Implications for Real Estate Investors and Occupiers
Exploring Lease Provisions – Part 2
Dear Clients and Colleagues,
The COVID-19 pandemic has impacted our lives like nothing ever before…. Its implications on the healthcare system, financial markets, and economy are far-reaching… including commercial real estate…
Over the past few weeks, I have been on the phone and video conference calls with many clients, investors, occupiers, service providers, design-builders and experts of many facets of commercial real estate, including calls with Cushman & Wakefield’s GTA and Global leadership, SIOR, etc…
I wanted to provide you with a brief update on what I have learned so far about the impact of COVID-19 pandemic, but please keep in mind that the situation is changing on a daily basis…
So let’s take a look at where we stand as of today… April 17th, 2020
We are all in this together…
Both Landlords and Tenants share a common and unprecedented challenge with the COVID-19 crisis…
All businesses deemed to be non-essential are now closed…. With many employees being laid off or furloughed…
And the situation is constantly evolving; having a significant impact on all businesses, occupiers. investors, and property owners…
These challenges may include complete or partial loss of use, whether by governmental mandate, landlord action, or corporate directive, a loss of income, service disruptions, construction and delivery delays, as well as increased health, safety and sanitation costs.
Small- and medium-sized businesses have been hit especially hard…
Smaller Landlords, Private Equity and Institutional Landlords alike have all received calls looking for some kind of rent relief.
To get a better sense of the impact on even larger corporate occupiers we can look at Prologis, one of the world’s largest property owners of industrial real estate with a market cap of $60 Billion and a portfolio size of about 964 Million SF, as a sort of litmus test. They announced this week that nearly a quarter of its Tenants are seeking some kind of rent relief. Drilling down into the weeds, on average, 24% of Tenants are requesting 69 days of rent relief; where only about a quarter of those may be granted.
The biggest – and admittedly difficult to address – issue for Landlords is to determine which of their Tenants have legitimate, existential issues and which ones are simply being opportunistic and looking to receive the same benefits as everyone else…
The bottom line is: Landlords still need to make mortgage payments and there is no obligation on the Landlord to bail out Tenants… Technically and legally, Tenants will be in default if rent is not paid on time…
This is a starting point from where we can then examine other possible solutions.
In the wake of these challenges, many of you may be wondering if and how your financial obligations under your leases might be alleviated; either by the lease language itself or through your insurance policies.
The determination of these solutions is further complicated by the rapidly evolving body of pending and proposed legislation, economic relief programs, and governmental actions.
In our view, tenants should consider keeping meticulous records of any COVID-19-related issues, as such documentation may prove helpful during discussions with your landlords and advisors, as well as with any potential filing of insurance or legal claims or applications for emergency funding.
These issues are lease and fact-specific, and as such, consulting with your solicitors, insurers, tax consultants, and other advisors will help you to best understand and protect your rights.
It is therefore important to review the provisions of your Lease Agreement that may be applicable to this situation.
This week we will cover one of the provisions that has received much attention and coverage over the past two to three weeks… and that is Business Interruption Insurance.
Business Interruption Insurance
A lot of attention and focus has been on Business Interruption Insurance these days, and rightfully so…
Tenants will be looking to recover their losses based on their inability to operate from factors beyond their control… In the event the Lease requires the Tenant to continue paying its rent (minimum rent and additional rent) notwithstanding the casualty or unforeseen event, the Tenant will need a source of funds to replace the revenue it loses so that it can continue paying rent.
This is what Business Interruption Insurance is for.
Landlords usually insist on Tenants keeping in place Rental Interruption Insurance to ensure they can still collect rent in the event their Tenant’s business is not able to operate… In the event the Lease allows the Tenant to temporarily abate the rent for the duration of casualty or unforeseen event, then the Rental Interruption Insurance is intended to cover such loss.
In general terms, Business Interruption Coverage is an add-on to a commercial policy that protects a tenant against economic losses (such as lost income, operating costs, and the cost of temporary space) due to physical damage to the insured property (such as following a fire or other casualty).
Business Interruption Insurance Lease Agreement Clause – Typical Example:
“The Tenant shall, at its expense, obtain and maintain in force throughout the Term and any period when it is in possession of the Leased Premises, in the name of the Tenant with the Landlord and the Landlord’s mortgagee (if any) as additional insureds, the following insurance:
- Business interruption insurance in an amount that will reimburse the Tenant for direct or indirect loss of gross earnings attributable to all perils insured against under Section 8.01 (b) and (c) herein, and other perils commonly insured against by prudent tenants, or attributable to the prevention of access to the Leased Premises as a result of those perils.”
Based on the nature of losses a policyholder incurs, certain coverages may exist and, depending on the policy’s wording, may or may not extend to COVID-19-related losses. Traditional policies with one-size-fits-all wording are more likely to exclude atypical events while policies customized for an insured party are more likely to have coverage that might be applicable to COVID-19.
Business interruption coverages may include: Interruption by Civil Authority, Prevention of Ingress/Egress, Infectious Disease and Other Non-Physical Damage Endorsements and Contingent Business Interruption.
Interruption by Civil Authority / Prevention of ingress/egress
Interruption by Civil Authority covers the insured when denied access to the premises where they operate their business as a result of an order made by a government or civil authority. The order must be a result of physical damage of the type for which the policyholder is insured. Further, the indemnity period (period losses can be claimed) on this coverage is often limited from two to eight weeks. Although widespread government orders have shut down businesses globally and would appear to trigger this coverage, having the underlying cause related to physical damage may be a barrier that prevents many policyholders from making successful claims.
Prevention of ingress/egress is very similar, but with somewhat wider application. It includes the inability to access the business premises for reasons other than an order by civil authority. It also often includes cases when physical damage has not yet occurred, but a threat of physical damage exists.
Infectious disease and other non-physical damage endorsements
Coverage for infectious disease is relevant to COVID-19. This coverage could take a variety of forms and may be related to the contamination or presence of a disease at the insured’s premises and, as a result, loss of access to the business premises by order of civil authority. If the infectious disease endorsement identifies only specified diseases, COVID-19 is unlikely to be included due to its recent discovery. If the policy is an “all risks” or broad form of infectious disease endorsement, then coronavirus would likely be included. These types of endorsements are highly dependent on the policy wording and should be reviewed in detail by a coverage expert to determine if a claim can be successfully advanced.
Non-physical damage endorsements that cover business interruption are not very common in traditional commercial policies. However, if included, they may trigger coverage for business interruption losses. When non-physical damage endorsements are included in a policy it is typically because the specific risk could have a high impact on the business operated by the policyholder; accordingly, they insure against that specified event.
Contingent Business Interruption
Contingent Business Interruption insurance provides coverage for loss of profit or extra expense to an insured when one of their customers or suppliers is shut down due to an insured loss, typically direct physical damage, which has a direct impact on the insured’s operations.
Since the business closures relating to COVID-19 are wide-reaching, if an insured’s primary policy does not cover business interruption losses, it is not likely that the contingent business interruption would apply. However, if the insured’s business impacts are primarily due to a customer or supplier that is shut down, the policy wording should be reviewed in the event that coverage is broad enough to consider the current situation with COVID-19.
Key terms to look for are “actual loss sustained”, “business income” and “period of restoration”.
Business Interruption Insurance would cover the actual loss sustained by the insured as a result of a physical loss or damage to the insured’s property by a peril NOT otherwise excluded from the policy.
The policy would cover the reduction in net business income that would have been earned by the insured and that has come as a result of the suspension of operations due to a physical loss at the insured’s premises.
Further, the policy would cover the loss of business income only during the period of restoration, which is defined as the length of time required to rebuild, repair, or replace the damaged or destroyed property.
Insurance policies are contracts that are notorious for their fine print…. with exclusions from and limitations on coverage…
Therefore, it is important to say that the particulars of the policy wording are key, which may provide some policyholders the ability to make claims under one of these coverages. Although at this time there appears to be limited opportunity to submit claims, it is advisable to consult with a claims professional and understand the coverages your policy may afford and how the claims process works.
The bottom line is, will these policies give landlords and tenants relief? The most likely answer is, NO, it will not. For two reasons, first, most of the business interruption clauses don’t include pandemic coverage. Second, all of the policies require physical loss, and thus, business income needs to be lost because of a physical event. Plus, a large number of all-risk insurance policies include a 2006 ISO endorsement form, which basically excludes coverage for viruses, bacterium and other micro-organisms that induce or are capable of inducing physical distress, illness, or disease.
This is a continuously evolving situation…
Whether you are an Investor or Occupier or Lender we understand that the impact of the COVID-19 pandemic on your business may be significant. All parties involved have keen issues they are focused on and potentially different priorities at this moment. Proper and transparent communication is what will sustain and strengthen the relationships that will get us to the other side… Just remember…
We are all in this together…
DISCLAIMER: All information herein is for informational purposes only. This is not intended as professional legal, tax or accounting advice. We are not liable for any damages, real or perceived, as a result of you receiving or consuming this information. Please consult your attorney, accountant, or other counsel prior to making any decisions…
As we navigate through these uncertain times, rest assured that our team is working diligently to meet the needs of our clients and colleagues. The manner in which we do business is changing constantly, but our commitment to providing the best information and advice remains the same.
Cushman & Wakefield’s leadership team and research resources are committed to providing information on the overall economic and, specifically, the commercial real estate impact due to this pandemic. Please continue to check cushmanwakefield.com for the latest information regarding COVID-19 and the commercial real estate industry.
We’re all in this together, so please reach out with any needs you may have during this time.
Please stay healthy and safe.
Goran Brelih, SIOR
Senior Vice President, Broker
Cushman & Wakefield ULC, Brokerage.
Immediate Past President, SIOR – Central Canada Chapter