Green building

Not Easy Leasing Green

Consider these provisions before pursuing LEED certification.

Regardless of the pros and cons, landlords and tenants may have no choice but to embrace green building and other sustainability practices. California was the first state to adopt a mandatory green building code, and other states have implemented similar requirements. In addition, several cities such as Los Angeles, Phoenix, Honolulu, Las Vegas, and New York have adopted mandatory green building ordinances. There is some overlap and some distinction among federal and state code requirements, city ordinances, and various prerequisites and credits that can be earned under the U.S. Green Building Council’s Leadership in Energy and Environmental Design rating system, should the landlord or tenant seek LEED certification. But all of these programs will impact the leasing relationship between landlord and tenant in some way.

Therefore, whether dealing with green tenant improvements in a single- or multitenant building or the construction of a new green building for one or more tenants, the landlord and tenant should come to an agreement on each party’s expectations and responsibilities. Because mandatory green building requirements vary among states and cities, this article will focus specifically on how the LEED rating system affects the following lease provisions.

1. Delivery of Premises; Commencement Date; Rent Commencement Date

The delivery, term commencement, and rent commencement dates are typically determined by the party — landlord or tenant — that is constructing the tenant improvements. These dates could be further impacted if either party expresses an interest in obtaining LEED certification.

If the tenant is seeking LEED certification, the landlord may not want it to affect the dates noted above. For example, certain LEED credits, such as enhanced commissioning, are not awarded until eight months to 10 months after substantial completion. Other credits, such as thermal comfort verification, are not awarded until six months to 18 months after tenant occupancy.

2. Operating Expenses

If the landlord seeks LEED certification for a multitenant building, it may want to reconsider whether to enter into gross or net leases as there will be costs associated with obtaining and maintaining LEED certification, commissioning, and green building capital expenditures, repairs, and replacements. If it chooses to use net leases, the landlord will want to expressly list these costs. Otherwise a tenant could argue they are not standard pass-through operating expenses. As a trade-off, a tenant may want to negotiate for a share of tax credits and/or other incentives in exchange for paying for such additional operating expenses.

3. Use of Premises; Alterations, Additions, and Improvements

A typical use clause restricts the tenant to a specific use of the premises, but sometimes allows all other lawful uses. Regardless, the use must comply with applicable law, including state or local green building codes and/or ordinances.

In addition, if the landlord or the tenant seeks LEED certification for the property, the tenant should expressly agree its use of the premises will comply with LEED prerequisites and credits. The tenant should be required to comply with whichever is the most stringent — state codes, local ordinances, or the applicable LEED prerequisites and credits. Any alterations, additions, or improvements that jeopardize LEED certification should be prohibited. By example, LEED for Green Interior Design and Construction MR Credit 1.2 requires maintenance of 40 percent to 60 percent of non-shell, nonstructural components of the premises.

4. Maintenance and Repair; Surrender of Premises

The tenant and landlord should agree on who should be required to maintain what portion of the premises or building, as applicable, in its LEED-certified condition so that it does not run the risk of losing its LEED certification. If LEED certification is not concurrent with delivery of the premises to the tenant, the parties should expressly clarify the condition (pre- or post-LEED certification) under which the premises must be surrendered at the expiration or termination of the lease.

5. Parking

Parking is a source of revenue for landlords. However, certain LEED credits, state codes, and local ordinances require bicycle parking, changing rooms, and that parking not exceed the minimum per zoning. The LEED credits calculate parking based on full-time and part-time staff and peak transients but don’t seem to take into consideration that the number of tenant employees may change over time. The lease needs flexibility to allow for changes to parking corresponding with the changes in the number of tenant employees.

6. Assignment and Subletting; Relocation; Early Termination

The landlord should determine whether a prospective assignee/subtenant’s proposed use of the premises will comply or conflict with applicable LEED requirements. In addition, both the landlord and tenant should be cognizant of the impact of seeking to obtain LEED for Green Interior Design and Construction MR Credit 1.1, which requires that the tenant enter into a minimum 10-year lease. This may hinder the ability to assign the lease, sublet the premises, relocate the tenant, or terminate the lease, especially if the consequence is revocation of the LEED certification.

7. Damage and Destruction; Insurance

If the LEED-certified premises is damaged or destroyed, the parties should clarify whether replacement includes LEED certification and, if so, whether to the same level (LEED Platinum, Gold, Silver or certified) and/or the same credits obtained. Architects, engineers, and contractors should consider obtaining green errors and omissions insurance, which covers liability if, for example, a contract to design and build a LEED Gold building is entered into but the building is only awarded LEED Silver.

In addition, the tenant should be required to maintain green property insurance, which covers LEED re-certification costs. The party engaging the contractor may consider holding back funds until LEED certification is obtained; however, this can create problems between the general contractor and its subcontractors, even if the general contractor is not in default. Some credits can take six months to 18 months to be awarded after substantial completion.

8. Expansion Option; Right of First Refusal/Offer

The parties should consider the impact an expansion has on the original premises that has already achieved LEED certification. If maintenance of LEED certification is important, the expansion premises should similarly comply. In addition, if the tenant has a right of first refusal/offer to lease additional, non-adjacent space, the parties need to consider whether to use two different leases, especially if the new space is not required to be LEED certified, as the LEED-related tenant lease obligations will not apply to the non-LEED-certified space.

9. Extension Option — Fair Market Rental Value

It is common for the landlord and tenant to provide that if the term of the lease is extended, the rent during the extension term will be based on a fair market rental value formula. Issues may arise using this formula, especially if the property is LEED certified, because there may not be any LEED-certified comparables. The parties will also want to make sure the appraisers have significant experience on LEED projects.

10. Default; Remedies

The parties should clarify whether there should be a default and corresponding remedy if LEED certification, a specific LEED level, or a specific LEED credit is not obtained due to tenant or landlord action. In addition, the parties should clarify the appropriate remedy if the tenant is not in monetary default but its actions cause the property to have its LEED certification revoked. The landlord will want the right to monitor the tenant’s performance of LEED-related covenants, and the tenant will want to require that the person monitoring have significant skill and experience related to LEED projects.

11. Work Letter

A work letter is usually an exhibit to the lease that provides tenant improvement guidelines. The landlord and tenant may agree that they will each perform certain portions of the work. The landlord usually wants control over any changes to the building systems; however, doing so might result in the landlord unintentionally taking on certain LEED certification responsibilities.

Regardless of who performs the work, the contractor and architect who are engaged should be LEED-APs with the requisite experience. Since the architect and the contractor are involved in the LEED certification process, architect and construction contracts should be modified to address LEED expectations, responsibilities, and remedies for failure to comply. The landlord or tenant may offer varying incentives to the design team based on the level of LEED certification obtained. The design team will likely want to obtain its own errors and omissions green insurance to provide some coverage in the event it fails to deliver a LEED-certified project or the level of LEED certification requested.

In addition, the contractor will likely want the landlord to be required to provide training to its building maintenance staff so that building equipment and systems are operated and utilized properly in accordance with LEED requirements. This shifts the burden from the contractor to the landlord in the event LEED certification is revoked for improper maintenance. Similarly, the landlord may want to pass this obligation on to the tenant, to the extent feasible.

12. Letter of Intent

Since the aforementioned LEED-specific lease provision modifications are not customary, they should be addressed in the letter of intent. At the letter of intent stage, the landlord and tenant should agree upon the expectations of the level of LEED certification and credits to be pursued, how the responsibilities in connection with obtaining and maintaining LEED certification should be allocated, and what the remedies should be if either party fails to comply with those responsibilities.

Eric A. Altoon, JD, LEED-AP, is a partner with Gordon Kemper LLP in Los Angeles. Contact him at eric.altoon@gordonkemper.com.

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