Are you a landlord for a commercial property? Do you have tenants in which you are providing the build out in their leased space? Or are you a tenant leasing space and you just finished building out your lavish office? Who is responsible to repair/or replace after a loss?
Read on to learn how to protect your investment or better off, to make clear to your tenants that you are not responsible.
Jennifer Moffitt, CIC, CWCA
Improvements And Betterments:
Who Owns And Insures Them?
If you rent your business premises, any improvements you make—such as interior remodeling—automatically become the landlord’s property. When these improvements and betterments are damaged by fire or other insured catastrophe, who is responsible for replacing them? Since the improvements belong to the landlord, technically the tenant hasn’t lost any property. What the tenant has lost is the use of the improvements for the remainder of the lease.
Check lease wording to determine whether it permits you, as a tenant, to make improvements, whether it requires insurance for these improvements, and who must insure improvements. Since your improvements might be essential to your business operations, it’s important to determine who has responsibility for replacing them if they become damaged.
When The Tenant Is Responsible…
If the lease stipulates your business, as the tenant, is responsible for insuring improvements and betterments, you can take the following steps to transfer the risk of damage to improvements and betterments.
First, you can negotiate to have the landlord assume responsibility for insuring the improvements. The landlord can do this in the lease or by separate written agreement with the tenant. Using a mutual waiver of subrogation is also recommended. This means both the landlord and the tenant waive their right to recover damages from the other party, even if the other party may be responsible for those damages. A waiver of subrogation will not impair insurance recovery.
If the landlord assumes the responsibility of insuring the improvements, make sure that the lease also requires the landlord to repair or replace improvements (along with the building) if they are damaged or destroyed. If your lease doesn’t require this and you can’t renegotiate, you may want to buy leasehold interest insurance. Although designed primarily to protect tenants from losses suffered due to the cancellation of a favorable lease because of insured loss or damage to the building, it also covers your improvements and betterments.
Alternatively, you can buy insurance to cover your improvements or betterments. Your commercial property policy covers your “use interest as tenant in improvements and betterments.” However, the amount the policy will pay you for damage depends on how quickly you repair damages. If you repair them “promptly,” the insurer will pay their actual cash value.
When you don’t or can’t repair improvements promptly (as when the building is destroyed and not rebuilt or if you decide to move), the policy will pay the “unamortized” portion of the original cost of the improvements. For example, if you invested $20,000 in improvements at the beginning of a 10–year lease, and your building is destroyed at the end of the second year, you’ve lost 80 percent of your investment. In this case, the policy would pay you $16,000 (minus any deductibles), regardless of the actual cash value of the improvements when they were destroyed.
So before making an investment in improvements and betterments, protect yourself by reading your lease terms. Who has responsibility for repairing or replacing them in the event of a loss? If the lease makes your business responsible, you can transfer your risk of financial loss by buying insurance. For more information, contact your insurance broker.
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