- Some Popular Misconceptions About Property Insurance
- November 6, 2003 | Author: David P. Kassoy
- Law Firm: Ervin, Cohen & Jessup LLP - Beverly Hills Office
Property insurance carried by shopping center landlords is designed to provide, in the event of a casualty, the amount of money required by the landlord to restore the common area and building improvements in compliance with all codes and regulations applicable to new construction, and to replace up to one year of abated effective rent pending the resumption of tenant rentals after reconstruction has been completed and access to the premises has been restored. Rental income insurance is typically a part of the landlord's property insurance package which covers not only the cost of repairing physical damage to the shopping center from a casualty caused by a covered risk but, also, the loss of rental income pending the re-occupancy of the premises by the tenants that were displaced by the casualty. The landlord is almost always required by its own lender to carry such insurance.
Property insurance carried by shopping center tenants is designed to provide, in the event of a casualty, the amount of money required by the tenant to restore furnishings and tenant improvements within the Premises in compliance with all codes and regulations applicable to new construction and to compensate it for lost profits and extra expenses likely to be incurred even if rent has been abated pending resumption of business in the premises. It covers loss of business income and extra expense resulting, as well, from damage to the common areas that prevents the tenant from conducting business in the premises. Well drafted shopping center leases always require tenants to carry such property insurance in order to insure that a casualty does not precipitate tenant insolvency.
Too often, out of date lease forms are still in use that prescribe property insurance requirements that are no longer available or which cannot be purchased at commercially reasonable rates. Moreover, the scope of the casualty risks covered by property insurance is a prime source of confusion for many landlords and tenants. "All-risk" or, as they are now called, "Causes of Loss-Special Form" policies, typically exclude from coverage certain risks such as earthquake, flood, acts of war and terrorism. More recently, an exclusion was added for "mold." Where endorsements deleting such exclusions are unavailable or not cost effective, indemnification provisions may be designed to close the gap with respect to responsibility for the cost of repair and restoration of damage attributable to uninsured casualties.
It is not unusual to come across landlord lease forms with property insurance provisions that reflect misconceptions about what shopping center landlord's should be trying to achieve when allocating responsibility for carrying property insurance between the landlord and the tenant. Often, this is indicative of a lack of understanding about how insurance is supposed to work and a reluctance on the part of persons uncertain as to their own expertise to make changes in lease forms that have been in use for a long time. The worst part, is that it may cause protracted lease negotiations over what our clients regard dismissively as "boiler plate" and, unless properly resolved, may not only increase costs by duplication of coverage, but may actually cause delays in the repair and restoration process when an insured casualty actually occurs.
Although such misconceptions may abound, there are several in particular worth discussing. Firstly, there is the notion among some landlords that it is to their advantage to make their tenants pay for the restoration of common area improvements or deny rental abatement when the premises are inaccessible in instances in which the damage may have been caused by the acts or omissions of the tenant, its employees, agents or customers, even though the replacement costs, cost of repairs and loss of rental income are covered in full by the landlord's property insurance. The corollary may be true, too. Not infrequently, there are tenants that believe that the landlord should be liable for the cost of restoring the tenant improvements, personal property and lost profits of the tenant pending completion of repairs, for damage caused by the acts or omissions of the landlord, its employees, agents or contractors, even though the cost of repairs and the lost profits are covered by the tenant's property insurance. Neither the landlord nor the tenant will reduce their respective property insurance premiums by virtue of these misconceptions being reflected in the lease. What they may accomplish by doing so, however, is to cause a delay in the insurance adjustment process while each of the property insurance carriers scrutinizes who was at fault.
It should be incontrovertible that, in the typical shopping center lease, the tenant ultimately pays for the landlord's property insurance as well as its own. It is included in the operating costs for which the tenant pays a pro-rata share. It makes no sense for either party to insist on insurance coverage that duplicates the other's coverage and/or unnecessarily increases the amount of the other's property insurance costs.
The mutual waiver of subrogation advances the objectives of both parties, at no additional cost to either party, and protects both parties from potentially financially debilitating litigation instituted by the other's property insurance carrier after an insured loss. It is not unusual for the landlord's lease form to require the tenant to name the landlord, the shopping center manager and the landlord's lenders, each as an additional insured on the tenant's Comprehensive General Liability insurance policy to protect those parties from liability arising out of the ownership, maintenance, or use of the premises leased to the named insured, albeit not to claims based upon their actual negligence. This imposes no financial burden on the tenant.
There is little justification to deny rent abatement to a tenant that has been displaced by a casualty just because the damage may have been caused by the negligence of the tenant, its employees, agents or customers, when the landlord can be made whole by the rental income insurance, the premiums for which were paid for by the tenant as a pass through of operating expenses. However, some landlords draw a distinction between tenant negligence on the one hand, and gross negligence or intentional torts on the other, on the theory that the denial of rent abatement is a deterrent to aberrational behavior on the part of tenants, their employees, agents or customers. However, that is unlikely to reduce the cost of a landlord's property insurance premium and, arguably, is an unproven deterrent to persons (often over whom the tenant may have no control) bent on doing harm to the landlord's property.
Not only should property insurance packages in the case of Landlords include rental income insurance, and in the case of Tenants include business income/extra expense insurance (ISO Form CP 00 30 04 02), but, in each instance such combined insurance coverage should be carried with the same carrier. This provides an inducement to the property insurance carrier to expedite the claims adjustment process and, in appropriate instances, to authorize over-time and other measures designed to complete reconstruction sooner. By covering such expenses, the property insurance carrier may reduce the size of the potential claim for abated rent, in the case of the landlord, and for lost profits and extra expenses, in the case of the tenant.
Another misconception about property insurance is the notion among some landlords that they always save money if they require their tenants to carry the property insurance on leasehold improvements in their own Premises. That may be logical and customary for the retail tenants that build-out their own leasehold improvements at the outset and who may even insist on controlling the restoration of their store interiors after a casualty. However, tenants should not necessarily be required to make the interior repairs after a casualty in circumstances where tenants lacked the capability to build-out their own leasehold improvements in the first instance, or preferred not to do so, or the nature of the leasehold improvements are such that for the landlords' own protection they should insist on doing the work themselves. For leases that fall into one of these categories, the landlord should carry the property insurance on the leasehold improvements; of course, passing on the premium expense to such tenants as part of operating expenses.
There are actually some collateral advantages to landlords when they carry property insurance on their tenants' leasehold improvements: Firstly, the cost of insuring the leasehold improvements for multiple tenants in a shopping center is significantly lower than the aggregate cost of each such tenant insuring its leasehold improvements separately, and it reduces the redundancy of "deductibles." Secondly, it eliminates time consuming negotiations after a casualty between the respective property insurance carriers over the extent of the repairs required to restore the shell of the premises as distinguished from the repairs required to restore the tenant improvements in the premises, as well as the inefficiencies attributable to multiple contractors trying to perform their work simultaneously.
Finally, consideration must be given to the interaction between the lease provisions allocating responsibility for carrying property insurance between the landlord and the tenant and the lease provisions regarding indemnification (i.e., contractual liability) against claims, actions and proceedings, brought against either of the them, seeking compensation for damage to property, and the need for consistency. Presumably, there should be no right to indemnification by either party against the other for claims for damages covered by the type and amount of property insurance coverage required under the terms of the lease to be carried by the aggrieved party. Alternatively, indemnification may be appropriate for claims arising from the acts or omissions of either party to the extent that the claims are not covered by or exceed the amount of coverage of the type property insurance required to be carried by the aggrieved party. In the latter circumstances, either indemnification must be ruled out or each party must look to the scope and adequacy of its own Comprehensive General Liability insurance coverage measured against the magnitude of the risk of such claims.