A waiver of subrogation provision is one of the most misunderstood, yet critical provisions, in a commercial lease – and one that benefits both the landlord and the tenant. The importance of a protective mutual waiver of subrogation is more clearly seen through a practical example.
A tenant leases space from a landlord in a multi-tenant building. The landlord maintains property insurance covering the entire building while the tenant maintains a personal property insurance policy covering its interior goods. The tenant reimburses the landlord for the tenant’s proportionate share of the building property insurance policy premium. The parties fail to include a waiver of subrogation provision in their lease, and neither party requests a waiver of subrogation on their respective property insurance policies from their insurance providers.
The tenant negligently causes a fire which destroys the entire building. The landlord files a claim with its insurance company and receives funds in the amount of the replacement cost of the building.
After the landlord’s insurer pays the claim, the landlord’s insurance company steps into the shoes of the landlord and makes a claim against the tenant for the damage caused by the tenant’s negligence. This “stepping into the shoes of the landlord” is the concept of subrogation – a derivative claim held by the third-party insurer. However, this result is not the outcome the landlord and tenant intended when they negotiated their lease.
In the example above, without a waiver of subrogation from the landlord’s insurer, the tenant may be obligated to pay the insurer for the damage to the building (although the tenant’s liability insurance may cover the tenant in this situation). This result provides an insurer with double recovery: (1) on premium payments from the landlord (which, in part, were paid by the tenant); and (2) on its subrogated claim against the tenant for the damage the tenant caused. Note that a landlord may be detrimentally affected by this result as well since a tenant with a judgment in favor of an insurance company may be too burdened to make its rental payments to the landlord (to the extent that the tenant’s liability policy did not cover the full tenant liability). A waiver of subrogation clause by the landlord in the lease prevents this unintended result by preventing the landlord’s insurance company from filing a claim or collecting from the tenant.
A landlord also directly benefits from a waiver of subrogation by the tenant. If a tenant is covered by an insurance policy on the personal property in its leased premises, and the landlord negligently causes the leased premises to be destroyed, the tenant’s insurance company may make a claim against the landlord for the personal property loss paid to the tenant by the insurance company. A waiver of subrogation clause by the tenant in the lease prevents such a claim against the landlord. Since it is common for tenants to carry personal property insurance while landlords carry the property insurance on the building, a mutual waiver of subrogation clause in the lease protects both the landlord and tenant.
Here are some practical tips for commercial leases to ensure that the insurance company, and not the landlord or tenant, bears the risk of loss. Most commercial leases contain some form of waiver of subrogation, and so often the issue is negotiating an acceptable form of the waiver:
- An experienced commercial insurance broker or insurance agent should review the insurance policies and limits required by the lease to confirm that the property of the landlord and tenant is adequately insured.
- Landlord and tenant should negotiate whether the waiver will be mutual, or only benefit one party. Generally, a mutual waiver will be a “market” term in most circumstances.
- Landlord and tenant should negotiate whether they will request waiver of subrogation clauses in their property insurance policies, liability insurance policies, or both (it is less common for the parties to request waiver of subrogation clauses in liability insurance policies, but possible). Because the waivers are usually mutual, often each party will weigh the risk of it causing damage (where it would want a waiver) versus being damaged (where it might not want a waiver).
- Landlord and tenant should negotiate which risks and damages are included in the waiver of subrogation clause. Should the waiver be limited to: (i) the extent insurance proceeds are received, (ii) the risks that are required to be insured under the lease (whether or not actually insured); or (iii) for all claims, on the theory that each party takes its own risk in deciding what and how much insurance to carry?
- Landlord and tenant each confirm with their insurers that their policies (whether they be property, liability, or both) will allow them to waive their respective insurer’s rights against the other party and should confirm the waiver limits negotiated between the parties, since a waiver might otherwise impair the insurance coverage. A request for a waiver of subrogation clause on a property insurance policy is not uncommon and most insurers will not object; a request for a waiver on a liability policy is not as widely granted.
- As part of a mutual waiver of subrogation, landlord and tenant often include a direct waiver of claims provision in the lease under which each party (as a prospective injured party) directly waives claims it may have against the other based on the policies and for the limits negotiated above. This is a broader protection than a simple waiver of subrogation, because it means that neither the party nor its insurer will seek recovery for insured claims.
- For maximum protection, each party should confirm (by review of the other party’s insurance policy) that the other party’s insurer did include the waiver of subrogation language in the insurance policy or that the other party’s insurance policy permits waiver of subrogation by the insured.