Green leases: what are they and how do you draft them?

The United Nations Principle for Responsible Investment predicts that by 2025 we will see a dramatic acceleration in climate policy across the globe.

Current and anticipated government policy around the greening of building stock, coupled with public desire, has seen landlords and tenants consider their impact on the environment and how they can mitigate this.

Environmental impact of property

One weapon in the environmental armoury is green leases.

Green leases contain a series of additional provisions that impose an obligation on the landlord and tenant to manage and reduce the environmental impact of a property by way of improvements.

Green leases tend to only relate to commercial properties rather than residential.

A softer alternative to green leases is a memorandum of understanding.

This is an agreement entered into between the landlord and tenant that dictates how the environmental impact of the property should be managed.

A memorandum of understanding not legally binding in nature and is more easily updated and amended than a lease.

For this reason, it’s usually a quicker way to agree environmental objectives between the parties.

When considering the environmental impact of a property, the buildings’ energy efficiency rating is often one of the most common considerations.

However, the environmental impact of a property goes beyond its energy efficiency rating and includes:

• energy and water consumption
• waste generation
• travel to and from the buildings and the materials used in the fit out
• refurbishment and alterations of the property

The obligations contained in green leases and memorandum of association can go beyond simply ensuring that the property has a higher energy efficiency rating.

Why green leases?

Concerns about the significant contribution of buildings to greenhouse gas emissions has led to an increased appetite to address energy efficiency issues in property.

New-build properties can address these concerns at the point of construction but, as most of UK property stock already exists, it needs to be made more energy efficient retrospectively.

While there is no requirement in the UK to enter into a green lease, there are pieces of legislation that impose energy efficient requirements, as well as policies such as the Minimum Energy Efficiency Standards (MEES) regime.

Minor energy efficiency works do not need to be costly – a landlord may simply require that their tenant turns off the lights at the end of the day or use energy efficient light bulbs.

However, the more recent instability of energy supplies and higher prices presents another incentive for landlords to reduce costs by ensuring that their properties have as little energy wastage as possible and to rely less on insecure supplies.

Businesses, particularly larger businesses, are increasingly pledging to meet environmental targets and bind themselves to green policies.

This is in part due to a desire to mitigate their environmental impact, improve the optics of this from a marketing perspective and align themselves with the values of their staff and potential recruits.

A notable example of this is Marks and Spencer, which pledged to implement green clauses in all its stores by using its brand power to dominate negotiations.

Softer green pledges can include ‘going paperless’, which translates into a promise to significantly reduce the use of paper. This in turn may also reduce the cost incurred by the business in ink, printers and paper.

Buildings occupied or owned by central government are required to be renovated to meet a minimum energy efficiency standard if they are heated or cooled (or both).

Public body tenants, such as an NHS trust, should seek energy efficient buildings to lease (where they can).

Why aren’t green leases more popular?

Both landlords and tenants want the benefit of an environmentally friendly property but often neither want to bear the cost associated with it.

Usually, landlords incur the responsibility and cost for improvements that cannot be recovered via the service charge (unlike repairs).

While in theory the landlord may be able to charge a premium for a green property, this is only true if there is sufficient demand – and this depends on the cost benefit to the tenant.

Often, the improvements to a property are long-term investments in which the landlord and tenant reap the rewards over an extended period.

Post-COVID-19, tenants appear to be taking a more cautious approach and are increasingly taking non-registrable shorter-term leases to avoid making a longer financial commitment.

For this reason, tenants are reluctant to invest in capital expenditure for works that they are unlikely to see the benefit of.

Standard leases are also drafted so that the tenant is required to leave the property in the condition it was in when the lease was granted.

While it would seem unlikely that the landlord would request this where improvements are made, if they did, this would mean further costs for the tenant.

To circumnavigate this issue, we may see an increase in an environmental improvement funds as part of the service charge collected by the landlord, but this is still not widely used.

Alternatively, the parties could choose to only commit to less costly obligations, as a way of introducing the benefits of green leases without the associated financial risk.

Solicitors may also be reluctant to agree to the green clauses in leases because it imposes additional and unfamiliar obligations on their client.

Similarly, agents may be hesitant to deal with green leases for fear of it making the matter more complicated and delaying completion.

Drafting green leases

There is no legal requirement in the UK to have any form of green lease or green clause and as such, there is no widely used standard form of wording.

Each green lease, clause, or memorandum of understanding will be unique depending on:

• the type of property
• its environmental priorities
• the commercial needs, wants and budget of the landlord and tenant

However, the clauses generally seen will vary in severity.

Depending on whether the environmental obligation in the lease is considered an outline of best practice or legally binding, clauses can be categorised as light, medium or dark green.

Light green clauses

Light green leases generally contain clauses which are not legally binding, require limited commitment and extend to improving energy efficiency only.

Examples of light green actions may include:

• the parties entering into a memorandum of understanding rather than a green lease (which offers the landlord and tenant greater flexibility)
• the document that is agreed is outside of a lease and is personal to the parties
• it is not passed on when the lease is assigned or transferred

A light green clause within the body of the lease may include the tenants’ environmental improvements being disregarded upon rent review, encouraging the tenant to engage with green policies without fear that this will increase the market rent following the review.

Dark green clauses

Clauses which are legally binding, require a significant level of commitment and cover more issues than just energy efficiency are likely to be considered dark green.

This could include:

• an obligation on the tenant to use only sustainable materials when completing tenant works, or
• an obligation on the landlord to offer a rent reduction should the tenant meet its energy efficiency targets

A breach of a dark green clause should not lead to a forfeiture event as this is considered too draconian.

Using green leases

Green obligations can be incorporated by reference to them within the lease, such as a requirement for the tenant to comply with tenant regulations, estate regulations or an environmental handbook.

Although there is no widely-used and standardised form of green lease there are common objectives often represented in the drafting, such as an obligation to co-operate with each other – this includes the legal representatives of both the landlord and tenant working together to achieve the common goal.

While this does not impose meaningful obligations on either party it does set clear intentions of how their relationship is intended to look moving forward.

Depending on the size of the property, the parties may also agree to the creation of a building management group who oversee the implementation and compliance of green lease clauses.

Data sharing, efficiency monitoring and sharing meter data provides a greater understanding of the energy, waste and water consumption, providing a benchmark for the landlord and tenant to work from.

A landlord with a greater negotiating position may seek to ensure that the lease allows them to make improvements to the property unilaterally if they reasonably believe that this will improve its environmental impact.

Conversely, a landlord’s ability to complete works could be limited to the extent that the landlord is absolutely prohibited from finishing works which would negatively impact the energy performance rating of the property, or only with the tenant’s consent or without first considering the tenants reasonable proposals – depending on the bargaining strength of the tenant when the lease is negotiated.

A mutual obligation on the tenant’s ability to make alterations may also be imposed.

Green leases are an evolving area of property law which is expected to be more prevalent in the coming years.

Getting to grips with the basics now is essential to best advise clients and stay up to date with property trends.