Natural Capital: Landlords, tenants & carbon ownership

The recently published Dasgupta Review on the Economics of Biodiversity is further confirmation of our mismanagement of natural capital, because of a failure to value it correctly. Mistakes have been made both in terms of the process conducted by valuers and in the lack of appreciation of the important role it plays.

There is a need to have a standardised approach to auditing the stock of natural capital and to consider this alongside the conventional balance sheet. Only then can informed decisions be made about the sustainable use of our dwindling natural resources.

Landowners and tenants have many questions about their role in the stewardship and exploitation of natural capital and its associated value. Many of these questions have been prompted by the shift away from the Basic Payment Scheme, as set out in the Agriculture Act 2020 and the requirement in the Environment Bill to increase biodiversity.

Information about the new ELMS regime is slowly appearing, but land managers often cannot wait for the Parliamentary draftsman and decisions need to be made now. A delay in decision making risks a slowing down of the sales and letting of land and the postponement of tax and succession planning.

Relevant questions

This is the first of a series of articles, which will focus on some of the relevant questions, starting with the fundamental issue of carbon and how an improved ability to sequestrate it might be treated in the context of the landlord and tenant relationship.

For such a market to operate efficiently, it will be necessary to establish:

  • how much additional carbon has been sequestered by any specific measures taken;
  • who owns the sequestration potential and the underlying carbon;
  • legal mechanisms to quantify, define and transfer ownership of such potential; and
  • confirmation that the sequestration potential can operate within existing carbon credit systems.

It must be stressed that this article is considering the ownership of the sequestration potential and not the valuation of any associated credits or tradeable instruments. This is about the ownership of the opportunity to lock up more carbon and any financial benefits that flow from that will be a function of the market place, which is evolving all the time.

Opportunities

In an agricultural context the prime movers for carbon sequestration are plants and the soil they grow in. The scale of UK farming and forestry means that it has a potentially huge role to play in taking CO2 out of the atmosphere and locking it up. It therefore makes sense to consider the control and use of these natural assets in assessing who can benefit from the process of increasing carbon sequestration.

However a distinction has to be drawn between the ability to increase carbon sequestration and the existing bank of carbon stored in the soil and associated vegetation. It is the potential for increasing sequestration, which attracts the value, because that is the basis of the carbon credit market. If an airline is pumping COinto the atmosphere, it has to take an equivalent amount out and so maintaining the status quo will not be sufficient.

Obviously, ownership or ability to control the store and/or the potential may be different and that becomes very relevant in the context of the landlord and tenant relationship.

Freehold ownership

In order to analyse the landlord and tenant relationship, the extent of the fee simple absolute ownership needs to be considered. At the risk of bringing back awful memories of land law lectures, the fee simple absolute estate includes the soil, vegetation growing within it and the minerals lying in strata underneath it.

This is as comprehensive as real property ownership gets and if one considers that a freehold owner is entitled to remove mineral deposits, peat and even the top soil itself from his land, then that provides strong evidence that carbon stored within these components of ownership is also owned by the freeholder.

But are such rights included within the definition of mines and minerals, as the freeholder might have severed such rights and conveyed them away to a third party?  In Coleman v Ibstock Brick Limited [2008] EWCA Civ 73 the Court of Appeal considered the meaning of "minerals" in the context of a lease and found that it meant substances "exceptional in use, in value and in character" and did not mean the ordinary soil of the district.

That definition and the fact that carbon is in vegetation, root systems and topsoil in the main, points towards these rights not falling within the meaning of "minerals." The location of the carbon in the topsoil and upper layers is also not consistent with the definition of mines and minerals, which are inevitably in stratas of sub-soil beneath.

It follows that if the freeholder occupies the land then they will also control the sequestration potential of the land, through their management and husbandry of it. Different considerations come into play if third parties are permitted to occupy.

As the market develops we may well need legislation to clarify the legal nature of ownership of sequestration potential, or to resolve how they are dealt with in a leasehold context.

The landlord and tenant relationship

 If a leasehold interest has been granted then the terms of the lease will be important in clarifying what, if any, ability the tenant has to influence or control carbon sequestration, without obtaining the landlord's consent.

Some of the relevant provisions will span both the Agricultural Holdings Act 1986 ("1986 Act"), the Agricultural Tenancies Act 1995.

User clause

Most tenancy agreements will restrict the use of the holding to agricultural purposes only and so any carbon sequestration will have to be achieved within the definition of agricultural operations. That may be possible if the activities are based around soil improvement, such as increasing organic matter or varying crop rotations, subject to any permanent pasture restrictions etc.

However, the planting of trees or permanent crops is usually forbidden so that particular avenue of carbon storage will be unavailable.

Further, the tenant will often be under a positive obligation to comply with the Rules of Good Husbandry (ROGH) which (along with the corresponding Rules of Good Estate Management) are the last surviving remnant of the Agriculture Act 1947. The problem for tenants, as with the definition of agriculture under any piece of legislation you care to consult, is that the ROGH are aimed at maximising production of agricultural commodities and not the provision of environmental benefits.

This focus on production means that activities like the creation of wild bird habitats, which utilise extensive conservation grazing, will not be possible because of the requirement in the ROGH to keep "permanent pasture properly mown or grazed and maintained in a good state of cultivation and fertility and in good condition" and "properly stocked."

However, carbon sequestration through husbandry, such as reduced or no tillage farming is squarely within the control and purview of the tenant, along with increasing soil biomass through increasing organic matter.

Entering agreements

The challenge for the tenant is then finding a scheme or commercial arrangement, which monetises the carbon sequestration. For tenancies under the 1986 Act an immediate potential problem arises from the term of the tenancy; tenants are invariably granted an annual periodic lease and therefore may struggle to enter into any credible long term agreements with third parties.

The standard alienation provisions of an agricultural lease are unlikely to prevent a tenant from entering into a scheme, as acts of carbon sequestration are unlikely to involve sharing possession or occupation of the holding, never mind any sub-letting or assignment. Some alienation clauses, however, cast their net wider to prevent contract farming arrangements and these might possibly also catch a carbon offsetting agreement, but each lease will need to be individually reviewed.

However, tenants will not be able to enter into long term agreements which restrict how the land can be managed if a long fixed term is required. For example, biodiversity net gain agreements with their 30 year minimum commitment for tenants will not be an option, but perhaps a market will emerge for short term commitments. Parties may also be willing to be more flexible given the security of a 1986 Act lease or in circumstances in which an FBT has several years left to run.

It must be stressed that the focus of this article is on private payments for environmental services and not public money in the form of financial assistance under the Agriculture Act 2020. Measures have already been taken in the 2020 Act to ensure that 1986 Act tenants are not excluded from claiming such annual payments by providing for the reference to arbitration of a landlord's refusal to consent or vary the terms of the tenancy.

The Agriculture Act 2020 has laid the statutory foundation for moving financial support away from the EU focus on direct support to embrace environmental protection policies, designed to fulfil DEFRA's 25 year plan to improve the environment. However the legislation governing landlord and tenant relationships in the agriculture sector and the customary contractual arrangements made under this legislation, sit uncomfortably with newly defined assets, such as natural capital and activities like the sequestration of carbon. The conservation covenants and biodiversity gain provisions included in the draft Environment Bill may solve some of these issues in due course. However greater flexibility and imagination is going to be needed if tenancy legislation is going to fit more closely and the wider industry is to be weaned off a course of dealing between landlords and tenants, which has evolved with production as its primary focus. The world still needs to be fed but the landscape is different now and sustenance must be sustainable.