2023 saw new rules come into force under the minimum energy efficiency standards regulations (MEES), which means it is now unlawful for landlords of commercial premises to continue to let property with an energy performance certificate (EPC) rating of ‘F’ or ‘G’.
It’s proposed that by 2027, commercial buildings will require an EPC rating of at least a ‘C’ have recently been called into question, therefore MEES is now embedded in the minds of real estate practitioners. With a significant proportion of commercial premises falling below the ‘C’ rating, landlord and tenant negotiations will increasingly involve discussions over the management of energy performance, regardless of changes in the government’s timeline.
Landlords and occupiers are reviewing their portfolios and policies to take into account their environment, social and governance (ESG) strategy and duties. This is starting to impact lease negotiations and tensions can occur in relation to ‘standard’ lease provisions such as alterations and alienation. Some landlords are trying to persuade tenants to share the burden of complying with MEES obligations, whereas tenants might take the view that compliance is solely a landlord obligation.
Landlords are introducing policies that impact on the type or categories of tenants they will let to and some are demanding a greener approach to tenants’ alterations and the way in which they operate generally, such as utility consumption.
In this article, we outline some of the more common headline issues we are seeing in lease negotiations, including for example in the health and social care sector.
Tenants are commonly obliged to obtain the landlord’s consent to assign or sublet, such consent not to be unreasonably withheld. It is likely we will see landlords wanting to take into account a proposed assignee’s or subtenant’s green credentials when considering applications for consent and green credentials being specified as a reasonable ground to refuse.
Leases frequently require landlord consent to carry out works. For internal works, generally consent cannot usually be unreasonably refused. However in the case of structural and external alterations the position is often different and these are sometimes not permitted.
Landlords will have their own ESG policies and will now likely scrutinise materials and working methods more closely and look at the sustainability of a project. This may lead to increased costs or time delays. Tenants are increasingly prevented from carrying out alterations which alter the EPC rating of a property.
We are starting to see an increase in the use of green lease clauses to oblige:
There seems to be a general acceptance that compliance needs to be a shared responsibility and it is better for the parties to work together to achieve overall ESG targets.
There are a number of organisations and industry bodies that have prepared green toolkits and clauses, including the NHS, which has its own ‘green lease framework’ to help organisations improve their green credentials, both as landlord and tenant.
In existing leases, the extent to which a landlord can recover MEES-related costs from a tenant through the service charge will depend on the definition of service charge items in the lease. In new leases, we are seeing parties scrutinise service charge items closely to establish where the cost for meeting MEES responsibilities lies.
The Royal Institution of Chartered Surveyors (RICS) service charges in commercial property, a professional statement on fair service charge provisions, states ‘subject to the terms of the lease and the principles set out in this professional statement, any subsequent costs of improving energy efficiency might comprise a legitimate service charge item, as long as there is a proportionate cost benefit to tenants’. This could be seen as a indication of the approach the market may take on the allocation of such costs.
The recent case of Clipper Logistics Plc v Scottish Equitable PLC highlights the difficulties a landlord can face when seeking to introduce green lease clauses on renewal. Any additional tenant’s obligations proposed in a lease renewal must be considered by the court to be ‘fair and reasonable’ in the circumstances of the case. This case suggests that the courts may not be willing to tolerate landlords’ attempts to offload their green liability where that would impose new and additional burdens on tenants.
There is a clear advantage to the parties working together to ensure MEES requirements are met, but that can be more difficult in existing leases that did not envisage such obligations. In some cases, parties may wish to vary existing leases to accommodate any changes the may be agreed. One issue is that in many cases landlords will not have the rights to enter a property and carry out energy improvement works. Equally, tenants will not have the capital or desire to incur expenditure upgrading properties.
The parties must consider the impact on the tenant’s business of carrying out significant works. We are increasingly seeing new clauses which oblige landlords to carry out energy improvement works, at its cost, subject to the tenant granting consent, although it should be noted that MEES does provide an exemption if the tenant refuses access. Sometimes it might make more sense for the tenant to carry out the works and manage the process in which case the landlord will often be required to pay for the works or make a contribution.
The ESG and energy efficiency landscape is constantly changing and landlords and tenants are adapting to evolving burdens. No doubt lease negotiations will continue to have an increased focus on these issues, with parties looking to find an even-handed way through the transaction.
For more information, please contact the energy and resource management team.
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