Many of our storefronts at ProgramBusiness.com offer insurance programs for the real estate sector, providing cover for a number of different niches, including commercial offices, rental centers, warehouses, light industries, and mixed-use, among others. Likewise, many of our insurance agency members work with insureds (tenants and owners) and their attorneys every day to make sure they understand the leases they're signing and what their respective insurance responsibilities are. In this feature, we turned to Steven Heller, attorney at Gilchrist & Rutter Professional Corporation, to discuss some of the insurance negotiation points that arise between landlords/owners and tenants.
Based in Santa Monica, California, Gilchrist & Rutter provides legal services to a broad array of real estate and business clients. The firm has successfully closed more than $5 billion in real estate financings; negotiated and documented more than 7 million square feet of office, industrial and retail leases; and handled the acquisition and disposition of all types of real estate, including individual transactions with a value in excess of $500 million.
Steven's focus with the firm is on commercial real estate transactions, primarily leasing, development, sales/acquisitions, financing, construction, mobile home park matters and associated corporate matters. He has specific experience in leasing retail, office and industrial properties. As a former Director of Leasing with BH Properties, Steven oversaw the company's leasing activities in 13 states. He is a member of the firm's Real Estate, Sustainability, and Mobile Home Park practice groups, and has written several articles for professional journals and business publications on commercial leasing strategy and retail development matters.
Annie George (AG): What types of issues arise during lease negotiations between property owners and tenants?
Steven Heller (SH): "Insurance plays a critical role during a lease negotiation and there are many issues to address during the course of discussion. Let's focus on a few here. A property owner requires that a tenant purchase certain basic coverages, including Property, Liability, Workers Compensation, and Auto (if applicable) insurance. Yet, the landlord may also require additional coverages to be purchased, such as Business Interruption in the event a tenant's business is shuttered and the business can no longer operate for a certain period of time. The property owner/landlord wants to ensure that the tenant can meet its rental obligation while repairs are being made and the business is up and running once again. Some landlords will also require Service Utility Failure coverage for similar reasons. If there is a power failure and a business is unable to operate, the landlord wants to know that the tenant will be able to meet his obligations.
"What's more, since Business Interruption is available with different term limits, for example, 60, 90, 180 days, the length of time the coverage applies is important to the property owner. A landlord may request that the tenant purchase the maximum length of time of coverage available to ensure that the rent is being paid. A property owner will also purchase Rental Interruption insurance in the event that the tenant cannot pay the rent. In this case, the landlord may seek to pass the cost of the premium on to the tenant. This will become a negotiation point during lease discussions, with tenants agreeing to pay up to a certain portion of the premium."
AG: What types of issues come up regarding additional insured status?
SH: "There are many issues involving additional insured status for both parties in a lease. A landlord wants to be named an additional insured on a tenant's Commercial General Liability policy so that his firm has the right to claim on the policy without having to go through the tenant. However, typically the landlord doesn't want to provide the tenant with additional insured status on the building's liability policy, as this coverage is usually much broader. Take the example of a shopping center that's comprised of 30 stores. A landlord would not want each of these stores to be listed as additional insureds on the shopping center's liability policy. It's impractical, as it covers the entire center and can become very messy. Tenants may also object to adding a landlord as an additional insured, especially if it's a large chain with hundreds of stores. Typically, a chain has a blanket policy that covers numerous stores, so it isn't comfortable with a landlord having the ability to make claims against its policy as coverage expands beyond insuring that one store in a particular shopping center."
Steven also provided insight into some of the issues that arise regarding policy renewals or in the event a tenant stops paying for coverage altogether. "Usually the lease includes a provision stipulating that prior to a tenant's policy being changed or cancelled, notification must be made to the landlord at least 30 days in advance. This is to avoid a gap in coverage and provide the landlord with sufficient time to act, including purchasing coverage for the tenant's premises to ensure that coverage continues without interruption. In this case, the landlord will then invoice the tenant for the coverage that was purchased. There are also instances in which tenants don't renew their policies until a few days before the renewal becomes due. For larger real estate companies, this isn't enough time to receive appropriate notification and policy copies. During lease discussions, this process will be negotiated, including at which point the tenant has the opportunity to purchase insurance before the landlord steps in to avoid a gap in coverage. A tenant doesn't necessarily want the landlord buying an expensive policy on his behalf."
AG: When it comes to a tenant's share of a building's operating expenses, including insurance, how does this typically work?
SH: "From a big-picture view, the landlord pays for cleaning, security, maintenance, and insurance. For shopping centers, this is known as Common Area Maintenance (CAM) costs; for office buildings, they're simply considered operating expenses. It's important during lease negotiations that the tenant's share of responsibilities for these charges is made clear. The landlord looks to pass these operating costs on to the tenants, including insurance premiums, based on the tenant's percentage of square footage in the property. For example, if you have a retail store, and your store represents 11% of the overall property, if the CAM costs are $100,000, your contribution would be $11,000, a part of which is the landlord's insurance. During lease negotiations, the tenant will look to limit and narrow the scope of the amount of insurance premium that can be passed to him. This includes his share of the deductible, for example. Would the tenant be responsible for a portion of the deductible in the event of a loss? Some tenants oppose the deductible pass-through, but on the flip side if the landlord asks for a low deductible the overall cost of the insurance will increase and consequently so will the tenant's percentage allocation of the premium.
"In other instances, you have negotiations around whether a tenant will pay for additional coverages once the lease and percentage of operating costs are established. This can occur when a landlord purchases additional coverages that were not part of the initial insurance purchase. Let's say, the landlord added Earthquake or Flood insurance. Is the tenant responsible for paying a percentage of this additional insurance since it wasn't part of the initial lease negotiation? This all becomes a part of the upfront negotiation process.
"A lease by definition is a marriage contract; it's going to last for a long time, therefore it's in the best interest of all parties to make it work. Insurance is the vehicle to help keep the peace, with both parties finding common ground and benefitting from having the proper coverage in place with a clear understanding of each party's responsibility and obligation in the event of a loss or accident."