As a lessee, you should be familiar with all aspects of leases. It is common for leases, particularly retail leases, to include an incentive to encourage entry into the lease. For example, this incentive could be monies or a benefit that the landlord provides. It is also common for those leases that provide lease incentives to include clawbacks: mechanisms by which a lessee must repay all or a portion of those incentives if certain events occur (usually early lease termination). However, some case law suggests that the court considers such provisions penalty and therefore void at law.
This article will discuss clawback provisions and how they might affect your lease or incentive.
What is a Clawback Provision?
As part of your lease, the landlord may offer you lease incentives to enter into the lease or improve the premises. The most common forms of incentive are:
- rent-free periods, where the landlord will not require you to pay rent for a certain time period from the commencement date of the lease;
- rent reductions, where the landlord reduces a portion of the rent each month until you use up the total incentive amount; and
- fitout contributions, where the landlord pays for your fitout (or a portion of it) by reimbursing the fit-out costs to an agreed sum. Alternatively, the landlord may carry out the fit-out works on your behalf.
The most common types of trigger events for a clawback include:
- if the tenant defaults or breaches the lease;
- if the tenant assigns or is deemed to have assigned the lease; or
- the landlord otherwise terminates the lease before the expiry of the term.
How much of the incentive you must pay back may be apportioned based on how far into the term you are.
A factsheet that sets out the three ways to end a commercial lease in Australia: surrendering your lease, assigning it or subletting it.
Clawback Provision Example
For example, for a 5-year lease, the landlord may apportion the clawback as follows.
If you trigger the clause in the:
- 1st year of the term, the tenant pays back 100% of the incentive,
- 2nd year of the term, the tenant pays back 80% of the incentive,
- 3rd year of the term, the tenant pays back 60% incentive;
- 4th year of the term, the tenant pays back 40% of the incentive; and
- 5th year of the term, the tenant pays back 20% of the incentive.
What Makes a Clawback a Penalty Provision?
Generally, the law will consider a provision a penalty if it does not represent a genuine pre-estimate of loss. Such a clause is seen as a penalty because it essentially imposes a ‘fine’ on one party. If a court considers a provision a penalty, the court may order that provision is void.
In the past, the court has determined that clawbacks are unenforceable, in certain circumstances. These include where:
- a tenant abandons the property, terminating the lease. In this case, the court found enforcement would be a penalty rather than a genuine estimate of the loss suffered. This was because the clawback provisions would give the landlord an advantage they would not have had otherwise; and
- a tenant has received an incentive of a fitout contribution and rent reduction. Upon termination, the court determined that whilst the landlord could enforce damages, they could not seek a refund of the incentive. Essentially, the landlord is already recovering their losses by way of damages. Thus, adding the clawback would have led to them being in a better position than had the lease been performed.
How Does This Affect You?
Although there have been cases whereby the court has determined certain incentive clawbacks are unenforceable, landlords will still try to include clawback provisions. Further, the law concerning the enforceability of clawback provisions remains a grey area.
There may be some situations where a clawback genuinely represents a pre-estimate of the landlord’s loss. In these cases, the clauses will remain enforceable. Therefore, landlords will frequently seek to have clawbacks included in their documents. However, whether or not they are enforceable will depend on the circumstances of the case. If you are concerned about a clawback, it may be worth negotiating for the clause to be deleted.
Key Takeaways
Clawbacks requiring the tenant to pay back part or all of the incentive they have received from the landlord if the lease is terminated early are common. Whether or not the provision is enforceable will depend on the circumstances of the case. A clawback needs to represent a genuine pre-estimate of the loss the landlord is likely to or has suffered. Otherwise, it will likely be considered a penalty. However, the costs of disputing a clawback provision’s enforceability once it has already been included in a lease may be exorbitant. As such, you should always seek to remove any clawback provision in the first instance and not rely on disputing the clawback provision, if it were ever relied upon.
If you need help with reviewing clawback provisions, incentive deeds or leases, our experienced commercial leasing lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
A clawback provision is a section in a lease that requires a tenant to refund an incentive they have received under certain circumstances, for instance, if they default or breach the lease.
A clawback is a penalty provision if it does not represent a genuine pre-estimate of loss. If this is the case, the court can order that the provision is void.
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