Client Alert - December 11, 2012
By: Marian A. Kornilowicz and Jonathan A. Cass
As commercial property owners and their tenants assess the damage caused by Hurricane Sandy, they need to understand their rights and obligations under leases, mortgage loan documents, and insurance policies.
As a result of storm damage, many buildings were temporarily uninhabitable or sustained such significant damage as to be uninhabitable or untenantable for the foreseeable future. The question becomes what rights and obligations do a tenant and landlord have under the terms and provisions of their lease? It should be kept in mind that these terms and provisions were negotiated and decided when the lease was executed.
First, it is necessary to understand the difference between a service interruption and casualty. A service interruption or disruption involves, for example, a loss of utility service to a property, thereby interfering with the tenant’s use of the property. A casualty involves the inability of the tenant to use or possess the property because of physical damage to the property itself.
Generally, commercial leases prepared by landlords will not provide for rent abatement or lease termination in the event the landlord fails to provide utilities or services. However, the lease should be checked because sometimes landlords will agree to abate if utilities or services are not provided for some period of time.
Commercial leases will often consider the extent of damage and the time necessary to restore or rebuild. For example, a lease may distinguish between partial and total casualty where the former means that the tenant was or is unable to use a portion of the leased space and the latter means that the entire leased space is unusable or untenantable.
The lease may provide for rent abatement in the event of a partial casualty and even the right to terminate if the premises cannot or are not restored within a certain period of time. Generally, a landlord’s lease may provide for a pro-rata abatement of at least the basic rent during the any period in which the tenant is actually dispossessed, but only to the extent of such dispossession.
If a total casualty has occurred, landlords under most commercial leases have the option, but not the obligation, to rebuild/restore the building. Tenants may or may not have the option of terminating the lease under certain circumstances such as if the landlord is unable or does not rebuild within a set period of time or if the casualty occurs toward the end of a lease term.
Both tenants and landlords need to not only understand what coverage is provided by their insurance policies, but also to provide immediate notice of any potential claims to their insurance carriers as required under the applicable policy. Additionally, it is extremely important to fully document the damages sustained so as to preserve rights under the policy, and to ensure that the claim can be properly defended if challenged by the insurer. Tenants and landlords should be talking to the insurance brokers to review and understand available coverage, and the notice provisions required under their policies.
Typically, under a commercial lease, a landlord insures the building structure and common areas and the tenant is required to purchase insurance coverage on any improvements it made to its leased space, and its personal property. Commercial property insurance is intended to cover losses from fire, theft and natural disasters. However, such policies do not cover property losses caused by flood, which are only covered by a separate flood insurance policy.
In the event that a landlord or tenant has lost business income because, for example, the landlord had to provide tenants with rent abatements, or the tenant has been unable to conduct business because the leased property is untenantable, it is important to determine whether the effected business has business interruption coverage. This type of coverage is not part of a standard property policy and is intended to reimburse the business owner for loss profits and fixed expenses incurred as a result of the interruption of the business.
To protect themselves against damage to their collateral, lenders place provisions in the loan documents specifying the insurance to be carried by the borrower and the borrower’s obligations in the event of a casualty loss. (These provisions are negotiable, to a degree, at the time of the loan.) A borrower is required to notify the lender in the event of a casualty loss of a certain magnitude. Additionally, the lender almost always is entitled to collect the proceeds of insurance, and can elect to either apply it to the loan balance or, under certain circumstances, escrow it and apply it to the cost of repairs to the collateral.
In the event of a casualty loss, it is important to understand the obligations owed the lender under the loan documents, and to ensure that the borrower complies with those obligations so as to avoid being declared in default. Additionally, in the event that significant repairs are required to the building, the borrower will want to negotiate with the lender to avoid any delays in gaining access to the insurance payments necessary to make the necessary repairs.
The Firm has extensive experience in commercial real estate and insurance coverage matters, and is available to answer any questions or respond to any issues that you may have. Questions concerning leases and mortgages issues can be directed to Marian A. Kornilowicz, Esquire, and concerning insurance coverage matters to Jonathan A. Cass, Esquire.