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Insurable Interest in Property.

Contracts can be the bane of a risk manager's existence. The lawyers who draw them up want to apportion the risk of loss among the parties, and that's a legitimate objective. Lawyers, however, very often know little about insurance and risk management, and they sometimes write impractical requirements into contracts.

Take for example a lease of premises that shifts part of the risk of loss to the leased property from the landlord to the tenant. That's not unusual. But risk managers know that there are some rules leases should follow. The lease we're talking about breaks those rules right and left. First, the lease holds the tenant responsible for damage to any improvements or alterations to any part of the premises. That obligation applies whether the tenant, the landlord or another tenant made the improvements or alterations.

It also applies to improvements required by law, specifically including the Americans with Disabilities Act. The lease goes on to make the tenant responsible for certain building items, including the roof, windows, and the plumbing, sprinkler and heating, ventilating and air conditioning systems. As if that were not enough, the lease provides for the landlord to insure the building against loss.

Some of the lease provisions, like splitting responsibility for parts of the building, are exceptional for any lease. They are what experts have become fond of calling anomalous. That's one way of saying they have no place in a well-written lease. A lot of them, on the other hand, are not unusual in a lease, but they usually appear only in a general or net lease that puts the tenant in the landlord's place. They also go hand in glove with a requirement for the tenant to insure the building.

That's not the case here. The tenant leases a portion of the building and does not control the entire premises. The landlord retains control over many of the items for which the tenant assumes responsibility under the lease.

That raises two questions in the risk manager's mind. The first is whether the tenant has an insurable interest in the property. Assuming that the tenant does, the risk manager wants to know how you go about insuring them.

The answer to the first question is simple, but not helpful. The tenant stands to suffer a loss from the occurrence of an event that damages any of the property named in the lease. That's enough to support an insurable interest, no matter who else holds an insurable interest in the same property. The landlord owns the property, and can insure it. Other tenants have an insurable interest in improvements and betterments they have made, and can insure them. None of that destroys the tenant's insurable interest created by the lease, so there's no legal barrier to insuring them.

Finding the coverage is a whole different story. The lease requires the landlord to insure the building, except for things like the roof, windows, plumbing, fire sprinklers and HVAC system that the tenant has to insure. The lease divides responsibility for insuring one piece of property between two parties, and does a very sloppy job of making the distinction. It also puts responsibility on the tenant for buying insurance that is customarily added on to the insurance the landlord has to buy. For some tenants that would not be an insurmountable problem, but those tenants probably have the resources to absorb those losses without insurance. The tenants who really need the coverage are going to have trouble persuading an underwriter to write it.

There's a lesson to be learned from this unfortunately true story. Risk managers need to have procedures in place to review all contracts before their organizations sign them. Beyond needing those procedures, they have to follow them. There's an organization out there that can't live with the lease it signed. Correcting that problem is the risk manager's job, and the only time to do that job effectively is before the lease is signed.

Joseph F. Mangan is a consultant in Scotch Plains, N.J.
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Copyright 2001 Gale, Cengage Learning. All rights reserved.

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Publication:Risk & Insurance
Date:Jan 1, 2001
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