§ 25.04A Determining the Adequacy of Insurance Coverage

• Jurisdiction: United States
• Publication year: 2022

§ 25.04A Determining the Adequacy of Insurance Coverage

Commercial leases almost always contain provisions that require the tenant to purchase and maintain insurance, and often require the landlord to purchase and maintain insurance regarding occurrences in common areas.¹ While the scope of these provisions may vary greatly, the goal of insurance is to protect both the landlord and tenant from claims of personal injury or property damage at the leased premises. It is critical to ensure that the policy carries adequate limits based on a current fixed-asset verification.²

Landlords and tenants often fail to adequately consider "the effect of certain aspects of the underlying insurance policy,"³ simply familiarizing themselves with the coverage summary in a declarations page or certificate evidencing the policy's existence. The parties should review the actual language of underlying insurance policies as part of their risk management strategy. Among the important points to consider when landlords and tenants make risk management decisions are extent of coverage, requirements, exclusions, deductibles, limitations, internal sublimits that may reduce available proceeds, and the interplay of the policy coverages. Further, some policies also place conditions on coverage based on the location of insured property, only covering property "within a certain distance from a covered location."⁴

[1]—Coverage Layers

Each party should consider the value of multiple insurance coverage layers, including the bottom layer of primary insurance, which is the initial policy triggered by a claim.⁵ Then there are a variety of "umbrella" policies, which "provide additional coverage that comes into play only after a predetermined amount of primary coverage has been exhausted. Umbrella policies, unlike other excess coverage insurance policies, may also provide additional primary coverage for gaps or exclusions in the underlying primary policy."⁶ Each such policy needs to be carefully evaluated to determine the extent of coverage, requirements, and limitations. Finally, there are excess coverage policies, which often provide coverage only of the same type as was provided by the primary insurance policy.

Among the distinctions between these layers of coverage, is that "primary policies typically (though not necessarily always) provide protection against the cost of defending the insured party or parties against claims involving covered risks. A general liability policy, for example, may cover the costs of defending litigation against an owner and occupant arising from injuries and other damages caused by alleged negligence or other wrongful acts or omissions that occurred at the leased premises. At the primary layer, these defense costs usually are not charged against the policy limits, which can only be exhausted by the so-called 'indemnity' payments made by the insurance company under the policy for settlements or judgments."⁷ This is a significant benefit that may not exist under umbrella or excess coverage policies.

[2]—Defense Within Limits Policies

In the mid-1980s, insurers began including so-called "defense within limits" (DWL) language in certain types of insurance policies, including some umbrella and excess policies.⁸ "A DWL policy is one where defense costs are charged against and reduce the policy limits."⁹ Several jurisdictions have restricted the use of DWL policies, including: Arkansas,¹⁰ Minnesota,¹¹ Missouri,¹² Montana,¹³ New York¹⁴ and Oregon.¹⁵

[3]—Enforceability

The enforceability of DWL language will depend on the applicable state law. In the absence of a clear choice of law provision in the insurance policy, a determination of applicable law will have to be made.¹⁶

"If DWL language is enforceable, it affects the amount of coverage available to the insured because every dollar spent on defense of litigation depletes the policy limits and diminishes the amount of coverage remaining to pay claims."¹⁷ Thus, the parties should carefully read the defense language in insurance policies and pay attention to the coverage being purchased by the other party to the lease.¹⁸ If DWL language exists, then from a risk management perspective, it may be wise to purchase or require additional insurance to cover defense costs and other policy limits or to increase the required limits.¹⁹

[4]—Establishing an Insurance Coverage Plan and Understanding Forms of Coverage

[a]—In General

Even when a company is insured, an unexpected or catastrophic loss can force the company to go out of business. Therefore, it is imperative to understand the risks and how various insurance policies cover those risks in order to be able to manage them and maintain stability.²⁰

First it is necessary to obtain the correct insurance. Simply covering tangible property itself is usually not enough to make most businesses whole in the aftermath of a natural disaster. Often restoration will take months to compete so that the company's operations and income stream will be interrupted.

Property and business interruption insurance policies are complex, and the insurance situation of suppliers, customers and other business partners may directly impact a business as well. For example, even if a business does not suffer direct physical damage to its facilities as a result of a natural disaster or other loss, if customers or suppliers suffer a loss or damage, that can affect the supply chain or cause an interruption to the business, including a loss of revenue or sales. Thus, insurance to cover business interruption will be an important component of insurance coverage planning. In addition, preparations for hurricanes have caused governmental authorities to order evacuations and business shutdowns, impeding access to business premises, and interrupting business operations, utility services, and supply chains. In the aftermath of storms, damage in the form of flooding and widespread power outages may continue for a significant period of time.

Further, as in any other business situation, it is advisable to ensure that the parties secure and maintain adequate and appropriate insurance for the term of their relationship.²¹ The lease agreement should specifically address insurance coverage types, risk allocation and liability issues, especially regarding potential liability arising from conduct in furtherance of the parties' agreement. If properly drafted, one party's insurance can be a source of additional coverage for the other party in the event that liability arising out of the one party's activities is attributed to the other.²² Determining the type of coverage and the extent of coverage needed will depend on the nature of the parties' activities and the associated risks. The following are some suggestions to consider when drafting insurance requirements provisions:

"Have your company (and, as necessary, your company's parents, affiliates, subsidiaries, directors and officers) specifically named as an Additional Insured in your counterpart's policies. By doing so, you can minimize the risk of having to claim under your own insurance in the event that you face liability arising out of your counterpart's conduct.

Make sure that the limits of insurance are sufficient to cover any potential exposure and, in no event less than the amount otherwise carried by your counterpart.

Do not allow your counterpart to limit the insurance obligations through sizeable deductibles or self-insured retentions (SIR). If your counterpart cannot secure first dollar coverage, then make it clear that, in the event of a claim, the counterpart is responsible for satisfying the deductible or the SIR.

Draft your insurance requirements so that they are wholly independent of and do not impact or limit any separate indemnity obligations you may otherwise seek to impose on your counterpart.

Expressly state that the required insurance shall not be deemed to release or diminish the liability of your counterpart.

Require your counterpart's insurance to be primary and non-contributory to any coverage you maintain. With such language, in the event that you make a claim as an additional insured, your counterpart's carrier will be prohibited from seeking contribution against your own carrier.

Require your counterpart's carrier to waive any and all rights of recovery, contribution and/or subrogation against you and your insurers. By doing so, in the event that your counterpart faces covered liability based on your conduct (either in whole or in part), its carrier will not be able to seek recovery against you.

Require your counterpart's carriers to provide you with advance notice of any policy modification, cancellation and/or non-renewal.
Have your counterpart specifically schedule your agreement as an Insured Contract. This will enhance the prospect of your counterpart obtaining coverage for any indemnified claim that you may have against it.

Specify that your acceptance of an incomplete policy or your failure to identify a deficiency in the required coverage shall not be construed as a waiver of your counterpart's insurance obligations."²³

[b]—Establishing a Plan

In addition to determining the correct insurance types and coverage amounts, it is important to have a plan in place to handle each aspect of a claim, including preparing the proof of loss and negotiating the claim with the insurance company.²⁴ Since most insurance policies require the insurer to preserve and protect insured property from further damage, failure to do so will prejudice the insured's recovery rights. Having a plan in place to assure that proper procedure is followed after a loss is important as well.

[i]—Before a Loss

Well before a loss occurs, it is necessary to understand the terms of existing policies, their coverage, limitations and exclusions. Among the policies to consider obtaining are: property damage, business interruption, contingent business interruption, extended period of liability, logistics and extra expense...