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22 Dec 2010

Innovative funding for sustainable retrofitting

by Sallyanne Everett, Brendan Bateman

Both NSW and Victoria now have schemes to promote the sustainable retrofitting of buildings.

Innovative funding arrangements to facilitate sustainable retrofitting of buildings are now possible after the introduction of important amending legislation in Victoria and New South Wales.

Victoria - City of Melbourne Act

The Local Government and Planning Legislation Amendment Act 2010 (Vic) inserts a new Part 4B into the City of Melbourne Act 2001 (Vic) to allow the Melbourne City Council (MCC) to use its rating powers to help secure private lending for building owners to fund environmental upgrades to their buildings as part of the 1200 Buildings Program.

The 1200 Buildings Program is an ambitious ten-year plan to retrofit 1200 privately owned commercial buildings, or two-thirds of the city's commercial office blocks, at an estimated cost of $1.3 billion. The retrofits aim to improve energy efficiency and sustainability and reduce water consumption. MCC estimates that if fully implemented and assuming an improved energy performance of 38%, the Program has the potential to deliver greenhouse gas mitigation of 383,000 tonnes of CO2 equivalent per year.

In March 2010, the Victorian Government announced that it would provide $500,000 in funding to support the Program's expansion and since that time appropriate financial mechanisms to provide low-cost funding for participants have been investigated. Securing funding at low interest has been a consistent obstacle for environmental retrofit programs worldwide and this legislation represents an opportunity to overcome not just this financial impasse but potentially also the split incentives between building owners and tenants over who will pay and who will benefit from the upgrade.

New funding scheme using Council rating powers

Part 4B of the City of Melbourne Act allows "primary parties" to enter into an "environmental upgrade agreement" in respect of rateable land with an existing building, to fund works that improve the energy, water or environmental efficiency or sustainability of the premises. The "primary parties" are the "Council, the lending body and the owner of the rateable land" and eligible buildings must be entirely or predominately used for non-residential purposes.

After entering into an environmental upgrade agreement, the owner of the building will be provided with finance from the lending body and must use those funds to carry out the retrofit works outlined in the environmental upgrade agreement.

Following entry into the agreement, MCC will declare an environmental upgrade charge (or two or more charges) in respect of the land the subject of the agreement and levy the charge by sending the requisite notices to the persons liable to pay, in the same way as MCC's general rates and charges.

As set out in the Vic Act, MCC will use the charge to return the funds advanced by the lending body in accordance with the environmental upgrade agreement. However, a proportion of the charge that accounts for MCC's administrative costs specified in the agreement and penalty interest imposed for non payment, can be retained by MCC.

Importantly for MCC, it is not liable to repay the lending body until the environmental upgrade charge has been paid or is recovered from the ratepayers. This could potentially give rise to concerns by lenders since they will not have a charge over the property. Instead, the charge would be in favour of the MCC. If MCC elects not to collect the charge then the lender bears the risk of non-repayment.

MCC's powers to recover unpaid environmental upgrade charge

Section 27O will apply the general rates and charges provisions of Part 8 of the Local Government Act 1989 (Vic) to environmental upgrade charges, subject to some important exclusions and adaptations. Pursuant to these provisions, unpaid environmental upgrade charges will become a first charge on the land in the same way as council general rates and charges. MCC will also have the power to take action to recover unpaid environmental upgrade charges in the same way that it can recover unpaid rates, including by selling the land. However, sections governing the right to appeal rates and charges under the Local Government Act 1989 will not apply.

Preconditions for environmental upgrade agreements

An owner or occupier will not be caught by surprise with an environmental upgrade agreement as certain conditions must be satisfied before MCC can enter into an environmental upgrade agreement. These comprise:

  • MCC must receive a notice from the owner that any existing mortgagee has been notified of the owner's intention to enter into an environmental upgrade agreement and the details of the environmental upgrade charges expected to be declared;
  • MCC must receive a notice from the lending body confirming that the total value of the environmental upgrade charges as set out in the proposed agreement when added to any taxes, rates, charges or mortgages owing on the land will not exceed the capital improved value of the land to which the agreement will apply;
  • each occupier who would be liable to pay all or any part of the environmental upgrade charge levied as a consequence of the agreement must be given a statement with details of the proposed charge, including the amount to be paid, the repayment schedule and providing the occupier with the opportunity to consent or object to the imposition of the charge; and
  • importantly, each occupier who receives the statement must consent to the imposition of the charge in the manner specified.

Limited to the City of Melbourne

Given these changes have been made to the City of Melbourne Act 2001 (Vic) only, no other Victorian local councils will be given the power to enter into environmental upgrade agreements under the Vic Act. Legislative amendments to the Local Government Act 1989 (Vic) would be required to give other councils similar powers.

The Victorian Climate Change White Paper - Action Plan identifies the 1200 Buildings Program as a good example of State and local governments working together to tackle climate change. Depending on the success of the arrangements, other councils may wish to follow the City of Melbourne's lead.

New South Wales - Local Government Act

The Local Government Amendment (Environmental Upgrade Agreements) Act 2010 (NSW) was passed in late November 2010.

In contrast to the Vic Act, the NSW Act inserts provisions relating to environmental upgrade agreements in the Local Government Act 1993 (NSW) which applies to all local government areas in NSW. While this means that any local council in NSW can avail itself of the scheme, in reality it is likely to be limited to the local government areas covering the commercial centres of Sydney, Parramatta, Ryde, Chatswood, Newcastle and Wollongong.

The scheme in the NSW Act is similar to the model in the Vic Act but with some salient points of difference. These include:

  • environmental upgrade agreements can apply to strata titled buildings. This enables agreements to be entered into in respect of multi-residence strata buildings (minimum 20 lots), not just non-residential buildings. In the case of strata buildings, the environmental upgrade charge is levied on the owners corporation, not the individual lot owners or tenants, and can be paid from either the administrative or sinking fund;
  • while a council is not liable for any unpaid charge to the lender, a council is obliged to use its best endeavours to recover the environmental upgrade charge;
  • more than one environmental upgrade agreement may be entered into in relation to the same works. This is likely to provide some flexibility in how works are carried out, financed and repaid; and
  • the environmental upgrade agreement can address early repayment of the amount payable under it.

Importantly, the NSW Act includes additional provisions to enable lessors to recover contributions to the upgrade costs from lessees. These additional provisions include:

  • a lease may require a lessee to pay to the lessor a contribution towards the environmental upgrade charge, provided that it does not exceed the reasonable estimate of the costs savings to be made by the lessee as a consequence of the environmental upgrade works;
  • the environmental upgrade agreement can specify the methodology for the calculation of the costs savings attributable to both the leased premises as well a proportion of savings to all occupants (such as in respect of the common areas and base building components) from the upgrade works. The lessor and lessee may agree their own methodology;
  • the lessor does not require the lessee's consent to entry into the environmental upgrade agreement before the lessee can be made liable to pay a contribution to the costs of the upgrade works. It is sufficient that the lessor provide a copy of the agreement to the lessee. The lessee's liability however is capped to the reasonable estimate of the costs savings made by the lessee;
  • contributions are not treated as a capital cost which would otherwise not be recoverable under section 23 of the Retail Leases Act 1994 (NSW);
  • the lessor's obligation under section 40 of the Residential Tenancies Act 2010 (NSW) or section 19 of the Residential Tenancies Act 1987 (NSW) to pay rates taxes and charges does not apply environmental upgrade charges;
  • a contribution by a lessee to the cost of the upgrade is an outgoing for the purposes of the Retail Leases Act 1994 (NSW); and
  • a term of a lease entered into before the commencement of the NSW Act which requires the lessee to pay to the lessor any charge payable by the lessor is taken to require the lessee to also pay a contribution towards any environmental upgrade charge that relates to the leased premises.

The final wording of the NSW Act in so far as it relates to the treatment of lessees represents a significant improvement on the original terms of the Bill, and unlike the Vic Act, provides a clear mechanism to overcome the split incentive both in relation to existing and new leases, These improvements were the result of consultation undertaken by the Department of Environment, Climate Change and Water with key stakeholders (including Clayton Utz) on the issues identified in the Vic Act as potential impediments to the success of that scheme.

Will the Schemes work?

A number of issues arise from the current structure of the schemes which may impact on their effectiveness and success. For example:

  • the lender assumes the risk of non-repayment while the council has no obligation to assume the debt or pursue payment from an outstanding debtor, although under the NSW Act, the council at least must use its best endeavours to do so. Further, the charge over the property is for the benefit of the council and not the lender;
  • with the Victorian scheme, there may be difficulty in the lending body providing confirmation that the total value of the environmental upgrade charges, when added to existing debts and other charges, will not exceed the capital improved value of the land. In most cases, owners of commercial properties will generally have a portfolio of such properties and have their own financing arrangements with their lender. While the environmental upgrade agreement will relate to a specific building, the total amount of outstanding debt within a property portfolio will in many cases exceed the value of an individual property within that portfolio. This may make it impossible for a lender to satisfy this requirement unless a notional allocation of the debt is made across the portfolio of properties;
  • Victoria's requirement that each occupier of a building liable to pay all, or any part of, the environmental upgrade charge must consent to the imposition of the charge fails to overcome split incentives which currently inhibit exploiting the significant emission abatement opportunities in the commercial building sector. While the immediate capital cost of the upgrade will be funded by a loan over a period of time, spreading out the cost of the upgrade rather than incurring it up front, requiring each occupier to consent can mean that a single tenant could oppose entry into an environmental upgrade agreement. If the upgrade is to proceed in those cases, this will mean the building owner must accept a greater level of liability, thereby undermining the rationale for the scheme. In providing a statutory mechanism to overcome the split incentive, the NSW scheme is clearly to be preferred; and
  • if the advance of funds from the lender is characterised as debt, this may breach negative pledge covenants in a building owner's existing loan facilities. Consequently, while neither scheme mandates that the consent of existing mortgagees be obtained, negative pledge covenants will effectively require that consent. This may act to stymie funding from new lenders. Ideally, the schemes should have contemplated flexible arrangements for both the advance of funds as well as repayments, rather than prescribing a central role for the finance provider.

The proof of success of the schemes will, as they say, be in the pudding - in this case whether sustainable retrofit projects can achieve funding at scale to make a significant difference to resource consumption by Australia's current building stock.

 

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.