ABA Green Lease Task Force WAREHOUSE & INDUSTRIAL GROUP 1. Lease Provisions Regarding Green Building Elements. By Jack Fersko 2

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1 ABA Green Lease Task Force WAREHOUSE & INDUSTRIAL GROUP 1 Lease Provisions Regarding Green Building Elements By Jack Fersko 2 As part of your client s green initiative, it will be reevaluating its current insurance policies. The client asks you to provide information on potential insurance issues involved with green building elements. The potential benefits of green development have been well publicized and, depending on the nature of the work being done, could include increased worker productivity, reduced operating costs, improved air and water quality, improved corporate image, and the availability of federal and state financial benefits, such as tax credits, accelerated depreciation, grants and proceeds from the sale of renewable energy certificates. Although much as been written on the topic of sustainable development, the full significance of the question what will insurance cover? is only first beginning to be understood. This article provides a general overview of the myriad of issues that need to be considered in the context of green development, describes some of the insurance products currently available in the market and offers an insurance clause to consider when crafting a lease for a green certified building. It is important to underscore that the insurance issues affecting green development are complex and require the assistance of a skilled insurance professional to ensure that all issues are properly addressed. Developing Green One of the first considerations in the context of green development concerns the related undertakings between and amongst the real estate owner/landlord, architects, engineers, building contractors and prospective tenants. If the project involves new construction, and a real estate owner/landlord enters into a lease with a prospective tenant to develop and lease a green building, how will liability be distributed amongst the various parties in the event that the project fails to achieve its stated green threshold for example, LEED Silver, LEED Gold or LEED Platinum? 3 Who will be responsible if components of the development fail to function as designed for example, water infiltration due to an improperly designed green roof? How will 1 The leaders of the Warehouse and Industrial Group of the ABA Green Lease Task Force are Stacia Palser (Stacia.Palser@koleyjessen.com) and Theresa Shea (theresa.b.shea@lmco.com). 2 Mr. Fersko is a member of the Westfield, New Jersey law firm Farer Fersko, a Professional Association, where he chairs the Real Estate and Redevelopment Group. The firm s practice focuses on the areas of industrial and commercial real estate, environmental law, including related insurance issues, redevelopment, condemnation and business law and related litigation. The author gratefully acknowledges the assistance of Ursula Knowles and Fred Frey in the preparation of this manuscript. Ursula and Fred are insurance professionals with Marsh and may be contacted at Ursula.Knowles@Marsh.com and Fred.Frey@Marsh.com, respectively. Attachment A, The Green Built Environment in the United States 2008 Year-end Update of The State of the Insurance Market ( The Green Built Environment ) is reproduced with the permission of Marsh. 3 LEED means Leadership in Energy and Environmental Design and is a rating system developed by the United States Green Building Council. 1

2 liability be distributed if grants or tax credits are lost because a building fails to satisfy the necessary LEED certification threshold or if energy costs are greater than anticipated because alternative power generating equipment does not achieve the anticipated level of efficiency? Will any of the foregoing risks be covered under traditional commercial general liability policies or professional errors and omissions policies? Traditional commercial general liability coverage protects against claims relating to bodily injury and property damage; a breach of warranty or breach of contract claim, however, is excluded from coverage. Similarly, professional errors and omissions policies cover a professional for his or her negligence query whether the risks associated with green development fall outside the scope of ordinary negligence, involving a heightened level of care, and thus fall outside the scope of coverage of a professional errors and omissions policy. In addition, standard policy language excludes a breach of a guarantee or warranty. Similarly, what happens if there is a casualty during construction of a green development? Will the additional cost of construction due to the green nature of the development, be a covered loss under a traditional builder s risk policy? Many of the costs associated with green development are likely outside the scope of a traditional builder s risk policy, for example construction delays to obtain specialized equipment, added costs attributable to debris recycling rather than landfill disposal, building commissioning expenses, recertification fees, loss of tax credits and more. Some carriers are providing endorsements to their builders risk policies to address green issues. Coverage provided by the endorsements may include: Added soft costs associated with green development, such as recycling costs, which may be more expensive than landfill disposal; The cost to flush out space with 100% fresh air; Building commissioning expenses of qualified engineers; Re-registration fees; LEED accredited professional expenses; Additional expense for using green products; Financial losses due to changed standards, loss of earnings from alternative fuel sources (such as the sale of energy back to the grid from solar panel generated power) and loss of tax credits and other financial incentives. 4 In addition, and specifically concerning solar panels, an installation floater can provide coverage for loss due to damage to solar panels during transit, as well as during installation. Completed Green Buildings Many concerns also arise in the context of a casualty loss involving a green building. 4 For a more complete analysis, see pages 2 8 of The Green Built Environment, attached as Attachment A. It is not clear whether surety bonds will cover any of the risks associated with green development. See The Green Built Environment, pages

3 For example, what will be included within the like kind and quality language of a property casualty policy what if standards have changed, requiring additional costs to achieve the same LEED certification standard of a previously constructed green building? Is there coverage for the added costs associated with building commissioning expenses, recertification fees, construction delays due to the length of time to obtain green building products, recycling fees, and the loss of income from the loss of alternative energy production during reconstruction? A number of carriers are providing coverage to address many of the issues raised above, and more, either by way of endorsement to a property casualty policy or through a stand alone policy. Coverage may address a host of risks; however, it is important to carefully evaluate the coverage to understand its full scope and whether any applicable sub-limits apply to all or particular aspects of coverage. For example, green buildings usually have sophisticated HVAC, electrical and plumbing systems. Coverage can be obtained to pay for a professional commissioning engineer to oversee a system s reconstruction and commissioning to ensure that the system is properly aligned with all other systems and is properly balanced and thus functioning at its peak level of performance. Some carriers, however, impose a cap or sub-limit on coverage for example a limit of Twenty-Five Thousand Dollars. Other policies provide a lump sum amount equal to the coverage limits, and the insured then can determine what green components to apply the proceeds to during reconstruction. Some carriers will offer casualty insurance coverage to upgrade an existing green certified building to the next level of green certification and a non-green building to a basic green certified level. Coverage may be provided either by way of endorsement to a property casualty policy or through a stand alone policy. In each instance, there may be coverage for a wide variety of losses that may include, but are not necessarily limited to the following: The additional cost of upgrades due to a change in applicable green building standards; Losses associated with the loss of a LEED certification, including government tax credits, utility credits and other financial incentives; Additional debris removal cots associated with recycling in lieu of landfill disposal; The cost to hire a LEED accredited professional to oversee design and construction; The added expense to retain a qualified engineer to properly commission the building in order to ensure that the building s systems are designed, installed and tested to confirm that the systems perform according to the design intent, are properly aligned with one another and operate at peak performance; Registration and re-certification fees to re-certify the building; Increased business interruption coverage for the extended period required for recertification or to upgrade to green certified, as the case may be; The cost to reconstruct a vegetative roof; The cost of air testing as well as the cost to flush out the reconstructed space with 100% fresh air; 3

4 The cost of obtaining alternative energy producing equipment and any extra expenses that may be incurred in connection with the purchase of replacement power during the interim construction period; The loss of income if alternative energy producing equipment is sending surplus power to the public utility power grid; For a building that is not green certified, coverage may include the cost to upgrade furniture and equipment to green status, building materials to that which have lower odor emissions (such as paints and carpeting), lighting, heating and cooling that are energy efficient and plumbing that is water efficient; and Additional soft cost expenses such as additional interest expense, additional legal, accounting and architectural expenses, and lost rental value for the added period of construction attributable to green development requirements. Other Insurance Coverage, Benefits and Issues Because commercial general liability policies cover bodily injury and property damage, but do not cover breach of warranty and breach of contract claims, a charge that a building does not meet the announced green building status will be excluded from coverage under the typical CGL policy. A recently announced Green Reputation CGL endorsement will, however, provide defense costs and crisis management consulting services. 5 Also, some carriers are providing discounts to their insured that develop green. For example, AIG Environmental Group is providing up to a ten percent (10%) discount on their premiums for Pollution Legal Liability policies issued for LEED certified facilities. 6 And Fireman s Fund is offering a five percent (5%) premium discount off of its regular insurance coverage for green-certified buildings. 7 It is, however, imperative that the policy be reviewed carefully. For example, one policy reviewed by this author provided that the green building coverage would not apply if the building had been vacant for more than sixty consecutive days before the loss or damage. Consequently, the going dark issue typically found in a retail setting may take on an added level of importance in a green certified facility. Lease Insurance Clause The following insurance clause is presented from a landlord s perspective and represents, for illustrative purposes, a one-sided position. While some lease agreements lump insurance costs in the common area maintenance charge provisions of a lease, other lease agreements carve out insurance and address it in a separate clause. In either instance, in the situation of a green certified building, it is important that the clause entitle the landlord to obtain as broad a coverage as it elects to ensure that in the event of damage or destruction the building can be reconstructed to at least meet the then currently similar level of green certification as when initially built. It should be noted that the clause below entitles a landlord to 5 See Insurers Green Up Gray Coverage Areas Construction carriers tackling unique liability risks of green-building projects by Susanne Sclafane, Property and Casualty (January 11, 2010). 6 See AIG Environmental Adds Financial Incentives for Building Green, December 13, 2007, published in GreenBiz.com. 7 See Fireman s Fund Green Insurance Fact Sheet available on Fireman s Fund Insurance Company website. 4

5 obtain a very broad level of coverage; it does not, however, obligate the landlord to do so. (a) Casualty Insurance. The Tenant shall pay the Landlord, as additional rent, either upon demand or, in the Landlord s discretion, as provided in subparagraph (b) below, the Tenant s Proportionate Share of the Landlord s premiums for Property Insurance (Special Form). This coverage may include such coverage and endorsements as the Landlord shall determine in its discretion, including, without limitation, rent insurance, water damage insurance, building ordinance coverage, vandalism and malicious mischief insurance, flood insurance and war and terrorism insurance, as well as and any other coverage which may reasonably be required by a mortgagee of the Landlord. The Tenant acknowledges that the Building on the Property, of which the Premises is a part, has been certified as [insert rating] under the U.S. Green Building Council s Leadership in Energy and Environmental Design ( LEED ) system. Without limiting any of the foregoing, the coverage obtained by the Landlord may further include, without limitation, such coverage and endorsements that shall include the cost to reconstruct the Building in a manner that shall enable the Building to be certified as [insert rating] under the LEED system, or if the LEED system no longer exists, a similar rating under a then existing equivalent system, including, without limitation, the following risks and/or losses: (i) the additional cost of upgrades due to a change in applicable green building standards; (ii) losses associated with the loss of a LEED certification, including government tax benefits, utility credits and other financial incentives; (iii) additional debris removal costs associated with recycling in lieu of landfill disposal; (iv) the cost to hire a LEED accredited professional, or a then similarly qualified professional, to oversee Building design and construction; (v) the added expense to retain a qualified engineer to properly commission the Building in order to ensure that the Building s systems are designed, installed and tested to ensure that the Building s system are designed, installed and tested to ensure their performance according to the design intent, their proper alignment with one another and their operating at peak performance; (vi) registration and re-certification fees to recertify the Building as [insert rating] under the LEED system, or if the LEED system no longer exists, a similar rating under a then existing equivalent system; (viii) the cost to reconstruct a vegetative roof; (ix) the cost to obtain and reconstruct any alternative energy producing system existing at the time of casualty; (x) the cost of air testing as well as the cost to flush out the reconstructed space/building with 100% fresh air; (xi) the cost of obtaining alternative energy during the interim construction period; (xii) the loss of income if alternative energy producing equipment was sending surplus power to the public utility power grid; and (xiii) additional soft cost expenses such as additional interest expense, additional legal, accounting and architectural expenses, and lost rental value for the added period of construction attributable to green development requirements. This insurance may: (A) name only the Landlord and the Landlord s mortgagee, if any, as the insured and provide that any loss shall be payable to the Landlord and the Landlord s mortgagee, if any, as their respective interests may appear; (B) be in an amount equal to the full replacement cost of all buildings, improvements, alterations, additions and replacements now or hereafter on or at the Property; (C) provide that no act of the Tenant shall impede the right of the Landlord or the Landlord s mortgagee, if any, to receive and collect the insurance proceeds; and (D) provide that the right of the Landlord and the Landlord s mortgagee, if any, shall not be diminished 5

6 because of any additional insurance carried by the Tenant for the Tenant s own account. (b) Insurance Review. At the option of the Landlord, which the Landlord may exercise at any time, and from time to time, during the Lease Term, the Tenant shall pay the Landlord the Tenant s Proportionate Share of all insurance premiums for the insurance coverages referred to in subparagraph (a) above, on the first day of each month, in advance, in a sum equal to 1/12 th of the Tenant s Proportionate Share of all insurance premiums then due and payable. Additional rent based upon insurance premiums payable for the first and last years of the Lease Term, shall be adjusted and prorated, so that the Landlord shall be responsible for the Landlord s prorated share for the period prior to and subsequent to the Lease Term, and the Tenant shall pay the Landlord its prorated share for the Lease Term. While the foregoing clause is intended as an example of a pro-landlord insurance provision, it nevertheless underscores the need for careful review by a tenant s counsel. First, a tenant s counsel may, subject to a cost analysis, want to make a minimum level of coverage mandatory. In addition, both the landlord and the tenant need to carefully align the risk of loss clause with the insurance provisions of the lease. While a tenant may have an interest in requiring the landlord to rebuild to a particular green certified level, before committing to do so the landlord needs to ensure that the actual insurance coverage purchased will permit the landlord to achieve compliance without an out-of-pocket expense. As a result, while the lease may structure the landlord s insurance requirements in a permissive fashion, the rebuilding requirements of the lease will dictate the coverage that actually should be procured by the landlord. In addition, depending on where responsibility rests with respect to the interior space of the building, the landlord and the tenant may be in a role reversal relative to the required insurance and rebuilding standards. Conclusion While the current economic crisis has significantly reduced development generally, as the real estate industry moves out of this crisis, there will be an ever increasing need for real estate developers to distinguish their product and therefore a green certified building may well become more common place in the industry. As the sustainable development model becomes more popular, even limited efforts, such as solar panels and other forms of alternative fuel production, will require a more careful analysis of the risks and related insurance needs. Just as the insurance industry responded to the increased risks associated with Brownfield redevelopment, it is likely that there will be an increasing number of products available to meet the demands of sustainable development. As such, real estate counsel will have to better understand the related risks and the insurance products available to address those risks. 6

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33 ABA Green Lease Task Force WAREHOUSE & INDUSTRIAL GROUP 1 Solar Panel Hypothetical By Max J. Burbach 2 Hypothetical: A tenant in a multi-tenant industrial flex building would like to install solar panels on the roof of the building. Your client is the landlord, and the landlord s primary equity investor has adopted a new green code of conduct. How do you proceed? Detailed Fact Pattern For purposes of the following discussion, the client is the owner of a United States industrial real estate portfolio. One of the industrial properties in the client s portfolio is a 75,000 square foot industrial flex building in the Midwest (the Midwest Building ). The building, constructed in the 1970s, is in relatively good condition. Currently, there are three tenants in the building. The largest of these, occupying 45,000 square feet, is a distributor of restaurant equipment ( Equipment Tenant ), whose primary use of its rented premises is warehousing and storage. Most of the Equipment Tenant s energy consumption is for space heating and lighting. The two other tenants, a custom cabinet fabricator ( Cabinet Tenant ) and an interior window blinds designer and distributor ( Window Tenant ), occupy 20,000 and 10,000 square feet, respectively. The Equipment Tenant has been in the Midwest Building since it was constructed and has just renewed for a ten-year term. The Equipment Tenant s lease provides for one additional ten-year renewal option. The Cabinet Tenant has been in the Midwest Building for ten years and has seven years remaining on the current term of its lease with one seven-year renewal option remaining. The Window Tenant has three years left on its lease and has indicated that it will likely relocate to different space at the end of the term. Each tenant of the Midwest Building currently pays its pro rata share (based on square footage) of operating costs of the Midwest Building. Each tenant s premises are separately metered for utilities. The client s primary equity investor is publicly-traded and has adopted a new green code of conduct. The client is interested in making environmentally friendly improvements and upgrades to the properties in its portfolio with the goal to obtain and maintain a green image. Currently, none of the properties in the client s portfolio has green lease language and will need to be updated to address these issues. 1 The leaders of the Warehouse and Industrial Group of the ABA Green Lease Task Force are Stacia Palser (Stacia.Palser@koleyjessen.com) and Theresa Shea (theresa.b.shea@lmco.com). 2 Max Burbach is the Chair of Koley Jessen s Real Estate, Environmental and Natural Resources Law Practice Group. Max practices primarily in the areas of real estate purchases, sales, leasing, and financing. He advises clients on financing matters associated with the acquisition and construction of development projects, as well as the negotiation and drafting of all documents related to such developments. Max has represented developers, owners, landlords, and tenants with respect to office buildings, mixed use centers, strip centers, and other commercial, industrial, and warehouse space. Max earned his law degree in 1992 from Creighton University School of Law, and his undergraduate degree from the University of Nebraska - Omaha.

34 The Cabinet Tenant has approached your client and would like to install solar panels on the roof of the Midwest Building. What do you do? After receiving the Cabinet Tenant s inquiry regarding installation of a photovoltaic system ( PV System ), your client approached the other tenants of the Midwest Building to gauge their interest in a PV System for the Midwest Building. The Equipment Tenant has expressed an interest in a potential reduction of its energy costs, but is unwilling to pay for the PV System. Because the Window Tenant plans to relocate in three years, it doesn t want to pay for the PV System and doesn t really care about the benefits. The Cabinet Tenant is willing to contribute some amount to the costs of installation of the PV System, but will not pay for all of it. The client, as part of its green initiative, is extremely interested in installing and maintaining the PV System and would like to work with the tenants of the Midwest Building to accomplish this. The client asks you to provide an analysis of the issues to consider in determining whether to install the PV System. The following is a list of items that the client should consider in making its decision on installation of the PV System: a. Local Codes, Covenants and Easements i. Does local code permit, prohibit or limit the installation and use of the PV System? ii. Are there any code or covenant requirements to screen rooftop equipment? If so, does a PV System constitute rooftop equipment? Even if there are screening or third party approval requirements, are there applicable state laws that would invalidate such restrictions if they acted to frustrate the use and development of renewable energy sources? iii. Are any easements for solar power, light, view, etc. in place burdening the property that may restrict the ability to install a PV System or does the property require easements for light or view over adjacent properties in order to protect the sunlight exposure of the PV System? b. Cost and Maintenance i. What is the cost of installing and maintaining the PV System? Do the costs outweigh any expected economic benefits? ii. What are the projected energy and cost savings? This may include an evaluation of available sunlight. iii. iv. What is the useful life of the PV System? Who will pay to maintain, repair and replace the PV System? v. Are there any other financial incentives available to defray the purchase or installation cost of the PV System? 2

35 vi. Are the costs of the PV System operating expenses or capital expenses? Many leases contain provisions that allow the landlord to include in operating expenses some or all of capital expenditures that reduce, or reduce the potential increase of, operating expenses. vii. Are there additional insurance costs that may result from the installation of the PV System? If so, can the client pass those costs on to the tenants? viii. Is there an ability to sell any excess power generated by the PV System to the local utility company? If so, who is entitled to any income generated by the sale of such excess power? ix. If the Cabinet Tenant pays for some or all of the cost of the PV System, can the Cabinet Tenant remove it when it vacates the premises or demand payment of some amount to release any interest or claim it may have in the PV System? x. If renewable energy credits (RECs) are available, who is entitled to those credits? xi. System? Does it make sense to lease, rather than purchase, the PV xii. Will normal roof maintenance, repair or replacement costs be greater with the PV System installed than without? If so, who will pay the extra costs? Note that the useful life of a roof-mounted PV System may exceed the life of the roof, and that replacement of the roof may be more expensive and difficult with the PV System installed. c. Structural Issues i. Can the roof support the PV System without additional structural improvements? ii. iii. Will installation invalidate applicable roof warranties? Will installation unduly disrupt the operations of any tenant? After thoroughly evaluating the issues above, the landlord client has decided that, in light of its new green policies and because this is a multi-tenant building with varying interest levels in the PV System, the client will pay for the installation of the PV System and will be responsible for maintenance, with the cost of installation and maintenance thereof to be passed through to the tenants of the Midwest Building as operating expenses. Although the Equipment Tenant did not want to pay for installation of the PV System, the client has managed to convince the Equipment Tenant that the energy savings over the remaining term of its lease will more than make up for the initial costs involved with installation of the PV System. The costs will be distributed on a pro rata basis. Anticipating higher rentals due to the greening of the Midwest Building, the client will pay for the Window Tenant s pro rata share of the costs of installation, but will transfer pro rata maintenance costs to the new tenant in the Window Tenant s space effective as of the date of the new lease. 3

36 The client asks you to provide language that can be implemented in the existing leases and any new leases for the Midwest Building addressing the PV System. Below is example landlord-friendly lease language that can be implemented by amendment into the existing leases and can be included in the lease form for all new tenants. (a) PV System. Landlord may, at its option, erect, maintain, repair, replace and remove a photovoltaic system ( PV System ) on the roof of the Building. All costs associated with the PV System shall be included in the Operating Costs of the Building and shall be paid by the Tenant according to its Pro Rata Share. Landlord shall be the exclusive owner of energy generated by the PV System and any and all proceeds from the sale of excess energy generated by the PV System and any Renewable Energy Credits. Landlord shall use commercially reasonable efforts to minimize disruption to Tenant s business in installation and maintenance of the PV System. Landlord does not make any representations or warranties to Tenant that the PV System will result in a reduction of energy costs for the Building or Tenant s share of Operating Costs. Landlord shall not be liable to Tenant for any loss, damage or expense that Tenant may sustain if the PV System or the quantity, quality or character of electricity generated by the PV System are no longer available or suitable for Tenant s requirements, or if the supply of energy from the PV System ceases or is interrupted as a result of any cause, and no such change, interruption or cessation of service shall constitute an eviction of Tenant or give rise to any claim of damages. The client should be aware that for tenants to accept language with respect to the PV System, the tenants may require a cap on annual maintenance and repair to be passed through as Operating Costs, and may not agree to payment of replacement or removal costs. The tenants may also request that, if they are contributing to the installation and maintenance of the PV System, they should also share in the benefits of any profits received from the sale of excess generated energy. To the extent that any of the costs associated with the PV System are capital costs, if a tenant agrees to pay them, the tenant at a minimum will require that the costs be amortized over the useful life of the PV System instead of passed through in a single year. 4

37 Green Leasing Task Force Retail Group Hypotheticals By: Trevor Jones Murphy McMillan Benjamin Hutton & Jason Meyerpeter Introduction There is no doubt that these are difficult times for the commercial real estate industry, in general, and the retail industry, specifically. The current economic slowdown, however, ultimately may prove beneficial for both as an opportunity to re-evaluate and revise current business practices in light of the green building movement, which has persisted in the midst of the current downturn. Environmental responsibility and sustainability are increasingly mainstream concepts (subject, of course, to debate over their precise meaning and how best to achieve them). In this context, retail buildings will receive considerable attention because of the amount of energy they consume. This energy includes natural gas and electricity for heating and cooling, cooking and refrigeration systems, and the running of electrical systems. Retailers also are finding that environmental responsibility could be good for their pockets. Some research shows that green buildings have higher occupancy and rental rates, lower operating expenses, and higher sales prices than their non-green counterparts. Because retailers often are tenants, not only must their premises be green, but the documents governing their leasehold interest also must be green. The following hypotheticals address common issues that landlords and tenants will confront in drafting green leases. The first hypothetical involves an existing shopping center and a landlord and tenant who are eager to adopt green goals, but not yet ready to commit to the time and expense required under a thirdparty certification system. This is a common scenario in today's economic environment. The second hypothetical involves a new shopping center and a lease drafted with LEED (Leadership and Energy and Environmental Design) certification in mind. This hypothetical provides an opportunity to discuss LEED certification under two new LEED rating systems designed specifically for retail projects LEED for Retail and LEED for Retail Interiors which should be launched by the end of

38 Hypothetical #1: A major tenant ("Tenant") has proposed to lease inline space in an existing retail shopping center from your client ("Landlord"). Early discussions between Landlord and Tenant have indicated that each party would like to enter into a "green" lease, but due to current market conditions, neither party is ready to commit to a specific third party rating and certification system, such as LEED (Leadership in Energy and Environmental Design). Tenant has asked Landlord to submit a draft lease that incorporates "green" provisions, including an environmental performance objective. I. Threshold Issues A. Local or State Codes If the local or state jurisdiction has adopted green codes, ordinances or regulations that would apply to any of the tenant improvements or to the management or operation of Tenant s space and/or common areas of the shopping center, then Landlord and Tenant would, of course, be required to comply with those. B. Rent Structure One of the initial issues of going green with a lease relates to the economics of being green. Basically, who pays for what? Tenant should do its best to avoid having to pay for a great deal of Landlord's green expenditures, though the pass-through of some costs will likely be necessary for the lease to work. This can be addressed through the set up of the rent structure. The rent structure issue is more fully addressed in Hypo #2. C. Audits While this discussion will focus on the use of an environmental performance objective, another option might be to conduct a green audit of the shopping center during the first year of the lease, and then set measurable goals for energy saving, recycling and the like using the initial audit as a baseline. However, because the results of such an audit would not be known when the lease is entered into, it would be difficult to define the goals in the lease. II. Lease Specifics A. Tenant Improvements / Alterations While Tenant will want to leave some flexibility in the lease to allow for its desired improvements, the lease must ensure that Tenant's initial improvements or subsequent alterations are consistent with the green building design and operations agreed upon by the parties. Landlord should insist on the incorporation of appropriate language into the Tenant Improvements/Alterations section requiring Landlord's review of proposed work to ensure the work is performed in accordance with the agreed upon sustainability practices (keeping in mind that sustainability practices and standards change over time). 2

39 The plans and specifications attached to the lease and/or work letter may require the use of recycled materials, non-toxic paint, floor finishes and carpeting, use of energy efficient lighting, Energy Star appliances and low-flow water fixtures. Landlord should have the power to condition approval of plans and specifications on, among other things, the anticipated compliance with the environmental performance objective. As Tenant makes improvements or alterations, it likely will need to dispose of or remove equipment, furniture, or material that is no longer in use. Improper methods of disposal or removal could frustrate the environmental goals of the parties. A lease provision such as the following from BOMA's Lease Guide could alleviate this concern: Tenant shall dispose of in an environmentally sustainable manner any equipment, furnishings, or materials no longer needed by Tenant and shall recycle or re-use in accordance with Landlord s sustainability practices. Tenant is responsible for reporting this activity to Landlord in a format determined by Landlord. 1 While this language provides a goal, it does not define environmentally sustainable. In addition, the Tenant will want the reporting requirement to be reasonable. B. Operational Performance Leases generally do not establish any specific operational performance requirements for building services that are provided by the Landlord, particularly for heating, ventilation, and air conditioning. Including lease provisions that provide for clear, measurable operational performance requirements will clarify the obligations of Landlord and Tenant. For example, Tenant may want to require Landlord to monitor indoor air quality and report the results on a regular basis. A lease generally provides that the Landlord will furnish air-conditioning and heat during normal hours of operation during the seasons when they are required. Often, this provision gives the Landlord discretion to determine when these services are provided. A better option may be to use standards set by a third-party, such as the American Society of Heating, Refrigerating and Air-Conditioning Engineers (ASHRAE). ASHRAE has developed standards for thermal comfort 2 and indoor air quality 3 that could be incorporated into the lease. Tenant also may want an audit right to examine Landlord s books and records to ensure that Landlord is maintaining accurate records regarding recycling and energy usage and savings. 1 TEITELBAUM, STEVEN A., BOMA'S GUIDE TO WRITING A COMMERCIAL REAL ESTATE LEASE, INCLUDING GREEN LEASE LANGUAGE (Jones Day 2008) (hereinafter "BOMA GUIDE") at ASHRAE : Thermal Environmental Conditions for Human Occupancy. This standard specifies the combinations of indoor space environment and personal factors that will produce thermal environmental conditions acceptable to 80% or more of the occupants within a space. The environmental factors addressed are temperature, thermal radiation, humidity, and air speed; the personal factors are those of activity and clothing. 3 ASHRAE : Ventilation for Acceptable Indoor Air Quality. This standard sets minimum ventilation rates and other requirements for commercial and institutional buildings. 3

40 C. Environmental Performance Objectives Because the parties have determined that it is not economically practical to comply with a third party certification system, such as LEED, then another approach needs to be developed. One approach would be to establish the parties own environmental performance objectives. To do so, the lease should provide for the parties' negotiated environmental performance objectives. One group has suggested the following environmental performance objectives language: (a) The parties agree it is in their mutual best interest that the Building and Premises be operated and maintained in a manner that is environmentally responsible, fiscally prudent, and provides a safe and productive work environment. (b) The Tenant shall conduct its operations in the Building and within the Premises to minimize (i) direct and indirect energy consumption and greenhouse gas emissions; (ii) water consumption; (iii) the amount of material entering the waste stream; (iv) negative impacts upon the indoor air quality of the Building and the Premises. (c) The Landlord shall operate and maintain the Building and the Premises to minimize: (i) direct and indirect energy consumption and greenhouse gas emissions; (ii) water consumption; (iii) the amount of material entering the waste stream; (iv) negative impacts upon the indoor air quality of the Building and the Premises. (d) The Landlord shall use its reasonable efforts to cause other tenants of the Building to conduct their operations in the Building and their premises in conformity with the Environmental Performance Objective. 4 Query the potential problems that the foregoing language creates by establishing goals rather than specific objective standards. In addition, establishing environmental performance goals will impact other provisions in the lease. The following are examples of provisions likely to be affected. 1. Use A use provision could be drafted to prohibit Tenant from using the premises in a manner that conflicts with the environmental performance objective. Another provision in the 4 B. Alan Whitson, RPA, President, Corporate Realty, Design & Management Institute and Chairman of the Model Green Lease Task Force, Model Green Lease Presentation at Greenbuild 2008 (November 2008). 4

41 use section could detail requirements relative to energy saving measures, such as lighting and Energy Star appliances. BOMA's Lease Guide provides an example of such tenant requirements: Tenant shall use proven energy and carbon reduction measures, including energy efficient bulbs in task lighting; use of lighting controls; daylighting measures to avoid overlighting interior spaces; closing shades on the south side of the building to avoid over heating the space; turning off lights and equipment at the end of the work day; and purchasing ENERGY STAR qualified equipment, including but not limited to lighting, office equipment, commercial and residential quality kitchen equipment, vending and ice machines; purchasing products certified by the U.S. EPA s Water Sense program. 5 Another use provision could detail requirements relative to recycling and waste management. BOMA's Lease Guide provides an example of such a provision: Tenant covenants and agrees, at its sole cost and expense: (a) to comply with all present and future laws, orders and regulations of the Federal, State, county, municipal or other governing authorities, departments, commissions, agencies and boards regarding the collection, sorting, separation, and recycling of garbage, trash, rubbish and other refuse (collectively, trash ); (b) to comply with Landlord s recycling policy as part of Landlord s sustainability practices where it may be more stringent than applicable law; (c) to sort and separate its trash and recycling into such categories as are provided by law or Landlord s sustainability practices; (d) that each separately sorted category of trash and recycling shall be placed in separate receptacles as directed by Landlord; (e) that Landlord reserves the right to refuse to collect or accept from Tenant any waste that is not separated and sorted as required by law, and to require Tenant to arrange for such collection at Tenant s sole cost and expense, utilizing a contractor satisfactory to Landlord; and (f) that Tenant shall pay all costs, expenses, fines, penalties or damages that may be imposed on Landlord or Tenant by reason of Tenant s failure to comply with the provisions of this Section Operating Expenses The lease could include a green fee (similar to a marketing fee), the proceeds of which would be used to pay for capital or other improvements that help achieve a sustainability goal, such as roof-top solar panels, recycling bins, water conserving fixtures in common area bathrooms, and motion sensing lighting, and bicycle storage. This issue is discussed in more detail in Hypothetical #2. 5 BOMA GUIDE, supra note 1, at BOMA GUIDE, supra note 1, at 19. 5

42 3. Maintenance and Repairs Maintenance and repairs could be tied not only to a good working order or first class retail space standard, but also tied to the environmental performance standard of the Lease. D. Enforcement The lease should provide for specific rights and remedies in the event one party violates the green objectives in the lease. A workshop conducted at an ICSC Law Conference recommended that the following rights and remedies be considered: General default and general remedies; Cure and self-help rights to take corrective action; Injunctive relief and specific performance; Damages (actual and consequential); Penalties and liquidated damages; and Termination rights. 7 Of course, the difficult issues to be addressed are how to determine which default remedies (which vary widely in terms of scope and effect) are appropriate for particular violations. E. Incentives State and federal legislation has been passed which provides tax incentives, rebates, and other financial assistance to promote further growth in the green building industry. The leading federal incentive is the Energy Efficient Commercial Building Tax Deduction (26 U.S. Code Sec. 179D) for energy efficiency in retail stores, shopping centers and other commercial buildings. Section 179D (recently extended through 2013 by Section 303 of the Energy Improvement and Extension Act) allows a commercial building owner to deduct part or all of the cost of certain energy efficient commercial building property. The amount of the deduction is typically equal to the cost of qualifying property placed in service during a taxable year, subject to a cap of $1.80 per square foot. This deduction is generally available to owners who install (1) interior lighting; (2) building envelope, or (3) heating, cooling, ventilation or hot water systems that reduce the building s total energy and power cost by fifty percent or more in comparison to a building meeting minimum requirements set by Standard of the American Society of Heating, Refrigerating, and Air Conditioning Engineers and the Illuminating Engineering Society of North America. To the extent Landlord will need Tenant's cooperation in achieving the benchmarks above, this issue should be noted in the lease. 7 BRIAN W. BLASSER & NEIL B. OBERFELD, GREEN LEASES FOR GREEN BUILDINGS: LANDLORD AND TENANT PERSPECTIVES ON KEY ELEMENTS OF THE GREEN LEASE (October 2009). 6

43 Hypothetical #2: Your client ("Landlord") is developing a new shopping center. A grocery store tenant ("Tenant") has agreed to anchor the shopping center, with the understanding that Tenant s building (the "Premises") will be LEED (Leadership in Energy and Environmental Design) certified. How should LEED certification be addressed in the Lease, and how will this certification impact the development of the Premises and the common areas? I. Threshold Issues A. LEED Basics Both Landlord and Tenant should first understand the basics of the LEED process as promulgated by the United States Green Building Council (USGBC). LEED is a performancebased measurement system designed for rating new and existing commercial, institutional and residential buildings. As of June 27, 2009, all construction projects seeking LEED certification must proceed under the new LEED 2009 system (also known as LEED Version 3). While the new system is substantially similar to the previous LEED rating system, there are several notable improvements and differences that Landlord and Tenant should understand in order to assure compliance with the new system and achievement of the desired level of certification. 1. Certification Levels Certifications are awarded based upon a project's ability to meet certain mandatory prerequisites and earn certain credits. If a project fails to meet even one prerequisite, it does not qualify for LEED certification. Points are then awarded based upon the project's achievement of credits. Each credit contains specific requirements, and points are then awarded to projects that meet these requirements. LEED 2009 retains the same four certification levels as the previous version (Certified, Silver, Gold and Platinum), but adjusts the scoring criteria to a new 100 point scale (110 points are actually available after bonus points are taken into consideration). One notable change under LEED 2009 is the availability of up to four "Regional Priority" bonus points for certain credits deemed to be of particular interest to a given geographic regions. 2. Rating Systems Landlord and Tenant should decide which LEED rating system(s) to use. LEED 2009 expands the previous LEED rating systems to include rating systems specifically tailored to the building's use. For example, the expanded rating systems include LEED for Schools, LEED for Healthcare, LEED for Retail, LEED for Retail Interiors, LEED for Existing Buildings. Some of these rating systems, including LEED for Retail and LEED for Retail Interiors remain in the pilot phase, and thus have not been officially launched. The official launch for the retail-specific rating systems is expected by the end of 2010, though draft forms are available at the USGBC website. Retail projects seeking certification prior to that time should use LEED for New Construction or LEED for Commercial Interiors. 7

44 In developing the retail-specific rating systems, the USGBC recognized the rigidity of the previous LEED rating systems, and tailored the standards to the specific needs of retailers. These new standards are designed to offer more options and increased flexibility for retail projects. While the LEED for Retail and LEED for Retail Interiors rating systems remain in draft form, it is apparent that they will award certifications based upon the project s ability to earn credits within the following environmental categories: Sustainable Sites, Water Efficiency, Energy and Atmosphere, Materials and Resources, Indoor Environmental Quality, Innovation in Design and Regional Priority. Because the present case involves the construction of a new shopping center by Landlord, LEED for New Construction or LEED for Retail (depending on the timeframe for construction and completion) would probably be the most logical rating systems to use for the Premises. 2. LEED Certification Process Overview. The process for LEED certification may be summarized as follows: a. Because Landlord will be constructing the Premises, it should assemble a project team, which will likely include engineers, architects and attorneys, at least one of which should be a LEED AP (LEED Accredited Professional). Landlord should also appoint a project team administrator who will be responsible for the managing of information compiled by the team. USGBC website. b. The project team should register its intent for certification on the c. After registration, the project team should gather information and performs calculations to satisfy the prerequisite and credit submittal requirements. d. The project team should choose the one phase or two phase certification application path. Under the one phase certification application path, the project team should submit all documentation for a project at the end of the construction phase of the project. Under the two phase path, the project team may instead submit some documentation at the end of the design phase of the project, and other documentation at the end of the construction phase. e. If the project team has chosen the one phase path, the USGBC will formally rule on the application after all construction phase documentation is submitted by designating each attempted credit as either "achieved" or "denied". Under the two phase path, after the USGBC receives all design phase information for the application, it will formally rule on the application by designating each attempted credit as either "anticipated" or "denied." Then, after receiving all construction phase information for the application, the USGBC will formally rule on the full application and designate each credit as either "achieved" or "denied". f. Appeals may be filed within twenty five days of either after the design phase review or the final review. 8