Is a more pragmatic approach to legal indemnity insurance required? asks Peter Sugden
For many years legal indemnity insurance has been used in property deals to address perceived title risks. The insurance market has provided a valuable service to the real estate sector by offering a broad and growing range of products.
Generally, the range of cover available has kept pace with changes in the property market and its regulatory and legal landscape. Policies protect against risks ranging from the commonplace (such as historic restrictive covenants) to the obscure (such as a freehold interest being forfeited under the Reverter of School Sites Act 1987).
To some extent this has been driven by market forces. The insurance market is increasingly competitive, so the range of products and premiums that its customers are prepared to spend money on grows. In many ways that market is functioning properly in that property insurance is being used more frequently as a matter of course. Indeed, in some sectors policies are increasingly viewed as an inevitable component of an acquisition. For example, chancel repair liability searches are now carried out routinely and, equally routinely, search results revealing a potential risk are usually now presented alongside a competitively priced insurance option.
This partly reflects that, nowadays, the vast majority of lenders are understandably risk-averse. For example, the Council of Mortgage Lenders’ UK Finance Mortgage Lenders’ Handbook tells residential conveyancers that if a property is subject to a restrictive covenant then “if you are unable to provide an unqualified certificate of title as a result of the risk of enforceability, you must ensure that indemnity insurance is in place at completion of our mortgage”.
However, there is an element to which increased perception of risk is of commercial benefit to insurers in increasing the volume of policies taken out. Chancel insurance, which did not exist 15 years ago, with its “reasonable” premiums, could be seen from that perspective.
Restrictive covenants context
Another perspective is to question whether the increased use of insurance in commercial property transactions is now creating a self-generating market? Are lenders’ lawyers now requiring cover as a reflex response to any risk, no matter how small and how remote the prospect of actual loss?
Take, for example, a Victorian covenant preventing the use of land for anything other than as a school, where the school was long-since demolished and replaced with offices, and it is inconceivable that the covenant could or would be enforced. Even in such a situation the default response of a lender’s lawyer is to insist that the borrower obtain insurance. Some may say it is best to err on the side of caution – since such policies are so readily available and so frequently used, why not “go with the flow” and just get cover?
This is fine up to a point – save for the fact that the borrower is left to pick up the tab. Yes, the premium will undoubtedly reflect the risk (or lack thereof) but no matter how commercially reasonable the cost of the premium, it is still a material and frequently unnecessary expense. Instead of using their legal training to advise their lender client that the covenant poses no risk, the lender’s lawyer has hidden behind the insurance policy simply because that is an acceptable – and easy – option.
Forfeiture context
Another example of a developing policy offering concerns the risk of forfeiture. Many long commercial leasehold interests are actually subtenancies. Above it could be a headlease at a peppercorn rent of a larger area with hundreds of years left to run and a freeholder. On the face of things, there is a risk the headlease could be forfeited through no fault of the subtenant’s. In such event, the sublease would also determine because forfeiture of a superior lease also terminates all derivative interests created out of it.
This would obviously be catastrophic for a purchaser and its lender. Accordingly, when dealing with this orthodox lease structure, some lenders’ lawyers are now starting to insist that the borrower obtain insurance to protect against the consequences of the headlease’s forfeiture. But realistically, how likely is forfeiture of the actual headlease? And even if it were, why would the subtenant not obtain relief from forfeiture if it were not at fault?
In fairness, it can be difficult to predict the terms on which relief would be granted. The court has a wide discretion and there is little helpful case law dealing with issues such as whether a subtenant of part would be expected to take a lease of the whole. Nevertheless, this uncertainty does not increase the likelihood that the headlease would actually be forfeited.
The market survived for decades lending on such investments without insisting on a policy, yet some lenders’ lawyers are far too quick to conclude that as there is a risk on paper the buyer must obtain insurance cover. Such policies do not come cheap because they must protect the entirety of the lender’s investment.
Equally, they can take some time to finalise, which can mean the borrower cannot properly explore other ways of dealing with this perceived risk (for example, the purchaser could invite the freeholder to agree that if the headlease were forfeited the purchaser could take a particular form of lease).
Insurance is not always in the best commercial interest of the borrower, buyer, seller or lender. It may be time for a market shift, and the re-education of lawyers, to avoid the knee-jerk reflex to insist on it.
A “box-ticking” approach by the lender’s lawyers runs the risk of achieving little other than increasing the deal’s complexity and cost. Although this may be great for insurance companies, it surely cannot be for the long-term good of the UK real estate industry.
Peter Sugden is the managing partner at Katten Muchin Rosenman UK LLP
