Uninsured Risks and Commercial Leases - Is the tenant at risk?
If you are a landlord or a prospective tenant, have you thought about the consequences of the property being damaged or destroyed by a risk which is not covered by insurance?
Traditionally in standard commercial leases, the landlord insures. This allows the landlord to ensure that their interest and investment is properly protected. The tenant will then reimburse the landlord for the cost of insurance. If the property is destroyed or damaged by an insured risk the tenant’s obligation to repair does not apply and, usually, the tenant does not have to pay rent for a specified period.
In a standard full repairing and insuring lease, the tenant covenants with the landlord to keep the property in good repair and condition. This may or may not be limited by a schedule of condition, dependant on the agreement between the parties.
However, what happens if the property is destroyed or damaged by an uninsured risk?
An uninsured risk is a risk the landlord has not insured because insurance cover is not available, too expensive or the insurer imposes onerous provisions. A common example of this is damage caused by terrorism. Many leases are silent on uninsured risks. If the lease is silent and the property is destroyed or damaged by an uninsured risk the tenant is responsible for making good the damage and must continue to pay rent.
Because of the potential costs and burden imposed by the repairing obligation, tenants are increasingly seeking lease provisions to deal with the issue of uninsured risks. They do not want to be responsible for repairing the property or continue to pay rent for a property that is not fit for use or occupation. On the reverse side, the landlord does not want to lose the rent or pay the costs to reinstate damage without the benefit of insurance.
There is limited guidance available regarding uninsured risk provisions. The Royal Institute of Chartered Surveyors (RICS) has recommended that either the landlord or the tenant should be permitted to terminate the lease if the landlord does not agree to reinstate the property at its own cost. The RICS Code for leasing business premises also recommends that the lease should provide for rent suspension if damage is caused by an uninsured risk.
However, as this is just currently guidance, there is no standard market practice. So, it will come down to what the parties agree as part of the negotiations. Some landlords may still refuse to include uninsured risks provisions. However, others may consider doing so depending on the terms agreed (length of term, rent etc, type of property) and the relative bargaining power of the parties.
The basic provisions requested by tenant are that if the property is destroyed or damaged by an uninsured risk:
- the rent will be suspended until the property is reinstated; and
- the repairing covenant does not apply to destruction or damage by an uninsured risk. So, either the property must be reinstated at the landlord’s cost, or the tenant may terminate the lease if the landlord does not reinstate.
Considerations as part of negotiations relating to uninsured risks include:
- The level of damage that would trigger the provisions. The landlord would not want the rent suspended in the event of minor damage. A key marker here would be whether the property is still fit for use and occupation.
- Will the rent be suspended and if so, is there a time limit that would provide the landlord sufficient time to reinstate the property? Is the service charge also going to be suspended?
- Will the lease allow the landlord to choose whether to terminate or to reinstate the property? If so, will there be any time limits for this? This may be done by way of an election to reinstate.
- Will the tenant have the right to terminate following a specific period (for example 12 months)? If so, will this apply if the landlord has not elected to reinstate or if reinstatement works have not finished?
- Damage by an uninsured risk caused by the tenant should not trigger the uninsured risks terms. So, if the tenant causes the damage the provisions would not apply, the rent would not be suspended, and the tenant would not be permitted to terminate the lease.
As ignoring issues relating to uninsured risks could prove complex and costly it is highly recommended that the parties take professional advice.
If you feel you could benefit for advice regarding uninsured risks or any other issues relating to commercial leases, please contact Karin Horsley or another member of our expert commercial real estate team.
This update is for general purposes and guidance only and does not constitute legal or professional advice. You should seek legal advice before relying on its content. Greenwoods Legal LLP is a Limited Liability Partnership, registered in England, registered number OC306912. Our registered office is Queens House, 55-56 Lincoln’s Inn Fields, London, WC2A 3LJ. A list of the members’ names is available for inspection at our offices in Peterborough, Cambridge and London. Authorised and regulated by the Solicitors Regulation Authority, SRA number 401162. Details of the Solicitors’ Codes of Conduct can be found at www.sra.org.uk. All instructions accepted by Greenwoods Legal LLP are subject to our current Terms of Business. VAT Reg No: 161 9287 89.