Commercial property considerations for damage by insured risks

Many commercial landlords and tenants, whose premises were forced to close because of Covid-19, had an unwelcome surprise when they found themselves with no loss of rent insurance cover and no tenant rent cesser.

The insurance provisions in a lease set out important principles about who pays for insurance and what happens if the property is damaged. What the landlord and tenant agree at the outset can make a big difference when it comes to getting the building reinstated, so it pays to get good advice on what to expect.

‘If disaster strikes, the last thing the landlord and tenant want is a dispute about whether the damage is covered by insurance and whose job it is to put it right’ says Yildiz Betez, head of the commercial property team. ‘The insurance clauses in a lease can catch people out if they haven’t been properly explained.’

What is covered and who insures?

In a typical full repairing and insuring (FRI) lease, the landlord will be obliged to insure the property for its full reinstatement value against a list of insured risks. These are usually standard risks commonly covered in the UK insurance market, including things like fire, explosion, storms, and earthquakes. The insurance may be subject to an excess and some risks may be expressly excluded (flood and terrorism are the risks most often mentioned in this context, although in most places, they can be insured). The key thing is to make sure that the obligations in the lease match the actual insurance policy for the property, otherwise the landlord could be in breach.

The landlord will also insure for ‘loss of rent’ for an agreed period, typically three years. This will allow the tenant a rent holiday (or ‘cesser’) if the property is unusable after damage by an insured risk.

Who pays for insurance?

The tenant will pay the landlord’s insurance costs, including the premiums for both building insurance and loss of rent cover, any excesses, and the cost of an annual valuation. This is usually defined in the lease as ‘insurance rent’ and is paid in addition to the main rent for the property.

Impact on the tenant’s repairing obligation

The tenant is generally required to repair the property included in the lease, but not if there is damage by an insured risk. This is the fair position, because the damage should be covered by the insurance policy for which the tenant pays the premium. However, most leases will add an exception to this rule for situations where the insurers have refused to pay out because of something the tenant has done.

There are ways to deal with this, for example by providing for the tenant to reimburse the landlord for any amount the insurers are withholding. The landlord’s insurance policy may also have a non-invalidation clause, which stops the policy being affected by the tenant’s actions. Your solicitor will be able to advise you on the best way to deal with these in the lease.

Dealing with damage by an insured risk

If there has been damage by an insured risk, under a full repairing and insuring lease, the landlord must claim under the insurance policy and carry out the necessary repairs. The lease will usually set out a timescale within which the building must be reinstated, with an obligation on the landlord to use reasonable endeavours to make sure this is achieved.

The landlord will often want some flexibility to make changes to the building when it is reinstated, but this can be controversial with tenants so it is an area where the parties need good advice on the right drafting.

Tenants should understand that even if they cannot occupy and trade from the property because it has been damaged, the lease will not automatically end and the rent is, as a matter of law, still due. In practice, the landlord will rely on the loss of rent insurance, so the lease will allow the tenant a rent cesser for an agreed maximum period. It is vital to check the detail of the loss of rent cover because it will probably apply only if there has been physical damage to the property.

The loss of rent period and timescale for reinstatement should reflect the time it is likely to take to restore the building. Neither side will want the reinstatement period to drag on, but their commercial perspectives may differ. The tenant will want either to get the business up and running again or be able to move elsewhere. The landlord will not want to be left with an unusable building, but might see this as a chance to redevelop the site.

To create some certainty, the lease will usually say that if the property has not been reinstated by the end of the loss of rent period, there will be a right to end the lease. This is sometimes just for the landlord and sometimes for both parties, so it is important to get your solicitor to negotiate what you want to achieve.

How we can help

The insurance provisions in the lease should reflect the degree of flexibility the parties want if the building is damaged, and how long they are willing to wait for damage to be repaired. Good advice, both when the lease is negotiated and if there has been damage, will help landlords and tenants avoid the extra disruption of a dispute over reinstatement.