Friday, March 28. 2014
10:00 – 10:30 am
COME HELL OR HIGH WATER:IT CAN HAPPEN TO YOU (OR WORSE—YOUR CLIENT).LEASE CLAUSES AND INSURANCE CLAIMS IN THE WAKE OF LARGE CATASTROPHES
Presented to
American College Of Real Estate Lawyers
2014 Spring Conference
Kauai, hawaii
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Neil C. Kahn
Goodman-Gable-Gould
Company/Adjusters International
Baltimore, Maryland 21208
410-559-2127
Rocco Sansone
Marsh USA, Inc.
745 Fort Street, Suite 1100
Honolulu, HI 96813
808-585-3555
Leopold Z. Sher
Sher Garner Cahill Richter
909 Poydras Street, Suite 2800
New Orleans LA 70112
504-299-2101
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Moderator: Elwood F. Cahill, Jr.
Sher Garner Cahill Richter Klein & Hilbert, L.L.C.
909 Poydras Street, Suite 2800
New Orleans, LA 70112
504-299-2103
OUTLINE
- Leases
A.Casualty Provisions in General
1.Right to Terminate Upon a Casualty
- Time Period for Repairs
- Time Period for Notice
2.The Landlord’s Restoration Obligations
a.Time Periods
b.Ability to Restore
3.The Tenant’s Obligations to Restore, Restock, and Recommence Operations
a.Time Periods
b.Ability to Restore
4.Right to Rent Abatement
5.Co-Tenancy
B.Entering the Premises and Removal of Tenant’s Property
C.Insurance provisions
1.Insurance Issues for Leases
2.Casualty Insurance
3.Business Interruption Insurance
- Elements of loss
- Zombie Lease
- Law Firm Anecdote
4. Gap in coverages
- Exclusions
- Flood
- Named storms
- Service Interruption exclusion
- Anticoncurrent causation clauses
- Civil Authority; Ingress/Egress
5. Force Majeure Catch-All
III.Public Adjusters
V. Lessons Learned From the Aftermath of Sandy
VI.Miscellaneous
VII.Conclusion
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COME HELL OR HIGH WATER:IT CAN HAPPEN TO YOU (OR WORSE—YOUR CLIENT).LEASE CLAUSES AND INSURANCE CLAIMS IN THE WAKE OF LARGE CATASTROPHES
Superstorm Sandy struck the Northeast United States five miles outside of Atlantic City, New Jersey, leaving devastating flooding and storm damage in its wake across wide swaths of the Mid-Atlantic and Northeast. Although storms like Superstorm Sandy are extraordinary in power, they no longer are a rarity. In 2004, a number of major hurricanes devastated the Atlantic Region and especially Florida. Hurricanes Frances, Charley and Ivan, all occurring in 2004, were three of the top ten costliest hurricanes in U.S. history, causing a combined $43.4 billion in damages. Then in 2005, Hurricanes Katrina and Rita devastated the Gulf Coast, causing a combined $120 billion in damages, with Hurricane Katrina’s record $108 billion total in damages being the Number One costliest storm in U.S. history. Hurricane Irene, which hit in 2011, caused an estimated $6 billion in insured losses.[1]
Then, very next year, along came Superstorm Sandy, which was the second costliest storm in U.S. history, causing over $50 billion in damages and wreaking havoc across the Atlantic Region.In fact, the number of extreme weather events has increased significantly over the past thirty years.[2] Do major catastrophes happen? You bet they do. And when they do, everything changes.
In the aftermath of all of these catastrophes, real estate attorneys were called upon to deal with a number of issues that arose under leases, insurance policies, reciprocal easement agreements (REAs), and other legal arrangements. Among the provisions that were being carefully scrutinized were the casualty and co-tenancy provisions in leases and the obligations of the parties in those agreements. The insurance that was maintained or that should have been maintained by the parties also became crucial. Although many issues are unique to a widespread disaster, the issues can arise in most any casualty situation. Unfortunately, critical provisions such as casualty and insurance are often given short shrift during negotiations. For this reason, the hurricane experiences can teach attorneys, wherever located, which provisions they should reviewcarefully in their lease and other agreements,and the insurance that should be maintained to protect their clients, as well as provide general practical guidance for lawyers with clients who do business in or with areas that may be subject to widespread casualties.
- LEASES.
- The Right to Terminate upon a Casualty.
In the wake of Superstorm Sandy, casualty clauses, the standard provisions of leases and real estate contracts which deal with the destruction of property, have taken center stage. Falling under the label of “Casualty”, this clause defines the rights and responsibilities of the landlord and tenant in the event of damage to the Building or Premises. Underlying casualty provisions are the competing interests of the parties. The landlord wants the most latitude to consider whether to repair and timing to do so. By contrast, the tenant wants functional space available as soon as possible which includes relocation where necessary and relief from rent where the space is unusable.
Many casualty provisions in commercial leases state that if a significant portion of the premises are damaged or destroyed by casualty, then the landlord, the tenant, or in some cases, either party, has the right to terminate the lease. After Superstorm Sandy and the other recent major storms, many of these lease termination provisions have become the source of litigation because the parties did not anticipate the effects of such a widespread disaster. The three following problems arose involving lease termination provisions.
(a)Time Period for Repairs.
After Superstorm Sandy, many landlords discovered that the time needed for repairs was longer than they anticipated. First, insurance claims had to be asserted and settled. In a widespread disaster, the adjusters are overwhelmed with many claims, and the landlord may have to wait to meet with its adjuster. In addition, many insurers wished to negotiate the claims and did not appreciate fully the increased cost of construction work. Landlords that had included in the damage termination period the time for asserting insurance claims and recovering insurance proceeds were in a better position than those that had not. Second, because there was so much demand for construction work in the area, landlords found that obtaining contractors, workers, and materials for the restoration took longer than under ordinary circumstances. In addition, most contractors were working on many projects at the same time, so in many cases, the work progressed more slowly than normal.. Many landlords also found that utilities for reconstruction were not available for an extended period and that there were delays in obtaining building permits. Consequently, one of the most important hurricane lessons is that restoration of damaged buildings and space will take longer if there is a widespread casualty. Landlords should assure that if the lease gives the tenant the right to terminate if the damage cannot be restored in a certain period of time, this period is long enough to accommodate these delays. A force majeure clause may help the landlord avoid the harsh results of a short restoration period, but to prevent tenant arguments, a long restoration period is preferable.
(b)Time Period for Notice
The time provided for the party or parties with the right to terminate to give notice of termination also created issues after Sandy. Many leases specified that if the party with the right to terminate wished to exercise that right, it was required to give the other party notice of termination within thirty (30) days after the date of the casualty. Below is a standard type provision:
SAMPLE CLAUSE: If (a) there is material damage to the Leased Premises that is not covered by insurance, or (b) more than twenty-five percent (25%) of the Leased Premises is damaged, or (c) the Retail Complex or the building of which the Leased Premises are a part is damaged to the extent of more than twentyfive (25%) percent of its replacement cost, even if the Leased Premises are not damaged, Landlord will have the right, at its option, to terminate this Lease by notice to Tenant given within thirty(30) days after the occurrence of the event causing the damage. If the damage to the Leased Premises makes the Leased Premises unusable and the damage was not due to the act or omission of Tenant or any of its agents, contractors, licensees, or employees, then the Fixed Annual Minimum Rent will be abated in the same proportion that the Floor Area of the Leased Premises made unusable bears to the entire Floor Area of the Leased Premises immediately before the casualty. This proportionate abatement will begin on the date of the casualty and will end when Landlord has completed its work in the Leased Premises to a degree sufficient to permit Tenant to perform its work in the Leased Premises. There will be no rent abatement if only Tenant’s Work or its inventory, fixtures, equipment, furniture, or other property are damaged or no work by Landlord in the Leased Premises is required. Upon any damage to the Leased Premises or its contents, then commencing promptly after the damage, or if Landlord is obligated to perform repairs to the Leased Premises, commencing promptly after Landlord has completed these repairs to a degree sufficient to permit Tenant to perform its work, Tenant shall (x) restore Tenant’s Work to its condition immediately before the casualty, (y) repair or replace its inventory, fixtures, equipment, furniture, and other property, and (z) if Tenant has closed, reopen for business. If Tenant fails to begin, proceed with, or complete the repair and restoration of Tenant’s Work (including, without limitation, its wall and floor coverings) or its inventory, fixtures, equipment, furniture, or other property promptly as required in this Article, or to re-open for business as promptly as required, then at Landlord’s option, an Event of Default will occur, and in addition to its other rights and remedies for this Event of Default, Landlord shall have the right to receive all proceeds of Tenant’s insurance covering Tenant’s Work and all other Tenant property that is to remain on the Leased Premises at the expiration or sooner termination of the Lease.
If each party knows within a short period whether the other party will terminate the lease, then the landlord, can avoid reconstructing the space if the tenant will not return, and the tenant, can start looking for a new location quickly. However, after Sandy, many areas were inaccessible for several weeks. After Katrina, that time frame of inaccessibility was months. Both landlords and tenants were unable to return to assess the extent of the damage or find contractors who could quickly estimate the reconstruction period or cost within such relatively short time periods of thirty (30) or sixty (60) days.
In fact, many landlords found it difficult to locate contractors that would estimate quickly the reconstruction period or cost. Both landlords and tenants with the right to terminate were put in the position of having to decide whether to exercise a right to terminate the lease when that party was not certain that the damage was sufficiently great to permit termination. Some tenants that did not know the extent of the damage tried to preserve their rights by giving the landlord notice within the required notice periodeven if the damage was, in fact, greater than the damage that permitted the tenant to terminate. In this widespread casualty circumstance, leases that gave the party or parties sixty (60) days or longer within which to evaluate the damage and give notice of the termination proved more realistic. However, even in an ordinary casualty situation, more than thirty (30) days may be needed to permit the parties to determine the repair time and whether they want to terminate the lease.
As a result, parties wishing to terminate were faced with two unattractive options:
(1) provide notice without having first being able to assess the damage in order to meet the time period requirement for notice; or
(2) let the deadline for providing notice pass, wait to assess the damage when possible, and then, if warranted, attempt to submit an “untimely” notice of termination, claiming that these Sandy-related delays prevented the party from being able to meet the requirements of the lease.
The former option requires making an uninformed decision…never a prudent business tactic. Yet the latter course of action will inevitably wind up in litigation, requiring that a court read outside of the “four corners” of the agreement to determine if the untimely notice was justified. This presents a business risk in and of itself. If the court disagrees with that position, the loser will not only remain bound under the lease but may also likely be hit with court costs and attorney fees pursuant to the “prevailing party” clause contained in most commercial leases because a court may hold that such “untimely” notice is not effective under the terms of the lease.
2. The Landlord’s Restoration Obligations.
Many commercial leases state that if neither party terminates the lease within the period provided for termination, then the landlord must restore the premises. Again, the landlord’s form should state that it is not obligated to begin its restoration until it has actually received its insurance proceeds (so that its access to the necessary funds), and that its restoration obligations are subject to actions of governmental authorities, the availability of utilities, inability to obtain workers or materials, subsequent casualties, and other delays that are not in landlord’s reasonable control. Depending on the way the lease is drafted, delays caused by these outside factors may be covered by the standard lease force majeure clause, particularly if a time for restoration is not fixed. However, if the landlord is obligated to restore the leased space within a certain period of time, then the landlord should make it clear that this time period will be extended by delays caused by matters not within the landlord’s control. The time period provided for each party to decide whether to terminate the lease should also be considered by the landlord when it establishes its restoration period.
In most cases, and unless the landlord has insured the tenant’s improvements, the landlord will want to restore only the parts of the premises that it originally delivered to the tenant. The lease should therefore state that the landlord is not obligated to restore the tenant’s leasehold improvements, fixtures, equipment, and furniture, but that the tenant must insure this property and restore it if it is damaged.
Sample Clause:
If the Leased Premises are damaged by fire or any other insured casualty, then, subject to Landlord’s right to terminate set out below, the damage shall be repaired by Landlord within a reasonable time period after the casualty, but (i) Landlord will not be required to commence such repairs until Landlord has full access to the Leased Premises and has received the proceeds of the insurance for these repairs, (ii) Landlord will not be obligated to perform repairs costing more than the net insurance proceeds received for these repairs, and (iii) Landlord will not be required to repair or restore any of Tenant’s Work (including, but not limited to, its floor or wall coverings), or any of its inventory, fixtures, equipment, furniture, or other property, and the Leased Premises will not be considered untenantable or unusable by reason of the fact that the Tenant’s Work or its inventory, fixtures, equipment, furniture, or other property has not been repaired or restored.
3.The Tenant’s Obligation to Restore, Restock, and Recommence Operations.
The landlord needs each of its tenants to restore its leasehold improvements, fixtures, equipment, and inventory and re-open for business immediately after the landlord has completed its restoration of the base building. Having the tenants open for business as quickly as possible is particularly important if some leases of space in the shopping center contain co-tenancy provisions that permit the tenant to remain closed, or to reduce its rent or terminate the lease, if other tenants are not open and operating. If the lease provides for percentage rent, the landlord will also want the tenants to be open and making sales as quickly as possible. The landlord’s form lease should state that the tenant must restore, re-stock, and re-open immediately after the landlord has re-delivered the leased space to tenant.
4. The Right to Rent Abatement.
Most commercial leases provide the tenant with a rent abatement while the premises are not usable by reason of casualty damage. That is, the Tenant is relived of its obligation to pay rent during the pendency of the casualty repair period. Often, the Tenant’s rent will abate only to the extent that Lessor receives insurance proceeds that compensate Lessor for this lost rent. The landlord should carry appropriate insurance to cover this abatement period. Some landlord form leases provide that the tenant’s rent will not be abated if the casualty was caused by tenant or those for whom it is responsible.Tenants are frequently able to have this condition deleted because the landlord will be relying on its lost rents coverage, and the tenant’s negligence should not keep the landlord from receiving these proceeds.