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Minimum Energy Efficiency Standards: what you need to know

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19/12/2016

From April 2018, a new legal standard for minimum energy efficiency will apply to rented commercial buildings and in our article at the start of this year we discussed some of the background information surrounding this somewhat controversial new law and provide our initial thoughts on how leases could cater for these new requirements. Since then the industry has become much more aware of the changes that the legislation will impose and as such we thought, almost 12 months on, now would be a good time to revisit the topic and ascertain how it could affect you

What is the Minimum Energy Efficiency Standard (MEES)?

Research has revealed that 18% of commercial properties fall into the two lowest EPC bands (F and G), a fact which been identified by the Government as a threat to the UK meeting its carbon reduction targets for 2020 and 2050. Whilst Building Regulations prescribe minimum standards of energy efficiency for new buildings, improving the performance of existing buildings is seen as key in achieving the Government’s aims and thus the Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015 [1] (the Regulations) were enacted.  The Regulations provide that, subject to certain exemptions, from 1 April 2018, landlords will be prevented from granting new tenancies, or renewing any existing tenancies, if the building in question has an EPC rating of less than E.  After 1 April 2023, landlords may not continue to let any buildings that fall below the MEES.

Which buildings does the MEES apply to?

MEES do not apply to:

  • Any building which is not required to have an EPC, for example, industrial sites, agricultural buildings with low demands for energy, workshops, temporary properties and holiday rentals;
  • Any building with an EPC that is over 10 years old (or where there is no EPC;
  • Buildings let on tenancies of over 99 years or less than 6 months (where such tenancy does not contain a right of renewal).

Determining whether a building is within the scope of the Regulations is therefore not always straightforward as not only does a landlord have to consider the Regulations but also a second set of regulations, the Energy Performance of Buildings (England and Wales) Regulations [2] (as amended) to determine whether an EPC is actually required for a building.

What exemptions are there?

The following exemptions apply to the prohibition on letting buildings with an EPC rating below the MEES:

  • Third party consent – where consent from persons such as a superior landlord, tenant or the planning authorities has been refused or provided subject to conditions with which the landlord cannot reasonably comply;
  • Devaluation – where an independent surveyor determines that the improvements required to improve the energy efficiency are likely to reduce the market value of the property in question by more than 5%; and
  • The ‘Golden Rule’ – where an independent assessor determines that all energy efficiency improvements that have been made or that could be made would not pay for themselves through energy savings within seven years.

None of these exemptions last indefinitely and a landlord must therefore reconsider regularly whether any energy efficiency measures can be implemented to increase the energy efficiency rating, or whether the grounds for exemption still apply.

To qualify for an exemption a landlord must register the exemption that it is relying on in the PRS [3] exemptions register which is required to be kept by the Secretary of State.

Where a landlord purchases an investment property already subject to leases, or where a landlord is required to grant a lease as a result of either a statutory or contractual obligation, for example a renewal pursuant to the Landlord and Tenant Act 1954, the landlord will not be in immediate breach of the Regulations. Instead the landlord will have six months to comply or demonstrate that one of the exemptions apply (exemptions do not pass from one property owner to another).

What penalties are there for a failure to comply?

The Regulations will be enforced by local weights and measures authorities who will have powers to impose civil penalties. The penalties, which are set by reference to the rateable value of the property in question, are as follows:

  • For renting a property for a period of less than 3 months in breach of the Regulations, the penalty will be equivalent to 10% of the property’s rateable value, subject to a minimum penalty of £5000 and a maximum of £50,000.
  • For renting a property for a period in excess of 3 months in breach of the Regulations, the penalty doubles to 20% of the rateable value, subject to a minimum of £10,000 and a maximum of £150,000.

A failure to comply does not, however, affect the validity of the lease as between the landlord and tenant.

Practical impacts of the Regulations

Whilst as yet there is no settled industry practice as to what amendments will be required to lease to cater for the Regulations there are various points that parties may wish to consider including:

  • Right of entry – the landlord may wish to specifically reserve a to enter onto the premises to carry out energy efficiency improvement works, if the tenant consents (and if the tenant doesn’t consent the landlord may be able to rely on the exemption referred to above);
  • An obligation to do works – a landlord may wish to attempt to impose an additional tenant covenant, requiring them to carry out works required by the Regulations. On the other hand, a tenant may wish to specifically exclude from its repairing obligations any such works. To the extent that works constitute improvements rather than repair then it is unlikely that a tenant would be required to undertake them in any event. A well advised tenant may however wish to benchmark it’s repairing obligations as against a schedule of condition or insert a specific statement that it will not be responsible for energy efficiency improvements.
  • Costs – the question as to who covers the costs of energy efficiency works will be key. It is arguable that the tenant will be the party who benefits from the improvements either through reduced energy bills or lower service charge contributions and the landlord may therefore want to impose an express obligation on the tenant to pay. A landlord may be able to recover such costs in the absence of such a provision via any service charge imposed provided the works can be construed as repair rather than improvement (and the landlord may wish therefore to check that the heads of recovery in the service charge provisions of its lease are drawn widely enough). In the alternative a tenant may wish to seek an explicit covenant on the part of the landlord not to look to recover the costs of any works required by the Regulations from the tenant;
  • Alterations – the landlord may seek to prevent the tenant from undertaking alterations that would otherwise be permitted if those alterations would adversely affect the environmental performance of the demised premises. In circumstances where landlords are able to reasonably withhold consent to alterations such a provision may not be required as the concept of reasonableness is sufficiently wide to enable consent to be withheld if the alterations would have a detrimental effect or put the landlord in breach of its statutory obligations;
  • Obtaining an EPC – the landlord may wish to prohibit the tenant from obtaining an EPC unless it must do so by law (for example on an assignment or underletting) in order to avoid the possibility that an EPC that the landlord already holds is replaced by an EPC with a rating below E;
  • Yield up – an amendment to the yielding up provisions in the lease requiring the tenant to yield up with no lesser EPC rating than as at the date of the lease, or no lesser rating than E would clearly be beneficial to the landlord.   A tenant on the other hand may wish to specifically exclude any obligation on it to do such works and prohibit the landlord from including such works in any schedule of dilapidations; and
  • Break option – the landlord may wish to consider inserting a break option, permitting it to terminate the lease if to continue letting it would place it in breach of the Regulations.

What to do now

The Government has confirmed that it intends to issue detailed guidance on the application of the Regulations. That guidance has yet to be issued however and regulatory bodies such at the Law Society are awaiting the issue of the guidance before amending their standard form leases.

That isn’t to say however that parties should do nothing, landlords (and tenants) would be well advised to start preparing for the Regulations now by assessing their portfolios to ascertain whether properties are within the scope of the Regulations and whether any exemptions will apply, and understanding how lease terms, renewal dates, etc fit within the timetable for implementation of the Regulations as failing to take action now could lead to increased costs and limited options in the future.

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[1] SI 2015/962.
[2] SI 2012/3118 as most recently amended by the Energy Performance of Buildings (England and Wales) (Amendment) Regulations 2016 (SI 2016/284).
[3] Private rented sector.