§ 25.03 Types of Coverage

• Jurisdiction: United States
• Publication year: 2022

§ 25.03 Types of Coverage¹

Generally, small and medium size tenants are required to carry specific types of insurance and limits are clearly delineated. However, there is usually little or nothing mentioned about the landlord's obligations in these regards. Nearly all landlords require that their tenants carry liability insurance. After the tragic events of September 11, 2001, tenants should be concerned that landlords carry adequate insurance as well.

Coverage in the case of a disaster like the World Trade Center tragedy can come from many types of insurance. Business interruption insurance² and rent insurance are just a couple. "Business interruption insurance is intended to compensate the tenant for revenue interrupted by an event and incremental increased costs of doing business incurred during such an interruption."³ However, what will be covered, the extent of coverage, and the coverage period all depend of the language of the specific policy.⁴ Businesses that could not resume business because the government closed off the financial district may be able to recover if they have civil interruption (civil authority coverage) insurance. Again, the specific language of the policy will determine whether and to what extent the insured is covered.

"Rent insurance is intended to protect the property's rental stream in case of an event that allows tenants to stop paying rent or makes the orderly payment of rent impossible. This coverage is principally the concern of building mortgagees."⁵

Insurance costs are really borne by the tenant in the form of operating expenses or a combination of base rent and escalations and operating expense escalations. In light of the WTC disaster, certain types of insurance have become very costly or unobtainable. Landlords argue that tenants should rely on business interruption insurance while the tenants argue that the landlords should rely on their rent insurance to cover displacements. However, neither type of insurance is paid forever. There are limits. In the future, tenants will likely want to require that landlords provide usable space, not simply space to lease.⁶

Financial losses arising out of the September 11, 2001 terrorist attack exceeded $100 billion.⁷ A significant portion of that was paid by the insurance industry. In fact, losses sustained by the insurance industry were unprecedented in virtually every respect, producing catastrophic losses not only in terms of property coverage but also in the life insurance, disability and workers' compensation lines. Aviation and liability insurers also suffered their largest losses stemming from a single event.⁸ The first, major question involving 9-11 was whether the terrorist act constituted an "act of war," since most insurance policies exclude "acts of war" from coverage. Note that President Bush referred to the attack as an "act of war" in his address to the nation. Other types of claims included those against the building owners and managers based on "improper or inadequate evacuation plans and/or implementation."⁹

Other issues included the extent of business interruption, determining how such losses should be calculated and whether and to what extent such losses are covered.¹⁰ Businesses in neighboring building that were not destroyed in the WTC tragedy also submitted claims based on losses resulting from business interruption. They claimed that services were impaired, including telephone and utilities, and access to the area was denied or restricted, etc. Civil authority coverage arguably covers losses caused by "government or police activity impeding access to the insured's building."¹¹ The securities industry had claims based on loss of income during the closure of the stock market. Service industries like hotels, airports, etc., also claimed lost income as well. When access is impeded, an ingress/egress policy may provide the necessary coverage. Service coverage comes into play when telephone and utilities, etc., are unavailable and contingent business interruption covers the insured for losses resulting when other businesses are unable to provide necessary services to the insured.¹² Coverage in each instance is dependence on the precise wording of the policy involved. There is no simple answer.

In the first World Trade Center attack in 1993, the court of appeals said, in spite of a lower court jury finding that the Port Authority was negligent in failing to listen to the warnings from its security experts that the center's underground garages could be targets of terrorist's attacks, that the agency was entitled to the protection of sovereign immunity and could not be treated as a private landlord that had failed its duty to meet security obligations to tenants. The court made it clear that the agency had good reasons to believe it had to concentrate its security efforts in other places in the center. The court noted that the agency had engaged in "informed, policy-based decision making that entitles a governmental agency to immunity "and that "governmental entities cannot be expected to be absolute guarantors of public safety."¹³ The Court reasoned that, "if the essential nature of the governmental agency's injury-causing acts or omissions was a failure to provide security involving police resources—i.e., police protection—then a governmental function was being performed. Any failure to secure the parking garage against terrorist attack predominately derives from a failed allocation of police resources."¹⁴

Although there are many specific types of insurance coverage, typical insurance in commercial leasing transactions involves two types of broad coverage: property and liability. The tenant may be responsible for procuring these and additional types of coverage or endorsements depending on the nature of the tenancy, such as a "net" or "triple net" lease.

[1]—Property Coverage

[a]—Direct Losses

Property insurance for a commercial lease generally encompasses fire insurance, fire and extended coverage and "all-risk" insurance. This insurance includes such specialized coverages as boiler and machinery insurance and electronic data processing (EDP) insurance. Property insurance pays claims directly to the insured party. As such, it is "first-party" insurance. Property insurance coverage is narrowly defined. The policies pay for only named, covered perils and generally exclude flood, earthquakes and hazardous waste coverage. These perils can be insured for in special riders, but they are expensive to obtain.

A common form of coverage carried by landlords is a fire insurance policy with "extended coverage endorsement" (ECE). ECE perils are named perils, that is, risks specifically listed in the policy. Typical ECE perils are fire, smoke, explosion, windstorm, civil commotion or hail. High-risk events such as nuclear explosions, state sponsored terrorist attacks and steam boiler and pipe explosions are excluded.

A very popular form of coverage in recent years is "all risk" property insurance. It would now be unusual for any insured to purchase an ECE or other specified perils policy if an all risk policy were available. In an all risk policy, insurers are covered against all perils except those that are expressly and specifically excluded.¹⁵ However, would the insurer be covered for business losses resulting when its employees working in the World Trade Center vicinity failed or refused to return to work because they were too traumatized to do so. It remains to be seen whether and to what extent that will have any bearing on tenants' recovery rights.

There are four common but troublesome exclusions to the typical all risk policy. These exclusions are: (1) the "ordinance or law" clause, which generally denies coverage for losses due to the "enforcement of any ordinance or law regulating the construction, repair, demolition or condemnation of any building or structure; (2) the "flood or earthquake" hazards clause, which also covers damage from surface water overruns, sewer and drain backups or damage caused by sub-surface waters under hydrostatic pressures; (3) the "computer-related or electronic data processing" (EDP) damages clause; and (4) the "boiler and machinery" clause.¹⁶ When one or more of these clauses are in force, the following events may not be covered by an all risk policy: electronic disturbances (except when attributable to a sudden event such as lighting); mechanical breakdown and damages caused by sudden temperature changes; and damages caused by atmospheric conditions or extremes, to name but a few.

An all risk policy may cover damages differently depending upon the circumstances. For instance, in the recent World Trade Center blast, all risk coverage paid for the cleaning of soot, dust and electromagnetic residue on thousands of computers from the explosion and smoke generated from the blast, but did not cover any subsequent mechanical breakdown of the computers from the accumulated soot if left untreated.

Natural disasters and calamities—hurricanes, natural disasters, high winds flooding and fires—require that professionals draft their documents to deal properly with property damage coverage that needs to be to allow rebuilding and recovery.¹⁷

The Insurance Service Office, Inc. (ISO) promulgates forms for its underwriter clients and these forms show customary form coverage's as opposed to what can be provided by a manuscript policy.¹⁸ The first two sets of letters and numbers identify the type of form and are usually consistent through many years (e.g., #CP 10 30 04 02). The last two sets of numbers identify the year and month in which the form was promulgated. Leasing professionals should be careful about the dated forms since they periodically change.

The ISO form #CP 00 10 04 02 Building and Personal Property Coverage Form describes what is insured and what is not insured with generally three types of commercial property

Property coverage varies despite the existence of standardized Insurance...