Understanding Your Commercial Lease: Insurance, Subrogation, and Indemnification
In this latest post in the Understanding Your Commercial Lease series we’re going to discuss insurance, subrogation, and indemnification. (Subrogation will often be grouped under the insurance provision in your lease.) The insurance, subrogation, and indemnification provisions of your commercial lease allocate risk between the landlord and the tenant (and each of their insurers).
In nearly every commercial lease you will find robust insurance requirements for the tenant that are mandated by the landlord. The tenant is going to be required to pay for insurance that will include general liability insurance, property damage insurance for the tenant’s property, business interruption insurance, automobile liability insurance, worker’s compensation insurance, and then often an umbrella policy. The landlord will often ask the tenant for insurance the tenant would probably not otherwise have in place.
The insurance provision in your commercial lease is going to detail what insurance is required to be carried, what the limits are, and whether the insurance is on an “occurrence” or on a “claims made” basis, among other requirements. The insurance provision will also cover what type of insurer is acceptable, and generally a landlord is going to require a high-quality insurance company. They’ll have specific requirements for the type of insurer including what their rating is. AM Best is an insurance rating organization whose standard is often referenced.
The tenant will not typically negotiate the insurance provisions of a commercial lease heavily. But it’s something that you’ll definitely want to discuss with an insurance broker to make sure that you understand what you’re required to cover, what the cost is, and how to ensure your policy meets the requirements of your lease.
As the value of the lease goes up, tenant’s may be able to assert more control over the insurance provisions. Tenants may be able to negotiate for lower limits, higher deductibles, to remove ancillary insurance requirements, or for the landlord to carry certain types of insurance.
Insurance is one of the most important provisions in the lease, because so much of the risk in a lease is defined and allocated through the insurance policy. But most insurance provisions are fairly uniform in their drafting and application, so the major work is simply understanding your rights and responsibilities under the insurance clause in your particular lease and how much it will cost you to comply. (Tenants with particularly hazardous businesses or businesses that deal with hazardous materials should be particularly aware of the requirements of the insurance clause in their commercial lease.)
Subrogation is an issue that arises in the insurance context of your commercial lease and warrants particular discussion. Subrogation is basically the idea that if there is an insurable event that’s caused by one party—say that there’s destruction to the premises and it’s caused by the tenant—then the landlord’s insurer can pay the landlord and then step into the landlord’s shoes to sue the tenant to collect damages for the destruction.
By waiving subrogation (which is what we generally talk about in the context of a commercial lease), the tenant and landlord agree that their insurance companies cannot step into the other party’s shoes and sue the party who may have caused the damages. By doing so, each party (subject to some potential exclusions) knows that, at least up to the insurance limit, they’re not going to be directly responsible for anything major that happens to the premises. Because there are some exceptions and because these can be cleverly (or ignorantly) written by landlords to allow the landlord’s insurance to argue a way out of the waiver, you’ll want to ensure you understand the impact of the subrogation related clause in your particular lease.
Indemnification is another issue you’ll encounter in virtually every professionally drafted commercial lease. Indemnification is the allocation of risk much like insurance. Indemnification provisions detail who’s responsible for paying for the defense and other damages if a third party sues one party (for example, the tenant) based on the acts of another (for example, the landlord). By way of example, a customer comes onto the property, trips on the sidewalk coming in, and decides to sue. The tenant’s customer sues the landlord because the landlord is the building owner with unsafe sidewalks (and presumably deep pockets) and the tenant because the tenant invited the customer to a store it knew or should have known had unsafe sidewalks. The indemnification clause, in conjunction with the insurance clause, would detail who is responsible to defend the lawsuit and who pays for any damages sustained.
Generally, indemnification clauses in commercial leases are written so that the tenant will protect the landlord from almost anything, and the landlord will protect the tenant from nothing (or just about nothing). The tenant should consider whether the landlord should be responsible for indemnifying the tenant for damages associated with the landlord’s breach of the commercial lease, negligence, or intentional act. Indemnification clauses in commercial leases can be very valuable to tenants and should be thoroughly considered as a part of the review of any commercial lease. “Do-it-yourselfers” should be particularly aware when trying to draft and negotiate indemnification clauses, as these clauses are generally as complex as they are important.
When reviewing the insurance, subrogation, and indemnification clauses in your lease, it pays to reference the damage, destruction, and business interruption clauses as well.