You lease one floor of a multi-story office building. One of your employees leaves a toaster oven on overnight, resulting in a fire that causes $7.5 million in damage to the leased premises and other portions of the building. The landlord files a claim with its insurance company under its fire and casualty policy and […]
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You lease one floor of a multi-story office building. One of your employees leaves a toaster oven on overnight, resulting in a fire that causes $7.5 million in damage to the leased premises and other portions of the building. The landlord files a claim with its insurance company under its fire and casualty policy and receives funds to restore the building. After the landlord's insurance company finishes its investigation and pays the claim, it sends you a notice demanding reimbursement for the amount of the damage.
The legal basis for this claim by the insurance company is called “subrogation.” When the insurer pays the claim, it steps into the shoes of the landlord and has the right to assert a claim against you for the amount it had to pay to repair the damage caused by your employee's negligence. While some defenses might exist under the lease depending on how various provisions are worded, you definitely have a big problem. To avoid potential business-ending liability, keep the following in mind:
1. Avoid the rush to sign
It is natural for a business owner to feel pressure to sign a lease quickly. After a lot of market research and number crunching, you might have found the ideal location for your new store. The last thing you want now is to be held up by lawyers negotiating over the boilerplate terms. Perhaps you read carefully the landlord's 50-page lease, and it seems to accurately reflect the terms of the letter of intent. Other people you know have avoided delays and legal fees by negotiating lease terms themselves. But not all provisions in a lease are as simple and straightforward as they seem. Many people do not realize that there are some provisions that can result in catastrophic liability if they are absent or incorrectly worded.
2. Recognize that insurance provisions are highly technical and have limitations.
Most tenants do not maintain fire and casualty insurance on the buildings they occupy, only on their contents. Although a tenant typically maintains liability insurance to protect it against injury and damage that it causes to others, a tenant will not typically have $7.5 million in liability insurance. Even if it did, a tenant's liability policy usually excludes claims arising out of property damage to premises leased or occupied by the tenant, with a limited exception. This limited exception provides greatly reduced coverage (usually $100,000 or less) for damage caused to premises occupied by the tenant. In addition, this coverage is available for damage caused by fire, not by other hazards. There are other types of insurance that might be purchased in order to provide some protection in this situation, but they can be expensive.
3. Have an attorney review the lease
The best way to avoid the potentially business-ending liability described above is to have a properly worded “waiver of subrogation” clause in the lease. Such a clause is reciprocal in nature and protects both the landlord and the tenant from claims by the other party's insurer. The clause reflects the presumed intent of most landlords and tenants that each party should look to its own insurance policy for casualty claims to its property. Mutual waivers of subrogation have been widely accepted in leases of all types for many decades. Such clauses must be drafted carefully, however, since a poorly drafted waiver of subrogation clause can be as bad as having no provision at all. Poorly worded clauses often result from either a misunderstanding by one party as to the purpose of such clauses or an attempt to make it more one-sided.
4. Consult your insurer
It is always best to confirm with your insurer that your insurance coverage satisfies the requirements of the lease. A good insurance agent can provide advice on other ways to reduce the risks present in the scenario described above.
There is potential for enormous liability in commercial leases and provisions that represent traps for the unwary. With experienced counsel, lease negotiations addressing these matters do not need to be protracted or highly adversarial.
Raymond A. Pelletier and John D. Devine are attorneys at Verrill Dana LLP, in Portland. You can reach them at verrilldana.com