I recently worked with a commercial tenant in Trafford Park who had installed a big mezzanine level in their store, introduced offices and changed the lighting to LED as part of the fit out.
The EPC* rating was a B, but the landlord wanted the company to strip it all out when the lease came to an end, despite being told that the EPC would then drop to an E. It was frustrating for the tenant, but they didn’t have a leg to stand on as they’d made changes suitable for their occupation that the landlord simply didn’t want to accept – despite not having another tenant lined up.
At the end of any commercial lease, the principle is always to reinstate a building to how it was when you first rented it, because the layout and fit out – however great – might be unsuitable for the incoming tenant. If there’s any damage to the building fabric, including the brickwork, cladding and floors, you might also need to rectify this. When you’re moving out, you could well have to pay for these repairs, called dilapidations, which will have been written into the lease. A dilapidations claim relates to the state of repair, itemising all the work needed. If this isn’t done, the landlord can claim compensation, although they must have complied with the dilapidations protocol by sending you a dilapidations schedule setting out the breaches, the works required and estimated cost.
Tenants also need to comply with the minimum commercial MEES** obligation – currently an EPC band E until 2027 when it becomes a C – but the EPC is ultimately a landlord’s obligation. As such, they might be required to carry out works to improve the rating at the end of the lease, if the property is sub-standard, in order to allow the premises to be lawfully let. Such improvements could make any repair works tasked to the tenant under the lease unnecessary. Plus, if the tenant has carried out works to improve the building’s EPC rating, the landlord might want to benefit from the resulting improvements and not insist on reinstatement.
When working out what the EPC might be if tenants need to reinstate back to a shell – and if there are additional works needed to bring it up to MEES standard – landlords will consider how much they can pass on to the tenant – and tenants are pushing back against this. In one court case – Clipper Logistics v Scottish Equitable – the landlord wanted to add a lease prohibiting the tenant from carrying out any alterations or additions to the property which would result in it being designated as ‘sub-standard’ under MEES regulations, as well as requiring them to compensate the landlord for the cost of obtaining a new EPC certificate if they made any alterations which invalidated or adversely affected the EPC, and to oblige the tenant to return the premises to the landlord with the same EPC rating and undertake remedial works to restore the rating if it had dropped. The court ruled that it was the landlord’s responsibility to comply with the energy efficiency regulations, but also recognised that the landlord could be placed in breach of the regulations through no fault of their own.
While the courts might sympathise with the landlord under the existing MEES regulations, adding obligations onto tenants in a bid to reduce their liability won’t be considered fair or reasonable in the context of lease renewals. Some landlords have historically gone down this route, in the same way they might just want to collect the rent and avoid paying out whatever they can, but that’s not the best way to operate. It will be interesting to see how this plays out, especially when the EPC calculation methodology changes (as it did in 2022 to take account of the reduced carbon intensity in electricity) which could improve or degrade an EPC rating at the time the lease was granted. It’s quite a complex area which will undoubtedly lead to disputes and more case law, but the use of green clauses is helping to provide clarity. These can include terms to manage energy efficiency and might restrict the tenant from carrying out alterations which could have an adverse impact on the building’s EPC rating or environmental performance, or there may be an obligation that a tenant’s fitting out works mustn’t affect the energy efficiency standard.
There are also now green dilapidations clauses that – although not common – are being included by some landlords. Due to the timescales set out in a traditional lease there is often little flexibility to look at anything other than a full reinstalment when it expires. However, with a green dilapidations clause, the focus is on the landlord and tenant working together to try to agree what elements of the tenant’s fit-out could remain for a new tenant. Extending the principles more widely might mean exploring whether landlords can market units with a basic non-bespoke fit-out in situ, potentially reducing the materials that need to be removed at the end of a tenancy. It’s a sensible idea and a good way to reduce conflict and waste. But as ever, in situations where a landlord is arguing points around MEES, a tenant needs professional advisors who will be acutely aware of MEES regulations so they can help them get the best deal possible. It’s a bit like having a mediator in a divorce settlement. Perhaps Murton & Co could add counselling to our specialties…
*EPC – Energy Performance Certificate
**MEES – Minimum Energy Efficiency Standards