Commercial and Retail Lease Incentives Fitout Contributions and Consequences for Poor Implementation on Lease Commencement

Lease incentives provide a mutual benefit to both parties to a Lease. From a Landlord’s perspective, advertising an attractive lease incentive gives the Landlord a commercial ‘edge’ over competing Landlords. For a Tenant, a lease incentive allows a small reprieve from rent obligations while establishing a fledgling business, allowing funds to be utilised elsewhere.

Lease incentives can take many forms. Examples include (but are certainly not limited to):-

1. Rent free or rent reduction periods;
2. Fitout contributions;
3. Interest free loans;
4. Relocation costs – where a Landlord offers to pay a Tenant’s costs for moving to the premises from another location.

Lease incentives are contained in the lease itself or more commonly by a separate Deed, so that the lease incentives remain confidential and are not disclosed to future or surrounding Tenants.

Fitout contributions explained 

A Fitout Contribution is a payment from the Landlord (either as a lump sum or instalments over time) which is applied to the Tenant’s fitout works. It is customarily paid after the Tenant has completed their fitout and supplied the Landlord with the tax invoices of its contractors, to show the value expended by the Tenant in the fitout of the premises.

Alternatively, the parties may pre-agree on the value of the Landlord’s contribution to the Tenant’s fitout and the Landlord carries out the works, up to that value.

It is beyond the scope of this article to examine the triggers and mechanics behind the actual payment of the Fitout Contribution by the Landlord, however in very general terms, the Tenant must have satisfied the Landlord’s requirements for granting the lease before same becomes payable. Standard requirements may include (without limitation):-

• Signing the Lease;
• Payment of any rent required in advance;
• providing the requisite security (bond, bank guarantees and any personal guarantees);
• Obtaining insurance and providing evidence of same;
• Obtaining the Landlord’s approval to the proposed fitout works.

Tax implications associated with Fitout Contributions

Both a Landlord and a Tenant should seek accounting and financial advice regarding same, as there are often tax implications for both parties.

For example, lease incentives are ordinarily treated as assessable income, from a Tenant’s perspective[1] and therefore, the Tenant would be entitled to depreciation deductions over time. However, where the terms of the Fitout Contribution Deed provide that the fitout is owned by or remains the property of the Landlord, the Tenant will not obtain any depreciation benefits, even if the lease expires and the Tenant is required to vacate the premises and take the fitout.

Traditional rights of a Landlord upon the occurrence of default

When a Tenant has defaulted under a Lease, the Landlord may exercise the following rights, provided it has served all requisite notices and allowed the applicable remedy periods to pass:-

1. Terminate the Lease and recover possession of the premises;
2. Take steps to mitigate loss by reletting the premises as soon as possible;
3. Sue the Tenant and any Guarantors for damages in respect of:-
   1. Rent for any vacant periods, before a new Tenant moves in;
   2. The costs for re-letting the Tenancy, including advertising, marketing and letting costs, incentives offered to the new Tenant, make good or fitout changes costs.
   3. Any shortfall in rent if the rent payable by the new Tenant is lower than that paid by the defaulting Tenant;
   4. Legal costs associated with enforcement.

Generally speaking, the Courts consider an award of damages for the matters contained in paragraph 3 above are sufficient to compensate a Landlord for a Tenant’s unremedied breach of the lease.

That said, any clause that requires a Tenant to pay an unjustifiable, exorbitant or an excessive amount in addition to the above is typically be viewed as a penalty and therefore void at law. 

Can a Landlord recover a Fitout Contribution?

It is common for the Lease or the Fitout Contribution Deed to contain a provision that if the Tenant:-

1. defaults under the Lease; or
2. wishes to assign its lease to a third party;

the Landlord may, in addition to its other rights, seek to recover the Fitout Contribution, or a proportion thereof, depending on the time at which such a triggering event occurs.

There are two significant cases which have determined that a Landlord needs to be very careful when demanding repayment of a Fitout Contribution (or a part thereof) from a Tenant.

The first, is a High Court decision in Andrews v Australia and New Zealand Banking Group Ltd,[2] which had nothing to do with leases or lease incentives, but has since been expanded to apply to same. On its facts, this was a case concerning a bank’s decision to impose a “late payment” fee on a customer’s account. The Court found that the bank could not adequately justify the quantum of the fee charged, which was held to be excessive and unconscionable as it was not a true estimate of the bank’s loss following conduct of the customer. The Court held the fee to be a penalty at law and therefore unenforceable.

The principles in the above case were extended to lease transactions by the Queensland Supreme Court in 2014, in the case of GWC Property Group v Higginson & Ors[3]. This case did involve the consideration of lease incentives and whether the Landlord could, in addition to its other rights, seek to recover payment of same.

In that case, the Tenant was a law firm and the lease incentives provided to it included a fitout incentive, rent abatement and others, all documented in a Deed, rather than the Lease itself. The Deed contained a clawback provision, where the incentives (or part thereof) were repayable upon termination of the Lease.

Partway through the term, the Tenant abandoned the premises, which was a repudiation that the Landlord relied upon to terminate the Lease. The Landlord then sought to recover the usual damages (along the lines of paragraph 3 above) plus the fitout contribution, via the clawback provision.

The Court found that the obligation to repay the Fitout Contribution (or part thereof) was a penalty because it was not a genuine pre-estimate of the Landlord’s damage resulting from the Tenant’s breach. Justice Dalton followed the High Court’s decision in Andrews v ANZ Bank above and determined that in addition to claiming the usual damages, the Landlord was wrongly seeking to place itself in a much better position by imposing liability on the Tenant for payments that it was not entitled to, thereby unjustly enriching the Landlord.

Justice Dalton went even further, and made it clear that the outcome would be the same where the Tenant had not defaulted, but, for example, where the Tenant was seeking an assignment of the Lease and the Landlord required repayment of a Fitout Contribution (or part thereof) as a precondition to consenting to such an assignment.

Lease incentive provisions can be fraught with danger in circumstances where a Landlord was to try and recover a Fitout Contribution (or part thereof) from a Tenant under a poorly drafted clause allowing for same. The prima facie position will be that such a provision in any lease or Fitout Contribution Deed is liable to being defeated.

That said, if a Landlord is able to show that the repayment of the Fitout Contribution or a proportionate sum thereof is a genuine pre-estimate of the damage the Landlord may suffer as a result of a breach of the Lease, then it may well be that a Court might consider such a clause to be valid and enforceable.

Marino Law regularly advises Tenants in relation to the mechanics of fitout contribution deeds prior to their initial signing of the lease and also assists Tenants who have defaulted under their Leases in defending clawback claims by their Landlords.

Conversely, Marino Law also advises Landlords in relation to effective drafting of Fitout Contribution Deeds, the operation of Fitout contribution payments and enforcement of claw back provisions.

Marino Law also acts for Landlords in the enforcement of their rights as a result of breach under Leases by Tenants and can provide tailored advice as to the effectiveness of any Fitout Contribution claw-back provisions. Such advice is tailored as it is largely dependent on the facts, matters and circumstances of each matter.

For a no obligation quotation, please contact one of our Property Law or Litigation team today.

[1] Commissioner of Taxation v Cooling 90 ATC 4472

[2] (2012) 247 CLR 205.

[3] [2014] QSC 264 per Dalton J.