Subrogation is the principle under which an insurer that has paid a loss under an insurance policy is entitled to all of the rights and remedies belonging to the insured against a third party with respect to any loss covered by the policy. In simple terms, subrogation means substitution of one person for another. Subrogation permits a landlord’s insurer, in the event of a casualty negligently caused by one of its tenants, to “step into the shoes of landlord” and make a claim against such tenant. Because such a claim could mean millions of dollars to a client, counsel should pay careful attention to matters of subrogation in lease negotiations.
How subrogation works is best explained with an example:
A tenant leases office space from a landlord in a multi-tenant office building. The landlord is responsible for maintaining insurance covering damage to the office building and common areas, while the tenant is responsible for maintaining insurance covering tenant’s personal property and any improvements within the leased premises. The lease agreement between landlord and tenant does not include a waiver of subrogation provision. As a result of tenant’s negligence, a fire causes $1.5 million in damage to the building. Landlord files a claim with its insurer and landlord’s insurer pays landlord $1.5 million. Under landlord’s policy, the insurer is subrogated to landlord’s claim against the tenant (meaning that once the insurer pays landlord, landlord’s claims against tenant are assigned to its insurer). The insurer then sues tenant for the $1.5 million loss.
Without mutual waiver of subrogation the landlord’s insurer could obtain a judgment against landlord’s negligent tenant, which may make it difficult or impossible for tenant to make its rental payments. Such a result would have a direct impact on landlord’s income stream.
By including a waiver of subrogation provision in the lease, however, landlord and tenant waive the right of their respective insurers to make a claim against the negligent party who caused the casualty. Mutual waiver of subrogation can be desirable to both tenant and landlord because it places the risk on the insurer. Because the insurer has been paid (in the form of premiums) to assume the risk of a casualty, insurers frequently agree to waive subrogation. Waiver of subrogation also can prevent costly litigation for all parties.
If the parties negotiate a mutual waiver, here are some practice tips to keep in mind:
- If subrogation is waived, each party will look to its own insurance to cover the damage, so it is critical that landlord and tenant have their respective insurance advisors confirm whether the applicable insurance policy’s coverage amounts are adequate. Counsel should check that the correct additional insured parties are named.
- Simply including waiver language in a lease agreement is not always sufficient. Tenant and landlord should each review a copy of each other’s insurance policies to see if they allow waivers of subrogation.
- Counsel should consider how the remaining sections of the lease fit together with the waiver of subrogation provision, particularly the indemnification section. Counsel should revise such section to make clear that the obligations are subject to the waiver of subrogation provision.
- Some lease provisions are conditioned on obtaining a waiver of subrogation from the insurer of each party. It is good practice for counsel to advise its client of the need for follow up to obtain the waiver from the insurer and to confirm that the other lease party has done the same.