Several years ago, I was on a lease negotiation call with an attorney for a tenant and a real estate representative of her client, a national retailer. After about 45 minutes of back-and-forth on hot-button issues like the tenant exclusive, the co-tenancy provision, and sales reporting, the tenant’s counsel and I turned our attention deeper into the body of the lease.
Within seconds of mentioning the words “partial destruction,” the real estate representative chuckled and asked, to no one in particular, “Are we really discussing the casualty section? I thought everyone just skipped that part.”
Although he was joking, he was saying what we were all thinking. As attorneys, we could never just skip or gloss over any part of a document we’re reviewing for a client, but I’ll admit that this particular section often tests the efficacy of the coffee I’m drinking.
Besides the fact that this section is usually encumbered with unfamiliar insurance jargon and often contains complicated contingency trees, I think the reason most people’s attention span hits the proverbial wall at the casualty section is that most clients don’t want to waste their mental energy on something that neither they nor the other party have any control over, and, for that matter, may never happen.
But as complicated and unexciting as the casualty section may be, with extreme weather events, wildfires, and flooding seeming to occur more frequently and with greater economic impact, landlords and tenants would be best served to pour themselves another cup of coffee (or two) and to try to get a deeper understanding of what rights and obligations they have under the casualty sections of their leases.
The experienced attorneys at Brousseau Naftis & Massingill, P.C. have represented clients in business matters for decades. For more information, contact us today for a no-obligation consultation.
The Basics of the Casualty Section in a Commercial Lease
In its basic form, the casualty section of a commercial lease outlines the circumstances under which the landlord and tenant are obligated to restore the leased premises following a casualty event, i.e., any natural or unexpected event that results in damage, destruction, or loss to property, assets, or people. But over time, landlords and tenants have incorporated ancillary considerations and provisions into their leases, including termination rights in the event of extensive damage and rent abatement during periods of repair. Below is an overview of each of these basic and ancillary concepts:
Obligation to Repair
The lease usually specifies who is responsible for repairing or reconstructing the premises after a casualty. In most in-line shopping center or mall leases, the landlord agrees to restore the premises “to substantially the same condition” within a reasonable time, subject to the availability of insurance proceeds and feasibility. However, in leases of free-standing buildings solely maintained by the tenant, it’s usually the tenant who’s responsible for the repairs.
Insurance Proceeds and Use of Funds
Most commercial leases will require the landlord to carry property insurance (i.e., special form property insurance), the pro-rata cost of which is typically subject to reimbursement by the tenant. Meanwhile, the tenant is required to insure its personal property and any improvements made to the premises.
Most casualty events will be covered in some manner by a combination of these two types of policies. Leases typically provide that the landlord receives insurance proceeds related to the building and that tenants receive proceeds for their personal property or improvements. The lease may also specify that repair obligations are contingent on the availability of insurance funds.
Rent Abatement or Suspension
Many leases provide for rent abatement — partial or full suspension of rent — while the premises are unusable due to damage. The extent and duration of rent abatement typically depend on the severity of the damage and whether repairs are underway. Landlords are naturally resistant to any type of abatement language in a lease, even more so when the reason is something completely outside of the landlord’s control, like a casualty event. Regardless of whether a lease contains abatement language, landlords should consider including rent loss insurance in their property insurance policies, and tenants should carry business interruption insurance.
Termination Rights
If the damage is severe and repairs are not feasible or timely, the lease may provide either party with the right to terminate the lease. Often, this right is triggered if the premises are substantially destroyed and cannot be restored within a specified period. Many parties will also negotiate a separate termination right if the destruction occurs near the end of the lease term, regardless of the extent of the damage.
Key Considerations for Tenants
- Negotiate Rent Abatement Terms: Tenants should seek clear rent abatement provisions that protect them from paying full rent when the premises are unusable.
- Clarify Repair Responsibilities: Tenants of multi-tenant buildings will want to limit their repair obligations, especially for structural elements, which should be the landlord’s responsibility.
- Termination Rights: Tenants should negotiate provisions that allow them to terminate the lease if the repairs will be too disruptive to their business, either by reducing the usable area of their premises or taking a significant amount of time.
- Expand the Scope of the Clause: A tenant may be harmed by damage to areas outside of the premises, such as parking lots, elevators, and entrances and exits. Tenants should therefore ask that certain critical common areas be included in the scope of the casualty provision.
Key Considerations for Landlords
- Ensure Timely Repairs: Landlords should strive to maintain control over repairs to preserve property value and maximize rental income. In ground leases, where tenants typically have control over the repairs, landlords should require that tenants remit the insurance proceeds to the landlord in the event the tenant elects to terminate the lease, and should also require that tenants take necessary measures to safely secure the damaged building (fencing, razing if necessary).
- Limit Rent Abatement Exposure: While rent abatement is often requested by tenants, landlords should attempt to limit the scope and duration to avoid bearing the brunt of a situation they did not cause.
- Maintain Termination Protections: Termination rights should be balanced to prevent tenants from abandoning leases over minor damage. At the same time, landlords should have the benefit of termination provisions that prevent them from being committed to economically wasteful exercises, such as rebuilding a premises for a tenant with only a few months left in their lease term.
- Insurance Clauses: Landlords should clearly specify insurance requirements and the application of proceeds.
That Wasn’t So Bad, Was It?
If you’ve made it this far, you probably understand that casualty provisions in commercial leases are vital for managing risks associated with unexpected property damage, ranging from minor to catastrophic. Tenants and landlords both benefit from carefully negotiated clauses that fairly allocate repair responsibilities, rent obligations, and termination rights.
So, the next time you are drafting, reviewing, or negotiating a commercial lease, don’t just “skip over” this section, because understanding casualty provisions is essential to protecting your or your client’s interests and ensuring business continuity when things take a turn for the worse.
