The purpose of a lease is to remove risk from the landlord-tenant relationship by clearly detailing the responsibilities of both parties. However, an improper lease can create an adversarial relationship, result in unnecessary costs for one or both parties and still leave the landlord and tenant at risk.
Leases sometimes are unclear or even contradictory in the manner in which they allocate risk for potential losses resulting from injury or damage to people or property. Sometimes the responsibility for certain losses may fall on a party that is not insured to cover the loss.
Good relationships between a landlord and commercial tenant begin with a good lease. Rather than creating a situation where one party is trying to get the other to absorb as much risk as possible, landlords and tenants are better off reviewing risk together and determining how they can use their insurance coverage to jointly minimize risk.
An Effective Lease
An understanding of insurance issues that need to be considered when drawing up a lease can help ensure that the lease will benefit both parties. Key issues to consider in depth before a lease is signed include:
• Rental abatement provisions,
• Liability for additional hazards,
• Insurance requirements, and
• Liability for damage to premises.
Rental abatement provisions: When a fire or other circumstances make leased property unusable by the tenant, the lease typically allows the tenant an abatement. Whether the abatement covers the full rent or a percentage depends on circumstances such as the extent of the damage and the desirability of the property.
Rent abatement is a good example of an area where the lease can be designed to benefit both parties. Assume the landlord obtains rental income insurance and the lease reflects that rent is always abated for insured casualties. The tenant could then be eligible for reduced premiums for business interruption insurance, since there would be no need to cover the cost of rent.
Liability for additional hazards: Some tenants may increase the landlord’s insurance costs because of the nature of their business. A restaurant moving into an office building, for example, increases the probability of a fire, which will affect premiums. A tenant that will increase traffic to the building significantly also could affect premiums. Landlords should be aware of the impact of any tenant on insurance premiums.
Insurance requirements: A well-written lease agreement should require building insurance, public or general liability coverage, boiler and machinery insurance, plate-glass insurance and coverage for removal of pollution or debris.
Any requirements built into the lease agreement should be tailored to the insurance policy language. For example, the lease should consider whether coverage is based on replacement value or actual cash value, as well as any co-insurance provisions.
An insurance agent or an attorney with in-depth knowledge of insurance should draft insurance-related provisions, while an insurance attorney should review the lease to ensure that appropriate terminology is used. For example, the lease may require personal injury insurance, which many people think covers slip-and-fall injuries. However, in the insurance industry, personal injury insurance covers libel, slander and defamation of character. People with inadequate experience often slip such language into leases.
The landlord and tenant also need to determine who owns and who is responsible for any improvements made to the property, especially non-standard improvements. There is often a gray area between improvements made by the landlord to bring property up to code and improvements made by the tenant that are directly associated with the tenant’s business.
Make certain both parties define who owns what and whose insurance is covering it. Ambiguity often results in duplicate coverage or in property being left uninsured. Insurance carriers may also dispute whether they are responsible for coverage when ownership is not specified.
Having the landlord insure all improvements often costs less and can help avoid disputes over coverage.
Liability for damage to premises: The circumstances for liability should be carefully spelled out in the lease. If, for example, a tenant is a heavy smoker and his carelessness results in a fire loss, who should be responsible for the damages?
There are multiple exclusions on a general liability policy that expose a property owner to many risks. Property owners should recognize that they cannot depend on their liability insurance to cover damage to their real or personal property. In fact, when they are responsible for damage to the property the renter occupies, property owners cannot rely on their general liability policy for coverage, but must purchase an appropriate form of property insurance.
For example, a general liability policy would exclude coverage for property damage to real or personal property in the care, custody and control of the landlord or the tenant, creating a possibility of being liable for both, depending on how the lease is written. If you are a property owner with an insignificant exposure, basic property insurance should provide sufficient coverage. However, if you have significant exposure to the property of others, you will need legal liability insurance to cover losses for which the property owner may be held legally liable.
Conversely, the tenant may use legal liability insurance to cover the building, plus the real and personal property of others.
Management Tools
There are several risk-management tools that can be used in lieu of purchasing legal liability insurance.
Commonly used risk-management tools include hold-harmless clauses, indemnity agreements and waivers of subrogation. Both parties should consider these carefully, though, because they can sometimes expose one party or the other to unnecessary risk.
Hold-harmless clauses: Using a hold-harmless clause, one party agrees that the other should be free from any liability under certain circumstances. For example, a contractor may seek to be held harmless for damages caused to property while constructing a new office building. Unfortunately, when one party is held harmless, another party must absorb the risk. Worse still, one party must assume responsibility for the actions of another party.
Indemnity agreements: Using an indemnity agreement, both parties agree in writing that one party will be free from liability under certain circumstances, which are spelled out in the agreement.
For example, the tenant typically indemnifies the landlord for anything that occurs on the tenant’s premises, regardless of who caused the damage or injury. The agreement also typically indemnifies the landlord for any damage or injury caused by the tenant or its employees or agents anywhere on the property.
Such requirements may create unnecessary risk for the tenant without providing the landlord with the intended level of protection, since the tenant may lack the resources to pay settlements from an uninsured indemnification. Again, the key is to allocate liability based on the landlord and tenant’s insurance coverage. The tenant should not sign an indemnity agreement without first purchasing property and liability insurance, and ensuring that he or she is covered for potential liability.
Waivers of subrogation: Subrogation allows one party to assume the role of another and to pursue any legal action available to that party. For example, if a tenant’s negligence causes $1 million in damages to the property, the landlord can ask its property insurance carrier to pay for the damages. Typically, the landlord’s insurance carrier will subrogate through the landlord and sue the tenant, seeking to recover the $1 million.
With a waiver of subrogation clause in place, the carrier would be unable to sue the tenant. Waivers of subrogation are usually reciprocal and must apply to all officers, employees, agents and subtenants of both parties. The liability insurance company must consent to the waiver of subrogation, but that consent is usually already in the policy or is readily given.
While leases typically use standard language, never assume that the lease exists to protect you. Read every detail carefully and review it with an insurance expert and an attorney to ensure that you are not taking unnecessary risks.
