Strategic Risk Management is Imperative for Property Owners
For owners of commercial buildings, requiring tenants to carry adequate insurance is not just a formality – it is a critical risk management strategy. A well-structured insurance clause in the commercial lease protects the landlord’s assets, reduces legal exposure, helps ensure the long-term financial stability of the property and sets expectations in case an unfortunate accident occurs.
1. Protecting Against Liability Claims
Commercial properties can be high-traffic environments. Customers, vendors, delivery drivers, and employees frequent the premises. While landlords may have some control over the risk factors of common areas such as hallways, lobbies and parking lots, tenants control the vast majority of activities within their units and may create liabilities through their operations, equipment, employees and customers. If someone is injured on premises or inside a tenant’s leased space, the injured party may sue the tenant and also the building owner.
Even if the landlord is ultimately found not at fault in a court of law, legal defense costs alone can be substantial.
Requiring tenants to carry commercial insurance ensures there is coverage available to respond to certain lawsuits arising from the tenant’s operations. This can reduce the likelihood that the landlord will be drawn into a legal situation, or minimize the impact if litigation is unavoidable.
2. Preserving the Value of the Property
Rental income is a core driver of commercial property valuation, and proper tenant insurance can help protect it.
Even a small-scale property damage incident, such as a fire, can disrupt the tenant’s business operations. Without insurance, the tenant may not have the finances or guidance to properly repair the building or replace damaged equipment and inventory.
If the tenant’s operations suffer significant interruptions, the tenant my be unable to pay bills or they may go out of business. Without insurance, a tenant may not recover from the incident, leading to tenant default or worse, leaving the unit – or the building – unfit for occupancy.
Legal fees and judgements from uninsured lawsuits can also bankrupt a tenant, again leaving a landlord with a vacancy issue.
The financial risks of vacancy issues include not only lost rent, but other costs related to making the unit rentable again. For example, these costs could include removing heavy equipment left behind by the tenant, cleaning or redecorating, or other costs associated with re-leasing the property.
3. Preventing Coverage Gaps and Subrogation Issues
Without proper contractual insurance requirements in the tenant’s lease, a landlord may face coverage gaps or conflicts between their insurance policies and a tenant’s insurance policies. Requiring tenants to carry specific limits and coverage types clarifies responsibilities for tenants and their insurers.
Landlords should require that they be named as an Additional Insured on the tenant’s general liability policy. This provides protection to the landlord under the tenant’s policy and recognizes that the tenant is taking responsibility for the risks associated with their business operations.
Whenever possible, landlords should also require a waiver of subrogation in favor of the landlord, preventing the tenant’s insurer from seeking recovery against the property owner after paying a claim. This further reinforces that the tenant is responsible for their own liabilities.
Recommended Coverages and Limits
While limits may vary based on the type of tenant and risk exposure, the following are common minimum standards for most commercial properties. Be sure the insurance clause in the lease asks for several policies at a minimum: Commercial General Liability, Commercial Auto Liability, Workers’ Compensation and Property insurance.
1. Commercial General Liability (CGL)
Commercial General Liability insurance policies offer protection against exposures commonly seen in the commercial real estate industry, such as slips and falls. Commercial leases often include requirements such as:
- $1,000,000 per occurrence
- $2,000,000 general aggregate
- Products/completed operations aggregate of $2,000,000
- Coverage for premises, operations, contractual liability, and personal/advertising injury
- Landlord named as Additional Insured
- Primary and non-contributory wording in favor of the landlord
- Waiver of subrogation in favor of the landlord
Higher-risk tenants (restaurants, fitness centers or auto service for example) may warrant more coverage, such as an umbrella policy to provide excess limits.
2. Commercial Automobile Liability
Add this insurance requirement if the tenant owns, hires, or uses vehicles in connection with their business. Pro tip: many tenants drive to work. Don’t look past this requirement.
- $1,000,000 combined single limit (CSL) for bodily injury and property damage
- Coverage should include owned, hired, and non-owned autos
This requirement helps protect against claims arising from vehicle accidents tied to the tenant’s operations, including delivery services. If the tenant’s operations include significant auto-related activities or risks, consider including an additional insured requirement to the auto coverage.
3. Workers’ Compensation and Employers Liability
Many states require employers to carry workers compensation, even if the business only has part-time employees. Add a workers’ compensation requirement to the insurance clause of the lease. This ensures that employee injuries are handled through the workers’ compensation system, and adding a waiver of subrogation can further minimize lawsuits against the landlord.
- Workers’ Compensation: Statutory limits as required by state law
- Employers Liability:
- $1,000,000 each accident
- $1,000,000 disease – policy limit
- $1,000,000 disease – each employee
Some businesses operate without employees, but owners can also be injured on the job. Think twice before waiving this requirement for a tenant who doesn’t have employees. They may hire employees after signing the lease, and the owner can also be covered under workers compensation. Don’t leave these exposures up to chance.
4. Property Insurance
Tenants should be required to insure their own assets within their unit, and they should also purchase business income insurance adequate to cover certain expenses in the event of disruptions related to a property loss. If they are responsible for their buildout, the lease should also require the tenant to insure the buildout. This ensures that tenants will be able to resume operations and occupancy as quickly as possible and cover certain expenses in the meantime.
Require tenants to fully insure their contents and select an affordable deductible when they purchase property insurance. Be clear that the landlord is not responsible for insuring the tenant’s contents/assets.
Additional Best Practices
Insurance requirements should be carefully spelled out in the tenant’s lease to set expectations and because it will become an important agreement in the event of a major incident or insurance claim. Tenants should provide a Certificate of Insurance (COI) to demonstrate proof of insurance before taking occupancy, and also renewal certificates as their insurance policies and/or lease renew.
Lease agreements should clearly specify required coverages and include indemnification provisions. For higher-risk tenants, landlords may also require umbrella/excess liability coverage of $2,000,000–$5,000,000 or higher, depending on exposures.
Consider requiring tenants to procure insurance from an insurance company with solid financials. There are a variety of financial rating agencies that specialize in the insurance industry. These rating agencies will evaluate the financial strength of the insurance company, which is a good indicator of its ability to pay claims. Often the rating agency will assign a grade such as “A.” It is a common and reasonable request to require tenants to purchase insurance from highly rated insurance companies.
If the tenant’s operations include any toxic chemicals or pollutants, landlords should consider adding pollution insurance to the list of required policies.
Consult with an attorney to review and update your commercial lease as is appropriate.
Conclusion
Requiring tenants to carry adequate insurance is a foundational safeguard for commercial property owners. Including insurance requirements in the tenant’s lease sets the expectations. It transfers operational risk to the party creating it, protects the landlord from costly claims, and supports the long-term value and stability of the commercial property.
