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Carbon trading

The next commercial imperative in lease drafting?

Peter Reekie

Environmental issues have made their presence felt over the years, but to suggest that these should play a significant part in everyday lease drafting, let alone find their way into office precedents still seems a bit far fetched. However, with the advent of carbon trading – about to impact the bottom line for many of the bigger land owners - it looks as if practitioners will not be able to ignore the environmental agenda in lease drafting.

Buildings are thought to account for approximately 40% of energy consumption and 50% of carbon dioxide emissions. The division is roughly equally split between residential and commercial buildings. One of the principal ways in which the Government proposes to tackle climate change and to meet their emission reduction targets under e.g. the Kyoto Protocol is through improving the energy efficiency in buildings. For more background on the scope of the Government’s intentions generally see the UK Low Carbon Transition Plan published in July 2009 which sets out how the UK will meet an intended cut in emissions of 34% on 1990 levels by 2020. This is available from:

Although carbon trading is a significant driver for lease change, there are other energy related developments in the offing which should be borne in mind. This article considers some of the legislative background and then looks at some example clauses for leases.

Energy performance certificates - the new proposed directive

On 13 November 2008, the European Commission published a draft Directive which, if adopted, will replace the current legislation. Proposed changes include the following:
  • As different member states currently set energy performance requirements differently, minimum energy performance requirements of buildings are intended to align eventually with what are called “cost-optimal levels”. The intention is that a universal comparative methodology will be developed and Member States will have to use it for comparison purposes and to report results after 2017. The "cost-optimal level" is a balance between investment and energy cost savings during the life-cycle of a building. Criteria will include investment costs, maintenance and operating costs (including energy costs).

  • The development of plans for increasing the number of buildings that are carbon neutral.

  • Minimum energy performance requirements will apply to the installation of technical building systems, such as heating and lighting. This means that the feasibility of alternative heating and energy supply systems will have to be taken into account before construction begins.
  • In addition to buildings being constructed, sold or let, EPCs will also be required by 31 December 2010 for all buildings where a public authority occupies over 250 square metres of the total useful area.
  • The draft Directive provides that where a building has a total useful floor area of over 250 square metres that is "frequently visited by the public" any EPC that has been issued must be displayed. This will affect some private sector premises, e.g. shops. Government is now consulting on this proposal. The consultation paper is available from:

Building MOT’s

UK Green Building Council have put forward proposals for a single code governing all non-domestic buildings and regular “building MOTs” with minimum standards being gradually increased over time. This would deal with CO2 emissions, energy efficiency, waste and water performance. The Government is reportedly intending to consult on this proposal.

See further:

Carbon trading

The Carbon Reduction Commitment Energy Efficiency Scheme (CRC)

The CRC is an emissions trading scheme to be set up under Part 3 of the Climate Change Act 2008. In its currently proposed format it is likely to affect up to 5,000 large organisations. Essentially it looks likely to cover all organisations whose electricity consumption is greater than about £500,000 pa. The Government estimate that about 20,000 organisations will be affected in that they will be required to provide information about energy use. All business with UK billing addresses with half-hourly meters will be sent registration packs during 2009. Information must be provided based on electricity consumption in 2008.

See further:

In outline, once eligibility is established, organisations are required to calculate emissions and determine their CO2 output. All energy use by the organisation will be covered, such as electricity, gas, fuel and oil (but not transport use).

The first phase is due to start in April 2010, which looks like being a monitoring year. The first sale of allowances will be in April 2011 for the year ahead at a fixed price. From April 2013, allowances will be allocated through auctions with a diminishing number of allowances available over time. The scheme is intended to be revenue neutral for the government so that the revenues generated through the sale of allowances will be given back plus or minus a bonus or penalty dependent on their position in a league table of carbon use performance.

Consultation on the proposals including a draft Carbon Reduction Commitment Order 2010 has been undertaken and the results were published at the beginning of October 2009. The final order is expected to come into force next April. A copy of the documentation including the results of the consultation and a copy of the draft order can be obtained from:

A guide is also available from the British Property Federation, which includes a detailed analysis of landlord and tenant issues. A copy can be obtained from:

Some government guidance documentation is available and more is promised by the end of October. This available from:

Landlord and tenant concerns

Where the landlord is to be a participant in the CRC scheme, in most cases where there is a lease of the whole of the building the tenant is likely to be buying energy direct and there will be no issues for the landlord under the CRC scheme. If the landlord is (unusually) buying the energy in this case and re-selling it to the tenant then the landlord will have the same concerns as in the case of a multi-let building. If the lease is of part of a multi-let building and if the landlord pays the energy bill for the building the landlord’s new costs in respect of the building will include:
  • The increased administrative costs of the CRC scheme, some of which could be regarded as attributable to the building; and
  • The cost of the proportion of the CRC allowance in so far as this could be attributable to the building.
Landlords may therefore wish to consider influencing the tenant’s energy consumption in some manner. In particular landlords may want to:
  • Obtain information on the tenant’s energy consumption and possibly even impose an obligation not to exceed a particular figure, with appropriate penalties;
  • Obtain a contribution from tenants to the administrative costs of the CRC; and
  • Obtain a contribution towards the cost of buying the CRC allowance attributable to the building.
The proposed legislation will now include an obligation on tenants to cooperate with landlords for the purposes of complying with the CRC.

The BPF Guide sets out in some detail the considerable range of issues that will have to be considered when determining how the costs are actually to be dealt with between the parties. It is clear this task should not be underestimated, particularly in dealing with penalties or bonuses because of the position of the landlord in the league table. Quite how it will all work is the subject of some debate at present.

Indeed some landlords may wish to avoid buying energy direct for a building and re-selling this to their tenants in future. Therefore, it seems likely that some landlords will wish to ensure that tenants buy direct for their own energy needs as much as possible. Although it may be that the nature of the building or the wiring may not permit direct metering or this may be very expensive. It may not be feasible therefore to arrange for sale by the electricity supplier direct to tenants in a multi-let building.

Where the tenant is a participant in the scheme and it is buying the energy direct then it will wish to have some degree of input into, or control over, the energy consumption of the building. In a lease of whole this may relate to the extent to which works may be done to improve e.g. insulation. In a multi-let building this could be through membership of a "building management committee" - see section on Green Lease Toolkit below.

Existing leases will, clearly, require variation if they are to be amended to give effect to these issues. New leases can be drafted from the outset with this in mind.

It will, of course, be tempting to ignore all this if neither landlord nor tenant is within the scheme. However, account needs to be taken of the possibility that either party may pass its interest to an entity that is within the scheme and then the absence of appropriate lease clauses may cause problems for the parties. Further, it is possible that the scheme may be extended, or for some other reason one of the parties could find themselves within the scheme at a later date.

It is probably fair to say that it is early days yet and quite what will be the preferred approach and an understanding of what clauses will be commonly used in leases has yet to emerge.

The “Green Leases Toolkit”

The toolkit

One example of an approach to landlord and tenant issues can be seen through the Green Leases Toolkit. This has been developed by the "Green Lease Working Group" of the Better Buildings Partnership. This is a publication that includes a set of lease covenants to promote energy and water saving and effective waste management. It is currently being used by BBP members and feedback is being monitored.

The Better Buildings Partnership is a group of some of the larger property owning organisations under the auspices of the London Development Agency. It includes British Land, Canary Wharf, GE Real Estate, Hermes, Hammerson, Grosvenor, Land Securities, Legal & General Property, Quintain, TfL and Workspace Group.

The toolkit contains best practice recommendations, model green lease clauses and a model memorandum of understanding. It was published in April 2009.

A copy can be obtained from:

Best practice recommendations

This is a set of topics that should be considered for including in a lease or in a "memorandum of understanding" between landlord and tenant. For example:
  • "Owners and occupiers should share data on energy consumption"
  • "Alterations which adversely affect the energy performance of the building should be avoided"
  • "Irrigation systems should, where possible, be fed with captured rain water, grey water, or on-site treatment and employ relevant water saving control systems."
The areas covered include such things as: energy, waste, water, building operations, service charge, managing agents, and transport.

The Memorandum of Understanding

This contains a statement saying that it is not intended to be legally binding. It deals with such items as data sharing, the agreement to set up a Building Management Committee, the building management system, possible waiver of re-instatement obligations and managing agents.

The parties also agree to co-operate in complying with any CRC scheme to which either of them may be subject.

It contains a schedule of items which the parties agree to "work together to consider and seek to implement". The schedule contains tick boxes by which the parties indicate which of the items applies to them, so, for example, one item is e.g. "separate metering facilities for individual utilities for the Premises and the common parts and for other occupiers and special uses."

Clauses for new leases or on lease renewal

There are also suggestions for clauses that are intended to supplement the points covered in the memorandum of understanding by a set of covenants to be incorporated into the lease. In most cases precedent wording is offered. Some of the clauses are reproduced here by kind permission of the Better Buildings Partnership. Where the publication gives alternatives only one has been given here for ease of reference. The publication makes it clear that the clauses are not a substitute for legal advice and that the parties should discuss them further with their legal advisors.

No recommendation in relation to the wording or use of these clauses is made here, they are reproduced for illustration purposes only and, clearly, no responsibility or liability for their use is accepted.

They deal with a number of areas including the following.

Environmental Management Plan

It is suggested that arrangements should be made to ensure that the tenant is obliged to cooperate with the manager of the property in respect of sharing data needed for an environmental management plan. This plan is intended to be formulated by a building management committee (as to which see below) and it would contain specific targets for the building.

Example clause:
    "The Landlord will use reasonable endeavours to ensure that:

    (a) when appointing third parties for the supply of services to or management of the Building they are suitably qualified and accredited for their specified role

    (b) its Managing Agent or other party responsible for the operation or management of the Building will:
      (i) either put in place an appropriate Environmental Management Plan that is suited to the size and occupation of the Building or where the Memorandum of Understanding requires the Building Management Committee to put in place an Environmental Management Plan, work with the Building Management Committee to achieve this objective;

      (ii) attend the meetings of the Building Management Committee; and

      (iii) keep all data provided by the Tenant confidential (save where disclosure of it is required by law) and only to use such data to ensure that the Building is run in a sustainable way that minimises its environmental impact.
    The Tenant agrees that the Managing Agent or other party responsible for the operation or management of the Building will be entrusted to use the energy and water consumption data and the data regarding waste generated by the Building provided by the Tenant at or ahead of each BMC meetings for the purposes of creating the EMP and ensuring that the Building is run in a sustainable way that minimises its environmental impact."
The appointment of a building management committee

The building management committee is intended to ensure that communication between the parties in relation to the environmental issues concerning the running of the building is enhanced. It is envisaged that the members of this committee will include appropriate representatives of the landlord or its managing agent and the tenant.

Example clause:
    "The Landlord will set up a Building Management Committee comprising a representative of the Landlord,(or its Managing Agents), the Tenant(s) and such other third parties deemed necessary by the parties to meet [quarterly] (or on an ad hoc basis) to:
      (a) consider the adequacy and improvement of data sharing on energy and water use and waste production/ recycling;

      (b) agree the targets and strategies to reduce energy use and water consumption, improve waste management in the Building, consider green travel options and agree strategies to implement other aspects of any agreed Memorandum of Understanding;
    Where Building Management Committee meetings are attended by more than one tenant, the Landlord and Tenant shall hold additional meetings as may be reasonably necessary to discuss matters relating to a) and b) above which are concerned exclusively with the Demised Premises [and which either party wishes to discuss only with the other].

    The Tenant will co-operate in the setting up of the Building Management Committee and the Parties' representatives will attend the meetings of the Building Management Committee wherever reasonably practicable and provided that appropriate notice of such meeting is given by the party arranging such meetings."

Obligations to share data and metering information

It is considered important that the parties share data about consumption of energy and waste generated by the occupation of the building.

Example clause:
    "The Landlord and Tenant will share the data they hold in respect of energy and water use and waste production/recycling [quarterly] between themselves and with any other third party who the parties agree needs to receive such data.

    The Parties will keep the data disclosed under this provision confidential and will only use such data for the purposes of ensuring that the Building is run in a sustainable way that minimises its environmental impact.

    The Landlord will ensure that similar restrictions on the publication and use of such data are placed on its Managing Agent and any other party responsible for the operation or management of the Building.

    The Landlord shall have the right [at its own cost] to install separate sub-metering of utilities used in the Common Parts and the Demised Premises and the Tenant shall have the right at its own cost to install separate sub-metering of utilities used in the Demised Premises. The Parties will give each other the necessary access in order to allow for such metering to be installed provided that reasonable notice of the intention to install such metering is given and provided further that such installation will not disturb the Tenant’s beneficial use and occupation of the Demised Premises."

Provisions to allow for works and access

The landlord will need to monitor energy and waste levels and to be able to access for the purposes of undertaking certain works to be undertaken.

Example clause:
    "The Landlord and its servants or agents or contractors shall be entitled at all reasonable times and on reasonable prior notice to the Tenant to enter and remain on the Demised Premises for:
      (a) the purpose of taking reasonable steps to review or measure the Tenant’s energy and water use and its waste production or waste management save where up-to-date information in this respect has already been provided to the Landlord by the Tenant;

      (b) carrying out works which are agreed by the Tenant (acting reasonably) and are aimed at more effective management of, or reducing, energy or water use or waste production and for setting up and managing recycling schemes (provided that such works cause as little disruption as reasonably possible and when complete do not adversely effect the Tenant’s beneficial use and occupation of the Demised Premises and that any damage caused by such works is made good);

      (c) for the purposes of preparing EPCs or DECs or undertaking an air conditioning inspection and for such purposes the right to carry out the necessary tests on equipment.
    The Tenant may with the Landlord’s consent (which shall not be unreasonably withheld) carry out alterations to the Demised Premises aimed at reducing energy use or water consumption or improvement of waste management provided such alterations do not adversely affect the performance or life cycle of any mechanical or electrical services or any other plant, equipment or services in the Building and are not structural alterations."
Restrictions on works that may have an adverse affect

As alterations and works can potentially have an adverse impact on the efficient use of energy or water then the landlord may want to control or prohibit these types of works. In the same way the tenant may want the landlord to consider representations concerning the environmental affect of any works that it proposes to do.

Example clause:
    "Where the Tenant wishes to make changes to the Demised Premises or its use which may adversely impact on an existing EPC rating or which may adversely affect the efficiency of the use of energy or water within the Demised Premises or the Building, the Tenant shall provide sufficient information to the Landlord to enable the Landlord to ascertain the effects of the alterations and the Tenant shall consider [and, where reasonable, implement] any suggestions the Landlord makes to [avoid /minimise] any such adverse effect.

    The Landlord will consider any reasonable suggestions made by the Tenant to [avoid/minimise] so far as reasonably possible, any adverse impact on an existing EPC [or DEC] rating or the efficiency of the use of energy or water within the Building which may be caused by any works to be carried out by the Landlord.

    Where the Tenant carries out alterations which necessitate the provision of a new EPC, the Tenant shall obtain a new EPC [at its own cost] and shall provide a copy of such EPC to the Landlord.

    Where the Tenant carries out alterations to any plant equipment or services in the Building which affect the energy efficiency of such plant equipment or services, the Tenant shall provide such information about the energy efficiency of the altered plant or equipment as the Landlord shall reasonably require."
Limiting tenants reinstatement obligations

As re-instatement requirement may have an adverse affect on energy and waste it may be appropriate to limit this requirement in certain situations.

Example clause:
    "(To be incorporated in reinstatement of alterations and yield up provisions)

    The Tenant shall not be required to reinstate any tenant’s alterations which have been carried out lawfully during the term and which improve the energy or water efficiency of the Demised Premises unless such reinstatement is reasonably required by the Landlord having regard to its intentions in respect of the use or re-letting of the Demised Premises or the Building after the expiry or sooner determination of the term."

Limiting the impact of certain works at rent review

Although no example clause is offered the publication makes the point that the impact of any works done for the purposes of reducing energy, water or waste at rent review may need to be considered. The starting point, perhaps not surprisingly, is considered to be that tenant’s works should be disregarded, although landlord’s works at its own expense should be taken into account.

CRC scheme

No clauses are yet suggested in the Green Leases Toolkit for dealing with the CRC scheme, although the publication promises that "subsequent versions of this document will cover this so far as the Working Group considers appropriate".

Developments in schemes for carbon allowances, energy performance certification and other initiatives designed to reduce waste and the carbon emissions from buildings probably have some way to go yet. Although the debate has only just started on lease clauses, the challenge is to ensure that developments in drafting keep up with the legislation.

© Peter Reekie
9 October 2009

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