Got it covered?

The starting point when considering insurance for commercially leased properties needs to be the fundamental question: 'Who will insure?' In most cases, it will be the landlord who covenants to insure the property against specified risks for the full reinstatement cost. A tenant should have the right to have details of the main terms of the policy as well as receive evidence as to payment of the most recent premium.

From the tenant's perspective, where the landlord insures, it will be obliged to pay the premium or a proportion of the premium where it only occupies part of the property. It is common practice for landlords to claim insurance commissions absolutely but, in the absence of any express provision, some accounting for the commission may have to be made to the tenants.

In practice, time is often wasted negotiating for a tenant's interest to be noted on the insurance policy. This does not create a joint insurance and it is best to assume that noting has no legal effect.

Risks covered

Tenants should scrutinise the definition of 'insured risks' since damage by an insured risk usually triggers:

• exemption from the tenant's repairing covenant;
• a landlord's reinstatement obligation; and
• suspension of rent pending reinstatement.

Although from the tenant's perspective the wider the definition the greater the cover, bear in mind that ultimately the tenant will be paying the premium; the greater the range of risks, the higher the cost. Qualifications to this definition are generally accepted where insurance cannot be obtained on reasonable terms and at reasonable rates in the insurance market. Landlords also often incorporate a sweeper-up provision to include such other risks, against which the landlord may from time to time decide to insure.

The sum insured

This should be the full reinstatement cost together with demolition and site clearance, recovery of professional fees and loss of rent cover. The loss of rent cover should directly tie in with the rent suspension period so that the landlord receives rent at all times.

The loss of rent cover takes account of rent reviews and the corresponding rent review provisions will assume that where there has been loss or damage to the property, the damage has been reinstated. Tenants usually pay the costs of any valuations for insurance purposes although this may be limited to no more than once in any agreed period.

What if damage occurs?

The consequences to consider are:

• the tenant may be obliged to repair the damage;
• without contrary provision, rent continues to be payable;
• the property needs to be reinstated or rebuilt; and
• one or both parties may want to end the lease.

In return for paying the premium, a tenant expects an express exclusion under its repairing obligation for any damage caused by an insured risk, save where the insurance is invalidated by an act or omission of the tenant. This should apply irrespective of whether or not insurance is actually in place.

Will the tenant still pay rent?

The tenant should ensure that there is a rent suspension where damage or destruction occurs which renders the premises or any access to the premises unfit for occupation or use. Again, this is subject to the proviso that the insurance is not vitiated by an act or omission of the tenant. The proportion of rent suspension usually corresponds to the level of damage.

Consideration should also be given as to suspension of other sums due, such as service charge and insurance rent. From the landlord's perspective, the ability to charge for such sums should remain. Basic services such as security may still need to be supplied to damaged premises.

The period of suspension is usually three years and the tenant should ensure that it is identical to the period for which loss of rent cover is obtained.

The landlord should be obliged to reinstate subject to obtaining all necessary consents; the premises should be fit for the equivalent purpose to those used before the damage. The tenant should ensure that the landlord is obliged to make up any shortfall in the insurance proceeds.

Where reinstatement is not possible, is impracticable or the parties decide not to reinstate, the landlord and/or tenant may have a right to break. This should be immediate.

Practice points

Whether acting for landlord or tenant, the diagram above is a useful visual aide to show the essential elements of any insurance provisions in a commercial lease (where a landlord covenants to insure). It sets out what each party should expect to find at each stage, assuming that we are considering damage by an 'insured risk'.

What if the property is damaged by an uninsured risk? The logical consequences will be:

• there is no rent suspension;
• there is no duty on the landlord to reinstate;
• the tenant may be obliged to reinstate under its repairing obligation; and
• there is no right to break.

It is therefore prudent to raise the issue of uninsured risks with clients at the negotiation stage. Some issues to consider are:

• The landlord and/or tenant could have a specified period, e.g. 12 months, to decide if they will reinstate; if they decide not to, the lease ends.
• Will rent be payable during the election period and/or the reinstatement period?
• Can the landlord recover the costs of reinstatement via the service charge?