Legal Solutions relating to Data Centre Leasing
2 July 2011
Data Centre Management
This article first appeared in a slightly different form in Data Centre Management, 2 July 2011.
Data centres are an increasingly important commercial property sector, however they raise their own unique issues which potential tenants ignore at their peril, warns James Dodsworth.
Data centres are now of fundamental importance to many sophisticated businesses. With IT budgets under pressure, the benefits of outsourcing to specialist developers and operators and taking a lease are compelling. However involving a third party as a landlord in a lease arrangement as opposed to an owner occupation model can be a hard concept to sell to management given the perceived reduction of control inherent by becoming a tenant. A properly negotiated and balanced lease will therefore be critical if outsourcing of this nature is to be acceptable.
Documentation related to data centres can differ quite substantially from occupational leases that have developed in relation to the industrial and office market. This is particularly apparent for larger data centre halls and data centres where the twin drivers of capital expenditure and business critical infrastructure are accentuated. Tenants approaching this sector without considering the specialist requirements and differences may find that the landlord/tenant relationship does not meet their expectations and that their legal and practical solutions and remedies are adversely affected. For larger facilities required for periods in excess of five years, the preference among an increasing number of tenants is to dispense with a service agreement (and the related "lift and shift" provisions contained in such agreements) and to adopt the exclusive occupation concept that a lease structure offers.This certainty relating to occupation in most cases outweighs the disadvantage of having to pay stamp duty land tax (SDLT) against the rent under a lease (none is due under a service agreement).
Because of the relatively high rents seen in larger scale data centre leases it is usual for landlords to require strong tenant financial covenants either directly or via a parent guarantee. Tenants should ensure that the alienation provisions do not unreasonably bind them into a minimum covenant test on assignment or under-letting. In the context of alienation, the ability to share the use of a facility without consent may also be critical to the tenant's business plans for it. Traditional alienation provisions may not accommodate this type of licensing arrangement, creating inflexibility for the tenant.
Different owner/operators will approach the cost of power provision in different ways. Some will charge an inclusive rent whilst others will flow through the costs either on a pass through basis or with a percentage uplift. It is important from a tenant's perspective to ensure that the necessary level of power is freely available without penalty and that the basis of charging is transparent. The lease might even include worked examples to ensure everyone is clear as to what is included and, importantly, what is excluded, from those costs. Power charging costs can be very large and a properly advised tenant will ensure that they are structured so as to be separately itemised outside the lease's definition of "rent", together with any other landlord services, so as to ensure that the level of SDLT is not unnecessarily increased.
It is also important to consider how the Carbon Reduction Commitment (CRC) is addressed. The CRC will affect organisations with annual electricity costs over £500,000, who have to purchase carbon allowances equivalent to their energy use. Critical to its application to the data centre market is the issue of which “organisation” is required to surrender the allowances, who pays for them (and decides when to buy) and who gets the benefit of any credits. Standard service charge provisions may be inadequate to deal with data centres’ energy consumption and the impact of environmental legislation.
Alterations provisions may be subject to less restrictive provisions than those typically found in multi-let office buildings. Alterations which are customary in the sector, such as the installation of cabling and racking, should not be the subject of landlord's consent so long as they do not affect the building's structure and integrity. At the end of the term, the costs of removing racking and cabling may be substantial. Landlords will want to receive back a facility which they can generate income from and re-let as quickly as possible. Traditional yielding up may, therefore, be undesirable to both parties and, therefore, early commercial negotiation is important.
Many data centre rent reviews are fixed by way of a stated annual percentage uplift. However, there are potential pitfalls upon lease renewal or where the lease includes traditional open market review provisions. In Martin’s Property Investments Ltd v Cable & Wireless UK plc  EWHC 582 (Ch), the review clause included an assumption that the “demised premises comprise High Class Professional or Commercial Offices”. Following a change of use, the clause was amended to provide that the new rent was to be 90% of the open market rent for high class offices or, if greater, for a computer centre. The Court decided the parties intended rent to be reviewed on the assumption of office use as there was difficulty ascertaining the open market for the computer centre due to an absence of comparables. Basing the review on the actual premises would have opened up debate as to what alterations would be required to meet the assumption of offices, which had not been altered by the drafting amendments. Greater care in varying the lease would have assisted the parties, but the general lack of comparable evidence remains an issue on open market reviews.
The appropriate provision of services including power, cooling, heating and humidity control are core to the controlled environment which allows premises to function as a data centre. Careful drafting around the provision and levels of service are key. Equally important are the remedies available for a service level breach and the trigger that leads to such a breach. Rental credits, self help remedies and ultimately termination rights are common in modern data centre leases. The quality of the existing facility and equipment within it, combined with the level of the rent, will dictate in part what combination of service levels and remedies for breach can be negotiated. The landlord will want to ensure that appropriate caps on its liability are included in the lease given the substantial sums which can potentially be lost on failures, particularly for applications such as trading platforms. The tenant will also wish to manage its position carefully. If power draws are exceeded by the tenant beyond pre-determined levels it is not unusual to see provisions that interrupt the service or impose large financial penalties for exceeding pre-determined levels. Such provisions can be very damaging to a tenant's business and highlight the need for tenant's IT specialists to be involved in lease negotiations to ensure that the lease is consistent with operational objectives.
James Dodsworth is a partner at Mayer Brown International LLP, and is head of their Data Centre and Technical Real Estate Group. He has advised clients in multiple jurisdictions around the world on their data centre requirements and their legal risks and solutions.