Legal Blog

Insurance

We have spent many hours negotiating the wording of insurance and repair clauses in leases, both for landlords and tenants. However, is the wording of those clauses critical for the allocation of risk? That question was answered in Deslaurier Custom Cabinets Inc. v. 1728106 Ontario Inc., (2016) 130 O.R. (3d) 418 (C.A.).

 

Lease

When determining whether a landlord or a tenant is liable for a loss in an insurance context, the lease, not the insurance policy, is the most important document. Who has agreed to obtain insurance and for what? In any subrogated claim, the insurer’s rights are no better than the rights of its insured.

The lease obliged the parties to obtain insurance coverage for specified risks:

• The landlord was to maintain coverage caused by identified perils to the “Premises” and the landlord’s property.
• The tenant was to obtain business interruption insurance to meet its obligations to the landlord and protect the tenant against loss of revenue. It was also to obtain insurance against all risks of loss or damage to its property. Further, if that provision were not wide enough, the tenant was to carry insurance against all perils, including fire, to its property within the Premises.
• The tenant was to add the landlord as an additional insured under the policies.
• The tenant and landlord had cross-indemnity covenants. The tenant indemnified the landlord against all claims arising out of the tenant’s occupancy of the Premises for damage to the Premises occasioned by any negligence of the tenant or people for whom it was responsible. The landlord indemnified the tenant in the same manner arising out of the landlord’s use or occupancy of the Premises for damage to the Premises occasioned by the negligence of the landlord or people for whom it was responsible (the “Landlord’s Indemnity“).

 

Premises, as defined in the lease, meant specific rental units of a specified size in a described location set out (probably a diagram) in a lease schedule.

Peril

While the tenant’s business was closed for a seasonal holiday, the landlord’s welding contractor carried out repairs at the Premises causing a fire that significantly damaged the landlord’s building and the tenant’s property and shut down the tenant’s business. The tenant’s insurance covered the occurrence, but, because the tenant underinsured, policy limits were only sufficient to cover about 70% of the loss.

The tenant sued the landlord, relying on the Landlord’s Indemnity for subrogated losses of $11 million and uninsured losses of $4 million. As an aside, the tenant had failed to add the landlord as an additional insured under its policy and therefore the insurer alleged that it was able to make a subrogated claim against the landlord for reimbursement of the insurance proceeds.

The matter was dealt with by way of a summary judgment motion. The motions judge agreed with the tenant’s position and granted judgment in favour of the tenant for the full $15 million. The landlord appealed.

Basic Concepts

In a trilogy of Supreme Court of Canada cases between 1976 and 1978, the court held that a landlord’s contractual covenant to insure also operated for the benefit of the tenant, relieving the tenant of the risk of liability for fire damage even when the tenant’s negligence caused the fire. Subsequently, courts have held that the same principle applies when the tenant is obliged to insure against specified perils. Accordingly, a tenant’s covenant to maintain insurance protects the landlord from a claim for loss or damage arising out of its negligence.

The purpose of these principles was explained in a 1997 Ontario Court of Appeal case as follows:

“A contractual undertaking by the one party to secure property insurance operates in effect as an assumption by that party of the risk of loss or damage caused by the peril to be insured against. This is so notwithstanding a covenant by the tenant to repair which, without the landlord’s covenant to insure, would obligate the tenant to indemnify for such a loss. This is a matter of contractual law not insurance law, but, of course, the insurer can be in no better position than the landlord on a subrogated claim. The rationale for this conclusion is that the covenant to insure is a contractual benefit accorded to the tenant, which, on its face, covers fires with or without negligence by any person. There would be no benefit to the tenant from the covenant if it did not apply to a fire caused by the tenant’s negligence.”

 With these basic concepts in mind, the court had to determine whether the tenant’s insurance obligations precluded it from collecting damages against the landlord for the negligence of the landlord’s contractor or whether the Landlord’s Indemnity overrode those insurance obligations.

Contract Interpretation

The motions judge correctly set out the principles of contract interpretation. A commercial contract is to be interpreted:

• as a whole giving meaning to all of its terms without rendering one or more ineffective
• determining the parties’ intention according to the language they use and assuming that they intend what they say
• considering objective evidence of the factual matrix underlining the contract negotiation without reference to subjective intention (but only if the language of the contract is ambiguous)
• in a manner that avoids a commercial absurdity and accords with sound commercial principles and good business sense

 

The motions judge interpreted “Premises” as more than just the rentable space, but also the tenant’s property within it. Accordingly, she decided that the Landlord’s Indemnity governed the circumstances. The court took issue with the motion judge’s interpretation on three grounds:

• Premises was a defined term under the lease. The definition made no mention of the tenant’s property or business.
• The judge ignored multiple sections of the lease, including the insurance provisions themselves, that drew a clear distinction between the Premises and the tenant’s property.
• The narrow and proper interpretation would not render the Landlord’s Indemnity meaningless. It would still apply to the tenant’s leasehold interest in the Premises and its interest in trade fixtures. It would bridge a gap if there were policy exclusions for which the tenant was not required to insure. It would apply to landlord’s negligence for which the tenant was not required to insure.

On this basis alone, the appeal was allowed.

Extrinsic Evidence

The court also noted that the motions judge used, as an interpretive aid, other leases that the landlord had entered into with other tenants. The court noted that this was improper on two grounds. First, the lease was not ambiguous and, therefore, extrinsic evidence was not necessary. Second, extrinsic evidence can only be objective evidence of background facts that were or reasonably ought to have been within the knowledge of both parties at or before the date of contracting. The tenant had no knowledge of other leases between the landlord and other tenants.

Additional Insured

 Even if the court had held for the tenant, it would not have allowed the insurer’s subrogated claim. Had the tenant added the landlord as an additional insured to its policy, as it was contractually obligated to do, the insurer would have had no subrogated claim because an insurer cannot have a subrogated claim against its own insured. The court held that neither a tenant nor its insurer can benefit from a breach of the lease to found a subrogated claim that would otherwise not exist.

In Answer

A $15 million claim perished based on the lease’s insurance provisions. The time spent in negotiating those provisions was, for the landlord, time very well spent.

 

Image courtesy of fieryn.

Written by Jonathan Speigel Jonathan Speigel, the founding partner of Speigel Nichols Fox LLP, leads the litigation and construction practices.