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20.11.2019

News

Lease incentives and defaulting tenants

In our August edition of Fundamental, we looked at why tenant incentives are generally unrecoverable, being void as penalties. In this edition, partner Kristy Dorney looks at a Western Australia decision illustrating which damages a landlord can recover when a lease is terminated early and reaffirming it will not include incentives.


Background

The case involved premises at the Block Arcade in Melbourne, Victoria and Finetea Pty Ltd, the operators of the iconic Hopetoun Tea Rooms.

Finetea entered into a new lease for the arcade basement and a second shop: it intended to expand its tearoom business by opening a licensed restaurant.

The lease provided Finetea was responsible for developing the new premises to operate the restaurant business. However, the landlord granted an incentive valued at $555,000, being a rent credit of $355,000 (credited monthly over one year) and a cash incentive of $200,000, which could be put towards the cost. The lease included a provision to claw back the incentive in part if the lease was terminated early. Finetea took possession of the premises and began substantial construction works.

When it had difficulty securing construction finance to complete the development, an entity related to the landlord (Winchelada) agreed to loan up to $2 million to complete the development. The loan agreement provided that if Finetea defaulted, certain shares and trust units would be transferred to Winchelada as security.


Default and termination

Finetea ran into numerous hurdles with the development works. Completion was significantly delayed and costs had increased.

The works were not completed by the time the rent credit incentive period ended and rent arrears began to accrue.

The landlord terminated the lease and changed the locks. It then went on to spend $265,000 to reinstate the premises. This included removing a lift and partially completed mechanical works, reinstating air-conditioning, electrical distribution, sprinklers, water supply and stairwells, and completing partially constructed works.

The premises were then re-leased to new tenants, which included a period of rent-free occupation as an incentive.


Damages recovered

Finetea commenced the court proceedings. It sought to void its lease and loan agreement on the basis of unconscionable conduct. It alleged the landlord was responsible for its failed venture, given the landlord's heavy involvement in planning and discussions around the venture, communications with contractors, recommendation of consultants and sourcing of equipment.

These allegations were not accepted by the court. The lease and loan documentation were upheld. Finetea was ordered to repay the principal and interest on the loan and the following sums to the landlord:

  • Debt and damages of $220,000, being unpaid rent and outgoings, plus loss of rent and outgoings while the premises were untenanted and up until the new tenant's rent-free incentive period expired.
  • $261,000, being the cost to make good the premises.

Incentives

The landlord also sought to be reimbursed the rent credit and cash incentive it had advanced, valued at $555,000. However, the court refused and noted:

  • The rent-free incentive and the fit-out contribution were part of the landlord's consideration to secure entry into the lease.
  • Allowing recovery of the incentives would be akin to ordering double recovery, because the landlord would receive 'both damages for what it has lost and also the price that it paid to acquire what it has lost'.
  • The clause, having that result, imposed a punishment for the tenant's breach and did not protect any legitimate interest. It was therefore a penalty void at law.

Lessons learned

A landlord can recover damages when a lease is terminated early which will put it close to the same position it would have been had the lease continued to the end of its term. These damages include the cost to reinstate premises and rent-free periods given to new tenants. However, trying to recover lost rent and incentives is effectively 'double dipping' and likely to be unenforceable. For a more detailed discussion, please see our article in the August edition of Fundamental.


Authors

Kristy Dorney

Kristy Dorney

Partner

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