148 Brunswick Street Pty Ltd v Strategix Training Group Pty Ltd (No 2) [2021] QDC 212

DISTRICT COURT OF QUEENSLAND CITATION: 148 Brunswick Street Pty Ltd v Strategix Training Group Pty Ltd (No 2) [2021] QDC 212 PARTIES: 148 BRUNSWICK STREET PTY LTD ACN 117 914 664 (Plaintiff) v STRATEGIX TRAINING GROUP PTY LTD ACN 108 064 526 (Defendant) FILE NO/S: BD3156/20 DIVISION: Civil DELIVERED ON: 6 September 2021 DELIVERED AT: Brisbane HEARING DATE: 6 September 2021 JUDGE: Barlow QC DCJ ORDERS: 1 Judgment for the plaintiff in the sum of $321,652.26, including interest to judgment in the sum of $10,579.02. 2 The defendant pay the plaintiff’s costs of the proceeding (except its costs of the application for summary judgment). CATCHWORDS: CONTRACTS – GENERAL CONTRACTUAL PRINCIPLES – CONSTRUCTION AND INTERPRETATION OF CONTRACTS – PENALTIES AND LIQUIDATED DAMAGES – OTHER PARTICULAR CASES – plaintiff leased premises to defendant – plaintiff and defendant agreed on variation to lease which provided certain financial incentives to defendant – financial incentives conditioned on defendant not exercising option to terminate lease early – defendant exercised option and terminated early – whether clause requiring repayment of incentives amounts to a penalty clause. Uniform Civil Procedure Rules 1999 (Qld), r 292(2) Agar v Hyde (2000) 201 CLR 552, cited Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205, considered Associated Distributors Ltd v Hall [1938] 2 KB 83, considered Deputy Commissioner of Taxation v Salcedo [2005] 2 Qd R 232, cited -- 1 of 17 -- 2 GWC Property Group Pty Ltd v Higginson [2014] QSC 264, considered Moran v Argonaut Equity Partners Pty Ltd [2021] WASCA 45, cited O’Dea v Allstates Leasing System (WA) Pty Ltd (1983) 152 CLR 359, considered Paciocco v Australia and New Zealand Banking Group Ltd (2014) 309 ALR 249, considered Paciocco v Australia and New Zealand Banking Group Ltd (2015) 236 FCR 199, considered COUNSEL: PJ Sams for the plaintiff No appearance for the defendant SOLICITORS: PHV Law for the plaintiff Leasewise Group (not appearing) for the defendant Contents Introduction .......................................................................................................................... 2 The issues ............................................................................................................................. 4 Was the notice given under clause 7.1?................................................................................ 4 Was there a mistake, of which the plaintiff took advantage? ............................................... 5 Was the notice of termination withdrawn?........................................................................... 5 Is clause 7.2 a penalty? ......................................................................................................... 7 Did the defendant pay all the rent due from June to November 2020? .............................. 15 The total debt due and interest ........................................................................................... 16 Introduction [1] In this proceeding, I have previously refused the plaintiff’s application for summary judgment.1 Having now heard the trial,2 I revisit the issues for the purpose of determining the final judgment. [2] The plaintiff was lessor and the defendant lessee under a lease of premises in a building in Fortitude Valley. The lease was for a term of one day less than five years and six months, commencing on 1 December 2017 and ending on 30 May 2023 (the “Expiry Date”). [3] In addition to the lease, the parties executed a deed, referred to as a “deed of variation”,3 by which the plaintiff relevantly agreed to waive the defendant’s 1 148 Brunswick Street Pty Ltd v Strategix Training Group Pty Ltd [2021] QDC 38. Much of my analysis of the law in these reasons is taken from my reasons on that occasion. 2 The defendant did not appear at the trial. I had it called and was satisfied that it was aware of the trial date, so the trial proceeded in accordance with rule 476(1). 3 The deed was not executed until 11 July 2018, while the lease was executed in April 2018. The delay in executing the variation deed was caused by the defendant simply not returning it to the plaintiff for some time. The plaintiff explained that it had intended that it be executed with the lease. At the summary judgment hearing, the parties agreed that the two documents should be read and construed together. -- 2 of 17 -- 3 obligation to pay rent for the first six months of the lease and to accept reduced rent for the balance of the term of the lease after the rent free period.4 The deed refers to those concessions as the “Incentive”.5 [4] For the first 2½ years of the lease, the plaintiff waived and then charged the defendant rent in accordance with the deed, thereby providing the Incentive for that period. The plaintiff claims that, in circumstances described below, the defendant is obliged to repay the entire amount of the Incentive that has been provided to it. [5] Clause 7 of the variation deed provides: 7 BREAK DATE 7.1 At any time in the Break Date Period the Lessee may serve the Lessor with a Notice of Termination of the Lease which will serve to alter the Expiry Date of the Lease to the Break Date. 7.2 If the Lessee serves the Lessor with a Notice of Termination of the Lease in accordance with the above clause the Lessee will be required to refund to the Lessor the value of the Incentive afforded to the Lessee. [6] “Break Date Period” is defined as the period between 1 December 2017 and 31 May 2020. “Break Date” is defined as meaning 31 May 2020. [7] On 29 May 2020, the defendant served on the plaintiff a notice of termination of the lease, in apparent reliance on clause 7.1. If it was served in accordance with clause 7.1, the effect of that notice was that the expiry date of the lease was altered from 30 May 2023 to the Break Date, 31 May 2020. [8] The defendant continued in occupation of the premises, holding over under a month to month tenancy (as provided for in the lease6) until 30 November 2020. It paid rent (at the discounted rate as if the lease were still on foot and it was entitled to the Incentive for that period7) and outgoings for the period up to 31 October 2020, but it initially paid nothing for November.8 [9] The plaintiff now sues to recover, as a debt, the amount of the Incentive that it provided to the defendant, plus the difference between the rent paid for the months of June to November 2020. It also seeks, in the alternative, the same amounts as damages 4 The deed provides that lower rent will be accepted for each of “year 1” to “year 5”, which on its face seems to refer to the first 5 years of the lease. However, it also defines “Rent Rebate Period” as the entire term of the lease (indeed, one day longer than that term). Construing it practically and commercially, I consider that its effect was that there be six months rent free and the remaining five years of the lease at a reduced rental. 5 There was another component to the Incentive, but that is irrelevant to this proceeding. For the purpose of these reasons, I shall refer only to the rent free period and the rent reduction as the Incentive. 6 Clause 14 provided that, in that case, rent was payable monthly in advance in an amount equal to one twelfth of the annual rent at the time of the expiration of the lease. This is material to the amount of any rent that the defendant owes to the plaintiff, as will become apparent. 7 Which, surprisingly, the plaintiff accepted without complaint, as if the rates payable under the variation deed still applied. The plaintiff claims those sums as amount owing “pursuant to clause 7.2 of the Variation Deed” when they are, at least arguably, not the subject of that clause, given that the lease had come to an end and it provided that, during any holding over period, the defendant would pay rent at the rates provided in the lease: clause 14. However, for present purposes it is unnecessary for me to consider whether the defendant indeed owes those sums and, if so, under which instrument. 8 The evidence is that it subsequently paid the lower amount of rent and the outgoings for November. -- 3 of 17 -- 4 for breach of the variation deed (in failing to repay the Incentive) and for breach of the lease or the monthly tenancy (in failing to pay the full rent for the holdover period). [10] In my earlier reasons, I criticised the parties’ pleadings and I made directions for the filing and service of amended pleadings. The plaintiff later filed an amended statement of claim, the defendant filed a defence to that statement of claim and the plaintiff then filed a reply. Belatedly, on 19 August 2021 the plaintiff filed a further amended statement of claim. The effect of the amendments was to refer to the outgoings, in addition to unpaid rent, for the June to November period. However, the plaintiff’s evidence is that all outgoings were paid, so the amendments are immaterial to the issues that I must determine. If it were relevant, the defendant has not filed a defence to that pleading. Therefore its defence to the amended statement of claim stands and, to the extent that that defence does not adequately respond to the additional allegations, it is deemed to have admitted them.9 The issues [11] The issues that arise on the pleadings are substantially those raised in the defence to the amended statement of claim. That defence remains short. Although the defendant did not appear at the trial, I consider it appropriate to deal with the issues raised in its defence. In essence, it pleads five principal bases for denying the plaintiff’s claim. First, that the notice of termination that it served was not under clause 7.1, but was simply notice purporting to terminate the lease, in breach of the lease. Therefore clause 7.2 has no application. As the plaintiff is not suing it for breach of the lease (apart from for rent and outgoings for June to November 2020), it does not have any obligation to repay the Incentives that it received. Secondly that, if the notice was under clause 7.1, the defendant sent it operating under a mistaken belief that it was not, which the plaintiff knew (because of the terms of the notice) and it would be unconscionable for the plaintiff to take advantage of that mistake and to rely on clause 7.2. Thirdly, that the notice of termination was withdrawn on 5 June 2020. Fourthly that, if those defences are not upheld, clause 7.2 is void, voidable or unenforceable as a penalty. Fifthly, that it has paid all the rent due under the lease for the period from 1 June to 30 November 2020. [12] I shall address those issues in that order. Was the notice given under clause 7.1? [13] The notice sent by the defendant was an email from Jeremy Rota of the defendant to an email address apparently associated with the plaintiff. The email relevantly stated: We wish to hereby give notice of our intent to break the lease as per the conditions of the Lease Deed of Variation and Annexure A, special condition 7. … Given the current environment we do not wish to commit to the additional 2 years but would be happy to continue month to month. [14] The email was expressly said to be giving notice “as per the conditions of the Lease Deed of Variation”. The only clause of the variation deed that entitled the lessee to “break” the lease was clause 7.1. That the defendant intended to refer to and rely on that clause is obliquely confirmed by Mr Rota’s reference to “Annexure A, special condition 7.” That reference is clearly to special condition 7 of an agreement to lease that the parties had made on 28 September 2017, before the defendant took possession 9 Rules 385(3) and 166(1) of the Uniform Civil Procedure Rules 1999. -- 4 of 17 -- 5 of the premises. That agreement contained a number of special conditions, including a six month rent free period and a reduction in the face rent for the balance of the term. Special condition 7 read: The Lessee shall have the right to serve a notice of termination of the lease between twenty four (24) months and the expiration of the fourty [sic] second (42) month of a sixty six (66) month lease that will result in the hand back of the Demised Premises at the end of the fourty second (42) month. [15] The change between that clause and the variation deed was the result of further negotiations, as explained in an affidavit by a director of the plaintiff, Mark Smith, who was primarily responsible for negotiating the lease and the deed of variation on behalf of the plaintiff. In summary, he records that the defendant initially wanted a lease for a three year term, but the plaintiff sought a term of at least five years. They initially compromised by agreeing in terms of special condition 7 of the agreement to lease, giving the defendant an option to terminate the lease after 3½ years, on condition that a fitout contribution which was part of the incentives offered by the plaintiff be partly refunded to it. However, during further negotiations after the agreement to lease, the defendant sought to reduce the term available to it at its choice, to 2½ years. That resulted in the plaintiff agreeing to that option on condition that all incentives be repaid if the option was exercised. That led to the final terms of the deed of variation being agreed. [16] Thus, in the process of agreeing the final documents, the terms of the initial agreement to lease were superseded. The final lease and deed of variation contained the agreed terms and those terms govern the parties’ rights to the extent that they are enforceable at law. [17] Of course, Mr Rota’s reference to special condition 7 of the agreement to lease was erroneous, as it was not reflected in the final lease and deed of variation. But his reference to it, as I have said, obliquely confirms that he was intending to rely on and to exercise the defendant’s entitlement to end the lease after 2½ years. [18] There is no doubt in my mind that the termination notice was given under clause 7.1 of the variation deed. Therefore, its effect was to reduce the term of the lease to 2½ years, ending on 31 May 2020. Was there a mistake, of which the plaintiff took advantage? [19] For the same reasons, there is no doubt that, in giving the notice, Mr Rota intended to rely– and did rely - on clause 7.1 of the deed of variation. He made no mistake in doing so. He did not intend to breach the lease, but to exercise an express right to bring it to an end earlier than at the conclusion of the full term. [20] The plaintiff therefore did not take unconscientious advantage of a mistake by the defendant. Was the notice of termination withdrawn? [21] After the plaintiff received Mr Rota’s email, on 3 June 2020 one of its directors, Colin Loel, wrote an email to Mr Rota in the following terms: -- 5 of 17 -- 6 Dear Jeremy, We acknowledge receipt of your notice given pursuant to clsuse 7.1 of the Variation Deed dated 11 July 2018. We note that clause 7.2 obliges the Lessee, if it serves a Notice of Termination, in accordance with clause 7.1, to refund the value of the Incentive afforded which includes the rent payable during the Rent Free Period (1 December 2017 to 31 May 2018) and the Rent Rebate Amount being the difference between the rent stipulated by the Lease and the amount referred to in clause 1.1(o) of the Variation Deed. We are in the process of calculating this sum and will write to you further regarding the amount payable in the immediate future. [22] In response, on 5 June 2020 Mr Rota sent an email to Mr Loel, relevantly saying: Thank you for your response. Based upon those assertions it seems we have little option other than to consider staying. [23] The defendant appears to rely on this email as “withdrawing” the notice of termination. However, the email did not even purport to do that. Rather, Mr Lota said the defendant would “consider staying”. That is, the defendant had made no decision at that time to attempt to withdraw the notice or to seek the plaintiff’s agreement to the defendant remaining in the premises under the terms of the former lease. [24] In any event, even if the email of 5 June 2020 had evinced a clear present intention to withdraw the notice of termination, it was sent too late to effect any withdrawal of the notice. On 31 May 2020 the lease term ended, in accordance with the notice under clause 7.1. That notice operated of its own effect and did not require acceptance of it, nor any other step by the plaintiff, for it to be effective. It may have been possible for the defendant to have withdrawn it before it effected the termination of the lease (that is, by a notice of withdrawal given by 31 May 2020), but after that date it was not open to the defendant unilaterally to withdraw the notice and retrospectively to re- enliven the lease. Those steps could only be undertaken with the plaintiff’s consent, which was neither sought nor given. [25] This conclusion is consistent with the law of options. An option given in a lease (such as an option to renew or extend the lease) may only be exercised during the term of the option, as specified in the lease. It cannot be exercised once the option term, or the lease term, has expired, without the lessor’s consent or other acts constituting a waiver of the time limit for exercise of the option.10 Clause 7.1 effectively gave the defendant an option, not to extend or renew the lease but to shorten its term. Once that option was effected, the term was shortened accordingly. It required the plaintiff’s agreement for the lease to be renewed or re-enlivened. [26] There is no evidence that the plaintiff took any steps that acceded to the alleged withdrawal of the notice of termination. Rather, it continued to seek repayment of the Incentive. Indeed, nor did the defendant pursue any assertion that the lease had not been terminated. On the contrary, in a letter dated 25 June 2020 from its solicitor (Mr Polites) to the plaintiff’s solicitors, Mr Polites relevantly said, We refer to the Notice to Terminate provided on 29 May 2020, prior to the cut- off as defined in the Lease as the Break Date, 31 May 2020. 10 Farrands, The Law of Options and Other Pre-emptive Rights (Thomson Reuters, 2010), 94-96; Duncan, Commercial Leases in Australia (Thomson Reuters, 9 th ed), [12.6800]. -- 6 of 17 -- 7 Please provide confirmation as the client has had no acknowledgement provided to it. He went on to assert to the effect that clause 7.2 was “inoperable”, presumably as a penalty. [27] Therefore, the purported “withdrawal” of the notice of termination was not effective to overcome the consequences of the defendant having given the notice. The lease had come to an end on 31 May 2020. Is clause 7.2 a penalty? [28] The defendant pleads that the purported obligation to repay the Incentive is a penalty for a number of reasons. It is simplest to quote those reasons from paragraph 7(d) of the defence.11 i the Notice of Termination was not a condition precedent to paragraph 7.2 of the Variation Deed taking effect; ii the repayment of the incentive payment did not represent a genuine pre- estimate of the loss suffered in the event of the Defendant breaching the Lease but was extravagant and unconscionable in amount to the greatest loss the Plaintiff could have been suffered iii clause 7.2 of the Variation Deed was, collateral to and consequent on the Defendant’s non-observance of the primary obligation in the Lease to pay rent for a period of 5 years and 6 months commencing on 1 December 2017 (clause 2.1 and item 1). iv clause 7.2 of the Variation Deed imposed an additional detriment on the Defendant, to the benefit of the Plaintiff that was in the nature of security for and in terrorem of the satisfaction of the primary obligation to pay rent for a period of 5 years and 6 months commencing on 1 December 2017 (clause 2.1 and item 1). [29] The first point is difficult to understand. Clauses 7.1 and 7.2 must clearly be read together. Clause 7.2 is clearly premised on the defendant having served a notice of termination under clause 7.1. In that sense, the issue of a notice under clause 7.1 was a condition precedent to the operation of clause 7.2. The plaintiff’s entitlement to recover the incentives depended on the early termination of the lease by the defendant under clause 7.1. [30] It may be that, by this ground, the defendant is intending to assert that clause 7.2 purports to operate if the defendant breaches the lease by leaving the premises before its full term expired and thus operates as a form of penalty for breach. That is wrong. The clause only operates where the defendant exercises its option to end the lease early: an option granted by the variation deed so that the defendant can do so without being in breach of the lease. [31] This ground of defence therefore has no merit. [32] The defendant has not demonstrated its second point to be correct. It has called no evidence to demonstrate the likely extent of the plaintiff’s loss arising from the loss of a 5½ year lease with a five year option, so that it could be compared with the value of the incentives now sought by the plaintiff. Without such evidence, it would be 11 The grammatical and other errors are set out as they appear in the pleading. -- 7 of 17 -- 8 speculative to assume that the plaintiff’s loss was substantially greater or less than the value of the incentives payable under clause 7.2. [33] But a cursory consideration of the issue, even without evidence, indicates that the plaintiff’s loss arising from the early termination of the lease is likely to be roughly the same or even substantially greater than the sum of the Incentives. First, there is a real possibility that, once the defendant vacated the premises, there would be a period within which the plaintiff would be unable to secure a new lessee for the premises, thus losing any rental for that period. Secondly, it would incur costs in finding and negotiating a new lease. Thirdly, it seems likely that, in order to secure a new long- term lease, it would provide similar incentives to the new lessee. In that case, it would be providing the incentives for at least 2½ years more than the period the subject of its lease to the defendant (that is, for the entire period of a new five year lease). On this last basis alone, there is a real possibility that its loss would amount to no less than the same as the incentives that it seeks to recover from the defendant. [34] Therefore, the second basis for the assertion that the obligation is a penalty fails. [35] The defendant’s third and fourth points may be considered together. They appear to be that, although the plaintiff’s entitlement to repayment of the Incentive did not arise as a consequence of the defendant breaching the lease, the obligation to repay the Incentive arose only because the defendant chose (as it was entitled to do under the variation deed) not to comply with the primary obligation in the lease - that the defendant take the premises for a 5½ year term - by reducing it to a 2½ year term. At the hearing of the plaintiff’s application for summary judgment, the defendant submitted that the requirement that it repay the Incentive in that circumstance was in the nature of punishment for its non-observance of the primary obligation. The penalty doctrine is not limited to where there has been a breach of contract. It can apply where the penal obligation is, as a matter of substance, collateral to and consequent on the defendant’s non-observance of another obligation. The collateral obligation imposes an additional detriment on the defendant, to the benefit of the plaintiff. It is in the nature of security for and in terrorem of the satisfaction of the primary obligation.12 The collateral obligation is prima facie a penalty in that circumstance. The true effect of clause 7.2 of the variation deed is in substance the same as a clause in a lease that has been held to constitute a penalty by requiring that, in the event of default by the lessee, it became liable to pay the primary amount of rent rather than the discounted amount.13 [36] The plaintiff submits that the obligation to repay the Incentive did not arise because of any breach by the defendant of either the lease or the variation deed, nor is it akin to a clause concerning such a breach. Rather, it was consideration for the defendant exercising its choice to shorten the term of the lease from 5½ years to 2½ years. Far from arising on breach or being punishment for, or in terrorem of, the defendant’s failure to complete the 5½ year term of the lease, the obligation arose from compliance with the variation deed. It was consideration for the exercise of the option to shorten the term of the lease that was granted to it by the plaintiff. It does not amount to a penalty. 12 This formulation substantially derives from the reasons of the High Court in Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205 (“Andrews”), [10]. 13 Squash Vision Pty Ltd v Il Mito Pty Ltd [2020] QSC 328. -- 8 of 17 -- 9 [37] The plaintiff also submits that this case is different to other claims for repayment of incentives under a lease that have been dealt with by courts. In GWC Property Group Pty Ltd v Higginson [2014] QSC 264, for example, the incentive deed that was executed with the lease provided that the tenant must repay the incentive if the lease was terminated early by reason of default by the tenant. Dalton J held that it was clearly a penalty. This case differs for the reason I have summarised at [36] above. [38] In O’Dea v Allstates Leasing System (WA) Pty Ltd,14 Gibbs CJ considered a number of cases in which courts had held that a payment obligation is not a penalty. His Honour considered there to be two classes of case in which there can be no question of penalty. The first, relevantly, is one:15 where a creditor agrees to accept payment of part of his debt in full discharge if certain conditions are met but stipulates that if the conditions are not met he will be entitled to recover the original debt: Thompson v. Hudson;16 Ex parte Burden; In re Neil.17 In all the cases of this kind there is a present debt, which, by reason of an indulgence given by the creditor, is payable either in the future, or in a lesser amount, provided that certain conditions are met. The failure of the conditions does not mean that the creditor becomes entitled to damages; the consequence is that the sum which was always owed, but which the debtor was allowed to pay by instalments or in a smaller amount, becomes recoverable at once or in full. The second class of case arises where the parties have stipulated that a sum shall become payable on a certain event which, although brought about by the party required to make the payment, does not involve a breach of contract. It has been held that where there is a contract for the payment of a certain sum in a certain event, and that event has happened, the sum is payable and no question of penalty versus liquidated damages arises: In re Apex Supply Co;18 Alder v. Moore.19 [39] His Honour went on to discuss hire purchase agreements within the second class of case. Relevantly, he said:20 If, however, the agreement is terminated by the hirer himself, e.g. because he is unable to keep up his payments, it has been held that the question whether the sum payable is liquidated damages or a penalty does not arise, since what has occurred is that the hirer has exercised his option to put an end to the contract on paying a certain sum, and the sum for which he has made himself liable must be paid: Associated Distributors Ltd v Hall.21 Conflicting opinions have been expressed as to the correctness of that decision (see Campbell Discount Co Ltd v Bridge;22 and United Dominions Trust (Commercial) Ltd v Ennis23) but the question whether it was correct does not fall for consideration in the present case. 14 (1983) 152 CLR 359 (“O’Dea”). 15 (1983) 152 CLR 359, 367. 16 (1869) LR 4 HL 1, 15-16, 27-28, 30. 17 (1881) 16 Ch D 675. 18 [1942] Ch 108, 119. 19 [1961] 2 QB 57, 65. 20 (1983) 152 CLR 359, 367-368. 21 [1938] 2 KB 83 (“Associated Distributors”). 22 [1962] AC 600, 614, 631, 633. 23 [1968] 1 QB 54, 64, 67. -- 9 of 17 -- 10 [40] Mr Sams of counsel, appearing for the plaintiff, submitted that his Honour’s general description of the second class of case set out above applies here. More particularly, the situation of a hirer exercising an option to terminate the hire purchase agreement early on payment of an agreed sum appears to be broadly analogous to the situation in this case. [41] As Gibbs CJ recorded, there has been disagreement whether the decision of the Court of Appeal of England and Wales in Associated Distributors was correct. I have reviewed that and later decisions to which his Honour referred. The question does not appear to have been authoritatively decided, at least in Australia. Shortly after O’Dea, Mason and Wilson JJ (with whom Gibbs CJ agreed) considered Associated Distributors and subsequent cases at some length, but again did not decide whether it was correct.24 Their Honours did note that “the doctrine of penalties has pursued such a tortuous path in the course of its long development that it is a risky enterprise to construct an argument on the basis of the old decisions.”25 Unfortunately, the “tortuous path” in the development of the doctrine continues and this case sits somewhere along that path. [42] Having regard to the differences of opinion on the question expressed by eminent jurists, including in the House of Lords, and the High Court’s reluctance to determine whether Associated Distributors was correct,26 there remains a live issue whether, at least in the case of hire purchase agreements, such a clause does provide for a penalty or simply “confers on the hirer a right for which he agrees to pay a price.”27 An analogous issue arises in the present case. [43] More recently, the High Court has made clear that a clause of a contract may be a penalty even if it does not provide for an additional obligation arising on breach of that (or another) contract.28 Thus, even if the obligation in this case does not arise on a breach of contract, it is necessary to consider whether it may possibly amount to a penalty. [44] In explaining Andrews in a subsequent related decision, Gordon J described steps that she thought may (but not must) be considered in determining whether a particular obligation may be a penalty. Her Honour said:29 To assist in understanding the form and substance of the following analysis, a particular stipulation may (not must) be considered by reference to the following steps: (1) Identify the terms and inherent circumstances of the contract, judged at the time of the making of the contract: Dunlop30 at 86-87 and AMEV- UDC Finance Limited v Austin (1986) 162 CLR 170. (2) Identify the event or transaction which gives rise to the imposition of the stipulation: Dunlop at 86-87 and Andrews High Court at [12]. 24 AMEV-UDC Finance Limited v Austin (1986) 162 CLR 170, 183-186. 25 (1986) 162 CLR 170, 186. 26 Notwithstanding the view expressed by David J of the Supreme Court of South Australia that “the decision in Associated Distributors Ltd v Hall still stands:” South Australian Famers Fuels Pty Ltd v Whittingham [2008] SASC 211, (2008) 257 LSJS 153, [33]. 27 Campbell Discount Co Ltd v Bridge [1962] AC 600, 613. 28 Andrews, [78], [84]. 29 Paciocco v Australia and New Zealand Banking Group Ltd (2014) 309 ALR 249 (“Paciocco trial”), [15]. 30 Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79 (footnote added). -- 10 of 17 -- 11 (3) Identify if the stipulation is payable on breach of a term of the contract (a necessary element at law but not in equity). This necessarily involves consideration of the substance of the term, including whether the term is security for, and in terrorem of, the satisfaction of the term. (5) Identify if the stipulation, as a matter of substance, is collateral (or accessory) to a primary stipulation in favour of one contracting party and the collateral stipulation, upon failure of the primary stipulation, imposes upon the other contracting party an additional detriment in the nature of a security for, and in terrorem of, the satisfaction of the primary stipulation. (5) If the answer to either question 3 or 4 is yes, then further questions arise (at law and in equity: see Andrews High Court at [77]) including: (5.1) Is the sum stipulated a genuine pre-estimate of damage? (5.2) Is the sum stipulated extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved? (5.3) Is the stipulation payable on the occurrence of one or more or all of several events of varying seriousness? These questions are necessarily interrelated. (6) If the answer to question 5 is that the sum stipulated is not a genuine pre- estimate of damage and is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have been sustained by the breach, or the failure of the primary stipulation upon which the stipulation was conditioned, then the stipulation is unenforceable to the extent that the stipulation exceeded that amount. Put another way, the party harmed by the breach or the failure of the primary stipulation may only enforce the stipulation to the extent of that party’s proved loss: Andrews High Court at [10]. [45] Her Honour went on to analyse the reasoning of the High Court in Andrews. Helpfully for the parties and the court in this case, her Honour made the following apposite remarks:31 (a) the law of penalties is not confined to payments (or other obligations) imposed upon breach of contract; (b) as a matter of substance, the collateral or accessory stipulation constituting a penalty operates “in the nature of a security for, and in terrorem of, the satisfaction of the primary stipulation;” (c) in other words: (i) the primary stipulation carries the substantive objective of the contract; (ii) the collateral stipulation is engaged on the failure of the primary stipulation and fulfils the function of acting as a security for, and in terrorem of, the satisfaction of that primary stipulation; (iii) the objective of the contract is achieved by payment of the money sum not being made rather than by being made - the second party wants the primary stipulation observed, not the payment of the penalty sum; the first 31 Paciocco trial, [26]-[28], [31], [38]. -- 11 of 17 -- 12 party is so averse to paying the exorbitant sum that it will observe the primary stipulation; (d) the primary stipulation may be the occurrence or non-occurrence of an event which need not be the payment of money; (e) the question before her Honour was therefore – as a matter of construction of the relevant contract, was the requirement to pay the fee to be regarded as security for performance by the customer of other obligations to ANZ or was it a fee charged in accordance with pre-existing arrangements according to whether ANZ chose to provide something more and further to the customer? [46] On appeal from her Honour’s judgment, the Full Court upheld her decision insofar as it concerned what were termed “over-limit fees”. Allsop CJ said about that type of fee that it “was payable for a contractually permitted transaction, effectively extending the drawing limits temporarily.”32 His Honour went on to say:33 as a matter of substance, her Honour construed the clause and came to the view, correctly, in my view, that the clause provided for a payment for honouring of a transaction that could be rejected as beyond arrangements. To the extent that the submissions asserted that the clause cannot have any feature of encouragement to a desired end of compliance with contractual obligations such overlooked the fact that such is permissible. As Jacobs JA said in Metro- Goldwyn-Mayer v Greenham at 723 (earlier set out): It may well be intended by the agreement that such an additional showing should be strongly discouraged. For this reason a very large hiring fee compared with the original hiring fee is provided. [47] Of particular relevance to this proceeding, the basis of which is that the contractual clause in question cannot, on any reasonable construction, be said to impose a penalty, are these additional remarks by the Chief Justice:34 It can be accepted that, in a given fact situation, the surrounding circumstances, including the level of the relevant fee, may lead to the conclusion that a provision, that on its face provides for a fee for an additional contractual benefit, is in substance a disguise for a fee for a breach that is extravagant and unconscionable. Any such judgment recognises the possibility of the overlapping of the processes of construction of the instrument and its characterisation from all the circumstances. The true legal substantive meaning of the clause is integral to any process of characterisation. A high fee for the contractual benefit may, however, be just that – a high fee for the additional contractual benefit. [48] Justice Middleton made the following additional remarks about considerations relevant to determining whether a contractual term imposes a penalty:35 The object and purpose of the penalty doctrine (controlling the use of extravagant or unconscionable terms) must always be kept in mind when determining the ultimate issue of whether a term is a penalty. Exceptions from freedom of contract, as the case law indicates, require good reason to attract judicial intervention in setting aside commercial bargains. This explains the 32 Paciocco v Australia and New Zealand Banking Group Ltd (2015) 236 FCR 199 (“Paciocco appeal”), [217]. Besanko J (at [371]) and Middleton J (at [398]) agreed with the Chief Justice. 33 Paciocco appeal, [219], quoting Metro-Goldwyn-Mayer Pty Ltd v Greenham [1966] 2 NSWR 717. 34 Paciocco appeal, [222]. 35 Paciocco appeal, [400]-[401]. -- 12 of 17 -- 13 high hurdle required in the case of a propounded penalty, such that it must be found to be “extravagant and unconscionable”. One starting point in considering whether a penalty has been imposed is to identify the commercial interests that are sought to be protected by the bargain reached between the parties. This can be achieved through a consideration of the language used by the parties, the circumstances addressed by the bargain, and the objects that the bargain intended to secure. [49] The Full Court’s decision about the over-limit fees was not appealed to the High Court, which was restricted to considering late payment fees and concluded that they did not constitute a penalty.36 In considering the law relating to penalties, Kiefel J (with whom French CJ agreed) said that:37 the point to be made is that threats and punishment were regarded as the essential characteristics of a penalty. A sum stipulated to be paid on default, which amounted to a threat to the person obliged to pay it if the principal obligation was not performed, bore the character of a penalty, as did a sum stipulated to be paid which could not be accounted for other than as a punishment for default. [50] Her Honour went on to record that:38 [The] policy [of the law] has not changed over time. It is that a sum may not be stipulated for payment on default if it is stipulated as a threat over the person obliged to perform; it may not be stipulated where the purpose and effect of requiring payment is to punish the defaulting party. [51] Mr Smith gave evidence about the circumstances in which the lease and the variation deed were negotiated. He explained that it was the plaintiff’s preference to have a long term lease: that is, for a term of at least 5 years, with the lessee having an option to renew the lease for another five year term. Such a lease reduces the expense and inconvenience to the plaintiff of having to re-let premises more frequently and adds to the capital value of the property. In order to secure such a lease, the plaintiff was prepared to negotiate and grant incentives to a prospective tenant, such as an initial rent-free period and a discounted rent for part or all of the initial term of the lease. The incentives would vary from lease to lease, having regard to various factors, including the length and overall value of the lease. [52] On the other hand, if a prospective tenant sought a shorter term lease, such as three years, the plaintiff would not normally be prepared to offer incentives to secure such a lease. [53] In this case, in negotiations for the lease, the plaintiff sought a five year term with a five year option, but the defendant sought a three year lease. The defendant then offered to accept a five year lease, provided that it could have an option to exit the lease part way through. The plaintiff agreed to that proposal on the basis that the option would entitle the defendant to terminate the lease after 3½ years but, if it did so, it would repay part of the incentives provided by the plaintiff. That offer was reflected in the agreement to lease. However, the defendant then sought to alter the option to entitle it to reduce the lease term to 2½ years. The plaintiff agreed to that option, but on condition that, if it was exercised, the defendant would refund all the 36 Paciocco v Australia and New Zealand Banking Group Ltd (2016) 258 CLR 525. 37 (2016) 258 CLR 525, [17]. 38 (2016) 258 CLR 525, [32]. -- 13 of 17 -- 14 incentives that the plaintiff had granted to it in consideration for the 5½ year lease. That arrangement was reflected in the final terms of the variation deed. [54] The plaintiff also tendered a report of Mr Cliff Allard, a registered valuer with considerable experience in valuing commercial premises. Mr Allard said that there are commercial benefits to a landlord in securing long term leases that are often recognised in the market by a landlord providing incentives such as rental discounts to the tenant in order to secure a long term lease; incentives that would be reduced or not offered at all for a shorter lease. [55] Mr Allard also said that the arrangement provided for by clause 7.1 of the variation deed in this case would have been of commercial advantage to the tenant. In particular, it gave the tenant the security of a long term lease but, if the busines conducted there was not successful or the tenant wished to terminate early for other commercial reasons, it had the flexibility to terminate the lease early should it consider it commercially beneficial to do so. [56] Mr Allard’s evidence is consistent with that of Mr Smith, but Mr Smith’s evidence is most relevant in demonstrating the commercial circumstances in which the parties ultimately agreed to the variation deed. [57] On a proper construction of the terms of the variation deed, the clause in question operates to grant an option to the defendant to reduce the length of the lease by over 50% (without being in breach of the lease) in consideration of the repayment of the incentives that the plaintiff had provided to it as incentives to enter into a 5½ year lease, not the shorter lease that the defendant ultimately chose. Of course, in addition to the flexibility given to the defendant by the clause, there may well be advantages to it in not being in breach of a lease. For example, it may damage its reputation with other prospective lessors in the future. Whether for that or other reasons, the defendant decided to accept the price of securing and (if it chose later) exercising that option, thus entitling it to leave the premises earlier than after 5½ years if it later concluded that that was in its interests. That price may seem to be high, but that was a matter for the defendant’s commercial judgment.39 The clause is simply the result of a fairly negotiated, even though possibly harsh, commercial bargain. The requirement to repay the incentives was neither a threat to the defendant nor punishment for exercising its option to shorten the term of the lease. The doctrine of penalties will not apply simply to relieve a person from the harsh consequences of a bargain freely entered into. [58] This construction is confirmed, if confirmation were necessary, by the circumstances in which the lease and the variation deed were created. They were the result of arm’s length commercial negotiations between equal parties, each with the assistance of legal advisors. The defendant chose to accept the terms offered by the plaintiff in order to secure to itself the option to terminate the lease early. The defendant must have known that the price for early termination was the refund of all the incentives offered by the plaintiff to secure the longer lease that the plaintiff preferred. That price may be considered high, but it is the consequence of an agreement freely made and of the defendant’s decision to exercise its option. 39 cf Moran v Argonaut Equity Partners Pty Ltd [2021] WASCA 45, [89]; special leave to appeal refused: [2021] HCASL 138. -- 14 of 17 -- 15 [59] The plaintiff also submits that clause 7.2 is not collateral or accessory to the defendant’s obligation, under the lease, to pay rent for the period of 5½ years. Rather, it is a primary stipulation, engaged by the defendant’s exercise of the option provided under clause 7.1.40 I agree. It was the price that the defendant chose to pay for the exercise of that option. [60] Clause 7.2 was not, therefore, an unenforceable penalty. The defendant’s exercise of its option to shorten the period of the rent gave rise to the obligation to repay the Incentives. The amount payable under that obligation is a debt due to the plaintiff. Did the defendant pay all the rent due from June to November 2020? [61] Having terminated the lease with effect from midnight on 31 May 2020, the defendant sought to remain in occupation of the premises as a month to month tenant for a further six months and the plaintiff consented to that happening. Clause 14 of the lease governed the parties’ rights, including the rental payable, during such a period. Relevantly, it provided that the monthly rent under such a tenancy (payable monthly in advance) was “equal to one twelfth of the annual rent at the time of expiration of the Term and the terms and conditions of this Lease (including those relating to outgoings) … shall apply to any period in respect of which the Lessee so holds over.” The “Term” of the lease was defined in clause 1.23 of the lease, tautologically, as “the term of this Lease and shall extend to include any extension thereof.” The expiry date of the Lease was stated, in item 6 of the registered lease form, to be 30 May 2023, but the effect of a notice of termination under clause 7.1 of the variation deed was that it would “alter the Expiry Date of the Lease to the Break Date.” Thus, the annual rent at the time of expiration of the lease was the rental payable in the year to 31 May 2020. [62] The plaintiff’s claim is for rent for the holding over period at the rate that would have been payable under the lease from 1 June 2020. It is not entitled to rent at that rate. Although the incentives did not apply, as the lease had been terminated, the annual rent “at the time of expiration of the Term” was that payable up to 31 May 2020. The lease provided (in clause 2.4) that “The annual rental shall be increased on the date referred to in Item 9 of the Reference data and on each subsequent anniversary of that date by three percent (3%).” The date in item 9 was 31 May 2019. However, that was the date on which rent was reviewed. The reviewed annual rent was for the following year. Clause 2.2 provided that the annual rental was payable in twelve monthly instalments, each of which was due to be paid on the first of the month. Rent up to and including 31 May 2020 had been paid by the defendant at the beginning of May. Therefore, if the lease had continued beyond 31 May 2020, the rent would have increased by 3% per annum on and from 1 June 2020. The rent at the time of expiration of the lease, on 31 May 2020, was one twelfth of the annual rent for the year up to and including that day, namely $21,314.56. That monthly sum was therefore payable during the holding over period, from 1 June to 30 November 2020. [63] Therefore, the plaintiff is only entitled to recover the difference between the monthly rent of $21,314.56 and the rent paid by the defendant during that six month period. [64] In its amended statement of claim, the plaintiff claims that it was entitled to payment of the defendants’ proportion of outgoings for the last six months of its occupation of the premises, at the rate of $5,996.46 a month (a total of $35,978.76). However, Mr 40 cf North Queensland Pipeline No 1 Pty Ltd v QNI Resources Pty Ltd [2021] QSC 190, [162]. -- 15 of 17 -- 16 Smith’s evidence is that the defendant paid those outgoings. I shall therefore consider only the rent due. [65] I am satisfied, on the evidence, that the monthly rent payable during the holding over period was $21,314.56. For six months that equates to $127,887.36. The defendant paid $92,206.6241 and therefore owes the difference: $35,680.74. The total debt due and interest [66] The value of the incentives paid to the defendant, as demonstrated in the affidavit of James Loel,42 comprised the rent otherwise due during the rent free period ($124,162.5043) and the discount in the rent for the period 1 June 2018 to 31 May 2020 ($151,230.0044), a total of $275,392.50. [67] The plaintiff is therefore entitled to judgment for the outstanding rent and the incentives, in the sum of $311,073.24. [68] The plaintiff claims interest on the debt, pursuant to s 58 of the Civil Proceedings Act 2011. Mr Sams submitted that it was appropriate to apply the rates determined under rule 283(2) for interest on judgments in default. I consider those rates to be an appropriate guide to the exercise of my discretion under s 58 and I shall apply them. [69] The variation deed does not provide when the incentives were repayable. That means they were repayable on demand or within a reasonable time of them becoming due. In a letter dated 2 July 2020 to the defendant’s solicitor,45 the plaintiff’s solicitors provided their calculations of the amounts repayable by the defendant. Those amounts differ from (and are less than) the amounts I have found to be payable. In the letter, the plaintiff’s solicitors asked the defendant to confirm whether it agreed with their calculations so that the plaintiff may arrange to issue an invoice. The plaintiff has not tendered any response to that letter, nor any invoice. It commenced this proceeding on 10 November 2020. In these circumstances, the latter date is the appropriate date from which interest on the incentives should accrue. [70] The plaintiff also seeks interest on the monthly amounts due during the holding over period from the first of each month. However, there is no evidence that the plaintiff demanded payment of the full monthly rental due during the holding over period at any time before it commenced the proceeding (although, in their letter of 2 July 2020, the plaintiff’s solicitors did say that the amounts of the Incentive that they had calculated did not include “any liability arising subsequent to 20 May 2020”). In the proceeding, the plaintiff claimed the difference between the rent paid and the amounts it claimed constituted the Incentive for that period. I have found that sum to be mis- described as the Incentive, rather than as rent due. Given the confusion, I consider that it is appropriate to award interest on the outstanding rent from the date of commencement of the proceeding. 41 $15,367.77 x 6. 42 A manager of the defendant’s holding company. The affidavit was filed on 28 January 2021 and is exhibit 3 in the trial. 43 $20,693.75 x 6. 44 $6,208.13 monthly for the 12 months to 31 May 2019 plus $6,394.37 monthly for the 12 months to 31 May 2020. 45 Exhibit JLB-07 to Mr Loel’s affidavit. -- 16 of 17 -- 17 [71] Therefore, I shall award interest on the total debt due ($311,073.24) from 10 November 2020 to today, calculated at the default interest rates. That totals $10,579.02. [72] I shall give judgment for a total of $321,652.26, including interest of $10,579.02. [73] The plaintiff is also entitled to the costs of the proceeding (other than the costs of its summary judgment application, about which I made a separate order after deciding the application). I shall hear submissions from Mr Sams about the basis on which those costs should be awarded. -- 17 of 17 --