Understanding Your Commercial Lease: Damages, Destruction, and Business Interruption
This latest post in the Understanding Your Commercial Lease series discusses damages, destruction, and business interruption. The damages and destruction provisions of your commercial lease will detail who (between the tenant and landlord) will be responsible for damages to (or destruction of) the premises, the building, and the entire real estate complex. Business interruption is often closely associated with damages and destruction as those events often interrupt the tenant’s business, but business interruption can also come about in the context of repairs, maintenance, and utility-related issues. The language in your commercial lease that discusses “smaller” damages is often included in the repairs section of the lease, and the destruction clause (sometimes called the “casualty” clause) will generally cover major damages.
Damages clauses that cover the “smaller” or minor damage issues normally start out pretty straight-forward—the tenant is generally going to be responsible for damages to the premises, the landlord is generally going to be responsible for damages to anywhere else in the complex unless those damages are caused by the tenant or by anybody that the tenant invites onto the premises (an invitee or guest). But this allocation of risk for damages is not always the case, and you want to make sure that you examine the damages clause in your lease carefully. You’ll also want to ensure that you detail in the lease what defines the “premises” and how to account for damages to things like exterior walls and glass, as those areas are often a “gray area” in terms of who is responsible for damages.
Damages can come from a number of different places. Sometimes damages are caused by neither the tenant nor the landlord, and those type of damages are the damages generally specifically addressed with the typical lease language. But often, the damages are caused by the landlord or the tenant (or more specifically, someone acting on behalf of the landlord or tenant or invited onto the property by the tenant). The landlord will often be responsible for damages to the property that are outside the premises, but only if the tenant is not at fault (and if the tenant’s invitees are not at fault) for that damage. The landlord should also be responsible for damages it causes regardless of whether the damages are in the tenant’s premises (but generally the landlord is not liable unless the tenant negotiates for it). So who actually causes the damage can make a significant difference in who is responsible for paying to repair the damage.
Destruction clauses (sometimes referred to as “casualty clauses”) are similar to damages clauses, but destruction is generally those damages that are so major that they make the premises entirely or partially “uninhabitable” by the tenant. Destruction clauses describe what happens if something serious damages the building—for example, a fire, an earthquake, or similar event. Often, destruction clauses provide that the landlord will have some discretion in deciding what to do if the building is seriously damaged (even if the tenant’s specific premises may not be damaged at all). The lease will generally make a distinction between partial and complete destruction of the premises (and if it doesn’t, it probably should).
If there is total destruction of the building, the landlord will generally have the option of replacing the premises within a certain period of time or terminating the lease. Often, the landlord will make any requirement to repair or replace the premises dependent on collecting insurance proceeds. So the landlord generally won’t be responsible for rebuilding the premises unless they actually collect insurance proceeds that would pay for it. For total destruction, the tenant will ideally have an option to terminate the lease. A tenant with a lot of bargaining power may be able to dictate what the landlord must do in the event of total destruction (that is, rebuild or terminate the lease).
If there is partial destruction of the building, the landlord will generally be obligated to fix the damage, subject to certain exceptions (generally that it won’t cost more than a certain amount or take more than a certain amount of time). The tenant will generally be obligated to continue with the lease and wait out the repairs regardless of whether the tenant might want to terminate the lease.
Destruction clauses are not often heavily negotiated, though there are often negotiations around timing of notice and repairs. The tenant wants to make sure they at least have the right to know what’s going to happen with the premises within a short period of time after the casualty event. The tenant will also want to make sure that they’re not obligated to the lease for an open-ended period of time (even if rent is abated while the premises is being repaired). Often the tenant will be required to wait at least 180 days for the premises to be rebuilt. At some point the tenant needs to be able to move on from the lease, so the tenant will generally want the lease to provide for a specific and limited period of time that the tenant will wait for the landlord to rebuild after major destruction.
There will often be an abatement of rent, meaning rent won’t be due, in proportion to the amount of premises that the tenant is not able to use. So if there is a fire or some other destruction that only damages a certain part of the premises, the landlord will collect rent for the portion of the premises that’s not damaged and the landlord will be responsible for rebuilding the portion of premises that is damaged. As long as the tenant is not using that portion of the premises while it’s being rebuilt, then the tenant will not pay rent on that portion of the premises. For many businesses, this will be an important term to negotiate because the landlord’s idea of usable space may be different from the tenant’s idea, and some tenant’s may not be able or willing to operate unless they have full use of the entire space.
How damages and destruction are addressed in the lease is also impacted by the insurance provisions of the lease. Landlords will almost always require tenants to insure the premises against damages and destruction, and landlords will also often require the tenant to pay for the landlord to insure all other parts of the building against damages (through the operating expense pass through provisions of the lease). Landlords will also require that in certain situations, including if the tenant decides to terminate the lease after a casualty event, the tenant will assign its insurance proceeds to the landlord.
When considering damages or destruction (and also with respect to utilities, which we talked about in our last post), the tenant will want to address business interruption. Business interruption issues often arise when the landlord needs to make a repair to the common areas near the premises and because of access issues or because of where the repair needs to be made, the landlord’s work interrupts the tenant’s business. Business interruption in the context of utilities often arises when there’s a problem with utility service that prevents the tenant from operating its business. For example, if the tenant doesn’t have electricity for lights or gas service for its cooking appliances.
Generally, the tenant is responsible for any business interruption unless it is specifically negotiated otherwise in the lease. And generally the tenant is required to carry business interruption insurance. If there is an issue with the tenant’s access to its space, the tenant would look to that business interruption insurance to make the tenant whole for the business interruption. Often, that’s the tenant’s only option for dealing with damages for business interruption.
But a savvy tenant will want to negotiate for the landlord to pay for damages associated with any business interruption caused by the landlord’s negligence or misconduct.