Insurance for Commercial Leases – Risk Allocation Between The Parties

Author: Michael A. Faerber Date: 07/18/2011

Categories: Commercial Leasing, Real Estate Law

When reviewing and negotiating commercial leases there should be a discussion between the landlord and the tenant to address who should obtain the different types of applicable insurance coverages, the amount of coverage and which party will be responsible for paying the premiums. The answers to these issues differ depending upon the type of lease situation and also upon the negotiation of the parties.

When dealing with space in a commercial office building, a tenant may be responsible to obtain insurance policies to cover (i) commercial general liability with coverages agreed to by the parties, (ii) “all risk” extended coverage property insurance with coverage equal to full replacement value of such property, (iii) workers’ compensation insurance as required by applicable law, (iv) employer’s liability insurance, (v) business interruption and extra expense insurance and, possibly, (vi) automobile liability insurance. Landlords may include language in the lease making the tenant responsible to obtain (i) general liability insurance, (ii) insurance covering loss or damage to the property and building in an amount or percentage of the full replacement cost, up to the full replacement cost of the property and building, (iii) rental interruption insurance naming the landlord as the loss payee, which insurance may also cover all operating expenses, (iv) insurance coverages and/or bonds related to the operation of the parking areas, and (v) insurance coverage for flood and earthquake damages.

While the landlord may elect to obtain such insurance coverages, payment of the premiums for such insurance is often passed on to the tenants as part of shared operating expenses or common area maintenance costs. Each tenant pays its pro-rata share of such premiums based on the square footage of their premises in relation to the full square footage of the building, as part of the overall operating expenses incurred by the landlord for maintenance and repair of the different parts of the building.

In a retail lease setting, determining which party is responsible for obtaining the various types of insurance may depend upon whether the tenant is one of a number of tenants in a shopping center or mall versus a tenant that is the sole tenant in a stand-alone building. In addition to the various types of insurance listed above for office leases, a retail tenant in a shopping center or mall may typically be required to obtain the following types of insurance: (i) liquor legal liability coverage (also known as dram shop insurance); (ii) products liability; (iii) plate glass insurance covering all plate glass in the premises; and (iv) comprehensive boiler and machinery coverage, including electrical apparatus.

Here, again, the cost of the landlord’s insurance may be passed on to the tenants as part of common area maintenance costs. Where a tenant is the sole occupant/tenant of a building, it is more likely that the landlord will shift more responsibility for insurance coverage to the tenant. Whether it is appropriate for the tenant to obtain such insurance will depend upon the circumstances. In some instances it may make more sense for the landlord to obtain the insurance policies, particularly if the landlord will be the party responsible for rebuilding the building after a casualty event. The landlord may be in a better position to obtain such insurance based on its ownership status as well as its ability to more accurately determine the value of the property and the amount of insurance to be acquired. In that instance, the landlord may consider passing on the cost of such insurance to the tenant.

It is important for a tenant to involve its insurance agent in reviewing the insurance requirements in a lease. The insurance agent should provide comments and input on whether the insurance being requested is appropriate given the circumstances, in addition to giving the tenant a quote for the cost to purchase the insurance.

Typically, in the event of a casualty loss that triggers the need for repairs that result in some or all of the premises being unusable (so long as the casualty loss was not caused by the tenant), rent will abate until such time as the premises are usable again. How long it takes to address insurance claims for such casualties and the repairs will affect the length of such abatement. Landlord’s rental interruption insurance will cover the loss during the abatement. In some instances, the rent may not abate if the tenant’s business interruption insurance is used to cover the rent during the casualty period. However, the parties should not be held to an indefinite period of non-use of the premises, and language should be considered in the lease to allow each party to consider termination of the lease after a reasonable period of time following the casualty if it is determined that the repair time will take a lengthy amount of time.

The parties will also need to understand who is responsible and liable for damages and repairs in all circumstances. Pay attention to the insurance, repair and casualty provisions of the lease, and negotiate the intent of the parties for the same to help avoid confusion and arguments when and if such situations arise throughout the term of the lease.