From 12 November 2016, all leases a landlord and small business tenant enter into will be subject to the “unfair contracts terms” regime under the Australian Consumer Law (ACL). Under this regime, any provisions in a small business contract (which a lease may fall under) may be declared void and unenforceable if it contains unfair terms. A clawback provision is one such term in a lease which could potentially be unfair. This article explores the new unfair contracts regime in more detail in light of lease incentives and clawback provisions.
Which Leases Do the Unfair Contracts Laws Apply?
The unfair contracts law will apply to a lease if at the time parties entered into the contract, the following apply:
- At least one party to the contract is a business that employs less than 20 people; and either
- The upfront payment of the contract is not more than $300,000; or
- If the contract’s duration is more than 12 months, the upfront price payable is not more than $1,000,000.
Lease Incentives and Clawback Provisions
As part of a leasing transaction, the landlord may offer a tenant some form of incentive, such as:
- Rent-free periods: The landlord will not require the tenant to pay rent for a fixed timeframe from the lease start date. The rent-free period is usually given to allow the tenant to fit-out its premises and help get its business up and running before it starts paying rent.
- Rent reductions: The landlord reduces a portion of the rent each month until the tenant uses up the total incentive amount.
- Fit-out contributions: The landlord pays for the tenant’s fit-out by way of reimbursement of the fit-out costs, or the landlord carries out the fit-out works on behalf of the tenant.
It is common for a landlord, in the above circumstances to require the tenant to pay back the lease incentive if the parties terminate the lease before the expiry date. This payback scheme is referred to as a clawback provision. The clawback provision usually states that if the parties terminate the lease early or if the tenant assigns the lease, then the tenant will have to repay all or a portion of the incentive amount.
Landlords have rationalised such provisions as necessary to protect their upfront investment in the tenant. The landlord offers money as an incentive on the understanding that the tenant will remain for the whole duration of the lease term. If the parties terminate the lease before the expiry date due to the tenant’s breach, then the landlord would arguably lose their upfront investment.
Can a Clawback Provision Be Unfair?
A term is unfair if:
- It would cause significant imbalance between the parties;
- It’s not reasonably necessary to protect the legitimate interest of the party benefiting from the term; and
- It would cause detriment to a party if they relied on the clause.
The onus will be on the party benefiting from the term to prove that the term is reasonably necessary to protect their legitimate interest.
It is possible a clawback provision will fall foul of the ACL, given:
- It forces the tenant to repay the incentive;
- Repayment would cause a financial detriment to the tenant; and
- A landlord does not need reasonable protection in circumstances where the tenant assigns the lease.
When a tenant assigns a lease, the incoming tenant effectively steps into the shoes of the existing tenant and continues to pay the rent and other money owed under the lease. They also perform all of the lease obligations. The landlord does not have a case that suggests they are worse off by the assignment of the lease and consequently have no legitimate grounds to make the outgoing tenant pay back the incentive amount.
Where the landlord had to terminate the lease due to the tenant’s breach, the Court in GWC Property Group Pty Ltd v Higginson and Others  QSC 264 ruled that the clawback provision was merely a penalty and unenforceable.
In that case, the tenant abandoned the premises. The landlord then terminated the lease. The landlord gave the tenant a fit-out contribution and rent and signage abatement spread over the first three years of an initial seven-year term lease.
The landlord argued that the Court should consider the incentive as consideration for the tenant entering into the contract, and therefore, they were entitled to recover the amount. That argument failed, and the Court held that the clawback provision falls within the description of what constitutes a penalty following the High Court’s decision in Andrews v ANZ Bank  247 CLR 205.
The new unfair contracts regime offers an additional layer of protection for small business owners in their leasing transaction. Landlords will need to reconsider their pro forma lease documents to ensure that no provision in their standard lease is unfair.
Lease incentives are a standard offering in a lease, and it is important for a tenant to understand their rights with any requirement under the lease. In particular, they should be weary of how clawback provisions operate.
If you have any questions about whether your lease contains unfair terms or need assistance with your lease transaction, get in touch with our commercial leasing team on 1300 544 755.