The Operator: R22 Gas phase-out - who pays wins

3 July 2012

CAROLINE DELANEY HIGHLIGHTS THE STEPS THAT TENANTS SHOULD BE TAKING TO PROTECT THEMSELVES FROM A TICKING COSTS TIME-BOMB ARISING FROM THE 2015 DEADLINE FOR THE REPLACEMENT OF AIR CONDITIONING AND REFRIGERATION SYSTEMS.

Service charges, repairing obligations and rent reviews are three common areas of landlord and tenant disputes. One particular area of argument that is increasing in frequency concerns the replacement of air conditioning and refrigeration systems. Unfortunately for the food and hospitality industry, because of the central importance that this equipment plays in its day-to-day business, it looms large as a costs time-bomb.

EU Regulation 2037/2000 (replaced by EU Regulation 1005-2009) introduced the phased elimination of ozone-depleting substances. The most harmful ozone-depleting substances such as CFCs were banned in the 1990s. Their less harmful cousins HCFCs started being phased out from 1 January 2010. R22 gas is an HCFC and is the most common refrigerant used in refrigeration and air conditioning systems. From 2004 the use of R22 gas in new air conditioning systems was banned. From 1 January 2010 it became illegal to use virgin R22 gas to top up the refrigerant in existing equipment and since that time, people have been relying on recycled R22 refrigerants. These are
becoming increasingly hard to come by and by 1 January 2015 recycled R22
refrigerant will also be banned. This will mean that R22 gas cooled air conditioning and refrigeration systems will need to be replaced.

The food and drink industry has been publicising the R22 gas phase out for some time and has produced a guide on the topic as part of the industry’s refrigeration efficiency initiative, a project sponsored by the Carbon Trust and supported by the Food and Drink Federation, the British Beer and Pub Association, the Cold Storage and Distribution Federation, Dairy UK and the Institute of Refrigeration. The guide promotes the organised and timely phase out of HCFC cooled equipment in advance of the 1 January 2015 deadline.

The most cost-effective short term option has been to keep existing plants running with recycled R22. However, this is only a short term fix which serves to delay the inevitable capital expenditure as the complete phase out date approaches. There is evidence also that as the scarcity of recycled R22 gas increases, its cost has risen significantly.

There are two longer term options. The first is the modification of the existing
plant by way of drop-in replacement refrigerants running on non-banned
gases. These have a lower capital cost than full plant replacement however,
manufacturers warn that there may be a gradual drop-off in performance of the
equipment and increased energy costs. The second is to replace the whole plant but this is obviously the most expensive option in terms of initial capital outlay.

If you own the property that you occupy, the timing and costing of the replacement options are within your own control. If however you are a tenant you need to agree with your landlord who is to replace the equipment, when and who is to pay for it. As 1 January 2015 approaches, we are seeing an increase in disputes concerning the replacement costs of R22 gas cooled systems. Most commonly they involve arguments about repairing covenants and service charges. This may, in time, have a knock-on impact on rent review.

In relation to repairing covenants, landlords are beginning to include the
cost of replacement air conditioning and refrigeration equipment as part of a dilapidations claim against the tenant at the end of the lease. An incoming tenant will require updated equipment, but the landlord will not want to pay for it.

It remains a central requirement of dilapidations claims that the subject
matter in question is out of repair. It is accepted that if statute requires changes as a consequence of repair works, the cost of these changes will generally be recoverable as part of the dilapidations claim. For instance, it may no longer be lawful to repair electrical installations without upgrading another part of the system in light of additional safety regulations. But what if statute requires replacement of equipment that is not out of repair? The answer depends on the precise terms of the lease. If the systems are in working order but only have a limited future life due to the banning of recycled R22 in two years’ time, an outgoing tenant is unlikely to be responsible for the cost of replacement under narrowly drafted repairing covenants. There may be other covenants in the lease that allow a landlord to pass the costs on to a tenant, for instance to maintain the plant and keep it in good working order or to service installations and keep them up to date. This area of dispute will increase as the 1 January 2015 deadline approaches. As a departing tenant you need to be alive to it. If you are a tenant staying in a property beyond the 1 January 2015 deadline, you need to check the terms of your lease to see who is responsible for the maintenance and replacement of the airconditioning and refrigeration equipment. If you have a full repairing and insuring lease of a whole building, it is likely to be you. If, however, you are in a building with more than one tenant in it, there is a possibility that the landlord is responsible for the equipment, particularly the air conditioning system if it serves the whole building.

We have begun to see landlords trying to pass the cost of upgrading through the service charge in a multi-let building. Again, you should scrutinise the precise wording of your lease to assess what cost, if any, the landlord is entitled to pass on to you through the service charge. Even if you are potentially liable, you need to give consideration to the amount of time left on your lease. It is an established legal principle that the landlord is entitled only to recover the proportion of capital expenditure commensurate with the unexpired term of your lease. In very crude terms, if you have two years left to run on your lease and the landlord installs replacement equipment with a life expectancy of 20 years, the landlord will only be able to recover one-tenth of the cost.

Be aware that less scrupulous landlords are trying to pass the full capital
replacement costs through service charges in advance of lease expiry in
order to avoid the argument as to who is responsible for replacement costs as part of the dilapidations claim at the end of the lease.

Finally, the replacement costs posed by the elimination of R22 refrigerants may be a factor on rent review. There will be high replacement costs for tenants if replacement is their responsibility and there will be a significant service charge increase if the landlord is able to pass the costs onto the tenant in this way. The impact again will depend on the precise terms of the lease.

As a tenant you need to be aware of the issues and to clarify now who is
responsible for the replacement of R22 refrigerants and who is to bear the costs of doing so. 1 January 2015 is closer than you might think.

Caroline Delaney

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