Sunday, April 21, 2024

BARRISTER MAGAZINE

Read the Barrister Magazine, a fantastic legal resource for online News, Articles & Information for Barristers in the UK. Keep abreast of Law Articles, Find a Barrister, Subscribe to our Articles on the Latest Legal News, Legal Services, Law Events, Expert Witnesses & Barrister Services. Its all here, ready to educate, inspire & Inform

ESG Leases: Brave new world or false dawn?

Featured ArticleESG Leases: Brave new world or false dawn?

Introduction

The UK Government has set a target for decarbonising all sectors of the UK economy to reach Net Zero by 2050. That includes real estate. The ambition to “green” the landlord and tenant relationship can be traced back to the early 2000s, when discussions about “green leases” began in earnest, attracting comment in various legal periodicals, though initially gaining a little less traction in the market. That has changed significantly. First, green clauses are now much more common. Secondly, drafting of “ethical’ leases has moved beyond environmental concerns to embrace more diffuse notions of promoting social and governance goals – those three areas being shortened to the acronym familiar to ethical investments, “ESG”. So, the ESG lease was born. This article will consider some of the legal challenges focusing mainly on the better developed environmental/green aspect.

The Form and Content of ESG Leases

There is no single form of ESG (or even “green”) lease. There are “toolkits” that suggest various clauses that might be considered, for example suggested by the Law Society or the Better Buildings Partnership, representing some of the biggest names in the real estate sector. These can be picked and chosen from. There are, however, themes that can be picked up from the published material on such leases.

Firstly, unlike traditional leasehold covenants, there is a spectrum of enforceability. Clauses can range from the “soft” (unenforceable; setting aspirations and common goals) through the to “hard” (enforceable; setting specific obligations). In green leases, one speaks instead of a colour spectrum from “light green” (soft) to “dark green” (hard), with all shades between (“medium green”). “Hard” terms might be such terms as obligations in relation to recycling or the use of sustainable materials by the tenant, or a commitment to the (existing) legal obligations in relation to anti-slavery and fair employment practices. “Soft” terms might be terms connected to more general concepts (a commitment to equality and diversity), or to goals the attainment of which might be difficult to predict (the phasing out fossil fuels from the supply chain). Clauses of the latter type naturally also avoid verbs like “shall” or “will”. Further, soft clauses may not be included in the lease at all (though they do appear as recitals or non-binding terms). A standard technique of drafting is to include them in a collateral (and presumably personal) memorandum of understanding.

Further, there are serious question marks around enforcement, even if the clause in question is dark green. The Law Society suggests that a breach of a green obligation should not lead to rights of forfeiture. It may also be difficult to enforce other terms – many green lease terms – such as the need to recycle – do not cause direct measurable loss to a landlord if breached, and may not be suitable for injunctive relief or specific performance. If the law of remedies cannot give dark green lease clauses teeth in many cases, what is their point?

The Most Immediately Important Green Terms

Green leases have been catapulted to prominence principally by the Minimum Energy Efficiency Standards (“MEES”), deriving from the Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015. The focus in this section is on Part 3, as applicable to commercial property. Part 3 is intended to ensure that commercial properties falling below a minimum energy efficiency banding (a) cannot be let and (b) as of 1st April 2023, cannot be continued to be let. A landlord who grants or is party to a lease is subject to substantial fines, unless they are able rely on a statutory exemption. The threshold banding is presently “E”, but that is likely to increase over time.

The challenge for the landlord’s draftsman is to ensure that the clauses provide protection for the landlord during the currency of the lease, which, if sufficiently long, might see further changes to the MEES regime. One can therefore expect to see an increase in clauses requiring tenants to protect the MEES rating contained in an Energy Performance Certificate (EPC), but also requiring the premises, by some mechanism, to be upgraded if that should be required by a change to (for instance) an increase in the lowest banding at which commercial property can be let. It seems likely that obligations to ensure MEES compliance will find their way into covenants governing alterations, improvements and repairs, where the choice of material may jeopardise them. It may also be that landlords will require wider rights of re-entry and (possibly) break clauses (with tenants receiving rent abatement clauses in turn), though the latter may be harder to reconcile with the existing grounds for termination business leases under the Landlord and Tenant Act 1954. The traditional lists of recoverable service charge items will also need to be reconsidered. There are also difficult questions as to what the effect on a rent review is if, on the review date, premises had ceased to be compliant. How, in those circumstances, is one to value the subject premises assuming compliance with lease terms and the usual assumptions and disregards, if the premises cannot be let under MEES? What, also, of the effect of non-compliance with MEES shortly before the end of the term of the lease? Will, in such a case, a landlord who is (as many are) presently unprotected from the costs of complying with MEES be faced not just with a significant bill for compliance, but also lost out on damages for disrepair (and associated loss of rent claims) on the basis that the premises need a total overhaul, thereby producing a “nil” figure for the diminution in the value of the reversion under section 18 of the Landlord and Tenant Act 1927 (and arguably on the common law measure of damages too?).

Nor can a landlord with an existing lease hope to solve the problem on renewal under the 1954 Act. The presumption under section 35 (non-financial terms of the new tenancy) is that the renewal tenancy’s terms will track the terms of the tenancy that preceded it, unless the party seeking to depart from them can give good reasons why this is so:  O’May v City of London Real Property Company [1983] 2 A.C. 726. The fact that the change makes sense from the landlord’s commercial perspective is not a good enough reason on its own. As, in cases where there is no agreement, it is more likely than not landlords who will be seeking the change to protect themselves against the effects of MEES non-compliance, one can expect that they face an uphill struggle when the change will visit cost on the tenant for the first time:  Clipper Logistics Plc v Scottish Equitable Plc (Sheffield County Court, Unreported, 7th March 2022), allowing only a term to the effect that the tenant should return the premises with the same EPC rating as it enjoyed on the  date of the renewal lease. Perhaps a small light on the horizon is the proposal by the Law Commission to review the 1954 Act, with a view to bringing it, amongst other things, into line with the Government priority to render commercial property more sustainable. That is most likely to mean that the policy of section 35 – based on the notion that the existing lease represented the free bargain of the parties which the Court should not interfere with on renewal – may give way to a more flexible approach in which freedom of contract gives way to broader social objectives. Whether that will help a landlord who is saddled with an unexpected MEES burden is however another matter.

Conclusions

As can be seen from the above, green leases, and the legislation that is intended to green our commercial landlord and tenant relationships, give rise to a whole host of problems. There are headaches for landlords with subsisting leases

Check out our other content

Most Popular Articles

Translate »