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Social and Good Governance Clauses for Leases

Social and Good Governance Clauses for Leases


There are various ways in which a landlord might wish to ensure the alignment of its tenant with social and good governance principles, in line with the landlord's own ESG strategy and wider market requirements.


The primary way to achieve this alignment is to seek:

(a). covenants from the tenant to observe certain core principles within the lease;

(b). greater controls over the identity of the tenant from time to time;

(c). a covenant within the lease to comply with the requirements of law; and

(d). an obligation on the tenant to report to the landlord regarding its level of compliance with the above.

The extent and nature of the obligations on the tenant under a lease will depend on the relationship between the landlord and tenant (is the lease agreement the only contract between them, or do they have a wider relationship for example under a joint venture), the nature of the asset, the identity of the tenant and the perceived sustainability risks that arise as a result.

This paper considers how a landlord investing into retail or office asset classes might look to introduce social and good governance related clauses, and how they may approach this decision making.

Is this something that landlords should be introducing?

This will depend on the landlord's own investment profile, the requirements of its investors and funders, and its own objectives under its particular ESG strategy.

There is no one size fits all. However, in a world where the identification of risks to sustainable investment and business, and the implementation of strategies to manage those risks, is increasingly upon us, it is sensible for any landlord investor to ask itself these questions and how it is managing the risks associated with the occupiers within its portfolio.

Landlords must be aware of accurately reporting their investment objectives and alignment with those. It is increasingly important that there are underlying lease covenants to substantiate any statements landlords wish to make to the market about their broader ESG strategy.

It is increasingly common to include 'green leasing' provisions on new lease transactions. Organisations such as the Better Buildings Partnership and the Chancery Lane Project are leading the way to establish a market norm. Whilst we are not yet at an established best practice per asset class/sector type on the extent of green clauses, the following are emerging as a baseline requirement:

(a). a set of controls to ensure minimum efficiency standards are met over time;

(b). provisions designed to encourage better waste management and the recycling of materials; and

(c). provision of data to the landlord for key environmental performance criteria.

Over time, it is reasonable to assume that these provisions will become commonplace and will need to speak to other social and governance objectives, something that we also understand is to be considered by the Government in its consultations on updates to the Landlord and Tenant Act 1954, and the extent to which the legislation should provide a mechanism for the inclusion of green leasing in statutory lease renewals.

There are increasing reputational and legal consequences for landlords associated with the occupiers of their assets. It is no longer the case that a landlord can say it has pushed all such risks down to the occupier as a result of a lease being in place, something that Travers Smith identified and considered It is against this context that clauses such as those set out in this paper may be considered in 2017. This litigation risk is increasingly recognised by fund managers who are seeking to minimise that risk through:

(a). a more focused selection of tenants against a set of objectives that align with the landlord's own strategy; and

(b). the collection of data to monitor the alignment of tenant occupiers with the landlord's own strategy, identify areas of risk and therefore be in a position to seek to address those through active asset management.

What are the social objectives we are referring to?

This is a moving picture in law and will also depend on the asset, the sector, the identity of the parties and the locality in which the property sits, to name a few factors.

Broadly, we know that investors are concerned with certain common themes as reflected in the Principles for Responsible Investment, the UN Declaration of Human Rights and the European Social Charter.

Within the UK, increased regulation and reporting obligations on investors has largely been climate focused. However, with the recent publication of the FCA's Sustainability Disclosure Requirements (SDR) and investment labels, an increasingly politicized work force within the UK and the general trend towards greater accountability of UK business, investors are increasingly considering wider social risks such as:

(a). employment and work conditions, including equal pay, fair recruitment policies, training and retention policies, and the protection of the vulnerable with anti-discrimination procedures;

(b). health and safety, and social well-being; and

(c). good business practice such as anti-bribery and anti-corruption policies, both in respect of employees but also through the wider value chains of the tenant's business.

Can't this be achieved through a compliance with laws clause?

It is well established practice that leases contain a compliance with laws clause. This pushes the responsibility of complying with legal requirements that affect the use and occupation of a premises onto the tenant. This will include compliance with disability legislation, health & safety legislation and good governance legislation such as data protection and anti-bribery laws.

The approach in the legal drafting of leases as to whether to identify any particular laws has varied over time. In the context of works to a premises, for example, it is common practice to restate the obligation to comply with health & safety laws. Some leases also include anti-bribery clauses, usually driven by the landlord's own compliance needs that requires asset managers to reflect this drafting into lease documents.

Given the universality of these clauses, landlords should be cautious about whether it is right to include any specific requirements beyond a general compliance with laws clause. Tenants may fairly argue for a reciprocal covenant that goes beyond what the landlord would want to give to many tenants across large portfolios. Landlords may also find that certain risks within those specific legislative regimes are pushed back onto the landlord in the course of negotiations; something that would not have been the case under a general compliance with laws clause that has not traditionally been over-negotiated.

A compliance with laws clause requires observance to the minimum legal standard, which may fall short of the landlord's own ESG strategy and the messages it wishes to take to market.

What clauses may a landlord look to include, in addition to a general compliance with laws clause?

What should the consequences be for failure to comply with social and good governance clauses?

It is established practice that breach of a compliance with laws clause, or alienation clauses, would give the landlord a right to forfeit and terminate the lease (subject always to a tenant's right to seek relief against this action).

It is also established practice that landlords have forfeiture rights (subject to applications for relief) for material breaches of the lease. Whether non-compliance with a social and good governance clause can be said to be material is fact specific, depending on the nature of the breach.

In the current market, it is unlikely that tenants will generally accept a termination of their lease for failure to comply with social and good governance clauses. These are matters still largely viewed as operational and therefore private to the tenant, not of relevance to its landlord and tenant relationship. Whilst we believe that the market is moving as tenants appreciate the pressures on landlords to demonstrate their own efforts to implement social and better governance practices, there will be nervousness in opening up the workings of the tenant's business to the landlord in this way for some time to come and for some, particularly larger/corporate tenants, this is likely to remain unpalatable for a while yet.

The use of established lease principles, such as change of control restrictions and pre-emption rights, would provide an effective mechanism for landlords to better control the identity of their tenants over time. It is possible that landlords look to widen the scope of other established lease terms to further ESG objectives, such as:

(a). contractual options to renew being aligned with certain ESG criteria; and/or

(b). the increased use of key performance indicators for certain ESG criteria that could unlock certain incentives for the tenant under the lease (financial or otherwise), although currently we have not seen any attempt to include such provisions within lease negotiations. It is also not yet clear how such provisions could impact rents achievable in the context of open market rent reviews if they are deemed to be onerous.

There will always be arguments on a case-by-case basis where there is a particular social and good governance risk that runs through the lease transaction and the underlying asset class will become increasingly relevant. However, in terms of general asset management of retail and office premises, we expect only those obligations that are soft, or reflect established lease practice, to be acceptable on scale. These are shaded green in the table above.

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