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Heating, Ventilation and Air Conditioning (“HVAC”), Solar and Other “Green” Heating Alternatives in Retail Leasing

By Gary D. Buchman on April 10, 2014

HVAC for Retail LeasesA topic that arises in virtually every retail lease, and yet is barely addressed in the letter of intent (LOI), is the heating and cooling of the demised premises.  The LOI is typically cursory:  “Landlord shall deliver the demised premises to tenant with a 15 TON HVAC system in good working order.”  Who is responsible to maintain and repair the system?  Whose obligation is it to replace the system if it can no longer be repaired?  While these are all business issues, they are most often left for the lawyers to determine during the lease negotiation.  A standard landlord clause would provide:

The property which tenant is required to maintain is the demised premises and every part thereof, including, but without limitation, all walls, floors and ceilings, the heating system, the air conditioning system, including rooftop heating and air conditioning units if the same are used ….  Tenant agrees that it will obtain and maintain in full force and effect a non-cancellable heating and air conditioning equipment service contract which shall provide for the periodic inspection and maintenance of the heating and air conditioning equipment serving the demised premises.  Said contract shall be made with a reputable contractor and shall be subject to Landlord’s approval.  Copies of said contract and any renewals and/or replacements thereof shall be delivered to Landlord.

The landlord’s lease will, generally, also provide that the obligation to “repair” includes replacement when necessary.  A tenant’s failure to negotiate these provisions may prove costly.  Generally, it is tenant’s obligation to pay for regular maintenance of HVAC units, either by maintaining the service contract mentioned or, in the event landlord maintains the units serving tenant spaces, by paying a proportionate share of landlord’s cost of such maintenance.  Replacement of an HVAC system is, however, a much more expensive proposition.  HVAC replacement is a capital expense, and so one would assume that replacement cost is landlord’s to bear.  However, most retail leases require tenant to replace the system when necessary as the tenant has had the sole use of the system during the term.  Landlords generally accept an equitable sharing of HVAC replacement cost whereby the initial expenditure is tenant’s obligation; with the unit being deemed to have a useful life of some years (for sake of this discussion, say 10 years); and landlord reimburses tenant at the end of the lease term for the remaining unamortized cost of the unit.

How will leases deal with solar and other “green” methods of heating and cooling?  Who bears the cost of installing, repairing or replacing solar panels?  The parties will need to consider rooftop or ground access and control; who has the right to install energy generation systems or other features such as skylights and who benefits from any cost savings?  In triple net leases, the capital costs of “green improvements” are most likely to be borne by landlord, yet the operational savings are enjoyed by tenant.

Landlords have less incentive to invest in energy saving technology as the cost savings do not accrue to the investor.  As these “green” leases evolve, landlords and tenants will need to find ways to share the burden of the underlying infrastructure cost of “going green,” taking into consideration any tax credits, lower operating costs and refunds in the possible sale of power back to the grid.  Expect to see clauses like this:

On Site Electrical Generation.  In the event Landlord elects to install any on-site electricity generation system, including without limitation, photovoltaic solar panels, Landlord shall have the right to:  (i) use the electricity generated by such system in the operation of the Shopping Center, including use in the Common Areas and/or to the Premises, and (ii) include the reasonable cost of such electricity in Operating Costs.  The cost shall be determined by Landlord based upon the then-current market rates for electricity being charged by private utility providers in the area where the Shopping Center is located.

and

Green Credits.  Landlord shall be entitled to all tax credits, carbon credits and other such credits or entitlements (“Green Credits”) that may be created, credited or recoverable because of energy savings or other sustainability activities conducted within the Shopping Center or the Premises, excluding Green Credits to which the Tenant is entitled in accordance with applicable law.  Landlord shall be entitled to allocate, in its reasonable discretion, any Green Credits created with the participation of the Tenant and/or other tenants in the Shopping Center.

Gary D. Buchman

Gary D. Buchman is a partner in the firm’s Real Estate Department. Read Bio