The Minimum Energy Efficiency Standard will impact commercial leases at every stage of their existence – and afterwards too, warn Guy Fetherstonhaugh KC, Stephanie Tozer KC and Michael Ranson.
The trouble with something being trailed as a life-changing event is that when it does finally arrive on our doorsteps, we are already complacent about it. Bad mistake, though, because the advent of the Minimum Energy Efficiency Standard is something that will be of fundamental importance to those of us who are involved with commercial leases.
Consider this: MEES is not something to be ticked off for compliance at just one stage of the life of a lease. It impacts the creation of a lease, governs rent reviews and alterations during the lifetime of the lease, affects the terms of any lease renewal, and will have a profound effect on the extent of any remedial works once the lease has come to an end. And these changes are not imminent: they have already arrived.
MEES in summary
MEES is set out in the Energy Performance of Buildings (England and Wales) Regulations 2012 and the Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015, which were introduced pursuant to the Energy Act 2011. Although MEES also applies to residential property, we focus in this article on commercial property.
Subject to various exemptions (see below), from 1 April 2023 MEES prohibits both new and existing lettings of commercial property that has an EPC rating of F or G (“sub-standard property” in MEES parlance). The government originally proposed in a consultation paper in 2019 to raise the minimum EPC rating to C by 2027, and to B by 2030, although there have been suggestions in recent months that it may be seeking to resile from this. This uncertainty (highlighted by the British Property Federation, among others) will be unhelpful when it comes to the medium-term impact of the points discussed below.
The exemptions from MEES are important. First, MEES does not apply to short (less than six months) or long (more than 99 years) leases. Second, it does not apply to certain types of building (some listed buildings; those with no air conditioning or heating; various agricultural, religious or temporary buildings). Third, it does not apply where the landlord has unsuccessfully made “reasonable efforts” to obtain tenant consent to carry out the necessary compliance works. Fourth, it does not apply where the relevant works would devalue the property by more than 5%. And last, MEES does not apply where all relevant works have been carried out, the property remains sub-standard and the further works required would not pay for themselves in seven years. To qualify for these exemptions, the landlord will need to furnish evidence rather than rely on assertions. While it may at first sight seem straightforward to qualify for an exemption, landlords will need guiding through the statutory requirements.
It is important to note that MEES does not require either landlord or tenant to carry out works: it instead makes it unlawful for the landlord to let or continue to let its property where it does not achieve the requisite EPC rating. So, a landlord may lawfully leave its sub-standard property vacant, occupy it itself or license rather than let it, which may lead to a resurgence of the old lease/licence debates.
The impact of these rules on commercial real estate is worth emphasising. According to an EG investigation last year, some 120m sq ft of commercial real estate in England will have failing EPCs in 2023 if necessary work has not been undertaken – rising to 257.2m sq ft in 2027, and 413.2m sq ft in 2030. A Carter Jonas report echoed those findings, estimating that nearly a fifth of the UK’s office space is already effectively unlettable, while nine out of 10 offices in Glasgow, Edinburgh, Birmingham and Bristol would be unlettable by 2030.
So, what exactly is the impact of MEES on the lifetime of a standard commercial lease?
MEES and lease creation
If a sub-standard property is let, the lease will still take effect as a legal estate, and the tenant will still be obliged to comply with the lease covenants. However, the consequences for the landlord will be grave, since it will have committed a breach of statutory duty, and may face substantial financial penalties and reputational damage. The landlord remains at risk of enforcement and financial penalties for so long as the tenancy remains in force and the property remains sub-standard – and for 18 months afterwards.
Whether the creation of the lease is itself a breach, MEES should be considered when drafting the lease, as we explain below.
MEES and works during the term
A penalty notice can specify action which the landlord must take to remedy the breach and a time frame within which it must be done. If the landlord does not comply with a penalty notice, a further penalty notice and financial penalty may be imposed.
The landlord will be unable to force its tenant to carry out the requisite remedial works without specific drafting in the lease, and it will be unable itself to enter the property to carry out the works unless, again, the lease makes provision for that. Given the shifting threshold for “sub-standard property” over the lifetime of the lease, some provision for this should be included in new leases.
What if the lease terms do not allow for the works to be done? The enforcement authority can, before serving a penalty notice, serve a “compliance notice”, which requires the provision of information, including a copy of the tenancy. It is to be hoped that enforcement agencies will use this power, rather than imposing requirements in penalty notices that the landlord cannot in practice comply with.
The covenants against alterations also need to be considered. While many leases provide that alterations may only be carried out with landlord’s consent (not to be unreasonably withheld), often non-structural alterations are permitted without the need for the tenant to seek consent. Landlords will have to be vigilant to ensure that their tenants cannot inadvertently reduce the EPC rating as a result of their alterations, particularly when carrying out air conditioning works. The inclusion within the lease of an appropriate term to this effect should be considered.
MEES and rent review
A standard rent review clause in a lease will posit a hypothetical letting of the property, subject to certain assumptions. This will ordinarily require the property to be valued for letting as it stands, but assuming that the tenant has complied with its repairing obligations, and disregarding tenant’s improvements. Suppose, however, that at the review date the property is “sub-standard” (against whatever criteria are then in force): what is the consequence, given that the hypothetical letting must proceed?
One possible outcome is that it must simply be assumed that the letting will proceed, however unlawfully, given that this will mirror the reality. But what if the EPC rating only results from the disregard of the tenant’s improvements? Is it then to be assumed that the works necessary to increase the EPC rating have been carried out; and if so, when (ie before or after the hypothetical letting), by whom and at whose expense?
These philosophical problems worsen when it comes to the MEES exemptions considered above. The actual landlord in the real world may have qualified for an exemption – say on the basis that the actual tenant has refused to grant consent for the necessary compliance works. But can the same be said of the hypothetical parties?
True to form, the wonderful world of rent review bristles with difficulties like these. Unhappily, the resolution of such difficulties will be achieved behind closed doors at arbitration, depriving the rest of us of the opportunity to learn how the law is developing in this new area. We shall have to see whether the Law Commission accedes to our chambers’ response to its recent consultation on the Arbitration Act 1996, suggesting that domestic property awards be published as the default position – as notably were awards under the Commercial Rent (Coronavirus) Act 2022.
MEES and lease renewal
As noted above, properly advised landlords seeking to let their properties will wish to introduce protective provisions which will not merely prevent their tenants delivering their property up in a non-compliant condition, but which will also require their tenants to carry out such works as are necessary to comply with any further MEES uprating.
But at lease renewal, the introduction of such protective provisions into leases that do not already contain such drafting may at first sight be said to be unlikely to succeed. That is because, in determining the terms of the new tenancy, the court is required by section 34 of the Landlord and Tenant Act 1954 to have regard to the terms of the current tenancy and to all relevant circumstances. This is commonly interpreted to mean the replication of the terms of the old tenancy, subject only to minor amendments to reflect modern drafting practice (according to the seminal decision of the House of Lords in O’May v City of London Real Property Ltd [1982] 261 EG 1185).
A recent working example of this approach in the context of MEES is provided by the decision of a recorder sitting in the Sheffield County Court in Clipper Logistics plc v Scottish Equitable plc (Claim No G00SE930, 7 March 2022). In that case, the landlord sought to render the tenant liable to comply with MEES through a proposed raft of new terms on the renewal of a lease granted in 2010 (and thus pre-MEES). The judge rejected most of the terms. He was, however, persuaded to include a clause which obliged the tenant to return the premises to the landlord with the same EPC rating as it had at the date of the new lease, as evidenced by a current EPC. The judge considered that the inclusion of that new term could be justified on grounds of essential fairness, and that it was a fair and reasonable change. Without that clause, the landlord would lack any meaningful protection against omissions or inaction by the tenant which could, during the course of a potential 10-year lease duration, reduce the EPC rating, such that the property became sub-standard, and, in consequence, bring about significant adverse consequences for the landlord. It is difficult to quarrel with that reasoning.
The landlord was not given any protection against the risk that the property would become sub-standard as a result of the changing threshold. Any attempt to introduce new clauses requiring the tenant to deliver up the premises in a way that complies with MEES is likely to be met with some resistance in court. The tenant will say that the new clauses impermissibly shift the burden of MEES compliance (which the rules impose on landlords and not tenants). As against that, we can see an argument that MEES introduces an entirely new burden that was not part of the parties’ original bargain when they negotiated their lease, that MEES is one of the “relevant circumstances” in section 34 to which the court should have regard, and that a fairer approach is for the parties to share the burden. It will be interesting to see how this plays out in court.
And lastly, what of the renewal of a lease of property that is sub-standard? It is worth noting the curiosity that the court order requiring the grant of the new lease will be mandating something that is unlawful. This is almost certainly a topic for the Law Commission to consider for reform as part of its forthcoming consultation on the 1954 Act.
MEES and terminal dilapidations claims
Landlords may well consider that they will be able to rely on the standard drafting that most leases employ requiring tenants to carry out works required by statute. But this will not work, because MEES does not require works to be done; it merely renders lettings of sub-standard property unlawful. So, landlords will not be able to pass on the burden of MEES compliance to their tenants, unless the lease contains a wider clause, such as a clause to comply with notices relating to the property, and an enforcement notice has been served.
Without such drafting, this is where life may get seriously complicated. Recall the facts of Riverside Property Investments Ltd v Blackhawk Automotive [2005] 1 EGLR 114, where the tenant succeeded in arguing that it should not be liable for the cost of a new warehouse roof, because the patch repair the tenant had carried out was good enough. Well, the tenant may now have another string to its bow: that any works of repair would be rendered nugatory by the rather greater works that its landlord would have to carry out in order to be able to relet the warehouse in a MEES-compliant state.
So, welcome to the brave new world of MEES. It is difficult to think of another statutory intervention in commercial property in the past 40 years which will have had such a widespread and substantial effect.
Guy Fetherstonhaugh KC, Stephanie Tozer KC and Michael Ranson are barristers at Falcon Chambers
