduced under the Act apply to:

• standard form contracts made or renewed on or after 9 November 2023; and
• a term of a contract that is varied or added on or after 9 November 2023.

Next Steps

Businesses should carefully review their own contracts and consider:

1. Is it a standard form contract that falls within the changes brought about by the Act?
2. Will the contract be used with consumers or small businesses (noting that the definition of small business has changed to a business with fewer than 100 employees or its annual turnover is less than $10 million)?
3. Does the contract include any unfair terms?

Hitch Advisory is well placed to assist in reviewing and updating your standard form contracts to ensure you do not fall foul of the revised UCT regime. Do not hesitate to contact us on hello@hitchadvisory.com to discuss next steps.