Collaboration between landlords and tenants is key to agreeing green lease clauses, but how well is that theory currently being mirrored in practice?
Green lease drafting is now a regular feature in commercial leases. The purpose is to ensure that landlords and tenants consider the environment and undertake specific responsibilities and obligations to minimise carbon emissions arising from the development, operation and occupation of property.
This has led to landlords looking to future-proof their position in the face of evolving legislative and other requirements. However, such drafting can place additional obligations on an occupier. There is no “one size fits all” solution, but it is clear that both communities need to adopt a collaborative approach to ensure a workable solution alongside the improvement of the environment.
What is driving this?
There has been a shift from green leases being a nice-to-have to being a must-have. The change in the Minimum Energy Efficiency Standard Regulations has focused minds not only on energy ratings, but on the topic of sustainability more generally. In addition, both communities have ESG policies and, in some instances, green financing is pushing parties to comply with additional environmental requirements. The conundrum is: whose responsibility (and cost) is it, and has this gone beyond a tick-box exercise?
It is acknowledged that the existing stock of property contributes significantly to the UK’s total greenhouse gas emissions. Against the backdrop of legislative targets of 78% reduction in greenhouse gases by 2035 and achieving net zero by 2050, there is a spotlight on what the communities can do to achieve these goals. Most government aims are not legislative, but rather guidance and proposals that result in complex negotiations amid trying to future-proof both communities’ portfolios to anticipate future changes.
Green leases need to reflect what is happening across business activities, and disclosure of information is, therefore, necessary. Landlords are showing an increased interest in reporting regimes to which occupiers are or will become subject. Emissions reporting is a key area going forward as this will underpin how businesses assess whether they have achieved net zero.
Challenges
The landlord community is trying to balance external pressures from legislative disclosure requirements, EPC minimum standards, internal pressures to achieve ESG objectives and cost reduction where possible. Landlords are keen to offer properties with excellent green credentials, improve their reputation and protect or increase the value of their asset and its rental value.
From an occupier’s perspective, there is balance to be struck by weighing up potential cost savings through, for example, better energy efficiency across building management, services and utilities against the cost of such improvement considering the length of the lease term at a particular property, but they also want to satisfy their own internal ESG objectives.
Benefit vs cost
In lease negotiations, the ideology of green clauses is not contentious. Both parties are cognisant that they need to reduce their impact on the environment and that investment in ESG agendas is becoming more prevalent. The challenge in lease negotiations is if the agendas do not align. We are seeing varying shades of green clauses in leases, which need careful consideration based on the parties involved, the strategic importance of the property and the term of the lease.
There can be significant cost implications to implementing such initiatives, and the core principles of traditional leases are being challenged to incorporate green drafting. For example, it would be usual for a landlord to bear the cost of refurbishment or improvement that goes beyond the usual repair, but where sustainable works are concerned, landlords are sometimes looking to recover the cost of this through service charge or obliging the occupier to undertake the works as it will have the benefit of them.
Common green clauses
• General co-operation and setting energy goals By its very nature, this part of the green provisions is very broad to allow for flexibility. It is often difficult for parties to identify what needs to be achieved or actioned by this.
• Preserving the current energy efficiency rating Landlords will often include drafting to preclude the occupier from doing anything which lowers the energy efficiency rating. This is important from a landlord’s perspective to ensure that properties do not deteriorate or become unlettable. This needs to be balanced against the occupier’s ability to repair, alter and yield up the property. Where the rating has been improved by the occupier, is it then fair for them to have to maintain that rating and ensure the property is handed back to the landlord at that higher rating, having incurred the cost?
• Improvements Sustainable improvements will generate benefits for an occupier, in time. The challenge is that occupiers are taking shorter, flexible leases, meaning they are often reluctant to incur expenditure when they are unlikely to realise any benefit. Without dialogue and compromise on both sides, the risk is that neither is satisfied with the outcome.
• Data sharing and consumption monitoring Data sharing is a major negotiation point, with some lease provisions defining exactly what data is required, the minimum frequency this should be shared and how it can be published. Owing to the increased depth and frequency of disclosure being recommended/required across both communities, it is necessary for parties to have access to such information to ensure there is not a gap in their reporting, but this comes at a cost. For example, an occupier with a significant portfolio dealing with multiple landlords can be inundated with requests, needing them to employ staff solely to handle them.
Concerns are also raised from a cybersecurity and GDPR perspective, and the potential reporting and PR impact. The data captured and shared is only as reliable as the technology capturing the data, which also raises the question of whether the technology can do this reliably and consistently.
• Management of waste (rubbish and recycling/water/electricity) Green leases often refer to a waste management policy, but this needs to be balanced against any waste policy that the occupier may have, and also raises the question of enforceability and governance. Occupiers may be nervous to sign up to prescriptive measures for fear of inadvertently being in breach if they dispose of their waste themselves. That said, in a managed property (shopping centre, large office, etc) the landlord is likely to have systems and procedures in place for the entire scheme and so may push occupiers to adhere to these.
There may be clauses obliging occupiers to keep the property lit during certain hours (commonplace long before considerations of the environmental impact). This does not sit well with the ideology of a green lease. Conversely, there may be requirements for occupiers to power down during certain periods of the day or night. To some occupiers, this may not be an issue, but to a manufacturing or logistics base that operates 24-hours a day, this would be impossible to comply with. Both communities must consider operational reality against their green objectives and the fact that these may not align, meaning that a degree of collaboration is required.
There is currently no market standard approach and, in practice, we are seeing provisions being drafted on a “reasonable endeavours” basis where there are to be “no material costs” incurred by either party. This makes it difficult to establish if there is a breach of any lease covenants or, if there is a breach, what action a landlord would, or could, take.
Final word
Is a lease the right document for green provisions? Both communities are sometimes rightly frustrated by delays in negotiations, and green issues add a further challenge. There are so many commercial factors involved and, in practice, it would be very difficult for either party to establish a breach.
The legislation is likely to change and potentially become more prescriptive, and what parties might agree in 2023 for a 10- or 15-year commitment may not be relevant or reflective of the market practice during the lifetime of the lease. Would a separate agreement be more appropriate, which could be referred to in the lease and updated as necessary?
We are eagerly watching this space to see how the landlord and tenant relationship evolves to incorporate green provisions, and we continue to work with clients across the communities to find solutions that reflect both commercial and practical reality.
Gemma Siviter is a senior associate in the real estate division at Shoosmiths LLP
