Introduction
In the United States of America, the number of natural disasters has gradually increased. Most of the costliest disasters have resulted from hurricanes and terrorist attacks. Other major casualties have resulted from earthquakes, monsoons, tsunamis, and wildfires. The damage to business and property from these events substantially affects the lives and livelihoods of millions of Americans who look to their attorneys to protect them from the collateral effects of these disasters that occur on an irreparable scale. Inherent within the operation and management of a business and building comes the risk of unexpected and unpreventable outside elements. Nevertheless, informed businesses and building owners can save their businesses or properties from the financial and physical ruin attendant on any catastrophic disaster and also be better prepared to protect themselves in lease negotiations, as well as understand the scope of available insurance liability coverages and equally important but less-known insurance strategies.
It Takes More than an Informed Building Owner to Save the Nation on a Larger Scale
Not discussed extensively in this article are some observations that need to be given serious consideration by policy makers. First, the worst disasters occur where the existing structures are not built with the ability to withstand a major storm or other disaster. This is why some towns and cities can recover faster than others. The manner and way the real estate is built, combined with the sewage systems, roads, and overall urban structure and planning, separate the impact of the damage. One concrete example stems from information collected after Hurricane Irma in Florida. Almost 80 percent of the homes subjected to and able to sustain Irma’s highest winds were built after the adoption of Florida’s new building code (which was put in place after Floridians had experienced Hurricane Andrew’s wrath).[1] On the other hand, take, for example, Ocracoke, an Outer Banks island village located twenty-six miles off of the mainland coast of North Carolina. This island, which averages out at five feet above sea level, was overwhelmed by the wrath and ferocity of Hurricane Dorian’s previously unheard of seven-foot storm surge.[2] The omnipresent lack of protective infrastructure and flood-preventative measures throughout the sun-kissed, beautiful community of Ocracoke left this otherwise small, natural disaster susceptible island drowning and desolate in the aftermath of Hurricane Dorian.[3]
Second, people and businesses are rebuilding or building in areas that are most likely going to be targets again. Some of this rebuilding has been done well by taking the worst-case scenario and putting homes and businesses high enough in the sky so they will hopefully be able to survive the next Hurricane. Other rebuilding efforts, for example, those depending on highly vulnerable broken levees, should probably be condemned to avoid putting the real estate and its residents in peril. Governments need to make difficult decisions on when to stop challenging mother nature right up to the point where technology becomes incapable of protecting against the worst floods and natural disasters.
As New York lawyers, we spent over a hundred hours learning how New York prepares for the next natural and unnatural disasters. We were very impressed by many of the requirements for new construction that focused on rebuilding to withstand the next natural disaster. Second, without governmental prodding, many large property owners themselves undertook measures to get ready for the next storm by moving equipment to the roof and waterproofing the lower floors of the building. This is joined with the observations of how other large and small commercial buildings whose owners obviously have decided to do nothing to prepare for the next hurricane or a terrorist attack, thus putting design and profits ahead of prudential planning for any possible disaster.
Preparing Businesses and Building Owners to Better Protect Their Property When A Casualty Occurs
This article is limited to instructing businesses and building owners in how to best prepare for another disaster and the state of the law when such casualty strikes. Although this article is written for the nation, it has a focus on New York not only because of the authors’ residence but it is home to several unnatural disasters including the costliest casualty on record as well as another relatively recent natural disaster.
The catastrophes that struck New York City on the large scale, such as Superstorm Sandy and 9/11, or even the relatively smaller scale ones such as the 1993 World Trade Center bombing and the various construction crane collapses, furnish striking examples and counterexamples, for businesses and building owners, as to how to protect their cities, States, and property interests with proper preparation.
In dealing with catastrophes, businesses and building owners on the front lines fall into two categories; those who prepare for catastrophes and those who challenge or defend the adequacy of the preparations. Courts will evaluate whether a business or property owner is liable for a natural disaster’s damages based on its foreseeability. While the specific catastrophic events that occur continue to evolve with changing technologies and changing understandings of science, the doctrines around foreseeability of harm, assignment of risk, and drafting of documents to encapsulate this precognition have their roots in well-established common law.[4] While lease clauses can vary greatly state by state and yet remain of paramount importance in preparation for catastrophe, insurance policy clauses are, to a large extent, the same across the country and many states share the same rules of construction with respect to them.
Catastrophic events, such as the 9/11 terrorist attack at the World Trade Center and Hurricanes Harvey, Katrina, Ike, Rita, Wilma, and the resulting consequences that follow in their wake, also require businesses and building owners to be especially attentive to the insurance requirements of their property interests. Subsequent weather-related events, such as Hurricane Maria in the summer of 2017 and the widespread power outages that occurred during the 2017-2018 winter snow storms, show the continuing need for coverage against such hazards. Commercial property owners and commercial tenants require insurance coverage that offers effective protection against the next unforeseen disaster that will cause widespread damage and disruption to property and business. New York’s experience in dealing with such catastrophic events can offer much guidance on the coverage items that property and business owners, no matter where they are located, should seek from their insurers.
As is well illustrated in case law, both before and after 9/11 and Sandy, the coverage that property owners and commercial tenants purchase from insurance companies, against hazards that will cause a business to entirely shut down, either temporarily or permanently, may not necessarily offer the protection that the buyers understood they would receive. Commercial insurance policies invariably contain strict limitations or exclusions on the coverage that is actually provided – whether the damage suffered can be said to proximately result from terrorism, storms, fire, flood, electrical power outage, sewage backup, or governmental mandate. It is therefore extremely important for businesses building owners to be conversant with the basics of commercial insurance coverage.
By far, besides the most expensive disaster events are hurricanes, accounting for seven of the ten worst disasters,[5] although they are not as frequent as the most common disastrous events—tornadoes, flash floods, and winter storms. Thus, of all of these, the most important insurance considerations for businesses and building owners will relate to those most likely to require attention, hurricanes.
Buildings Deemed Foreseeable to and Vulnerable to Attack Have A Duty to Prevent Attacks
In re World Trade Center Bombing Litigation,[6] was focused on the duties owed by operators of facilities that attract international attention to prevent the facility being used as a terrorist target. It recognized that certain buildings and gatherings, perhaps best called “attractive targets,” are going to be more likely to attract terrorists and thus disaster than others, noting:
In the early 1980’s the Port Authority was aware of terrorist activities occurring in other areas of the world, and that the WTC, as a highly symbolic target, was vulnerable to terrorist attack. Terrorist bombings, including car bombs, were becoming more prevalent, not only in the world but in the United States as well. In fact, the Port Authority recognized that, in 1983-1984, two thirds of domestic terrorist incidents occurred in the New York- New Jersey metropolitan region.
This awareness, the court decided, placed a duty on the operators of the World Trade Center and indeed any attractive target to take heightened steps to prevent use of the facility as a focus of terrorist activity.
The decision in that case rested entirely on foreseeability.[7] While the case acknowledges that foreseeability is a question for the trier of fact, it discusses at great length the special duties of the operators of these attractive targets to take stronger steps to prevent the very kind of terrorist attacks that can obviously take place in such facilities. Indeed, the Port Authority had been specifically warned that its parking ramps where the attack litigated in this case did in fact take place were particularly vulnerable to the very kind of attack that took place in 1993. In the case of attractive targets, there is a duty to make reasonable efforts to prevent the catastrophe in the first place.
The decision focused on the actual site of the 1993 terror attack but discussed at length the specific warnings that the FBI had received of a skyscraper attack coming from across the Atlantic. New York City is full of large gatherings of people, perhaps most famously, Times Square on New Years Eve, but also major baseball and other professional sporting games. Under the teaching of In re World Trade Center, the sponsors of these activities, at least when they have been warned of a terrorist threat, are under duty to protect against that threat.[8]
Generally, a landowner or landlord, who holds its land open to the public, is under a legal duty to exercise reasonable care under the circumstances to maintain the premises in a reasonably safe condition.[9] The duty includes taking minimal security precautions against reasonably foreseeable criminal acts by third parties.[10] Accordingly, given the potential liability that could befall a property or business owner in the event of a catastrophic terrorist attack, it is incumbent upon every property or business owner to obtain insurance protection not only against their own property damage and potential loss of business income, but to also obtain appropriate levels of insurance protection against the potential liability that might be adjudged against them for failing to implement security measures that could have forestalled or prevented the terrorist act, or diminished the amount of injuries and damages it caused.
That same duty was not, however, breached in the 9/11 disaster, also at the World Trade Center. In a case arising out of that attack, Aegis Ins. Services, Inc. v. 7 World Trade Co[11], the Federal District Court refused recovery to Consolidated Edison for its facility being destroyed when part of the Trade Center was crushed, reciting the particulars of the events that led to the building collapse and holding it unforeseeable in that the owner of the building that collapsed was not found negligent. The Plaintiff was Aegis Insurance Services, Inc., an insurance company that had insured Consolidated Edison against this loss. One notes that while the District Court found the negligence claim far-fetched, the insurance carriers found the coverage issue sufficiently well-stated to pay on the claim. However, while affirming the District Court’s order, the Second Circuit[12] reasoned that the issue of foreseeability did not resolve the case as foreseeability only determines the scope of the duty. Rather, the determination that any negligence of the designers of the building was not, under the totality of the circumstances, the cause-in-fact of the Plaintiff’s loss. The court wrote, “A defendant’s conduct is not a cause-in-fact of an injury or loss if the injury or loss would have occurred regardless of the conduct.” Here the actual collapse was occasioned by the Fire Department of the City of New York having no water with which to subdue the blaze that caused the building to collapse, not any questions of building design. Thus, there was no recovery against the owner.
Generally, in New York’s law of negligence, in order to sustain recovery, there is a requirement that a defendant be found to have been lax in a duty to the plaintiff. When there is no such breach of duty, the case law frequently uses such terms as “the defendant is not an insurer.”[13] This, then is the key difference highlighted by this case. The owner of the property that collapsed due to a terror attack on another’s property was not an insurer of the latter; the insurance company was. Liability for the adjacent landowner had to be tied to a duty, a duty not including envisioning everything that could possibly go wrong outside of its control.
Although Standard Commercial Leases Compel Tenant to Bear Burdens of Non-Structural Repairs and Insurance, Other Grounds for Rent Abatement Exist
At common law, the conceptual model for a leasehold is essentially a temporary conveyance. New York’s highest court, the Court of Appeals explained in Park West Management Corp. v. Mitchell:[14]
- Under the traditional common law principles governing the landlord tenant relationship, a lease was regarded as a conveyance of an estate for a specified term and thus as a transfer of real property. Consequently, the duty the law imposed upon the lessor was satisfied when the legal right of possession was delivered to the lessee. The lessor impliedly warranted only the continued quiet enjoyment of the premises by the lessee. This covenant of quiet enjoyment was the only obligation imposed upon the landlord which was interdependent with the lessee’s covenant to pay rent. As long as the undisturbed right to possession of the premises remained in the tenant, regardless of the condition of the premises, the duty to pay rent remained unaffected.
While recent decades of statutory and case law development have made residential tenancies more a contract for services than a conveyance with abatements in rent commonplace, commercial leaseholds follow, only somewhat modified, the common law model.[15] Even to the extent that the common law of commercial leaseholds allows for abatement of rent, with rare exception, commercial leases can exempt landlords from nearly all assignments of risk.
Common and enforceable in commercial leases are not only various requirements that the tenant obtain various kinds of insurance on pain of eviction, but that the tenant’s recovery for risks described in the lease is limited to recovery from the insurance the lease requires the tenant to carry.[16]
For example, in the Maiden Lane Props., LLC v. Just Salad Partners LLC[17]lease, one clause provided, “[a]nything contained in Article 9 to the contrary, Tenant shall be solely responsible for the insurance for, and in the event of fire or other casualty, the reconstruction, replacement or repair of any damage…” Most such leases require provision of proof to the landlord of such insurance coverage and the failure to provide such proof is deemed sufficient violation of the lease to warrant eviction.[18]
In a standard lease,[19] the destruction of the premises generally completely relieves the tenant of the rent obligation, but in a triple net lease, the rent obligation endures notwithstanding such destruction. The tenant has taken on the risk of the destruction and the obligation to undo it. In Rodriguez v. Nachamie,[20]where the parties had allocated the risk of loss to the tenant in a building destroyed by fire, the Second Department held the tenant liable for the balance of the rent on the lease, explicitly finding nothing unconscionable in the parties’ risk allocation.
While in residential premises, there is a warranty of habitability,[21] no such law currently exists in the commercial context in New York. While Real Property Law § 227[22] allows both commercial and residential tenants to abandon the premises and the rent obligation in the event of the premises becoming “destroyed or so injured by the elements, or any other cause as to be untenantable, and unfit for occupancy,” it also expressly allows for written waiver of the statute.
However, standard leases do not eliminate the possibilities of either actual eviction or constructive eviction. If the landlord actually evicts the tenant from the entire property or a significant part of it without the tenant’s fault, under New York’s rule,[23] the tenant is forgiven the remaining rent on the lease.[24] However, there is no such abatement if the amount of space taken away from the tenant is de minimis.[25]
The Landlord’s Failure to Maintain the Premises to the Point of the Tenant’s Abandonment of Them Forgives the Rent
A tenant’s rent may also be abated by reason of “constructive eviction,” a situation in which the landlord’s upkeep of the premises is so badly performed that the tenant is compelled to abandon all or part of the premises. Key to the concept of constructive eviction, however, is fault on the part of the landlord. Mere happenstance is not fault. In Barash v. Pennsylvania Terminal Real Estate Corp.[26], the court wrote:
- To be an eviction, constructive or actual, there must be a wrongful act by the landlord which deprives the tenant of the beneficial enjoyment or actual possession of the demised premises. Of course, the tenant must have been deprived of something to which he was entitled under or by virtue of the lease….
- On the other hand, constructive eviction exists where, although there has been no physical expulsion or exclusion of the tenant, the landlord’s wrongful acts substantially and materially deprive the tenant of the beneficial use and enjoyment of the premises.
In Pacific Coast Silks, LLC v. 247 Realty, LLC,[27] the First Department wrote, “[t]o establish constructive eviction, a tenant need not prove physical expulsion, but must prove wrongful acts by the landlord.”
Thus, for a tenant to claim constructive eviction, mere casualty to the premises is insufficient. There must also be proof of the landlord’s wrongful acts. However, while the landlord may have been blameless in causing the injury to the premises, such as in a severe storm or a terrorist attack, the landlord’s failure to repair the premises after an innocent casualty is blameworthy enough to support a constructive eviction.
As we have seen, however, landlords do have the obligation to prevent foreseeable casualties, such as taking reasonable precautions to prevent a terrorist attack when such an attack is, in fact, foreseeable or even actually foreseen.[28]
Pacific Silks also refused to allow the tenant an abatement because, inter alia, the tenant did not give written notice of the defective condition as required by the lease. The court reasoned that the written notice was intended to give the opportunity to fix the situation and therefore that aspect of the lease was entitled to full enforcement.
In Manfra, Tordella & Brookes, Inc. V. 90 Broad Owner, LLC[29], Plaintiff-tenant’s theory is that the landlord was liable for neglecting to take supposedly reasonable precautions against flooding caused by Superstorm Sandy such as window boarding and sandbagging.
- Amongst the allegations of the complaint were:
- 32. “Because of its history of flooding and location in low lying Zone A, Defendant was well aware that 90 Broad in general, and MTB’s offices in Particular, were highly susceptible to flooding and would likely experience severe flooding in the event of a major storm, such as Hurricane Sandy.”
- 37. Defendant was thus fully aware and warned of the potential flooding that would occur as soon as Sandy made landfall. Despite this knowledge, and expectation of storm related flooding, Ms. Arce’s email did not include any information regarding any steps Defendant took or would take to prevent or at the very least, mitigate, the potential damage to the Building from storm related flooding.
The presence of this kind of lawsuit should remind landlords to purchase liability insurance insuring against liability for even the most exotic theories of liability. Regardless of whether tenants actually prevail in a suit such as this, the mere defense of the suit is an expensive proposition that could be funded by the insurer’s duty to defend. Clearly, the tenant should have insured itself and the suit, if any, should have sounded in subrogation.
Whether by Statute or Negotiation, Leases Must Contain Casualty Clauses Permitting Terminating The Lease After A Casualty
Many states have a legislatively produced casualty clause for leases which usually operates unless the parties agree otherwise. For example, New York has Real Property Law §227 states:
- § 227. When tenant may surrender premises. Where any building, which is leased or occupied, is destroyed or so injured by the elements, or any other cause as to be untenantable, and unfit for occupancy, and no express agreement to the contrary has been made in writing, the lessee or occupant may, if the destruction or injury occurred without his or her fault or neglect, quit and surrender possession of the leasehold premises, and of the land so leased or occupied; and he or she is not liable to pay to the lessor or owner, rent for the time subsequent to the surrender. Any rent paid in advance or which may have accrued by the terms of a lease or any other hiring shall be adjusted to the date of such surrender.
This statute applies both when there are written leases and when the tenancy is entirely oral. However, all commercially available lease forms and all properly drawn leases expand on the simple ideas in §227 so as to be more precise as to what does and does not trigger the tenant’s rights. A clause substituting the Casualty Clause for the statutory provision could read as follows:
- Tenant hereby, to the full extent allowed by the law, agrees that the provisions in this article shall govern and control in place of any statutes or other laws to the contrary.[30]
All well written commercial leases call for payment of rent without offset, counterclaim or defense and expressly refer to and waive RPL §227. Such clauses are enforceable.[31] However, tenants’ counsel negotiating such clauses will seek abatement of rent any time the building is rendered unusable, regardless of whether the building itself suffered a casualty or whether the neighborhood where the building is located suffered the casualty that had the effect of making the tenant’s space unusable for a time.
Properly drawn leases give landlords the option but not the requirement to terminate the lease in the event of a casualty. These clauses typically call for some very sensitive timing and may require the landlord to sit mute for a period while the tenant’s option to terminate expires. However, where the landlord is exercising its right of termination in spite of the tenant’s desire to resume operation after the catastrophic event, the tenant generally has no ability to contest the termination and can cover the damage to its business only with properly drawn insurance.
The tenant can procure a Loss of Leasehold Interest endorsement appended to its All Risk policy, using ISO form CP 00 60 06 95. Under this form, if the landlord terminates the lease by reason of a disaster, the insured will pay: (a) the “Net Leasehold Interest,” defined as the present value of the (i) monthly rental value of the premises minus (ii) the actual monthly rent and other amounts payable by the tenant (the present value will be determined by the rate of interest set out on a Schedule), plus (b) the unamortized portion of the tenant’s improvements and betterments that will be lost if the landlord terminates the lease (a normal property policy would cover damage to these improvements, but this endorsement will cover loss of the undamaged improvements if landlord terminates), and (c) the amount of any prepaid rent (amortized by the number of months remaining in the lease).
Despite Casualty, Courts Enforce Properly Drawn Lease Clauses Absolving A Landlord from Responsibility for Utility Failure
While practitioners debate the advantages and disadvantages of using preprinted commercial lease forms, such as those developed by the Real Estate Board of New York (REBNY), the meaning of clauses in many preprinted commercial leases have been developed through a common law-like construction by the courts; e.g., specifically, the casualty clause found in ¶9 of the REBNY leases.
New York’s leading case in all matters of lease construction, Vermont Teddy Bear,[32] specifically deals with the effect and use of ¶9 and its complex mechanism for suspending the rent or terminating the lease in the event of casualty.
However, neither ¶9, Vermont Teddy Bear nor any other New York case defines just what a casualty is. Rather, under the structures of ¶9, there is no casualty at least until one of the parties to the lease declares there to have been one.
In Maiden Lane Props., LLC v. Just Salad Partners LLC,[33] when a restaurant resisted paying its rent in the wake of Superstorm Sandy due to the failed electricity it suffered, the New York City Civil Court upheld and enforced a rider containing lease clauses absolving the landlord of responsibility for electricity. It recognized that often as a result of a widespread disaster, such as a hurricane, the loss of utilities to the property is no fault of the owner. Although usually electricity, it can be any utility, such as natural gas, water, telephone, internet, cable television, or even steam. The court ruled that where there is exculpatory language in the lease, releasing the landlord from responsibility for such a loss of utilities, the exculpatory language is to be enforced.
Maiden Lane’s lease language with respect to electricity is readily adaptable to any utility at all:
- Landlord shall not be liable to Tenant in any way for any interruption, curtailment or failure, or defect in the supply or character of electricity furnished to the demised premises by reason of any requirement, act or omission of Landlord or of any public utility or other company servicing the Building with electricity for any reason except Landlord’s gross negligence or willful misconduct.
- Landlord reserves the right to stop service of the electrical systems or facilities in the Building when necessary, by reason of accident or emergency, or for repairs in the judgment of the Landlord desirable or necessary to be made, until said repairs shall have been completed. Landlord shall have no responsibility or liability for interruption, curtailment or failure to supply electricity when prevented by any cause whatsoever reasonably beyond Landlord’s control or by reason of the conditions of supply and demand which have been or are affected by emergency. The exercise of such right or such failure by Landlord shall not constitute an actual or constructive eviction, in whole or in part, or entitled Tenant to any compensation or to any abatement or diminution of Rent or impose any liability upon Landlord by reason of interruption of Tenant’s business. Landlord shall not be liable to Tenant in any way for any interruption of any service furnished by any public utility.
While tenants might object to such a clause, they can offset its effects with the purchase of appropriate insurance.
Businesses Must Prepare for Disaster with Proper Insurance Policies in Place
Although insurance policies are nationally sold and can be purchased anywhere in the United States, property owners and businesses, in those States in which frequent Hurricanes and flooding occur, are going to purchase different policies than property owners and businesses in parts of the country that have never been devastated by a Hurricane, but which may be prone to Tornadoes or Terrorist Attacks. After Hurricane Katrina and the September 11, 2011 attacks a new menu of options have been offered.
Commercial properties and businesses require insurance protection offered to them in two broad categories: property insurance policies and business interruption insurance policies. Basic policies in both categories can and should be backed up by so-called “umbrella” policies with higher coverage for extra protection. Generally, the coverages for both property and business losses may be offered separately or combined in a single policy. In any event, the property or business owner seeking protection against the type of losses caused by potential catastrophic events requires more than the coverage normally contained in basic policies or in standard umbrella policies.
Basic “Property Insurance” generally covers damage to real property and other items related to real property, including buildings, fixtures, permanently installed machinery and equipment, and the materials and equipment used to maintain or service the real property. Basic coverage for “Contents Insurance” extends to basic business personal property, including furniture and fixtures, machinery and equipment, “stock,” and other personal property used in the business and located on the real property. In some cases, damage to the property of third parties may also be covered. Such basic policies do not protect the property or business owner against loss of business income, loss of rental income, or any extra expenses that would not have occurred, but for direct damage to the insured property or its physical loss resulting from the catastrophic event involved.
Standard Forms Allow for Uniform Interpretation
Effort should be made to obtain coverage for every conceivable property interest that the business or building owner may plausibly be said to have in the physical property specified in the policy.
The Insurance Services Office, Inc. is “[a]n organization that collects statistical data, promulgates rating information, develops standard policy forms, and files information with state regulators on behalf of insurance companies that purchase its services.”[34] These standard policy forms are national in scope and subject to a substantial body of case law interpreting them, although, as in all things, different states interpret identical language differently.
Policies taking advantage of these standards are built of two standard forms, The Building and Personal Property coverage form, and the Causes of Loss form. ISO form CP 00 10 10 12[35] is the Building and Personal Property Coverage Form, setting forth which property is covered. The form includes real personal property and lists these items with great specificity, including not only the insured’s own property, but those of others. The form is equally specific about items of personal property not covered, such as, for example, currency, paved surfaces, and contraband. It is important to recall, however, that these excluded items can be included by procuring coverage for those specific items the business needs to insure. Thus, for example, a private airport may well wish to obtain insurance protecting its paved surfaces.
The ISO Causes of Loss forms are more complicated. There are three choices, the Basic form, ISO form CP 10 10 10 12;[36] the Broad Form (which is anything but broad), ISO form CP 10 20 10 12;[37] and the Special Form, ISO form CP 10 30 10 12[38] (formerly and inaccurately known as “All Risk.”) These forms provide for more expansive coverage in ascending order. However, none of these general forms cover every possible peril and if there is a particular peril peculiar to a specific business, the business owner should be procuring insurance to cover that unusual peril. Counsel must also research whether the particular peril for which coverage is sought is insurable in the business’s home state.
Businesses and Building Owners Need to Consider What Property Is Covered Against What Hazards
A typical business policy should cover the replacement cost value of the building or office, including (a) coverage for the costs of demolition of the building, and (b) coverage for lost value of the undamaged portion of the building, if local ordinance or law requires the demolition of the undamaged portion of the building in addition to the damaged portion. The policy should also cover the increased cost of construction repairs or reconstruction that must be incurred to comply with current laws and ordinances; e.g., for sprinkler systems and/or electrical codes that were not in effect when the building was originally constructed.
Coverage for the replacement of the contents of the building or office should also be obtained, and such Contents Insurance policies should list all of the valuable contents separately, to avoid any “caps” on total insurer liability that might otherwise apply.
Loss of Business Income/Loss of Rental Value Insurance
The policy should insure against “all perils” or “all risks” (All Risks Policies). Policies that insure against specific “named perils” only, such as fire, flood, and electrical power loss, would not have coverage for damage caused by terrorism, war, “Act of God,” tornadoes, earthquake, or volcanic eruption, all of which have been excluded under basic policies. Nevertheless, the limitations and exclusions sections of “all perils” policies should be scrutinized to determine whether there are specified “perils” excluded from coverage that need to be covered for the particular business.
Where there is a business that is being conducted at a leased property, there has to be coverage for business income losses resulting from fires or other catastrophes affecting damage on the business. For a landlord, that will mean loss of rents, but the nature of the loss—loss of business—and the cause of the loss, a catastrophic event—is the same for both the landlord and the tenant and both need to be insured. However, along with the immediate loss of the business, there are likely to be additional expenses entailed and these too will require coverage, generally by means of an endorsement to the policy covering the physical loss.
In addition to the losses actually suffered, the standard form covers expenses for preventing further losses, except for those for extinguishing a fire. It also covers losses when civil authorities prohibit the business operator from accessing the covered premises.
Losses with respect to “Rental Value” receive considerable attention in the standard forms and will require that the forms be made out precisely to cover this, if it is an issue to the insured. Both the timing for covered periods and the kinds of physical events needed to trigger coverage require detailed reading of the policy. There are various options available to the insured and these will show up on the Declarations Page where they are either elected or omitted.
Business income/rental value insurance becomes a covered insurance loss and is payable only when there is physical damage to the insurer’s premises and physical property described in the policy’s declarations. Then it also has to qualify as an insured loss or “Covered Cause of Loss” as described in the property insurance policy. Loss of power from a utility company would not qualify as a covered event unless the direct damage from a utility pole or line exists.is not usually covered. So if a company cannot access its building or use its computers as a result of a loss of power, such would not qualify as an insurable business income loss.
Contingent Business Income Insurance should be purchased for business losses caused by damage to a key property such as a property relying on an anchor tenant which has been damaged or another structure that the business relies on to succeed.
Understanding Flood Insurance and Its Benefits and Inadequacies
Private companies must make their own preparations for catastrophes. Verizon rather spectacularly contracted with a Dutch company, hailing from a land renowned for its history of dealing with flooding issues, to develop a temporary dam to erect around its switching facilities if it has notice of an impending storm.
Standard insurance policies of the types we have been discussing do not cover damage from flooding or nearly any other water-based damage. Normally, one procures one’s flood insurance from the National Flood Insurance Program (NFIP), a federal program administered by FEMA, as more fully discussed below. While it does require the payment of premiums, the very design of the program is that it operates at a loss and, ultimately, receives tax-based support. As such, it is subject to the ups and downs of congressional and White House philosophy as to the extent to which it should figure in the federal budget and periodically comes up for renewal, as it recently received. Since it is not a profit-making venture, its premiums are also the subject of periodic congressional adjustment. One question constantly up for discussion before Congress is whether the premiums for a second casualty after there has been a previous payout should be higher than the original premiums. While the existence of the program itself remains politically popular, its funding is less so. Two ways Congress has of cutting its expense to the taxpayer are to increase its premiums and to reduce (or hold steady) the coverage it provides. Coverages under the program are only for actual cash value of a loss, rather than its replacements value and it does not provide for loss of business income or rent.
These policies cover $500,000 damage to a building and another $500,000 for damage to the building’s contents.
Under the program, maps are created setting forth the risk of flooding. Obviously, oceanfront property is mapped as the most flood-prone, but other less obvious areas can be as well, based on the peculiarities of their geography.
While flood insurance is obviously a good idea, many contracts require it. Landlords routinely require it in their leases. Lenders routinely require it in their mortgages, but in theory any business relationship could require the procurement of flood insurance.
Where the owner desires so or where there is a contractual obligation to procure higher limits on the insurance, there are insurers who will insure floods and other water casualties above the NFIP limits. Normally, these policies do not cover the NFIP limits (setting them as a deductible), but only the losses above those limits. Such policies normally do cover replacement cost and for losses of business income and rent. By reviewing the economic realities resulting from many of the stricken states, this amount of insurance offered only covers a small fraction of the cost to replace or repair.
Besides obtaining additional insurance from more expensive private markets, many businesses have decided to take action to protect their properties. For example, as noted above, Verizon rather spectacularly contracted with a Dutch company, hailing from a land renowned for its history of dealing with flooding issues, to develop a temporary dam to erect around its switching facilities if it has notice of an impending storm. Truly remarkable are the specifications for the wall:
- James M. Callahan, an engineer and a vice president of Arcadis, which designed the barrier, said the wall’s height was determined by the six-foot flooding that can be expected during a 100-year storm, plus two feet for storm surge, plus one foot to account for the anticipated rise of sea levels by 2050.[39]
Notably, Verizon assumes that by the middle of this century the seas will rise by another foot. The explanation is simple: “’We follow the science and act accordingly,’ said John M. Vazquez, at the time of this article, the senior vice president of Verizon for global real estate, human resources and administration.” [40]
Numerous developers have built newly constructed buildings and existing business and building owners have mitigated potential damages to its infrastructure by moving integral building systems to the top of the building to taking measures to weatherproof these structures.
Congressional Mandated Terrorism Insurance
To stabilize the insurance market after 9/11, Congress, in 2002, enacted the Terrorism Risk Insurance Act (“TRIA”) to guarantee the availability of insurance coverage against acts of international terrorism. Under TRIA, as amended by the Terrorism Risk Insurance Program Reauthorization Act of 2007 and the Terrorism Risk Insurance Program Reauthorization Act of 2015[41] (“TRIPRA”), insurers must offer coverage against such incidents and are reimbursed by the federal Government for paid claims subject to certain deductible and retention amounts. [42]
The Government share of compensation to be paid under TRIPRA to insurers, set originally at 85 percent for paid losses above an insurer’s individual deductible required to be paid in 2016, decreases on a declining scale of one percentage point, for each calendar year thereafter, until equal to 80 percent of the amount of the insurer’s paid losses in excess of the deductible it is required to pay in such calendar year. [43]
Currently, the Insurer Deductible set at 20% of an insurer’s direct earned premium and the federal share of compensation at 85 percent reduced by 1 percentage point per year since 2016 will be at 80% in 2021 and 81% in 2020 of insured losses that exceed insurance deductibles. [44] However, terrorism insurance will only be paid when the following occurs:
- The term is limited to violent acts dangerous to human life, property, or infrastructure, that have been certified by the Secretary of the Treasury in consultation with the Secretary of Homeland Security and;
- to have resulted in damage up to a maximum of $5,000,000, within the United States or outside the United States, and
- that have been “committed by an individual or individuals as part of an effort to coerce the civilian population of the United States or to influence the policy or affect the conduct of the United States Government by coercion.” [45]
As such, the Boston Marathon bombing was deemed to not qualify as an act of terrorism under the law. However, despite the terrorism exclusion clauses in their basic policies, insurers chose to pay many claims made for the personal injuries and property damage that resulted from that event.
There Is A Variety of Government-backed Insurance and Private Stand-Alone Insurance
Nevertheless, although terrorism coverage is an option for all property owners, TRIPRA’s narrow definition of “terrorism” is likely to discourage small property and business owners from opting to pay the higher premiums for terrorism coverage offered under TRIPRA. Alternatively, for organizations that insurers deem as “high risk,” so-called “stand-alone” terrorism coverage is offered by certain international insurers, on a worldwide basis — for a broad range of acts committed for political, religious or ideological purposes, not necessarily solely to influence the policy or conduct of the United States Government. One such company’s “terrorism” coverage includes not only traditional terrorism-type acts, but such actions as “active shooter,” “malicious attacks,” “sabotage,” and “nuclear, chemical, biological, and radiological (“NCBR”) attacks. Its policies for such terrorism events covers property damage, loss of business income, crisis management costs, additional security requirements, employee counseling, and public relations costs incurred. Price is based on a risk profile analysis, and coverage does not depend on government certification. When evaluating the coverage limitations imbedded in the TRIPRA program, property and business owners with substantial financial resources are likely to opt for stand-alone policies that offer greater and more certain protection against the variety of terrorist-type actions that the World has witnessed in recent years.
There Must Be Proof That the Hazard Was The “Dominant and Efficient Cause” Of the Damage
The hazard insured against must be the proximate cause of the damage, i.e., “that cause which is most nearly and essentially connected with the loss as its efficient cause.” For example, in Throgs Neck Bagels, supra, the Court explained that “the damage for which fire insurers are liable is not confined to loss by actual burning and consuming, but they are liable for all losses which are the immediate consequences of fire or burning, or for all losses of which fire is the proximate cause.” Nevertheless, the “concept of proximate cause when applied to insurance policies is a limited one. . . [and] the causation stops at the efficient physical cause of the loss, it does not trace events back to metaphysical beginnings.”[46] Accordingly, “[o]nly the most direct and obvious [efficient] cause should be looked to for purposes of the exclusionary clause.” [47] Therefore, if a flood causes a fire to occur in a building’s electrical system, fire would be the proximate cause of the resulting damage to the building and would be covered by fire insurance.
Unless the property or business owner’s policy insures against damage to the property originating outside the insured property, such as an interruption in utility supply service at the utility’s power plant or substation, recovery will be denied under a policy that covers only “direct physical loss of or damage to Covered Property at the premises caused by or resulting from any Covered Cause of loss.” Even when the policy does insure against potential interruption of utility service or water supply outside the insured’s premises, the policy is likely also to require that the utility or water company have suffered “direct physical damage” that caused the service interruption that damaged the insured. Whether or not coverage will be granted under such policy provisions is often hotly disputed by the insured and the insurer.
For example, in La Casa Di Arturo, Inc. d/b/a Arturo’s v. Tower Group, Inc.,[48] Hurricane Sandy caused a restaurant to sustain losses and damages for food spoilage, business interruption, inability to conduct plaintiff’s usual business, and loss of business income. It also alleged that, as a result of Sandy the restaurant remained for various times without electrical power, refrigeration and freezer use, and that it ceased operations from October 31, 2012 through November 3, 2012, with resulting alleged loss of business income. The insurer’s denial of coverage was upheld by the Court on the ground that the restaurant’s policy “expressly and unambiguously provided (a) that coverage for loss associated with power interruptions are limited to those that ‘result from direct physical loss or damage by a Covered Cause of loss” (italics added),and (b) that “damage caused directly or indirectly by [Water] is excluded [from coverage] regardless of any other cause or event that contributes concurrently or in any sequence to the loss.”
One Must Examine the Business Losses to Be Covered
The primary business losses incurred by property owners and business owners from catastrophic damage or destruction to property is loss of business income and loss of rental value. “The purpose of business interruption insurance is to indemnify the insured against losses arising from inability to continue normal business operation and functions due to the damage sustained as a result of the hazard insured against. In other words, the goal is to preserve the continuity of the insured’s earnings.” [49]
Coverage for business losses may be provided to the insured as part of policies issued to insure against ordinary property damage, environmental hazards, other specified hazards, or under “all perils” policies. The business losses insured against should include loss of business income not only due to the physical damage or destruction caused by the catastrophic event, whether terrorism, fire, explosion, wind or snow storm, hurricane, flood, or electrical power loss, but also attributable to any widespread trade disruption, or event cancellations required by the circumstances, and caused by the disaster generally. There should also be coverage for Contingent Business Interruption losses incurred due to the insured’s inability to receive essential inventory from its suppliers, or for losses incurred from its customers being unable to receive deliveries from the insured. Civil Authority Coverage should be obtained against losses necessarily resulting from building evacuations and/or destruction or mandated by governmental authority, both of which cause either the temporary suspension of business operations or their complete termination.
As noted in a different context above, business income interruption insurance policies generally include provisions requiring (a) that the business loss incurred be caused by a casualty that directly impacted the premises where the business was conducted, and (b) that the affected business show actual loss of profits during the time of incapacity until the time that restoration is completed. [50]
In Order for It to Be Covered, The Suspension of The Business Must Have Been Necessary
Business interruption policies typically insure against loss of business income sustained “due to the necessary suspension of your ‘operations’ during the ‘period of restoration.’” The New York State Appellate Division, First Department, has held that the plain meaning of this language is unambiguous and means exactly what it says: i.e., that in order to be eligible for business interruption coverage, there must be “a total interruption or cessation of operations.” [51]
In Duane Reade, Inc. v. St. Paul Fire & Marine Insurance Co.[52] , a case involving a Duane Reade drug store located at the World Trade Center that was totally destroyed in the 9/11, Duane Reade’s business interruption policy provided as follows:
- The measure of recovery or period of indemnity shall not exceed such length of time as would be required with the exercise of due diligence and dispatch to rebuild, repair, or replace such property that has been destroyed or damaged, and shall commence with the date of such destruction or damage and shall not be limited by the date of expiration of this policy.
The “Restoration Period” provision of the policy also required, “as soon as practicable after any loss,” that “the Assured shall resume complete or partial business operations and reduce or dispense with such additional charges and expense as are being incurred.”
- Duane Reade contended that the policy should be interpreted as providing that:
- The Restoration Period consists of the actual time period that would, or will, be required to restore Duane Reade’s operations to the kind, quality, and level which existed at the WTC Store prior to the terrorist attacks and that such Restoration Period is coterminous with the time necessary to rebuild the complex which will replace the World Trade Center.
The Court held (a) that Duane Reade’s proposed interpretation was without support in the text of the policy and was “manifestly unreasonable,” (b) that the Restoration Period was “the time it would take to rebuild, repair, or replace the WTC store itself, not the entire complex that once surrounded it, and (c) that “[o]nce Duane Reade could resume functionally equivalent operations in the location where its WTC store once stood, the Restoration Period would be at an end.” The federal court decision cited no New York case law but was nevertheless consistent with New York law.
In a similar situation, in Broad Street, supra, the property owner’s building located approximately three blocks away from the World Trade Center was completely shut down following the events of September 11, 2001 until September 18, 2001. Nevertheless, despite being able to permit its tenants to return to the building on the latter date, the property owner claimed coverage for rent abatements and rent reductions that it felt compelled to provide to tenants thereafter through September 30, 2002. Citing evidence that tenants had in fact returned to the building on September 18, 2001, the Court rejected the insured’s contention that “because it was unable to provide a habitable environment for its residents by September 18, it [could] not be considered to have resumed operations.”
The First Department of the Appellate Division of New York’s Supreme Court also rejected a similar World Trade Center claim from a property owner in Royal Indemnity Company v. Retail Brand Alliance, Inc. [53] , where a retail business was shut down following the September 11, 2001 events until September 12, 2002. The Court held that “[o]nce the store resumed operations on September 12, 2002, a year after the terrorist attack on the World Trade Center, the Business Income coverage terminated, regardless of whether the insured’s income was back up to pre-loss levels.”
Likewise, the Court had previously held (in a non-World Trade Center case) that, where Civil Authority had denied access to insured’s restaurant for two days, but permitted access thereafter, the insured could not recover lost business income when the restaurant reopened, even though vehicular and pedestrian traffic was diverted; “the restaurant was [still] accessible to the public, plaintiff’s employees and its vendors.” [54]
One Must Consider Business Loss Valuation and Deductibles
In Howard Stores, supra, the First Department explained that while the “losses payable under a business interruption policy are estimated based on ‘experience of the business before the catastrophe and its probable experience thereafter,’ the burden is on the insured to establish the extent of the damage caused by the interruption, and applicability of the policy thereto.” Measurement of damages by the insured’s “experience before the catastrophe” requires proof of the business income the insured would have realized if business operations had not been suspended. This is inherently speculative, and insurance companies often argue that, in the midst of the catastrophe, the insured could not expect to realize the same business it had before the event. There is no formula for calculating business interruption losses and no guideline to determine the “probable experience thereafter.” To eliminate unnecessary litigation over the measurement of damages, property and business owners should therefore attempt to include a formula in their business interruption policies that fixes a set per diem loss value for each day that their business is completely shut down by a future catastrophe.
Property and business owners also need to be attentive to the deductibles included in their business interruption policies. The policy may specify that the deductible will apply per occurrence, per event, per loss, or per claim. Consideration should be given also to the possibility of a dispute arising over whether the potential future catastrophe will constitute a single occurrence, or a series of catastrophic events occurring simultaneously. This issue was highlighted in World Trade Center Properties v. Hartford Fire Insurance Co.,[55] where the insured contended that the two airline crashes constituted two separate occurrences. The Court held that the two crashes were part of a single coordinated plan of attack and constituted “at the least, a ‘series of similar causes [as defined by the policy].”
The Amount Insured
There are three concepts that will govern how much the insurer will pay in the event of a loss: the limits set forth on the declarations page, the Actual Cash Value, and the Replacement Cost. The insured selects how much insurance to buy (the limits) or whether to use the lower Actual Cash Value of the property that is insured or the generally higher Replacement Cost. All of these factors will influence the amount of the premium. These numbers may be with reference to a single occurrence or aggregated if they are covering multiple properties. This concept was at the center of SR Int’l Bus. Ins. C. v. World Trade Ctr. Props., LLC. [56]
If the owner merely seeks to recover the loss, Actual Cash Value could suffice, but if the property owner is seeking to rebuild, either on the same site or elsewhere, the insurance coverage should be for the Replacement Cost. Of course, calculating what those costs would be can also be the subject of considerable controversy and litigation.
Contractual obligations may, however, essentially make the choice for the owner. This choice, most often, is indeed for Replacement Cost. Certainly, landlords requiring insurance of their tenants should require Replacement Cost. However, since insurers do not allow for profit to the insured from the insurance contract, if no actual replacement takes place, the insurer will only pay Actual Cash Value. Typically, the insurer starts by paying the Actual Cash Value and reimburses the Replacement Cost after the replacement has actually taken place.
However, “Replacement Cost” may be a tricky affair. Many policies include “sublimits” placing dollar figures on particular pieces of the replacement process. An underrun in the expense of one of these particular pieces will not allow an overrun on another. Thus, the insured will need good quality estimates of the projected expense for each of these sublimited items.
Coinsurance Penalties
Insurance companies are not naïve. Popular culture is full of awareness of insureds attempting to commit insurance fraud. The means of doing so are simple and crude—overstating the expense of the reconstruction. In order to fight this, the insurers have a few weapons at their disposal. One of the most important of these is the so-called “coinsurance penalty.” On its face, the penalty compels the insured to insure the entire cost of the rebuilding. The standard forms (such as ISO form CP 00 10 12) establish a so-called “coinsurance percentage” of the Actual Cash Value or of the Replacement Cost, as the insured has elected. Typical coinsurance percentages are 80% or 90%.
The first question for the penalty to come into play is whether the insured limit the owner purchased reaches a certain threshold. If the insurance limits the insured bought were below the “coinsurance percentage” of the Replacement Cost (or, if Actual Cash Value was selected, then of that amount), then the coinsurance penalty comes into play. For example, if the insured bought $50,000 of insurance on a $100,000 building, it is below the coinsurance percentage of (for example) $80,000. Thus, the penalty comes into play. Note that this question is without regard to the loss the owner actually suffered. The underinsurance reduces the recovery for the loss even if the insurance purchased was in an amount greater than the actual loss.
This invokes the formula for the actual penalty, a completely mathematical calculation. It is as follows:
- Take the actual Replacement Cost and multiply it by the “coinsurance percentage”. This gives rise to what we will call the “Insured Replacement Cost.”
- Divide the purchased limits of coverage by the Insured Replacement Cost, providing a fraction we will call the “Insured Replacement Percentage.”
- Multiply the actual loss by the Insured Replacement Percentage to create a dollar figure we will call the “Insured Actual Loss.”
- Deduct from the Insured Actual Loss the policy’s agreed deductible to arrive at a number we will call the “Penalized Loss Payment.”
Thus, owner receives from the insurance company the lesser of the purchased limits or the “Penalized Loss Payment.”
However, the insured can protect against this entire system by either fully insuring the building or accurately estimating Replacement Cost or Actual Cash value.
The insured can avoid the system altogether by using a so-called “Agreed Value Endorsement” which waives the coinsurance clause and replaces it with an ironclad agreement on what the value of the building is, regardless of the on the ground reality. The insured and insurer reset these Agreed Value Endorsements each year.
Where a landlord is requiring insurance of a tenant, the landlord should always insist upon an Agreed Value Endorsement with waiver of the coinsurance penalty.
Court Cases Presenting Additional Flood Insurance Issues
As stated above in brief, since 1968, protection against flood damage, for “business properties which are owned or leased and operated by small business concerns,” has been covered primarily under the federal National Flood Insurance Program (NFIP). [57] The Federal Emergency Management Agency (FEMA) administers NFIP which was established to make flood insurance mandatory for those properties located in areas of special flood hazard, i.e., any area subject to a one percent or greater chance of flooding in any given year as determined by FEMA. Over the years, the NFIP has been amended several times to extend the program for relatively short periods of time. On December 21, 2018, Congress reauthorized the NFIP through May 31, 2019. On June 6, 2019, the President signed legislation extending the NFIP to September 30, 2019, and on September 27, 2019, the President again signed legislation extending the NFIP to November 21, 2019. While there is a desire to enact legislation extending the program for a longer duration, Congress has lacked the collective will to achieve that goal.
More specifically, flood zones are land areas categorized by FEMA according to their degree of risk of flooding. Based on the flood risk, zones are classified as A (100-year flood risk), V (100-year flood risk with additional hazards associated with storm-induced waves), Coastal A (an area landward of a V zone, or landward of an open coast without mapped V zones, where the principal source of flooding will be astronomical tides, storm surges, seiches, or tsunamis, but not riverine flooding), and Shaded X (an area that has an 0.2% probability of flooding every year. Zone A is an area not subject to high velocity waves, but subject to flooding for a 1% chance per year.
Under NFIP, commercial property owners and businesses are eligible for flood insurance coverage up to $500,000. [58] Flood insurance is also available from private insurers who can offer higher levels of coverage. Claims for both property losses and business income losses may result from a flood catastrophe. Flood insurance exclusions need to be carefully scrutinized, as they are often ambiguous and lead to litigation over what coverage was intended. [59]
As noted in the discussion above regarding La Casa Di Arturo, Inc. d/b/a Arturo’s v. Tower Group, Inc., [60] the policy in that case expressly excluded coverage for damage caused by water, and the resulting damage the restaurant suffered from flood waters generated by Hurricane Sandy was not covered.
Sandy generated many possible causes of loss: wind, wind-driven rain, storm surge, flooding, power outages, orders by civil authority, and looting. In some cases, more than one of these conditions were associated with an insured’s losses.
The definition of “flood” in policies may vary significantly from insurer to insurer and from policy to policy. One policy may define “flood” as meaning “rising water, surface water, waves, tidal water, tidal wave, or tsunami; rising, overflowing or any breach of streams, rivers, lakes, reservoirs, or other bodies of water; or spray from any of the foregoing, all whether driven by wind or not.” Some policies may not include the phrase “whether driven by wind or not.” In addition, some policies may include a definition for “high hazard flood zones.”
Other unique issues arose from Sandy’s devastation. In Pietrangelo v. S&E Customize It Auto Corp., [61] the plaintiff had left her car at defendant’s motor vehicle repair shop before Sandy hit the New York City area. The defendant’s carrier disclaimed liability for damage to the car that was “totaled” as a result of significant flooding of the defendant’s repair shop. The plaintiff’s auto liability carrier paid the plaintiff the total value of the car, less a $1,000 deductible. The defendant refused to pay the $1,000 differential to plaintiff and plaintiff sued defendant in Small Claims Court. The issue the Court ruled upon was whether defendant had been negligent in not procuring flood insurance. The Court ruled that the law of bailments applied to the case, and that “it is not negligence for a bailee such as defendant to fail to carry insurance to cover the bailor’s property.” The Court further ruled that, in the absence of liability under the law of bailments, it was still defendant’s burden under the common law to establish a non-negligent cause for the damage to plaintiff’s property, and the Court ruled that Sandy, a “hurricane/superstorm” was an “act of nature” that relieved defendant of any liability.
National studies have shown that it is common for persons to go without flood insurance. For example, with Hurricane Harvey, that number, with regard to homeowners, is estimated at about 80% of the victims not having been insured. [62]
Elite Catering Company, Inc. v. National Specialty Insurance Co., [63] involved a similar situation, where the plaintiff catering company suffered extensive property damage, food spoilage, and loss of business income from the impact of Hurricane Sandy. Plaintiff alleged that when its principals returned to the premises on the day after the storm, they found the restaurant filled with refuse from a sewer backup that occurred during the storm. A claim was filed but was denied by the insurer-defendant on the ground that all the alleged damages were the result of “flooding,” a circumstance expressly excluded from coverage under the policy. Plaintiff sued. The issue that arose was whether the special additional rider plaintiff had purchased, as protection for sewer back-up, was overridden by the policy provision that excluded coverage “for covered losses if those losses were occasioned, even in part, by uncovered causes, i.e., that damages caused by a combination of uncovered losses (e.g., flood) and covered losses (e.g., a sewer back-up) rendered the entire loss non-compensable.”
The Court concluded that it was unable to find, as a matter of law,
- [w]hether the facial inconsistency in policy language . . . i.e., where the terms of a separately-purchased rider providing additional coverage for damages by, e.g., a sewer back-up, and the “anti-concurrent causation” exclusion upon which [insurer] relies, is subject to “no other reasonable interpretation, when read together [with the failure to purchase flood insurance], other than to exclude coverage for all losses caused by any combination of covered and non-covered occurrences”, or represents, e.g., a trap into which an “average insured” might fall as a result of the purchase of additional coverage specifically written to cover sewer and drain back-ups.” (Emphasis added).
When the Covered Person and the Purchaser of the Insurance Are Not the Same Person
Leases have various ways of reducing the insurance expense the landlord will bear. These include clauses prohibiting the tenant from taking actions that will increase the landlord’s insurance expense, a clause which receives relatively rare enforcement, compared to the other insurance clauses one finds in leases. By far, the more important clauses are those in which the lease obliges the tenant to procure insurance at the tenant’s expense that will, in some manner either pay the landlord directly for losses suffered during a casualty or provide funding for the tenant’s compulsory repair of the casualty. Obviously, the landlord is least secured by any scheme by which the tenant gets the funds and is merely obliged to spend them on the repairs.
Further, there can be allocation issues where the tenant’s insurance covers more than one location, sustains a loss at both, but the landlord is only the owner of one of those locations.
The first level of protection the landlord must write into the lease is that the insurance must be for replacement cost rather than for current actual value. Such lease should not allow such a policy to have anything more than a minimal deductible. Further, the policy must name the landlord as an additional insured and loss payee.
Where the tenant is purchasing the insurance, the policy will, at most, name the landlord as an additional insured and loss payee. However, some tenants bargain for giving the landlord only the status of additional insured.
All of these entail risks for the landlord as, in spite of the fact that the lease has a do-nothing-to-hurt-the-insurance clause, if the tenant does do something to hurt the insurance, this will likely only come to light after sustaining a loss and it is cold comfort to the landlord who could have evicted for the breach. The whole reason to insist on the insurance in the first place was the probably justified belief that the tenant itself would not have sufficient financial resources to cover the landlord’s loss. While there are proofs that the tenant acquired the insurance, generally landlords do not receive notification that that insurance is canceled or worse, that the insurance is in effect, but useless because the tenant is out of compliance with its requirements. However, in ISO form CP 12 18 10 12 insurers undertake to inform the loss payee of cancellation of the insurance policy with a ten day notice if the reason for cancellation is nonpayment and a thirty day notice if the reason for cancellation is anything else. That same form also indicates that the insurance company will pay the claims to the landlord and the tenant, “as interests may appear.” This is, of course, an invitation to litigation, but it does at least allow for the ongoing question about the tenant recovering for what it has physically invested in the property itself. The landlord and tenant may, however, resolve their differences about how their interests appear by a contract defining such, meaning normally, within the lease itself.
The ISO form for additional insureds, CP 12 19 06 07, contains only one operative sentence. It reads, “The building owner identified in this endorsement is a Named Insured, but only with respect to the coverage provided under this Coverage Part or Policy for direct physical loss or damage to the building(s) described in the Schedule.” Note that it does not call for the additional insured to be informed of any lapses in coverage. As we have noted, it does not call for much at all, and the rights it confers on the landlord are skeletal at best.
Proof of Insurance and Securing Important Documents and Contracts
The most common “proof” of insurance is also the most useless and, one could argue, worse than useless, as laypersons and sophisticated business and building owners alike treat Certificates of Insurance as if they mean something. The forms in question are the ubiquitous ACORD forms 25 and 27, respectively the Certificate of Liability Insurance and the Evidence of Property Insurance. On their faces, they state that they do not bind the insurance company. The first sentence of each form states, “This (document) is issued as a matter of information only and confers no rights upon the certificate holder.” Indeed, in common practice, the lowest level of clerk in an insurance brokerage issues these forms and anecdotes abound of these forms being issued without any actual policy in place behind them. A landlord looking for genuine proof should settle for nothing less than a certified copy of the complete policies.
Further, these documents make no undertaking that the landlord will be informed of cancellations. Only the actual policy can do that, reason enough for the landlord to want to see a certified copy of the actual policy, together with all of its endorsements. When casualty hits it may become very difficult to find the original documents that exist in a perfect world. But a few precautions should be taken. An original of all insurance policies, leases, maintenance contracts and any other important information should be placed in a safe deposit box far away from the property being protected. Also, these documents should also be placed in the internet hemisphere, backed up so they can be reached despite the destruction or loss of documents as a result of casualty. With this information in the safe deposit box, in another office, and the internet hemisphere along with a list of contact people to contact from the insurance broker to your lawyer to the landlord listed on paper assuming that the internet does not work, you have started a preparation process that should be continuous added to as your client’s business and the world changes.
Conclusion
The life of a human, the life of a building, the life of a society is an endless concatenation of discrete events, many of which, in their own right are highly unlikely events. The unexpected will occur; no one will experience a life made up solely of utterly predictable events. The vagaries of the weather are, for most human beings, mere metaphors for the utterly predictable nature of an unpredictable life. But for businesses and building owners, the weather along with tectonic forces, rebellions, insurrections, and acts of terror are of the very fabric of events for which citizens must be prepared, but rather for which they have written the mechanisms that already demonstrate the preparations in place, ready predictably to spring into action when the unpredictable actually happens. Documents must be clear and concise, giving absolute certainty in enabling your business and property to cope with omnipresent uncertainty.
Cities and states that build better structures, have stronger building codes, and are governed by stronger documents, when suffering catastrophic losses, more rapidly get back on their feet. Haiti and Puerto Rico are unfortunate examples of everything that can go wrong both in superstructure and infrastructure. New York City, by contrast, rose from the challenges of weather and terror to create a modernized gleaming downtown financial district. It owes its success to the preparations made in the wake of earlier disaster. Our duty as citizens serving the nation and protecting our society as a whole is to support the physical structures with strong preparation and knowledge, as legal dikes against the storms of adversity.
* Adam Leitman Bailey is the Founding Partner and Messrs. Desiderio and Treiman are partners, Mr. Desiderio chairing the Real Estate Litigation Group and Mr. Treiman chairing the Landlord-Tenant Group in New York City based real estate law firm, Adam Leitman Bailey, P.C. The authors wish to acknowledge the invaluable contributions in research for this article by William Pekarsky, a former summer associate, whose admission to the bar is currently pending, and who is presently with the firm.
