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Thousands of buildings open during the next two weekends 11 September 2015

We are approaching the time of year when thousands of buildings in England open to the public over two weekends, entirely free of charge.  Some of these are normally not open at all, while others normally charge but visiting will be free on these days.

First of all, this weekend (12/13 September 2015) will be Heritage Open Days around the whole of England, with the exception of London.  On Saturday, to take just one example near where I live, you can visit the elegant Woking railway control room, constructed in the 1930s when the railway was electrified.  It is no longer used but has been beautifully preserved, with all its art deco features intact.  There are several thousand other places to choose from, and a brilliant interactive map on the website to help you decide where to go.

And next weekend (20/21 September 2015) is Open House London.  As usual, I will be acting as a volunteer guide at one of the buildings on the Sunday.  This year it is the office of the London Mathematical Society, at 57/58 Russell Square, London WC2.

Click through to the respective websites and plan your visits now !  May the sun shine for us all.

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The implications of protecting the priority of an agreement for lease 11 September 2015

Is it important whether the wording of a lease granted pursuant to an earlier agreement for lease follows exactly the form annexed to the agreement?  There might be SDLT implications, I suppose.  But there is a definite possibility that it could affect the effectiveness of any priority protection for the agreement for lease at the Land Registry.

I wrote about the case of A2 Dominion Homes Ltd v Prince Evans Solicitors [2015] EWHC 2490 (Ch) in my article “Effect of registering a notice at the Land Registry to protect an agreement for lease” on 21 July 2015.  At the time all we had was a Lawtel summary.  The court ruled that a notice lodged to protect an agreement for lease was effective also to provide priority for the lease granted pursuant to the agreement for lease.  In that case, the landlord had granted a mortgage over the property between exchange of the agreement for lease and the grant of the lease itself (there were 33 of them, in fact).  The court held that the tenants’ leases took priority over the mortgage, and therefore that the mortgagee’s consent was not needed under the terms of the mortgage.

That made sense.  In fact, it was what we had always assumed to be the case – had we stopped to think about it.

The devil is in the detail

But, as usual, the devil is in the detail.  The transcript is now available (although only available so far to Lawtel subscribers).  In summing up what the judge considers to be the law, there is a nasty sting in the tail:

“32.  In relation to the two points raised by Mr Denehan, in what I must say was a most attractive argument, it seems to me that a clear distinction between the agreement for the leases and the leases themselves is rather artificial. The latter are the product of the former.  In my view, so long as the leases themselves strictly conform to what the agreement for the leases provides, it is wrong to make a distinction between equity and the law in the way that Mr Denehan does [ie to distinguish between the priority afforded to the agreement for the lease and the priority afforded to the resulting lease].  In the result, I will answer the preliminary issue in the negative.” (My underlining)

The underlined wording is where a problem may lie in the future.  Grudgingly, I think I have to agree with the judge’s view.  From the point of view of the mortgagee in this case, for example, the terms of the lease were known, and the mortgage was granted subject to that lease – but not any other lease.  So when will a change in the wording of a lease take it beyond what any prior agreement provides for?

Keen landlord and tenant anoraks (are there any other kind?) will remember that a similar issue arose in Receiver for the Metropolitan Police District v Palacegate Properties Ltd [2001] Ch 131.  This was a case under the old contracting-out system under the Landlord and Tenant Act 1954, which required a court order to be obtained.  The question in that case was whether the contracting-out agreement was still valid if the wording of the lease had been changed after the court order (which exhibited a copy of the lease) had been made.  The alteration in that case was merely that the rent would be payable in advance rather than in arrears.  Pill LJ in the Court of Appeal in that case said —

“The words “that tenancy” in section 38(4)(a) [of the 1954 Act] require its terms to bear a substantial similarity to that before the court when authority was given.  In particular, changes material to the need for protection may nullify the authority granted.  For example, the length of the term would be a material consideration in the case of a lease which contemplated substantial capital expenditure by the tenant.”

So, on the facts of that case, the (extremely minor) amendment to the lease did not vitiate the parties’ agreement to contract out the lease.

In passing, the issue is, of course, still relevant to the more modern contracting-out procedure involving the landlord’s warning notice and tenant’s declaration (or statutory declaration) introduced in 2004.  At what point does one start worrying that the lease that the tenant is entering into is no longer in the same form as the lease in respect of which the landlord’s notice was served?  In other words, does the Palacegate ratio still apply under the current procedure?  (Or, to complicate matters, does it even matter, as I suspect that it was assumed by the civil servants who wrote the new procedure that the warning notice would be served at heads of terms stage, long before any draft lease had even been proffered to the tenant.  On that view, no variation of the wording would be relevant so long as the core details of the transaction have not changed.)

So where does that leave us, in relation to protecting an agreement for lease?  My feeling is that Palacegate is irrelevant, as it related solely to a specific statutory procedure under which it was important for the tenant’s interests to be protected.

So we are in completely unknown territory.  I imagine that the court (if ever asked) would say that one looks at the question from the mortgagee’s point of view.  Is the mortgagee disadvantaged by the lease that has been granted as compared by the lease that was envisaged to be granted by the agreement for lease to which the mortgagee took subject.  That would be something that the mortgagee would probably find it difficult to show – perhaps a materially lower rent, or a longer term.

McCausland

It might also be necessary to consider the implications of McCausland v Duncan Lawrie Ltd [1996] 4 All ER 995.  In that case the Court of Appeal held that the effect of varying a contract is to create a new contract.  In that case the variation (of the completion date) was by exchange of letters, which was held not to satisfy the requirements of section 2 Law of Property (Miscellaneous Provisions) Act 1989.  That meant that, on the facts, there was no new contract.

Of course, if there had been a new contract, it would be necessary to consider whether any notice to protect the old (superseded) contract would also protect the new contract.  That could be relevant in a case like this.  However, in our case, the likelihood of a new contract coming into existence where the form of lease is varied slightly between exchange and completion is slim, I think, as there would probably be no one document that would satisfy section 2.

The practical answer

Of course, some agreements for lease may provide for the lease to be granted “in the form of the attached lease with such amendments as the landlord and the tenant may agree“.  Might that solve the problem entirely?  Would that mean that a mortgagee would be subject to any changes that the parties agree?  Perhaps, but it must be rare for this type of problem to arise – so we may never find out.

Click here for the transcript on Lawtel (subscription required)

 

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The effect on commercial leases of the Minimum Energy Efficiency Standard – Part 2 1 September 2015

This is a very long article. I have therefore prepared a PDF version of it, to make it easier to read and print out.

PDF version of this article

In Part 1 of this article, published on 27 August 2015, I started to consider the effect on commercial leases of the Minimum Energy Efficiency Standard, which I shall term MEES.

I looked at seven different aspects of commercial leases, and concluded that in relation to MEES, typical lease provisions will make it relatively difficult for landlords to pass on the costs to their tenants.  So for future lettings, might landlords want to alter the wording of typical leases so that they are more in their favour?  I will consider this question under the same seven headings.

As in Part 1 of this article, everything that I am talking about relates to commercial lettings.  I don’t know enough about residential lettings to be able to talk sensibly about what is likely to happen.

Also as in Part 1 of this article, this is only a very quick summary of some of the key issues.  I have not carried out any detailed research into the cases.

Again, I am grateful to Charles Woollam of Sustainable Investment & Asset Management (SIAM) for commenting on the initial draft of this article (but of course the views in it are my own).

1.  Service charges

Assume that a lease allows a landlord to recover via a service charge the cost of operating and maintaining a building, but not improving it, which is a good baseline (some leases may allow landlords the cost of improvements, in which case those landlords need not read any further).  In Part 1 of this article, I concluded that landlords may well be able to recover the costs of replacing plant by more energy-efficient versions from their tenants where this entails replacing kit that is life-expired.  But where the current system is in working order and is only being replaced because the landlord needs to obtain a better EPC rating, the cost of replacement is likely to fall on the landlord rather than the tenant.

So landlords may wish to ensure that they are expressly permitted to include in the service charge the cost of replacing kit that is still in working order in order to improve the building’s energy efficiency.  There are various ways of saying this, depending upon how obvious the landlord wants to make it.

By way of example, the Model Commercial Lease already contains a provision that allows the landlord to include in the service charge:

“Auditing the Environmental Performance of the Building and, where reasonable and cost-effective to do so, implementing the recommendations of any environmental management plan the Landlord has for the Building from time to time”

This looks pretty innocuous, so many tenants will overlook it.  Furthermore, a tenant who does see it may well be prepared to accept it given that the landlord cannot take advantage of this provision unless it is reasonable and cost-effective to carry out the improvement works.

2.  Yielding up

In Part 1 of this article, I concluded that a standard yielding-up provision does not require a tenant to bring the property up to a minimum E rating at the end of the term.

The suggestion I have heard is that the wording of the yielding-up provision should therefore be amended so that it requires tenants to ensure that, at the end of the term, the EPC rating of a building is no less than the minimum required under MEES, or perhaps even the same rating (or at least the same rating) as existed when the property was first let.

This seems unfair to tenants.  The basic position has always been that they should deliver the premises back to the landlord at the end of the term in a good state of repair – which might be a better state of repair than when they took it, but at least it is the same property.  Requiring a particular level of EPC rating might well involve handing back an improved property, which is more than a repairing covenant would normally require.  This was discussed in the seminal case of Ravenseft Properties Ltd v Davstone (Holdings) Ltd [1980] QB 12.  The key question, of course, is one of fact: is the tenant being asked to hand back something different from what was originally demised?  In that case the court held that a property with effective expansion joints in the exterior stonework was effectively the same property as had been demised (but with faulty expansion joints).

In passing, it is worth pointing out that it is possible that the criteria for obtaining a particular EPC rating may tighten over time, if the requirements of the Building Regulations change.  So a property that is rated D today may be rated E in five years’ time.  I have to say that this is something that I have heard many times, but I have no idea whether it is correct.  The workings of the algorithm inside the EPC software for commercial properties (SBEM – Simplified Building Energy Model) is a mystery not just to me but to everyone else I have spoken to about it.

If this is correct, then a tenant who agrees to hand back a property with at least the same EPC rating could be taking on a commitment potentially to hand back a different property at the end of the term.  Tenants would be ill-advised to accept such a provision, in case this argument is correct.

3.  Statutory compliance

In Part 1 of this article, I concluded (tentatively) that a tenant that agrees to comply with statute in respect of the property does not become liable to ensure that the property has a minimum E rating, or to pay the costs of work necessary to achieve it.  I cannot see landlords trying to change that situation.

In fact, perhaps tenants should be asking for a specific carve-out to this provision to make it clear that tenants are not liable to carry out any works that are required directly as a result of MEES (although from a landlord’s point of view, this is not desirable, as it may not be possible to ascertain whether particular works would or would not fall within such a carve-out).

4.  Governing how, and when, a tenant obtains an EPC

It is relatively rare for leases to govern how, and when, a tenant obtains an EPC, but this is likely to change pretty quickly.

There are a number of reasons why landlords may be concerned about this.

First, there is a perception (unproven, I hasten to add) that some EPC assessors “mark higher” than others, and landlords may have their favourite assessor, and may not want the tenant to use any other assessor.

Also, a later EPC supersedes an earlier one, so a landlord will not want a tenant inadvertently to reduce the rating of the property by obtaining its own EPC rating that turns out to be lower than the current one (not impossible – rating a complex building seems to be as much an art as a science).  It is still unclear what effect a later EPC of part of a building will have on an EPC of the whole.  Possibly it will supersede the earlier EPC to the extent of the part of the building to which it relates (it is thought unlikely that it will supersede the EPC in relation to the whole building).  In any event, this is an area that a landlord will want to stay well clear of.

Thirdly, where a building does not yet have an EPC, a landlord may wish to prevent a tenant obtaining one, except where the tenant is legally bound to obtain one (ie in advance of a proposed assignment or sub-letting).  This is to try to ensure that the building is not brought within MEES as from April 2023 when it would otherwise be outside MEES because it does not have an EPC at all.  (However it may be too late to worry about that now, since any lease granted now will require an EPC to be obtained in any case.  So it is only relevant to leases that were granted before 2007 and that will still exist in 2023.  There probably are not too many of those.  Although that is of course assuming that landlords obtained EPCs when they were meant to obtain them, which might not be the case.)

So for all these reasons, there may be provisions in new leases about EPCs.  It is thought that it is unrealistic for a landlord to stipulate in a lease that a tenant must not obtain its own EPC, given that there are occasions when the tenant is under a legal obligation to pass a copy on (to a potential assignee or sub-tenant).

However, a landlord may wish a tenant not to obtain its own EPC when there is already an EPC in place for the building.  Where there is no EPC, landlords might wish tenants to use the landlord’s choice of EPC assessor.  The landlord might even wish the tenant to ask the landlord to obtain an EPC where the tenant needs one, where there is no EPC in place already.  The fact that the tenant would not then have to pay for the EPC may be sufficiently attractive for the tenant to accept such a provision.

It is worth mentioning that if the tenant breaches such a covenant against obtaining its own EPC, the landlord is going to be unable to do much about it.  The tenant’s EPC will exist and cannot be made to unexist.

5.  Alterations

Currently alterations covenants do not mention environmental performance.  I have heard it suggested that landlords might wish to be able to prevent tenants carrying out alterations that would (or perhaps merely might) have an adverse effect on the building’s environmental performance, or perhaps on the EPC rating.

Tenants would be nervous about accepting such a restriction.  It could interfere with their normal use of the property for their business.  A change of use of part of the property to, for example, a server room could worsen the EPC rating.  Or at least a landlord could raise that argument, and leave the tenant to try to refute it.

As an alternative, it has been suggested that landlords might be prepared to let tenants carry out whatever alterations they are permitted to carry out under the lease, without regard to any effect those alterations might have on the EPC rating, on condition that the tenant returns the property at the end of the term with an EPC rating at least as good as when the lease was granted.  That would only be appropriate in a letting of whole, where it would be clear that it was the tenant that was responsible for the drop in the EPC rating during the term (this would not be the case in a multi-occupied building).

For the reasons explained in the “yielding up” section above, tenants should be wary of agreeing to such provisions.  In addition, one cannot be certain that a property that is rated X today will be rated X in ten years’ time, such is the complexity of obtaining an EPC for a commercial building.

6.  Landlord’s right to carry out works to improve energy performance

Landlords may wish to include in new leases a right to enter to carry out energy-efficiency improvement works during the term of the lease.  Tenants will probably not be keen on this, but some may agree.  They might want to limit the type of works that are permitted: would a tenant be happy to see a complete recladding exercise carried out, while it was in occupation?  It happens occasionally when (for example) defective panes of glass need to be replaced, but tenants would not want it to become the norm.

However, as mentioned in Part 1 of this article, landlords might be better off by not having such a provision in the lease, as it would deprive them of one of the exemptions within MEES – that works required after April 2023 cannot be carried out because the tenant will not give its consent.

7.  Rent review

Rent reviews present the most difficult area.  A rent review provision assumes a notional letting of the actual property to a notional tenant on the rent review date.  If – at a rent review after April 2018 – the property requires works to be carried out in order to comply with MEES (because it has only an F or G rating), the tenant could argue that a letting would be unlawful and so the rental value of the property would be zero.  In a standard upward-only rent review, that would mean no rent increase for the landlord.

It is quite likely that one or more of the existing assumptions in a typical rent review clause will already cover the point, such as the assumption in the Model Commercial Lease’s rent review schedule that “the Premises may lawfully be let to and used for the Permitted Use by any person throughout the term of the Hypothetical Lease”.

But would it be sensible to include an additional assumption to deal with the point?  Something along the lines of “assuming that the landlord would carry out (at its own cost) any works to the Premises [or the Building] that would be required by the [MEES regulations] before the landlord grants the notional lease of the Premises”.

Inclusion of such words could be criticised on the basis that it is creating a false assumption – and might perhaps require the third party to ascertain exactly what notional works the landlord would have carried out.  Another viewpoint (which I think I favour) is that its inclusion is simply to ensure that the tenant cannot argue that the notional letting envisaged by the rent review machinery cannot take place.  Time will tell whether landlords and tenants feel it necessary to adopt wording of this nature.  My mind is not yet made up one way or the other.

 

IN CONCLUSION

I am pretty sure that we can expect to see some changes to typical leases in the coming months, with a view to enabling landlords to recover from tenants the costs of complying with MEES, and of improving their buildings’ energy efficiency generally. This is not necessarily a bad thing, in theory, since tenants ought to benefit from lower energy bills.  The devil will be in the detail, as usual, and rent review looks like the issue that is going to cause the most difficulties.

 

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