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Risk allocation in commercial leases: What to watch out for post-pandemic

Rental-lease-agreement-form-on-an-office-desk Print publication

16/03/2022

Insured risks

It is common practice for commercial landlords to insure their property against damage caused by foreseeable risks, such as fire, storm, earthquake and riot. Providing a landlord has purchased a comprehensive insurance policy, the tenant is unlikely to be called upon to directly contribute to the cost of repairing any damage caused by such risks – instead the tenant will indirectly reimburse the landlord for the cost of the insurance premium through its ‘Insurance Rent’.  These risks are often referred to and defined as ‘Insured Risks’ in standard commercial leases and it is widely accepted that this common approach works well for both landlords and tenants.

However, it is important to remember that the risks covered by such provisions in commercial leases are a matter for negotiation between the landlord and tenant, and may not necessarily be ‘standard’ at all.  They are often prompted by world events (war, terrorism, pandemics, for example), and dictated by what is available in the insurance market.

Rent cessation?

Where an Insured Risk has resulted in a tenant being unable to use the demised premises, the tenant may have the contractual right to withhold rent, providing the lease contains a rent suspension clause. In these instances, the landlord would seek to recover this loss of rent from its insurance provider for the duration of the rent suspension period.

A hot topic, in the post-pandemic world, is whether and when tenants will be able to rely on rent cesser (or, suspension) clauses where their premises have been closed due to Covid-related reasons.

In the 2021 case of Bank of New York Mellon (International) v Cine-UK [1], the High Court held that rent suspension under the commercial leases in question would only be invoked where physical damage to the property had left the tenant unable to access, use or occupy their premises. Therefore, the various tenants in this case, who were forced to shut shop during lockdowns, were not able to rely on their rent cesser clauses to withhold rent, even where significant business interruption and economic loss had been suffered.

(An alternative option for tenants in this position might be to explore the possibility of claiming under their own business interruption insurance cover, if any.)

The court in Bank of New York Mellon confirmed that a rent cesser clause in a standard modern commercial lease should be construed, like any other contractual clause, by accepted principles of contractual interpretation and words should be given their ordinary, natural meaning. The phrase ‘damage or destruction’ within a rent cesser clause therefore means physical damage only, and should not be read more widely as if it also means economic damage resulting from the inability to trade due to the pandemic, unless that is clearly and specifically stated.

It is possible, therefore, and no doubt dependent upon individual parties’ bargaining positions, that the post-pandemic market may start to see a shift towards much more widely-drafted Insured Risks provisions.

Quite apart from the inevitable increased awareness of the physical and economic risks associated with epidemics/pandemics, recent events in Ukraine and a growing international understanding of environmental and climate risks are likely to manifest in evermore expanding insurance requirements.  It would certainly seem to be in tenants’ interests for insurance provisions to cover both a wider range of risks and potentially also a wider range of economic loss and damage caused by such risks (that is, not just physical damage) going forward, albeit that is likely also to mean increased premiums and insurance rents as a result.

How we can help

Whether you are a commercial landlord or tenant, Walker Morris’ Tier 1 rated Real Estate team can help you to ensure that the insured risk allocation provisions negotiated in your commercial leases reflect the level of protection and flexibility you require.

If and when disputes concerning insured risks; where liability lies; financial recovery; and/or physical reinstatement do arise, Walker Morris’ experienced and expert Real Estate Litigators can help you to achieve a sensible, commercial resolution.

For further advice or information on any property insurance-related query or concern, please do not hesitate to contact David Manda.

 

[1] Bank of New York Mellon (International) Ltd v Cine-UK Ltd and related cases AEW UK REIT Plc v Mecca Bingo Limited and v Sports Direct.com Retail Ltd [2021] EWHC 1013 (QB)

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