§ 25.07 The "No Fault" Approach

• Jurisdiction: United States
• Publication year: 2022

§ 25.07 The "No Fault" Approach

[1]—In General

Recently, some notable authorities in the commercial leasing field have advanced the position that by combining certain lease provisions on insurance, indemnification and subrogation, the parties can achieve a "no fault" indemnification in the lease. The "no fault" scheme essentially shifts liability and property damage risk (without regard to fault) to the parties most able and willing to carry these risks, namely the landlord and tenant's insurance carriers. While the no fault indemnification is not absolute (some liability still remains), it is clearer, much fairer and more user friendly than the shifting of risk for liability and damage that typically occurs in most commercial lease negotiations.

One prominent commentator and commercial real estate attorney speaks most eloquently on this topic. He states: "A simple solution to the problem of negotiation on indemnity clauses is to convert the lease, as to indemnity, to no fault. Resistance to this proposition—as efficacious as it sounds—is nearly universal. Some day, I hope to have the reasons explained to me."¹

The theory of "no fault" is simple. The risk of loss for any given damage or claim of damage falls on the party who is obligated to carry the insurance for such a loss under the terms of the lease. For example, as one commentator explains, if the landlord is obligated to carry an "all risk" policy for the building, it does not matter why the building burned down.² Except for certain exclusions, the landlord is then declared to be the responsible party.

"No fault" has clear advantages to both parties, particularly the landlord, since most of the insurance obligations rest with the tenant. Liability, property and insurance for tenant's improvements installed by the tenant are typically all a tenant's obligations. The landlord is usually obligated to carry property insurance only for the building and will be obligated to indemnify the tenant from any claims arising out of damage to the building. Except for the common areas, which the landlord is required to keep and maintain, the parties should be able to have simple "no fault" handling of normally insurable claims. Excluded from normal insurance are those casualties that are caused by gross negligence and those that the courts in a particular state will forbid indemnification of, such as a party's own acts of negligence or injuries and damage caused by a party's willful acts.

There may be some types of exculpatory clauses that have the potential to defeat even a "no fault" approach. Landlords may attempt to completely exculpate themselves or excessively limit the extent of their liability even for the negligence of their own work, for failure to respond to the tenant's needs or fulfill their own obligations under the lease.³ Take, for example, the situation where a plumber negligently tightened a value on a high pressure water column, therefore shutting off pressure on lower floors. As a result, a valve exploded, flooding several floors. Due to an exculpatory clause in the lease, the landlord was able to avoid paying for the resulting damage.⁴

What are some of the reasons mitigating against no fault? Some carriers claim that premiums are based on the landlord's loss history. With a switch to "no fault," the party takes on the obligation for losses that may not be its fault, but rather are the fault of another party. However, a protected party can protect itself against this result by providing examples of its own exemplary loss record and stipulating that the "no fault" provisions will not apply if the other protected party does not keep an exemplary loss record.

One of the leading commercial leasing lawyers in the country makes one of the few persuasive arguments for retaining exculpatory clauses.⁵ He states that due to the IRS regulations, landlords use partnership and non-corporate entities to enter into leases. Under these types of structures, the landlords are not able to avail themselves of the protection of the corporate shield. Therefore, they need the protection of exculpatory clauses against a tenant that might be able to bring an action or obtain a judgment against a landlord, possibly decimating the landlord vehicle and going against the individual partners comprising the ownership.⁶

The better, clearer and easier way, however, is the "no fault" scheme. A mutually satisfactory end can be achieved by clearly stating the intent of the parties to the lease, setting up a scheme of mutual waiver of subrogations and mutual indemnifications for items that can be indemnified, by striking out exculpation clauses and setting up strong insurance clauses.

[2]—A Sample "No Fault" Clause

The following is an example of a "no fault" clause prepared by a prominent real estate attorney:⁷

Example 3

VI. RISK ALLOCATION AND INSURANCE

6.0. Allocation of Risks. The parties desire, to the extent permitted by law, to allocate certain risks of personal

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