Often, when negotiating commercial leases, the indemnity, release and risk of loss provisions are hotly contested. Landlords, on one hand, might be reticent to make any changes to these clauses for a number of reasons: the deal is too small to justify deviations from the standard form lease, and the landlord does not want to set a precedent for future negotiations; these clauses are filed under the heading “legalese”, and the landlord may not want to engage external counsel to assess what risk the proposed changes pose; or my personal favorite, based on the advice of the landlord’s insurer, the answer is simply “no” (acknowledging that beyond the fact the insurer is not a party to the lease, the interests of the insurer do not align with striking a commercially reasonable risk allocation between the landlord and tenant in furtherance of completing the lease transaction expeditiously).
Tenants, on the other hand, will often look to strike what they believe is a more balanced risk allocation by proposing amendments to the indemnity, release and risk of loss provisions. Placing liability on the landlord for the “landlord’s negligence, and the negligence of those for whom the landlord is responsible” is an obvious starting point. But beyond that, where should tenants look to try to strike that more even-keeled approach? In this regard, we would argue a review of the “Trilogy” of cases, and how those cases have been considered in subsequent jurisprudence, is a worthwhile endeavor.
In each case comprising the Trilogy, the tenants had negligently caused fires that resulted in property damage. After paying to repair the damage caused, the landlords’ insurers brought subrogated claims against each of the tenants.
The Courts directed that in commercial leases, when negligent acts of tenants cause a loss or damage outside of their leased premises, two main principles will guide a Court’s allocation of responsibility between the parties: 1) subject to express language in the lease to the contrary, liability for the loss or damage is placed on the party that has agreed to obtain insurance that covers such loss or damage; and 2) if an insuring party (i.e. a landlord) has had their insurance costs paid for by another party (i.e. a tenant) in whole or in part, liability rests on the one insuring against that particular loss or damage, even if that loss or damage is caused by the negligence of the party contributing to the cost of insurance.
Beyond those two main principles, the Trilogy of cases, and the Courts that have subsequently considered those decisions, have outlined additional factors a Court will take into account when determining whether, absent an “express release”, an “implied release” can be established, including:
- The presence or absence of exclusions for damage by fire or repairs necessitated by perils against which the landlord is insured, from a tenant’s maintenance and repair obligations;
- The presence or absence of an express obligation in the lease that the landlord will maintain its own fire or “all-risk” insurance; and
- The presence or absence of a “notwithstanding” clause, that places the liability for repairs necessitated by the tenant’s negligence on the tenant, notwithstanding the tenant’s contribution towards the landlord’s cost of insurance, or any other provision of the lease to the contrary.
At a high level, what our Courts have said is that while it is possible for a tenant to waive an implied release, in practice, our Courts appear more willing than not to support the notion that where a tenant has contributed to the cost of its landlord’s insurance, it should be able to receive the benefit or protection of that insurance (by barring a subrogated claim from the landlord’s insurer against the tenant) if a loss or damage is suffered that compels the landlord’s insurance to respond, even if the loss or damage is caused by the negligence of the tenant.
We would suggest there is a policy argument to support this, given the landlord may suffer little as a result of an implied release (other than potentially incurring higher insurance costs in the future, which it will presumably pass onto its tenants in any event), provided it is maintaining a suitable property insurance program and the damage and destruction clauses in its leases are properly drafted, and in light of the fact that a large contractual or subrogated claim against a tenant for property damage, if successful, may effectively put that tenant out of business, if that claim exceeds the limits of the tenant’s own insurance.
As far as practical take-aways for tenants, it would be unwise to assume an implied release can be inferred; the express language of the lease cannot and should not be ignored. Wherever possible, negotiate an express obligation on your landlord to carry “all-risk” insurance against the building and common areas on a replacement cost basis. Seek a contractual release from your landlord for claims covered by your landlord’s insurance, and ensure, wherever possible, that the lease provides that the landlord’s property insurer will be barred from bringing a subrogated claim against the tenant to the extent it has to pay out on the policy.
For landlords, consider who you are negotiating your lease on behalf of: yourself or your insurer? Does it make sense to spend time negotiating provisions that, in our view, may provide marginal benefit to the landlord, and if actually relied upon, could impose liability on the tenant the extent of which could put that tenant under, which in turn, may lead to incurring additional costs in filling the resultant vacancy? We would point out that in our experience, property insurers will often waive subrogation in favour of tenants at no cost. Also, be mindful that landlords will often insist that a tenant’s insurer waive subrogation in favour of the landlord, even if a claim arises as a result of the landlord’s negligence. Sophisticated tenants frequently insist upon reciprocal releases for insured claims and waivers of subrogation, so does refusing to adopt this reciprocal structure across the board really put the landlord ahead? These are questions we suggest are worthwhile for landlords to consider when developing and negotiating its leases.
For further information or questions regarding Commercial Leasing, please contact Ryan C. Kemp.
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