Reprinted with permission from The John Liner Letter, Volume 44, Number 2; January 2007. Copyright 2007, Standard Publishing Corp., Boston, MA. All rights reserved. www.spcpub.com A MONTHLY BUSINESS INSURANCE ADVISORY SERVICE VOL. 44, NO. 2 JANUARY 2007 Handling Real Property leasing exposures In this Letter, we look at managing exposures in connection with the leasing of real property. Major Areas of exposure Leasing real property creates major exposures for both the landlord and tenant. Among the main concerns are determining which party is responsible for liability to third parties arising out of the ownership, maintenance or use of the property; which party is responsible for damage to the leased property; and what rights and responsibilities the lease assigns to each party should the leased property be damaged. The person responsible for managing a firm s risks should have some input in the negotiation process. Establishing the appropriate lines of communication may require the involvement of top management as well as other departments that negotiate or set policy for leasing. negotiating Risk Transfer The landlord s and tenant s respective bargaining positions determine how a lease transfers risk. Make sure you know what liabilities you have assumed, especially when the other party is in the driver s seat. Most leases require tenants to assume sole responsibility for all liability arising out of an occurrence in connection with the leased premises, except liability stemming from the sole negligence of the landlord. Note that the tenant pays damages and defense costs when both tenant and landlord are negligent. An intermediate hold-harmless and indemnity clause may state: Tenant shall hold Landlord and its agents harmless and indemnified from all loss, damage, liability or expense incurred, suffered, or claimed by any person by reason of Tenant s negligence or use of the leased premises or the building of which the leased premises are a part or of anything therein, or the parking facilities on or adjacent thereto... or by reason of any injury, loss, or damage to any person or property upon the leased premises not caused by the negligence of Landlord... ROBERT MONTGOMERY, CPCU, AU, Editor JANN BROWNING, CPCU, ARM, Technical Editor ALLISON BROWN ATKINS, Copy Editor SUSANNE EDES DILLMAN, Marketing Manager KELLY COTTER, Circulation Manager JULIE REILLY, Production Manager ROBERT DAUER, Publisher Emeritus JOHN C. CROSS, Esq., Publisher THE JOHN LINER LETTER (ISSN #0021-7204) is published monthly by the John Liner Organization, a division of Standard Publishing Corporation, 155 Federal Street, Boston, MA 02110. Subscription price: $249 per year plus shipping and handling, U.S. and U.S. possessions; $323.70 plus shipping and handling in Canada and elsewhere. POSTMASTER: Send address changes to THE JOHN LINER LETTER, 155 Federal Street, Boston, MA 02110.
Courts will generally enforce this type of intermediate indemnity clause. For example, in Great Northern Ins. Co. v. Interior Construction, 2006 NY Slip Op 07519, a lessee challenged such an agreement, requiring the tenant to indemnify and hold harmless the landlord against any and all claims... (unless caused solely by landlord s negligence)... The tenant asserted that the lease agreement did not unmistakably require indemnification for the landlord s negligence. In New York, courts will construe a contract to provide indemnity to a party for its own negligence only when the contractual language evidences an unmistakable intent to indemnify. Since the parties had stipulated that the landlord was 90 percent at fault and the lessee s contractor 10 percent, the landlord was obviously not solely at fault. Also, a requirement in the lease that the tenant purchase general liability insurance naming the landlord as an additional insured, along with the language in the indemnity clause in the lease, persuaded the court that the unmistakable intent requirement had been met. The tenant also cited a state law that voided agreements in a lease of real property that exempted from liability injury or damage caused by the lessor s negligence in the operation or maintenance of the premises. The New York Court of Appeals had previously ruled that the statute applied primarily when an agreement excuses a landlord from liability for otherwise valid claims that might be brought against them by tenants or others. The statute doesn t prevent two sophisticated businesses from contractually allocating between themselves the risk of liability for injury or damage to a third party, essentially through the employment of insurance. Some leases contain abbreviated agreements that nevertheless transfer a wide range of liabilities. For example, the lease may state that the tenant will hold the landlord harmless and indemnified from all loss, cost, or damage that may occur or be claimed with respect to any [person, organization, or property] on or about the leased premises, or to the property itself, resulting from the acts of any person other than the lessor... This language will most likely appear under a net lease when the tenant is the sole occupant of the leased premises. Phrases like all loss, cost, or damage occurring on or about the premises covers a wide range of circumstances under which a tenant may be required to assume liability. Other than fire legal liability, damage to the leased property itself is, of course, not usually a risk covered under general liability policies. Note, too, that such agreements are not limited to bodi- 2
ly injury or property damage claims. The indemnification agreement can take in claims arising out of personal injury offenses, environmental pollution, or other exposures that might or might not be insurable with respect to liability assumed under a contract. What Does Your Liability Insurance Cover? Most leases require tenants to carry liability insurance protecting both tenant and landlord against claims arising out of the use of the premises by the tenant. These requirements vary with respect to limits, types of coverage required, insured status of the landlord, and other issues. Note the distinction between an indemnity agreement and other provisions in a lease requiring insurance. Often, the latter fail to address the broad scope of responsibilities assumed by the tenant under an indemnity clause. If you are a landlord, make sure the lease s liability insurance requirements clearly spell out what insurance the tenant must arrange for your protection. Provisions describing the tenant s liability insurance should describe the required coverage from the standpoint of current policy language and forms. If you are a landlord, keep in mind that clear, unambiguous terms in the lease will help reduce your liability exposures under your own insurance program. Don t assume that you have transferred all liability risks to your tenants. The ISO Commercial General Liability Coverage Form, CG 00 01, covers claims arising out of personal injury offenses: false arrest, detention, imprisonment, malicious prosecution, wrongful entry, or wrongful eviction, for example. Such offenses committed by a tenant s employees would not normally create liability for a landlord. Nevertheless, a personal injury lawsuit could drag in a landlord, who would then want protection under the tenant s liability insurance policy. Note that CG 00 01 policies exclude contractual liability under the personal and advertising injury coverage. That fact provides more reason why a landlord should be named as an additional insured under a tenant s policy. Selling Alcohol on the Premises If you sell alcohol or otherwise engage in the liquor business, you should have liquor liability insurance, and the landlord should be named as an additional insured on your policy. CG 00 01 excludes liquor liability if the named insured is in the business of manufacturing, distributing, selling, serving, or furnishing alcoholic beverages. 3
If you are a landlord and not engaged in the liquor business, your own CGL will cover your vicarious liability that arises from the activities of a tenant that is so engaged. You should have coverage as long as you did not manufacture, distribute, sell, serve, or furnish alcoholic beverages. Additional Insured Status Leases often require that the tenant s liability insurance include the landlord as an insured. Some leases specify that coverage be written for the mutual benefit of both parties. Others might require that the landlord be named as additional insured, additional interest, or even named insured. Analyze this language carefully; ordinarily, a lease should not require more than naming the landlord as an additional insured for all coverages under the tenant s liability policy. ISO endorsement CG 20 11 serves this purpose. It provides insured status to the lessor or manager of the leased premises named on the endorsement with respect to liability arising out of the ownership, maintenance, or use of that part of the premises leased to the named insured tenant and shown in the schedule. Note that ISO did not change this endorsement in the 2004 revision to add language requiring the named insured to be partially at fault for the additional insured to have coverage. But the endorsement does have important limitations. It does not cover losses arising out of that part of the premises not leased to the tenant and not described in the endorsement. This would include common areas, maintenance and service facilities, adjoining roadways, and so forth. Compare that language to the indemnity agreement in your lease. Also, the additional insured does not have coverage for losses arising out of an occurrence that takes place after the lessee ceases to be a tenant. Coverage is further limited in that the landlord does not have protection for claims stemming from structural alterations, new construction, or demolition operations performed by or on behalf of the landlord. The endorsement also does not cover the stockholders, directors, officers, or employees of the additional insured. If you are the landlord, your own CGL should afford coverage for such exposures. In connection with new construction or renovations, the landlord may also require that contractors hired to do the work provide separate protective liability insurance. Don t Forget Pollution Risks If you are a landlord, you want the lease to transfer liability for any contamination that your tenants may cause. The lease should also grant you the right to inspect the property during 4
the term of the lease. Keep in mind that any period of indemnity in the lease should not be limited to the term of the lease. Also, the lease should describe the condition of the site at the time the landlord turns the premises over to the tenant. This may require site assessments prior to and at the termination of the lease. The lease should then hold the tenant responsible for all contamination and cleanup costs and other obligations resulting from occurrences during the term of the lease whether mandated by government agencies or the result of third-party liability actions. In view of the sweeping pollution exclusions in CGL and umbrella policies, you cannot rely on having coverage under either your own or your tenant s policy. In recent years, insurers have designed environmental insurance for a variety of situations. Property leasing Risks and Insurance The lease should clearly state which party has responsibility for damage to the premises as well as for providing property insurance. These requirements may appear throughout the lease rather than be consolidated in a clearly labeled insurance section. Is the Tenant a Co-insured? A lease and common law generally hold tenants responsible for damage caused by their own negligence. Even when the landlord s insurance covers the loss, the insurer may subrogate against the tenant. To protect themselves, tenants should negotiate a subrogation waiver clause into the lease. Under a joint waiver, a tenant also waives subrogation rights against the landlord. A subrogation waiver may state that the lessor will not make a claim for recovery against the lessee for damages to either the premises or improvements if the lessor has insurance covering such damage and may contain a clause permitting the insured to waive such rights prior to a loss. In fact, standard property insurance forms allow the insured to waive rights of recovery against the insured s tenant after a loss. See our March 2006 Letter for more information on waiver of subrogation provisions in insurance policies. Even when the lease does not contain a waiver, courts sometimes bar subrogation against tenants. Some courts have held that the tenant is an implied co-insured absent an agreement to the contrary. In doing so, some courts have recognized that the tenant has a possessory insurable interest in rented property. Since the rent probably reflects the landlord s insurance premium as well as other expenses, these courts have held that a tenant is, in effect, paying for the insurance. 5
In most cases, the court will be guided by the terms of the lease. For example, in Travelers Indemnity Company v. Deguise, 2006 VT 87, the insurer subrogated against the tenants, who had dropped smoldering materials in the trash causing a fire that damaged the apartment. The court ruled that the tenants were not co-insureds under the landlord s property insurance policy. The same court had previously held that a tenant s liability to the landlord s insurer for negligently causing a fire depends on the intent and reasonable expectations of the parties. Where the lease required the landlord to carry fire insurance on the premises, the insurance was for the mutual benefit of the parties. Under those circumstances, the court had deemed the tenant a co-insured. In Deguise, however, the court found that the lease neither expressed nor implied a requirement that the landlord carry insurance. For the same reason, the court also rejected the argument that the tenant should be deemed a co-insured on the grounds that the landlord would certainly take insurance costs into account when setting the rent. Naming the tenant as an insured under the landlord s property policy should eliminate any doubt and effectively block the lessor s insurer from taking subrogation action. Neither a waiver of subrogation nor additional insured status necessarily provides a tenant with totally adequate protection. For one thing, the tenant has protection only to the extent provided by the landlord s insurance. Also, subrogation waivers sometimes contain even stricter provisions for the benefit of landlord. For example, the lease might make the wavier contingent upon valid and collectible insurance or the actual receipt of insurance proceeds. As a result, the tenant might be exposed to subrogation because the amount of insurance carried by the landlord was not adequate. The tenant also could be liable for the portion of a loss incurred by the landlord due to a coinsurance penalty or substantial deductible. Moreover, the landlord s policy might insure against a limited range of perils. For example, leases commonly specify that the lessor will provide fire and extended coverage, roughly comparable to the basic causes of loss. If the tenant s negligence causes a loss from some other peril, water damage, for example, neither a subrogation waiver nor insured status under the landlord s policy will help. Who is Responsible For Property Insurance? In most cases, landlords should buy their own property insurance 6
covering the leased property. Sometimes, though, a tenant can do better than the landlord in arranging broader coverage at a lower cost. Under those circumstances, the landlord might benefit from having the tenant assume responsibility. The lease should require that the tenant obtain the landlord s approval of all insurers to be used. The document should specify the particulars of the required coverage, such as the perils to be covered, actual cash value or replacement cost valuation, and determination of property values and amounts of insurance. The policy should name both landlord and tenant as insureds and cover the interests of any mortgagees. The landlord should have specific rights under the policy such as notice of cancellation, notice of reduction in coverage, and so forth. If feasible, the landlord should retain the original policy or otherwise receive pertinent forms if the policy covers several locations. The lease should require that the tenant furnish certificates of insurance indicating that the tenant has complied with the insurance requirements. Establish Procedure for Adjusting Values When the tenant buys the insurance, the lease should set forth a specific procedure for adjusting values over time. Rather than a fixed percentage, the parties might agree to have the amount of coverage adjusted annually or at some other interval, subject to a specified building cost index or the landlord s approval. The lease should also specify the maximum deductible acceptable. Sometimes, when a policy includes a large deductible under a policy affording coverage over a number of locations, the insurer might agree to adjust claims within the deductible area with the landlord and obtain reimbursement from the insured tenant. A lease that requires a tenant to buy property insurance should also require the purchase of related coverages, such as ordinance or law coverage. Sometimes, the need for such coverage might not be apparent at the outset of a long-term lease but might become a substantially more pressing concern before the lease expires. Carefully consider such requirements and include a provision for future negotiations as need may arise. Giving Attention to Rent Leases vary as to how they deal with payment of rent if the premises suffer damage and become untenantable. For example, the lease might terminate if the damage to the building cannot be repaired within a certain length of time. Alternatively, the landlord might have the option to repair the damage with all 7
Reprinted with permission from The John Liner Letter, Volume 44, Number 2; January 2007. Copyright 2007, Standard Publishing Corp., Boston, MA. All rights reserved. www.spcpub.com reasonable speed and dispatch and abate the rent during the period of untenantability. In any event, the lease should clearly express the tenant s obligations to pay rent when the premises are damaged. If the lease is silent, state law will generally govern the tenant s obligations. Although variations occur from state to state, the law in most jurisdictions provides that a lease may be canceled or the rent abated or adjusted under specified circumstances. An express agreement between landlord and tenant can often supersede the relevant law. Determine exactly to what extent rent obligations continue. Both Landlord and Tenant Have a Business Income Exposure Tenants have a serious continuing-expense exposure if they must continue to pay rent for untenantable premises. Landlords face a loss of rental income when damage to the premises causes rent abatement or termination. A landlord that occupies a portion of the building and leases out the remaining space faces the loss of rental value of the owner-occupied portion as well as loss of rental income from the portion leased to others. You can use standard business income forms to cover loss of rents and rental value. The ISO business income coverage forms can be written with or without rental value coverage. Leasehold Interest Coverage Tenants can incur financial losses due to the termination of a favorable lease. Leasehold interest coverage insures against financial loss that results when a landlord cancels the lease as a result of damage from an insured peril. The ISO leasehold interests form can be used to cover tenants lease interest, bonus payments, improvements and betterments, and prepaid rent. Tenants lease interest covers the difference between the rent actually being paid for the premises and the present rental value of those premises for the unexpired term of the lease. While tenant s improvements and betterments can be covered under standard property insurance policies, coverage applies only if the improvements and betterments sustain direct damage caused by an insured peril. A leasehold interest form covers loss when cancellation of the lease is triggered because of damage to any property at the described premises. The insured would be covered even if the improvements were not damaged. Copyright 2007 Standard Publishing Corporation. All rights reserved.the JOHN LINER LETTER is published monthly by the John Liner Organization, a division of Standard Publishing Corp., 155 Federal Street, Boston, MA 02110. Quotation or reproduction of material, in whole or in part, only with permission of the publisher. Subscription price: $249 per year plus shipping and handling in U.S. and U.S. possessions; $323.70 plus shipping and handling in Canada and elsewhere. To order your subscription, call toll-free (800) 682-5759 or call (617) 457-0600. E-mail: k.cotter@spcpub.com for customer service; r.montgomery@spcpub.com for editorial inquiries. Please visit our Web site, www.spcpub.com. The John Liner Letter is now available on-line and on CD-ROM from Silver Plume.