A bleak winter is ahead – commercial energy prices are around double what they were in October 2021 with the unnerving prospect of even higher prices when the government's 'Energy Bill Relief Scheme' ends, with the possibility of rolling power cuts through the winter and dented consumer confidence.
With these factors in mind both owners and occupiers now need to be carefully considering the viability of their future operations and thinking about what steps may be taken to improve or mitigate their position.
For commercial real estate lawyers the current situation begs the question: how will these factors play into the complex relationship of landlord and tenant?
Outgoings & Services
Most commercial leases provide that the tenant is to be liable for 'outgoings' – including the cost of utilities. These costs may be payable direct to the relevant supplier, to the landlord or rolled up into an 'inclusive' rent. There may also be an additional element of outgoings payable by tenants via service charge in respect of the supply of these items to common parts.
The obvious question here concerns the quantum of such sums: a tenant who is directly liable to a utility company may have the opportunity to negotiate a supply contract, and potentially hedge against future energy price hikes – albeit in a highly dysfunctional market. Most leases oblige a tenant to pay these outgoings 'when demanded' – a tenant who is in arrears for its utility payments will be in breach of its lease covenants.
For supplies which are provided via the landlord the tenant will find itself at the mercy of the landlord's own procurement process. Tenants will likely find themselves facing demands for increased contributions. It will be in the landlord's interest to keep the cost of such supplies (and service charge) as low as possible (particularly where a landlord has voids for which they are responsible for the costs). For tenants careful scrutiny of lease terms dealing with service charge and service costs may be appropriate. With inflation at levels not seen since the 1980s, and inflation in energy markets even higher, it is possible that service charge caps which may originally have been seen as theoretical protection for a tenant may come into play. Remember that arrears of service charge contributions will likely constitute a breach of the lease terms.
For a landlord who is cutting back on key building or estate services such as heating, lighting and security consideration should be given to the terms of the service obligations in the lease and the extent to which the services are mandatory, or at the discretion of the landlord. It may also be advisable to liaise with tenants and tell them of proposed changes in advance – this may help pre-empt, or reduce, disputes and complaints.
Blackouts pose a serious challenge – a landlord may simply not be able to provide the affected services during these periods, though they may be protected by a 'force majeure' provision which absolves them of their obligations. There may also be landlord obligations to mitigate the impact of such events – for example a landlord may find itself under an obligation to install temporary generator facilities, and this may prove expensive in a strong market for such apparatus. The cost of temporary equipment is likely to be recoverable via service charge.
Repair
Straitened times pose the risk that both landlord and tenant will attempt to constrain cash flow by 'cutting back'. Reducing, or ignoring the need for, cyclical repair and maintenance is an obvious target for businesses trying to balance the books. For landlords this may mean that the risk of exposure to accrued tenant dilapidations is likely to be enhanced. Landlords should keep a weather eye on the state of repair and think about their prospective remedies during the term.
During blackout periods there is the potential for damage to premises and/or plant and equipment which could fall to the landlord or tenant to repair. Owners and occupiers should consider conducting a technical review of their premises to ensure that the impact of periodic three-hour electricity shutdowns is understood and any risks and impacts mitigated.
Statutory Compliance
Most leases contain a general obligation on the tenant to comply with statute, and there may also be similar duties on the landlord in respect of retained and common parts. Special care should be taken to ensure that properties are generally compliant with statutory requirements during blackouts. Health and safety, security and fire safety are particular issues worthy of detailed scrutiny. Property managers should take preparatory steps to ensure that back up batteries and other systems are in full commission. Additional security and fire safety patrols may be needed for areas which are unlit or especially vulnerable.
Insurance
It will be important for owners and occupiers to establish whether or not there are any special insurance requirements during blackouts – particularly with regard to security, fire safety, damage to plant, equipment, stock and materials.
Access
Will interruption to electricity affect rights granted in a lease? For example, can the landlord maintain access to the building controlled by security systems if power is down? There are many potential difficulties – particularly with large multi-let buildings with extensive common parts, escalators, lifts, roller shutters, or electric locks. Landlords should stress test their systems to ensure that they are able to cope.
Keep Open
Some leases contain obligations to 'keep open' – particularly in a retail context where such arrangements are relatively common, for example in a shopping centre where a tenant will be required to keep its property open for trade. For a tenant considering permanent closure or mothballing to reduce costs across its portfolio the presence of and risks presented by such clauses always should be considered. A landlord may seek to enforce breach of such obligations by way of injunction (or in Scotland by way of specific implement).
A tenant may look to the 'force majeure' provisions for protection, care should be taken before relying on such a provision. There may be express or implied obligations to mitigate, even where the closure is caused by force majeure. During blackout periods a conflict between such a provision and the other terms of the lease may arise.
A landlord may also owe obligations to enforce similar covenants against other tenants in a building or centre – again this may also conflict with other lease terms. A conflict may also arise in relation to landlord obligations to provide facilities (e.g. a car park with electric barriers and payment machines).
Turnover Rents
For a tenant paying a turnover rent periods of closure will need to be dealt with. A well drafted turnover rent will make reasonable provision for periods of closure – and indeed should allow closure where the premises are inaccessible or for other reasons. Business interruption insurance may cover the tenant loss of income for periods of forced closure. From the landlord perspective, the proceeds of such insurance should form part of the turnover calculation.
Tenant Solvency
The energy crisis poses a clear threat to the viability and solvency of many tenants and may be a final fatal blow for those struggling to recover following the COVID lockdowns. Blackouts may contribute to this by further disrupting trade and operations. There may be a need for landlords to agree monthly or reduced rents to help keep ailing businesses afloat. A fresh round of company voluntary arrangements is a distinct possilibty – which will bind a landlord and can be difficult to resist.
Environmental Performance
This crisis may well bring the environmental performance of a property to the fore. Landlord and tenant are likely to look longer and harder at their energy consumption and the overall energy efficiency of a property and perhaps even the extent to which it is capable of its own power generation via independent 'off grid' operation. These factors are likely to feed into the overall marketability of a particular property – particularly when taking into account the gradual tightening of minimum energy performance standards. (There is currently no equivalent to the MEES Regulations in Northern Ireland and therefore no minimum energy performance requirements. There are no current proposals to implement equivalent regulations, something that is likely to be delayed further due to the current lack of a functioning government in Northern Ireland. This lack of minimum standards may result in increased energy costs for occupiers of Northern Irish properties. In Scotland the MEES regulations do not apply, there is a separate regime currently in force). Both owners and occupiers should take all available opportunities to review and improve energy efficiency.
This article has been prepared with a focus on England & Wales and current market conditions. For any queries or concerns in relation to these or other real estate issues please contact Damian Fleming.
For the following jurisdictions, please note our key contacts below:
Ireland: Órlaith Molloy
Northern Ireland: Julie Galbraith
Scotland: David Ratter
