§ 25.01 Allocation of Risks and Responsibilities

• Jurisdiction: United States
• Publication year: 2022

§ 25.01 Allocation of Risks and Responsibilities

[1]—Introduction

One of the major issues arising under a commercial lease is the allocation of the risks and responsibilities for casualties, injuries, damage or destruction on the leased premises.² Until the advent of modern insurance, the responsibility for these occurrences under most leases was governed by the common law. To a certain extent, the harshness of the common law standards imposed upon a tenant for repairing the premises has been carried forward in modern insurance provisions.

[2]—Common Law Standards

At common law, the landlord was not responsible for repairing the premises or leased improvements. The medieval tenant typically rented agricultural lands. The improvements on these lands, such as a barn or a shed, were merely incidental to the leased property. Most often, the landlord lacked the necessary tools and skills for repairing and maintaining these structures. As such, the tenants took the leasehold in an "as is" condition, with the rule of caveat emptor applying.

Under the common law, the tenant was under no legal obligation to restore a structure damaged by fire, flood or other casualty. However, the tenant was frequently economically compelled to rebuild the damaged or destroyed structure if it wanted to receive the maximum benefit and use of the land and the premises it was leasing. Therefore, a tenant assumed considerable risk and liability in entering into a common law lease.

This scenario no longer applies in quite the same fashion. Most modern leases involve urban and suburban offices and retail shops where the improved space is the main focus of the lease agreement rather than the underlying land. Moreover, most tenants do not have the time, skill or tools necessary to maintain and keep up a building or premises.

A few states have refused to follow this common law rule. In addition, recent cases have tended to repudiate the common law standard on the theory of commercial frustration.³ In New York, for instance, a tenant may surrender possession of the premises and will be relieved of further rental obligations so long as the casualty was not the tenant's fault.

While most courts and modern leases are moving away from these standards, a few jurisdictions still retain these common law rules. Due to the variety of case law among the states, a tenant cannot be fully assured of what its obligations will be in a particular situation unless it is thoroughly familiar with the laws and cases of the jurisdiction governing the lease. It is a tedious job for a user with multiple operations in numerous states to keep abreast of the applicable law, but it is nonetheless extremely important.

[3]—The "Hub and Spokes" View of Casualty and Insurance

The authors use the "Hub and Spokes" method of reviewing lease casualty and insurance provisions. Within the scope of the casualty and insurance provisions are at least a dozen interrelated clauses, which are tied to the two main sections. Grouped under the casualty set of clauses are services, repairs, rent abatement, default, compliance with law as well as the primary casualty provision. Force majeure can also go under this grouping.

These six sections are interrelated because when there is a casualty, the parties' rights and responsibilities with respect to each of these areas will be affected. The parties will certainly go to the casualty provision in the lease to determine their rights immediately after the event. They will also go to the repairs and services sections to see if there are any suspension rights following a casualty, what rent abatement rights accrue following the casualty, termination rights following the event (which may be contained in either a default provision or casualty section) and which party may have repair or other obligations following the event under the compliance with law section.

Insurance issues and obligations tie in closely with the casualty section, especially in developing a "no fault" indemnification scheme. In reviewing the contract and determining the rights and obligations, the parties should first go to the insurance clause to see which types and amounts of coverage apply. Typically, parties are required to maintain a form of property insurance (e.g., the basic form-CP 1010, the broad form-1020 or the special form-1030), commercial general liability, workers compensation and automobile liability. Next, the parties should determine the types and extent of indemnification they each must provide, whether or not there is an exculpation clause,⁴ limitations of liability.⁵ Damages are usually limited to the landlord's "equity in the building" and tenants often negotiate to supplement that limit with "building cash flow and insurance proceeds." If the parties intend to set up a "no fault" indemnification scheme, there may also be a separate section or preamble to the insurance section stating that intent.⁶

Using the "Hub and Spokes" approach allows the negotiator to tie the chief concepts of dealing with a disaster into a general scheme and to tackle all of the provisions, which will all be affected at the same time. This assures that each topic gets a complete examination. It also allows the negotiator to develop a consistent approach to these provisions so that there will be little or no possibility of vague or ambiguous clauses addressing any of these sections.

Insurance coverage should be defined with each party having specific coverage requirements. The casualty section should delineate each party's rights and responsibilities in the event of an event covered by that section. At the onset, the casualty section should define what constitutes a casualty under the lease, namely, a "sudden unexpected occurrence, natural disasters or an act of God ("force majeure"). Such events are sudden, unanticipated events, not expected events such as Year 2K. The clause should spell out each party's termination rights and to what extent and when the tenant may be able to expect to receive a rent abatement if the premises and building cannot be occupied. The casualty section should also set out a schedule to reconstruct the premises and building and each party's obligations to do so. Usually, this reconstruction schedule will follow the initial work schedule, with the owner being responsible for repairs and reconstruction of the common areas and structural and operational (e.g., HVAC) elements of the building and premises and the tenant being responsible for its own build out along the lines of its initial improvements and for replacing its own personal property.

Casualty rights and responsibilities should be delineated in a specific schedule. This helps take the emotion out of determining which party has what obligation following the event. Usually, the parties will want to continue the leasing relationship after the casualty. However, they need to find out how long it will take to...