Rising energy costs and commercial lease terms

Having battled through an unprecedented pandemic to a now contracting UK economy and with inflation at a 40-year high, lower energy costs will be just one request that features on tenants’ Christmas lists this year. But how are energy costs addressed in commercial leases and does a tenant have any control? This article revisits how utility and energy costs are usually covered by commercial leases and what controls may be available to a tenant.

What am I obliged to pay? 

This will of course come down to the particular provisions of the lease. Typically, a tenant will be obliged to pay all utility costs incurred in connection with the premises they let and contribute towards the cost of utilities for any common parts, where a lease of part is taken.

The costs will be calculated by the meter for the building where the tenant leases the whole building. For premises in a multi-let building the cost of utilities payable by the tenant will be calculated either by a sub-meter for the individual premises which measures actual use, or, where there is no sub-meter, using an underlying method of apportionment (such as floor area) where the usual obligation on the tenant is then to pay a fair proportion of the total costs payable in respect of the building. This is fine where occupiers all use the same amount of energy but can otherwise lead to disputes. The Service Charge Code issued by RICS views separate metering or full submetering of utility supplies as essential to ensure apportionment of costs that reflects actual consumption and usage.

If you were fortunate enough to have agreed on an all-inclusive rent, the level of rent will have been fixed inclusive of utility costs and so the landlord will take the hit on any increases in energy costs unless a specific provision was made for increases to be passed on to the tenant.

Can I control the terms of the utility supply contract? 

Where a tenant takes a lease of whole, they will invariably contract directly with an energy supplier and so control over terms and price sit with the tenant.

Where a lease of part is taken, the landlord will usually retain control of arranging the supply of utilities for the whole building but where submetering is used the tenant may be responsible for utilities directly with the provider.

Leases have not traditionally allowed for tenants to be involved or have a say on the contracts arranged by the landlord. This may understandably cause concern to a tenant, however, it is not in a landlord’s interest to cause financial strain on their tenant’s business as this could jeopardise their income stream and if the building has empty units, the landlord will have to meet the energy costs for those parts. Service charge provisions may provide some comfort for utility costs relating to the common parts as the tenant may have the benefit of a service charge cap.

What next? 

Whether or not you control the terms of the supply agreements, there will be things within an occupier’s control, whether it’s changing to LED bulbs, turning down the heating or, subject to the terms of your lease, undertaking alterations to the premises to lower energy consumption.

Where a lease obliges the landlord to comply with or have regard to the Service Charge Code, there is an implied obligation that services are procured on an appropriate value for money basis and that competitive quotations are obtained or costs benchmarked. If energy supply arrangements have not been reviewed for some time, a tenant may be able to insist that the landlord investigates alternative suppliers.

With the government’s net zero targets, recent changes to the Minimum Energy Efficiency Standards and the growing demands from tenants to achieve ESG goals and environmental credentials, landlords are going to have to think creatively about how they can improve the energy efficiency of their existing buildings and how new buildings will be designed to satisfy these requirements from which tenants will reap the benefits of a more energy efficient building helping to lower their energy costs.  

Even tenants in a strong negotiating position may be unable to insist that utility charges are capped in a new lease. Nonetheless, many are successfully demanding much more oversight over the Landlord’s energy supply arrangements and ESG requirements are rapidly moving up the priority list at building selection stage. Well advised tenants are insisting that pre-let arrangements contain binding commitments on developers to actually deliver buildings that live up to the energy performance targets mentioned in marketing materials.