Green Leases in the UK Letting Market Malcolm J Dowden Solicitor and Property Law Consultant Malcolm.dowden@lexisnexis.co.uk ABSTRACT: A Green Lease has additional schedules providing a legal basis for monitoring and improving energy and minimising the environmental impacts of a building or portfolio of buildings. Green Lease Schedules were developed by the Australian Department of the Environmental and Water Resources and the Australian Government Solicitor for Australian government agencies. They entered into force in September 2006 and have since expanded to the private sector as a voluntary initiative. In the UK, bodies such as the London Climate Change Partnership have recently been promoting the introduction and use of Green Leases as a means of driving climate change adaptation, as well as mitigation. Already, 2008 has seen the launch of a number of Green Funds, with the improvement of energy performance and enhanced climate change resilience being presented as key elements in investment performance and growth. A number of high profile UK landlords have called on tenants to sign up to Green Leases. Drawing on the work of the London Climate Change Partnership, this paper considers: What are the barriers and drivers to making green leases a reality in the UK? What would make green leases: o Effective; and o Attractive to the UK commercial property market. The introduction of green leasing Leading UK landlords have recently attracted considerable (and not always favourable) press coverage as they have added green lease schedules to their letting documents. Hermes has added clauses, covering energy efficiency and co-operation with the landlord s environmental policies to the standard lease for all new tenants in its portfolio, covering both new builds and existing schemes. In June 2008 Land Securities announced the use of a Green Lease schedule for its new Elements shopping centre in Livingstone, while British Land is calling on tenants at 201 Bishopsgate and Broadgate Tower in London to sign up to a memorandum of understanding covering similar issues.
Green Leases in the UK Letting Market 2 As well as high and rising energy costs, landlords cite legislative and market drivers to support the introduction of green lease schedules. They include: The Energy Performance of Buildings Directive ( EPBD ) implemented in the UK in stages since 2006. It has led to amendment of the UK Building Regulations, with mandatory airtightness testing and energy performance targets for new, extended or refurbished buildings. Transparency in energy performance is to be achieved by compulsory energy efficiency rating when the building is constructed, sold, let or refurbished. Reports from Government and the Royal Institution of Chartered Surveyors suggest that Green Buildings will be of greater value 1. Assertions that better performing buildings may provide better value for the tenant in terms of the rent, whilst offering more flexible leases. The possible introduction of compulsory carbon trading for larger occupiers and property owners who use more than 250,000 energy per annum. 2 While it is easy enough to see why major landlords find these factors compelling, it far more difficult to see what is in it for the tenants of anything other than a new development, designed and constructed in accordance with best environmental practice. For existing buildings, and even for new builds that do not measure up to best practice, the introduction of a Green Lease might be viewed simply as an invitation to share the pain and cost of improving the performance and rating of the landlord s capital asset. Unless linked with incentives that promise sufficiently direct and short-term cost benefit to tenants that invitation would be easy to decline. What is a green lease? A green lease consists of a standard lease with a number of additional clauses providing: Obligations between the landlord and the tenant governing the tenant's use of, and the landlord's improvements to, a building. Rent review incorporating energy efficiency measures. 1 www.rics.org/greenvalue 2 http://www.greenleases-uk.co.uk/senvics.php
Green Leases in the UK Letting Market 3 Requirements on assignment or underletting for the assignee or sub-tenant to covenant with the landlord to comply with the landlord's environmental policy. Requirements for tenant's initial fit out and any subsequent works to meet certain standards of energy efficiency (for example insulation and ventilation). The inclusion of an adjustment system for service charge contributions, which may penalise tenants who have not met specified energy efficiency targets. Requirements for the landlord to keep in good and efficient working order all plant such as air conditioning systems and boilers that are subject to the EPB Regulations and which contribute to the energy use of a building. Looking beyond direct energy use, some Green leases also include matters such as building management, waste disposal, transport, catering and caretaking services that may have a green element. Energy performance the evidence so far A press release issued by the UK government s department for Communities and Local Government on 1 July 2008 3 reported that commercial buildings are scoring an average 'C' energy rating, according to early results from the introduction of Energy Performance Certificates (EPCs) to the commercial sector. Since the introduction of EPCs in 2007 nearly 800,000 buildings have had an energy assessment - including more than 500 large commercial buildings. The top five recommendations given by assessors for improving energy efficiency have been: Introducing more energy efficient lighting Introducing solar control measures - reflective coating, shading devices to windows - to reduce cooling demand Introducing electronic control gear to improve efficiency of fluorescent lighting Installing solar water heating 3 http://www.communities.gov.uk/news/corporate/868858
Green Leases in the UK Letting Market 4 Undertaking a review of boiler plant to look for energy efficiency improvements These are potentially big ticket items. In the case of a normal lease any attempt by a landlord to pass these costs on to tenants (for example, through service charge) would meet significant resistance, based on the principle that tenants are required to contribute towards maintenance and repair, but not to improvements. Tenants would also be likely to resist any direct attempt by landlords to require them to carry out such works (for example, where the lease is of a whole building). Energy assessors make recommendations. They do not have power to impose obligations. Consequently, lease provisions requiring tenants to comply with statutory requirements will not be engaged by the energy assessor s report. A contract to occupy? Lease terms have reduced dramatically since the early 1990s. The headline findings of the British Property Federation/Investment Property Databank Annual Lease Review 4 for 2007 were: The average length of all lettings fell from 6.2 years in 2005 to 5.7 years in 2006/07, measured on an equally weighted basis and including the first break where applicable. If licences and short leases of 4 years or less are excluded, then the average length of new leases (again including break clauses) fell from 8.8 years to 8.2 years. Retail units have the longest lease lengths with and without breaks, followed by offices, while industrials have the shortest lease lengths of the three sectors probably because of short term licences that are sometimes granted on these properties. Shorter leases have become more and more frequent. 67% of all leases granted in 2006/07 were for 5 years or less. Against this background, tenants can credibly argue that a commercial lease is merely a contract to occupy space. The capital value, and with it interest in and responsibility for the long term energy performance of the building remains with the landlord. This is particularly the case where an EPC reports on the asset rating of the building, rather than Display Energy Certificate ( DEC ) which also reports on the operational rating of public sector buildings. 4 http://www.bpf.org.uk/pdf/20970/bpf_ipd_annual_lease_review_2007[1].pdf
Green Leases in the UK Letting Market 5 Unless the location or some other attribute of the property is sufficiently compelling, tenants may be reluctant to sign up to an agreement if the costs associated with it are greater than occupying a conventional commercial building with a standard commercial lease. Location and footfall will be extremely significant for retail, A3 or A5 premises, but much less so for offices and other types of commercial building. Recent judicial authority must also be taken into account. As leases have become shorter, the court has been reluctant to oblige tenants to meet the cost of significant capital works unless compelled by extremely clear wording 5. The wording that would be required to overcome judicial reluctance would have to be clear enough to flag up the key points (i) that the tenants can be called upon to fund or contribute towards the cost of improvements and not just repairs, and (ii) that the landlord can pursue its environmental agenda without having to settle for the cheapest option. Any such wording would be subject to close scrutiny and, in case of ambiguity, would be construed against the landlord. The distinction between expenditure that can properly be recovered through service charge and the irrecoverable cost of improvements will remain a live issue. A realistic balance incentives and penalties For Green Leases to work, they must set measurable targets and benchmarks for environmental performance to enable the landlord and tenant to measure their own and each other's performance. Those targets and benchmarks should be linked with incentives and penalties that take into account the tenant s strictly limited interest in the property. It is important that the parties assess and agree to a penalty that provides sufficient incentive for them to comply with the lease terms and achieve environmental targets and performance criteria prescribed by the lease. The landlord must play its part, and must accept the risk of penalties as well as seeking the benefit of enhanced tenant obligations. Failure by the landlord to meet a target (for example, maintaining or improving the existing energy rating) could trigger reduction of the tenant s rent by the amount of any increased outgoings and costs arising from that failure. Similarly, a landlord and tenant may jointly commit to targets for energy and water consumption, waste disposal and recycling. A tenant signing up to any such obligation must ensure that success or failure depends upon its own efforts and actions. One tenant cannot be expected to police another. Commercial lease terms to achieve these objectives could include any or all of the following: 5 Scottish Mutual Assurance PLC v Jardine Public Relations Ltd [1999] EGCS 43, [1999] All ER (D) 305; Fluor Daniel Properties Limited v Shortlands Investments Ltd [2001] 2 EGLR 103
Green Leases in the UK Letting Market 6 an obligation on the landlord to separately meter the energy and water consumption of each tenant a mechanism for the appointment of a qualified and independent consultant to monitor energy and water consumption and reuse, assess compliance with the targets and benchmarks prescribed by the lease and assess the compliance/contribution of each tenant setting targets to reduce waste production and disposal and increase waste recycling Another variation might involve tying the landlord s fixed annual rent review to achievement of a defined rating. In the event that the landlord fails to maintain the rating, then there will be no rent review for that period. A more stringent variant is the right to terminate the lease if the building fails to meet the requisite rating for an agreed period of time (perhaps 90 days). More conventional landlord remedies such as step-in (under a Jervis v Harris clause) or forfeiture would be available to the landlord in the event of a breach by the tenant. Fit-out In conventional commercial leases, fit-out is usually the responsibility of the tenant, but subject to approval by the landlord. A Green Lease may impose a more prescriptive regime on the tenant detailing the nature or type of materials that must be used, or requiring tenants to comply with a fit-out policy annexed to the lease. For example, a landlord may wish to ensure that the tenant uses recycled or recyclable materials in the fit-out where practicable, or that the fit-out is designed so that a prescribed percentage of occupants of the leased premises are exposed to natural sunlight and ventilation. A prospective tenant will need to undertake a cost-benefit analysis and decide whether such obligations are unacceptably onerous. If a landlord imposes such obligations, then it ought to help with that cost-benefit analysis, for example by indicating where the cost of recycled materials will in fact be lower than new materials, and providing evidence of the feasibility of achieving improvements in performance (for example, enhanced insulation or reduced solar gain) by using the prescribed materials or design. Crucially, the landlord should be able to show that the tenant has a reasonable prospect of recovering up-front costs over the term of the lease through improved performance and lower running costs. In practice, a fit-out requirement that imposes additional cost burdens for a tenant is only likely to be commercially palatable for longer term leases, typically those in the retail, A3, A5 or hotel sectors. A landlord should be in a position to demonstrate to a prospective tenant that the building can, under normal operating circumstances, achieve the proposed environmental targets provided the tenant conducts its operations as directed.
Green Leases in the UK Letting Market 7 Depending upon the circumstances, the landlord may need to rely on warranties from its architect and/or developer when it markets its building to prospective tenants as a green building. If a tenant requires warranties from the landlord regarding the design specifications and performance of a new or retrofitted green building, then the landlord should procure back-to-back warranties from the developer in its development agreement. A tenant would undoubtedly wish to satisfy itself that if it complies with its management and fit-out obligations under the lease, then the building will achieve the desired environmental performance. Retrofitting existing buildings For new buildings negotiating and implementing Green Lease arrangements may be relatively straightforward so long as the building is capable of achieving the environmental performance required by the landlord. However, where a building has not been designed to achieve environmental performance targets and benchmarks the situation is more difficult. If a landlord or tenant is proposing to retrofit an existing building, or to introduce improved environmental practices to minimise energy and water consumption and maximise waste recycling and reuse, then the parties should first consider the terms of their existing lease to see if it can accommodate any or all of the green measures the landlord is seeking to achieve. For example, an existing commercial lease may contain clauses that: require the tenant to use the services of contractors engaged by the landlord. Through this clause, a landlord may be able to use recycling contractors and limit the availability of general waste contractors that collect and dispose of waste to landfill restrict alterations or additions without landlord s consent, potentially allowing the landlord to veto any refurbishment proposal that do not use recycled materials, or materials that could endure for the life of the building. However, a substantial retrofit of a building that involves substantial construction works and imposing additional obligations on a tenant may well require a variation to a lease, or substitution of a new lease. What would be addressed in a Deed of Variation of Lease? A deed of variation might empower the landlord to enter and remain upon the leased premises for the purpose of undertaking physical alterations to the building to increase solar access or ventilation, install wastewater storage and recycling facilities, plants and associated infrastructure or systems.
Green Leases in the UK Letting Market 8 Likewise, a deed of variation could require a tenant to accept new responsibilities in its use of the premises, such as implementing energy and water efficiency practices, waste collection and recycling, complying fitout obligations. Tenants who are called upon to agree to a variation must ensure that it will not trigger a surrender and regrant. If the variation involves any addition to the premises or extension of the term, then a surrender and regrant will be triggered whatever the parties stated intention. 6 In most 7 other circumstances it will be open to the parties to state that the original lease is to continue in full force and effect, save as varied. If a variation does trigger a surrender and regrant then the tenant may face Stamp Duty Land Tax liability and additional land registration formalities and costs. Who is responsible for what? The importance of dispute resolution A Green Lease, or a deed of variation to an existing lease, should not only specifically define the responsibilities of the landlord and tenant, but should include a dispute resolution mechanism in the event of a disagreement between the parties as to why a particular target or objective prescribed by the lease is not achieved. The Green Lease Schedules developed in Australia by the Commonwealth Government for lease transactions involving its agencies and departments attempt to avoid disputes by requiring the parties to work together earlier through joint remedial plans. This form of green lease aims to achieve outcomes which are shared by landlord and tenant. The manner and form of the dispute resolution mechanism is generally negotiated on a case-by-case basis 8. If however the lease includes a requirement for an annual independent audit then the lease could include a requirement for the auditor to advise not only on the performance of the building, but also to include: an explanation as to why the building is not achieving a prescribed target, and advice on who, in the auditor's opinion, is responsible for that nonperformance. 6 Friends Provident Life Office v British Railways Board [1996] 1 All ER 336 7 Although not covered in Friends Provident, it is likely that inserting a landlord s break option into a business lease and contracting out from 1954 Act protection so that the break will be effective to end the tenancy would also effect a surrender and regrant of the original protected lease. 8 If the dispute relates to construction works, the statutory regime prescribed by Housing Grants, Construction and Regeneration Act 1996, ss104-117 might apply.
Green Leases in the UK Letting Market 9 Conclusion Green leases represent a real attempt by UK landlords to devise lease structures that reflect the pressing need to improve energy performance and climate change resilience. However, untried and unusual lease provisions are likely to meet resistance particularly in a weak letting market - if they are perceived by tenants merely as an attempt to lay off the costs of improvement to short term occupiers.