There Must Be Coverage Somewhere

Your client, a tenant in a local strip mall, signs a five-year lease with an option to renew. The lease contains the following language: Lessor shall pay property insurance premiums on the leased premises including the personal property in a sufficient manner to cover the entire property. Lessee will provide insurance on any personal property that the Lessee moves to the leased premises.

In a perfect world, every lease would read like this. The landlord is responsible for the building and the tenant is responsible for their business personal property and any improvements they make. But even this isn’t a perfect lease.

Three years into the lease, a section of the roof collapses and does damage to the structure and your insured’s business personal property. The claim is reported to both insurance carriers. The landlord’s policy pays for the damage to the structure, and the tenant’s policy covers its personal property. Is it starting to sound a little too good to be true? Well it is!

Several months after the claims have been settled and the insured has resumed operations, she receives a notice from the landlord’s insurance company indicating their intent to subrogate against your insured for the real property damages they paid. As it turns out the roof collapse occurred because the storm gutters were never cleaned. The lease, much to your insureds surprise, contains a clause that requires the premises be “maintained,” which includes the regular cleaning of the storm gutters. Had they been cleaned properly, water would not have backed up on the roof, and no collapse would have occurred. Your client’s next call is to you, her insurance agent. What is your advice?

You report the claim to the property insurance carrier. They deny the claim, stating that the policy only covers business personal property — no building coverage was purchased. Likewise, the general liability carrier denies the claim because the building is in the insured’s care.

Obviously had you known about this exposure, you could have properly insured your client. But now that the claim has happened, what do you do?

Let’s look at a couple options.

Option 1
Review the insured’s lease for a mutual waiver of subrogation. You might assume that because the carrier is seeking subrogation, they reviewed the lease and didn’t find a mutual waiver. But stranger things have happened –— so look. Such language may read as follows:

In the event of fire or other loss to the premises, Lessor and Lessee mutually waive their rights of subrogation and recovery against each other, their officers, agents, employees, sublessee, or other persons under their control. … to the extent they are insured or are required to carry insurance. … to the extent said loss is paid by insurance.

Most mutual waiver of subrogation clauses found in leases apply to “the extent” that an insurance policy paid the claim. This wording allows subrogation for losses outside of the scope of coverage. If this type of language is in the lease, your insured may have an “out.”

Option 2
Can the building owner waive subrogation after the loss has occurred? Before you think I have lost my mind, allow me to refer you to the Commercial Property Conditions. They read:

Transfer of Rights of Recovery Against Others to Us
If any person or organization to or for whom we make payment under this Coverage Part has rights to recover damages from another, those rights are transferred to us to the extent of our payment. That person or organization must do everything necessary to secure our rights, and must do nothing after loss to impair them. But you may waive your rights against another party in writing:
1. Prior to a loss to your Covered Property or Covered Income.
2. After a loss to your Covered Property or Covered Income only if, at time of loss, that party is one of the following:
a) Someone insured by this insurance;
b) A business firm: (i) Owned or controlled by you; or ii) That owns or controls you; or
c) Your tenant. This will not restrict your insurance.

Notice in section 2c that the insured building owner may, in fact, waive subrogation against the tenant after a loss. The property owner can waive its rights against the tenant, thus removing any obligation for damages that may be assignable to the tenant. Your next question must be, “who in their right mind would do this?” Any landlord that is interested in keeping a good tenant; remember this is a five year lease with an option to renew. The landlord has a vested financial interest in keeping this tenant. It will come down to the leverage the tenant has with the landlord — it is worth a try if all else fails.

Moral: Review your client’s leases to assure proper coverage is provided or proper risk management is utilized!