Elizabeth Thomson looks at the importance of being well informed about property insurance
Insurance may be uncharted territory for those embarking on a career in law. It is not typically studied in any depth, yet it is a subject with which new practitioners will quickly have to become familiar. Real estate lawyers need to be confident in drafting detailed insurance provisions, advising clients on risks that may or may not be covered by insurance, reporting on existing insurance in the course of property due diligence, and using insurance creatively to solve legal problems.
Starting point
The fundamental principles and commonly used insurance jargon are the starting point for any legal adviser:
To obtain any benefit from insurance, an entity must have an insurable risk in the property. Those with an insurable risk include legal and beneficial owners, landlords, tenants and mortgagees.
• Insurance policies are normally renewed annually and their existence is evidenced by a certificate. As a rule, they provide for an excess, which is the proportion of any claim which the insured bears before the insurance kicks in. Excesses can range from very small sums to hundreds of thousands of pounds. Policies also typically contain exclusions, which are circumstances the insurance will not extend to, such as loss caused intentionally by the insured. Insureds of multiple properties may have block policies that encompass all their properties.
• Subrogation is a common-law right for an insurer to recoup, from third parties who are at fault, sums that have been paid out under a policy. Subrogation means that the insurer “steps into the shoes” of the insured and thus can pursue any rights the insured may have. Parties to an insurance contract may agree to rights of subrogation being waived. The most likely circumstance where a real estate lawyer will encounter this is where a tenant pays for, or contributes towards, a policy of insurance taken out by the landlord. In such cases, the insurer may agree to waive its right of subrogation against the tenant.
• Noting. The legal effect of noting is uncertain, but it typically means that the party whose interest is noted will be kept informed if events occur in relation to the insurance policy. Some insurers choose not to exercise rights of subrogation against those whose interests have been noted, but this should not be relied upon. Mortgagees and tenants might both want to note their interests on the insured’s policy.
• Double insurance is when a single insured has the benefit of more than one policy. It is generally to be avoided because it can lead to complications and delay in recovery. Sometimes, the term is used where different insureds insure the same risk (for example, the seller and buyer under a sale contract). However, this latter circumstance is not strictly double insurance and each insured should be able to recover its own loss without difficulty.
Sale and purchase
At common law, the risk in a property passes to the buyer on exchange of contracts, unless the contract provides to the contrary. In an unconditional contract, it is also the case that the beneficial ownership in the property moves to the buyer on exchange. In a residential context, the Standard Conditions of Sale (Fifth Edition) give effect to the open contract rule and the risk in the property passes to the buyer upon exchange.
This is also the position in a commercial transaction where the Standard Commercial Property Conditions (Second Edition) are used, unless the seller is obliged to insure the property under the terms of a lease (as landlord or tenant). As a rule, then, the seller insures before exchange and the buyer after exchange.
Between exchange and completion, and assuming there is no contractual variation in the standard conditions, the buyer must be advised to insure the property as the risk has passed. The buyer and seller will have separate insurable interests and it will be prudent for the seller to also continue to insure until completion. Moreover, the seller may be under an obligation to continue to insure under the terms of its mortgage or a lease to which it is party.
In the event that the property is damaged between exchange and completion, and barring any contractual provisions to the contrary, the risk in the property will have passed to the buyer, who will be obliged to proceed with completion. The buyer will then need access to insurance funds to reinstate the property.
If the buyer completes paying the full purchase price and neither the buyer nor its insurer asserts that the seller caused the damage to the property, then the seller will have suffered no actual loss and cannot claim under its insurance policy. If, however, the buyer is entitled to rescind the contract under its terms, or refuses to complete in breach of contract, or sues the seller for causing the damage, then the seller may be able to claim for loss under its own insurance policy.
The crucial point is that failing to advise a client as to whether or not risk passes on exchange, and of the need to insure, could amount to negligence.
Grant of a lease
The insurance provisions in a rack rent lease are likely to be too lengthy to detail here. However, some fundamental considerations are as follows:
• A landlord of a multi-let property will typically want control of the insurance and its proceeds and will want to recover the cost of insurance (premiums, valuations and excesses) from its tenant(s), preferably as rent. The landlord will also require the ability to insure the common parts and to recover this cost via the service charge. In the event that the property is damaged by an insured risk, it will need to be certain that its rental stream is protected (by way of loss of rent insurance to cover the entire period of any rent cessers that may be afforded to the tenants).
The landlord will also want some flexibility as to whether or not to reinstate and the manner of such reinstatement. For example, the landlord will not want to reinstate an older building in exactly its previous form. It may well want to build a more modern, or entirely different, building. The landlord will also want the tenant to comply with the terms of the insurance policy and to make good any shortfall in insurance proceeds due to the fault of the tenant.
• The tenant of a single building might want to have control of the insurance itself. In a multi-let building or centre, however, the tenant will want the landlord to be obliged to insure on competitive terms against a comprehensive suite of risks. Having contributed to the insurance costs, the tenant will not want to be liable for damage that ought to be covered by the landlord’s insurance, whether via the tenant’s repair obligation or the service charge.
Tenants will also want a rent cesser in the event of damage by an insured risk and an obligation upon the landlord to reinstate. The tenant will usually require that equivalent accommodation is provided in the event of reinstatement and will also want the ability to bring the lease to an end if the landlord has not reinstated after a given time period.
• One of the principal areas of debate between landlords and tenants over recent years has been around uninsured risks. These are usually considered to be those against which insurance cannot be obtained on reasonably commercial terms or at all. Examples could include flood or subsidence in certain parts of the country. Many landlords will now agree to bear this risk, provided that they are given some flexibility around terminating the lease if they do not want to reinstate the property.
Other types of insurance
There are several other types of insurance policy of which real estate lawyers should have knowledge. These include restrictive covenant indemnity insurance, which covers the risk of enforcement by the dominant landowner in the event of a known breach. Chancel repair insurance, as the name suggests, protects against the risk of a chancel repair liability. Latent defects insurance, sometimes known as “decennial” insurance, covers new construction projects against damage arising from defects, usually for a period of 10 years. Business interruption insurance is necessary to cover the cost of moving a business to temporary accommodation following damage of its premises. Finally, public liability insurance deals with damages that may be awarded to the public as a result of injury or damage caused by the insured’s business.
The insurance market is wide-ranging and constantly evolving and real estate lawyers should always consider whether insurance might be available for a risk they encounter, ranging from missing search results to previous planning breaches.
Why this matters
If the worst comes to pass and a property is damaged by fire, flood or another risk typically covered by insurance, your client (whether owner, occupier or mortgagee) will want to be reassured that they can recover their losses by way of insurance or that the risk in such damage lies elsewhere and that the party bearing the risk is adequately insured. If there is uncertainty about liability and insurance obligations, this will cause further stress to clients at what will already be a time of heightened tension.
On a sale and purchase, typically, the seller (as the only party with an insurable interest) will insure before exchange of contracts. After completion, the buyer (as the only party with an insurable interest) will insure. Failing to advise a client that they are at risk, or obliged to insure, or that certain events are not or cannot be insured, could give rise to an action in negligence.
Even if the property is currently in rude health, inadequately drafted insurance obligations in a lease could make it difficult for either the landlord or the tenant to dispose of their interest in the property or to raise finance on it.
The problem of uninsured risks is often an area of contention between landlords and tenants and thought should be given to how they are dealt with and where the risk should lie.
Finally, a broad knowledge of the type of risks that can be insured against will enable you to better serve your clients. If there is a deadlock in negotiation, insurance could be a solution and an ability to include creative and practical solutions in your advice to clients is desirable. It is also important to be aware of the actions that you or your client could take that could prejudice the availability of insurance.
For example, if there is an historic restrictive covenant on your client’s registered title that they may want to insure, no direct approach must be made to the owner(s) of the dominant land (with the benefit of the covenant) because this could prevent insurance being obtainable at a later date.
Elizabeth Thomson is a professional support lawyer at Irwin Mitchell
