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Chilling Costs

17 February 2009

A potentially hot issue could be lurking in air-conditioning systems still using R22 cooling fluid. Building owners and tenants could be caught out with substantial replacement costs, as Stephen Lemmon explains

DEADLINES FOR THE PHASING OUT OF THE USE OF THE OZONE -depleting R22 cooling fluid in refrigeration and air conditioning equipment are getting critically close. This affects a surprisingly large number of buildings and facilities managers must take action now to determine how this regulation affects their buildings.

The HCFC compound R22 is a widely used cooling fluid in refrigeration and air conditioning equipment, which has been proven to be an Ozone Depleting Substance (ODS). This discovery is the rationale behind the introduction of European Regulation (EC) No 2037/2000 (commonly referred to as the ODS Regulation), which requires the gradual phasing out of ODS use. The issue of HCFCs is not new and this regulation follows measures including the ban of HCFCs in all new equipment since 2004, for example.

There are two important future deadlines set out by the ODS Regulation.
● From 1 January 2010 it will become illegal to use virgin HCFCs in the maintenance and servicing of refrigeration and air conditioning equipment: only recycled HCFCs will be permitted.
● A complete ban on its ‘use’ will take effect from 1 January 2015.

All R22 systems require at least annual maintenance inspections and more complex systems, which are more susceptible to refrigerant leakage than simpler self-contained units, require ‘using’ additional R22 to top up the system. From 2015, this will be prohibited. Between now and then, experts are predicting that stocks of recycled R22 will deplete and may run out altogether well before 2015, making it very hard to source, putting up costs considerably. If you are unable to source the R22 you need, the system cannot be maintained and an unplanned replacement may be the only option.

Replacement is in fact the obvious solution in many cases. The majority of units will already be one to two thirds of their way through their life and replacing them could well be more cost effective than a repair. However, depending on the equipment in use, there may well be other options such as the replacement of the R22 with an alternative non ozone-depleting refrigerant. While this sounds like an attractive option in theory, in practice it is usually only economically viable in larger scale equipment such as chillers where the refrigerant change can be undertaken as part of a full refurbishment. Also, whilst using a different refrigerant may seem cost-effective and extend the equipment’s lifespan by another 10 years, the equipment’s performance could be affected and become less efficient as a result.

A key point to make is that the phasing out of R22 has a knock-on effect on two major aspects of a lease - dilapidations and service charges. Replacing a chiller is expensive and would represent a hefty chunk of a dilapidations claim or service charge. This has implications for both the landlord and the tenant.

As with all M&E installations, at some point the replacement of an R22 system will be necessary – and expensive. Landlords of multi-tenanted commercial buildings will already be very aware of the risks associated with spikes in service charge expenditure. In a recession, this becomes a particularly serious issue as landlords don’t want to upset their tenants and tenants do not want to hear about more and unexpected costs that they need to cover.

We can also expect tenants to be unwilling to contribute to the cost of the replacement of air conditioning equipment just before their lease term ends, when they will not enjoy the benefit of the replacement for any reasonable length of time. This was a consideration in Fluor Daniel Properties Ltd and others v Shortlands Investments Ltd [2001] – a case that may well have been argued differently had the ODS Regulation been in existence.

Landlords should therefore aim to undertake any works as far in advance of lease termination as possible so that the risk of dispute or nonrecovery of service charge contributions is minimised. In addition, landlords should be aware of tenants wanting to walk away from the issue by exercising break options or by declining the opportunity to renew leases before the end of 2009.

In terms of dilapidations claims, landlords and their surveyors will need to be careful when inspecting properties so as not to miss the opportunity to include, where appropriate, the necessary works associated with any R22 equipment in the Schedule of Dilapidations.

It is almost certain that interesting debates will emerge in relation to tenant-installed plant containing R22, which, under the lease, the tenant was not required to reinstate and/or which the tenant left behind. Firstly, the lease will have to be carefully interrogated to check whether the tenant’s obligations to its landlord extended beyond the originally demised premises to include alterations made by the tenant. Also, the distinction between the tenant’s repair and compliance with statute obligations could become relevant in the event that the landlord subsequently replaces the plant with non-R22 equipment and claims that cost from the tenant. The tenant might also argue that the most economic way to have complied with statute was simply to have disposed of the equipment rather than replace it.

Tenants, on the other hand, face their own challenges. With a full repairing lease, tenants will, in addition to their repairing obligations, also have to comply with statute, including the ODS Regulation, and so may well be liable to replace R22 plant where it is in disrepair.

The ODS deadlines will mean that a lease terminating on 31 December 2009 may be substantially preferable to one expiring the following day – a situation that we can expect to be amplified further at the cusp of 2014/5. Tenants should therefore consider very carefully whether extending a lease and remaining in occupation of an R22 building beyond the deadline dates really does outweigh the potential consequence of doing so– namely, the possibly imminent obligation to install a new air conditioning system for their landlord.

An upshot of this is that tenants might find their landlords very accommodating to the concept of extensions beyond the critical dates. Enthusiastic but ill-informed tenants might find themselves lumbered with a substantial, unforeseen liability. Conversely, tenants can also expect landlords to be less than keen on the exercising of conditional break clauses. Vacant possession and material or absolute compliance is already a complex area, and one which will, no doubt, be even more intensely contested by landlords keen to hold on to their tenants over the ODS Regulation thresholds.

We should also consider R22 equipment installed by the tenant but which is deemed to be a landlord’s fixture (in the legal context) and which the tenant is therefore obliged to leave behind. Despite this obligation, if the tenant still goes ahead and strips out the R22 equipment without replacing it, the landlord could claim that the tenant should have left the equipment in-situ and moreover that it should have been replaced with a new non-R22 version.

Next steps
The first step for any landlord or tenant is to ascertain if R22 is used in the building’s systems and this should be done now. The second is to take advice, explore the options available and put in place a scheduled and costed plan for replacement, refurbishment or upgrades. The FM will play a critical role in managing this process in conjunction with a services specialist.

FMs will also need to manage senior decision makers within the organisation. In the current economic climate, any nasty surprises that lead to unforeseen expenditure will be very unwelcome and put the FM in a difficult position. By acting now, being thorough and explaining all the facts, the reaction is likely to be more favourable.

For the senior level directors of the organisations that own or lease property, expert help should be sought as soon as possible to scrutinise the lease terms in order to determine exactly who is responsible for a building’s air conditioning and refrigeration plant. As the ODS Regulation will affect all buildings with R22 systems, forward planning will be crucial to achieving a smooth transition to compliance, particularly for those businesses reliant on refrigeration or air conditioning to function on a day-to-day basis.

Regardless of whether you’re an owner occupier, a landlord or a tenant, you need to plan ahead, analyse the impact of the phase out, and take action. At a time when the recession is taking hold, everyone needs to become more prepared for the challenges that come with owning or occupying property. Doing nothing in the run up to the deadlines, and increasing costs, legal risks and disruption in the process really is not an option and a major risk for the reputation of the facilities manager.

● Stephen Lemmon is an Associate at commercial building consultants, Malcolm Hollis

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