Consultation draft CRC clauses for insertion into standard form leases

We have decided to expand the outgoings clause rather than the utilities clause, since the cost of purchasing CRC allowances is not incurred in connection with the supply of the relevant fuels to the Property (as is required by that clause), but rather in connection with the emission of carbon dioxide as a result of the consumption of fuels in the Property.

These amendments to the outgoings clause are deliberately low key (and thus may not be contentious to a Tenant). However, Landlords should be aware that the amended clause will not enable the Landlord to bill to the Tenant all the costs which the Landlord may incur under CRC.

Generally, an outgoings clause is intended to cover only things like rates and taxes. The "catch-all" wording ("other impositions") is construed ejusdem generis so would not be enough on its own to stretch the clause to cover the costs of purchasing CRC allowances (CRC costs). These costs are incurred as a result of Tenant-specific conduct at the Property (consumption of energy and resulting emission of carbon dioxide). They are not like a generally imposed tax or charge. We have therefore inserted the additional words "levies, costs, charges" and "of whatever nature" to try to avoid the ejusdem generis rule.

Since it might also be argued that the CRC costs are not incurred "in respect of the Property or its use or works carried out there", we have also broadened the chargeable types of expense to include those incurred "in connection with the occupation" of the Property (since the emission of carbon dioxide arises in respect of energy consumed in the Property by the occupant). For those that still feel this is not wide enough, consider adding the words in square brackets ("including energy consumption") to make this point clearer. However, doing so may highlight unnecessarily that the amendments to the clause are intended to permit on-billing to the Tenant of the CRC costs, which may not be something that it is prepared to accept.

The draft clause does not deal expressly with the recoverability of CRC costs where the Landlord is not a single entity participant in CRC but is part of a group participant in CRC. In the latter situation, another UK based group company will be nominated as responsible for compliance with CRC, the purchase of CRC allowances and the receipt of the recycling payment. The draft clause does not expressly require the Tenant to pay the CRC costs which may be incurred by the parent company in the Landlord's group.

We would argue that this is not fatal to the recovery of CRC costs. The standard outgoings clause obliges the Tenant to pay all rates and taxes which are payable in respect of the Property or its use. The clause does not limit those rates and taxes to those which are billed in the name of the Tenant. Were the Landlord to receive a bill in its name for such rates and taxes, it would be able to require the Tenant to pay them under this outgoings clause, so long as they arise in respect of the Property or its use. By analogy we would argue that CRC costs, whether incurred directly by Landlord, or by a parent company (and whether billed down by that parent company to the Landlord or not), would be covered by the clause, as long as these CRC costs are payable in respect of occupation of the Property. We welcome comment on this argument.

This draft clause is unlikely to be wide enough to permit the Landlord to bill to the Tenant the additional costs it may incur in connection with CRC (other than the costs of purchasing CRC allowances). These additional costs might include:

• The fees which the Landlord has to pay for initial registration as a CRC participant;

• The annual fee the Landlord will pay as a participant in CRC; or

• The costs incurred internally by the Landlord (or the costs of instructing external agents) in calculating and advising the division of the CRC costs and recycling payments between buildings, tenants and (if relevant) other companies in the Landlord's group.

This is because such costs are not truly payable in respect of the "use or occupation" of the Property. They arise instead as a result of the Landlord's obligation to register as a CRC participant, and, as such, to comply with its reporting obligations under CRC. The only exception might be where the Landlord has to register as a CRC participant solely because of the energy consumption in the Property and has no other properties. In that case, all the additional costs could be said to arise in respect of the use or occupation of the Property.

A well advised Tenant, who realises that this expanded outgoings clause will result in the on-billing to it of CRC costs should insist on the Landlord passing on to it an appropriate share of the recycling payment received by the Landlord or its group. The following clause may be suitable to achieve this but the Landlord may not wish to offer this clause unless and until asked to do so.

There are considerable difficulties in drafting a clause whereby the Landlord passes on to the Tenant a share of the recycling payment that the Landlord receives. The difficulties are set out in greater detail in the BPF paper (for more detail, see Legal Update, BPF publishes guidance on the Carbon Reduction Commitment (www.practicallaw.com/2-386-4249)).

In very broad outline these issues are:

• The Landlord may not receive a recycling payment at all (it may be paid to another company within its group). There is nothing in CRC that obliges a group participant to divide up the recycling payment it receives or how to do so, should it choose to divide it.

• Even if the Landlord receives the recycling payment (or part of the recycling payment received by another company in its group) there is no guidance in CRC about how the Landlord should divide that payment between the various properties in its portfolio.

• Even though this clause is intended for use in a lease of whole, it is possible that the Property will form only part of the building in respect of which the recycling payment is received by the Landlord (for example, a physically separable part of a shopping centre). If so, there will need to be some allocation of the recycling payment between the Property and the other parts of the building. There is no guidance in the CRC Order or any document published by the Government relating to CRC on how to do this.

• There may have been a change of Landlord between the Tenant paying for the CRC allowances and the recycling payment being received. It will be the former Landlord (who bought the CRC allowances) who will receive the recycling payment, not the current Landlord. There may, therefore, be no recycling payment to give back to the Tenant.

• There may have been a change of Tenant between the Tenant paying for the CRC allowances and the recycling payment being received. Should the former Tenant receive the recycling payment, since it paid for the CRC allowances, or should the current Tenant receive the recycling payment?

This clause does not try to deal with these issues in any complex manner. How it will be interpreted in practice may not be predictable. The clause requires the Landlord to work out what is a "fair and reasonable" amount of the recycling payment to attribute to this Tenant and to demonstrate how it calculated this amount. If the Tenant wants to challenge the calculation, it can ask for an explanation of the principles employed by the Landlord in working out the figures. Whether mounting such a challenge will be worthwhile will depend on the size of the share of the recycling payment that is at stake, in comparison with the time and costs involved in mounting the challenge. If the Tenant decides to challenge the calculation, it can put forward any ground that it thinks establishes the calculation was not fair or reasonable (e.g. perhaps because the proportion of the recycling payment received by the Landlord's group that was given to the Landlord was insufficient, or too much of that recycling payment was allocated to buildings in the Landlord's portfolio other than the Property). The concept of "fair and reasonable" will enable the Tenant (and indeed the Landlord when defending its calculation) to point, as a guide to what is fair and reasonable, to whatever the market practice is on the division of CRC costs and recycling payments at the time of the challenge.

We believe that this approach is preferable to setting out a detailed regime for calculation of the recycling payment due to the Tenant, at least until such time as an industry consensus has been reached on how to allocate recycling payments between tenants. A more detailed regime may, when it comes to be applied, be wildly out of line with the then market norm. This might lead (at rent review) to an allegation that the lease is onerous, and thus reduce the rent that can be achieved. This would have an adverse impact on value, which might far outweigh the benefit of clarity on how to divide up the recycling payments.

The draft clause does not require a reference to a third party arbiter if there is a dispute about what is fair and reasonable. This could be added easily, if feedback suggests that the parties would generally require such a mechanism.

There are two alternatives for describing the recycling payment which is to be shared. People using these clauses may worry that the phrase "recycling payment" is not a defined term, and may not be defined in the final form of the CRC Order and related legislation. They may prefer to use the more generic wording to describe credits or rebates, so that the clause will work as intended, regardless of the final form of the CRC Order and related legislation. Do you think that such caution is unnecessary and that use of the phrase "recycling payment" is sufficient?

We explained (in the drafting note to the amended outgoings clause) that that clause would not permit the Landlord to recover from the Tenant the ancillary costs and expenses incurred by the Landlord in complying with CRC. If the parties have agreed that these ancillary costs should also be recoverable from the Tenant, then it would be possible to achieve this by adapting this recycling payment credit clause. All that is needed is to change the repayment obligation so that the Landlord pays to the Tenant any recycling payment (or fair and reasonable proportion of such payment) only after first deducting from it those accumulated ancillary costs and expenses.

What should qualify as CRC Costs?

The first limb of the definition covers the cost of CRC allowances incurred (either by Landlord or a Group Company) relating to carbon dioxide resulting from the energy consumption in the Building alone. The second limb applies where the Landlord or Group Company is buying CRC allowances for use across its portfolio (not for particular use for this Building) and part of the cost of those CRC allowances is intended to qualify for inclusion in the service charge for this Building.

In both there is a reference to both directly and indirectly incurred costs. The former applies where it is the Landlord or its Group Company that is the CRC participant and buys the CRC allowances. The reference to indirectly incurred costs covers the situation where the Landlord is itself a tenant, and is (under its lease) obliged to pay the CRC Costs incurred by its own Landlord in relation to the consumption and emission of carbon dioxide from the Building. In those circumstances, it may wish to pass these costs down to its subtenants in the Building.

The third limb of the definition is intended to cover the ancillary costs of registration and reporting under CRC. If the parties only intend the Tenant to contribute to such overheads the Landlord incurs as a CRC participant if the Property is itself caught by CRC, then include the words in square brackets.

The fourth limb of the definition picks up any external fees or charges for administering compliance with CRC. If this work is handled by the Landlord's own staff, then a reasonable internal management fee can be charged instead. As it is likely that administering CRC will be time consuming, recoverability of costs will be important to the Landlord.

We have presumed that most Landlords and Tenants would want to confine the chargeable CRC Costs to costs incurred under CRC. If so then the words in square brackets in the first and second limb of the definition should be included. If the Landlord wants the regime to pick up costs incurred under other legislation (eg EU ETS) in connection with carbon dioxide emissions then the words in square brackets should be deleted. If the Landlord wants the regime to pick up costs incurred in connection with the emission of greenhouse gases then a definition of greenhouse gas will be required and these definition clauses should refer to greenhouse gases rather than emission of carbon dioxide (the CRC relates only to carbon dioxide).

The definition of CRC Costs does not mention rates and taxes. We think a Tenant would reject these as potentially allowing the Landlord to bill to it any direct taxes that the Government may in due course levy in respect of carbon dioxide emissions.

No sophisticated accounting - rely again on test of "fair and reasonable"

As in Version A of these consultation draft clauses (for use in the lease of whole), this Version B does not attempt a sophisticated regime for the division of either CRC Costs or the recycling payment.

It applies a "fair and reasonable" test (in the definition of CRC Costs) to determine how much of any CRC Costs should be included in the Service Costs for the Building. To calculate this particular Tenant's share of those Service Costs, the lease then applies its normal test (for this particular PLC precedent lease) of whatever is a "fair proportion".

It applies a similar test of what is "fair and reasonable" to work out how much of any recycling payment should be credited to the Service Costs.

Either party is free to raise arguments as to why what they did or propose should be done in the calculations is, in the circumstances, "fair and reasonable". Either can, if relevant, point to the market practice on division of CRC Costs and/or recycling payments at the time of the dispute. The arguments made in the drafting notes to Version A may all be relevant, and a Tenant of part may have an additional argument, which is that, as a particularly "green" tenant in the Building (perhaps by turning its lights off or using passive infra-red (PIR) sensors, or changing its pattern of behaviour e.g. opening windows not using airconditioning, or by adopting the principles in a "green lease" or memorandum of understanding) it should get more of the recycling payment or less of the CRC Costs in the first place than other, less "green" tenants in that Building.

The Landlord may consider that the time and expense they will incur (in order to comply with a request from the Tenant for evidence of the method of calculation of the fair and reasonable proportion of CRC Costs and recycling payments) is not worth the contribution to CRC Costs they receive from the Tenant. As long as CRC allowance costs are low, this may be true. The Landlord could, if it felt this way, simply omit from the Lease all references to CRC and bear the costs itself. However, this would leave it exposed in the future, if the cost of CRC allowances rises. Instead, the Landlord can incorporate the drafting now, but not implement the charging of CRC Costs to the Service Charge for the moment. Doing so will mean the Landlord is not obliged to share with the Tenant any recycling payment that is received (because the obligation to make the credit is conditional, under new subclause 8.10, on having charged the CRC Costs).

Charging the cost of new meters to the service charge

The amendment to Clause 8.2 (A) is designed to allow the Landlord to charge to the Service Costs the cost of putting in either a totally separate utility supply to the Tenant or the cost of installation of a check meter or sub meter to monitor what supply is reaching the Tenant. The first of these would result in the Tenant contracting directly with the energy supplier, and therefore being responsible for its own energy supplies, and liable to purchase its own CRC allowances, if it is a CRC participant. The second option will be needed where the Landlord wants to have an idea of how much energy each of its tenants is consuming, so that it can then divide up the CRC Costs in a fair and reasonable manner.

Should an estimate of CRC Costs be made and billed by way of advance service charge?

This consultation draft clause allows the Landlord to bill for the estimated full cost of the CRC allowances as part of the advance Service Charge arrangements. The CRC Costs are included as one of the many heads of service chargeable expenditure. This will mean that it is the Tenant, not the Landlord, that has to bank roll the CRC Costs between the point of payment for the CRC allowances (or indeed here, the point of advance payment on account) and the point when the recycling payment is credited against Service Costs. Some Tenants will not like this, particularly not when they realise that a change in parties, between the advance payment of the CRC Costs and the point at which the recycling payment should be credited against those costs, may mean that they have paid a cost but will not receive a share of the recycling payment.

The draft does not match CRC compliance years and Service Charge Years

This consultation draft clause makes no attempt to match up CRC compliance years and Service Charge Years, or to apportion CRC Costs/recycling payments for a CRC compliance year between the two Service Charge Years that it may straddle. Instead it takes a simplistic approach. What can be billed in the relevant Service Charge Year are the CRC Costs actually incurred i.e. paid, in that Service Charge Year. What must be credited to the Service Costs is any recycling payment actually received in that Service Charge Year (regardless of which CRC compliance year it relates to). Therefore, there is only a credit if the Landlord preparing the end of year accounts has himself (or via its Group Company) received that recycling payment. If there has been a change of Landlord and it is the former landlord that has received the recycling payment, there will be no credit. This may seem unfair, but its simplicity is considered preferable to the very complex provisions which might be needed to deal with attribution across Service Charge Years.

The draft does not try to deal with what happens where there is a change of party midway through the Service Charge Year

As this consultation draft clause allows the Landlord to bill the Tenant in advance for the likely CRC Costs, but only credit any recycling payment at a much later date, it is possible that either, or both, Landlord and Tenant may assign their interest in the Property in between these two events. This can cause problems, which this version of the clause does not try to solve:

• Where the Landlord changes, the outgoing Landlord has received the advance service charge payments towards the CRC Costs and will still receive the recycling payment. However, by the time it receives the recycling payment, it will no longer be the Landlord, and therefore will not be obliged to pass that recycling payment (or the appropriate part of it) back to the Tenant that paid the advance service charge.

• Where the Tenant changes, the outgoing Tenant will have paid the advance service charge payments, but under this consultation draft clause, the incoming Tenant will get the benefit of the credit of the recycling payment.

Whilst we realise that neither outcome is "fair", we have decided that it is better to be simple rather than to impose on former parties obligations to pass on recycling payments or track down former tenants to receive these. It may be possible for assignor and assignee to agree (in the transfer or assignment or contract for either) suitable compensation.

What should the tenant do if it is unwilling to bank roll the full cost of purchase of CRC allowances until the end of year service charge reconciliation or is concerned about the effect of a change of parties?

There are two possible alternatives, both of which reduce the Tenant's risk of being billed too much by way of CRC Costs. We favour Option 3 but would welcome views on whether either of these alternatives is more popular that Option 1, in which case the draft can be altered (or perhaps both options drafted, so that the user can select the most suitable clause).

• Option 2 would allow the Landlord to add in to the Service Costs estimate, and charge an advance payment towards, the anticipated "net" CRC Costs which the Landlord will incur that Service Charge Year (ie the full CRC Costs that the Landlord anticipates it will incur less the amount that it anticipates that it will obtain by way of recycling payment). There would then be the usual end of year adjustment if the net CRC costs were more or less than the estimate.

  The advantage to the tenant of this Option 2 is that it need only bank roll (through to the end of the service charge year) the net CRC Costs . Moreover it reduces (though does not entirely eliminate) the risk inherent in a change of Landlord between the point of advance charge and the end of year service charge reconciliation. Although the former Landlord will owe no duty to the Tenant to pay to it the recycling payment when it receives it, this will matter much less because the Tenant will have been given advance credit for the estimated recycling payment in the calculation of the advance charge. It will only be where the estimated recycling payment and the actual recycling payment are significantly different that the Tenant may lose out due to the change of Landlord.

  If the incoming Landlord were to incur more CRC Costs than those estimated in the calculation of the advance charge, even after deduction of any recycling payment that it may receive that is fairly attributable to this Property, it can put through the excess charge in the service charge reconciliation at the end of the year.

• Option 3 is similar to Option 2 but permits no advance payment towards CRC Costs. It would allow the Landlord to charge, via the Service Costs, only the "net" CRC Costs it has incurred (i.e. the costs the Landlord incurs in purchasing CRC allowances and the other expenses of operating CRC (e.g. registration and reporting), less the amount of the recycling payment received by the Landlord, or another group company, on a fair and reasonable basis as attributable to this Building). However, Option 3 would go further than Option 2, in that it would prohibit the Landlord from including those net CRC Costs in the calculation of the advance service charge. Instead, the Landlord would be entitled to bill for the net CRC Costs only at the end of the Service Charge Year, when the reconciliation is done.

  As the Landlord is carrying the cost of the CRC allowances right through to the end of the Service Charge Year, it would be reasonable to allow the Landlord to bill, via inclusion in the CRC Costs (if not already recoverable as an existing head of Service Charge expenditure) the interest cost incurred in carrying the net CRC Costs (ie the actual interest charged to the Landlord, where it borrows the funds to pay for the CRC Costs, or notional interest, where the Landlord has sufficient funds of its own to meet the CRC Costs).

  The approach in Option 3 would help the Tenant because it is only ever asked to pay the actual net CRC costs. By the time it is asked to pay, the precise amount spent and the actual amount received by way of recycling payment by the then current Landlord are known.

  However, this approach disadvantages the Landlord in several ways:

  • The Landlord will need to have enough funds available (or borrowing facilities) to bank roll the purchase of the CRC allowances and hold that cost until the recycling payment is received and the Tenant can be asked to pay the net CRC Costs.

  • The Landlord will have to be confident that the Tenant will be able to pay the bill for the net CRC Costs at the end of the year (otherwise it will be out of pocket).

  • If there is a change of Landlord during the Service Charge Year, the outgoing Landlord will have paid the cost of the CRC allowances, and will (if not already received) still be entitled to some sort of recycling payment even if by the time of receipt thereof it has disposed of the Property. However, there is likely to be a shortfall. As the outgoing Landlord will not be compiling the end of year Service Charge Accounts, it will not be entitled to bill anything to the Service Costs to recover that shortfall from the Tenant. The outgoing Landlord's only method of recovering that shortfall would be to include a clause in the sale contract whereby the incoming Landlord agrees to pay such shortfall.

Description of recycling payment

There are two alternatives for describing the recycling payment which is to be shared. People using these clauses may worry that the phrase "recycling payment" is not a defined term, and may not be defined in the final form of the CRC Order and related legislation. They may prefer to use the more generic wording to describe credits or rebates, so that the lease clause will work as intended, regardless of the final form of the CRC Order and related legislation. Do you think that such caution is unnecessary and that use of the phrase "recycling payment" is sufficient?