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Eversheds Sutherland Property Column: September 2021

  • United Kingdom
  • Corporate Real estate
  • ESG - ESG Corporate
  • Real estate
  • Real estate development and regeneration
  • Real estate sector

21-09-2021

Are you a tenant with a net zero carbon target?

Many corporate occupiers are looking to play their part in responding to the climate emergency. With the built environment making up such a large part of any organisation's carbon emissions, its property portfolio is a good place to start. With minimum energy efficiency standards set to rise, it would seem that the landlords of these corporate occupiers must have similar ambitions and aligned interests, but is that so?

Any corporate tenant must consider whether the alterations provisions of its lease allow the tenant to carry out the sort of works that will comprise energy efficiency improvements, and whether those alterations require the landlord's consent. It is rare, for example, for a lease granting an internal only demise of part of a building to allow the tenant to carry out structural alterations or alterations outside the demise. This may mean that the tenant cannot carry out alterations which are most likely to reduce its carbon emissions, such as the replacement of a gas boiler with a heat source pump, without the consent and co-operation of the landlord. The problem is intensified because, in most cases, that consent will be at the landlord's absolute discretion.

If the tenant cannot "go it alone" due to restrictive alterations provisions in the lease, it will have to engage with the landlord in order to obtain its permission or co-operation in the carrying out of energy efficiency improvements. A fortunate tenant may have a landlord who is aware of its present legal obligations in relation to minimum energy efficiency standards and the proposals for raising those standards (as set out in the Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015 (SI 2015/962) (MEES Regulations) and the consultation paper, Non-domestic Private Rented Sector minimum energy efficiency standards: EPC B implementation (17 March 2021), on how best to implement the proposed minimum EPC rating of B. Such a landlord will likely be equally engaged with the process of improving the energy efficiency of a property. However, it is not necessarily the case that alterations which will reduce carbon emissions will also raise the energy efficiency rating. In this scenario, it will be a matter of finely balancing the works that a tenant wishes to carry out against those works which landlord will have to carry out, so as to not be in breach of the MEES Regulations.

Regrettably, however, many smaller landlords (perhaps owning a single property as part of a self-invested pension scheme, for example) may not be aware of their existing obligations, or of potential future obligations. Where a tenant has been in occupation of a particular property for many years, any valid energy performance certificate may have long since expired and the landlord would not previously have had to consider the restrictions on letting under the MEES Regulations. As the consultation paper suggests making it compulsory for a landlord to have a valid EPC in place for all commercially let property, this position will likely change in 2025. This change, if it comes into effect, will have the benefit of bringing more landlords to the table.

Perhaps there are already relevant lease provisions that will facilitate discussion. Some leases contain provisions expressing the parties' wishes to improve the environmental performance of the premises. Such provisions focus on sharing data and collaborating to realise that objective. Currently, wording to this effect (found in leases or sometimes in an ancillary memorandum of understanding) is often expressed as aspirational and not contractually binding. Maybe it is time to rely on those statements of intent.

Conversely, it may be that a lease has been deliberately drafted to give the landlord the possibility of an exemption under the MEES Regulations. This drafting usually comprises a tenant's obligation to pay for such works if the tenant, in its absolute discretion, allows the landlord to access the premises to carry out the works. If the tenant does not want to pay, it can refuse access and the landlord can claim an exemption. As a result, such provisions are seen as beneficial to both parties; for the landlord because the obligations under the MEES Regulations are its responsibility in the first place, and for the tenant because such wording is often coupled with a prohibition against the landlord more generally re-charging the cost of energy efficiency improvements to the tenant (whether through the service charge or otherwise). However, this sort of "stand-still" wording is looking increasingly incongruous when viewed against the stated net zero carbon targets of both landlords and tenants. Would a tenant with a well-publicised net zero carbon target wish to be blamed by its landlord for the fact that premises stay sub-standard?

Once the type and extent of the necessary works have been agreed, there comes the question of who is to pay the associated costs and, if the programme of works includes alterations both inside and outside the tenant's demise, the question of when and how those works are to be carried out. Although a landlord is responsible for ensuring that commercial premises are not sub-standard when let, the obligation on landlords not to continue to let sub-standard premises does not begin under the MEES Regulations until April 2023. A landlord might look to delay works, while a tenant with a net zero carbon target to reach by a certain date across a whole portfolio of property, might want to begin earlier. That said, a landlord of many let and sub-standard premises might have its own improvement programme to implement and might require access to premises at times which do not suit a trading tenant. No retailer, whether online or bricks and mortar, wants the builders in during the Christmas rush, but a lease might already reserve a right of entry for the landlord that it could insist on exercising.

Looking away from logistics to legals, the lease provisions relating to rent review and reinstatement should be considered. A tenant who has paid for improvement works will want to be sure that those works are not rentalised on review and that there is no obligation to reinstate them at the end of the lease, which would be the very worst sustainability scenario. Hopefully a whole combination of factors (carbon emission reduction targets, the MEES Regulations, corporate social responsibility, and (if all else fails) perhaps the imposition of green lending covenants by a landlord's lender), will ensure a landlord's co-operation to support a tenant's ambition to reach its net zero carbon target.