The risk of uninsured risks

November 1, 2023
Zevi Prager


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Virtually all leases, both residential and commercial, include an obligation on the landlord to insure the building, with the policy premium being apportioned among the tenants as part of the service charge.  The main reason for having the landlord insure is that the landlord has a capital interest in the building and wants to control its state of repair by way of insurance and service charge rent.  Additionally, where the building is let to several tenants, it is far simpler for the landlord to arrange the insurance for the whole of the building rather than to leave it to the various tenants.  It is also not easy to obtain a building insurance policy for just one floor, or part of a floor, in a building.

The lease will usually list the ‘insured risks’ which the landlord has an obligation to insure the building against.  These will include the standard risks such as fire, explosion, storm, impact by vehicles or planes, etc. 

In a fully repairing and insuring (FRI) lease, the tenant has an obligation to keep the property in good (and substantial) repair and condition, but this will usually exclude any damage caused by an insured risk.  This means that if the property is damaged by an insured risk, the tenant does not need to repair the damage (which is only fair seeing as the tenant is paying the insurance premium and otherwise would effectively be paying twice).  The landlord must reinstate the property and the rent due under the lease will be suspended until the property has been reinstated.

However, leases are often silent on what happens in the event that the property is damaged by a risk which the landlord has not insured for.  The most likely examples of uninsured damage are terrorism (many insurance policies do not cover terrorism due to the cost and insurer’s requirements), flooding (especially in parts of the country with a high risk of flooding), subsidence and heave.  If a property is damaged by an uninsured risk, the tenant will be responsible for remedying the damage caused under its repairing obligation, unless the tenants repairing obligation in the lease has been limited.  In addition, the tenant will have to continue paying the rent, despite the building having been damaged and in an uninhabitable state.

It is now becoming standard practice for tenants’ solicitors to demand a provision is included in the lease to protect the tenant in the event of damage by an uninsured risk.  The Code for Leasing Business Premises, made in collaboration between commercial property professionals and industry bodies, states that if properties are damaged by uninsured risks so as to prevent normal use and occupation, tenants should be allowed to terminate their leases, unless the landlord agrees to rebuild at its own cost.  It is therefore more common for landlords to be ‘forced’ to include provisions in the lease for what happens in the event of uninsured damage.

In agreeing to include an uninsured risks provision in the lease, a landlord must be careful not to covenant to reinstate unless it specifically elects to do so.  The risk for the landlord is that it will not receive any insurance pay-out for the damage and will need to fund the works out of its own resources.  The clause should be drafted so that if the property is damaged by an uninsured risk the landlord (only) has the option to elect to reinstate the property.  Some landlords may try to argue that the tenant should be required to continue paying the rent whilst they are paying for the reinstatement works, although tenants would understandably be reluctant to agree to this.  The clause should also set a long-stop date by which the landlord has to serve a notice confirming they will reinstate, so that if no notice has been received by the long-stop date the tenant should be allowed to terminate the lease.  The length of the long-stop period will depend on the building and the location, as it may be a listed building, be in a conservation area or a high profile location.  The long-stop period is to allow the landlord to evaluate the costs of reinstating, arrange funds to do so and obtain any necessary planning and other consents to the works.  The landlord will want to be able to do this safe in the knowledge that it will have a paying tenant in occupation as soon as the reinstatement works have completed.  The landlord will of course want as long as possible to decide whether or not it wishes to reinstate.  Understandably, the tenant will want certainty in determining how it will run its business going forward and will want the landlord’s election period to be as short as possible.

A well drafted uninsured risks clause (from the landlord’s point of view) would be limited to damage included in the list of insured risks but not covered by the landlord’s insurance policy due to insurance for the risk not being available from insurers at commercial rates.  However, tenants will want this widened to include any unforeseeable risks.

A prudent landlord will not want to be responsible for repairing minor damage caused by an uninsured risk and the uninsured risk clause should be qualified to only apply if there is substantial damage or where the damage prevents the tenant from using and occupying the property.  Of course, if the damage was caused by or because of the tenant it should not be allowed to terminate the lease. 

In conclusion, it is now standard practice for tenants to require a provision in leases in the event of damage to the property by an uninsured risk.  Landlords need to be careful to protect their capital investment by ensuring that they do not lose the tenant if the property is so damaged, but that they will be able to reinstate and have the tenant ready to move back in once the reinstatement works have completed.

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