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Leases Go Green

publication date: Nov 20, 2009
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Green buildingThere have long been minimum EU requirements for the energy performance of buildings such as energy certification of buildings and regular inspection of boilers and air conditioning systems. UK implementation of these include the Energy Performance of Buildings (Certificates and Inspections) (England and Wales) Regulations 2007.

The Better Buildings Partnership green lease toolkit provides certain, non-prescriptive guidelines to commercial landlords and tenants within the London Development Agency area for new leases with a view to making them more environmentally friendly by agreeing appropriate carbon, energy, waste and water reduction strategies. However, green leases are becoming increasingly common elsewhere, in anticipation of the Carbon Reduction Commitment Energy Efficiency Scheme (CRC) implemented under the Climate Change Act 2008.

The CRC will be a mandatory, auction-based emissions trading scheme for large businesses (e.g. large offices, banks, supermarkets and other retailers and rail operators) and public sector organisations (e.g. central government departments, large local authorities, schools and universities). Participants will be required to buy and surrender allowances in accordance with their annual energy use. Participants will be able to comply either by reducing their energy use or by purchasing additional allowances. A league table will rank participants according to performance.

Accordingly, a proposed tenant might find itself presented with a lease including provision for, among other things:

  • the cost to the landlord of purchasing CRC allowances and the landlord's administration costs incurred in connection with the CRC;
  • CRC receipts based on the position of the landlord in the league table and driven by the energy usage of the landlord and its tenants;
  • a ‘handbook' for tenants of the building including a guide to good environmental practice and an energy management plan relating to monitoring, improving and reviewing the environmental efficiency of the building, for resource reduction, etc. imposed by the landlord;
  • no change of use being permitted if it would not be compliant with the handbook and would adversely affect the environmental performance of the building, including any adverse effect on the asset/operational ratings or recommendations comprised in the Energy Performance Certificate and/or a Display Energy Certificate for the building; and
  • its landlord to apportion CRC costs and receipts among its tenants in its absolute discretion and in the interest of its tenants generally but not so as to favour one tenant over another or itself over its tenants generally, except in a case of sustained and ‘above trend' energy efficiency.
So, a green landlord has the opportunity to make its leases greener. But a green tenant should be mindful of the fact that, if it proposes any green additions to the building, it may require landlord's licence for alterations, which is often not to be unreasonably withheld or delayed. And the green tenant should also be mindful that any such green additions may become landlord's fixtures and fittings or they may be the subject matter of a schedule of dilapidations at the end of the lease term. Either way, unless the term is long enough for the tenant to reap a financial benefit from the alterations, it might not be cost-effective to make them.

That said, the green lease toolkit does propose restrictions on both tenant's alterations to the building and landlord's works to common parts or plant and equipment preventing them from having an adverse effect on the efficient use of energy or water in the building. It also proposes a dilapidations clause whereby the tenant is not obliged to reinstate permitted alterations which improve the energy or water efficiency of the building, unless their reinstatement is reasonably required by the landlord, given its intended use or re-letting of the building.

Indeed, the green lease toolkit proposes enabling the landlord to make improvements to common parts or plant and equipment with a view to reducing energy and water use and waste production without being liable for any resultant disruption to the tenant - generally, a landlord is able to carry out such improvements, provided nothing in the lease prohibits it and the lease reserves the right for the landlord to do so in the interests of good estate management. Whether or not the cost of any such improvements should be included in the service charge is a matter for negotiation between the parties. And it also proposes that, in the absence of agreement, either party should be able to carry out works with a view to reducing such use and production unilaterally.  

The green lease toolkit also proposes that tenant's improvements carried out in compliance with the terms of the lease should be disregarded on rent review, which would usually be the case in modern rent review provisions, and, conversely, the benefit of any landlord's works at its own cost to reduce utility bills or improve the environmental performance of the building should not be disregarded when ascertaining open market rental value for rent review purposes.

Landlords and tenants should be aware that the green lease toolkit also includes a model memorandum of understanding, which they can enter into during the term of a lease, so these green initiatives are not necessarily exclusive to new leases - for example, a landlord might commit to installing more energy efficient plant and equipment when it needs replacing.

However, new lease or existing, the emphasis is very much on co-operation between the parties. So the green lease toolkit proposes obligations to co-operate with each other and for the tenant to do so with any managing agents with regard to the necessary sharing of data, metering and access to the building. And it proposes building management committees and other methods of dispute resolution and even a limitation on the usual remedies as far as green clauses are concerned.

But the CRC and green lease toolkit will not apply to most SME landlords and tenants. And, unless green SME landlords and tenants happen to cross paths, many commercial leases will continue to exclude any green lease toolkit proposals. In which case, a landlord seeking to make green improvements will need to rely upon the service charge provisions of the lease enabling it to pass the cost on to the tenant on the basis that the lease provides for addition to such provisions at its discretion and/or in the interests of good estate management. There is potential for disagreement here as to whether green improvements exceed landlord's discretion and/or the principles of good estate management. Limited service charge provisions in existing leases may not afford a landlord the ability to dictate green improvements to the tenant who is not like-minded, while a proposed tenant might resist onerous, costly green improvement provisions in new leases. Therefore, the proposed tenant's position cannot be completely disregarded; commercially, an over-zealous landlord could jeopardize the marketability of its building.

The commercial reality is that many landlords will remain unconcerned about green improvements because, even if they can recover the cost from the tenants, they will want to avoid both the initial, capital outlay and potential disputes with tenants who are not of the same mind and may seek lower service charges elsewhere in future. Unless, of course, there is sufficient increase in demand for green buildings from green-minded tenants to justify the expenditure and a resultant enhanced rental, etc.

Andrew HardcastleFrom the tenant's point of view, however green-minded, it cannot oblige a landlord to make green improvements without either certain green lease toolkit provisions or some memorandum of understanding. Of course, the green-minded tenant can make its own green improvements with landlord's consent but they may not be cost-effective in the context of a lease with say only ten years to run. And, of course, a green tenant seeking to persuade the landlord to make green improvements and split the cost between all its tenants faces potential objection from a less green co-tenant.

On balance though, green or otherwise and however small, a landlord would be well-advised to consider making its standard lease more flexible in terms of giving it the ability to implement green initiatives, and claim appropriate costs from the tenant, if it chooses to do so in the future, if only to keep its options open. No landlord is currently obliged to embrace all of the green lease toolkit proposals, unless by the CRC, but green issues are here to stay and who is to say what new, green technologies and fiscal incentives or statutory obligations will be with us in the next decade or so?       

Andrew Hardcastle is a Partner at Moorcrofts LLP