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December 2014/January 2015 | practicallaw.com54

DRAFTING AND NEGOTIATING

GREEN LEASES

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55Practical Law The Journal | Transactions & Business | December 2014/January 2015

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As the green real estate movement expands, the concept of green leasing is increasingly impacting the drafting and negotiation of commercial real estate leases across all sectors.

MICHAEL A. BEDKEPARTNERDLA PIPER LLP (US)

Michael represents clients in all aspects of real estate and commercial financing work. His clients include institutional lenders, investors, national developers and retailers.



Although green real estate issues have impacted all areas of commercial real estate, leasing has been at the forefront of the green real estate movement. There has been much debate surrounding whether a green

building is more or less attractive to potential tenants. However, as more government bodies require green compliance and more companies embrace sustainable energy usage, it seems clear that green leasing is here to stay.

Green leasing concepts are emerging more frequently in leases for both newly developed and existing buildings. Factors driving this emerging market trend are fueled by the interests of both landlords and tenants. For example, owners want to maximize their green efforts by conforming their lease clauses to recoup and capture as much of their green improvement costs as possible from their tenants, while tenants want to ensure that the operating costs passed through to them are as low as possible.

This article, Part Two in our two-part series on owning and leasing green real estate, focuses on green concepts in leasing. Specifically, it examines the scope of green concepts in leasing practices and provides tips for negotiating key lease clauses that incorporate green concepts.

Search Owning and Leasing Green Real Estate for the complete, online version of this resource, which includes Part One explaining the US green rating systems, state and local green mandates for new and existing improvements, incentives for going green and financing-related opportunities for owners.

SCOPE OF GREEN CONCEPTS IN LEASING PRACTICESGenerally, a green lease is a lease involving space where the design, construction, build-out, operations and use of the demised premises focuses on environmentally friendly features. Green leasing concepts may be used in connection with both:

�� New development projects that include sustainable design features.

�� Existing buildings that are retrofitted with sustainable design elements.

However, there is no universally applicable definition for a green lease since owners and landlords incorporate green clauses and concepts for a variety of reasons that are not necessarily uniform. A property owner’s motivation for including green leasing concepts in its leasing practices often depends on different factors, including:

�� The type of real estate sector or use involved.

�� The building’s level of sustainable design elements and, in particular, whether the building is a new or an existing structure.

�� The building’s tenant make-up, including whether the building is leased to a single tenant or multiple tenants with different uses (such as office and retail).

�� The owner’s motivation for ensuring:�z compliance with legal requirements;�z its ability to capture the benefits of any available incentive programs;

�z best operation practices for maintaining building certification standards; and�z no action is taken that would lead to a breach of covenants tied to financial obligations.

�� The prevalence of green initiatives and incentives in the city and state where the property is located and the ease of accessing green programs.

Despite the wide spectrum of applicability for green leasing concepts, green leasing is increasingly impacting the drafting and negotiation of commercial real estate leases across all sectors.

Before determining which green leasing clauses to incorporate into the leasing practices of a particular building, landlords should conduct careful due diligence, including a thorough review of the landlord’s obligations under any existing:

�� Leases.

�� Loan documents.

�� Covenants, conditions and restrictions (CCRs).

�� Third-party agreements.

Landlords should review and analyze the risks of a potential default under any of these agreements before modifying their current leasing practices.

INCLUDING GREEN CONCEPTS IN LEASE AGREEMENTS

There are several ways to incorporate green concepts into the lease agreement itself. One way is to introduce and adopt a comprehensive green lease form in its entirety. This is typically adopted for new development projects, rather than for an existing building that has been retrofitted.

Another way is to incorporate individual green clauses into an existing lease form for all new tenants or attach a green leasing rider to the leases of existing tenants. For existing buildings, this practice may be the easiest way to introduce green concepts into the building’s existing operations and leasing practices. Complications may arise, however, when a landlord tries to incorporate green lease clauses into existing leases through amendments or newly applicable building rules and regulations. A landlord should carefully review the language of each existing lease at the property to determine its ability to impose new green obligations or restrictions on an existing tenant.

MODEL GREEN LEASES AND CLAUSES

There are several model leases available in the market that can be a good starting point for owners and tenants interested in adopting a green lease wholesale, or including key green lease clauses into an existing lease. The parties, however, will likely need to modify the language of any of the model lease forms and clauses to conform to the specific deal terms and accommodate the building’s characteristics and the scope of green concepts that may or may not be applicable.

The most commonly used forms of green leases include:

�� Real Property Association of Canada’s (REALpac’s) national standard green office lease for single-building projects.

�� Building Owners and Managers Association’s (BOMA’s) green lease form.



�� Corporate Realty and Management’s green lease.

�� New York City’s model “Energy Aligned Clause.”

REALpac’s National Standard Green Office Lease

REALpac has a good national standard green office lease for single-building projects that is also used in the US. The form is an office lease for a building with multiple tenants (although the concepts may be incorporated into retail and industrial leases and applied to single-tenant buildings). While the form includes a few green provisions in the body of the lease, for the most part, REALpac uses a green rider to supplement the lease.

BOMA’s Green Lease

BOMA has a form of green lease available for purchase. The original BOMA form was considered more flexible than the REALpac form because it contemplated some different uses and provided some variation in language, depending on whether the space was retail, office or industrial.

However, the first green version of the BOMA lease was, like the REALpac form, a fairly typical lease form that was “greened-up” with the inclusion of some LEED certification standards and sustainability concepts. This green version of the BOMA lease form was generally viewed as being pro-landlord, which is not surprising since BOMA is comprised of building owners and managers.

More recently, BOMA has developed a new, more neutral form of green lease. Because the new form consists entirely of green leasing provisions rather than a typical lease with a few tweaks, it is considered to be a true green lease. The new form also has the advantage of being set up to recognize various rent structures, including a triple net lease where the tenant pays for taxes, insurance and utilities and a full-service lease where the landlord pays for these items.

Corporate Realty and Management’s Green Lease

The Corporate Realty and Management’s green lease (sometimes referred to as the Model Green Lease) adopts an approach designed to incentivize landlords and tenants to control operating expenses and utility costs. These incentives do not exist for a landlord in a triple net lease situation since these costs are the tenant’s obligation.

New York City’s Energy Aligned Clause

New York City requires its model lease clause, the Energy Aligned Clause, to be included in every lease where it is the tenant. This clause provides form language that may be used in an operating clause for an office lease that is a modified gross lease. This clause is particularly applicable when the landlord has done a base-building energy retrofitting of an existing office building.

Effectively, this model lease clause provides a pass-through structure where both the landlord and the tenant share both the costs and the benefits of improvements aimed at energy efficiency. The clause, an overview of how it works and the financial model are available at nyc.gov/eac.

Search Office Leasing: Agreement of Lease (Pro-landlord Long Form NY) for a discussion of pass-throughs in office leases.

NEGOTIATING KEY GREEN LEASE CLAUSESBest practices related to negotiating green lease clauses are still relatively new and continue to evolve. Understanding green leasing issues, however, will allow landlords, tenants and their brokers to simultaneously advance their business and sustainability goals.

While green concepts can be incorporated throughout the lease, certain key lease clauses commonly negotiated in a green context include:

�� Permitted use.

�� Building rules and regulations.

�� Alterations.

�� Operating expenses.

�� Defaults and remedies.

�� Data sharing.

�� Assignment and subletting.

�� Relocation.

�� Lease term.

�� Carbon credits.

�� Standards and benchmarks.

PERMITTED USE

The permitted use clause in a lease defines how the tenant may use its premises during the lease term and what it may or may not do in the premises.

The permitted use clause in an environmentally friendly lease usually prohibits the tenant (or any assignee or subtenant) from using the premises in any way that does not conform to the building’s third-party certification, the landlord’s sustainability requirements or the environmental management plan negotiated between the parties.

While this clause tends to focus on the activities of the tenant, the clause should be negotiated with care by both sides. For example:

�� Tenants should require that the landlord seek enforcement against other tenants whose use or activities are not in conformity with the green building standards.

�� Landlords should be particularly careful not to guaranty matters that are beyond their control, such as providing natural light (which can be blocked by neighboring development).

Search Office Leasing: Key Provisions in an Office Lease for more on permitted use and other tenants’ rights.

BUILDING RULES AND REGULATIONS

Most commercial leases require a tenant to comply with the landlord’s rules and regulations for the building. When a building undergoes any type of retrofit, the landlord may need to amend the building’s existing rules and regulations to accommodate for any changes required under the retrofit.

The parties should be mindful of how they negotiate their covenants relating to the building’s rules and regulations. For example:



�� Landlords should ensure that they provide themselves with flexibility to amend the building’s rules and regulations throughout the lease term.

�� A tenant should ensure that it negotiates a reasonable standard for any future changes to the rules and regulations. In particular:�z if the tenant has sufficient negotiation leverage, the tenant should also reserve the right to review the landlord’s amended rules and regulations to confirm that they are in conformity with the tenant’s own green objectives; and �z a tenant should be aware of the potential to incur additional costs or fees in order to comply with the amended rules and regulations.

For existing leases, the lease must be reviewed carefully to determine whether there is built-in flexibility for a landlord interested in doing a retrofit and whether the tenant must accept any changes to the building’s rules and regulations. While most leases provide the landlord with sufficient flexibility, the terms of the signed lease ultimately govern the scope of what the parties may or may not do in connection with any amendments to the building’s rules and regulations.

Search Office Leasing: Agreement of Lease (Pro-landlord Long Form NY) for an example of a long-form agreement for the leasing of office space in a multi-tenant office building.

INITIAL BUILD-OUT AND ONGOING ALTERATIONS

Initial Build-out

Often there is an initial build-out of the premises before the tenant can occupy its space. Typically the most common green requirement of the landlord in a lease relates to the tenant’s initial build-out of its premises.

Both the landlord’s and the tenant’s green standards affect the design and initial build-out of the tenant’s leased space. Many landlords of both new and existing buildings are requiring that

tenants apply for certification under the LEED for Commercial Interiors program and other green programs (including Green Globes, ENERGY STAR and ASHRAE 90.1). These green requirements are generally considered to be reasonable in the marketplace.

Most lease negotiations with an initial build-out include a work letter, which is a legally binding agreement that governs the parties’ obligations relating to the initial build-out. Depending on the parties’ negotiations, initial build-outs may be performed by the landlord, the tenant or a combination of the two. Regardless of who is performing the build-out, however, the work letter should use well-defined metrics to clearly establish the specific green standards required and who is responsible for the various costs.

The initial build-out in a green building will most likely be more costly than in a non-green building since there are typically additional costs and requirements associated with green buildings, such as:

�� More expensive material, furnishings and fixtures.

�� The cost of:�z certified green consultants and contractors; and �z energy-saving fixtures and building systems.

�� More expensive means and methods during construction.

Tenants should negotiate a higher tenant allowance from the landlord to cover many of the extra costs a tenant incurs to comply with these green standards. For example, a specified LEED certification may be a required obligation for the tenant under the work letter and a LEED accredited consultant may have to be hired by the tenant to manage the sustainability aspects of the initial build-out.

Ongoing Alterations

After the initial build-out, any alterations performed at the premises will be governed by the alterations clause of the lease agreement. Leases typically require that the tenant obtain the

For existing leases, the lease must be reviewed carefully to determine whether there is built-in flexibility for a landlord interested in doing a retrofit and whether the tenant must accept any changes to the building’s rules and regulations.



landlord’s consent prior to making any alterations. Tenants often negotiate that the landlord’s consent to the alterations not be unreasonably withheld, conditioned or delayed.

A landlord should be particularly careful when negotiating the applicable consent standard with respect to a tenant’s alterations. What is reasonable in the context of a green lease may not be reasonable when dealing with a more traditional lease. If the landlord has agreed to not unreasonably withhold its consent for future alterations then the landlord should ensure that the reasonableness standard takes into account the landlord’s green requirements which may likely affect the tenant’s alterations in one way or another. Even minor alterations that jeopardize a third-party standard should be deemed as a reasonable rejection of the tenant’s request for the landlord’s consent.

Search Office Leasing: Key Provisions in an Office Lease for additional guidance on tenants’ initial build-outs and alterations.

OPERATING EXPENSES

In modified gross leases, a landlord passes through to its tenants its operating expenses for the building. Each tenant typically pays for its proportionate share of such operating expenses, subject to certain (often heavily negotiated) exceptions. One item tenants try to carve out of their operating expenses clause includes the landlord’s capital expenses.

A fundamental and threshold issue in negotiating a more green operating expense clause is often called the split incentive problem. This refers to a common division between the tenant and the landlord where the tenant agrees to pay for its proportionate share of operating expenses, but not its proportionate share of the landlord’s expenses relating to capital improvements made during the lease term. When leases are negotiated with the traditional split structure, landlords are not incentivized to retrofit their buildings because they would solely carry the burden of the upfront costs that cannot be passed through.

The split incentive problem results from:

�� Tenants not wanting to spend money to retrofit their landlords’ underperforming property.

�� Landlords not wanting to:�z spend money to save money for its tenants, since tenants will generally pay for their energy costs; and �z invest in capital improvements that require an immediate, upfront expenditure of significant capital improvement dollars.

Traditional gross leases effectively preclude or greatly limit a landlord’s ability to pass through the costs of capital improvements that are designed to increase sustainability. With respect to existing tenants, a landlord may not be able to pass through to its tenants the landlord’s costs for going green when these costs are tied to capital improvements. Because landlords typically pay for capital costs and tenants typically pay for operating costs, the landlord has little, if any, incentive to reduce utility costs. For example, depending on the negotiated language in the operating expense clause, the landlord may or may not be able

to pass through to its tenants the cost of replacing the building’s boiler with a more energy efficient model.

Commentary to BOMA’s green lease points out that the split incentive concept is overly simplistic since, in the real world, even in a triple net lease:

�� The tenant typically pays for some green-related capital expenses.

�� A landlord has incentives to green its building due to increased occupancy, reduced costs of capital and other benefits.

There are a few solutions that have been put forward to solve the split incentive problem, such as:

�� Separate sub-metering where a tenant pays only for the energy it uses, instead of paying a pro-rata share of the entire building’s usage.

�� The New York City’s Energy Aligned Clause, which provides incentives to the:�z landlord by ensuring it is able to pass through the costs of the capital expenses to its tenants; and�z tenant by ensuring a protection mechanism to avoid paying for underperforming retrofit improvements.

Additionally, Rocky Mountain Institute, a non-partisan nonprofit organization aimed at market-driven solutions for businesses to increase sustainability and energy efficiency, offers the following five ways landlords and tenants may work together to overcome the split incentive problem and arrive at a win-win outcome:

�� Make energy costs and use more transparent.

�� Encourage building occupants to save energy.

�� Incorporate energy efficiency into fit-outs.

�� Plan ahead for deep energy retrofits.

�� Structure agreements to benefit both parties.

Search Office Leasing: Schedule of Operating Expenses Exclusions for related guidance on operating expenses clauses.

DEFAULTS AND REMEDIES

Most green leases adopt a fairly traditional approach to defaults and remedies. Landlords and tenants may negotiate the following:

�� Commercially reasonable efforts. Tenants may negotiate for the REALpac green lease approach where, if the parties use commercially reasonable efforts to achieve the overall environmental objectives set forth in the lease, the parties are deemed to be in compliance with the lease. Landlords typically reject this approach because it makes certain lease provisions only aspirational in nature.

�� Remedy of self-help. This remedy can be difficult to implement in green leases. Landlords (and their lenders) generally will not agree to a self-help remedy because it may obligate landlords (or their lenders) to incur major expenditures.

�� Remedy of rent set-off or abatement. A tenant may negotiate for the right to receive a rent set-off or abatement if the landlord is in default of its obligations under the lease. Landlords and lenders generally will not agree to this because they do not want to see the income stream diminished in this manner.



�� Consequential damages. Tenants, in particular, should push back hard against consequential damages clauses and broad indemnification provisions. Doing or failing to do something that could result in the loss of a sizeable tax credit, enhanced floor area ratio (FAR), allowable reduction in parking or other incentive could result in damages far beyond the value of the lease.

�� Liquidated damages. Green leases are particularly well-suited for the use of liquidated damages clauses, particularly in situations where damages may be difficult to ascertain or there is a lack of a meaningful contextual remedy. However, fairness dictates that the ultimate remedy of eviction of the tenant by the landlord or the termination of the lease by the tenant must be available for the most egregious defaults. In a green lease, this would likely be reserved for events that put the entire sustainability scheme at risk by jeopardizing the underlying LEED or other applicable certification or rating.

Search Office Leasing: Key Provisions in an Office Lease and Office Leasing: Agreement of Lease (Pro-landlord Long Form NY) for guidance on defaults and remedies in lease agreements generally.

DATA SHARING

Providing information to one another is critical in green leasing. While most green leasing forms sprinkle the concept of information sharing throughout the body of the lease, including an express clause in the lease specifically devoted to the issue is helpful.

Landlords generally require the cooperation of tenants to provide information necessary for the landlord to obtain and maintain third-party certification. This information may include:

�� Hours of operation.

�� The cleaning products used.

�� The types of paints, carpeting and other materials used.

Tenants may argue that they should not have to provide information to the landlord unless the landlord is obligated to obtain and maintain a third-party certification. This position is not compelling, however, since even traditional leases often provide landlords with the right to receive this information as part of their routine approval process.

Tenants under a green lease may also require reporting from the landlord. A tenant may negotiate for the landlord to provide it with a report on the performance of the building or allow the tenant to audit the landlord’s books and records regarding:

�� The building’s energy use.

�� Compliance with third-party certification standards.

�� Any other components of the sustainability plan.

The landlord should carefully consider whether to give the tenant the right to audit its books and records because sharing this data may trigger confidentiality clauses with vendors or other tenants. If the landlord grants a tenant this right, it should ensure that the lease obligates the tenant to keep all disclosed information strictly confidential.

One compromise is to only require the sharing of information that is mandated, such as annual energy reports and audits

required by governmental authorities. At the very least, tenants should be able to review and obtain the information required by governmental ordinances to comply with all applicable laws.

An even better and more effective compromise is to require each party to provide the other with information that is:

�� Required by law.

�� Submitted to third-party certification or rating groups.

�� Non-confidential and sustainability-related in its possession or reasonably available to it from its architects, engineers, property manager or other consultants and vendors.

ASSIGNMENT AND SUBLETTING

The green lease forms, as in most other leases, generally require the landlord’s consent to an assignment or subletting. Typically assignment and subleasing clauses provide that the landlord’s consent may not be unreasonably withheld, conditioned or delayed.

The landlord of a green building should include an express statement in the assignment and subleasing clause of its lease that it is reasonable for the landlord to withhold its consent to an assignment or sublet if the proposed assignee’s or subtenant’s anticipated use or operation of the premises is inconsistent with the environmental or sustainability clauses of the lease.

RELOCATION

The provisions of green leases allowing the landlord to relocate the tenant to another space in the building or a similarly situated project are generally similar to those in standard leases. In a green lease, however, the concept of similar quality space expressly includes that the similar space must meet or exceed the former space in terms of its green certification levels and other similar standards with respect to indoor air quality, appropriate lighting, low-flow toilets and other green aspects, as applicable. Merely being relocated to a space that is similar in size and layout is not sufficient in green leases.

LEASE TERM

Green leases tend to have longer terms because:

�� More time is required to amortize capital expenses.

�� Resources are saved by less tenant rollover and new tenant improvements.

�� Incentives or certification points may be tied to a minimum term.

PRACTICE NOTES

The following related Practice Notes can be found on practicallaw.com

>> Simply search the resource title

Green Buildings: Laws and Practices

Office Leasing: Letters of Intent

Office Leasing: Key Provisions in an Office Lease

Retail Leasing: Drafting and Negotiating Key Provisions in a Retail Lease

Financeable Ground Leases: Key Considerations

Medical Uses in Retail Shopping Centers



A related and potentially far more important issue involves the negotiation of the lease commencement and rent commencement dates. Landlords should be cautious when negotiating these provisions because of the likelihood of delays tied to green construction or achieving third-party certification. A landlord does not want to be penalized or lose a lease due to delays that are beyond its control.

CARBON CREDITS

Most green lease forms treat carbon credits in a fairly simplistic manner. Generally, tenants receive the carbon credits to which they are entitled under applicable law and the landlords get the balance of credits associated with the building.

Tenants should demand that, at a minimum, landlords reasonably share any of these credits with tenants since it is the tenants’ green behavior that helped achieve the credits. A looming Environmental Protection Agency deadline in June 2015 to further reduce greenhouse gas emissions will influence how carbon credits are measured and credited.

STANDARDS AND BENCHMARKS

Both landlords and tenants under traditional leases generally want to maximize their flexibility while pinning the other party down. Both parties should decide if their green lease will contain standards that are carved in stone or if the lease will be a living document that evolves by automatically incorporating and requiring compliance with the latest technological advances.

One compromise is to require the parties to comply with the law but not allow either party to unilaterally change any standards. However, when negotiating these standards, the parties (particularly the landlord) should keep in mind that its lenders may insist on loan covenants that seek to maintain the status quo with respect to the project as it is underwritten and financed on the date the loan is made. As in any lease, clarity in drafting a green lease is of utmost importance.

The landlord and tenant should be cautious about committing to actually achieving a particular standard or certification because achieving a particular green standard or certification is not completely within their control. Agreeing to these types of clauses may subject both the landlord and the tenant to unnecessary risk. If a particular incentive (for example, a tax credit, grant or zoning enhancement) is at risk, the usual requirement of “reasonable effort” or “best effort” may not suffice.

This feature is Part Two of our two-part article on owning and leasing green real estate. For Part One and the complete, online version of this resource, including information on green standards, certifications and benchmarks, search Owning and Leasing Green Real Estate.

The landlord should carefully consider whether to give the tenant the right to audit its books and records because sharing this data may trigger confidentiality clauses with vendors or other tenants.

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