Hidden Dangers In Casualty Clauses
March 26, 2001
"This ws a goodly person, Till the disaster that, one mortal might, Drove him to this." Prince of Tyre, Act V, Scene 1
One of the more frequently negotiated
clauses in a lease is the casualty clause.In the course of
negotiations, the extent of damage relative to rent abatement and
termination are usually addressed. However, (i) certificates of
insurance; (ii) availability of proceeds for rebuilding; and (iii) the scope
of replacement cost insurance are often poorly addressed or understood and
present truly hidden dangers to a landlord.
Certificates of Insurance
Typically, a lease requires the tenant to
provide the landlord with either a certificate of insurance or certified
copies of the insurance policy and appropriate endorsements. Often, a
national or anchor tenant will not agree to provide copies of the policy and
endorsements because the documentation is voluminous and generally
indecipherable to all but the most sophisticated insurance experts,
particularly when, as is often the case, the tenant has a master or
“blanket” policy, umbrella coverage and/or a self-insurance component.
A national or anchor tenant usually will only agree to provide the landlord
with a certificate of insurance; however, the requirements for the
certificate of insurance are often too vague. Some landlords assume
that the certificates traditionally issued by insurers address the basics: (i)
that coverage in the amounts specified in the lease exists; (ii) that the
landlord is an additional insured/loss payee; and (iii) that there will be
no cancellation of or change in coverage without prior written notice by the
insured to the landlord. This is not necessarily so. Many
commonly used certificates only obligate an insurer to “endeavor to”
provide the landlord with notice of any cancellation of or change in
coverage. Therein lies the danger. It is important, if not
imperative, for the landlord to know that the insurance will not be changed
or cancelled without it having received prior written notice. This
danger can be avoided either by specifying in the lease that the certificate
provide such notice, that endorsements providing for such notice accompany
the certificate, or that an ACORD Form 27 certificate of insurance, which
obligates the insurer to provide such notice of insurance, be used.
Proceeds
If a lease obligates the landlord to
rebuild, the landlord frequently will get into trouble by not making this
obligation contingent upon the availability of sufficient insurance
proceeds. Essentially, the landlord assumes the availability of
sufficient proceeds, and often, nothing could be further from the truth
because either the landlord’s lender decides to apply the proceeds to the
outstanding debt on the property or the insurer decides to contest the
claim. In either event, the result is the same - the landlord is
obligated to rebuild and does not have the money to do so. To avoid this
danger, if a lease obligates a landlord to rebuild, the landlord must make
certain that the lease also states that the landlord’s obligation to do so
is contingent upon the availability of adequate insurance proceeds.
Replacement-Cost Insurance
Finally, if a lease obligates the landlord
to rebuild, a misunderstanding as to the scope of replacement-cost insurance
poses a significant risk to the landlord. Such a lease frequently
contains language requiring the landlord to maintain property insurance
“for the full replacement cost” of the improvements. Many
landlords assume that a standard replacement cost policy meets this
requirement. This is not necessarily the case. A standard
replacement-cost policy only obligates the insurer to pay the replacement
cost of the improvements up to the policy limits. Thus, if a landlord
is not careful, a situation can arise where the landlord is underinsured.
(Similar considerations arise when the tenant is obligated to rebuild and
insure, and thus, tenants should also be careful in this regard.)
Sometimes, a landlord can protect itself from this danger by obtaining an
“extended replacement-cost” endorsement. This endorsement usually
requires the insurer to pay the actual replacement cost, regardless of
stated policy limits, where the increased cost is attributable to inflation,
shortages of materials and/or changes in legal requirements.
Alternatively, a landlord can protect itself in this regard by having its
coverage limits reviewed every few years.
As the above makes clear, the hidden dangers
are significant, but by taking a few simple precautions, a landlord can
avoid the hazards which may arise as a result of insufficient knowledge
about the certificates of insurance, condemnation proceeds and
replacement-cost insurance.
Mr. Tannen is Senior Counsel in our Atlanta
office. He can be reached at 404-898-8109 or at drtannen@hklaw.com