ESG is not a new concept, and both landlords and tenants have had to deal with ESG-related issues for a number of years, ranging from Minimum Energy Efficiency Standards (MEES) to green lease clauses.
However, this barely scratches the surface of the sorts of ESG-related issues which will impact upon the landlord and tenant relationship over the coming years.
Landlord works to improve energy efficiency
We have already seen some institutional landlords announce that they are looking to improve the energy efficiency of their existing building stock, and one of the issues that will arise is whether a landlord can recover the costs of these works through the tenant service charge.
Whether a landlord will be able to recover the costs of these works through the tenant service charge will depend upon the nature of the works and also the detailed terms of any service charge provisions.
One of the stumbling blocks for landlords is that energy efficiency works are likely to be classed as ‘improvements’, and many service charge provisions do not allow landlords to carry out improvements and recover the costs of the same from tenants. Invariably landlords can recover the costs of carrying out repairs to a building, but if a landlord is carrying out energy efficiency works, it is not necessarily going to be the case that the existing building’s plant (e.g. air conditioning) or external structure (e.g. glazing) is in disrepair.
Looking at semi-analogous issues relating to defective cladding, post-Grenfell decisions in the First Tier Tribunal (such as FirstPort Property Services Limited v various leaseholds of Citiscape [2018]) have allowed landlords to recover the costs of replacing defective cladding through the service charge, in the absence of an express right to recover the cost of “improvements”, notwithstanding that the defective cladding itself was not in disrepair. In Citypoint this was in part because the lease stated that the landlord could recover the costs of works of “renewing or otherwise treating as necessary”, and the landlord was also obliged as part of the services it provided, to keep the property “in good and substantial… order and condition”. The tribunal considered that this wording went far enough to cover the replacement of defective cladding, notwithstanding that the cladding was not in disrepair.
Unfortunately for landlords, it would likely be too much of a stretch to adopt the same analysis for all and any works to improve the energy efficiency of a building, and so absent any specific right to recover the costs of energy improvement works and/or general improvements, landlords are likely to have to be prepared to fund their energy efficiency improvement works themselves. However, this will not always be the case. For example, if a landlord’s property is currently rated as substandard (F or G), and the landlord wants to carry out works to improve the energy efficiency of the building, the landlord may well be able to avail itself of the service charge if, for example, the landlord is required to keep the property “in good and substantial… order and condition”. It seems difficult to argue that a substandard property, from a MEES perspective, is in good and substantial “order and condition”.
Alienation
Obviously the impact of ESG on landlords and tenants is much broader than issues relating to energy efficiency and MEES.
For example, more and more real estate investors will have policies and directives governing the types of business that they will deal with. For example, an institutional landlord may decide that it wants to introduce a policy that it will only let space to tenants that meet certain benchmarks relating to, say, the ethical nature of the occupier’s business or sustainability.
What happens if a landlord receives an application from an existing tenant to assign or underlet to a tenant that falls foul of such a policy?
It is well settled that a landlord’s desire to keep a good tenant mix can constitute an adequate reason for refusing consent to assign or underlet (Moss Bros Group plc v CSC Properties Ltd [1999]), and so the concept of a tenant mix policy focussed upon ethical/sustainable benchmarks could well constitute a reasonable reason for refusing consent to assign or underlet, provided that any such policy was clearly defined and consistently enforced by the landlord and did not reduce the class of acceptable tenants to a level which severely restricted the prospect of assignment.
Alterations
Many landlords and tenants will have carbon reduction commitments and sustainability objectives, which are likely to impact upon their approaches to alterations.
For example, in relation to tenant alterations and fit-outs landlords may well want to try to require tenants to use certain types of sustainable materials, or try to require tenants’ fit-outs to be sufficiently generic so that there is less chance that they will need to be reinstated on reletting.
When it comes to alterations, many leases will allow tenants to make alterations with the landlord’s consent, such consent not to be unreasonably withheld. Disputes may arise as to whether it is reasonable for a landlord to try to impose sustainability-related conditions as part of any consent to a tenant’s fit-out or alterations, or to refuse consent to works which are inconsistent with a landlord’s carbon reduction objectives.
As carbon reduction and sustainability metrics and targets take on greater importance for more and more businesses, many landlords may want to try to impose sustainability-related conditions. Although this is not something that has yet been properly addressed in the Courts, it seems inevitable that it will become accepted over the coming years that it will be reasonable for landlords to refuse consent to alterations which do not comply with a landlord’s carbon reduction commitments or sustainability objectives. Landlords may however find this more challenging in the context of older leases where such objectives were unlikely to have been contemplated when the lease was entered into.
Redevelopment
In the last couple of years we have also seen a significant increase in the number of ‘sustainable’ or ‘reduced carbon’ developments.
In the case of a redevelopment, what this will often mean is that rather than completely demolishing an existing building and then erecting an entirely new building in its place, more and more redevelopments will retain some of the structure and fabric of the original building. There are big advantages to this approach from a carbon reduction perspective, as often much of the basement substructure and concrete superstructure can be reused.
However, if a landlord is looking to redevelop its building, it will want to ensure that it does not unnecessarily overcomplicate the process of obtaining vacant possession from its existing tenants.
A landlord may have tenants in occupation who occupy pursuant to leases which have the protection of the Landlord and Tenant Act 1954. Landlords are only able to oppose renewal of 1954 Act protected leases (in order to obtain vacant possession) on certain grounds. The most commonly used ground is ground (f), redevelopment, which provides that a landlord can oppose the renewal of a tenant’s lease if "... on the termination of the current tenancy the landlord intends to demolish or reconstruct the premises comprised in the holding or a substantial part of those premises or to carry out substantial work of construction on the holding or part thereof that he could not reasonably do so without obtaining possession of the holding."
Let’s say a landlord lets the basement of its building to a gym operator occupying the whole of the basement and the gym operator's lease demises certain elements of the structure. If the landlord’s redevelopment plans include retaining the existing basement substructure, this may complicate the process of relying upon ground (f) to obtain vacant possession of the basement. This is something that landlords should bear in mind when planning a redevelopment.
Where does this leave landlords and tenants?
ESG already gives rise to a number of issues for landlords and tenants, ranging from MEES to negotiations over green lease clauses. However, it is clear that going forward landlords and tenants are going to have to deal with a host of novel ESG-related issues which will affect key aspects of the landlord and tenant relationship, including but by no means limited to the issues discussed here.
This article was first published in EGi on 2 August 2022
Authored by Benjamin Willis.
