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Insuring Commercial Tenant Lease Requirements

Author: Mike Edwards

Here's a question from the VU's "Ask an Expert" service:

Question“I have a question about tenants’ improvement and betterments (TIB). A commercial insured of mine is planning on opening a second location in a nearby city. I’ve insured his current location for several years, where he owns the building. However, he has found what he thinks will be an ideal location, with a building already at the premises and available for lease. The owner is very agreeable to allowing him to install some significant upgrades to the building, and has offered him a very favorable lease.

“He and I had a meeting yesterday, and he gave me a copy of his lease to review. For some strange reason, the lease requires that the tenant be responsible for only the heating and air conditioning system (HVAC), under a provision that the tenant ‘maintain, repair and replace’ the system. So I need to be certain that my insured’s policy has coverage for the HVAC system – and that’s my question. Would the tenant’s improvements and betterments coverage in his 2007 CP 00 10 apply to the lessor’s HVAC system?”

Answer?

Short answer: no. Here is a description of coverage for TIB in the ISO Building & Personal Property Coverage Form (CP 00 10 06 07):


A. Coverage

1. Covered Property

      b. Your Business Personal Property located in or on the building described in the Declarations or in the open (or in
      a vehicle) within 100 feet of the described premises, consisting of the following unless otherwise specified in the
     Declarations or on the Your Business Personal Property – Separation Of Coverage form:

(6) Your use interest as tenant in improvements and betterments. Improvements and betterments are fixtures, alterations, installations or additions:

​​     (a) Made a part of the building or structure you occupy but do not own; and

​​     (b) You acquired or made at your expense but cannot legally remove;


Comment:
Note in A.1.b.(6)(b) that property subject to coverage as TIB must be “acquired or made at your expense.” In my view, any building property (such as the HVAC system) which is owned by the building owner, and is in existence prior to the lease, has not been “acquired or made” at the tenant’s expense. Granted the tenant has the benefit of using the HVAC, and is contractually responsible for it, but I do not think this constitutes it having been “acquired.”

As a comparison, when a person rent
s an auto on business or vacation, virtually all rental car agreements hold the renter liable for damage to the auto. But does the act of renting the auto, and being contractually liable for any damage, mean it is “acquired” by the renter? If so, then this auto would become an automatic Your Covered Auto (YCA) in the ISO Personal Auto Policy, since one of the definitions of YCA includes a “newly acquired auto.”

So, what options does your insured have in order to obtain coverage for the HVAC? Here are some suggestions.

Tenant’s Commercial Property Policy.
I can think of four possible options to consider.

1.
On your insured’s CP 00 10, write Building coverage for the HVAC system – or any other building property your insured is required to cover, which is not his TIB. One immediate concern about this suggestion might be the potential for a huge coinsurance penalty, given the small value of the HVAC (or other property such as plate glass, etc.) compared to the value of the building. However, the coinsurance problem is solvable. The coinsurance provision is based on the “value of Covered Property,” so the solution is to describe those specific items of building property as Covered Property (HVAC, plate glass, etc.) on the Declarations. Excerpt from the CP 00 10 06 07:

A. Coverage

   1. Covered Property Covered Property, as used in this Coverage Part, means the type of property described in this
   section, A.1., and limited in A.2., Property Not Covered, if a Limit of Insurance is shown in the Declarations for that
   type of property.

   a. Building, meaning the building or structure described in the Declarations


F. Additional Conditions

1. Coinsurance

   a. We will not pay the full amount of any loss if the value of Covered Property at the time of loss times the
   Coinsurance percentage shown for it in the Declarations is greater than the Limit of Insurance for the property.

2.
Depending on the type of property being insured, a specialty policy – such as Mechanical Breakdown in the case of HVAC – might be an alternative, especially since the coverage would be more attuned to the exposures to the property.

3.
Another approach to insuring property mandated by a lease is to consider the Legal Liability Coverage Form (CP 00 40). On one hand, the coverage seems quite appropriate:

CP 00 40 06 07

A. Coverage

We will pay those sums that you become legally obligated to pay as damages because of direct physical loss or damage, including loss of use, to Covered Property caused by accident and arising out of any Covered Cause of Loss.

On the other hand, however, since this is a property form, the legal liability is based on perils (Causes of Loss). One obvious example of being legally obligated for damage by a covered cause of loss would be a fire negligently caused by the tenant. But it’s difficult to imagine the tenant being negligent for windstorm damage to the building, for example. In fact, many leases hold the tenant legally liable for “any and all damages.” As we know, there is no insurance coverage this side of Mars which is
that broad.

One additional problem with the Legal Liability Coverage Form is that it requires a Causes of Loss form to be attached (CP 10 10, CP 10 20, or CP 10 30). And in all three of these forms, the following exclusion is included [emphasis added]:

B. Exclusions

3. Special Exclusions

c. Legal Liability Coverage Form

(2) The following additional exclusions apply to insurance under this Coverage Form:

(a) Contractual Liability

We will not defend any claim or "suit", or pay damages that you are legally liable to pay, solely by reason of your assumption of liability in a contract or agreement. But this exclusion does not apply to a written lease agreement in which you have assumed liability for building damage resulting from an actual or attempted burglary or robbery, provided that:

(i) Your assumption of liability was executed prior to the accident; and

(ii) The building is Covered Property under this Coverage Form.


Comment: Legal liability can be assigned to your tenant by virtue of his own negligence (tort), by statute, or by contract. But in the Legal Liability Coverage Form, pure contractual liability is excluded. As mentioned with the windstorm cause of loss, it’s unlikely that your insured would be liable under tort for any damage to the building, but he might well be liable under contract. If so, there would be no coverage under the Legal Liability Coverage Form.

4.
If the lease requires the tenant to insure a greater amount of building property, up to an including the entire building, one option is just write a joint policy in the name of the owner and tenant, ATIMA. A variation on that approach, which seems to be growing in popularity in the commercial real estate market, is the use of net leases. For example, in a triple net lease, the tenant is contractually obligated to pay not only the actual rent amount, but other expenses also, often including maintenance and operating costs, property taxes, and insurance on the building. Depending on the terms of the triple net lease, a policy on the building, with the owner as the named insured, may or may not cover the TIB of the tenant. If not, the tenant should secure TIB coverage in his own policy.

B
eyond the issue of providing coverage for non-TIB building items in the tenant’s policy, there are several other broader concerns to keep in mind.

Tenant’s CGL
. The tenant’s CGL excludes damage to the landlord’s building items in Exclusion 2.j.(1):

ISO CGL 00 01 04 13

Section I – Coverages

2. Exclusions

j. Damage To Property

"Property damage" to:

(1) Property you own, rent, or occupy,


​Comment #1:
One exception to exclusion 2.j.(1) is the so-called “fire legal” coverage, which is now called Damage To Premises Rented To You. The unendorsed CGL has a limit of $100,000 for this coverage. However, this coverage only applies for tort liability, and not contractual liability, for the fire damage. See the Resources section below for additional information.

Comment #2:
One of the most often-cited exclusions in the CGL which relates to damage to property of others is the “care, custody or control” exclusion. However, that exclusion [2.j.(4)] only applies to Personal property in the care, custody or control of the insured.”

Comment #3:
Although the tenant has signed a contract in which he incurs legal liability for damage to the landlord’s building, and the CGL provides coverage for “insured contracts,” the CGL contractual provision will not respond for such damage. Contractual liability coverage is provided through exceptions to the Contractual Liability exclusion (exclusion 2.b.). Damage to the landlord’s building is excluded under Damage To Property exclusion (exclusion 2.j.(1) – see above). The contractual coverage does not override any other exclusion in the CGL – 2.j.(1) in this case.

General comments about leases.
Many commercial leases have the readability of the tax code. Far too many are drafted using boilerplate language which is often outdated when it comes to insurance terms. For example, some still require the tenant to insure for “Fire and E.C.” or that the CCL can’t have an “x,c,u exclusion,” or “cross liability.” Only old-school insurance nerds even know what “E.C.” and “x,c,u” stand for. I feel old just thinking about how many years back those terms go! Here are some specific cautions about leases.

1.
In general, E&O experts recommend against agents reading contracts for insureds. However, in some cases, it is a necessity. But, as the car ads on TV warn: “Professional driver on closed course. Do not attempt.” So be sure you know what you’re doing. Also, even when the agent is well-versed in reading leases, experts recommend that the agent provide the insured with a written disclaimer, where it is stated that the agent is only reviewing the insurance provisions, and is not giving legal advice. See the Resources section below for additional information.

2.
But even trying to give only insurance advice can be difficult. While leases typically have an “Insurance” section, there are other sections which outline the tenant’s responsibilities for damage to the building, which the tenant’s insurance needs to address. This provision is often called the “Damage and Destruction” section, but can also be found in the “Repair and Restoration” section, or a similar provision with some other title.

3.
One additional subject that will likely surface in the lease transaction will be a requirement for the tenant to provide a certificate of insurance (liability and/or property). Given that the insured is entering into a contract with a third party (lessor), the lease might contain many specific requirements in favor of the lessor, including some which cannot be complied with under the tenant’s policy. In some instances, the lease will require that certain terms and conditions be added to the certificate. Extreme care must be taken by the agency in such situations. A number of states (including Louisiana) have statutes which greatly restrict or prohibit amending a certificate. See the Resources section below for additional information.

Resources.
Here are some additional resources which analyze some of the issues discussed in this article.

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Last Updated: April 5, 2016​

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