Works insurance: tenant beware

Who is responsible for the insurance of a building when a tenant is refurbishing a floor in a multi-let office? As a construction lawyer, I have this conversation with occupier clients at least once a week. Unfortunately, the answer is not what many people may assume. Let’s start with the typical agreement for lease plus licence to alter. These usually provide at least that the landlord will add the tenant to the existing buildings policy, that the tenant will procure that its contractor has substantial public liability insurance (not a huge amount, maybe £10m) and that, unsurprisingly, insurance of the tenant fit-out works is the tenant’s problem not the landlord’s. There is already an elephant in the room, and it’s a great big one. What happens if the tenant’s contractor burns down the landlord’s building? (Sorry, we lawyers do like to illustrate these points with these apocalyptic scenarios.) As we will see, the question is entirely relevant and sensible, for the reasons outlined below. It’s hard to start explaining this without reference to what standard building contracts say as they heavily influence, or even dictate, parties’ behaviour. We are talking here about insurance of works and buildings against damage by “specified perils”, so, paraphrasing somewhat: fire, flood, tempest, explosion and natural disaster. A number of these involve damage for which a contractor or designer is potentially responsible because they caused the event in question, or because their negligence or breach of contract made its impact worse (for example, not enough time for the fire brigade to put out a blaze)..  Standard terms The insurance provisions of the Joint Contracts Tribunal suite of construction contracts ask an employer under the building contract to choose from one of three standard assumptions. Option A: When the project is new-build, it is assumed the most cost-effective way to procure insurance of the works and materials against specified perils is for the contractor to add the project to its annual contractors’ all-risk insurance and to include the employer as a joint insured. They will make a modest charge for this. Option B: Once again with new-build, if the employer has a particular wish to control, and be first loss payee on, the insurance, it takes out the insurance policy and adds the contractor as a joint insured. This joint insured status means there is a waiver of subrogation against both insured parties, so that any damage to the works caused by the specified perils – fire, flood, etc – is paid out on a “no-fault” basis, and with no comeback. Option C: Works to an existing building complicate things. There will already likely be a buildings insurance policy in place for damage to existing structures. Option C assumes cover for the new works, with a waiver of subrogation for the contractor, can be tacked on to the existing buildings policy for a modest marginal increase in premium (bearing in mind it is for the duration of the works only). Once again, this is assumed to be the most cost-effective solution. However, option C also makes the underlying assumption that it is the employer who is the owner of the building as well as the person procuring the fit-out works. Where the tenant is procuring its own fit out, this is not the case and it is not in a position to add its contractor to the existing buildings insurance. It is, of course, perfectly at liberty to insure the actual fit-out works themselves (option B) or to ask the contractor to do so (option A). This, though, leads to a big gap in cover. What about damage to the existing structure and contents of the building, some of which may be owned by third parties? What is the potential quantum of such a claim? Ultimately, it is the full reinstatement value of the whole of the building, including contents. So the apocalyptic example above is not that wide of the mark. How many tenants entering into a lease of a large and valuable building, or any building, take steps to find out that figure? Especially when they may be using a minor works contract. Unfortunately, many of those procuring tenant fit-out works or those advising them look only at the words “existing building” and assume option C is the one applicable. Similarly, if the contractor sees option A in the contract particulars, they will seek to “correct” this to C. If the tenant does “tick the box for” option C and there is, for example, a major fire, what happens then? The landlord will make a claim on its insurance. The tenant may also be protected under the buildings insurance. So that’s fine, isn’t it? Well, no. The landlord’s insurers are likely to bring a subrogated claim against the guilty parties, ie the tenant’s contractor, subcontractors, and possibly consultants. The contractor may be good for the money depending on the reinstatement value of the damage and the amount of public liability cover which the contractor has. But then the contractor may go after its employer: the tenant. It is important for the tenant to understand that, by telling the contractor that the existing building and new works will be insured under option C, it is making a very clear promise to procure a waiver of subrogation for damage to the existing structure and the new works. In fact, if the tenant has not agreed this with the landlord and its insurers, neither the building nor works will attract a waiver of subrogation in favour of the contractor, leaving the employer to make good a shortfall of up to the full reinstatement value. Best practice It is advisable to have an open and honest conversation with both the contractor and landlord at an early stage, preferably before the licence to alter is signed. The JCT tender documents and eventual contract should specify, eg option A for the works and materials for the fit out itself to be insured through the contractor. Importantly, this does not constitute a promise to the contractor to cover damage to the rest of the building by the contractor caused by, for example, hot work. The contractor is likely to pick up on this and they will inevtiably ask about existing buildings cover. Therefore, it is also best for the tenant to ask the landlord at an early stage for a waiver of subrogation in favour of itself (if not already provided for) and its contractor in relation to the entire reinstatement cost of the building. Realistically, in return for this, the tenant will be asked to pay the increased premium cost for the waiver, which should be marginal. We have noticed recently that some agents are advising their landlord clients to refuse such requests on principle and cannot understand why this is viewed as preferable to the complications which could ensue if the landlord’s insurer tries to recover against the contractor’s public liability insurance, which may or may not be adequate, given that the levels specified in most licences to alter are modest. If the tenant is unsuccessful in persuading the landlord to insure its contractor, the only alternative may be a large increase in the contractor’s public liability cover, for which the tenant is likely to have to pay, at the same time making sure that it will respond to the relevant type of claim. Or the tenant can just cross its fingers and hope for the best. But under no circumstances is the correct insurance option JCT option C without significant amendment. Karen Kirkham is a construction lawyer at Broadfield and chair of the Joint Contracts Tribunal and the JCT Insurance Group Image © Adobe Stock