Natalka Falcomer

Why You Have to Care About Insurance Clauses

October 16, 2015

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The most hated of lease clauses - the Insurance Clause - is not only frequently ignored, but also poorly understood by almost everyone in the real estate industry. And that includes real estate lawyers. Yet, it can be the most dangerous.

According to Chris Case, B.A. Honours, MBA, Associate Broker of Dan Lawrie Insurance Brokers, the biggest mistake landlords and tenants make is assuming that “the standard insurance clause covers everything they need”. Based on this assumption, tenants and landlords then ignore the insurance clause and don’t seek the help of a professional. Unbeknownst to them, however, is the fact that standard insurance clauses actually exclude a lot of common scenarios, impose significant obligations on landlords and tenants and can cause financial hardship.

Given this reality, it is highly recommended that you seek the advice of a fully qualified insurance broker who also understands the peculiarities of the asset class you’ll be leasing. As someone who’s been under pressure to get a lease signed, I truly appreciate that there isn’t always the time get the professional advice you need. The next best step, then, is to arm yourself with knowledge.

Why You Have to Care About Insurance Clauses*The Scenario *

Your client is part of a growing franchise food industry and you’re excited to help them expand into their fifth location. They now have money to spend on a great location and you landed them a unit in a high traffic and highly coveted shopping mall. While the rent is high and the by-laws regarding equipment are strict, you were able to negotiate excellent tenant improvement and renewal rights. You gloss over the insurance clause because your client already has an “all risks” policy and he happily signs the lease.

A year after the store opened, vandals smash the glass windows and destroy the cooking equipment. Your client calls his insurance company to replace the vandalised equipment and they willingly oblige. This is no surprise because vandalism is covered underneath the “all risks” policy.

The windows and equipment are installed and your client is finally ready to re-open. Right before opening day, however, your client gets a personal visit from the property manager and landlord. They tell your client he must tear out everything that was just replaced and cannot open. The windows and equipment are not according to new building code rules, as well as the landlord’s by-laws. If your client doesn’t make the change he is in violation of the lease and will be evicted.

Your client calmly calls his insurer to explain the issue and requests reimbursement for the upgrade and replacement. Not being up to code is clearly something that should be included in an insurance policy, right? Wrong. No way, says the insurer. This is your problem. Not ours.

Your client is livid and felt that you didn’t provide him with the right advice. He vows to never use you again as you’re clearly no leasing expert.

What Happened?

You glossed over the terms of the insurance clause and you assumed that an “all risks” policy actually includes “all risks”. And as if this wasn’t complicated enough, you also didn’t carefully consider how the landlord’s by-laws would affect your client should he have to replace his equipment.

What is this Clause and Why Does the Landlord Want it?Insurance Clauses

There are numerous valid reasons as to why landlords require tenants to carry insurance. One reason is because most landlord insurance policies do not cover any personal property belonging to tenants, The policies also don’t protect the interests of tenants.

Other reasons are because a landlord wants to make sure that the tenant will be able to pay its rent. Business interruption insurance is, therefore, a common tenant insurance requirement. This insurance covers the loss of income that a business suffers after a disaster. Such insurance protects the revenue stream (and, therefore rental payments) if the tenant has to close its doors because of a disaster that requires repairs.

Insurance clauses, as well as other related clauses, also contain subrogation, waiver and indemnification obligations. These obligations hold the tenant responsible for a variety of claims against the landlord. This shift in responsibility from landlord to tenant has significant financial implications for the tenant because it shields the landlord from the financial or even legal implications of lawsuits, even if the landlord responsible for the harm caused.

By-laws and how it Relates to Insurance

Just like insurance requirements, by-laws are also critical to running any building; especially if the building is for high-end retail, medical or a specific industrial use.

It is simply good business practise to restrict unsightly advertising and prevent calamities by requiring tenants to use safe equipment and materials, as well as meet certain quality standards for installing fixtures such as internal windows.

By-laws are so important that many insurance clauses, in fact, require tenants to obtain “a by-law endorsement” or “law and ordinance coverage” with respect to tenant’s improvements:

*This Insurance will […] cover: (1) all property owned by a Tenant or for which the Tenant is legally liable, located within the Centre, including, but not limited to, Tenant’s Work and Leasehold Improvements, in an amount not less than the full replacement cost thereof, subject to a by-law endorsement.*

This endorsement ensures that the tenant is reimbursed for additional or increased repair costs that arise as a result of a change in the landlord’s by-laws or the municipality’s building codes.

In our example above, your client’s previous equipment and building material (i.e. the glass window) were no longer up to code or to the landlord’s by-laws. Rather, your client’s insurance only covered the replacement cost of the original equipment and the original window, not the ”up-to-code-and-by-law” versions. This means that without a by-law endorsement, your client is on the hook for the difference between the original equipment cost and the ”up-to-code-and-by-law” version.[1]What Should You Do?

The first misstep was not referring your client to a fully qualified insurance consultant or broker before the offer to lease was signed. You also failed to encourage your client to send his current broker the full lease. Why? The reason is perfectly demonstrated in this case; the tenant may have agreed to a variety of terms not included in the insurance clauses that affect the type of insurance required. For example, your client agreed to the by-laws which required him to install equipment and fixtures according to standards set by the landlord. A quick fax, email or scan to his broker would have solved this issue and ensured he received the correct coverage.

Another misstep was your assumption that an “all risks” policy protects an insured against every type of risk. It doesn’t. “All risks” policies only cover losses that aren’t excluded in the policy. A few of the typical exclusions are flood, volcanic eruption and title waves, for example. By-law endorsements are also not covered under “all risks” policies.

The next time you come across an insurance clause, advise your client of these hidden dangers. Review the insurance clause in detail and highlight key terms such as minimum insurance obligations, the type of coverage required and who must be named as an insured or loss payee (another complicated matter for a future article). Be sure to then send this to an insurance consultant or broker even if it slows the process. This cautious approach to insurance clauses will ensure your reputation stays in tact and that referrals come your way.

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[1] A “by-law endorsement” does not apply to the contents in a premises; it only applies to tenant improvements that arise out of repairs and replacement.

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Written by Natalka. Natalka is an award winning graduate of Osgoode Hall Law School & Wilfred Laurier University who is deeply committed to increasing access to justice and improving the way the law is practised and delivered.