July 30, 2020

Insurance Issues in Single Tenant Leases

In 2020, I have represented tenant clients on three significant single tenant lease transactions, the term I use when a tenant is leasing an entire building. The landlords in these transactions approached insurance issues quite differently and it provided the opportunity for me to consider what are the best practices for tenants when leasing all of a facility. For this article, I will use the terms Tenant and Landlord for the parties and the Premises for the facility being leased; the Premises includes the building and all related land, improvements and parking lot(s).

Net Leases
A “net” lease is where Tenant is wholly responsible for the Premises. In a net lease, Tenant is required to carry all liability and property coverages with respect to the Premises. This is the easiest lease type with respect to insurance because Tenant is fully responsible financially for any and all injuries occurring on the Premises and property damage that may occur. Furthermore, Tenant must restore and rebuild the Premises in the event of a casualty event and also pay out-of-pocket for any shortfall in insurance coverage. Landlord basically gets its base rent every month but otherwise has no obligations with respect to the Premises. In effect, there are really not any insurance issues in net leases, other than the types of coverages required by Landlord and the amounts of the policies, because Tenant has all of the obligations.

More difficult issues arise in leases where obligations with respect to the Premises are divided between Landlord and Tenant. Let’s call these leases “Standard Leases.”

Standard Leases
Property Insurance – “All-risk,” “extended coverage” or “special form causes of loss” property insurance is universally required in all sophisticated leases, with the latter being the most up-to-date description of a broad form policy. But when Tenant is the sole occupant of the Premises, which party should obtain and pay for the insurance on the Building? Landlord may be required by its lender to carry such insurance or even if there is no lender, Landlord may want to control the property insurance to make sure it is in place and in a form or placed with an insurer of whom Landlord approves. If Landlord purchases the property coverage, Landlord then passes the cost of the insurance premiums on to Tenant as an operating expense. Tenant, particularly if it has a portfolio of leased properties, may prefer to carry the property insurance if it can provide the insurance at a lower cost than Landlord. Tenant obtaining the property insurance also allows it to manage the deductible. Nonetheless, Tenant will still be required to provide the coverage Landlord’s lender requires and written by an insurer and in a form Landlord’s risk manager approves.

I think the answer to this issue should be decided by the casualty section in the Lease. For example, if a casualty occurs but the Lease is not terminated, which party has the obligation to rebuild? It is my opinion that the party who is obligated to rebuild the Premises should carry the property insurance and bear the risk that the insurance proceeds from such policy will be adequate to complete the restoration. That party should also bear the risk of an uninsured loss in the unlikely event there is an uninsured casualty.* By uniting the restoration and insurance obligations in one of Landlord or Tenant, that party now has an incentive to proceed with diligence with respect to the claim adjustment or else the time deadlines for completion of the restoration may not be met, potentially resulting in a lease default or tenant lease termination in the case of Landlord, or having to start paying rent on an unrestored building in the case of Tenant. In light of the direct nexus between the insurance and casualty issues, it may be better to negotiate first which party bears the responsibility of restoration of the Premises and the risk of uninsured loss in order to dictate how the property insurance provisions will read.

A second issue is which party should pay the deductible. I think that if Landlord is maintaining the property insurance and controlling the deductible, it is Landlord’s obligation to pay the deductible out of its own pocket unless the casualty has occurred due to the negligence of Tenant, its agent, contractor or invitee. In this circumstance, it is important for Tenant to negotiate a cap on Landlord’s insurance deductible which Tenant can easily pay out of pocket. Depending on the tenant, that number could range between $10,000 and $100,000. If Tenant holds the insurance, Tenant should pay the deductible unless the casualty was caused by Landlord, its employee, agent or contractor, in which case Landlord should be made to pay it.

Of course, if Landlord carries the property insurance on the Premises, Tenant must insure its own tenant improvements, furniture, fixtures and equipment located in and around the Premises. And do not forget to specify that any property insurance coverage under the Lease must be in the minimum amount of full replacement cost and contain a waiver of the insurer’s subrogation rights with respect to paid claims.

Liability Insurance – In a Standard Lease with a single tenant, it is common for Landlord to be responsible for maintaining the foundation, walls, roof, roof structure of the Premises and all underground utility connections; Landlord is often also responsible for repaving or other capital expenses for parking lots and driveways. Because these Landlord obligations require Landlord to send its employees or contractors to the Premises, Landlord should be required to carry comprehensive general liability coverage in case any person at the Premises is killed or injured as a result of Landlord’s activities. Property damage covered by such liability policies is not really an issue if, as is most often the case, the parties have agreed in the waiver of subrogation clause in the Lease to either a full mutual waiver of claims for property damage or a mutual waiver of property damage claims for which the party sustaining the damage is insured against. Tenant should carry its own comprehensive general liability insurance as well to cover its activities on the Premises.

* Examples of exclusions include damage occurring from the enforcement of laws or government action, earthquake, flood and war. The fact that earthquake and flood damage are excluded from a standard policy which underscores the need for Landlord or Tenant to obtain flood and earthquake coverage in affected areas.

Scott Hargadon heads up MPS Law’s Commercial Tenant Leasing team and is widely recognized as one of the leading authorities on the topic. To receive more articles like this one delivered directly to your inbox, join MPS Law’s email list today.

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