Complying with Triple Net Lease Insurance

Requirements
Abstract
Lease agreements can take many forms. One of the increasingly more popular ones is a
triple net lease. While it has historically been used more often for the long-term lease of
larger properties, it is showing up more and more often in 3-5 year leases of smaller
properties, many insured under BOP's. Here are some things to be aware of....
Bill Wilson

There are many types of leases...simple occupancy leases, percentage leases often used with retail
properties, and net leases, the latter of which is addressed here. Black's Law Dictionary defines a "net
lease" to be a "Lease in which provision is made for the lessee to pay, in addition to rent, such additional
expenses as the taxes, insurance and maintenance charges."
Under a single net lease, the lessee pays (in addition to the rent itself) the maintenance and operating
costs associated with the property. A double net lease adds property taxes to rent and
maintenance/operating costs. A triple net lease, in addition to the rental payment, includes
maintenance/operating costs, taxes, and insurance...and that's where WE come in.
Historically, triple net leases have been used for long-term leasing of larger properties because of there
alleged positive impact on taxes, cash flow, and other factors. Increasingly, however, agents are seeing
this form of lease being used in properties rented by relatively small occupants, many of which are
insured by BOP policies. In addition, we're seeing a wide variety of triple net lease requirements...some
effectively require the lessee to pay the landlord's mortgage interest payments, while others include
requirements to insured some of the real property in the structure. For example, here's a question
recently received by our "Ask an Expert" service:
"Question: When a tenant signs a lease and is responsible for heating, air conditioning,
plumbing, and kitchen fixtures (excluding removable appliances like a refrigerator), wouldn't all of
the items in the building that they are responsible for (carpeting that is glued to a slab, furnaces,
glass, water heaters, air conditioners, sinks, toilets, etc.) be considered Personal Property under
Tenants Improvements and Betterments????? If not, how do we insure?"
Unfortunately, Tenants I&B won't help much in this situation. Tenant's I&B refers to real property "you
acquired or made at your expense." Since the tenant didn't "acquire" the property (it was already a part of
the building), Tenant's I&B would not respond. So, what can you do?
First, it is essential that the lease be carefully reviewed and it's probably advisable that the insured have
an attorney do this and identify what specific real property the lessee (your client) is contractually required
to insure. Agents like reviewing leases about as much as they enjoy rating flood insurance, but this is a
critical need. Since few agents are skilled in contract analysis, it is important that the insured and his/her
attorney carefully review these legal documents to determine what exposures and risks are being
incurred.
If possible, delete onerous insurance requirements during the lease negotiation. Explain to the landlord,
even if there is a perceived tax or other financial advantage, why it is in his or her best interest to procure
his/her own insurance and not rely on that of a tenant. Now, back to the real world, what are the lessee's
insurance options?

Depending on the lease requirements, a BOP may not be the best way to insure the property. The ISO
BOP, for example, includes only Fire Legal liability for damage to rented property, which is far short of the
requirements of most triple net leases. However, many company-specific BOP's have Tenant Legal
Liability coverage instead of Fire Legal Liability coverage included in the form. The forms that include this
coverage usually refer back to the property coverage section for the perils insured against. Some BOP's
include additional coverages or coverage extensions (for special sublimits) for real property the
insured/lessee is responsible for.
Risk management guru (and VU faculty member) Jim Mahurin (who has seen his fill of triple net leases)
suggests the following:
"Contractual assumptions to replace improvements to rented space create risk very poorly
addressed under a BOP. The Damage & Destruction clause of the lease usually states that the
Landlord is responsible to rebuild the facility to an unfinished floor, with utility services stubbed at
the outer wall. The tenant may be responsible for damage to occupied space, and responsible for
loss of space they did not damage.
"The first task is to identify risk. What is the tenant's responsibility for damage to leased space?
This is usually not addressed in the Insurance section, but found in the Damage & Destruction
section of the lease.
"Second, Improvements & Betterments coverage as an extension under contents is often
inadequate. This part insures improvements made by the insured or acquired by the insured. It
does not address contractual obligations. Further, coverage for I & B under contents will include a
theft loading, a cost you should not pay.
"Third, the CGL excludes care, custody and control (CCC) claims, and usually won't pay for
damage to space occupied by the insured (other than fire if FDLL is selected).
"One suggestion is to add a building component for the value of I & B for the leased space. The
cost is lower than contents rates, and the risk is clearly identified, valued and insured. In addition,
add Legal Liability coverage form CP 00 40 to remove the CCC exclusion (though there are some
downsides to this approach...see below). This will provide coverage for damage to mechanical
systems that may not be a part of the I & B, but are responsibilities of the tenant in the event of
loss.
"This exposure is very serious. Tenants sign leases as officers of their corporation, and then
personally. Landlords pursue these contractual obligations. The landlords' insurance carriers
subrogate as well. Major losses in leased facilities are not pretty to watch.
"I'm currently examining a couple of leases. One requires removal of the CCC exclusion, and
both impose liability for damage to the improvements and mechanicals. The D & D clauses
require the tenant to rebuild from a bare floor, stubbed utility to finished Class A rental space
unless the loss occurs during the last 90 days of a ten year lease.
"The risk in both locations is very serious. The improvements are serious six to approaching
seven figure exposures. Damage to mechanicals could be a staggering sum. Take out the HVAC
in July in a 45-story building full of attorneys, and see what the incidental expenses total.
"Relying on BOP's for this magnitude of risk is not wise. (But guess what policy is being used on
one of the accounts above.)"

As indicated above, the CP 00 40 - Legal Liability Coverage Form may be used to insure such property,
but it has one significant drawback found in the special exclusions of the Causes of Loss forms:
(a) Contractual Liability
We will not defend any claim or "suit", or pay damages that you are legally liable to pay, solely by
reason of your assumption of liability in a contract or agreement. But this exclusion does not
apply to a written lease agreement in which you have assumed liability for building damage
resulting from an actual or attempted burglary or robbery, provided that:
(i) Your assumption of liability was executed prior to the accident; and
(ii) The building is Covered Property under this Coverage Form.
As you can see, this form does not cover any liability that exists exclusively by contract except for
burglary or robbery damage under a lease. By and large, the insured must be negligent for the damages
and they must be caused by a covered peril before the policy will respond.
So, what to do? Unless the BOP adequately and properly addresses the exposure (which the ISO BOP
does not), the lessee/insured is compelled to purchase specific property coverage for these items at
adequate limits. In addition, consideration should be given for business income and extra expense
exposures the insured may contractually incur not otherwise covered by property or liability forms, along
with any necessary boiler and machinery coverages.

UPDATE: Coinsurance Issues

One reader asked what were the coinsurance implications under a CP 00 10 Building & Personal
Property Coverage Form...would there be a significant potential coinsurance penalty since the tenant is
only insuring part of the building under Coverage A?
Here's what the CP 00 10 10 95 form says about the "building":
1. Covered Property
Covered Property, as used in this Coverage Part, means the type of property described in this
section, A.1., and limited in A.2., Property Not Covered, if a Limit of Insurance is shown in the
Declarations for that type of property.
a. Building, meaning the building or structure described in the Declarations.... [emphasis added]
Note that the insuring agreement applies to "covered property" buildings or structures "described" in the
Declarations. The coinsurance clause similarly states:
We will not pay the full amount of any loss if the value of Covered Property at the time of loss
times the Coinsurance percentage shown for it in the Declarations is greater than the Limit of
Insurance for the property. [emphasis added]
Again, this clause refers to "Covered Property" which is that described on the Declarations page. So,
there shouldn't be a coinsurance problem as long as the declared property is insured to the required
value. As always, it's important to clarify issues like this with the underwriter prior to policy issuance and
to explicitly declare the specific property being insured.