BY: Bill McLean, CIC
Commercial Risk Advisor
bmclean@bankersinsurance.netcreate new email | (828) 350-3136opens phone dialer
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Insurance considerations for commercial property lease agreements go well beyond the question, “Who is required to insure the building?” They encompass many aspects of occupying, maintaining, improving, and operating from a business location. As they say, “The devil is in the details,” and this could not be more relevant in commercial lease agreements. A well-written lease agreement is a playbook defining tenant and landlord responsibilities. If you are either party, read on to learn how to best structure lease agreements and ensure matching insurance coverage is put in place.
Leading Questions
Who insures the building?
This is the first consideration that comes to mind, and several lease provisions depend upon the answer. For this reason, the lease should clearly state which party, the landlord or the tenant, is responsible to procure insurance for leased buildings, contents, or equipment; which party is responsible to pay for that coverage; and how that payment will occur. Some leases require the landlord to insure the building and bill the tenant, some do not bill the tenant, and still others require the tenant obtain the coverage at their own expense. Terms vary, so be sure to understand the provisions.
A related consideration is which parties should be named on the policy, and how. If one party insures the interest of the other, the other party will want to be named on the policy. For example, if the tenant procures coverage for the building, the landlord may stipulate they be named on the policy as an additional insured and loss payee, or possibly a named insured.
How to insure the building?
If the tenant is required to insure the building, it is usually on a replacement cost basis (reference Business Property Insurance Valuation Options). Special care should be given to confirm proper replacement values and building ordinance coverages are included (reference Ordinance and Law Coverage for Business Properties). The landlord should be required to agree in writing to the coverage limits.
Who is responsible for building improvements?
Landlords or tenants alike may alter the property in a variety of ways. Typically, permanent building improvements (upfit) become part of the building and are insured as such by whoever is required to insure the building. If a tenant funds significant leasehold improvements, insurance policies and lease terms should be modified accordingly. In such a case, the tenant would insure those improvements and, should a large claim occur, the insurance check would be payable to them for repairs.
What happens if the building is damaged and cannot be occupied?
Most leases include a material damage/destruction clause that specifies a timeframe for repairs to be made. If the repairs cannot take place within this window, the tenant has the option to get out of the lease agreement. A tenant should consider coverage for business income and extra expense to not only protect against lost net income, but also the extra expense associated with relocating. Likewise, the landlord should consider coverage for loss of rents to replace the normal rental income stream.
Other Lease Considerations
Many leases separately address certain types of property and other insurance considerations.
Heating and Air Conditioning
Most leases require the tenant maintain, service, and repair HVAC equipment. Insurance can be used to cover damage to this equipment as well as its mechanical breakdown. We’ve seen offsite power surges and power failures cause costly damage to HVAC equipment, and affordable protection is available for this.
Exterior Glass and Doors
Some leases, even if they specify the landlord insure the building, break out the responsibility to repair exterior glass and place it with the tenant. Whichever party is responsible, ensure adequate coverage is in place.
Signage
Typically, the tenant is responsible for all tenant signage, whether on-building or otherwise, and any responsibility to insure it rests upon them.
Floor Coverings
Similar to exterior glass, certain leases specify which party is responsible for carpet and other floor coverings. Insurance should be procured by the responsible party.
Liability Insurance
Most leases require both the landlord and tenant to carry liability insurance. The tenant’s coverage is usually to protect their operations performed in tenant-occupied space, and the landlord’s protection covers liability associated with common areas and parking. Tenants are typically required to indemnify and name the Landlord as “additional insured” on a primary and non-contributory basis. This means the tenant’s policy pays first and protects the landlord and tenant from liability arising out of the use of their space. When providing additional insured status to a landlord, tenants should realize they are sharing their insurance with the other party and choose insurance limits wisely.
Mutual Waiver of Subrogation
This may be the most important lease provision for landlord and tenant. It addresses a common issue between the parties where one causes harm to the other, either by damaging property or by causing an interruption to business operations. For example, if the tenant negligently damages the rented premise, the landlord’s insurance company may pay for the repair and then require reimbursement from (subrogate against) the tenant. The same could happen if building damage causes harm to the tenant and the tenants’ insurance company seeks reimbursement. The solution is to include a mutual waiver of subrogation that prohibits either party from recovering such losses from the other. Each party is responsible for their own damages. Without this clause, the offending party’s insurance may not provide appropriate coverage and they could have to make restitution out of pocket.
Flood & Earthquake
Depending upon location, these coverages may be addressed in the lease. When they are, we typically see the landlord insuring the building and seeking reimbursement for flood or earthquake insurance costs from the tenant. Tenants are responsible for flood damage to their own contents and should purchase coverage separately.
Evidence of Insurance
Leases should define all insurance coverages required by either party, the coverage limits, and any other necessary details as explained above. Evidence of this coverage should be provided by both parties each time a policy renews, typically yearly. This can be accomplished through a certificate of insurance, provided by the insurance broker, which summarizes coverages and applicable details, confirming protection is in place.
Our View
When a disaster strikes the first thing an insurance company requests is a copy of the lease agreement. This is the playbook defining who pays and to what degree the responsibility for damage resides. Tenants and landlords should have an experienced real estate attorney review leases and make any necessary changes before signing. Both landlord and tenant have much at stake within the lease agreement and proper attention should be given to prevent surprises when damage occurs. Both parties should obtain and keep on file a certificate of insurance evidencing coverages meet the lease agreement.
Questions on insurance considerations for building lease agreements? Contact your Bankers Insurance agent. Not a client of ours? Let us earn your business! Each of our clients is assigned a personal insurance agent and provided their email address as well as a phone number that rings right on their desk.
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