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The Legal and Business Case for LEED Certification in the Post-Recession World

By Michael Mergens and Julie Perrus
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As the real estate market begins to recover, property owners, contractors, business tenants, and consumers will be looking for more guidance on what it means to own, build, or occupy a LEED certified building or home.

Before the Great Recession and the near collapse of the commercial real estate market, one of the hottest trends in development was the desire for sustainable buildings and the advent of the private sustainability rating system known as LEED (Leadership in Energy and Environmental Design), which was created by the United States Green Building Council (USGBC). LEED quickly caught on not only with private builders, but also local governments looking at ways to encourage sustainable design and practice. Of course, when commercial and residential construction came to a standstill, the LEED discussion shifted and those involved looked to find ways to maintain its vigor. As we discuss later in the article, the USGBC has responded to that need by expanding its rating system and continuing to make revisions to existing systems in order to improve the overall LEED product.

It is clear that LEED has become the referenced standard in green building. With membership of USGBC nearing 20,000 companies and organizations, LEED dominates the sustainable design conversation. LEED is a recognizable tool that allows governments to communicate a commitment to sustainability while allowing developers to showcase innovation and increase demand. Even during the economic downturn and the collapse of the housing bubble, companies have begun to determine that in order to stand out to consumers, "green" is the new gold standard, driving higher returns and lease rates as well as increased occupancy and customer satisfaction.

But this is not to say that there are not risks that should be recognized and accounted for in pursuing LEED certification. Indeed, since LEED first came into prominence, numerous articles have been written regarding the legal liabilities that might arise from the decision to pursue LEED certification for a new building. The potential legal issues from LEED certification even caused one commentator to write on the possibility for "LEEDigation."

As we begin down the slow track to recovery, it is worthwhile to review not only how LEED has changed, but to also review LEED's impacts on business and the potential "LEEDigation" and other legal hurdles that are relevant in this expanding green marketplace. In this article, we will discuss the recent changes to the certification process and the latest news on government incentives or regulations designed to encourage green buildings. Then, we provide a short update on the business costs and benefits from green buildings. Finally, we will discuss the legal risks and benefits that should be considered and accounted for once the decision is made to pursue LEED certification.

The Evolution of Green Building and LEED

Although commercial construction remains slow, the construction that is occurring, particularly of public buildings or publically-funded private projects, continue to emphasize green, or sustainable, construction. Green building, whether utilizing LEED, Green Globes, Energy Star, or a local standard, is a universally accepted component of the overall climate change mitigation strategy and method to address the need for sustainable development practices. While all of the various standards provide a symbol at some level of a project's sustainable features, LEED is most recognized and utilized in the building industry; and governments, both state and local, are utilizing LEED certification as a benchmark for approvals as well as funding. As potential building occupants and regulators have become familiar with LEED and the advantages of sustainable buildings, LEED certification has evolved from a marketing tool or a standard touted by green builders to a quasi-governmental sustainability code.

Since LEED first arrived as a private rating system, more and more state and local governments are using LEED certification in the entitlement process or are offering specific incentives for LEED certification. It has become common across the nation to require all new public buildings or publicly-funded construction to reach a certain level of LEED certification. But some cities continue to raise the bar. Many cities and counties now offer specific development incentives for LEED certification that in some cases can provide for larger-scale development than what would traditionally be allowed as well as an expedited project approval process. Perhaps more importantly, many cities have now enacted tax breaks for residential and commercial buildings that vary based on the level of certification. For example, in Baltimore, Maryland, the city council approved a bill in April 2008 that provides tax credits for LEED certified homes at the following levels: 40 percent property tax credit for LEED Silver, 60 percent for LEED Gold, and 100 percent for LEED Platinum. There is an existing county-based tax credit for any new commercial building that meets LEED Silver. In 2007, New Mexico passed legislation providing statewide tax credits, with an aggregate limit of $5 million, for the construction of sustainable building, which can be met through LEED certification. Some cities, such as El Paso, Texas, have gone a step farther to offer grants. Still other cities require certain private construction to meet LEED standards. As municipal ordinances and state statutes are continuing to be revised to meet the demand for sustainable design, it is critical that developers create a team that has the capacity to review local ordinances and state standards for development carefully; not only to prevent the failure to meet a requirement, but also to take advantage of any potential financing or development incentives.

While LEED has become a standard tool for governments and developers, USGBC has continued to evolve the LEED rating system as a response to market demands. LEED, now overseen by the Green Building Certification Institute (GBCI), is no longer just for new construction. The USGBC has developed specific rating systems for schools, health care facilities, and retail, and has increased its focus on interiors and existing buildings. The latest versions of LEED also respond to criticism within the development community that LEED did not go far enough to address energy costs, and the latest iterations of the certification process increase the focus on energy efficiency, renewable energy, and the overall carbon footprint of a site.

Traditionally, LEED for New Construction and Major Renovations (LEED-NC) has been the most utilized LEED certification measure to date. However, while extremely valuable, all new buildings become existing buildings on the date of occupancy. USGBC has begun to focus more of its efforts on recognizing that sustainable design is only truly effective if it actually remains sustainable. Ongoing monitoring in order to ensure on-site water usage and waste reduction remain at the levels committed to during the certification process is important, as is monitoring building maintenance and tenant improvements. While LEED-NC may ultimately become more prescriptive in its monitoring requirements, USGBC has also prioritized LEED for Existing Building Operations & Maintenance (LEED EB-O&M) as a tool to ensure that existing buildings get sufficient attention. Currently, the USGBC is just completing a public comment period on all of its rating systems and expects to hold additional public informational hearings on the continual changes to the LEED rating system this fall.

As LEED continues to develop, businesses are responding to a changed economic environment, many seeing increased fixed expenses, like energy costs, eating away at already impacted profit margins. In addition, shareholders and consumers have an increased interest in sustainability, and even though this interest is largely undefined, it requires a response. LEED, as a green building standard, can provide at least a partial solution.

The Business Case for LEED

While it is still true that in residential retrofits and new construction a premium often exists on green building, the cost gap for commercial and industrial green building has not only closed, the return on investment in both energy and water savings can provide more than a payback of the LEED certification costs within the first year of occupancy. But it is no longer just about energy and water.

Increasingly, we see decisions regarding sustainable development being driven by consumer expectations. A study out of University of California, Berkeley, in 2009 compared buildings that had been certified, under LEED and Energy Star, to control buildings. Certified buildings had sales prices that were, on average, 16 percent higher than those in the control group. Similar studies have shown increased occupancy rates and higher rents for certified buildings.

And businesses are starting to demand green design based on new links that are being made to sustainable design and productivity, attendance, and overall job satisfaction. Consider the scenario of a corporate headquarters with 500 full-time staff and an average salary of $36,000 plus benefits. Assume the company spends $150,000 on LEED certification as a premium over traditional development for its new headquarters. Not only would the green building provide significant increases in energy efficiency, but based on a CBRE survey conducted in 2009, the company would save over $1.2 million per year in reduced absenteeism and increased productivity.

While all of these links are becoming more accepted as marketplace realities, businesses must still be cognizant of the potential legal issues that are hanging around the edges of this discussion.

The Legal Risks in LEED Certification

One of the most common questions we hear is "what is a lawyer's role in LEED certification?" The short answer is that since failing to achieve LEED certification in the manner it was contemplated will likely cause real world losses for the owner, the decision to pursue LEED certification or to construct a building to that certification carries with it legal rights and liabilities. So the role of the lawyer is, first and foremost, to assure that any contract is properly drafted to account for and allocate the legal rights and liabilities. Property defining the respective rights and responsibilities of the parties requires that you understand where the concerns lie.

In advising your client, you must be aware of the most current LEED requirements. LEED is an ever evolving standard with new requirements and new certification options. The latest version, LEED v3, has made changes to address the perception that LEED was a one-time compliance scheme that had little teeth if a project failed to live up to its expected performance. Version 3 includes a requirement to provide whole-project energy and water usage "information on a regular basis in a free, accessible, and secure online tool or, if necessary, taking any action to authorize the collection of information directly from service or utility providers." Access to the information must be granted within one year of LEED certification and be available annually for five years. Version 3 also grants the GBCI the power to revoke LEED certification from a non-compliant building. In other words, long after the contractor has completed its work, there is still the potential for exposure. A wise practitioner must account for this risk in the construction contract and consider the insurance ramifications under a completed-operations policy.

Further, whether it is a construction contract to build a LEED certified building or a lease that requires the owner provide a LEED certified building, it is important to define the certification desired and who bears responsibility should a third party cause the loss of certification. For new construction, the first issue is easy; is the certification level Silver, Gold or Platinum? But the contract should also address whether there are ongoing obligations. As discussed above, LEED also provides for the opportunity to certify the ongoing operation and maintenance of existing buildings. In fact, GBCI offers free LEED EB-O&M registration for most previously certified LEED buildings. A property owner who seeks certification for the initial construction, or a tenant who desires to rent a sustainable building, may naturally wish to ensure the ongoing benefits of LEED. Projects certified under LEED EB-O&M must be recertified every two years. A contractor will likely want to disclaim any responsibility to maintain or achieve LEED EB-O&M certification. For a lease that calls for a LEED building, it should be clear if the tenant requires just LEEDNC or also the ongoing LEED EB-O&M. Further, if a lease requires LEED EB-O&M, especially in a multi-tenant building, consideration must be given to who would bear responsibility for the loss of certification for third parties. For example, if the janitorial service fails to abide by the green cleaning requirements or the actions of a second tenant who has no LEED requirements, pushes a building into non-compliance, is the landlord in default of the lease?

Finally, it is important to account for the consequences of not reaching, or losing, the desired certification level whether by acts of third parties or otherwise. This is especially important in those areas where LEED has been incorporated into state or local building regulations either as a mandate for public or publicly-funded building or as trigger for valuable incentives. In these jurisdictions, the failure to receive the required certification level will likely have clearly quantifiable damages. In addition, a property owner may also seek to recover the less tangible losses that could result from such as lower rent or the loss of expected increased employee productivity and reduced absenteeism. Whether such damages are recoverable and whether there are limits to recovery should be accounted for in the contract. When considering damage allocation and limits, it is also important to note that the new versions grant third parties the ability to challenge an award of points.

But construction contracts and leases are not the limits of legal implications arising from the LEED rating system. Nor are all the legal implications negative. Below, we outline the legal benefits LEED certification can provide for advertising and marketing.

Advertising and Marketing Issues

One of the growing legal issues in the new era of consumer-focused sustainable marketing is "greenwashing" and the potential for deceptive marketing claims from broad, subjective environmental claims. While this has not traditionally been an issue for real estate, as data on the direct benefits for the occupants of green buildings continue to grow and the battle for viable retail and commercial tenants continues, the need to market the sustainable features of an office building or retail location will increase as well. As tenants and purchasers recognize the benefits of green buildings in a very tight market, advertising your client's building as LEED Gold or LEED Platinum provides a clear and objective standard to tout and will help avoid any claims of greenwashing or misleading marketing claims.

This is especially important in light of the Federal Trade Commission's (FTC) recent decision to update its "Green Guides." The Green Guides apply to environmental claims included in labeling, advertising, promotional materials, and all other forms of marketing, whether asserted directly or by implication. Conduct inconsistent with the positions articulated in the Green Guides may result in corrective action. While the current Green Guides may be directed primarily toward product advertisement, the scope of coverage is broadly written and the proposed revisions would expressly cover claims relating to renewable energy and carbon offsets.

The most interesting component of the proposed changes is the FTC's concern with consumers' perceptions. Research suggests that consumers could be misled by factually-accurate claims because consumers interpret them differently than marketers intend. For example, in responding to comments that companies should be allowed to market that their buildings "host" a renewable energy facility, the FTC responded that claiming a location "hosts a renewable energy facility" may under some circumstances be misleading advertising. The FTC reached the conclusion because a significant majority of consumers did not understand the technical difference between hosting a renewable energy facility, having an on-site solar array where the owner has sold renewable energy credits, and having the property powered by renewable energy.

The FTC's reasoning can be important if you client is considering a building that is "LEED compliant" rather than "LEED certified." LEED compliance refers to a building that is build using the LEED principle without spending the additional money to pursue certification from GBCI. It is a technical distinction that many consumers are unlikely to understand. Applying the FTC's reasoning, there is a potential that that the FTC, or state agency interpreting state marketing statutes, could determine that marketing a commercial building or new home as "LEED compliant" is misleading or deceptive.

Conclusion

In sum, it is clear that the LEED rating system is here to stay and has evolved well beyond the point of being a mere marketing symbol. As the real estate market begins to recover and state and local governments increasingly look to incorporate LEED certification or LEED standards within their regulatory structures, property owners, contractors, business tenants, and consumers will be looking more and more for guidance on what it means to own, build, or occupy a LEED certified building or home. As questions arise, businesses must understand the unique positives and negatives of this private rating system that has become so deeply ingrained in the governmental push for sustainability.
© 2013 American Bar Association Business Law Section. All Rights Reserved.

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