In this article, we focus on the NSW Government’s Environmental Upgrade Agreements (EUA) initiative.  

This initiative, together with similar schemes implemented in other states, seeks to improve the environmental and energy performance of buildings through the promotion of private financing to building owners for the purpose of upgrading or retrofitting non-residential or multi-residential buildings.    

In our highly-competitive property market, energy efficiency is now a key factor in the design briefs for most significant property developments in Australia.  Under a statutory scheme introduced in 2010, owners and landlords are now required to disclose the energy efficiency ratings of their office buildings when selling a building or leasing an area of a building of 2000m2 or more therefore increasing the incentive to achieve better energy performance in commercial office buildings. 

Energy efficiency upgrades should result in lower occupancy costs for tenants and this in turn can increase asset-value for owners.  However, investment in energy efficiency upgrades can be hampered by high capital costs, soft markets and market barriers (described in more detail below).

For lenders, EUAs provide an opportunity to participate in innovative financing arrangements in an emerging energy efficient market. 

Background

The Local Government Amendment (Environmental Upgrade Agreements) Act 2010 (Act) commenced on 18 February 2011 with the purpose of making it easier for building owners and landlords to promote investment in energy efficiency in the building sector.  Traditionally, building owners faced market barriers to funding including:

  • The limited availability of traditional loans for energy efficiency upgrades.
  • ‘Net leases’ where tenants pay their energy costs directly instead of through lease payments.  This results in a ‘split incentive’ towards making the necessary capital investment in major environmental upgrades because, whilst building owners are responsible for investing in such upgrades, tenants receive the benefits through reduced power bills.

The Act provides a new framework designed and structured to overcome traditional barriers to investment in environmental upgrade works to buildings by utilising the powers of local government to levy statutory charges over land (Environmental Upgrade Charge).

What are EUAs?

EUAs are essentially a tripartite agreement entered into between a finance provider, the council and the building owner. 

An EUA essentially involves the following:

  1. a lender provides finance to a building owner wishing to upgrade its building;
  2. the building owner uses the funds to perform environmental upgrade works;
  3. the local council levies an Environmental Upgrade Charge against the land on which the building sits for the amount equivalent to the repayment of the   funding plus a service fee for the council;
  4. the building owner makes payments to the council to satisfy the charge; and
  5. the council passes on the payments to the financier subject to councilretaining an agreed service fee.

From a financier’s perspective, an EUA ‘secures’ the financial accommodation by the council levying the Environmental Upgrade Charge. 

The Environmental Upgrade Charge will rank on equal footing with a charge on the land under the Act but will rank in priority to any other charge or encumbrance in respect of such land.  In addition, where a transfer of the land occurs, the charge will, save for certain special circumstances,  ‘run’ with the land. 

The EUA scheme is designed to present a more attractive investment environment for a building owner, because under an EUA the building owner should find it easier to pass part of its costs of the upgrade onto the tenant.  The reason for this is that the costs are levied against the owner as a charge from the council and so they are usually capable of being passed onto the tenant like other council rates.  Under the EUA legislation, there is a cap on the tenant contributions to the extent of savings expected to be realised by the tenant from the upgrade project.

Whether the lease provisions allow for this pass-through and whether tenants will be willing to accept such charges in the current market conditions are two important considerations for those looking to implement EUA finance.

Are the arrangements ‘secured’ in the traditional sense?

EUAs do not contemplate traditional forms of security being provided from the building owner to a lender.  As noted above, they instead ‘secure’ the financial accommodation through the levying of the Environmental Upgrade Charge against the land. 

A financier holds no direct claim to the charge and therefore no direct enforcement rights against a building owner.  Instead, it is the council that is responsible for facilitating the agreement between the financier and the building owner and recovering payment of the loan.

How can financiers feel confident?

Regardless of the restrictions noted, financiers can explore ways to alleviate discomfort with EUAs. 

There is arguably room for negotiation of EUAs particularly where the enforcement procedure adopted by the council is concerned.  Further, financiers remain entitled to seek damages, specific performance and other court relief to ensure performance by the council of its obligations under an EUA.

In addition, financiers can explore offering EUA finance as an ancillary product to other traditional secured financing products (such as financing a building, where a mortgage is obtained as security).  Depending on the level of financing, cash collateral, bank guarantees or other forms of security may also be suitable.