Why Should Anyone Care If They Don’t Know What Constitutes An Insurable Interest In Property?

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It isn’t intuitive whether someone has an “insurable interest” in someone else’s property, but without one, an additional insured or loss payee will not see any money from that insured’s property insurance policy. This subject, admittedly, is a “little” arcane. So, we’ll try to explain is by way of a story, actually a court’s decision.

There is a lesson to be learned from a recent Bankruptcy Court decision where, most uncharacteristically, the court ruled against the bankrupt estate. Somewhat surprisingly, but probably correctly, it held that a bankrupt tenant’s landlord “owned” the insurance proceeds and took that money out of the reach of the debtor or its other creditors.

Yes, the landlord got to keep the insurance proceeds from insurance the tenant purchased to cover the tenant’s personal property.

Though we can’t get our arms entirely around the court’s ruling in In Re: Amiel Restaurant Partners, LLC, we’re going to try to figure out the implications of what is says about the rights of an additional insured under a property insurance policy. Click HERE to see the Bankruptcy Court’s opinion. The court didn’t make it easy. To Ruminations, the court’s “writing” could have been a lot better.

The simplest thing to say about the facts in the case is that the landlord was an additional insured on its tenant’s flood insurance policy; specifically, on that part of the policy covering the tenant’s personal property.

To get us all on the same page, we’ll give you our take on the background. A restaurant operator leased some buildings for its business. As would be expected, the tenant was required to obtain and maintain certain insurance coverages. One requirement was for “fire and extended coverage” insuring the leased space. [For today, forget this is an obsolete form of insurance. The tenant had a commercial property insurance policy in force and that’s what the lease should have called for in the first place. Click HERE to see why we say this.] Another requirement was that the tenant insure its own property, its own improvements, and the property of others in the leased space. [If you want to know (or remember) what Ruminations has to say about a tenant insuring “improvements,” click HERE.]

While we are at it, we’ll mention that the tenant also needed to get a waiver of subrogation from its insurance carrier and need to be sure that its insurance coverage be “primary.” To match the “waiver of subrogation” requirement, the landlord and tenant waived claims, one against the other. [For an extended discussion about subrogation waivers, click HERE and HERE.]

It isn’t clear from what this court has written whether the lease required such, but as to the three property insurance policies carried by the tenant, the landlord was named as a “loss payee” on a “commercial property insurance policy” [and note that’s the kind of policy the lease should have required instead of the obsolete “fire and extended coverage” insurance]. It was named as an “additional insured” under a primary flood insurance policy (for buildings and personal property) and had the same status under an excess flood insurance policy (but, for buildings only).

Hurricane Sandy destroyed the restaurant. The tenant claimed that the lease allowed it to elect to rebuild and thus avoid the lease’s termination pursuant to the lease’s damage and destruction provisions. In response, the landlord claimed that the tenant was in default under the lease and the landlord took the position that it had the right to terminate the lease by reason of the nature and extent of the hurricane damage.

Now that we’ve written that, thinking it to be interesting background, it would appear that by the time the parties came before this particular judge, the property had still not been restored. Admittedly, it appears that the tenant “lost” the lease, even though the decision recites that it had “assumed” the lease. That’s our best guess because it appears that the court had previously ordered that the landlord could use the building insurance proceeds to rebuild, even though, under the lease, it was the tenant who was obligated to rebuild. If you don’t understand the facts portrayed in this paragraph, don’t bend yourself into a pretzel because none of it is going to be very important by the time today’s posting reaches its end. We don’t think it will be availing for readers to figure this out by reading the court’s opinion for themselves, but nothing is stopping anyone from doing so.

If you recall, this was the Bankruptcy Court making the calls here. That’s because there is a lot more back story (most of which is only suggested in the court’s decision), including that the tenant filed for bankruptcy.

So what was the question in front of the court? It was “how to distribute the checks already written by the various insurance companies?” There were four checks. A small one was for windstorm damage under the commercial property insurance policy. [That’s because most of the damage was from the flood waters and only the windstorm damage resulted from an insured peril.] Another came from the excess flood coverage policy, all of which was on account of building damage.

The primary flood insurance policy generated two checks – one on account of building damage, and the other (the one in controversy in this story) on account of the building’s contents, meaning on account of damage to the tenant’s personal property.

Until this point, everything is background to today’s topic: “What does it mean to have an insurable interest in property?” That’s important because if someone is named as an additional insured or as a loss payee, it can only collect to the extent it has an “insurable interest” in the damaged property. In this case, did the landlord have an insurable interest in the tenant’s property?

Well, before we move into the pure law portion of today’s posting, for context, we need to tell you one more thing about this particular lease. And, it had to do with its “surrender” provision. In that regard, this is what the lease said: “At the expiration or earlier termination of this Lease, Tenant shall deliver to Landlord the Premises: (i) with all Alterations, additions, improvements, fixtures, trade fixtures, furniture, equipment and other property utilized in connection with the operation of Tenant’s restaurant, bars, and Pool Snack Bar (which fixtures, trade fixtures, equipment and other such property shall become the sole property of Landlord at such time) in reasonable good repair and condition… .”

That provision was the hook that got the landlord $359,000 in excess flood insurance proceeds (the award on account of the tenant’s damaged personal property).

A bankrupt estate consists of all of the equitable and legal interests the bankrupt debtor had in any property. A debtor’s insurance policy is one type of such property. But, there is a difference “between ownership of an insurance policy and ownership of the proceeds which it generates.” So the question as to the damaged personal property was not who owned the policy, but “who owned the proceeds?” As pointed out earlier, to collect insurance proceeds, the recipient must have an “insurable interest” in the damaged property. One does not have to be “an absolute owner” to have an insurable interest.

What is the test for an “insurable interest”? Basically, to have an “insurable interest, one has to be benefited by the insured property’s “preservation and continued existence or [one has to] suffer direct pecuniary loss from its destruction or injury by the peril insured against.” The test is applied at the time of loss, not when the lease is signed or the policy issued. What is more, all that is really needed is to know that one has an “insurable interest” if it has a “reasonable expectation of deriving such a pecuniary benefit from the insured property.

That’s why the cited lease provision, the one requiring the tenant to leave all of its restaurant equipment behind, was critical in the outcome of this case. It is why the landlord was able to keep the $359,000 out of the tenant’s bankrupt estate. There were no contingencies to the landlord’s right to become the owner of the tenant’s personal property’s; only the passage of time. Basically, the landlord had a non-contingent reversionary interest in the tenant’s restaurant equipment and fixtures. That, alone, constituted an “insurable interest.”

The absence of any pre-conditions, other than awaiting expiration or termination of the lease is critical. We know that from a 2005 United States District Court ruling that a landlord had no interest in its tenant’s personal property under the landlord’s own policy where the tenant’s personal property would become the landlord’s property if its tenant abandoned or intentionally conveyed that personal property.

This is complicated stuff. If you don’t think so, then let us tell you about the outcome of an 1897 Virginia case. It that case, the court found that a “landlord had an insurable interest in the contents of [its] tenant’s insurance policy, where [a] statute gave the landlord the right ‘to hold the good[s] upon the premises for the payment of the rent.”

Admittedly, for most readers, today’s posting will be purely “academic” until the day comes when there is a need to “collect” property insurance proceeds as a “loss payee” or as an “additional insured.” Then, it will be too late. If there is a simple take-away today, it is that you aren’t guaranteed to get a piece of someone else’s property insurance policy just by being named an additional insured or loss payee under that policy. You have to have a stake in the continued existence of that property.

[Well, we’re not very happy about the website problems that have plagued Ruminations over the last two weeks. It’s something called “php.ini.” At our level of technical proficiency, all we can do is throw money at the problem. And, that’s what we’ve been doing. This is an apology and we’re hoping we won’t have to apologize for website “bugs” again. Faithful readers, thanks for your patience.]

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Comments

  1. Henry Pharr III says:

    This topic, albeit perhaps a rare stone in the big pile of Landlord /Tenant issues, is an interesting one as many owners and lessees may not have taken the time to fully examine the implications of the various insurance policies, overages, rights and responsibilities under the lease. Throw in the equity context of Bankruptcy Court and you get a bizarre result like this one. However, I am intrigued by the decision for a number of reasons: 1) many landlords in our market require that they be named as additional insured as to at least improvements and fixtures; 2) many landlords and tenants are focused primarily on the amount and scope of coverage and not the “proceeds” issue in the LOI process; and 3) since it is a bankruptcy Court decision, it has more precedential value than a state court decision. I think the takeaways are to not lose sight of “rainy day” provisions and landlords’ use of this method of protecting their interest in the structure and premises. Unfair windfall for Landlord here or good outcome as the result of careful planning? I would enjoy hearing the comments of others!

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