Leases in the retail sector: Insurance
This series of articles explores key issues to be considered when agreeing heads of terms and negotiating the provisions of leases, with a focus on the retail sector.
The standard approach is that the landlord will insure the property against typical insured risks (such as fire, flood, and storm damage) for the full reinstatement value of the property. The tenant will then pay a fair proportion of the insurance costs incurred by the landlord.
However, there may be specific situations where the tenant is required to insure the premises themselves, or where a superior landlord is responsible for the insurance of the property, but this is less common.
Damage by insured risks
In the event that the property is damaged by an insured risk, the landlord will typically make a claim under their insurance policy. The landlord is obligated to use reasonable endeavours to obtain all necessary consents to reinstate the property and rebuild the premises. If the insurance pay-out is insufficient to cover the full cost of reinstatement, the landlord should be required to cover the shortfall from their own funds. This is particularly important in retail leases, where the tenant relies on the premises for its operations, and should not be put at a disadvantage if the landlord fails to adequately insure the property.
Rent cesser and termination rights
Retail tenants should ensure that, in the event of damage to the premises caused by an insured risk, a rent cesser clause is included. This clause generally suspends the obligation to pay rent and service charge while the property is unfit for occupation due to damage. Additionally, if the damage is significant enough that the landlord cannot practically reinstate the premises, both parties should have the right to terminate the lease.
A tenant should also confirm that any rent-free periods agreed upon in the lease are unaffected by the rent cesser, ensuring that the tenant fully benefits from the rent-free period, even if damage occurs to the premises during that time.
Uninsured risks
It is now standard practice for leases to include provisions for uninsured risks. Under these provisions, if the property is damaged or destroyed by an uninsured risk (a risk that is no longer insurable on normal commercial terms), the landlord has the option to decide whether to reinstate the property. If the landlord chooses to reinstate the property, it must do so at its own expense, and the usual rent cesser will apply until the damage is repaired.
If the landlord elects not to reinstate the property after damage from an uninsured risk, the tenant typically has the right to terminate the lease. In defining what constitutes an uninsured risk, the lease will generally specify that it includes any risks previously covered by insurance that are no longer insurable on commercial terms. However, tenants may try to negotiate broader definitions of uninsured risks to include any event that would fall outside the scope of the landlord’s insurance coverage.
Considerations for retail leases
For retail tenants, ensuring that the insurance clauses are clear and fair is crucial, especially as it relates to the impact of property damage on the tenant's ability to trade. The tenant's business may rely heavily on being able to quickly reopen or resume operations after damage occurs, and the insurance provisions should reflect this need for timely repairs and rent adjustments. Additionally, it is essential for tenants to understand how uninsured risk clauses will affect them, particularly in cases of significant damage that may result in business interruption.