Terrorism Insurance: A Two-Edged Sword

The current cases on this point have been decided in New York. These cases turn on the words used in the specific documents. While they are generally set in the context of borrower-lender relations, their reasoning is instructive.

In Omni Berkshire Corp. v. Wells Fargo Bank, N.A., 307 F.Supp.2d 534 (Dist. Ct. S.D.N.Y., 2004), the court held that the requirement that a borrower obtain and maintain “all risk” coverage does not necessarily mean that the insurance provide the exact same coverage that was included in all risk coverage at the time the agreement was made, coverage that at that time included terrorism insurance. The court did, however, hold that the “other insurance” clause allowed the lender to reasonably require the purchase of terrorism coverage. It should be noted that the Omni case involved a loan secured by a portfolio of hotels, including hotels in New York, Chicago, Houston, Dallas and Irving, TX. The court noted that hotels were destroyed and seriously damaged in the 9/11 attacks and held that it was reasonable for the lender to require the placement of terrorism coverage for this collateral package.

The issue of the effect of the evolution of all risk coverage in the insurance markets is interesting. If the coverage provided by the insurance market expands, the lease obligation may expand to include the requirement that the additional coverage be obtained. Is that what was foreseeable by the parties when the agreement was made? Did the tenant agree to obtain or pay for expanded coverage if the all risk concept expanded to include other risks at additional premium cost?

If the coverage offered by the insurance industry contracts, is the party who obtains the coverage excused from obtaining the coverage that is excluded merely because the custom in the insurance industry changed? What if the coverage is reduced and the newly excluded coverage is no longer available, or if it is available only by paying a significantly increased premium? This is precisely the issue at hand. Practically speaking, the courts may really be saying that the parties contracted for a flexible coverage, the requirements of which would change over time as the insurance market changed. If so, both parties assumed the risk that the coverage would expand or contract and the price of the required coverage may increase or decrease depending upon conditions that change from time to time.

A most recent case, BFP 245 Park Co., LLC v. GMAC Commercial Mortgage Corporation, 2004 WL 2744609 (N.Y. App. Div., May 13, 2004) addresses these concerns at least in the light of the contractual provision considered by the court. In that case, the lender's position, deemed by the court to be well founded, was that the loan documents at hand required the borrower to obtain casualty insurance covering “any peril now or hereafter” included within the classification “All Risk” or “Special Perils.” The court found that the “now or hereafter” language was a flexible obligation subject to change as the marketplace changed. The implication of the court's holding may be that the standard is not truly flexible, but rather is only expansive to include coverage that was included when the documents were executed and only additional coverage that the market may offer. The court went on to say that the borrower would also be obligated to procure terrorism insurance under the “other insurance” provision in that such a request was reasonable under the circumstances.

The application of these decisions in the world of retail leasing would seem to indicate that in an appropriate case, a tenant of a single-user building could well be obligated to obtain terrorism insurance to protect its and the landlord's interest and that landlords of multi-tenant buildings who are otherwise required to insure the premises and pass through to the tenants the cost of such insurance may well be within their rights in purchasing terrorism coverage and allocating the premium costs to the tenants.

One should not, however, leap to over-generalized conclusions. If the “other insurance” clause allows the landlord to obtain or requires the tenant to obtain “such other insurance as the landlord may reasonably deem appropriate,” then, in fact, the landlord must act reasonably in making its request. Obviously, a landlord of property in midtown Manhattan or on North Michigan Avenue in Chicago has a different set of factors to consider from those of the landlord of property in rural America or the landlord of a strip mall in a suburban area.

Similarly, language that merely allows the landlord or requires the tenant to obtain all risk property insurance, with nothing more, may not be sufficient to allow the landlord to require the tenant to obtain ' or to charge the tenant common area maintenance expenses relating to ' terrorism insurance. Words that were used in a lease that was negotiated long before the events of 9/11 were in our mind, must be construed in light of the current circumstances.

The courts will have their work cut out for them, and the words that were used by the parties when the bargain was made will be extremely important, even though those words were used in a different era. That is nothing new for courts. Courts have been tackling this problem for a long, long time.

In the landlord-tenant arena, the issue of whether terrorism insurance must be purchased has two frequently encountered aspects. In one factual pattern, a tenant of a single-user property is required by its lease to purchase certain insurance coverage to protect both its own interest and the landlord's. Does this lease provision include terrorism insurance, as well as other types of coverage generally required on the leased premises? In another factual pattern, tenants of a multi-tenant facility must reimburse the landlord for their share of the landlord's taxes, common area expenses and insurance premiums. Do those insurance premiums properly include the landlord's cost of obtaining terrorism insurance?

Leases entered into before 9/11 rarely mentioned the requirement that a tenant or landlord obtain terrorism insurance. Sept. 11 changed many things, including the way attorneys draft insurance clauses in leases. In pre-9/11 lease documents, the requirement for terrorism insurance is typically found in one of two places. The first is the casualty insurance clause. Leases typically require a party to obtain and maintain “all risk” property or casualty insurance. Up until 9/11, all risk insurance included terrorism coverage because there was no exclusion for losses resulting from a terrorist attack. After the tragedy and the losses that occurred in New York and Washington, D.C., insurance carriers began to exclude the terrorism risk from their all risk coverage. The second source of the provision for terrorism coverage is found in the so-called “other insurance” clause. Leases typically provide that the party required to obtain the insurance also obtain such other insurance as the other party may require or elect to obtain.

Because of the business response from the insurance community, ie, excluding terrorism losses from the all risk coverage, the Terrorism Risk Insurance Act of 2002 was enacted. The Act required that all insurers make terrorism coverage available for a certain set of defined conditions on the same terms and conditions as other casualty coverage. Coverage is now available for acts of terrorism committed on behalf of a foreign person or interest to coerce the U.S. civilian population or influence U.S. policy, if the terrorist activity is certified by the federal government. Other acts of terrorism, such as acts of domestic terrorism or those that may not be certified, are not covered. Nonetheless, in many instances, terrorism insurance may be mandated by the existing lease documents.

The current cases on this point have been decided in New York. These cases turn on the words used in the specific documents. While they are generally set in the context of borrower-lender relations, their reasoning is instructive.

In Omni Berkshire Corp. v. Wells Fargo Bank, N.A., 307 F.Supp.2d 534 (Dist. Ct. S.D.N.Y., 2004), the court held that the requirement that a borrower obtain and maintain “all risk” coverage does not necessarily mean that the insurance provide the exact same coverage that was included in all risk coverage at the time the agreement was made, coverage that at that time included terrorism insurance. The court did, however, hold that the “other insurance” clause allowed the lender to reasonably require the purchase of terrorism coverage. It should be noted that the Omni case involved a loan secured by a portfolio of hotels, including hotels in New York, Chicago, Houston, Dallas and Irving, TX. The court noted that hotels were destroyed and seriously damaged in the 9/11 attacks and held that it was reasonable for the lender to require the placement of terrorism coverage for this collateral package.

The issue of the effect of the evolution of all risk coverage in the insurance markets is interesting. If the coverage provided by the insurance market expands, the lease obligation may expand to include the requirement that the additional coverage be obtained. Is that what was foreseeable by the parties when the agreement was made? Did the tenant agree to obtain or pay for expanded coverage if the all risk concept expanded to include other risks at additional premium cost?

If the coverage offered by the insurance industry contracts, is the party who obtains the coverage excused from obtaining the coverage that is excluded merely because the custom in the insurance industry changed? What if the coverage is reduced and the newly excluded coverage is no longer available, or if it is available only by paying a significantly increased premium? This is precisely the issue at hand. Practically speaking, the courts may really be saying that the parties contracted for a flexible coverage, the requirements of which would change over time as the insurance market changed. If so, both parties assumed the risk that the coverage would expand or contract and the price of the required coverage may increase or decrease depending upon conditions that change from time to time.

A most recent case, BFP 245 Park Co., LLC v. GMAC Commercial Mortgage Corporation, 2004 WL 2744609 (N.Y. App. Div., May 13, 2004) addresses these concerns at least in the light of the contractual provision considered by the court. In that case, the lender's position, deemed by the court to be well founded, was that the loan documents at hand required the borrower to obtain casualty insurance covering “any peril now or hereafter” included within the classification “All Risk” or “Special Perils.” The court found that the “now or hereafter” language was a flexible obligation subject to change as the marketplace changed. The implication of the court's holding may be that the standard is not truly flexible, but rather is only expansive to include coverage that was included when the documents were executed and only additional coverage that the market may offer. The court went on to say that the borrower would also be obligated to procure terrorism insurance under the “other insurance” provision in that such a request was reasonable under the circumstances.

The application of these decisions in the world of retail leasing would seem to indicate that in an appropriate case, a tenant of a single-user building could well be obligated to obtain terrorism insurance to protect its and the landlord's interest and that landlords of multi-tenant buildings who are otherwise required to insure the premises and pass through to the tenants the cost of such insurance may well be within their rights in purchasing terrorism coverage and allocating the premium costs to the tenants.

One should not, however, leap to over-generalized conclusions. If the “other insurance” clause allows the landlord to obtain or requires the tenant to obtain “such other insurance as the landlord may reasonably deem appropriate,” then, in fact, the landlord must act reasonably in making its request. Obviously, a landlord of property in midtown Manhattan or on North Michigan Avenue in Chicago has a different set of factors to consider from those of the landlord of property in rural America or the landlord of a strip mall in a suburban area.

Similarly, language that merely allows the landlord or requires the tenant to obtain all risk property insurance, with nothing more, may not be sufficient to allow the landlord to require the tenant to obtain ' or to charge the tenant common area maintenance expenses relating to ' terrorism insurance. Words that were used in a lease that was negotiated long before the events of 9/11 were in our mind, must be construed in light of the current circumstances.

The courts will have their work cut out for them, and the words that were used by the parties when the bargain was made will be extremely important, even though those words were used in a different era. That is nothing new for courts. Courts have been tackling this problem for a long, long time.