11 April 2019
Understanding the insurance provisions in your lease
The insurance provisions in commercial leases tend to get glossed over when the lease is being negotiated, but they can have important practical implications. In particular, a commercial landlord should check the terms of the lease and get legal advice if the property is damaged and needs to be rebuilt using insurance money.
‘If a building suffers major damage, the terms of the lease probably will not be the first thing on a landlord’s mind’ says Maria Mowberry, commercial property solicitor at B P Collins. ‘In fact, it is really important to get your solicitor to go through the insurance clause with you, so you know how much flexibility you have when it comes to reinstating the property.’
The obligations of landlord and tenant
In a standard set of insurance provisions, the landlord will insure the property, recovering the cost of the premium from the tenants. The landlord must insure for the full reinstatement value (which means enough to cover all the costs involved in repair or rebuilding) with a reputable insurer, and subject only to excesses and exclusions that are standard in the UK insurance market. The lease will usually include a list of risks against which the landlord has to insure. These are mostly standard, although they can vary a little. The landlord’s insurance will cover the building but not the tenant’s fixtures and fittings.
Tenants will be required to pay their share of the cost of insuring (usually expressed as ‘insurance rent’) and, if the landlord has to make a claim:
- the amount of any excess on the policy; and
- any insurance monies which have been withheld by the insurer as a result of anything the tenant has done.
Tenants must also observe the terms of the policy and any requirements of the insurers, and not do anything that will render the policy void or entitle the insurers to refuse a claim or withhold money.
What happens if the building is damaged by an insured risk?
If the building is damaged by an insured risk, the landlord will be obliged to make a claim and spend the insurance money putting the property back into a usable condition. A tenant’s normal repairing obligations do not apply in these circumstances. If the damage has been extensive, the landlord might want to take the opportunity to rebuild something slightly different, particularly if the original building was outdated. This is where legal advice is crucial, because the lease may limit the extent to which the landlord can vary what was there before.
Do the tenants still have to pay rent?
The landlord will usually insure for three years’ loss of rent (sometimes longer for very large or high specification buildings). This means that if the damage is so severe that the tenants cannot use the property, the rent will be suspended for the time it takes the landlord to reinstate (or three years, whichever is shorter).
What if reinstatement is impossible?
Most leases provide that if it is impossible to reinstate the property within the period the landlord has insured for loss of rent, the landlord has the right to end the lease. This sometimes applies to tenants as well. The lease will usually say that if this happens, the landlord can keep any insurance monies, to reflect the landlord’s loss of its valuable asset.
Does it make a difference if the landlord has a mortgage?
A mortgage lender will normally insist on being named as ‘first loss payee’ on the landlord’s insurance policy. This means that the insurers will pay any money due in relation to a claim to the lender, not direct to the landlord. In practice, the lender will usually co-operate with the landlord to get the property reinstated, but landlords need to remember that they will not have complete control.
What if damage is caused by a risk that is not insured?
This is a complicated situation and landlords should get their solicitor to look closely at the wording of the lease. It is now common for leases to include provisions setting out how the landlord and tenants will share the cost if damage is caused by something that could not be insured. An example of this is flood insurance in particular areas where insurers have refused to offer cover.
Landlords should get legal advice promptly if a property is damaged, so they know exactly what they need to do and how long they have to do it. There may be scope to modernise the building while reinstating but if the landlord does not check what the lease allows, they could end up in a costly dispute with their tenants.