ESG and green dilapidations

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ESG and green dilapidations

ESG is increasingly dominating conversations between commercial landlords and their tenants on the management of their properties. The government’s aim to reach their net zero target by 2050 is continuing to put pressure on landlords to consider investing in the sustainability of their portfolios to achieve this goal. Tenants are looking for greener and more sustainable properties with better facilities and lower operating costs to help promote their business as being energy efficient.

The idea of re-using and reducing waste of materials is now increasingly being applied to dilapidations.

Traditional method of dilapidations

Broadly speaking, the traditional dilapidations model requires a tenant to reinstate the premises to the condition as at the grant of the lease. This will usually require the tenant to put the premises back into the same condition as at the date of the grant of the lease. Normally, a tenant will remove their fit out and the landlord will be left with an empty premises to then re-let to another tenant who will install their own fit out for their occupation.

The current regime of fit out, reinstatement and dilapidations is therefore undeniably wasteful.

New tenants often fit out the newly cleared space with very similar design and fittings, due to the nature of the building. For example, well-designed office fittings are often removed at the end of a lease only to be replicated with a pretty much identical fit out by the new tenant.

We are also beginning to see a rise in shorter leases which results in a greater rate of tenant churn. If each tenant’s fit out works are removed every few years, then the environmental impact is extremely concerning. In addition to this being wasteful, it is also both environmentally and financially expensive and is inconsistent with the drive for a circular economy.

How can we make dilapidations green?

Instead of removing the existing fit-out and replacing with a new, the landlord and tenant can work together to seek to agree what elements of the tenant’s fit out could remain for the incoming tenant. The key objective would be to repair and retain a portion of the older fit out, showing its most attractive and sustainable iteration, as opposed to the standard practice of presenting bare space to the market. If the new tenant likes what they see, the remainder of the space can be improved in the same way ahead of their arrival, saving time, money, and carbon in the process.

There may also be ways in which landlords judge a tenant’s application for consent for alterations. Most leases state that the landlord should be ‘reasonable’ when approving works that the tenant intends to carry out. The question is, what is considered ‘reasonable’ given today’s climate crisis?

Landlords may be able to lead the way here if they assess tenants fit-outs on criteria such as, future reuse, sustainable sourcing, disassembly and other requirements for items stripped out to avoid landfill or other carbon-intensive recycling.

How would green dilapidations be implemented?

The agreement would be underpinned by a memorandum of understanding, agreed and signed by both the landlord and tenant. The memorandum of understanding would identify the process by which the landlord agrees to try to let the premises without automatically removing the tenant’s fit out.

Whether or not the premises would be re-let with the current fit-out in situ to another party, the dilapidations process in the memorandum of understanding is intended to be fair to both landlord and tenant, and both will know they have at least attempted to reduce carbon emissions and waste.

The Chancery Lane Project has published ‘Aatmay’s Clause’ which is specifically aimed at green dilapidations. The clause encourages landlords and tenants to re-use goods and materials. Whilst the use of green clauses appears to be increasing, use of green dilapidations clauses is not as widespread.

What could be the future for green dilapidation claims?

It seems quite early to say with certainty where green dilapidations and landlord and tenant requirements will move to over the next few years. However, it seems inevitable that disputes may arise in this area, specifically when asking who is responsible for payment of these new strategies being implemented. This then brings the debate of accountability in paying for the necessary renovations that comply with new energy standards and achieving net-zero goals.

Currently, the assumption in dilapidation claims is that landlords will argue that their tenants pay for reinstatements. However, new green dilapidations and net-zero targets could provide tenants with an opportunity to reduce landlords’ dilapidations claims. The claims could be argued against the landlords’ net-zero targets and their adoption of the principle of a circular economy. It is expected that tenants may raise this argument as a defence to some claims.

This blog was co-authored by Richard Glover and Rachel Airriess.

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