Probate & Property Magazine
What Every Leasing Attorney Needs to Know About Insurance: Ask for What You Want, Then Make Sure the Insurance Covers What You Need
By Angelia D. Wesch and Carmen R. Rowe
Angelia D. Wesch is a member of Eisenhower & Carlson PLLC in Tacoma, Washington, and Carmen R. Rowe is an associate at Jay A. Goldstein Law Offices PLLC in Olympia, Washington.
Insurance is the elephant in the room that cannot be ignored when entering into a lease. A lease determines how the parties’ liabilities are allocated; insurance determines how the parties will pay for those liabilities, and just as important (if not more so), how the parties will pay related legal costs. Well-drafted leases blend these considerations into a cohesive whole, ensuring that the parties’ respective liabilities are backed by insurance to the fullest degree possible.
It is important to recognize the two distinct types of insurance relevant to leases. Property insurance covers losses to real and personal property owned by either the landlord or tenant. In commercial leases, this type of insurance also covers the interruption of business such as loss of business opportunity during repair, expenses for temporary operation off-site, or losses from interruption of utility services. Casualty insurance fills the gap to cover liabilities outside direct damage to the insured’s property, including bodily injury and damage to property of third parties.
The real trick in either form of coverage is to ensure that covered losses match up with assumed responsibilities. If the landlord is responsible for repairing major damage to an HVAC system, the landlord must be the one required to carry requisite property coverage. If the tenant is to assume all liabilities and the duty to defend both tenant and landlord for any personal injury claimed arising out of physical injury occurring on the premises during the tenancy, the tenant must be the one required to carry requisite casualty insurance. The savvy drafter will ensure that the lease clearly identifies the losses to be covered by any required insurance, that any property to be covered is properly defined as “covered property,” and that the party required to obtain coverage for specific losses is the same party identified in the lease as the one responsible for those losses.
One way to minimize such problems as who or what is covered is to ensure that both tenant and landlord are insureds. Leases commonly accomplish this by requiring that the landlord be listed as an additional insured (casualty coverage) or loss payee (property coverage) under any policy that the tenant is required to carry. The lease should require that the insuring party provide sufficient proof of insurance (a certificate of insurance, a declarations page and any endorsements, and even a copy of the policy) affirming the other party’s status as an insured for every year of coverage. The necessary proof may be a condition precedent to the commencement of the lease when the lease requires it. See, e.g., Woody’s Steaks, LLC v. Pastoria, 584 S.E.2d 41, 45 (Ga. Ct. App. 2003).
As obvious as it may sound, it is imperative that any party expecting coverage as an additional insured or loss payee confirm that such coverage and designation was in fact put into place. Too often a party never follows up to ensure that coverage was actually procured or that the party was properly named in the policy. Oversights happen, whether because proof of insurance was never provided, because the policy failed to name the proper party as an additional insured or loss payee, or because of a failure to secure proof of insurance in subsequent policy years. Such seemingly minor administrative oversights can rapidly evolve into problems of monstrous proportions should such omissions of coverage or named insureds preclude or impair coverage for the loss. It is also prudent to consider the effect that any subrogation clauses (or waiver of such rights) in the lease may have on the party’s status as an additional insured or loss payee. Careful consideration of such issues will help prevent unpleasant surprises down the road.
Courts typically find that failure to procure the required insurance constitutes a material breach of the lease. See John Francis Major, Material Breach of Commercial Lease, 7 Am. Jur. 3d, Proof of Facts, 655, § 16 (2007). Whether the breach warrants forfeiture will depend on the exact provisions of the lease. A default may even occur when a party procures a policy with a substantial deductible if such a deductible violates the overall insurance requirements. See, e.g., Rouse-Miami, LLC v. Bentley’s Luggage Corp., 948 So. 2d 928, 930 ( Fla. Dist. Ct. App. 2007). This is particularly true when the lease specifically identifies failure to procure the required insurance as an event of default. Unlike other forms of potential default, the courts have affirmed that there is no opportunity to cure such a failure. Once the failure has occurred, there is no way to go back in time and remedy the gap in coverage. See, e.g., Jackson 37 Co., LLC v. Laumat, LLC, 820 N.Y.S.2d 281 (App. Div. 2006) (landlord entitled to eject tenant for failure to obtain insurance; landlord was not required to exercise alternative remedies under the lease). Thus, the parties are well advised to be sure to procure all required coverages. Otherwise, they may find themselves responsible for a default and termination of the lease and, in turn, liable for damages that go well beyond the loss that was supposed to be insured.
Concerns Particular to Property Coverage
Scope of Replacement Cost
In the commercial context in particular, both landlord and tenant should ensure that the property coverage will provide actual replacement cost and not just “actual cash value,” because “actual cash value” may be substantially less than what is needed to put the parties back in the position they were in before the loss. The landlord needs to ensure that it regains a usable building, and the tenant needs to ensure that it receives the equipment needed to continue its operations as seamlessly as possible.
Effect of Updated Code Requirements
All too often the costs of upgrading new construction to comply with increasingly stringent local codes and regulations can rapidly outpace the costs of simply rebuilding what was there. Property coverage often excludes such costs. A well-drafted lease makes it clear who is responsible for such costs and whether or not additional insurance (such as through an endorsement) is required to cover them. If such losses are to be self-insured, the other party would be well advised to require security to ensure that the responsible party is able to pay should the need arise.
Concerns Particular to Casualty Coverage
The lease should address what will happen in the event of such severe damage that it is impossible or impracticable to rebuild the building. The impossibility or frustration of purpose doctrines may excuse performance—even when rebuilding may be theoretically possible but unreasonable expense makes it impracticable. See, e.g., Hopfenspirger v. West, 949 So. 2d 1050 (Fla. Dist. Ct. App. 2006). These doctrines apply, however, only if the event was not foreseeable at the time the contract was executed. See In re Dreliouch, 359 B.R. 9 (Bankr. D. Mass. 2006) (event must be unforeseen to apply impossibility doctrine); WRI/Raleigh, L.P. v. Shaikh, 644 S.E.2d 245 (N.C. Ct. App. 2007) (event must be unforeseen to apply frustration of purpose doctrine). A lease can address such situations in a manner similar to a condemnation or eminent domain proceeding. The parties must consider who is responsible for any business losses flowing from the loss of the use of the property and may want to consider putting appropriate insurance in place to cover such losses.
Practice Tip : One might think that it is really just up to each party to procure the requisite coverage for their own losses (typically, the landlord bears the loss of the building and the tenant bears the loss of the business). By ensuring that “the other guy” has appropriate insurance to cover such a loss, however, the parties protect themselves as well. Requiring adequate insurance to cover a permanent loss helps minimize the chance that one party finds itself without adequate coverage, thus facing a substantial and devastating loss for which it may turn to the other to recover.
In the event of substantial repairs or a rebuild, the parties also may find that rebuilding to comply with new government requirements creates a situation in which the changed components of the new building are no longer conducive to continued operations of the tenancy. Landlord’s counsel will want to ascertain that the tenant bears full responsibility for any such business losses. Both parties will want to ensure that the tenant has adequate coverage to protect against such a loss (the tenant’s interest is obvious; for the landlord, a tenant left stranded without the financial ability to move on with its business might have incentive to pursue remedies against the landlord for its business losses, whether justified under the lease or not).
Delay and Effect on Business Operations
When construction may be at issue—whether because the premises are being newly constructed or substantial repairs are being done—both parties must consider who is responsible for the intangible, but critical, loss of business. The landlord may lose monies in rent for every month tenancy is suspended. The tenant may lose monies and long-term business opportunities for every month it is not operating. Insurance should be required to cover any such losses.
Duty to Indemnify vs. Duty to Insure
It is important to note that an agreement to indemnify is separate from an agreement to insure. A party may be in breach of the lease if it fails to procure the requisite insurance even if it does not breach its duty to indemnify. For example a recent decision, Sears, Roebuck & Co. v. Charwil Assocs., LP, 864 N.E.2d 869, 875 (Ill. App. Ct. 2007), involved an injury sustained by a Sears customer in the common area of a mall. The injury was caused by a Sears employee while driving another customer’s car. The lease imposed three obligations on the landlord: (1) to obtain a commercial general liability policy; (2) to indemnify Sears for “any and all” claims arising out of any customer’s use of the common areas; and (3) to provide insurance for, among other things, “insuring the indemnity agreement.” The landlord’s policy had the requisite policy limits and correctly named the tenant as an additional insured but had an automobile exclusion, and the insurer thus denied coverage for the claim.
The court found that even though the landlord did not breach its duty to indemnify, the landlord still breached the lease by failing to procure insurance that met the lease’s insurance requirements—for example, to cover “any and all” claims, even those caused by the tenant’s employee’s own negligence. Thus, under the provisions and limitations of that particular lease, the landlord was held liable for the full policy limits of the insurance that was supposed to be in place.
Concerns That Affect Both Property and Casualty Coverage
Assignment of Liabilities—Assignment of Coverage?
Many leases allow one or both parties to assign their rights under the lease. It is imperative that the parties wrap insurance concerns into any assignment. Insurance policies, on their face, rarely allow for coverage to be assigned. Although courts will typically uphold an assignment made after a loss, depending in part on the exact language of the policy, courts also will tend to enforce anti-assignment clauses when policy rights are assigned before a loss because such an assignment may increase the insurer’s risks. See 17 Williston on Contracts § 49:126 (4th ed. 2007).
An assignment can result in a gap in coverage in several ways, such as failure to properly transfer the insurance to the new person or entity (including a different corporate form of an original party), failure to add the assignee as an additional insured or loss payee, or failure to procure new insurance as necessary. The lease should specify that any assignee shall shoulder all insurance rights and obligations in the lease and that the parties take whatever steps are necessary to ensure seamless coverage.
Coverage concerns extend to subleases as well. If the lessee is allowed to sublease the premises, the lease should clearly designate responsibility for any liability and attending insurance burdens. The belt-and-suspenders approach for the landlord requires the original lessee to remain ultimately liable for its original obligations, including any obligations to carry insurance, and that any insurance carried by the sublessee will name both the lessee/sublessor and the primary lessor as additional insureds or loss payees.
Be wary, however, of creating situations in which there are warring insurance policies. When multiple parties carry insurance to cover a potential loss, the lessee and sublessee can point a finger at each other’s policy as the primary policy responsible to cover the particular loss. This situation can engender lengthy and costly coverage battles that may impede timely recovery for any loss. A well-drafted lease makes it clear which insurance policy is to be the primary policy in the case of a sublease. Again, it is wise for all parties to review the certificates of insurance, applicable policies, and any endorsements once issued to ensure that the policy coverage issued provides the coverage intended and required.
Extreme Circumstances, Extreme Damage
A flood of cases and articles relate to insurance coverage for extraordinary catastrophic acts, be they natural (Hurricane Katrina) or act of man (9/11 and Y2K). A tightly drafted commercial lease will consider the effects of such unusual events because, although rare, the effects are devastating for all involved. The standard insurance policy will not cover such unusual risks. Also, a general lease provision requiring that the tenant (or landlord) procure basic property or casualty coverage, or even extended coverage against fire and other risks, does not typically require that either party obtain coverage for such extreme events as terrorism, and thus failure to procure such coverage will not be deemed a default. See, e.g., TAG 380, LLC v. ComMet 380, Inc., 830 N.Y.S.2d 87 (App. Div. 2007).
At a minimum, prudent drafters will clearly allocate who bears what risk in the event of such a disaster. The parties may not find it economically worthwhile to insure against a remote possibility. Whether or not to require insurance and in what form will vary according to relative risks. Geograph-ical location is a key factor in assessing relative risk, though a higher risk typically means that the premiums for coverage will be correspondingly higher. Even if the parties ultimately decide not to require such insurance in the lease, the parties should at least consider the issue before making a decision.
Successor Liability and Available Insurance
Recent case law suggests parties may be able to tap into insurance policies issued to companies related to the primary party, if necessary to cover claims for a defunct company or one with inadequate coverage for a particular loss. There is considerable debate, however, about whether this right exists and what entities are entitled to exercise the right. See, e.g., Patrick F. Hofer, Corporate Succession and Insurance Rights After Henkel : A Return to Common Sense, 42 Tort Trial & Ins. Prac. L.J. 763 (2007). While the court battles continue over just how far coverage for one company will extend over ill-defined lines between successor or related companies, the cautious lawyer may wish to allow as broad access to insurance coverage as possible by identifying all related companies in the lease, perhaps as additional named insureds in any required policies.
Coverage for Discrimination, Employment Law Violations, Advertising, and Other Seemingly Unrelated Problems
Landlords should ensure that the tenant retains full responsibility for any liabilities that may arise out of its business such as employment-related liabilities, labor-related liabilities, and business marketing liabilities. An advertising claim, for example, may be asserted against the landlord if it involves signage on the property. Creative counsel in a discrimination or personal injury suit may add the landlord as a party defendant if there is any indication that the landlord knew of an illegal or dangerous condition and failed to take steps to remedy it. Thus, the landlord must ensure not only that the tenant promises to defend and indemnify the landlord for any such claims, but also that the tenant carries sufficient insurance to protect against both parties’ direct liability. The same is true for liabilities that are to be borne by the landlord—a savvy tenant will include a requirement not only that such liabilities are insured, but also that the contractual duty to defend is covered by the landlord’s insurance policy.
If there is no requirement for insurance to protect the property, then the risks are self-insured and the party responsible for the damage under the lease must pay for the loss itself. This self-insurance option may be viable for some losses and in some situations, but it also carries a significant risk if the responsible party does not have the resources to timely cover the loss. For further discussion of self-insurance issues, see Ann Peldo Cargile, The Perils of Self-Insurance in Leases, Prob. & Prop. 46 (Sept./Oct. 2001). In addition, clients have myriad, less obvious ways to find themselves in a de facto self-insured situation, even when that was never their intent. This situation may happen when a party fails to procure insurance, when an insurance policy excludes or limits the loss in question and there is no suitable endorsement to close the gap in coverage, when the deductible is substantial, or when the insured is underinsured or runs into coinsurance issues. Conflicting priority clauses may also potentially reduce or eliminate coverage altogether, and at a minimum create a costly coverage battle. Such situations are best avoided through careful review of both the lease language and the language within the applicable insurance policies.
Time Limits in Lease vs. Policy Suit Limitations
Insurance policies tend to include suit limitations, and courts typically enforce such provisions, even in government contracts. See, e.g., Evergreen Park Sch. Dist. No. 124 v. Fed. Ins. Co., 658 N.E.2d 1235 (Ill. App. Ct. 1995). Both lessor and lessee must be wary of procuring a policy that includes such limits, the practical effect of which is that an otherwise covered loss may fall within the applicable statute of limitations but fall outside the suit limitations for available coverage. This policy provision would essentially render the loss as un- or self-insured.
Parties must carefully consider not only how environmental liabilities are to be allocated (such as claims that arise out of the actions of the tenant or out of actions of the landlord preceding the tenant’s occupancy), but also how such liabilities are to be insured. Standard policies frequently exclude or severely limit environmental claims absent the appropriate endorsements. The lease should clearly identify the desired scope of environmental coverage. In addition, the parties must carefully consider insurance coverage for defense of environmental claims. All litigation is expensive, but dealing with environmental claims may top the list of some of the most expensive and arduous types of claims to defend. The ideal lease will carefully specify who will pay for defending such claims for all parties and ensure that any applicable policy will recognize a duty to defend a “claim” or “suit” as early as possible in the process.
Allocation of Liability for One’s Own Negligence
Insurance also can be an important tool in facilitating the allocation of responsibilities between landlord and tenant. Of particular interest is the role of insurance in allowing an allocation that may be otherwise legally void as against public policy. For example, public policy (and in some cases specific statutes) can prohibit a party from disclaiming liability for its own actions or negligence. See, e.g., Great N. Ins. Co. v. Interior Const. Corp., 796 N.Y.S.2d 51 (App. Div. 2005). Insurance can open the door: when there is coverage for the loss, the public policy argument may not come into play. For example, in Sears, when a Sears employee’s negligence caused injury to one of Sears’ customers, the court upheld the landlord’s duty to both insure and indemnify Sears for those damages, finding that the lease “explicitly” required indemnity for “any and all” claims arising out of any use of the common areas by tenant’s customers, and required insurance to cover that liability. 864 N.E.2d at 874–75. Not all courts will assume such a result, however. See, e.g., Rouse-Miami, 948 So. 2d at 929–30, and cases cited therein (refusing to construe general terms for indemnification against “any and all claims” as intending to indemnify for the negligence of the indemnitee). It would thus seem prudent to ensure that any contract that truly intends for one party to indemnify the other for the indemnitee’s own negligence expresses such intent in an unequivocal fashion.
Final Practice Tips
Accidental omissions or failure to fill in details may preclude a party’s right to the insurance it expected. When insurance requirements are too vague to determine exactly what type or scope of insurance was required, and when the parties have no history of dealings such that the meaning of an ambiguous insurance requirement might be fleshed out, such a lease provision may be deemed unenforceable altogether. See, e.g., Gallogly v. Kurrus, 905 A.2d 1245 (Conn. App. Ct. 2006) (requirement that tenant provide “public liability insurance” was so vague and indefinite as to be unenforceable, and thus tenant did not breach lease for failure to procure such insurance).
As with any other type of insurance, it is imperative to ensure that the policies in place cover all intended losses, which may require additional endorsements to cover specific or commonly excluded perils. Endorsements are often required to ensure adequate coverage for property and other damages flowing from floods or other natural disasters, vandalism, terrorism, government takings of the property, or other major events.
In addition to ensuring sufficient coverage, it is also prudent to ensure that there is no duplicative coverage. The questions of “who is liable for what” and “who carries the insurance to cover it” get particularly complicated in any case involving common areas for which both landlord and tenant share responsibilities (and thus liabilities). Parties also must take particular care when the landlord’s total property exceeds the space actually being used by the tenant, when the tenant has made some substantial improvements to the premises, or when the landlord and tenant are engaged in any joint operations. The parties and their legal counsel must carefully review the lease to ensure that there is complete coverage without unnecessary duplication.
These issues may seem rudimentary, but too often through the various evolutions of a lease draft the parties’ obligations may shift in one section, without an appropriate revision of the insurance requirements for coverage of those obligations. Cross-referencing the damages each party is responsible for to the insurance to be carried by each party is a critical component of any final lease review.