Insurance considerations for tenant fit-out works

20 July 2017

When tenants are carrying out their fit-out works at the start of a new lease, or during the term of an existing lease, it is always important to ensure that adequate insurance has been taken out to protect the property. In this bulletin we highlight some of the risks associated with standard building contracts and the options available to mitigate these risks.

Third party fit-out contracts or extensions to existing structures are potentially high-risk as they involve working in a completed building, with the potential to cause a large amount of damage, resulting in loss of revenue if the building becomes unfit for occupation. It is therefore vital that the risks are fully understood by all parties, agreed in writing and insured appropriately.

Challenges to the insurance position

An agreement for lease or a licence to alter often allows for fit-out works to be carried out by the tenant. The clauses in these agreements dealing with the fit-out need to cover the question of insurance, both for the existing building and for the fit-out work itself. 

Problems can arise if the contractor’s employer does not control the buildings insurance. This usually happens if the tenant is the employer under the contract but the landlord arranges the buildings insurance, or if the landlord is the employer but the insurance is arranged by a freeholder. 

If the party that arranges cover refuses to have the contractor named on the policy, the employer could then be in a position where they are unable to comply with the terms of the fit-out contract. If this situation arises, a solution must be found, although it may be expensive and still leave the employer carrying some risk.

When agreeing a contract for tenant fit-out, the key insurance challenges are:

  • The tenant will not usually insure the existing building and is not in a position, contractually or otherwise, to arrange insurance for it
  • Adding tenants and contractors to the landlord’s policy could increase the insurance premium and, potentially, have a detrimental effect on the landlord’s claims experience in the event of a fit-out contractor negligently causing damage to the building. In a multi-occupancy building this could affect all tenants, not just the one carrying out the works
  • Contractors may assume liabilities that far exceed the level of third party liability insurance they carry.

What is best practice for landlords where tenants undertake fit-out works?

The Joint Contracts Tribunal (JCT) is widely used when negotiating an agreement for lease or licence to alter – a commonly adopted version is Design and Build Contract 2011. Under this form, insurance is dealt with under section 6, schedule 3 with the insurance options under clause 6.7. In the context of tenant fit-out, the most widely used insurance option is C as this relates to alterations or extensions to existing structures. This stipulates that the employer is required to: 

  • Insure the works in joint names on an “all risks” basis 
  • Insure the existing structure and their contents in joint names for damage caused by specified perils.

It is unlikely to be appropriate for a tenant to enter into a contract that makes them responsible for arranging insurance for an existing structure (as they will not usually be responsible for insuring the building they occupy) and landlords should exercise caution where a tenant is potentially entering into a contract where insurance option C is being proposed. The implication of noting a contractor as joint insured is that they will be held harmless in the event that they cause damage to an existing structure by a specified peril. 

Best practice dictates that landlords do not allow tenants’ contractors working within their buildings to be held harmless where their negligence causes damage.

The existing structure should be treated as a third party risk by the contractor and they should carry a level of public liability cover commensurate with the reinstatement cost of the building they are working in.

Subrogation

Insurers will retain subrogation rights against the tenant’s fit-out contractors as they will look to seek recourse against the party responsible for the damage in order to recover all claims costs. It will be the tenant’s fit-out contractor’s public liability insurance that would be called upon to pay this claim. Tenants must therefore not enter into option C without first receiving the written approval of the landlord, who in turn must obtain the agreement of their building insurer to waive their subrogation rights. 

If a waiver of subrogation is agreed and extended to the tenant’s fit-out contractor, this could impact the landlord’s insurance in the event of a loss where there is no remedy by way of recovery from the contractor. It should be borne in mind that this could adversely affect the landlord’s claims experience and should therefore be considered carefully before making such a request.

Changes to the insurance provisions in the design and build contract

JCT has published the new edition of 2016 Design and Build Contract with some key changes to the 2011 edition which is widely adopted. There are still three principal joint names works insurance options namely options A, B and C. The key change is that option C, which usually applies where there are existing structures, has been amended so as to allow alternative (non-JCT prescribed) solutions for existing structures and contents cover to be adopted through a replacement schedule. The rationale behind this is to provide some flexibility where works are being undertaken in only part of a multiple-occupancy building. 

The consequence of this is that paragraph C1 (of insurance option C in schedule 3) requiring the employer to insure the existing structures can now be made not applicable and replaced by bespoke provisions to be set out in a separate contract document (the replacement schedule). 

The intention of this is to achieve a balance of risk amongst all parties that is commercially and financially viable and takes into account the nature of the work in the context of the building they are being undertaken in.

How can your insurance broker add value? 

When agreeing a new lease or licence to alter, it is important to engage with your insurance broker at the outset. This will ensure that all parties are clear as to their insuring responsibilities and will eliminate the risk of either party entering into contractual conditions that could prejudice or invalidate cover under the landlord’s insurance policy.

Your broker should review the insuring clauses of the contract to be agreed, as well as evidence of the tenant’s contractor’s liability insurance arrangements.

The JCT Design and Build 2016 also recommends that insurance brokers are involved in preparing any replacement schedules that modify the standard position of the JCT.

Whilst generally speaking the existing structure is considered a third party risk to the tenant’s contractor during fit-out, it is appreciated that in some cases, there is a compelling commercial case to be made for a compromise. We offer a range of innovative solutions for landlords with tenants undertaking fit-out and have a proven track-record of negotiating arrangements for tenant projects which are satisfactory to all parties.

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For further information, please contact Jeremy Court, Client Executive on +44 (0) 20 7528 4119 or email jeremy_court@jltgroup.com

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