From 1 April 2018 landlords must not grant new leases of "non-domestic" properties with an Energy Performance Certificate (EPC) of less than E (subject to certain exemptions). The full regime can be found in the Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015 (the Regulations).
Official guidance on how the Regulations should be applied has recently been published by the Department for Business, Energy & Industrial Strategy (the Guidance). Amongst other things, the Guidance briefly deals with the overlap between the Regulations and the Landlord and Tenant Act 1954 (the Act). This article examines that overlap, identifies questions that arise and suggests how they might be answered.
Questions to consider
Unless the parties have 'contracted out', the Act gives business tenants a right to renew their tenancy at the end of the term. However, under Regulation 27 landlords are prohibited from granting a renewal lease to existing tenants, if the premises in question have an EPC of less than E. What happens then if a premises has an EPC rating of less than E, but after 1 April 2018 the tenant becomes entitled to a renewal lease under the Act?
The Guidance makes it clear that a landlord cannot refuse to renew under the Act simply because the premises does not meet the requisite standard of energy efficiency under the Regulations. Rather, landlords will have a duty to carry out any works necessary, so that the relevant premises comply with the Regulations.
Therefore, the questions that arise are:
- How will the works be carried out?
- When will the work be completed by?
- Who will pay for the works?
- What terms will the renewal lease contain?
- How can the landlord avoid being in breach of the Regulations whilst carrying out the works?
Access for works
Under the Regulations, the obligation to carry out the works falls on the Landlord. However, this does not mean that the parties could not agree that the tenant will carry out the works instead. Therefore, where a renewal lease is to be granted, and the landlord has a duty to carry out improvements under the Regulations, the first thing the parties may do is decide who will carry out the works.
If the landlord is going to carry out the works itself, some thought will have to be given as to how and when the landlord will have access to the premises to carry out the works. It could either (a) complete the works before the renewal lease has been entered into, or (b) afterwards. In either case, the tenant's consent to the works will be required.
Regulation 31(1)(a)(i) exempts landlords from having to carry out improvement works, if the tenant withholds consent to the works being carried out. Thus if the landlord asks the tenant for consent to do the works and it is refused, the obligation to carry out the works falls away and the renewal lease can proceed. However, this exemption only lasts for five years (or the term of the renewal lease if shorter), or until the tenant assigns. Therefore, any landlord looking to rely on this exemption will have to make sure that it asks the tenant for consent at least once every five years, and may well simply be storing up a problem for five years' time, or when the current tenant leaves. The landlord will need to register the fact of the exemption, with adequate evidence of the tenant's refusal, before the renewal lease completes.
Timing of works
Regulation 33(2)(e) gives landlords a temporary exemption from carrying out improvement works for a period of six months from the date of the grant of the renewal lease. Therefore, in theory, the landlord has a six month window in which to carry out necessary improvement works before a breach of the Regulations occurs.
Landlords may seek to include a term in the renewal lease which allows them access to the premises within the first six months – if their intention is to carry out improvement works after completion of the renewal lease.
Alternatively, if the parties have agreed that the tenant will carry out the works and that this is to be documented in the renewal lease, the landlord should insist that the lease requires the tenant to carry out the works within the first six months of the term. This may present a danger for the landlord however, if the tenant fails to carry out the works in time – i.e. the landlord could be in breach of the Regulations if the lease continues on beyond the initial six month period. This is unlikely to be a risk that the landlord will wish to take.
Cost of works
Generally, one would expect the landlord to pay for the up-front costs of the works because the duty under the Regulations is one which is imposed on the landlord. However, landlords could arguably charge higher rent for improved premises.
When determining the rent of a renewal lease pursuant to the Act, the Court considers the value of the premises as they stand – i.e. not in the condition that they may be in the future. If the parties have agreed that the landlord will carry out improvement works after the renewal lease has been completed, it is unclear whether the future works will be taken into account when the rent is set.
If there is a term in the renewal lease obliging the landlord to carry out the works, it is perhaps more likely that they will be accounted for when the rent is determined. This is because what is being valued is the premises as let on the terms of the renewal lease. However, it could also be argued that (even if there is not a specific term in the lease requiring improvement works) the rent should be calculated on the basis that the works have been carried out, as the landlord has an obligation to carry them out pursuant to the Regulations. The tenant may, however, argue for a rent free period or other discount by reason of the inconvenience that it will suffer whilst the landlord actually carries out the works.
Section 34(1)(c) of the Act states that tenant's improvements are to be disregarded when setting the rent under a renewal lease, "but only if carried out otherwise than in pursuance of an obligation to his immediate landlord". This is another reason why tenants will be unwilling to agree to bear the cost of the works, given that, upon any subsequent renewal, they are likely to find that the benefit of the works they have paid for is not disregarded when the rent is set, as the works would have been carried out pursuant to an obligation to the landlord. Nonetheless, depending on the way in which the lease is drafted, and how the obligations on the tenant to contribute to costs of works are worded, tenants may still find themselves ultimately having to pay for required improvement works.
How the issues may play out
Tenants are likely to wait for landlords to raise the issue of compliance with the Regulations as, from 1 April 2018, once a renewal lease has been granted, it is the landlord who will have an obligation (subject to the various exemptions, not all of which we have dealt with here) to ensure that the premises are at least "E" standard.
Landlords may ask for consent to carry out improvement works, prior to a renewal lease being granted (if the renewal falls due after 1 April 2018). If the works are completed by the landlord before the renewal lease is granted, they should be taken into account when the rent is determined. Tenants, however, could refuse immediate access for works and then argue, when rent is being considered, that the possibility of landlord's future works should not be factored in when the rent is set. What might happen once an exemption from the Regulation (because of a tenant's refusal to allow the works) expires is, however, a matter of speculation.
If a landlord has asked a tenant for consent to do works and the tenant has said "yes you can have access, but not before the renewal lease has been granted", it is unclear whether this would be considered refusal to give consent (and thus trigger the Regulation 31 exemption). More likely, the initial six month exemption will apply and the landlord will then have that time period to complete the required works.
It is likely that, in the next few years, the issues mentioned above will come to a head in the Courts. In the meantime, the advice to both landlords and tenants is that they carefully consider their position in light of the Regulations before entering into lease renewal negotiations, when dealing with premises below the required E rating.