A new financing mechanism designed to assist building owners to gain access to commercial finance for environmental upgrade works on their buildings has been introduced by the Local Government Amendment (Environmental Upgrade Agreements) Act 2010 (LGEUA Act). The financing mechanism is intended to reduce greenhouse gas emissions by improving energy efficiency in the building sector through cost-effective loan financing.
The LGEUA Act will amend the Local Government Act 1993 to enable local councils to enter into an Environmental Upgrade Agreement (EUA) with building owners and financial providers. The LGEUA Act commenced on 18 February 2011.
Under the new financing mechanism, local councils are able to voluntarily enter into an EUA with building owners and financial providers to improve building energy efficiency. An EUA will enable financial providers to lend funds to building owners to carry out environmental upgrade works. As part of the EUA, the building owner must make regular loan repayments to the council in the form of an environmental upgrade charge. The council then forwards this payment onto the financial provider to repay the debt.
Each EUA must include three parties; a building owner, a finance provider and a council and every EUA must specify:
- the environmental upgrade works to be carried out by the building owner
- the amount of the advance to be made by the finance provider
- the arrangements for repayment of the advance.
Environmental upgrade works are defined as works to improve the energy, water or environmental efficiency or sustainability. The works are intended to reduce greenhouse gas emissions caused by the building sector by improving energy efficiency in non-residential buildings or multi-resident strata schemes of 20 lots or more.
The financing mechanism was designed to address two barriers that have been identified as impeding energy efficiency retrofits to buildings.
In delivering the second reading speech for the Bill, the Hon. Michael Veitch stated that the first barrier to energy efficiency upgrade projects was access to capital. As many energy efficient projects on buildings can take up to 10 years, which is generally longer than the financial projections of most businesses, longer loan periods would be required to carry out substantial energy efficiency upgrades. In fixing the charge to the land, rather than the business, finance providers are able to loan money at lower interest rates and for longer terms.
The second barrier to energy efficiency upgrade projects is referred to as the 'split incentive' between landlords and tenants. Where a property is leased, any environmental upgrade works would ordinarily be paid for by the landlord and enjoyed by the tenant through lower power bills. Under these circumstances there is little incentive for building owners to invest in environmental upgrade works.
EUAs have been tailored to address this problem as many leases provide for a proportional pass through of council rates and charges. Under most EUAs, tenants will pay a reduced power bill and a contribution to the repaying of the upgrade works instead of paying larger power bills. When the environmental upgrade works are fully repaid, tenants will enjoy ongoing lower energy bills and landlords will own buildings that enjoy greater market desirability from the improved energy efficiency.
By addressing the two major barriers, finance providers will be able to offer building retrofit finance at a lower cost and with longer terms than existing available loans, which will result in bigger projects providing greater levels of energy efficiency.
Participation, costs and tax issues
Participation in an EUA by building owners, finance providers and local councils is completely voluntary. Under the LGEUA Act, councils are able to recover administrative costs through a service charge on the relevant building owner if desired.
In the event that a building owner does not make the required repayments to council, the council will not be held liable for the repayments, however the council must use its best endeavours to recover the upgrade repayments.
Guidelines will be developed for the operation of EUA by the Minister for Climate Change and the Environment and the Minister for Local Government. The guidelines are likely to detail the local council's functions under an EUA, the contributions made by tenants towards environmental upgrade charges and progress reports by building owners in relation to environmental upgrade works.
EUAs are also likely to give rise to tax issues, particularly Goods and Services Tax (GST) issues, which will need to be addressed. Given the novel nature of such EUAs, care needs to be taken when drafting and implementing these agreements to ensure that the arrangements do not give rise to unexpected GST liabilities or costs.
How will existing financing arrangements impact on EUAs?
As most commercial property will have mortgages registered against its title, which often include restrictions in the raising of additional debt by the mortgagor, it is likely that mortgagee consent will be required for the land owner to borrow funds under an EUA. In addition, it is unclear whether the EUA charge to be levied by the council will run with the land. Assuming it does, a mortgagee may not approve entry into an EUA as it may adversely impact on the ability of the mortgagee to sell the land if it has to enforce its mortgage.
Interaction with NABERS
The Commonwealth Government's Commercial Building Disclosure program commenced on 1 November 2010. The program requires owners of office space of 2000 square metres or more to obtain and disclose the National Australian Building Environment Rating System (NABERS) energy efficiency rating to prospective buyers and tenants (subject to certain exemptions and exceptions for the first year).
As more buildings will require a NABERS energy rating, more building owners may be interested in carrying out environmental upgrade works and are likely to look into the application of EUAs. For further information on NABERS, please see our earlier update.
How can DLA Phillips Fox help you?
DLA Phillips Fox can help you navigate your way around EUA and the relevant legislation. We can:
- prepare and draft environmental upgrade agreements specifically tailored to your business needs
- assist you with any negotiations that arise as part of a proposed EUA
- manage your interests through the lifespan of any environmental upgrade works and associated EUA.
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This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances.