Most leases require a tenant to obtain insurance that is consistent with the lease terms before they can enter a premises. Despite this fundamental prerequisite to enter, most tenants fail to meet the lease’s insurance provision. This failure can cause delays in construction, occupancy and the “grand opening”, not to mention tack on “surprise” premium increases. In order to avoid this disaster, a prudent agent will advise her client to have the insurer review the lease and the insurance clause; she will also have a general understanding of some critical insurance terms.
What is the right of subrogation?
The right of subrogation is one of the most misunderstood and overlooked rights related to the insurance clause. This right is not the landlord or tenant’s to exercise. Rather, it’s the insurer’s right to sue the party responsible for causing a loss or damage. This arises when the insurer pays insurance proceeds to the injured party to reimburse the insured for its losses due to damage or injury caused by another party. Once the insurer compensates the insured, the insurer then gets a right to “step into the shoes” of the insured and sue the party that caused the loss. This right makes the insurer “whole” as it recoups its payment to the insured by suing the party that caused the damage.
For example, let’s say that the tenant burns down the building. The landlord’s insurer will reimburse the landlord for its loss of the building. The insurer then gets the right to “step into the landlord’s shoes” and sue the tenant for the money it had to pay out to the landlord due to the loss.
Is this fair? What can you do?
I believe that right of subrogation is unfair because it allows the insurer to be paid twice; once by the insured and then a second time by exercising its right to subrogation. This outcome, as well as the fact that no one likes getting sued, is why you want to ensure that the parties to a lease both obtain a waiver of subrogation. A waiver of subrogation provision will require the tenant and landlord to get, in writing, their insurers to agree to not sue the party that caused the damage.
Tenants should be particularly vocal about getting a waiver of subrogation if the tenant pays for the landlord’s insurance, because operating costs usually include landlord’s insurance. This is because without a waiver, the landlord’s insurer can sue the tenant despite the fact that the tenant was the one paying for the insurance!
Do waivers affect insurance costs?
Most insurers will agree to execute a waiver of subrogation without any penalty or increase in the insurance premium. While tenants are typically required to obtain a waiver, landlords will only agree to “use their best efforts” to obtain a waiver of subrogation from its insurer. This loose language gives the landlord leeway in case it cannot obtain the waiver.
Can a release be signed instead of a waiver?
A release can be signed instead of a waiver, which simplifies the process of requesting waivers of subrogation from third parties. In fact, most balanced leases have a mutual release clause. This clause releases the landlord and tenant from claims they have against one another, but only to the point that they are insured or are required to be insured under the terms of the lease. In other words, both parties agree to not sue each other if they have insurance that covers the loss they suffered due to the other party’s action.
Releases have the same effect as waivers of subrogation because the insurer’s rights exist only if the insured has the right. If the tenant gives up a right by way of mutual release, then the insurer automatically loses this right as well.
Consider a scenario where a tenant signs a mutual release and a few months later the landlord accidentally destroys the tenant’s premises. The tenant may want to sue the landlord, but if the tenant’s insurance covers the loss, the tenant and insurer cannot sue the landlord. Rather, the tenant’s insurer will have to pay the tenant for the losses, but it can’t exercise its subrogation rights and step into the tenant’s shoes because the tenant has no shoes!
Cautionary note
Failure to obtain waivers or insurance may be a breach of the lease, which puts an unadvised tenant in a tough position. What’s more, many insurers are now refusing to insure tenants who are required to sign a release. Accordingly, it’s not only prudent to ensure that your tenant and has a full understanding of the insurance provisions, but it’s also prudent to ensure that the insurer reviews the entire lease and approves all terms before the tenant is bound.
Natalka Falcomer is a lawyer, real estate broker and Certified Leasing Officer who started her real estate career in private equity. She created, hosted and co-produced a popular legal call-in show on Rogers TV and founded and recently sold Groundworks, a firm specializing in commercial leasing law. She is currently the Chief Real Estate Officer of Houseful.ca, leading the development and expansion of the company’s personalized home buying and selling experience for the Canadian market. She sits as an advisor on NAR REACH Canada and is the former multi-year board member of the Ontario Trillium Foundation.
