WHY WAIT FOR A FIRE BEFORE YOU READ YOUR INSURANCE POLICY?

By Mary J. Drury , Esq.

Landlord and tenant sign a lease for a restaurant in a retail strip center. The landlord read the insurance provisions (and thought he understood them) and the tenant did not even bother. Both were happy until a fire started in the restaurant causing severe damage to the space and the adjoining spaces. Then, the landlord, the property manager, the tenant, their insurance adjusters, and their lawyers all read the insurance provisions of the lease and discover that there will be many months and perhaps years of investigation to find the party at fault. Worse yet, is the discovery that all of this could be avoided with a couple of simple provisions in the lease.

Just as a landlord ascertains the financial strength of a tenant and the tenant of its landlord, both parties should consider the financial strength ratings of their respective insurance companies. Five companies currently rate the stability of insurance companies: A.M. Best Company, Standard & Poor's, Wiess Research, Duff & Phelps, and Moody's Investors Service. Each rating agency has its own rating system, usually delineated by numbers or letters or both. A higher rating is obviously preferable to a lower rating given that the goal is to shift risk of loss to a party able and capable of paying that loss. Additionally, it is imperative that the insurance companies retained by the parties are licensed by the Nevada Division of Insurance (see http://doi.state.nv.us/ to check if an insurance company is licensed in Nevada , among other things).

Whenever two or more parties (such as a landlord and tenant) share an interest in real property, special issues arise in conjunction with the insuring of the property. One particular issue is what rights of action, if any, the parties will have against the other in the event of a casualty loss. Using mutual waivers of subrogation, a properly drafted lease can set up a “no-fault” arrangement to place the financial burden of the loss on an insurance company, rather than on the landlord and tenant.

Mutual waiver of subrogation provisions help to shift the risk of loss to an insurance company, assuming the insurance company is then-solvent.

Subrogation can be defined as “the substitution of one person in the place of another with reference to a lawful claim, demand or right, so that he who is substituted succeeds to the rights of the other in relation to the debt or claim, and its rights, remedies or securities” or “the right of one who has paid an obligation which another should have paid to be indemnified by the other.” Black's Law Dictionary , 6 th Edition. Subrogation rights of an insurance company arise after the insurance company has paid on a claim.

Example 1 : The landlord carries fire insurance on a building and the tenant causes a fire. The insurance company pays the landlord for the damage to the building under the policy. The insurance company is then subrogated to the landlord's rights against the tenant for causing the fire and the insurance company can proceed (absent waiver of subrogation rights) against the tenant for causing the fire and can collect damages from the tenant.

Example 2 : A tenant agrees to surrender possession of the premises in the same condition as received, reasonable wear and tear (which does not include damage by fire and casualty) excepted. There is a fire during the term of the lease. The landlord's insurance carrier pays the landlord for damage caused by the fire. The carrier is subrogated to the landlord's rights and proceeds (absent waiver of subrogation rights) against the tenant under the surrender provision in the lease because the tenant can no longer surrender the premises in the same condition as received due to the fire.

Example 3 : A tenant carries insurance on its inventory. Landlord's actions or inactions cause a fire and tenant's insurance company pays tenant for the value of its inventory. Tenant's carrier is subrogated to tenant's rights and can proceed (absent waiver of subrogation rights) against landlord.

If the parties (especially the Landlord as the customary drafter of the lease) desire a mutual wavier of subrogation rights, the insurance provisions should be shown to the insurance company. Insurance agents are in the business of insuring risk and while lawyers and broker/agents frequently deal with insurance issues, insurance agents are one's best source of information and confirmation of enforceability (that is, make sure each party's insurance company will honor (not exclude) waivers of subrogation).

Mutual waivers of subrogation are also beneficial as between tenants in close proximity with one another, e.g., shopping center tenants, since such waivers protect tenants from potential liability to each other and to each other's insurance company for losses generally expected to be covered by insurance. A landlord can obtain mutual waivers from its tenants by having each tenant agree in its lease to give a waiver to all other tenants from whom it receives a waiver. A tenant agreeing to waive rights against other tenants should first obtain approval from its insurance company.

Again, regardless of who drafts the insurance provisions, be sure to show all insurance provisions to an insurance agent to confirm coverage.

Mary J. Drury, Esq. is an attorney with the Las Vegas law firm of Marquis & Aurbach. She can be reached at (702) 382-0711 or visit the firm's web site at www.marquisaurbach.com .