As trends in lending remain volatile, insurance is increasingly necessary to support and facilitate major projects and transactions, whether as formal security for a lender, or less formal (but no less important) comfort to the parties. In lending transactions, a borrower needs to ensure that its rights are protected in the most efficient and cost effective way so that the impact on their business is minimal.
Types of insurance
When advancing funds, the lender will require that the borrower takes out insurance to cover a wide range of risks:
- material damage (loss/damage to goods/buildings)
- business interruption (income stream protection)
- third party liability and employer’s liability
- others, eg keyman, product liability.
Provisions in loan agreement
In a standard loan agreement, a lender will have strict requirements in relation to the insurance provisions. A lender will want to ensure that the borrower maintains adequate insurance over its assets and the loan documents will therefore contain a number of covenants by the borrower confirming that they will do so. A lender will require that the insurances contain the following:
- a non-invalidation and non-vitiation (breach of condition) clause
- waiver of subrogation rights as against the borrower and any tenants of the properties
- provision for insurers to give 30 days notice to the lender if policy is to be cancelled
- permit the borrower to assign insurance proceeds and its rights under the policies to the lender.
These clauses are common in landlord and tenant insurance arrangements. It provides that the insurance will not be invalidated by any act or omission of eg the tenant beyond the landlord’s control which increases the risk of damage to the landlord’s property. However, the clause invariably provides that the landlord must notify the insurer immediately on becoming aware of the act or omission and must pay the insurer an additional premium.
Subrogation is the right of the insurer who has indemnified the insured to step into the shoes of the insured and pursue, in the insured’s name, any right of action available to the insurer to be made available to the insured which may diminish the loss insured against.
A subrogation waiver clause prevents insurers from pursuing rights of recovery in the name of the insured against a specified third party.
A lender will need to be satisfied that a borrower’s insurance policies are adequate and that they comply with the provisions of a loan agreement. The costs of a lender’s insurance requirements can often be prohibitive to the borrower. To avoid unnecessary costs, a borrower or its broker should review the insurances early on in a lending transaction and the insurance provisions in the loan agreement should then be carefully negotiated with the lender.