If you were asked to carry out works to a small part of a large building on the basis that you had to insure the whole building for its full reinstatement value, at a disproportionate cost to the value of the works, would you take the job?
This is the issue that is currently facing many tenants and their contractors in multi-let buildings, and one which we have come across a number of times recently.
Insuring tenant’s works
In simplistic terms, the landlord of a commercial building will generally take out an insurance policy for the property in its own name. However, there are often a number of other insurable interests that require full protection under the policy: for example, a freeholder, a tenant, a mortgagee or a contracting purchaser may all have an insurable interest. The manner in which these third party interests are recorded (or not) on the policy can cause various problems.
When negotiating insurance covenants in a lease, tenants will generally seek to be named on the landlord’s insurance policy for the building in question to cover any damage to the building caused by the tenant, in particular when carrying out tenant’s works. This means that the tenant (and/or its contractor) is separately insured under the landlord’s policy for its own insurable interest (composite insurance).
Where a tenant has entered into a building contract in the JCT form with insurance Option C, getting the landlord to insure the existing building is perhaps the only way for the tenant to meet its obligation under the building contract, since it will not have the necessary information regarding valuation, methods of construction, contents, past claims and so on, in relation to the rest of the building.
“Noting” on a policy
Sometimes a tenant is simply “noted” on the policy. Although “noting” indicates to the insurer that the noted party has an interest in the proceeds and that no claim can be settled without its consent, there is no separate contract with the insurer. If the named insured (for example, the landlord) is guilty of a non-disclosure, breach of the policy or fraud and the policy is avoided, the beneficiary of the noted interest will not be able to recover separately. For this reason, parties whose interest is merely noted on the policy often look for non-invalidation wording in the policy. In essence, the insurer confirms that the insurance will not be invalidated by any misconduct of an insured party who is seeking to make a claim.
Waiver of subrogation
A tenant will also seek a specific waiver of subrogation in the insurance policy (in favour of it/its contractor). An insurer may be able to exercise rights of subrogation against the tenant in relation to damage caused or contributed to by the tenant, irrespective of whether the tenant is responsible for the insurance premium under the terms of the lease, and, following the Court of Appeal decision in Tyco v Rolls Royce, irrespective of whether the insurance is composite insurance in certain circumstances.
What is the problem?
Until relatively recently, most landlords have been happy to seek a waiver of subrogation and name tenants/their contractors on the insurance policy for the building, provided that the tenant/contractor paid any premium increase (for obtaining a waiver of subrogation) and/or any excess or premium increase resulting from a claim on the policy arising as a result of an act or omission of that tenant or its contractors.
However, some landlords are now refusing to do this with the result that when a tenant is carrying out works, say fit out works, the fit out contractor is put in a position of having to use its own insurance to cover any damage to the building (which will essentially be its own third party liability policy). The potential risk to a highly sophisticated state of the art building (such as “the Gherkin”) from even minor works could be huge and there is always the risk that a substantial part of building may be damaged (by, for example, fire). Any insurance policy would therefore need to cover the full reinstatement value of the building, the cost of which will usually be disproportionate to the value of the tenant’s works, especially if the fit out is for just one or two floors of the building.
In addition, third party liability insurance is not the appropriate type of insurance in that it usually covers death, personal injury and damage to third party property and does not extend to financial losses, such as business interruption and loss of profit. Depending on the terms of the policy, it may not even cover damage caused by particular risks. This would leave contractors exposed to these losses and risking insolvency if their balance sheet cannot cover them.
Why have landlords adopted this approach?
Some large developer/landlords have always excluded tenants/contractors from their insurance because they do not want their claims record adversely affected due to damage caused by them. Accordingly, they retain direct control over work that falls under their insurance. In relation to other developers, it is a relatively recent development, presumably for similar reasons, but possibly also in an attempt to keep insurance costs down in a market with rising premiums.
Commercially there is little incentive for landlords to share these costs with their tenants and this is perhaps why it is such a difficult problem. However, simply transferring the risk to a contractor in these circumstances is clearly an unsatisfactory solution from a contractor’s perspective.
How can contractors limit their exposure to this sort of risk?
Some larger contractors may well be in a strong enough financial position to simply refuse to accept this allocation of insurance risk as between them and the tenant. In turn, tenants may be able to negotiate a more favourable insurance position with the landlord.
Where does this leave smaller contractors? There is a concern that some are taking on this type of work out of necessity in the current economic climate and hoping for the best.
One thing is certain: contractors should not take on this type of work and leave themselves exposed to uninsured risks. One solution may be for tenants to effect one-off policies for works of this nature or effect additional third party liability cover and price the cost (or a proportion of it) into the cost of the overall works. Landlords may then conclude that naming the tenant/its contractor on their insurance policy may, in fact, be a better and cheaper solution.
Alternatively, the landlord could effect excess third party liability cover (over and above any existing third party liability cover) with the tenant paying a proportion of the premium for such excess cover. The excess policy would need to cover damage caused to existing structures (that is, the building) and indemnify the tenant and its contractor for any third party liability. However, the risk of, for example, fire is properly covered by a buildings/all risks policy rather than a third party liability policy, so this is probably not the best approach.
Perhaps a better solution is for the landlord to offer a policy extension, the cost of which is apportioned between the landlord and all tenants in the building. This may offer a more balanced and long term solution.
Increased awareness of this issue is probably the first step towards fully understanding why this trend has emerged and agreeing a common approach to sharing this risk that is mutually acceptable to all parties. Until then, this will remain an important point for discussion between landlords, tenants and contractors.