Green leases: from ambition to delivery
"Policy ambition has moved substantially with the publication of the UK’s Net Zero Strategy. Now is the time to deliver the promised action." 2022 Progress Report to Parliament, Climate Change Committee
We expect to see increasingly sophisticated drafting solutions over the next few years to improve and modernise leases, with an aspiration across the sector to move towards a new standard for institutionally acceptable sustainable leases. The provisions we discuss in this article are likely to involve more proactive management of properties and will require leadership from landlords on key sustainability requirements. Landlord and tenant attitudes and expectations relating to sustainability are likely to differ depending on the type of premises being let.
For a truly sustainable lease product, the legal understanding of the landlord and tenant relationship will need to be fundamentally reframed from a traditional expectation of passive land ownership with clear risk allocation to proactive management and collaboration. In practice, we have already seen many landlords embrace a shift over the past decade from a "tenant" model to a "customer" model, which seems set to continue. It will be interesting to see whether and how the changing legal landscape will reflect this fundamental re-characterisation of the real estate asset class.
Why is it important to ensure that leases are sustainable?
At the most basic level, leases need to ensure that properties and their occupiers comply with the laws and regulations that affect them.
Traditional leases contain requirements for the tenant to comply with law affecting the property at the tenant’s cost. This does not fully address the evolving regulatory landscape, which is expected to impose requirements that can only be met with landlord and tenant co-operation. For example, we would expect upgrades to improve the EPC rating of a property to involve extensive landlord access that would not normally be permitted in an occupational lease. Equally, upgrades to improve the EPC rating would normally be building-wide and would not be achievable by a tenant of an internal only demise of part of the building on its own.
Non-compliant properties will, over time, become impossible to let without further works. If such works cannot be carried out during the term of a lease, then this will result in avoidable vacant periods for landlords to bring properties up to standard.
In a traditional "fully repairing and insuring" occupational lease, the tenant is expected to meet all of the costs associated with repairing and maintaining the property, for example through insurance rent and service charge contributions. This is unlikely to deal adequately with the types of improvement works that may be required by law or to keep up with changes to accepted building standards, for example, replacing heating infrastructure.
It is important that there is clarity in leases as to which parties will meet which costs and how these may be shared by various occupiers of a building to avoid later disputes or inaction.
Both landlords and tenants have a vested interest in ensuring that their property interests are run efficiently and in accordance with good estate management practices.
Traditional leases deal with this reactively, for example, the tenant may not be required to pay service charge costs that have been incurred other than in accordance with the principles of good estate management.
We expect to see a shift towards much more proactive engagement by both landlords and tenants to ensure that buildings are keeping up with technological and best practice standards to deliver an efficient property. This has the potential to go far beyond mere compliance and will raise real questions around achieving a consistent approach on cost allocation across multiple occupiers for multi-let properties.
Landlords and investors will be focussed on improving tenant satisfaction and occupancy rates, which will be assisted by building a sound reputation for ESG standards. Both landlords and tenants may be under internal pressure from employees and boards, and external pressure from customers, to show progress towards sustainability goals. Making a better social impact will extend to property interests. There is a huge opportunity to improve well-being, productivity and engagement between tenants and occupiers with their landlords.
For both landlords and tenants, failure to meet the challenges of today’s world is likely to have a PR and reputational impact. We have increasingly seen negative media reports around "green washing" for those making unsubstantiated claims on environmental performance.
The pressures on both landlords and tenants may be exacerbated by the increased reporting/transparency obligations generated by regimes such as the EU Sustainable Finance Disclosure Regulation (SFDR), the Task Force on Climate-related Financial Disclosures and the forthcoming Sustainability Disclosure Requirements (SDR) in the UK.
The following factors all mean that energy usage data in particular is becoming critical:
- the general move towards detailed decarbonisation planning for assets;
- the introduction of transparency and reporting regimes such as SFDR and the forthcoming SDR in the UK;
- the requirements of many asset level frameworks and certifications (for example, UKGBC's advancing net-zero energy use intensity pathway); and
- the setting of their own net-zero targets and pathways by many organisations.
Leases will be a core part of ensuring appropriate data capture of sufficient quality.
What is a “green” lease and why do we need to think again?
So called "green leases" were traditionally standard occupational leases within which parties expressed intentions to operate a building or demise in accordance with green principles. These were also primarily leases of office space.
In the past, efforts to introduce green clauses have been somewhat limited and it has become typical for landlord’s lawyers to add green lease provisions into initial drafts, that are then struck out by the tenant’s lawyer without much resistance. This has damaged both the concept and effect of "green leases".
When they are successfully included, these provisions have tended to be minimal bolt-on clauses in leases related to maintaining the EPC rating or complying with BREEAM and potentially some restrictions around alterations. For example, tenants may have been prohibited from making alterations that would reduce the energy efficiency, EPC rating or other energy systems of the building out of which the lease was granted.
These provisions traditionally do not adequately deal with data capture, upgrades to efficiency of buildings, or provide flexibility for landlords to work up and modify sustainability strategies over time.
In practice, there are challenges to enforcing these limited provisions in law. They tend to be drafted on a "reasonable endeavours" basis or with significant caveats such as "so far as practicable" or "provided there is no increase in costs". This makes it difficult to demonstrate any breach. Further, even if there is a breach of such provisions, there is little opportunity for meaningful remedies. Forfeiture is unlikely to be available (or appropriate) for breaches of most "green" provisions and it could be difficult to demonstrate loss as a result of a breach of a "green" provision to support a claim for damages.
Against the backdrop of government targets, landlords and tenants may be motivated to graduate from ambition to delivery and to work towards a new type of lease that is truly sustainable. This would involve not just environmentally sound principles, but for landlord and tenants to fully commit to measurable ESG requirements that will ensure landlords and tenants engage in active and meaningful sustainability practices in respect of their property interests.
Even so, it is possible that there will be ongoing difficulty around the meaningfulness of such sustainability provisions. Part of the drafting challenge will be to ensure obligations are clear and measurable and to allow for enforcement of key requirements (i.e. data sharing).
There may also need to be recognition from parties that a lease is not always a natural home for wide ranging ESG obligations that may be less measurable and softer. For these obligations, the lease may be a starting point for a collaborative relationship outside of the legal framework through which change can be effected.
How can we draft an effective sustainable lease?
Some sustainability provisions may be best captured outside of the confines of a lease and in something more akin to an estate management plan. Tenants can then be required to comply with a sustainability plan as may be amended from time to time and notified to the tenant, which is analogous to estate regulations or tenant alterations handbooks that are sometimes used by landlords. This potentially allows for greater flexibility for landlords to keep lease obligations up to date, while what we mean by "sustainability" and "resilience" rapidly evolves.
There is a much greater focus on tenants and landlords engaging with each other in a meaningful way to operate buildings more sustainably, whether that is through agreeing a building management plan, key performance indicators or methods of improving building use with target setting and benchmarking. This may be more suitable for a collaboration agreement or a non-legally binding letter of intent that sits alongside a lease. Although this may be harder to enforce legally, there are other benefits: these documents can allow for much more ambitious plans for a property and they would not be registrable at the Land Registry, so they would remain confidential.
What might we expect to see in terms of sustainable lease provisions?
Data sets the benchmarks and targets for the building and is key to the reporting obligations on one or both parties. A lease can include provision for data sharing and metering but it is the practicalities of capturing the relevant data in the real-world that is more the challenge. It is commonly misunderstood how difficult it is to collect tenant data. From a legal perspective confidentiality will need to be preserved within multi-let buildings so that data is shared effectively but without breaching data guidelines. Concerns around cyber security and GDPR will also need to be navigated.
There is a difficulty in standardising metrics and the type of data collected by tenants across a landlord’s portfolio to allow meaningful analysis. Organisations such as the Real Estate Data Foundation are looking at how to manage the risks around data collection and how metrics can be standardised across the industry. We expect to see more clarity emerge in this area in the next few years and anticipate more robust data ethics and standards.
Proptech will play a central role in data collection, for example, sensors that measure environmental factors including temperature, air quality and energy usage. Certain providers are also developing products that enable occupiers of to access the data in real time, enabling them to check how their space is performing and to modify their use of their space to reduce usage. Given the current energy crisis and significant inflation, these tools have the potential to give a tangible financial benefit to tenants directly and through the reduced service charge in respect of common parts.
It is commonplace for leases to include prohibitions on tenant alterations to their demised premises that could reduce the EPC rating or the energy performance of the building.
We expect lease standards to progress on this point, for example, leases could require fit out works and alterations that require landlord consent to be assessed in light of their overall environmental impact. This can refer to the initial works and also to their ongoing performance.
There is a movement towards potential cost sharing for sustainability/environmental works which of course in turn goes to the heart of what makes a building resilient. Cost sharing for improvements to a building might be more palatable to tenants who have leases with terms that are long enough for the tenant to derive a benefit. Similarly, if measurable benefits to the tenant can be shown then this may facilitate negotiation of cost sharing provisions. It may be relatively easy to demonstrate a tangible benefit in the current climate given the rising costs of energy (e.g. improvement to equipment which leads to increased efficiency and lower energy usage). It is a case of moving away from the traditional landlord/tenant relationship where the tenant fears that costs will be unduly pushed-through to them in the lease and towards a more balanced cost-benefit approach.
There is of course also a difference between works carried out to retained or common parts of a building and those carried out within a demised area and how access arrangements and works methodology is to be catered for from a legal perspective.
Landlords will increasingly require the ability to carry out works to ensure the sustainable/environmental performance of their buildings - to meet statutory requirements and tenant expectations and to ensure viability of the building in the future. Such works are unlikely to affect only the structure and common parts of multi-let properties. Accordingly, leases may need to include rights of access for landlords in connection with works within demised premises. Without this right, landlords will need to wait for void periods to carry out such works, which could be costly and may result in delay.
As noted above, the costs of such sustainability works will need to be allocated as between the landlord and tenant. There may be discussion around the extent to which improvement works should be covered by the service charge or other costs-sharing provisions. If such works are likely to be costly and infrequent, then it may be appropriate to include provisions for a reserve fund to spread the costs over time. These are often resisted by tenants of short-term leases
We have seen examples of landlords taking control of the energy provision to buildings that is then passed through to occupational tenants, such that they can select particular energy providers that use mainly (or exclusively) renewable energy sources. This reduces tenant control over the cost of energy, but can allow for tenants to benefit from bulk energy rates and provides a consistent energy strategy for multi-let buildings. We anticipate that landlords will seek to make their buildings more ‘energy flexible’ - perhaps using technology that would feed energy back to the grid or seeking to use on-site renewables. Landlords are also expected to focus on efficient energy usage and cost reduction which in turn will maintain the appeal of their properties to tenants.
As an example, as more properties (mainly residential) move towards heat pumps, leases will need to include rights for tenant access to external ventilation. Therefore, rights and reservations granted in leases will need to be reviewed and assessed for their flexibility to accommodate future green technology.
For leases with an open market rent review, the parties will need to consider the extent to which energy performance will be disregarded for the purposes of the review. For example, if there have been significant improvement works to the property that the tenant has contributed towards it may be appropriate to carve these out of the review.
We expect to see a trend towards parties considering terms that address the social impact of the property. This is already partially addressed in traditional leases through specific permitted user and prohibited use clauses. However, certain landlord organisations have already started to address wider concerns through leases. For example, we already see lease provisions that oblige tenants to pay the London Living Wage to employees, require donations to be made to charity on lease completion and restrict the advertising of certain products. This is likely to become a growing area of interest for landlords, particularly from a reputational perspective.
The key consideration as to whether social provisions will be appropriate in a lease will be whether the provision directly involves the property interest or not. For example, we would not expect leases to become the natural fit for provisions relating to organisational diversity statistics. Instead, leases might be used to require tenants to provide access to particular facilities for community schemes on a regular basis.
It is probably in this sphere in particular that documents sitting outside the lease are likely to be more important and that this will be driven by the landlord and tenant relationship rather than just legal obligations.
Yes and no.
There are a number of bodies that have produced and are working to create drafting and frameworks for sustainable leases. These include The Better Building Partnership, The Chancery Lane Project and UKGBC. These models are ambitious and challenge both landlords and tenants to embed sustainability at the very heart of their documentation.
It is anticipated that standards, such as the City of London Law Society Certificate of Title, will be amended over time as sustainability provisions become more common within leases and associated documentation.
As discussed earlier in this article, traditional green lease clauses are almost impossible to enforce given that they are expressed in terms that do not place parties under absolute obligations but rather encourage efforts to be made. The question for the new iteration of sustainable leases will be: is it appropriate that the remedies available to landlords under leases for breach, especially forfeiture, should extend in circumstances where there has been a breach of a sustainability clause?
The remedies available for the various sustainability clauses will vary, for example:
- forfeiture may be appropriate for clear and objectively defined obligations, such as failure to contribute to costs or to provide data (the latter of which may be crucial to the landlord’s ability to comply with statutory or internal reporting requirements); and
- self-help remedies may be more appropriate for breaches relating to the physical condition of the property, such as a failure to maintain meters and data monitoring equipment, or alterations carried out by tenants that adversely affect the EPC rating.
For some sustainability provisions, there will be practical ways to encourage compliance or prevent breach without resorting to legal remedies. For example, buildings can be let with appropriate proptech in place which would capture tenant energy data in real-time without the need for active input from the tenant (in turn reducing a potential administrative burden for tenants). It might also be possible to align tenants’ and landlords’ objectives through a mechanic borrowed from the finance market i.e. by establishing defined KPIs and incentives linked to performance.
As always, the available remedies will be entirely dependent on the specific drafting and facts, but we can provide advice on the range of remedies available for particular drafting.
Who or what will drive this change to sustainable leases? Will this re-shape traditional landlord/tenant relationships?
This matters equally for landlords and tenants, but realistically we expect the changes to leases to be driven by landlords. Traditionally landlords’ lawyers draft standard leases for their properties to ensure consistency of approach throughout their portfolio and especially within buildings.
The size and type of tenant organisation is going to inform how focused the tenant is on sustainability matters and how agreeable they are to their inclusion in leases. Those tenants who are more likely to be subject to regulatory reporting requirements and more likely to have made public facing ESG commitments may in turn be more amenable to discussions regarding sustainability. There may be concerns about the potential additional costs (i.e. through an increased service charge) and the additional administrative burden of complying with data obligations.
Much of the ESG agenda still currently exists outside of legislation – there are overarching government targets (i.e. Net Zero by 2050) but this is not yet translated into law. Confirmation of higher Minimum Energy Efficiency Standards (MEES) in the private rented is still awaited. There are a number of other consultations that have been held, the outcome of which are also awaited. Proposed changes to EPC and MEES legislation is still in consultation.
As we move towards the Net Zero 2050 target, it is a considerable challenge to future proof leases both legally and technologically. Reaching some form of statutory clarity will be key to move towards more institutional standards for sustainability in leases.