"It will not be the actual running of the systems which will be illegal, but rather working on them."
"The principal consideration in deciding whether or not it is appropriate to assess damages by reference to the cost of carrying out the works which the tenant should have done is whether, in all the circumstances, it is reasonable for the landlord to carry out the works."
"The subtle difference with a lease containing a service charge provision is that the tenant is not obliged to replace the air conditioning system itself, but only to contribute towards a service charge."

A chilling end for R22 - but who will catch a cold?

16 May 2013

EU Regulation 1005/2009 on substances that deplete the ozone layer prohibits, with effect from 1st January 2015, the use of R22 and similar gases in air conditioning systems. As is explained later in this briefing, there are issues in Jersey as to whether the EU Regulation applies to Jersey, but even in the UK the precise scope of the prohibition needs careful examination.

The legislative position
Most UK commentators take the view that after 1 January 2015, under the EU Regulation, existing air conditioning systems can continue to be operated but the draining down of the system to carry out repairs, or the topping up of the system, will definitely be illegal. It will not be the actual running of the systems which will be illegal, but rather working on them.

The situation differs somewhat in Jersey because the EU Regulation is not of the kind which applies automatically to Jersey by virtue of the terms of Protocol 3 of the Treaty Relating to the Accession of the UK to the EEC. For the terms of the Regulation to apply, Jersey would need to adopt its own legislation in appropriate terms. To date, no such legislation has been adopted in the island, largely it seems in reliance upon the fact that from a practical point of view there will be no need because R22 will be un-obtainable within Europe and the local HM Customs officers will not allow it to be imported into the island.

Accordingly, if one can obtain R22 gas within the island post 1 January 2015, it will not be illegal in Jersey (as it will be in the UK) to do maintenance work on systems using that gas. The sale of virgin R22 was banned in Europe with effect from 2010, but since then, recycled R22 has been available at an ever increasing cost.

Terms of the lease
If one has established that the air conditioning system serving your building contains R22 gas, the next step is to establish the scope of the repairing obligations imposed by the terms of the lease.

The interpretation of repairing obligations in a lease is something of a specialist area and certain conventions have been established over the years based on judicial decisions. For example, there is a tendency to look at a repairing obligation which contains many variations of the word "repair", such as "renew" and "replace", and construe such words as adding little to the essential concept of "repair" unless the additional words are linked to obligations going beyond "repair" and make it clear that in appropriate circumstances, the entire object of the repairing obligation will have to be renewed or replaced and not just simply repaired.

Subsequent to 1 January 2015, if one is faced with a narrowly drafted repairing covenant and a system containing R22, which is still in working order, it is possible that the tenant will not be responsible for replacing that system. This is because repair only becomes necessary once the relevant item is "out of repair" and if the system is still working well, it can be argued that it does not need to be repaired.

As indicated, much will turn on the wording of the relevant repairing covenant. If the covenant contains a phrase such as "to keep in good working order" or "to replace where necessary", there are those commentators who take the view that such words might be enough to oblige the tenant to replace a system containing R22 with a new compliant system. A requirement within a repairing covenant, obliging the tenant to maintain and keep operating (and where necessary replace) all plant at all times in accordance with best modern practice and standards, almost certainly would have that effect. Determining the scope of the obligation will clearly be a matter for careful interpretation and considered judgement.

In many leases there may, in addition to the repairing obligation, be a clause imposing an obligation on the tenant to comply with all laws in force within the island. On the basis, however, that the EU Regulation is not legally effective within the island, such a clause, will not impose an obligation to either replace an air conditioning system containing R22 gas or to cease maintaining it if R22 gas can be obtained in the island. On the other hand, it is possible that a lease of premises in the island could contain a compliance with legislation provision going beyond compliance with Jersey Legislation and obliging the tenant to actually observe relevant EU Regulations. This is possibly most likely to be the case where UK lawyers have taken the lead in drafting the form of lease for a landlord.

Clearly, the combination of different factual situations and difficult questions of interpretation of repairing clauses in leases provides significant potential for disputes between landlords and tenants as to the extent of the obligations to replace any air conditioning system containing R22 gas. Landlords can be expected to challenge the tenant who maintains he can simply walk away and leave an R22 system which is operating "satisfactorily", on the basis that the landlord contends that it is not operating perfectly and will not be able to be maintained and operated if R22 gas cannot be sourced, or that there is no record that the system has been maintained and serviced in accordance with manufacturer's instructions so that the risk of a failure or defect is substantial and imminent. With, at times, truly significant sums of money involved, one can expect both landlords and tenants to raise all manner of arguments.

The practical solutions
Having obtained legal advice to the effect that you have a liability to take steps to replace the air conditioning system, the next step is to obtain advice from an air conditioning specialist as to what solutions are available.

In some instances, it might well be worth considering trying to keep the air conditioning plant patched up and running on R22 gas for as long as possible. This could well be appropriate in the case of a building subject to leases which are due to expire and the building itself will need a total re-fit before it can be re-let, or where it is clear that the building is to be demolished on the expiration of the leases.

It is worth noting that in the recent Royal Court case of Jersey Sports Stadium Ltd v Barclays Private Clients International Ltd (14 March 2013) [2013] JRC059 the Bailiff, Sir Michael Birt, made it clear that a landlord cannot recover the cost of works the tenant should have undertaken if the landlord has no intention of carrying out such works. He said: "The principal consideration in deciding whether or not it is appropriate to assess damages by reference to the cost of carrying out the works which the tenant should have done is whether, in all the circumstances, it is reasonable for the landlord to carry out the works.".

In some instances, replacement as such might not be needed, although the landlord will always seek replacement if the tenant is liable to bear the cost of such. In others, it might be possible to keep the air conditioning plant in place, operating satisfactorily by draining out the R22 gas and replacing it with a gas which is not harmful to the ozone layer. Several years ago such gases were available, but their performance was someway short of that of R22. More recently, alternative gases have been produced which perform better but still with some shortfall in performance. If an R22 system is struggling to, for example, provide the level of cooling required by an IT communication room, it is unlikely that deploying an alternative gas will be a viable option. In addition, deploying an alternative gas might entail modifications to the system and in turn warranties could be affected.

Another alternative is for just the external units to be replaced, although again modifications and warranties might be an issue. In addition, the existing system might simply not be susceptible to such a solution. Sometimes it might also be necessary to replace the internal units as well, and again, similar issues can again arise. In some instances, the internal piping between internal and external units is not suitable for the operation of these new units, and in such a situation, the whole system needs to be replaced (including the piping) and this can necessitate the removal of suspended ceilings and generally rendering the relevant premises unavailable for occupation, such that the business operating from the premises is massively disrupted. The disruption incurred and the need to make good in such a scenario can clearly result in significant costs in addition to the costs of the new system itself.

A further factor for a tenant to consider is whether, particularly if the term of its lease is still significant, it is not more cost effective in the long term to opt for a new air conditioning system and projected lower running costs and improved performance sooner rather than later if it seems inevitable that the system will have to be replaced before the end of the term.

Multi-let buildings
With multi-let buildings, where the landlord is obliged under the terms of the leases to maintain the air conditioning system serving the various tenants, similar considerations apply, but it is necessary in addition, for the landlord to act promptly and not leave the issue of replacing the air conditioning system until the expiration of the various leases. This is because a tenant in such a situation can successfully contend that it should not be made to contribute towards a very substantial capital outlay when it will not receive any material benefit from its contribution because the lease is just about to terminate.

The subtle difference with a lease containing a service charge provision is that the tenant is not obliged to replace the air conditioning system itself, but only to contribute towards a service charge. This is an obligation of a different kind to an obligation to actually undertake to repair an item oneself and additionally to render up that item in repair. The courts in the UK have held that a tenant does not have to contribute towards the costs of the replacement of an air conditioning plant when it only has a short term left of its lease unexpired.

Whilst it is clearly unwise to leave the matter of replacing an air conditioning system in a building, subject to service charge provisions, until very near the end of the tenant's term, it is even more inadvisable to try to deal with the issue by way of a schedule of dilapidations served on the tenant at the expiration of the term, because the landlord (and not the tenant) is contractually obliged to undertake the repairs to the air conditioning system. If the landlord falls into this trap, it will almost certainly end up having to pay the whole cost of the replacement air conditioning system.

Service charge provisions are a notorious ground for landlord and tenant disputes and the R22 issue will provide ample additional grounds for this. Disputes will arise as to whether or not the landlord can recover the costs of a replacement system where refurbishment is arguably an option, or where replacement is considered to be an improvement. Additionally, tenants might try to contend that if a landlord has recovered the costs of replacing an old R22 system, that should have a negative effect on any subsequent rent review.

Who is affected?
Clearly the issues affect both the current landlord and the current tenant of a building with an air conditioning system containing R22, but potential purchasers of such a building or a potential assignee or a new tenant looking to take a lease of the building, also clearly need to exercise caution and carry out suitable due diligence. A building served by an air conditioning unit running on R22 might well have to have that system replaced sooner than might otherwise be the case and that could have a detrimental effect on the capital value of the building.

Develop a strategy
The essential advice is to act sooner rather than later. The first step is to ascertain what gases are in your air conditioning system. If you establish that they will be illegal after 31 December 2014, then you should obtain legal advice as to what the scope of your repairing obligations are under your lease in respect of that system. That legal advice should then be passed on to your air conditioning specialist who should then be able to advise you as to the best solution for your building, taking into account that advice and the practical circumstances of your building and the existing air conditioning system.

You need to form a strategy and implement it without delay. Muddled (or delayed) thinking can lead to excessive legal and other costs and lost opportunities. If you leave matters too late, your ability to effectively negotiate a compromise agreement with the other party to your lease can be severely compromised because you might lose the opportunity to implement a cost effective works programme as an alternative to complying with the other parties' demands. Rushed and inadequate works will also often lead to disputes as to whether works have been carried out to the appropriate standard, and this can lead to disputes after the expiration of the lease and costs with lawyers and surveyors which could have been avoided. 

The R22 issue has frequently been likened to a ticking time bomb, but it is one the impact of which can be mitigated by acting promptly and obtaining the best available advice.