Carbon Emissions and the Recent Climate Mobilization Act of New York City

Pillsbury Winthrop Shaw Pittman LLP

Developers and building owners, tenants and lenders operating or underwriting loans in New York City, and perhaps beyond, should consider the impact of the city’s newly enacted Climate Mobilization Act (CMA or the Act).

TAKEAWAYS

  • The Climate Mobilization Act constitutes a profound shift in the regulation of commercial real estate in New York City—and all stakeholders including building owners, investors, sellers and purchasers, tenants, and lenders will need to consider how to quantify and allocate the costs of compliance (or non-compliance).
  • C-PACE (commercial property assessed clean energy) financing will likely become an increasing feature of the landscape of New York City real estate transactions.
  • A recent proposal in Governor Cuomo’s budget to the New York legislature may provide some flexibility in how compliance may be achieved—as the budget proposal provides that credits for energy generated outside of New York City may be eligible for purchase.

The new Presidential administration has set off a renewed emphasis on sustainability and climate change. While owners and other stakeholders involved in New York City real estate have been grappling with many of these issues for a while—for example because of events such as Superstorm Sandy and the requirements of an earlier statute, Local Law 87 (which was passed in 2009 and requires that periodic energy audits be performed for buildings over 50,000 square feet), they are now addressing compliance with the Climate Mobilization Act, 2019 (or Local Laws 92, 94, 95, 96, 97, and 147 enacted in 2019)—one of the most ambitious local efforts in the country. Simply, the CMA’s goal is to reduce New York City’s carbon emissions by 40 percent by 2030 and by 80 percent by 2050 (as against a 2005 baseline as provided for in item 3 of Local Law 97).

As more fully described below, the CMA is divided into three parts (broadly speaking). The first focus of the CMA is with respect to achieving CMA compliance for “Covered Buildings” (described below)—and contemplates the retrofitting of Covered Buildings such as the installation of energy efficient lighting and HVAC combined with increased insulation. Note that owners are likely going to have to work with an environmental consultant or architect/engineer to determine the specific changes to be made in each case. The second focus of the CMA is to establish a monitoring program for Covered Buildings. The third prong of the CMA is to describe an alternate means of complying, specifically the purchase of carbon offset credits or renewable energy.

The regulatory burden of the CMA falls on building owners and landlords initially—and failure to meet these targets will result in a fine of $268 per ton of carbon emitted by a Covered Building per year over the allowed limit specified initially by Local Law 97 (see § 28-320.3.2), and later by regulation which is to be promulgated, with a cap on the fine to be paid of $5 million per year per Covered Building.

Multiple stakeholders are clearly impacted.

A brief summary of the CMA follows—along with a discussion of C-PACE financing—and an analysis of the impact of the CMA on tenants, purchasers, sellers, investors and lenders.

The Climate Mobilization Act

The CMA establishes greenhouse gas emission targets for Covered Buildings that become increasingly stringent over time. Covered Buildings are defined as:

  • a single building larger than 25,000 gross square feet,
  • two or more buildings on a single tax lot that exceed 50,000 gross square feet, or
  • two or more buildings governed as a condominium that exceed 50,000 gross square feet.

The law exempts the following buildings even if they meet either the 25,000 or 50,000 gross square feet thresholds:

  • power stations,
  • buildings which are less than three stories and have and have units which maintain their own HVAC and hot water systems,
  • city-owned cultural buildings,
  • buildings owned by New York City Housing Authority,
  • buildings that contain more than 35 percent regulated units (as amended by Int 1947-2020, which was enacted in November of 2020),
  • houses of worship,
  • properties owned by a housing development funds company organized pursuant to the New York Private Housing Finance Law, and
  • buildings that participate in project-based federal housing programs from the definition of covered buildings.

Pursuant to the CMA:

  • beginning in 2024, Covered Buildings will have to meet the first emission targets—which are calculated by multiplying the gross floor area of each Covered Building by the occupancy classification as set forth in Local Law 97 in 28-320.3.2; and
  • in 2025, owners of Covered Buildings will need to establish compliance by submitting a report establishing such compliance (and prepared by a certified design professional) to the newly created Office of Building Energy and Emissions Performance.

Fortunately, for many of the owners of Covered Buildings (and their investors and lenders), most of the data that must be submitted to establish compliance can be found in the benchmark energy reports already required to be submitted by building owners as a result of Local Law 87 (which, as mentioned, requires periodic energy audits in the case of buildings over 50,000 square feet). These audits (coupled with inspections) take into account actual energy usage from utilities and test the efficiency of the systems in the building in question to determine what upgrades (if any) could be made to decrease usage. For a summary of the process as in effect in New York City see this link.

Buildings that have emissions exceeding the “target emissions” by 40 percent or more can apply for an adjustment with the New York City Department of Buildings (DOB) no later than July 1, 2021, but the adjustments are only given for cause and where special circumstances can be established. Adjustments are also not indefinite in duration. Rather, they are designed to allow enough time to permit compliance by the next set of targets, in 2030.

Approximately 20 percent of Covered Buildings in NYC currently fall short of the “target emissions” and will need to comply with the more stringent requirements by 2024, and approximately 75 percent of Covered Buildings in NYC currently fall short of the 2030 thresholds established by the CMA (as was determined during deliberations and fact-finding regarding the CMA). The body charged with determining the 2030 emission limits has been nominated—with their determination due in 2023. The list of members may be found here.

As mentioned, besides complying by making energy efficient installations and producing less carbon emissions, Covered Buildings can also meet their targets by purchasing “carbon offset credits” or by buying or storing clean energy. The carbon offset credits allow for payments to third parties to reduce carbon emissions at “another location or site” thus netting out the carbon emissions on an aggregate basis. Unfortunately, the full details of both the credits and the storage options were left to later rulemaking, which is not yet complete.

Note that both alternative methods of complying with the CMA are somewhat limited. For example, the carbon offset credits are only available to meet the first set of emission targets starting in 2024 and can only offset up to 10 percent of the target for each individual building. Currently, the “purchase and store” alternative, which is available past 2029, involves buying or storing energy within New York City (which is a scarce commodity in the city). However, as mentioned, Governor Cuomo’s recently proposed budget (if passed) would allow credits for energy generated outside of New York City to be purchased and therefore to count towards the cap (at least through 2034). Of course, there is no guarantee that this provision of the draft budget will become law—so, for now, stakeholders should expect to have to comply with the more stringent requirements of the CMA.

There is also a potential third option. The Act created a fifteen-member Climate Advisory Board to assist in implementing the law. Perhaps the most important recommendation that will come from the Board will be its feasibility study of a cap-and-trade style program—due in 2023.

Impact on Real Estate Transactions and Various Real Estate Stakeholders

As mentioned above, multiple stakeholders and various real estate transactions and relationships are impacted.

Tenants (and Landlords) in Covered Buildings Should Take a Particular Interest

Current and prospective tenants will want to consider the impact of the Act. Tenants under existing leases may well be responsible for complying with the CMA (by being required to make the necessary improvements) and/or paying for the costs incurred by their landlords in making such improvements (possibly even in purchasing or storing “greener” electricity). Provisions regarding operating expenses, the tenant’s obligation to pay for capital expenditures incurred by their landlords (often addressed in operating expense provisions), electricity and HVAC or supplemental HVAC, hours of use, compliance with laws including environmental laws and rights of access are likely to come into play. Conceivably, landlords may become more focused on the actual installations made or desired by tenants and their use of HVAC (or installation and use of supplemental HVAC units) which may be more (or less) energy efficient. Work Letters in the context of new leases will need to address these items as well.

Regarding operating expenses and capital expenditures incurred by owners, note that many leases are negotiated on this point—with some leases excluding capital expenditures from operating expense definitions but clarifying that certain capital expenditures are to be included nonetheless (to some extent) if, for example, such capital expenditures are required for the building to comply with legal requirements (if so, enacted when?). Discussions on these points may include a discussion of “when” the capital expenditure was or will be incurred, including the amortized cost of such expenses (amortized on what basis and over what period?) rather than the cost incurred “when incurred,” whether the capital expenditure will result in reducing operating expenses (and if so when actual savings are realized and therefore when such costs should be passed along), to name a few.

A new item to consider will be C-PACE financing and whether the costs of incurring C-PACE financing should be borne by the tenant (and if so, to what extent).

Of course, the reverse of the points noted above is true for Landlords in their negotiation of leases in Covered Buildings. Landlords may also want to consider what incentives they can put in place to encourage tenants to voluntarily reduce their demand for electricity.

Sellers and Purchasers of Covered Buildings Should Take a Particular Interest

Purchasers and sellers will also need to incorporate the concepts of the CMA—outlined above—into purchase and sale agreements and during the course of conducting diligence. For example, Sellers may be asked to provide information regarding (or make representations or undertake continuing covenants, perhaps even to set aside reserves, with respect to) emissions and compliance with the CMA (including with respect to installations and/or reporting). Leases will have to be reviewed with an eye towards the issues mentioned above, as part of a purchaser’s diligence.

If costs are to be incurred to comply with the CMA, those will have to be addressed in contracts of sale. Additional covenants may be added to address surviving obligations (or the particular state of facts in question).

Lenders Making Loans to Covered Building Borrowers Should Take a Particular Interest, as they may be asked to consent to C-PACE Financing and, at a Minimum, will need to Address the CMA in Underwriting and Loan Documentation.

C-PACE Financing

The CMA (under Local Law 96) authorized commercial property assessed clean energy financing in New York City for the first time—so as to permit building owners to access affordable capital to make the needed improvements. Typically, C-PACE loans are long-term loans designed to be repaid over the useful life of the improvements (e.g., 20 to 30 years) and can be in the amount of the total cost of the improvements. Traditionally, many mortgage lenders were reticent to allow (or even prohibited) C-PACE financing as C-PACE loans are in the nature of special assessments and are billed and collected in the same manner as real property taxes (bi-annually in New York City)—so C-PACE financing requires mortgage lender consent because it is on par with real property taxes and therefore prior to mortgage debt.

Lenders that do consent to C-PACE financing take into account various factors—in addition, of course, to the existing customer relationship, the potential increase in value of the mortgage collateral resulting from performance of the energy efficiency improvements and the borrower’s compliance with laws. Specifically, lenders consenting to C-PACE financing might take into account the facts that the C-PACE financing does not preclude mortgage foreclosure (and no intercreditor agreement is entered into between the C-PACE lender and the mortgage lender), the assessment for the C-PACE financing only secures outstanding amounts due to the C-Pace lender during the annual or semi-annual period in question (and not the entire amount of the C-Pace loan) and the fact that the lender can escrow the C-PACE assessment “along with” real estate taxes. Documenting the C-PACE financing as part of “taxes” is also relatively straightforward.

Underwriting and Documentation Considerations when Borrower owns a Covered Building

There are other considerations for mortgage lenders, of course.

On the practical side of things, Lenders should conduct due diligence as to compliance—at least initially by requesting the data from the benchmark reports required under Local Law 87 to determine the ability to meet the 2024 targets—possibly then by retaining consultants and asking borrowers to outline plans for compliance. If not addressed in the Property Condition Report (a PCR), a separate report may be necessary. However, unlike traditional improvements required by a PCR, and given the various prongs of the CMA, there may be multiple avenues to reaching an emissions target. Therefore, Lenders should be prepared to work closely with borrowers in crafting solutions and laying out multiple avenues for compliance.

Lenders can also consider requiring borrowers to provide reports or notices received under or with respect to the CMA; lenders may want to retain inspection rights regarding compliance and the energy improvements being performed; lenders may consider requiring the C-PACE loan proceeds to be reserved and then disbursed by the mortgage lender (as in the case in a construction loan); and mortgage and mezzanine lenders may want copies of notices of default (and rights of cure) with respect to the C-PACE loan (or delivery of estoppels, if the C-PACE loan pre-dates the mortgage loan). If a borrower applies for an exemption from the CMA, the lender will want to be made aware (and understand the grounds on which the exemption is granted).

If the owner of a Covered Building is purchasing credits to meet its obligations under the CMA, then a lender may wish to incorporate the purchasing of credits into the budget (or make advances on account of the credits or require borrowers to reserve the monies required to make such payments). Another potential consideration is whether a lender wishes to include the Act in the definition of Environmental Laws—so that it is covered as part of an Environmental Indemnity Agreement. If the Environmental Indemnity Agreement or a Non-Recourse Carveout (or other) guaranty were to cover obligations under the CMA, this may also present important considerations for mezzanine lenders who may be required to provide replacement indemnities and guaranties when they exercise remedies under their mezzanine loan documents and foreclose under the UCC.

In addition, mortgage and mezzanine lenders may want to address CMA-related issues in their intercreditor agreements.

Conclusion

The Climate Mobilization Act impacts multiple stakeholders in New York City’s real estate marketplace—and many transaction documents, involving all manner of real estate transactions, will need to address the CMA (and many need to address C-PACE financings). New York City may be ahead of curve on these issues—when compared to the rest of the country—but we can also expect that, with global warming and sea levels rising, this will not be the last effort we see in this area. Indeed, the CMA may only be the first of many such legislative efforts nationwide.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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