Could lease renewals be a driver for change when it comes to green lease provisions?

Anna Bevan-Jones at law firm Eversheds Sutherland looks at green lease provisions and the Landlord and Tenant Act 1954.

Related topics:  Property,  Energy Efficiency,  green,  commercial
Anna Bevan-Jones | Eversheds Sutherland
27th November 2023
Law

Climate change concerns have led to a greater focus on energy efficiency in buildings which, from their construction to their operation, continue to have an enormous impact on energy-related carbon emissions. Greener buildings quite naturally lead to, and in fact deserve, greener lease terms.

That is, provisions for the management and improvement of the environmental performance of a building. But what does that mean where it comes to the renewal of leases under the Landlord and Tenant Act 1954 (1954 Act)? Could lease renewal be part of the driver for change where it comes to green lease provisions?

A topic of great interest to landlords and tenants of commercial premises as well as their professional teams who advise on lease renewals.

What the 1954 Act says:

Part II of the 1954 Act offers certain business tenants protection in the form of a right to request a new lease from their landlord on expiry of their current lease, also referred to as security of tenure.

The 1954 Act applies where a tenant satisfies the qualifying criteria under the 1954 Act, broadly, it is in occupation for the purpose of business and the 1954 Act protection hasn’t been excluded from the tenancy in question.

A key point to consider when it comes to lease renewals pursuant to the 1954 Act is the extent to which a court might allow a green provision into a renewal lease under the framework set out in the 1954 Act.

Naturally, where landlords and tenants are negotiating new leases they have an opportunity to agree on lease provisions to deal with energy efficiency. These provisions may deal with any works that may be required to bring the premises up to standard, who will carry out and pay for the works, as well as practical issues such as access.

Parties looking to renew leases under the 1954 Act are, however, doing so from the starting point of leases which may not include any energy efficiency-related provisions or certainly not sufficient ones. They may then struggle to introduce new provisions on renewals of existing leases unless both parties agree to them.

The court will only order new terms they consider to be ‘fair and reasonable’ in the circumstances, following the principles set out in the 1983 decision of O’May v City of London Real Property Co Ltd. The case sets quite a high bar.

The starting point is always the existing lease – which may have no provisions relating to energy efficiency or inadequate ones. The burden of persuading a court to change the terms of the current tenancy sits with the party proposing the change.

Updating a clause to take account of legislative updates may amount to reasonable modernisation but not all green lease terms are to take into account legislative updates.

One factor which has impacted the drafting of green lease terms and to an extent the interpretation of existing leases is the Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015, often referred to as the MEES regulations. As a result of the MEES regulations, landlords have been prohibited from continuing to let commercial premises which are sub-standard (i.e. have an EPC rating of below E) since April this year.

MEES aims to prevent non-compliant or sub-standard, property from being leased, however, it does not place a positive obligation on a tenant to upgrade a property. Unless the lease expressly provides for it, the failure to achieve an E rating is not in itself a breach of the repairing covenant.

Whilst it is arguable that improved environmental performance should bring mutual benefit for both the landlord and tenant, disputes between them as to who is responsible for carrying out, and for the cost of, works to bring properties up to standard seem inevitable.

What do the courts say?

More and more parties, particularly landlords, are seeking to introduce green lease terms at renewal but what are the courts saying?

Clipper Logistics Plc v Scottish Equitable Plc (2022):

In this 1954 Act decision, the County Court held that a landlord could not introduce certain green lease provisions into the renewal lease.

The landlord wanted to impose new obligations on the tenant which it said were reasonable updates, required as a result of the MEES regulations. It had the burden of persuading the court to depart from the existing lease terms to introduce them. These terms were:

· A prohibition on making alterations that would result in a sub-standard EPC rating for the property

· A requirement to indemnify for the cost of a new EPC if the tenant made alterations which brought the EPC below E rating

· An obligation to maintain the current EPC rating and to carry out remedial works to restore the rating if it fails to do so

· A requirement to return the property to the landlord at lease expiry with the same EPC rating as at the start of the lease

The court rejected the first three provisions on the basis that they would unfairly and unreasonably impose on the tenant a number of duties which the statute expressly placed upon landlords and not tenants. These were costs for the landlord to bear rather than for the tenant.

The court did allow a new term, however, requiring the tenant to return the property with the same EPC rating as at the start of the lease term. Without this, the court recognised that the landlord would not have the benefit of any real protection against inaction by the tenant.

We would assume that similar requirements requiring the tenant to return the premises at lease expiry with at least the same EPC rating as at lease commencement would be granted by the court in most lease renewal cases.

The case suggests that whilst the courts are aware of and appreciate the heavy burden imposed on landlords by the existing MEES regulations they may not tolerate landlords’ attempts to offload their green liability where that would impose new and additional burdens on tenants. Although non-binding, this decision shows a potential obstacle to greener lease renewals.

WH Smith Retail Holdings Limited v Commerz Real Investmentgesellschaft MBH (2021):

Another 1954 Act decision which touched on the issue of green lease terms is the WH Smith case. This decision drew a lot of attention from commentators due to its analysis on the inclusion of a pandemic rent suspension clause but the parties could also not agree on the inclusion of new heads of expenditure within the service charge provisions.

In this case, the landlord wanted to specifically allow for the recovery of new heads of expenditure relating to environmental performance. The changes were largely requested in order that the renewal lease provisions matched those contained in their current precedent lease, such as:

· Undertaking environmental audits

· Carrying out works to increase energy efficiency

· Provisions of sub-meters

· Commissioning EPC’s.

The landlord argued that these terms should be included by way of reasonable modernisation to reflect changes in law since the original lease was granted. The original lease contained a sweeper provision but the landlord contended that the proposed amendments provided greater clarity for the future.

The court sided with the tenant, finding that the landlord had not met the high bar set in the O’May decision. The judge was not convinced that the new heads of expenditure provided greater clarity or that they were items that should be recharged to tenants (in particular the judge commented that some of the heads of expenditure had “the look of capital improvement”).

This is another county court decision and therefore non-binding but does suggest that some difficulties could be encountered with green leases at lease renewal.

What next?

The Government had planned to change what would be considered sub-standard from the current below E to below C. A move which could have a real impact on landlords’ ability to let some property stock. A further intended change was one that would require the landlord to have a valid EPC in place at all times for all let commercial properties.

The Government has since watered down a number of its policies, including this one, although remains committed to its aim to achieve net zero by 2050.

Whilst the courts may be conscious of the UK government’s targets where it comes to reducing greenhouse gases and achieving Net Zero, because of the O’May principles there is an inbuilt resistance to change clauses at renewal and that isn’t going to change.

As such the introduction of green lease clauses is most likely going to be driven at the point of freely negotiated new leases being granted and not renewal leases under the 1954 Act.

Lease renewal is therefore unlikely to be a big driver of change unless something happens to change the law. In that respect, it is noteworthy that the 1954 Act is currently subject to review.

The review is led by the Law Commission following its launch earlier this year and commissioned by the Department for Levelling Up, Housing and Communities. It will explore problems with the existing law with a view to developing a modern legal framework.

The scope of the review appears to be fairly wide and may well consider whether the O’May test remains the correct approach when it comes to incorporating new terms at review.

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