The cost of carbon

In May 2007, the Government published the Energy White Paper which heralded the implementation of a radical new emissions trading scheme. Now the Carbon Reduction Commitment, or ‘CRC’, is set to become law on 1 April 2010.

The CRC scheme is a mandatory emissions trading scheme which aims to cut the carbon dioxide emissions. It requires qualifying organisations that are currently using 6000kw/h of electricity per year to purchase carbon ‘allowances’ against the amount per tonne of carbon dioxide they are producing. Initially to be priced at £12 per tonne of carbon dioxide per ‘allowance’. Organisations must buy enough to off-set their carbon dioxide production for the year ahead. At the end of the year, if they have reduced their carbon output, companies can sell off their surplus.

Preparation is obviously key on this issue. There are penalties for non-compliance with the CRC scheme, ranging from fines to imprisonment. It is also anticipated that non-compliant businesses will be ‘named and shamed’. The CRC scheme will be relatively lightly regulated, with initial figures suggesting an annual audit of just 20 percent of particioants in the scheme. The audits aren’t intended to be random. Rather, the 20 percent will be selected based on individual businesses’ risk profile of having high CO2 emissions.
Implications for landlords and tenants.

For rented commercial property, the important initial question will be who is party to the energy supply contract – in simple terms, ‘whose name is on the bill?’

In many cases a tenant will pay the energy bills direct to the supplier, for example a supermarket chain. In such a case, the energy used by a particular store would count towards the total energy use of that tenant. Where, for example, a landlord of a shopping centre or an office building contracts directly with the energy supplier and recharges the cost through its service charge or similar lease provisions, it will be the landlord whose energy use contributes towards the scheme.

Landlords need to think now about how the CRC scheme will fit in with their management strategy for the building or buildings they own. They will need to identify a co-ordinator with overall responsibility for co-ordinating the landlord’s obligations under the scheme, who may in turn choose to delegate the day to day compliance issues to an agent or junior member of staff.

Landlords will also need to give thought to whether their existing service charge structure will cover the cost of purchasing carbon ‘allowances’-where the Landlord supplies energy to a tenant or where the landlord supplies energy via common areas. Now is the time to consider altering service charge provisions in current leases to take account of this. It may be the case that landlords need to consider trying to vary the terms of their leases to take account of their costs in complying with the scheme. Undoubtedly, this will be met with some resistance from tenants, so the earlier negotiations begins the less risk of being caught out by the beginning of the scheme.

For tenants, going forward they will need to be aware of the fairness, or otherwise, of items of expenditure the landlord may be looking to recharge for compliance with the CRC scheme through the service charge. Tenants will want to receive the benefit of recycling payments by way of refund to their contribution if it is through their efforts that their landlord reduces its energy use.

Landlords may also try to recover the cost of its compliance with the CRC scheme without any lawful authority to do that pursuant to the terms of the lease. There is discussion at the moment whether in the future, landlords will be looking to interpret whether compliance with the CRC scheme would be a reasonable ground for withholding consent to an assignment/subletting.

Property sales
The CRC scheme also introduces significant implications going forward in relation to the sale and purchase of investment property. Different landlords may have different methods of recharging tenants for ‘allowances’. In this case, there would need to be clear contractual provisions dealing with the apportionment of ‘allowances’ made or to be made in the sale contract. On a more basic level, a purchasing landlord who is within the CRC scheme will not look favourably on buying an investment property where the leases do not permit recovery of ‘allowances’ irrespective of whether the selling landlord is within the scheme.

Where a landlord is within a scheme and sells to a new landlord who is not, the sale contract will need to deal with how, presumably the selling landlord, deals with tenants in terms of outstanding scheme issues. For example, there may be recycling payments which are due by way of refund to tenants. An incoming landlord who is not within the scheme will have no interest in the scheme at all except to know that it has no liability going forward to account to tenants for payments it predecessor should have made.

In conclusion, it is anticipated that landlords and tenants will be expected to reduce their energy use. What isn’t known at present is what steps landlords will want to take to require their tenants to reduce their energy consumption and what view tenants will take of those steps. Thus far, ‘green clauses’ – that is clauses in leases obliging landlords and tenants to reduce their energy consumption – have been seen as something of an optional extra. The advent of the CRC scheme looks set to change that culture to make it a mandatory arrangement.

So far, awareness within the property sector of these issues is surprisingly and indeed worryingly thin. The implications of the CRC scheme will be with us in no time at all, so landlords and tenants need to prepare for this brave new world of carbon reduction now rather than face upset later.

Alex McCann is a partner in the Real Estate Group at Halliwells LLP