Growing Green Leases

As Kermit the Frog has been known to say, “It's not easy being green.” With the increased interest on the part of both landlords and tenants in “green” leases, more landlords are striving for LEED certification, and more tenants are considering this as a major factor in choosing a location. But how can the parties best write the lease to make sure that both landlords and tenants see some tangible accomplishments from the green status? This article suggests various areas to which attention should be paid to enhance the likelihood of enjoying those benefits.

Agree on Standards

The first things the parties should do is agree on applicable standards. A primary area for consideration is energy savings, both in terms of levels for attainment and permissible methods. Then, other subjects should be brought into play, such as participation in building-wide paper recycling measures, water usage measures (including with respect to landscaping), and controlling interior environmental quality through controlling the extent to which hazardous substances can be used, ranging from cleaning processes to painting and other decorating steps. These standards should be documented in a clear and concise operations manual that supplements each lease in question. The lease should allow flexibility for the landlord to monitor compliance with the standards and incentivize both parties to achieve the stated objectives.

Finally, the lease should contain provisions that let the landlord modify the objectives to allow the building to grow greener within reasonable limits over the term of the lease and also to keep up with changes in laws, technology and the leasing market. This should not be viewed as a sea change inasmuch as landlords have traditionally restricted permissible uses and activities, and for decades have carefully addressed the presence of hazardous materials. However, the process described in this article may represent a new trend of cooperative action for positive results rather than restrictive approaches for protective purposes, with the emphasis in this case on creating the infrastructure within the lease to realize the benefits that the parties are expecting from going green.

Include Specific Requirements

Since the landlord is most likely the party to be writing the lease, the landlord should include the specific requirements for operating in a comfortable, healthy and productive indoor environment as an exhibit to the lease. These guidelines may include, for example, reduced energy consumption, reduced water usage, use of recycled products in build-out of the premises, and the avoidance of materials that contain high levels of volatile organic compounds (VOCs). The lease should document specific target levels of energy usage, such as electricity use averaging not more than a targeted level of kilowatt hours per square foot of rentable space, or average natural gas consumption of not more than a targeted level of cubic meters per square foot of rentable space. Similarly, water consumption can be targeted at an average level of not greater than a certain number of gallons per square foot.

VOCs are chemicals that are emitted as gases from certain solids and liquids. They can come from a variety of sources, e.g., paints, cleaning products, adhesives, building materials, furniture and office equipment, such as printers and copiers. They can be highly concentrated in the indoor environment, and have adverse health effects, both short and long term. The landlord can monitor energy and water use in the building and (assuming that the premises is separately metered) at the premises, but the lease should also entitle the landlord to monitor the presence of VOCs from time to time. Such provision should include reasonable notice to the tenant and the tenant's right to have a representative accompany the landlord during such testing. If the level of VOCs exceeds that which is permissible under the lease, then the tenant, at the tenant's sole cost and expense, should be required to remedy the situation, whether by purging the air in the premises, modifying the filtration in the ventilation system, or eliminating the source of the VOCs.

Shared Benefits

The lease should be structured so that both parties get the benefit of reduced operating costs. The landlord should be allowed to amortize the costs of building improvements that are designed to reduce operating costs, and to include such amortization in the operating cost calculation to the extent that such amortized costs do not exceed savings. Such savings should be passed through to the tenant. On the other hand, the tenant should have the right to audit the operating expenses, provided that the tenant should pay the cost of such audit unless the landlord has overcharged the tenant by more than a stated percentage, in which case the cost of the audit would shift to the landlord. In addition, the tenant should be required to pay for services (such as after-hours and holiday air-conditioning) that are beyond the scope of normal building operations. The normal building operations hours should be defined in the lease, along with the current cost per hour of after-hours air-conditioning, which cost will be passed along to the tenant at its then-current rate during the term of the lease.

Provide Flexibility

Unlike a purchase agreement, which without specific surviving language becomes ineffective by virtue of being deemed to have merged with the deed at closing, many leases govern long-term relationships between the parties, often for a term of many years. It is important that the lease provide for a certain flexibility so that the “green” plan for the building can be adapted to changes in laws, changes in technology and changes in the leasing market. Regulation of the indoor environment is a relatively new area, and over the term of a lease, there may be new regulations, which landlords and tenants must consider in operating the building. The lease should provide that in the event a governmental authority imposes limits on use of resources, which limits are below the targets stated in the lease, then those targets for resource use will be deemed modified in accordance with the regulations. In addition, if regulations impose new requirements on landlords that significantly increase the landlord's cost of compliance, the lease should provide for some mechanism by which the landlord and tenant can agree on sharing the cost of such compliance. (For example, adding certain performance standards to zoning codes could have the effect of requiring a landlord to replace existing windows with windows of a greater insulation value as a condition to issuing a building permit for some other type of alteration to the grandfathered non-conforming property.) Factors to consider include the increase in useful life and value of the building due to the mandated improvement, and the remaining term of the lease. If the parties cannot agree, the lease should include a dispute resolution mechanism, such as arbitration.

The lease may provide that the landlord and tenant agree to cooperate from time to time in determining compliance with the environmental targets, and meet annually to discuss additional steps they could take to incorporate new technology or new procedures in order to further their environmental objectives. Landlords may also wish to consider the extent to which they can build into the lease the ability to participate (and require that the tenant participate) in conservation programs sponsored by utility providers, which programs may not become available until later in the lease term. Finally, market conditions may change such that in order to stay competitive, a landlord will feel obligated to become even more “green” by achieving a higher level of accreditation or certification. The lease should provide that the parties will reasonably cooperate in such initiatives, albeit the tenant may want to cap the costs of such initiatives that can be passed along to the tenant through the operating expenses.

Conclusion

Being “green” is a laudable objective, but to realize the tangible benefits of being “green,” the parties should incorporate specific objectives regarding use of materials and energy, water and other resources into their lease. They should provide for monitoring and measurement in order to determine their progress in meeting objectives. Finally, they should provide flexibility in the lease so that they are encouraged to evaluate and modify their environmental plan as the laws, technology and conditions of the marketplace change over time.

Patricia Ullman is a partner in the Real Estate Department of Schiff Hardin LLP, Chicago.

As Kermit the Frog has been known to say, “It's not easy being green.” With the increased interest on the part of both landlords and tenants in “green” leases, more landlords are striving for LEED certification, and more tenants are considering this as a major factor in choosing a location. But how can the parties best write the lease to make sure that both landlords and tenants see some tangible accomplishments from the green status? This article suggests various areas to which attention should be paid to enhance the likelihood of enjoying those benefits.

Agree on Standards

The first things the parties should do is agree on applicable standards. A primary area for consideration is energy savings, both in terms of levels for attainment and permissible methods. Then, other subjects should be brought into play, such as participation in building-wide paper recycling measures, water usage measures (including with respect to landscaping), and controlling interior environmental quality through controlling the extent to which hazardous substances can be used, ranging from cleaning processes to painting and other decorating steps. These standards should be documented in a clear and concise operations manual that supplements each lease in question. The lease should allow flexibility for the landlord to monitor compliance with the standards and incentivize both parties to achieve the stated objectives.

Finally, the lease should contain provisions that let the landlord modify the objectives to allow the building to grow greener within reasonable limits over the term of the lease and also to keep up with changes in laws, technology and the leasing market. This should not be viewed as a sea change inasmuch as landlords have traditionally restricted permissible uses and activities, and for decades have carefully addressed the presence of hazardous materials. However, the process described in this article may represent a new trend of cooperative action for positive results rather than restrictive approaches for protective purposes, with the emphasis in this case on creating the infrastructure within the lease to realize the benefits that the parties are expecting from going green.

Include Specific Requirements

Since the landlord is most likely the party to be writing the lease, the landlord should include the specific requirements for operating in a comfortable, healthy and productive indoor environment as an exhibit to the lease. These guidelines may include, for example, reduced energy consumption, reduced water usage, use of recycled products in build-out of the premises, and the avoidance of materials that contain high levels of volatile organic compounds (VOCs). The lease should document specific target levels of energy usage, such as electricity use averaging not more than a targeted level of kilowatt hours per square foot of rentable space, or average natural gas consumption of not more than a targeted level of cubic meters per square foot of rentable space. Similarly, water consumption can be targeted at an average level of not greater than a certain number of gallons per square foot.

VOCs are chemicals that are emitted as gases from certain solids and liquids. They can come from a variety of sources, e.g., paints, cleaning products, adhesives, building materials, furniture and office equipment, such as printers and copiers. They can be highly concentrated in the indoor environment, and have adverse health effects, both short and long term. The landlord can monitor energy and water use in the building and (assuming that the premises is separately metered) at the premises, but the lease should also entitle the landlord to monitor the presence of VOCs from time to time. Such provision should include reasonable notice to the tenant and the tenant's right to have a representative accompany the landlord during such testing. If the level of VOCs exceeds that which is permissible under the lease, then the tenant, at the tenant's sole cost and expense, should be required to remedy the situation, whether by purging the air in the premises, modifying the filtration in the ventilation system, or eliminating the source of the VOCs.

Shared Benefits

The lease should be structured so that both parties get the benefit of reduced operating costs. The landlord should be allowed to amortize the costs of building improvements that are designed to reduce operating costs, and to include such amortization in the operating cost calculation to the extent that such amortized costs do not exceed savings. Such savings should be passed through to the tenant. On the other hand, the tenant should have the right to audit the operating expenses, provided that the tenant should pay the cost of such audit unless the landlord has overcharged the tenant by more than a stated percentage, in which case the cost of the audit would shift to the landlord. In addition, the tenant should be required to pay for services (such as after-hours and holiday air-conditioning) that are beyond the scope of normal building operations. The normal building operations hours should be defined in the lease, along with the current cost per hour of after-hours air-conditioning, which cost will be passed along to the tenant at its then-current rate during the term of the lease.

Provide Flexibility

Unlike a purchase agreement, which without specific surviving language becomes ineffective by virtue of being deemed to have merged with the deed at closing, many leases govern long-term relationships between the parties, often for a term of many years. It is important that the lease provide for a certain flexibility so that the “green” plan for the building can be adapted to changes in laws, changes in technology and changes in the leasing market. Regulation of the indoor environment is a relatively new area, and over the term of a lease, there may be new regulations, which landlords and tenants must consider in operating the building. The lease should provide that in the event a governmental authority imposes limits on use of resources, which limits are below the targets stated in the lease, then those targets for resource use will be deemed modified in accordance with the regulations. In addition, if regulations impose new requirements on landlords that significantly increase the landlord's cost of compliance, the lease should provide for some mechanism by which the landlord and tenant can agree on sharing the cost of such compliance. (For example, adding certain performance standards to zoning codes could have the effect of requiring a landlord to replace existing windows with windows of a greater insulation value as a condition to issuing a building permit for some other type of alteration to the grandfathered non-conforming property.) Factors to consider include the increase in useful life and value of the building due to the mandated improvement, and the remaining term of the lease. If the parties cannot agree, the lease should include a dispute resolution mechanism, such as arbitration.

The lease may provide that the landlord and tenant agree to cooperate from time to time in determining compliance with the environmental targets, and meet annually to discuss additional steps they could take to incorporate new technology or new procedures in order to further their environmental objectives. Landlords may also wish to consider the extent to which they can build into the lease the ability to participate (and require that the tenant participate) in conservation programs sponsored by utility providers, which programs may not become available until later in the lease term. Finally, market conditions may change such that in order to stay competitive, a landlord will feel obligated to become even more “green” by achieving a higher level of accreditation or certification. The lease should provide that the parties will reasonably cooperate in such initiatives, albeit the tenant may want to cap the costs of such initiatives that can be passed along to the tenant through the operating expenses.

Conclusion

Being “green” is a laudable objective, but to realize the tangible benefits of being “green,” the parties should incorporate specific objectives regarding use of materials and energy, water and other resources into their lease. They should provide for monitoring and measurement in order to determine their progress in meeting objectives. Finally, they should provide flexibility in the lease so that they are encouraged to evaluate and modify their environmental plan as the laws, technology and conditions of the marketplace change over time.

Patricia Ullman is a partner in the Real Estate Department of Schiff Hardin LLP, Chicago.