News | June 13, 2024

Greener on the other side?

Lease renewals often prompt landlords to review lease terms, and the most frequent modernisation at the moment is environmental drafting. Is this a reasonable change which tenants must accept? Regardless of a landlord’s environmental stance, the green trend is being driven by black letter law and financial imperatives.

The legal “stick” which has focussed attention on environmental rights and obligations is the MEES Regulations (Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015) which means that a commercial building with an EPC rating of F or G cannot continue to be let after 1 April 2023.  The legislation does not mandate action for either landlord or tenant, but merely makes a lease of the commercial building unlawful, subject to some exemptions.  Landlords in breach of the MEES Regulations are liable to a fine of up to £150,000. What’s more, the direction of travel is clear – over time, buildings will need to meet more and more stringent environmental performance criteria in order to be let.

Less clear, however, is the date by which the next threshold is to be reached.  It had been thought that commercial buildings would need to be at EPC rating C by 2027 but this was delayed to 2028; further changes are subject to a government consultation, leaving the property industry in limbo.  The rules are different again for residential properties.

Some landlords have tried to protect themselves from a future change by drafting leases with a right to enter occupied premises to carry out improvement works. It very much depends on what works are needed to upgrade the building and the nature of the tenant’s business carried on from the premises whether this can be done without unfair interruption to the tenant. Even with a willing tenant, a landlord with the right to carry out improvement works closes the door on a possible exemption certificate under the MEES Regulations, so this drafting needs careful consideration before it’s proposed.

The lack of clarity on the relevant date is not the only challenge for landlords. Historically some EPCs have been of questionable quality. It’s now commonplace to see a requirement for the landlord to approve an EPC assessor before a tenant makes the appointment, so that premises are not downgraded purely due to a poor EPC.  Lease clauses prohibiting alterations which would reduce the EPC are often requested by landlords, prompting negotiation about whether “any” reduction or “material” reductions are the concern – if the premises stay in EPC grade A, which requires a rating from 0 – 25, does it really matter if the number slips from 12 to 15?

Recent changes to the EPC calculation methodology for non-domestic premises have had the side effect of changing EPC ratings without physical work being done to the building. Building Regulations Part L have, since June 2022, been updated to reflect the carbon emissions of the primary fuel source for the building. As about 50% of the UK’s electricity supply is now derived from renewable or low carbon sources, a building heated by natural gas is likely to have its EPC downgraded when it is next renewed.

When leases are renewed under the Landlord and Tenant Act 1954, the presumption is that the renewed lease will follow the terms of the existing lease. Modernisation of leases clauses is permitted but it is for the party proposing the change to make the case that the requested wording is reasonable. The County Court found against the landlord in the only case on environmental wording considered so far in the Clipper Logistics case. The County Court decision is not binding on others but cases on lease modernisation rarely reach the courts so we may need to wait for some time before a superior court makes a ruling on the issues.

Tenants seeking better environmental wording for their own ESG reasons also face challenges.  Many landlords require tenants to share information about utility usage in their demise with the landlord, but are not willing to share information about utility usage in the common parts with the tenant.  Leases prohibiting structural alterations or alterations visible from the exterior of the building will have the side effect of preventing a tenant from installing charging for electric vehicles, even if the local electricity grid has sufficient capacity. Rooftop solar panels present challenges for both landlord and tenant – is the structure of the building strong enough to support them? Are there any rooftop warranties which might be prejudiced by the installation of panels?

Each building has its own recommendations for upgrading its energy efficiency.  Those of us working in the built environment need to be mindful that corporate ESG policies intended to apply across an entire portfolio will need to flex to reflect the fabric and fitout on a property by property basis.