What do you mean, I have to cover YOUR property?

The Academy Journal is pleased to present the following article by our friend, Craig Andrews.

As questions come to me from property-casualty practitioners all over the country, one situation in particular seems to popping up more frequently. It can be exemplified by this hypothetical scenario.

A restaurant operates as a tenant in a leased building. Lightning strikes the heating and air conditioning (HVAC) unit owned by the landlord which is permanently attached to the roof of the building, totally destroying it. When the landlord hands the restaurant owner (tenant) an invoice for the replacement of the HVAC unit, the tenant discovers (for the first time) that his lease obligates him to pay for the repair or replacement of the landlord’s air conditioning unit in the event the HVAC unit is damaged during the term of the lease.

The tenant contacts his agent, who also knew nothing about his client’s lease obligation to pay for damage to the HVAC unit prior to receiving notice of the HVAC unit damage. The Commercial Property portion of the tenant’s Commercial Package Policy covers only Business Personal Property and Loss of Business Income. In reporting the loss to the insurer, the agent asserts the damaged HVAC unit is Tenants Improvements and Betterments (TI&B), attempting to get the loss covered under item A.1.b.(6) of the Your Business Personal Property provisions of the ISO CP 00 10 Building and Personal Property Coverage Form attached to the policy.

The insurer correctly denies coverage for the loss because the damaged HVAC unit did not comply with the definition of TI&B set forth in the CP 00 10. Why? The CP 00 10 requires that for TI&B to be covered as part of Your Business Personal Property, it must be “acquired or made” at the Named Insured’s expense. Of course, the tenant Named Insured in this scenario did not acquire, buy or otherwise pay for the HVAC unit; the landlord did. Therefore, there is no coverage for the loss. The agent and his client go crazy.

I have seen this scenario play out in all manner of situations in which tenants acquire a lease obligation to pay for damage to certain types of their landlords’ building property as specified in the lease of premises. Most of us are well accustomed to dealing with the insurance coverage issues inherent in triple net leases and in lease obligations to pay for damage to plate glass fronting leased premises. However, the situations presented to me in greater frequency recently involve obligations to pay for damage to many more types of building property owned by landlords, property such as walk-in freezers and refrigeration units; heavy manufacturing and processing equipment; steam boilers; automatic fire extinguishing systems; cooking equipment; ceiling, wall and floor coverings; doors; burglar and fire alarm systems; interior and exterior security and surveillance systems; sound systems; and on and on. Once these contractually-acquired obligations to insure property owned by landlords are identified and quantified, the insurance coverage limits required are often significant.

Of course, the first step in preventing sad stories like the hypothetical one above is for the tenant to be fully aware of the obligations acquired in leases of premises and to advise his or her agent accordingly. As we all know, that happens far too infrequently! So, what’s the agent with commercial tenant clients to do? Above all, agents should recommend in writing that all leases be reviewed for potential insurable (and even not-insurable!) loss exposures by competent legal counsel. The recommendation to seek legal counsel review of leases should be signed by the client and documented appropriately in agency files. Keep in mind: the agent personally assuming the responsibility of reviewing clients’ leases himself or herself in order to identify potential loss exposures could easily become vulnerable to allegations of practicing law without a license.

The good news is, when a tenant’s contractual responsibility for damage to the landlord’s building property is identified, there are two new ISO Commercial Property endorsements that agents can use to deal with the exposure. The two new endorsements, introduced in 2017, specifically insure building property tenants have acquired a contractual responsibility to insure. The CP 14 01 09 17 Scheduled Building Property Tenant’s Policy endorsement allows the user to specifically schedule the building property; either building glass or building fixtures and permanently attached machinery and equipment and assign specific limits to the property to be covered. The CP 14 02 09 17 Unscheduled Building Property Tenant’s Policy endorsement serves the same purpose (and includes the same definitions of building property) but neither building glass nor other building property are specifically described or scheduled. The limits shown on the CP 14 02 apply to all building property fitting the respective description. Either the CP 14 01 or CP 14 02 may be written with or without a coinsurance provision.

Insurance professionals know the practice of making tenants responsible for property owned by their landlords is just another manifestation of the decades-old and persistent trend to contractually push as much responsibility and expense onto tenants as possible. This situation serves as yet another reminder that as usual commercial insurance agents as well as underwriters must remain eternally vigilant to prevent insurance coverage nightmares arising from the financial consequences of unidentified contractual loss exposures