Triple Net Leases

Historically, triple net leases have been used for long-term leasing of larger properties, but increasingly they have been prescribed for smaller and/or short-term leasing arrangements, including rentals of individual offices or sections of buildings, along with window plate glass, HVAC units, built-in fixtures, mechanicals, etc.

Over the years, I’ve written extensively about the coverage gaps that can arise when real property is insured under a triple net lease. In a triple net lease, the tenant typically agrees to pay, in addition to the rent, for (1) operating costs such as maintenance and utilities, (2) property taxes, and (3) property insurance.

For the insurance portion, the important part is how the tenant pays for the insurance coverage. Including this and other triple net expenses within a monthly payment is fine, but problems can arise when a landlord places the responsibility for actually procuring insurance for the property on the tenant. How does the landlord ensure that his or her interest is properly protected?

Recently, I received an inquiry from a consultant about the best way to insure a tenant’s exposure when the lease does not make the tenant responsible for insuring the entire building or even a finite section of the building. In this case, the landlord is insuring the exterior structural walls, roof, and concrete slab and the tenant is responsible for insuring the rest of the building on a repair or replacement cost basis. The lease doesn’t specify what “the rest of the building” means.

In situations like this, I believe the landlord is asking for trouble at claim time in determining exactly who is responsible for what damage and the tenant incurs the responsibility of determining and properly insuring the values of a vaguely described exposure. Unfortunately, in this specific case, the landlord and his attorney refuse to budge on the lease requirements.

To come close to meeting the requirements in most of these leases, direct insurance is typically necessary. A limit of coverage can usually be added in a CGL policy for “fire damage legal liability,” but the covered perils are limited. ISO also has a form CP 00 40 – Legal Liability Coverage Form to which causes of loss forms can be added, but this form excludes damages (other than those arising from burglary or robbery) for which liability is established solely by the lease. Damages often, even usually, occur without any negligence on the part of the tenant (e.g., weather-related claims, vandalism, etc.).

This leaves the only option being coverage under something like the ISO CP 00 10 – Building and Personal Property Coverage Form or a businessowners policy (BOP) form. In a case like the one described above, one concern is the potential for a coinsurance penalty since only part of the building is being insured by the tenant. However, the CP 00 10, for example, defines Covered Property to mean the property “described” in the policy and not necessarily the entire building, though this still presents an issue in defining and valuing exactly what needs to be insured under the lease. If you’re talking about the entire building, the description isn’t overly complicated. But if you’re only insuring part of a building, it is easy to see how a description might be incomplete or vague.

In 2017, ISO introduced the CP 14 02 – Unscheduled Building Property Tenant’s Policy in an effort to simplify identification of coverage property without a specific, detailed schedule. This was an improvement, but we still have the issue of adequate valuation when we don’t know exactly what property is required to be covered.

In addition to these valuation issues in determining coverage limits and apportionment of coverage for damage at claim time, another issue is the tenant’s choice of insurer and policy forms. Why would the landlord entrust insuring a multi-million-dollar property to a tenant they may know little or nothing about? Why would the landlord concede the selection of the insurer and the policy forms to someone other than himself or his agent?

And, how is the landlord’s interest in the insurance purchased by the tenant addressed in the policy forms? Is the landlord covered as a named insured? Additional insured? Additional interest? In some claim scenarios, it likely doesn’t matter because the landlord and tenant both could have no coverage for a loss. This can happen even if the coverage is broad and the insurer’s claims service is outstanding.

For example, what if the tenant has financial problems and commits arson? This happened in one case I consulted on when the tenant torched the building mainly to recover on over $1 million of merchandise they claimed was in the building, though apparently the fire was so hot it vaporized the contents because not even a nonstructural ash was found inside the building, indicating that none of the property on the loss report was actually in the building.

In this case, the tenant had insured the building and contents on an ISO commercial package policy which included ISO form CP 00 90 – Commercial Property Conditions. The “Concealment, Misrepresentation Or Fraud” provision in that form said, “This Coverage Part is void in any case of fraud by you as it relates to this Coverage Part at any time.” It goes on to extend voidance if “any other insured” conceals or misrepresents facts concerning coverage. So, in the case of arson by the tenant (or landlord), it doesn’t matter what the landlord’s insured status is. There is no coverage for anyone except possibly a mortgagee under that clause.

Over the years, I’ve addressed these issues in seminars, always with the challenge to anyone in the audience who can convince me that a triple net lease where the tenant purchases all or part of the real property insurance is a good idea when weighed against the possibility that something could go wrong and coverage could be inadequate for the landlord. So far, no one has been able to meet that challenge.

I’ve heard a financial rationale regarding the alleged positive impact of such lease arrangements on taxes, cash flow, or other factors, but none of these explanations, to me, counter the risk of a potentially huge uncovered property loss. If I owned a multi-million-dollar building, I would want to insure every nut and bolt myself and pass that cost along to the tenant within the lease payments.

What do you think?