BOOM Goes the Premises! The Interplay between Casualty Clauses, Rent Abatement and Business Interruption/Loss of Rent Insurance in Commercial Leases
In the ideal world, every landlord and tenant hope to negotiate a lease, throw it in a drawer and never look at it until the time to renew. If COVID has taught us anything, every lease liability clause, including the casualty section, requires an in-depth understanding of the interchange between landlord and tenant obligations, insurance coverage and the very real possibility that insurance may not cover all casualties (including those caused by viruses…I’m looking at you SARS-CoV-2).
Who’s Covering Who?
Notwithstanding the slash in the title of this article, in insurance parlance, business interruption and loss rent coverage are two different types of policies. Both are property casualty triggered coverages that pay proceeds when a tenant’s business is disrupted and thereby precluded from paying rent. Rent loss insurance covers landlords when the lease allows the tenant to abate rent for a casualty. Business interruption insurance covers tenants when a lease requires a tenant to pay rent even if a casualty precludes tenant from operating its business at the premises.
Fortunately, if a lease provides that a party is to cover “lost rent”, “lost income” or uses the insurance buzzwords, most courts look to the intent of the parties and not the precise vernacular of “business interruption” or “loss of rent”. However, the question remains how the lease allocates the risk for lost rent and whether the landlord or tenant must obtain the requisite coverage.
What’s Covering What?
Business interruption and loss of rent coverage can be a separate policy or an endorsement onto a casualty policy. While policy terms and coverages vary from insurer to insurer, state to state, situation to situation, below are some general points on the coverage:
- Many policies require a “suspension” of the business “operations” that produces a “rental value” loss payable under the policy.
- To have an insurable interest, the insured party must have the authority to control the business operations that are being disrupted.
- Coverage is usually limited to a number of months, normally not to exceed 18 months of rental payment coverage.
- In some cases, the property is not required to be occupied to obtain proceeds.
- Rent loss recovery is limited to the amount of rent lost during the time that the property should have been restored.
- Most policies will pay upon business interruption or operation interruption or termination but not a mere reduction in volume of the insured’s business.
- Most policies allow for a percentage of recovery if the lease provided for a percentage of abatement or the tenant cannot occupy a portion of the premises.
- Some policies provide (and some courts allow) insurance companies to deduct costs of the insured’s operation from the payment of gross rents.
- Some policies may limit coverage to cases of fire or lightening. Common exclusions are: earthquakes, acts of war, strikes/riots/civil unrest, political violence, smoke damage, theft and, as we are all well aware now, biological agents and viruses.
Is that Covered in the Lease?
Getting back to that ideal world, the terms of the lease would mesh perfectly with the landlord’s and tenant’s insurance coverage—and no party would be left with any uninsured casualty liability under the lease. Unfortunately, in the course of negotiations, given the relative bargaining power of the parties and disconnect between those negotiating and drafting the lease and the risk management and insurance providers, the perfect world is rarely achieved. Some questions to ask:
- Does your lease require the responsible party to complete the repairs in the time limits proscribed in the business interruption policy?
- Does your lease require the party responsible for repairing to undertake repairs diligently—as insurers will only pay for time in which the property should have been repaired?
- Who makes up for the shortfall if the insurance coverage does not cover all of the rent obligations (or deducts the insured’s operational costs from the proceeds)?
- If a tenant is completely precluded from operating its business, is 100% of the rent abated? Most lost rent policies provide that the total inability to operate the business will allow for 100% recovery of the lost income.
- Is the landlord or tenant party the entity operating the business or property? If not, that party may not be able to recover the lost rent proceeds.
- Are both the landlord and tenant obtaining lost rent coverage; and if so, are there overlaps or redundancies in coverage?
- Is there a general statement in the lease that provides if the landlord’s or tenant’s insurance policy covers the casualty in question, then that party shall undertake the repairs (or pay proceeds to the party who is tasked with performing the repairs)?
What if I’m not Covered?
Considering the number of common exclusions for business interruption policies, a final and important question to ask of your lease: What if the lost rent income is not covered by insurance? Depending on the strength of each party’s bargaining power, either the landlord completely prohibits any rent abatement for any casualty; or, the tenant insists on full abated rent upon any casualty until full restoration of the premises and property. When pressed on this issue, the usual response is that “there is insurance coverage for this risk.” The initial court decisions dealing with COVID insurance coverage issues should remind us that this is far from a definitive statement. All parties to a lease should consider the consequences of a tenant’s ability to abate rent or a landlord’s requirement for a tenant to pay rent for a damaged premises that is not covered by business interruption insurance.
Larry N. Woodard is a real estate partner and Co-Leader of the Construction Planning Practice Group in the Chicago office of Honigman LLP.