Why it’s important to address uninsured risks on a commercial property

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Most commercial property leases provide for the landlord to insure their building so in the event of any damage insurance covers the cost of repair or replacement. However, issues arise where damage is caused by an uninsured risk which raises the question – who should foot the bill? Our commercial property specialist Joy Hancock explains.

While building insurance usually means the tenant is not responsible for the cost of repairing damage covered by the policy, The Code for Leasing Business Premises made in 2007 has helped to tackle the issue of who should be liable for these.

The Code states that, “if the premises are so damaged by an uninsured risk as to prevent occupation, the tenant should be allowed to terminate the lease unless the landlord agrees to rebuild at his own cost”. However, as things stand the Code is not legally binding unless both parties expressly agree to abide by it.

The default position (unless varied by the lease) is that a tenant is responsible to make good any damage for uninsured risk. With increased risks of flooding and terrorist activity, which might fall into the uninsured risk category, this can leave the tenant open to substantial financial risk of a building completely unfit to trade from and no income.  Equally the tenant could be obliged to continue to pay rent for such unusable premises.

With insured losses, the landlord insures for loss of rent which means if the property or part of it is damaged during the lease term by an insured risk, the landlord will suspend rent during this period where the tenant cannot trade. With uninsured risks, this rent suspension does not apply unless this is clearly addressed within the lease, meaning the cost of making good damage by an uninsured risk is the tenant’s sole responsibility.

This leads to a difficult situation, as while a tenant pays for the cost of the insurance the actual policy is chosen by the landlord and it is up to the tenant to identify any exclusions within it which could leave them open to uninsured risks. Most commercial leases also contain a long list of insured risks and a proviso that the landlord is not obliged to effect insurance against a risk where cover is not available in the insurance market, or only on terms the landlord considers unreasonable. This means any listed risk may become an uninsured risk during the lease term as a consequence of insurance renewal.

Depending on the negotiating strength between the two parties concerned there are several ways these issues can be resolved. Some landlords explicitly address this by accepting liability for uninsured risks within the lease, which means the suspension of rent will commence if insured or uninsured risks cause damage. The landlord would in such cases be responsible to repair any uninsured risk damage at his cost.

Another option is where the parties agree to abide by the Code, or alternatively expressly exclude uninsured risks within the lease from being the tenant’s obligation. Unlike the previous option, this does not place an obligation on the landlord to make good such damage, it purely acknowledges that it is not for the tenant to do.

It is prudent to have further provision to terminate the lease if the building is damaged through uninsured risks, or if the landlord did not make good such damage.

From the tenant point of view there needs to be as wide a definition as possible of insured and uninsured risks, so the landlord has the legal obligation to meet these and not the tenant.

From the landlord point of view it is important to address their expectations going forward in terms of uninsured risks and future rebuilding or development potential generally.

Flooding and terrorism are now more prevalent and it’s more important than ever to ensure these are covered within their policy. However, a proviso is usually included within the lease that should any risks no longer be available at a competitive rate the landlord is not obliged to continue to insure for it. These could potentially then become an uninsured risk at some point during the lease term.

Where there are risks which become uninsured risks, the landlord isn’t obliged to alert the tenant to this unless it states so within the lease. With that in mind a tenant should ensure there is an obligation within the lease that the landlord will produce a copy of the insurance following renewal of the policy to check if there have been any material changes.

When it comes to fixtures, fittings and contents, the tenant should cover this within their own insurance, and this should be reviewed if the value of these items increases. Other than this the tenant usually cannot arrange further building insurance cover in order to avoid competing claims occurring between the landlord and tenant insurance providers.

Advice to both landlords and tenants is to ensure that uninsured risks are clearly addressed at the start of the lease. This is in the interests of both parties, as should a tenant become insolvent due to a lack of ability to trade from a property through damage then the landlord won’t be able to pursue a claim against the tenant to reinstate the damage leaving the landlord to foot the bill.

Do you need commercial legal support or advice on a commercial property? Contact Joy Hancock today for advice on 01889 598888 or email joy.hancock@bowcockpursaill.co.uk