Monday, June 11, 2007

TRends In Real Estate And Title Insurance

What Does Green Mean?

By Peter S. Britell and Smita G. Korrapati

HE FORCES OF GREEN are revolutionizing design and construction. Governments impose green (envi-

Commercial agreements often conflict.

ronmentally safe) criteria on capital projects that they sponsor or finance.1 Developers, lenders and tenants require new projects to meet green standards of design, construction and operation. Green is good. Yet there has been little focus on what green means in commercial agreementsand what happens if a contracting party defaults in being green.

This article discusses issues for transactional lawyers in green developmentand possible consequences if green conditions are not satisfied or green covenants are breached. To paraphrase a famous frog, it isnt (always) easy being green.

The Green Requirement

The first question, of course, is what the specific green requirement is. This issue is the same in virtually every agreementarchitect agreement, construction contract, lease, loan agreement, government grant, management

Peter S. Britell is a member of LeBoeuf, Lamb, Greene & MacRae, where he chairs the real estate group. Smita G. Korrapati is an associate of that firm (admission pending in New York).

contract, tax-credit agreement, joint venture, etc. How does the agreement define the green requirements? What are the expectations of the parties? Until recently, green requirements in contracts have been simplistic. Typically, there has been reference to a LEED standard (see below), with a statement that a party or the project must achieve that LEED standard. While all players are becoming more sophisticated and giving more thought to the specificity of green criteria, this remains an area in its infancy. Also, green no longer means just LEED. Apart from new green standards emerging in laws and regulations, there are now two main

rating systems in the U.S., LEED and Green Globes. Others can be expected. (The first environmental rating system was created in the U.K in 1990BREEAM, the Building Research Establishment Environmental Assessment Method.2)

The Rating Systems

LEED (Leadership in Energy and Environmental Design), a rating system developed by the U.S. Green Building Council (USGBC), provides a six-category rating system for building performance and sustainability, with four levels of target criteriaCertified, Silver, Gold or Platinum.

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New York Law Journal LEED, first introduced in 1998, is currently the most widely-used system.3 The second U.S. rating system is Green Globes, brought to the U.S. in 2005 by the Green Building Initiative, a non-profit created to promote green building approaches (GBI).4 Users can gain one to four globes for levels of certification with ratings in seven categories, based on a 1,000 point scale. Green Globes is growing in popularity. Besides LEED and Green Globes, government agencies are adding alternative or generic standards and/or are adopting LEED or Green Globes with modifications (such as, e.g., standards for vehicular emissions, pedestrian movement, access to transit, etc.).5 For a history of green rating systems and a comparison of LEED and Green Globes, see Timothy M. Smith, Green Building Rating Systems,6 an excellent crib sheet on green standards. Neither USGBC nor GBI are governmental agencies. Rather, both LEED and Green Globes offer reference standards that become applicable either by contract or by governmental specification. This article does not compare green rating systems. The key points for lawyers are that green ratings systems: (1) are only a few years old and evolving; and (2) will impact virtually every aspect of real estate development, investment and use. Indeed, green standards will likely have the same impact as the early developing building codes.7 This article considers some of many green contract issues that may arise. project: The Cotswolds Developer X has acquired half a city block in Metropolis and applied for zoning approvals (changes in set-backs and height limits) to construct a 36 story mixeduse building (The Cotswolds) with the following components: Floors 1-2: a 15,000 sq. ft. non-profit 400 seat theater and a 15,000 sq. ft. retail store; Floors 3-9: offices (30,000 sq. ft. per floor); and Floors 10-36: 150 apartments. The Cotswolds will be a four-unit condominiume.g., theater, retail, offices and residential. The residential unit will be a sub-condominium, with each apartment a separate unit in the residential unit. Developer X has contracted to sell the theater unit to Small Theater Company, which is obtaining funding: 50 percent through a capital grant from the City of Metropolis; 20 percent from Good Intentions Foundation; and 30 percent from private donations. Small Theater Company has a commitment for bridge funding (secured by its grant/donation commitments) for its fit-out from the not-for-profit group of XYZ Bank.

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How Many Standards?

The following green standards apply to The Cotswolds (please refer to the footnotes for examples of similar green requirements already in existence): Zoning Metropolis offers zoning incentives keyed to LEED Silver. These are administered by the Metropolis City Planning Commission.10 Building Code Metropolis requires LEED Certified for issuance of a temporary and permanent certificate of occupancy. This requirement is administered by the Metropolis Buildings Dept.11 Tax Credits The Cotswolds is eligible for state green building incentive tax credits keyed to Green Globes (two globes required).12 Developer X believes, also, that Congress will add a green bonus to the federal housing tax credit program (keyed to LEED Certified) and wants to be ready to apply. Tenants British Green Earth Fuels (the office tenant), an early supporter of BREEAM in the U.K., insists that landlords of buildings in which it is a major tenant attain a BREEAM good score.13 This is its first major U.S. lease. With-It Apparel, the retail tenant, while supporting green in its publicity, resists any green requirements in its store leases, believing that green costs more.14 Theater Financing The Good Intentions Foundation, a supporter of GBI, requires four Green Globes in all grants for new development, including its grant to Small Theater Company. Small Theater Companys Metropolis grant will be administered by the Metropolis Department of Cultural Affairs, which requires LEED Certified from its grantees.15 XYZ Banks notfor-profit group, which is bridge-funding the theater construction, requires LEED Gold from its borrowers. Construction Lender ABC Global Bank, the project construction lender, requires borrowers to comply either with LEED Silver or the rating system required by applicable building code or zoning,16 whichever is more stringent. Architects; Construction Company Famous British Architect is experienced with BREEAM but not LEED or Green Globes; Local Designers LLP has never done a LEED or Green Globes project. No Problems Construction Company has just hired a LEED expert for its preconstruction services studioto develop a green handbook for site logistics,

Initial Practice Note

Apart from knowing which green standard applies, it is important to get the right reference date or version. Because green rating systems may change rapidly, incorporation of LEED, Green Globes or another standard by private lawyers in commercial agreementsor by government lawyers in rules and regulations should key to a reference date or version, e.g., the thencurrent version of LEED or Green Globes. (For instance, New York City Local Law 86 references LEED Silver version 2.2 for many of its requirements.8) Failure to specify a reference date or version can result in ambiguity or, worse, application of a changing green standard to a project already in construction.

If green requirements are in a covenant, rather than being a condition, failure to comply may result in the termination of lease, acceleration of debt, foreclosure of mortgage, or damages.
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Many Are the Ways

How many ways can your project be green? Since there are yet few cases or rulings, we frame this discussion with a hypothetical

Developer X is negotiating to lease (a) the entire 210,000 sq. ft. office unit to British Green Earth Fuels, a U.K. energy company and (b) the retail unit to With-It Apparel, a trendy national clothing chain. Developer X expects to sign agreements with Famous British Architect and No Problems Construction Company. Famous British Architect will engage Local Designer, LLP as its local associate architect. Developer X has a commitment for construction funding from ABC Global Bank equal to 85 percent of construction costs and an equity commitment of 15 percent from Smart Money Hedge Fund LLC. Developer X will seek green building tax credits available under state law.9

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transportation ecology, use of temporary water and utilities, waste disposal, and other LEED means and methods issues. Equity Smart Money Hedge Fund LLC has no interest in green (at least environmentally) but holds a completion guaranty for this project secured by Developer Xs Connecticut farm.

Issues for Counsel

What are the green legal issues and green transactional problems in this project for: (a) counsel for Developer X? (b) counsel for the other parties? What advice would you give your clients to deal with these issues and solve these problems? [Take three hours to complete your Blue Book!] Following is a very brief overview: Certain issues are the same for Developer Xs counsel and counsel for the other parties. But Developer X has project-wide issues that counsel for the other parties will not have. Counsel for Developer X must deal with differing green standards in (a) negotiating agreements with each party in the transaction; (b) structuring the project so that it obtains the zoning permits, tax credits and certificate(s) of occupancy; and (c) attempting to insulate Developer X and the other parties from consequences of project-wide non-compliance. Counsel for all parties must (a) articulate the correct green rating standard in their clients agreements, (b) define clearly their clients obligations with respect to that green rating standard (and be precise as to which elements of their clients project are subject to the green requirement); and (c) consider the consequences to their clients of failure of a green condition or default in a green covenant.

For example, if each element of the project has a different green standard (e.g., British Green Earth Fuels requiring a BREEAM score of good and XYZ Bank requiring LEED Gold), Developer X might try to negotiate a single standardperhaps LEED Silverthat would be most stringent for a majority of the parties. (This raises, of course, the muchdebated issue of whether green standards are more expensive.17) Developer X should also review the green requirements of each government agency and its rules for determining compliance. If an agency has adopted a LEED standard, is the agency bound by the USGBC determination of LEED compliance?

Critical Issue: All or Nothing

There is also an all-or-nothing aspect of green ratings that is important to consider. For example, construction must be complete before the LEED rating is issued21 (and also before issuance of a certificate of occupancy, certification of tax credits, etc.). How does a developer or contractor spot, and fix, problems in mid-construction? While this is not really different from building to code, most building code requirements are well known to architects and engineers. Green rating requirements are brand new to many design professionals. Accordingly, counsel may wish to suggest: (a) monthly review of the work by a qualified green consultant; and (b) some type of interim mechanism for resolving disputes and achieving certainty as the work progresses. A project team can make progress checks and reviews to ensure conformity with green requirements. (The American Institute of Architects has available a form of LEED Certification addressing this point.22) Also, in the LEED certification process a project team may request clarification on unclear credits in the form of a Credit Interpretation Request before submitting any documentation.23 However, there is no guarantee until after completion that the project will obtain its targeted certification; only after construction is completed and the final application is reviewed will the project team learn its certification. Needless to say, the liability of architects and engineers in this area will require review of (and likely changes to) professional liability insurance coverage by design professionals and their insurers and clients.24 Given the possible uncertainties, counsel for Developer X should negotiate for cure provisions under which Developer X is given time and the right to correct problems before the requisite LEED or governmental filing. Counsel should also review grace and appeal periods in government green rules and regulations.

Failure of a Condition
If Developer X fails to meet the condition of obtaining a green standard, the project may lose funding, financing or tax credits, or may fail to obtain a certificate of occupancy.18 The building may lose a major tenant (if a condition to lease commencement is not satisfied). The unit purchaser(s) (e.g., Small Theater Company) may not be able to close title (or be excused from closing title).

Consequences of Default
If green requirements are in a covenant, failure to comply may result in the termination of lease, acceleration of debt, foreclosure of mortgage,19 or damages. Developer X might forfeit government approvals, entitlement or tax credits. Due to a default, there may be a requirement to repay a grant or a loan. As to damages, there is always, of course, the usual issue of direct versus consequential damagesperhaps more focused here because the completed project will either pass or fail the green test.

Strategy for Developer X

One obvious goal for Developer X is to limit the number of different green rating systems applicable to the projecti.e., (a) minimize inconsistent requirements or interpretations that could impact funding, issuance of certificates of occupancy, or other project milestones; (b) reduce potential for disputes; (c) minimize extra design costse.g., a specialty consultant for each rating system; and (d) avoid extra legal fees (and other transaction costs) to negotiate different green standards with different parties.

Concept of Materiality
In evaluating whether a contractual condition has been satisfied, or covenant breached, courts often consider materiality. The key issue is how materiali.e., essential to the transactionthe particular requirement is. Courts have addressed similar issues for many years, for example, in the context of a requirement to comply with laws.20 With reference to green standards, the issue is likely to be how material (a) the green requirement is in the particular context or (b) the failure or breach of the green requirement is in the particular context.

LEED Appeals
If a project does not obtain its LEED targeted points, the developer/owner can appeal the certification process under the USGBC review process. However, the decision of USGBC is final within its rules as to LEED certification, and by registering a project with LEED a project team is bound by the certification process of USGBC.25 If issues arise with a projects LEED

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certification before the final appeal under the USGBC certification process, apparently the developer can attempt to fix the problem by restructuring or reworking. However, delay may prove costly or fatal in the context of particular agreements or government programs.26 (Counsel should seek clarification on the LEED appeal process.)

Delegation Issue
As noted, the LEED rating system has been incorporated by government agencies in laws and regulations.27 To the extent that such local laws simply refer to the LEED determination, or make the USGBC certification conclusive (expressly or impliedly), there may be an issue of the legality of the delegation of authority by the respective agency to USGBC (with whom the agency may have no contractual or other relationship). While this problem might be cured in several ways (perhaps, for example, by having a right of judicial or administrative appeal from USGBCs determination), thought should be given to this question in future legislation and regulation.28

numerous green issues that a transactional lawyer will need to consider in advising clients in the development, financing, construction, use and operation of real estate. Indeed, green requirements will soon be ubiquitous in real estate transactions. To offer only a few basic rules, we suggest that counsel: (a) understand the different green rating standards (and reference dates) under the laws, regulations and contract requirements applicable to your transaction (and be precise as to which elements of your clients project are subject to each green requirement); (b) be familiar early on with the appeal process (if any) for the required green rating system; (c) try to minimize and rationalize the number of different green standards applicable to the project (to the extent that you can achieve this result by voluntary agreement); and (d) provide for interim progress checks by qualified green consultants to ensure on-going compliance and avoid undesirable surprise after construction.

Other Matters
This article has focused on green issues in new development. However, green legal problems may arise in numerous other situations. For example, government agencies will typically have transitional rules for the application of new requirements to projects for which design is already complete or which are already in construction (see, e.g., NYC Local Law 86)or when new green requirements require retro-fitting of existing buildings.29 (Note that LEED currently has separate requirements, LEED-EB for Existing Buildings.30) New use and operating requirements may also become applicable to existing buildings. Since leases, mortgages, property management contracts and service contracts usually require compliance with applicable law, who will bear the risk/cost of compliance with new requirements under existing agreements? The tenant? The landlord? The property manager? Answering this question will likely require dusting off of existing documents.

Conclusion
Time is now up for handing in your exam Blue Books. As the foregoing merely hints, there are

1. See, e.g., Local Law of the City of New York for the Year 2005 No. 86, which requires a majority of New York Citys capital projects, including private projects receiving city funds, to comply with green building standards keyed to LEED Certified or LEED Silver, depending on occupancy group (hereinafter Local Law 86). 2. http://www.breeam.org/page.jsp?id=13; http://www. englishpartnerships.co.uk/print.aspx?pointerid=10007Kf MwYBTWAfPUH7LCgLbwqXQ6lzb. 3. GSA Says LEED Most Credible Green Building Rating System, Inside Green Business, Sept. 27, 2006. 4. Green Globes evolved from a Canadian eco-rating program called Green Leaf which was based on BREEAM. History of the Green Globes System, at http://www.thegbi. org/greenglobes/history.asp. 5. See, e.g., LMDC/PANYNJ Sustainable Design Guidelines for the World Trade Center, available at http:// www.renewnyc.com/content/pdfs/Memorial_Sustainable_ Design_Guidelines.pdf. 6. Smith, Timothy, et al, Green Building Rating Systems: A Comparison of the LEED and Green Globes Systems in the US (Sept. 2006), at http://fpmdi.cfans. umn.edu/Projects/greenbuildingratings/GG_LEED_10_ 06.pdf. 7. David Hattis & David Listokin, Building Codes and Housing (April 2004), available at http://www.huduser. org/rbc/pdf/Building_Codes.pdf. 8. Local Law 86, supra note 1. 9. See, e.g., New York State Green Building Tax Credit Legislation, available at http://www.dec.ny.gov/ energy/1540.html (hereinafter NYS Tax). 10. See, e.g., NJMC District Zoning Regulations 19:4-6.6 (March 2006). The New Jersey Meadowlands Commission administers zoning regulations by providing financial incentives, such as refund of zoning certificate application fees, density incentives such as additional FAR, for buildings that are at least LEED Certified. 11. See., e.g., Washington DC Green Building Act of 2006, available at http://www.dccouncil.washington.dc.us/ images/00001/20070116085504.pdf. 12. See, e.g., NYS Tax supra note 9, keyed to green requirements enumerated in the Tax Credit Programi.e., does not incorporate LEED or Green Globes. 13. The authors have seen green covenants required by tenants in several major leases, a trend that is likely to continue. 14. See Neil Pierce, Green Sounds Greatbut Is It Affordable?, The Washington Post Writers Group,

http://www.postwritersgroup.com/archives/peir0706.htm (hereinafter Pierce). 15. See, e.g., Local Law 86, supra note 1. 16. See, e.g., Text Amendment No. 331, City of Boston Zoning Commission, available at http://www.cityofboston. gov/bra/gbtf/gbtfhome.asprequires all projects over 50,000 sq. ft to be designed and planned to be LEED Certified. 17. See Pierce, supra note 14; David Ritchey Johnston, Building Green in a Black and White World, Chapter 3 (2000). 18. Gaia Napa Valley Hotel waited until recently for its LEED certification months after its opening in order to receive a tax rebate of up to $1 million, conditioned on the LEED certification. (hereinafter Gaia) http://www. greenbuildingsnyc.com/?cat=39; In a case set to go to trial in August 2007, Shaw Development LLC sued Southern Builders, among other things, for failure to provide the certificate to file for credit under LEED. Shaw expected to get a $635,000 tax credit as a result of the green building. (Developers Sue Builders, Crisfield Times, http://www. newszap.com/articles/2007/03/05/dm/eastern_shore_of_ maryland/crs02.txt) (hereinafter Shaw). 19. See, e.g., Rockaway Park v. Hollis Automotive Corp., 135 N.Y.S.2d 588 (Sup. Ct. N.Y. Cty. 1954) (re equitable standards for mortgage foreclosures, especially as pertains to non-monetary defaults.) 20. See, e.g., Lease provisions allowing termination or forfeiture for violation of law, 92 A.L.R 3d 967 as updated. A critical issue is materiality. 21. See USGBC: Certification Process, http:// www.usgbc.org/DisplayPage.aspx?CMSPageID=1497 (hereinafter LEED Certification Process). 22. See AIA Standard Form B214-2004, Standard Form of Architects Services: LEED Certification. 23. See LEED Certification Process, supra note 21. 24. For a discussion of professional liability issues, see Gary Kingery, Professional Liability, Eco Structure, June 2006; AIA Convention on Architect Responsibility, May 2007; www.greenbuildingsnyc.com. 25. LEED Policy Manual, August 2006, available at http://www.usgbc.org/ShowFile.aspx?DocumentID=2039. 26. Gaia supra note 18; Johnston supra note 17. 27. See, e.g., Local Law 86, supra note 1. 28. For an interesting discussion of the issue of invalid or unconstitutional delegation, see Gillian E. Metzger, Privatization as Delegation, 103 COLUM. L. REV. 1367 (2003). 29. Transforming Existing Buildings: The Green Challenge, The Royal Institution of Chartered Surveyors, March 2007, http://www.rics.org/ transformingexistingbuildings. 30. LEED for Existing Buildings, at http://www.usgbc. org/DisplayPage.aspx?CMSPageID=221.

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