ESG Clauses in Commercial Leases

Organizations now consistently include environmental, social and governance (ESG) factors in their policies, and the real estate sector is no exception. For stakeholders in the real estate sector, ESG factors are increasingly important.

ESG factors are on the radar of investors and lenders, who rely on these criteria to assess real estate companies’ long-term objectives and commitment to providing sustainable, time-tested and socially responsible buildings. A high ESG performance can lead to greater property values and lower property operating costs.

Similarly, environmental protection initiatives implemented in certain municipalities, particularly with respect to building decarbonization and net-zero emissions, now require property owners to pay closer attention to environmental factors.

That said, a building’s ESG performance is largely dependent on its occupants. As a result, leases are becoming indispensable tools when it comes to ESG. The following are certain types of clauses that may be included in lease agreement templates to encourage or require both tenants and landlords to engage in certain behaviours aimed at occupying, managing and improving a building in a manner consistent with established sustainable development objectives and targets.

Environment

The environmental factor is the ESG element most commonly included in leases. Provisions for improving and managing a building’s sustainability and environmental performance can cover a variety of aspects, including:

• The collection and reporting of data on energy use and waste generation
• The cost allocation for the building’s energy efficiency initiatives
• The use of the building’s heating, air conditioning and lighting systems
• The building’s waste management, including recycling and/or composting initiatives
• The use of environmentally friendly or non-toxic cleaning products
• The prohibition of, or restrictions on, work by tenants that would negatively impact the building’s energy and environmental efficiency

Clauses may vary from one lease to another and may be tailored to a building’s characteristics and the environmental objectives set by the parties. They may also be adapted to a building’s ongoing certification requirements, such as LEED or BOMA BEST certification.

However, it may be beneficial to use general terms in leases to better adapt to constantly evolving environmental standards.

Social & Governance

The social and governance factors are less commonly incorporated into leases.

The social factor covers human rights, employee health, safety and well-being, diversity and inclusion, and employee compensation. The governance factor includes corporate business practices and codes of ethics, among other things.

Given that these factors are intended for fundamental aspects of corporate conduct, tenants may be reluctant to agree to social and governance obligations in their leases. In addition, it may be difficult to obtain social and governance data from tenants, as these are generally subjective factors. Parties that wish to incorporate social and governance considerations into their leases may find it preferable to use reasonable efforts commitments rather than fixed objectives.

Integrating ESG factors into leases requires dialogue and collaboration between landlords and tenants, both in negotiating the lease and in implementing the desired practices. However, strong ESG performance creates value for each party, in terms of lower operating costs, branding, as well as employee and customer retention.

Due to the priority given to ESG objectives in most organizations, particular attention should be given by those organizations to how their lease agreement templates might be tailored to meet their ESG goals.

For further information on ESG factors in the real estate sector, please contact a member of our Commercial Real Estate group.