Green leases and Minimum Energy Efficiency Standards

It covers:

• what is green lease drafting?
• what this means for solicitors and their clients
• why green leases?
• green lease impact on the market and client demand
• MEES and duty of care to advise on client risk
• landlord liability under MEES
• solicitors' duty to advise under MEES
• climate legal risks impacting UK property
• model green lease clauses

Commercial properties are “non-domestic real estate that fulfils an operational or occupational purpose for business and is commonly sold or let in the market. It may also be referred to as ‘investment property'”.

Other asset classes such as rural, residential, public sector and infrastructure fall outside the remit of this guidance note.

The guidance includes coverage of Minimum Energy Efficiency Standards (MEES) legislation and other requirements.

Whilst MEES refers to ‘non-domestic properties’, the term ‘commercial property’ is used instead in this guidance, as this more accurately reflects the terminology our members use.

What is green lease drafting?

‘Green lease drafting’ is drafting that provides for the landlord and the tenant to undertake specific responsibilities and obligations to minimise carbon emissions arising from the sustainable development, operation and occupation of a property.

Examples include:

• energy efficiency measures, including obtaining and/or maintaining an Energy Performance Certificate (EPC)
• data sharing – including, for example, utilities consumption
• waste reduction and management and recycling
• using sustainable materials for repairs and alterations
• water efficiency
• measures to comply with statutory environmental standards and/or achieve target certifications such as MEES and Building Research Establishment Environmental Assessment Method (BREEAM)
• consideration of wider adverse climate impacts

Reducing scope 1-3 emissions of properties

Green lease provisions can help reduce scope 1-3 emissions (below) from properties.

This can assist in complying with any environmental, social and governance (ESG) or Net Zero strategies clients may have.

What this means for solicitors and their clients

The Royal Institution of Chartered Surveyors (RICS) Code for Leasing Business Premises in its lease negotiation and best practice section states:

“Parties are encouraged to include in leases provisions relating to sustainability and the environment that urge cooperation throughout the lease term between the landlord and the tenant to ensure that the property is used as sustainably as possible. These are sometimes called ‘green clauses’…”

Solicitors are also encouraged in all appropriate cases to discuss with their clients whether to include green provisions in leases they are producing and negotiating (see why green leases?).

These could include:

Some clients may wish to use a blend of green lease provisions (see NHS model green lease) to suit their current needs and any plans to increase their climate ambition over time.

The incorporation of green clauses is not limited to new or renewed leases.

Where a lease is already in place, the parties can enter into a memorandum of understanding (MoU) which provides a roadmap for co-operation between the parties on increasing the sustainability of the property.

Currently, it is not common practice for the parties to vary the provisions of an existing lease to introduce new green clauses.

Why green leases?

Improve the environment

Ultimately, green leases will contribute towards improving the quality of the environment and create a cleaner, healthier and biodiverse planet with sustainable resources for all.

Future policy, regulatory, and legal landscape

UK government policies are already beginning to oblige developers, landlords and occupiers to focus on the environmental performance and sustainability of buildings (see guidance on MEES).

Legislative target

The UK government has set a legislative target of 78% reduction in greenhouse gases by 2035 and a target to achieve Net Zero by 2050.

According to the UK Green Building Council, the built environment contributes around 40% of the UK's total greenhouse gas emissions.

Further, it is estimated that 80% of buildings that will exist in 2050 have already been built.

The United Kingdom has some of the oldest housing stock in the world. Currently, the median EPC rating in England and Wales is D.

The government estimates that 18% of commercial properties hold the lowest EPC ratings of F or G.

Disclosure standards

ESG disclosure standards, including the Task Force on Climate-Related Financial Disclosures (TFCD) recommendations, are the most prominent global set of climate-related risk disclosures that have been incorporated into many public bodies as well as regulator policies, including the Bank of England.

Further disclosure standards are also being finalised by the International Sustainability Standards Boards which provide sustainability disclosure standards for financial reporting globally, including specifically on real estate.

The Financial Conduct Authority’s (FCA) Sustainability Disclosure Requirements (consultation paper) implementation timeline is 30 June 2023 to 30 June 2026.

Once implemented, the FCA will require real economy companies, including insurers, and asset managers and asset owners to report on their sustainability risks, opportunities and impacts.

Regulation in this area will likely increase.

Solicitors

It's important for solicitors to keep apprised of current practice relating to green lease provisions so that they can give their clients the opportunity when appropriate to include such drafting in their leases.

Benefits for landlords

In addition to contributing towards a sustainable environment and planet, green leases can help landlords to:

• address investor and regulatory concerns about climate risk and compliance with environmental legislation (for example, MEES)
• respond to tenant and investor demand for sustainable buildings and particularly help broaden the appeal of the asset to sustainability focused lenders/debt markets, investors and investment funds
• reduce risk of greater costs, such as increasing insurance premiums, caused by the physical and transition risks of climate change (and in some cases increase profitability through the potential for more sustainable returns)
• improve cash flow through allowing capital expenditure to be spread more equally
• protect or improve asset capital and rental value
• encourage mutually beneficial behaviours with tenants
• incentivise tenants to use the property efficiently
• improve their reputation in the market
• provide data for regulatory and professional sustainability and ESG disclosure requirements
• assist with associated real estate matters such as insurance, secured lending, financial reporting

Benefits for tenants

In addition to contributing towards a sustainable environment and planet, green leases can help tenants to:

• achieve potential cost savings through, for example, better energy efficiency across building management, services and utilities
• enjoy enhanced wellbeing through a living/working environment that is better adjusted to the physical impacts of climate change (such as extreme heat or precipitation)
• have confidence that their ESG policies can be delivered
• attract and retain talent by demonstrating sustainable values
• support their own potential sustainability commitments or ESG policies and requirements, including CSR (corporate social responsibility) objectives
• understand and plan for sustainability matters rather than them be exclusively handled through external pressures, for example dilapidations and EPC

Green lease impact on the market and client demand

Both landlords and tenants will also benefit from enhanced protection from climate change transition risks by future proofing their businesses in line with expected changes to climate policy.

While commercial green leases are still being phased into the market, their adoption is likely to rapidly increase with broader implementation of the national sustainability related disclosure requirements.

Therefore, as businesses adopt Net Zero strategies and evolve their ESG policies, the demand for green leases may increase directly and indirectly through broader supply chain demands.

MEES and duty of care to advise on related risk

In many cases the biggest impetus to introduce green provisions to leases is the Minimum Energy Efficiency Standards (MEES).

The legislation to create the MEES came into force on 1 April 2018. At the time of writing, the effect of the legislation currently is that:

• if the energy performance certificate or EPC rating a property is termed ‘sub-standard’ (a rating of F or G), then
• the grant of a new lease or the extension or renewal of an existing lease of that property is unlawful and carries the potential of penalties for the landlord, unless
• a valid exemption has been registered

From 1 April 2023, this rating requirement (of a minimum lawful EPC rating of E) applies not only for the grant, renewal or extension of leases of commercial property but also for the continuation of any existing lease or tenancy of a commercial property.

In each case, where the property has an EPC rating lower rating than E, the landlord will be liable to a penalty unless a valid exemption is registered.

Beyond April 2023, the government currently proposes that staged rises in the required EPC rating for commercial properties are due in 2027 and 2030.

These rises will ultimately lead to a required rating of at least B.

The 2027 and 2030 rises will include a prior 'window' period in which landlords must obtain EPCs and are expected to carry out any necessary improvements or register a valid exemption.

We will update this guidance when details of these EPC rating requirement rises are finalised.

Landlord liability under MEES

The government estimates that the proportion of rented commercial property that will be required to be upgraded in order to meet MEES standards will increase from around 10% to around 85% (approximately 1,000,000 buildings across England and Wales).

The MEES requirements provide an important incentive for owners to investigate the energy efficiency of their property portfolio.

Local authorities have the power to serve MEES non-compliance notices on landlords and currently the financial penalties that may be imposed under such notices are as follows:

• financial: in cases of three or more months’ non-compliance the greater of £10,000 or 20% of rateable value of the premises up to £150,000. A penalty can be levied in respect of each unlawful lease, so in a large multi-let building, the penalties would quickly add up
• reputational: landlords in breach may be identified on the public part of the Private Rented Sector Exemptions Register, which will give details of the breach. Entries will not necessarily be removed when a breach is remedied. Therefore, a non-compliant landlord may also suffer unwanted adverse publicity and damage to its reputation

It should be noted that non-compliance is not a criminal offence.

Only the landlord suffers the penalty, so the tenant will not be liable unless it becomes a landlord itself by sub-letting all or part of the property.

Exemptions

One of the ways to avoid penalties is to establish and register one of the statutory exemptions.

The exemptions are:

• third-party consent refused: if the consent of a third party (such as a tenant or a local planning authority) is required to carry out works but is refused
• improvement would devalue or damage the property: if the improvements would result in a devaluation of the property by 5% or more or that the works would damage the property
• EPC rating substandard following works: if all cost-effective improvements have been carried out but this still does not result in an EPC rating of E or higher or there are no such improvements that could be carried out but the EPC rating remains substandard (for example F or G)
• improvement costs will not be recouped within seven years: under the ‘seven-year rule’ if it can be shown that the improvements would not pay for themselves through energy savings within a seven-year period

Exemptions are not automatic, require registration in advance on a government register and need to be renewed at least every five years.

They are also personal to the specific parties, so successors will not be able to rely on an existing registered exemption.

Solicitors’ duty to advise on MEES

Solicitors acting on transactions involving leases of property should, in all applicable cases, discuss the implications of MEES with their clients, especially in view of the changes taking effect on 1 April 2023.

This may be combined with a discussion about wider environmental issues, including green leases.

Climate legal risks impacting UK property

Solicitors should, in appropriate cases, draw their clients' attention to the risk of potential changes in:

• legislation or regulation, or
• the practice of insurers, mortgage lenders and other stakeholders in the property market

There are well-known risks from climate change that may directly affect property, such as increased flood risk and coastal erosion, and the tightening of MEES requirements.

However, there are numerous additional risks that might affect the use, occupancy costs or value of a property over the foreseeable future as the UK’s regulatory and legislative agenda shifts to support the transition to a net zero economy by 2050.

For example, it is anticipated that there may be an increase in the designation of areas as ultra-low emission zones and restrictions on the production or sale of certain categories of vehicles.

These can be categorised as climate legal risks (see the Bank of England’s taxonomy of climate risks).

Model green lease clauses

This section is not intended to provide a recommendation of specific green lease provisions, but instead identifies some commonly encountered green lease provisions, MoU and implementation guidance.

We encourage solicitors to examine these resources when developing or reviewing green lease clauses.

Judgment is required as to the appropriate circumstances where particular clauses may be relevant and suitable.

The Chancery Lane Project (TCLP)

TCLP has published a suite of frequently updated, leading ‘dark green’ lease clauses that are aligned with the Paris Agreement goals and which represent best practice:

These template clauses can be amended by solicitors according to their clients’ needs and sustainability targets.

The climate ambition of provisions can be scaled up over time as client demands shift.

Every TCLP clause comes with “essential notes and guidance” outlining the relevant climate issue, the commercial context and tips for overcoming barriers to use.

Each clause is given a child's name to remind users of the next generation who will benefit most from their use in contracts today.

Aatmay’s clause – sustainable and circular economy principles in leasing arrangements for repair and alterations

Aatmay’s clause enables landlords and tenants to reduce unnecessary waste and purchase of new products (and the associated greenhouse gas emissions) by prompting them to follow circular economy principles in repair and alterations and to prioritise the use of reclaimed, re-used or recycled goods or materials, where possible.

The Environment Agency has used the circular economy elements of Aatmay’s clause in drafting its own construction materials supplier sustainability clauses. (See TCLP case study.)

Rosie’s clause – alteration/improvement provisions in leases to improve climate impact of buildings and better use of shared space

Rosie’s clause requires the landlord to act reasonably and not delay its consent if a tenant proposes alterations that will improve the environmental performance of the premises, the building, or the wider development.

Toryn’s clause – green assured shorthold tenancy (AST) clauses

Clauses to give tenants a modest rental rebate for 'green' household management and to give landlords the ability to invest in renewable energy installations while their rentals are occupied.

Lotta’s clause – landlord and tenant obligations to provide renewable electricity

Lotta’s clause is a relatively low barrier to entry clause that delivers emissions reductions for landlords and tenants by ensuring that electricity supplied to a leasehold property is from renewable sources.

Oisín’s clause – landlord and tenant obligations to create additionality in renewable electricity generation

Building on Lotta’s clause, Oisín’s clause provides a series of stepped options for commercial leases that help corporate landlords and tenants generate additional 'green' electrons for the electricity grid where their leasehold property is located.

Hannah’s clause – green service charge provisions for commercial leases

Hannah’s clause allows landlords to include the costs of improving the environmental performance of leased buildings in the service charge (where such works are not otherwise required by statute).

The Better Buildings Partnership (BBP) Green Lease Toolkit (2013)

The BBP has published a free toolkit to enable owners and occupiers of commercial buildings to adopt green lease clauses.

As the guidance is non-prescriptive, it represents more of a ‘light green’ approach to green lease clauses.

The toolkit includes the following:

• best practice recommendations: non-prescriptive best practice recommendations by which, through a partnership approach, owners and occupiers can agree appropriate arrangements to best fit with the circumstances of individual properties.
• a model MoU which can be used in full or in part and which parties can enter into at any stage of a lease.
• model Form Green Lease Clauses: which the BBP believes should be included in new and renewal leases as a minimum as best practice. The extent to which these clauses are used will depend on the parties’ ambitions and what is appropriate for individual circumstances.

At the time of writing, the Green Lease Toolkit is being reviewed, and a revised version is set to be published in 2023.

Law Society business leases

The model short-form business leases we published will be supplemented by optional light-green clauses following the revision of the BBP Green Lease Toolkit (above).

Model commercial lease

The model commercial lease draft leases have received widespread adoption across the market.

The leases contain a ‘sustainability’ schedule which includes clauses focusing on co-operation, data sharing and consideration of impacts on environmental performance.

The drafting “is not intended to impose onerous obligations in relation to sustainability issues but is intended to facilitate a discussion between the parties about these issues”.

The NHS model green lease for commercial premises

The NHS has published a standalone suite of sustainability provisions that can be bolted on to a new commercial lease with an accompanying MoU and draft set of clauses.

It contains versions of both dark and light green provisions to suit the ambition level of the user.