Loss-of-rents coverage under commercial property insurance
Policy language is the key to rental loss coverage; a look at folksamerica reinsurance and the clarity it brings to this topic
Commercial property owners are covered for physical damage to their building, but what if the time to repair that physical damage results in a tenant moving out or refusing to pay rent, or what if the building was it in the process of was it rented at the time of the loss?
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Of course, it all comes down to policy language, but some policies are unclear when coverage for rental loss kicks in. Under a homeowners policy, if a covered physical loss occurs at the property and the repairs (or the damage itself) force the insured to move, the coverage is usually pretty straightforward. The insurance company must pay up to the policy limits for the time the insured have to move in a monthly amount that is proportional to the insured property. the only issue here is if the insurer takes an unreasonable amount of time to adjust and pay the property damage claim. then, the limits can be suspended for the period of time that is an unreasonable delay.
Reading: What does loss of rent insurance cover
For commercial property, the situation can be quite different. what is insured is not the right of the insured to live in a place similar to his insured residence. instead, what is commonly secured is the building owner’s right to collect rent from a third-party occupant of the property. If the tenant must move due to covered damage, then the rent that tenant was paying is recoverable under most commercial insurance policies. however, if the building is vacant at the time of the loss, say when it is between tenants, then what? In most policies, the coverage still exists, even if there is no rent paid that needs to be reimbursed. the reason there is still coverage is because of the economic concept of “opportunity cost”. if, for example, it takes a year to repair the property, then that is a year in which the property cannot be rented and coverage must be provided for that loss.
the california court of appeals ruled in 2013 that when the policy promises to pay the insured for “rental loss”, but does not elaborate on the actual presence of a tenant at the time of the loss, the claim is covered even if the building is vacant at the time of loss.
ventura kester, llc, v. folksamerica reasurance co.
in ventura kester, llc, v. folksamerica reasurance co. (2013) 219 cal.app.4th 633, the appellate court found that lost rents are covered even when there is no tenant: “because the landlord’s need for rental income and loss of rental income were not dependent on having a tenant on the premises at the time of the covered incident, it was reasonable for the policyholder to expect the policy to cover the owner’s actual lost rent as a result of the damage and not depend on the chance of having a tenant on the premises when it occurred the damage”. (id. at 642.)
•the language of folksamerica politics and the iso form
folksamerica’s policy is not an insurance services bureau (“iso”) policy. it is written by folksamerica and differs slightly from the iso form used by most property and casualty insurers.
the iso form says:
(2) “rental value”
If the necessary “suspension” of your “operations” results in a “rental value” loss payable under this policy, we will pay for the actual “rental value” loss you incur during the period that:
(a) begins on the date the property is actually repaired, rebuilt, or replaced and rental capacity is restored; and
(b) ends the first of:
(i) the date on which it could reasonably promptly restore the tenant’s occupancy to the level that would generate the “rental value” that would have existed if no direct physical loss or damage had occurred; or
(ii) 30 consecutive days after the date determined in (2)(a) above.
Under this language, rental loss is covered until “rental capacity is restored.” coverage also requires an “actual loss” of “rental value.” Some insurers argue that if there is no tenant at the time of the loss, then there is no “actual loss.” Ventura Kester removes this argument as a defense against hedging in those circumstances.
folksamerica’s policy defines if the loss of rentals claim is covered in two areas of the policy. the first is in the granting of coverage:
Subject to the terms, conditions and limitations of this policy, we insure you against financial loss resulting from:
. . . .
(3) rentals, including accrued rentals that become uncollectible and additional expenses incurred to prevent loss of rentals, due to damage or destruction of covered structures as a result of an accident.
all that is required for rental loss coverage to apply is (1) a financial loss, (2) resulting from rentals (including accrued rentals) or additional expenses, (3) due to damage to structures covers. in other words, if there is “damage to . . . covered structures caused by an accident,” then there is rental loss coverage.
The first element was present in ventura kester. Ventura Kester suffered a financial loss of approximately $3.8 million in lost rent as a result of a vandalism claim. Surely the fact that the building was vandalized and needed time to repair would prevent Ventura Kester from collecting rent from a tenant. even folkamerica admitted that the damage would cost nearly a million dollars to repair; certainly not a repair that could be done in an afternoon. Ventura Kester’s expert estimated that it would take approximately a year to complete the work. Had there been no vandalism, Ventura Kester could simply have completed the lease he was negotiating with Officemax prior to the loss and rented the building. It could not be seriously asserted that Ventura Kester did not suffer any “financial loss” as a result of not being able to rent the building. although the parties may disagree as to the amount of damages, there can be no dispute that there was any financial loss.
The second element is that the financial loss must result from additional rents or expenses incurred to avoid the loss of rents. here, because the building was vandalized and needed to be repaired, it couldn’t be rented, so there was a loss of rents. Ventura Kester also incurred significant additional expense in trying to avoid loss of rents by hiring attorneys, designers, and architects to try to return the building to a state where it could be rented. ventura kester also had to pay taxes and insurance, which normally would have been paid by the tenant.
the third element was indisputable. folksamerica paid $927,424.03 on the building portion of the claim.
•These policies provide “all risk” rental loss coverage.
Because this type of policy is typically an “all risk” policy, all risks of loss are covered unless specifically excluded. such policy does not cover, for example, only losses as a result of earthquake risk, but covers all risks not specifically excluded.
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Under an “all risks” policy, the coverage limits are defined by the exclusions. (Garvey v. State Farm Fire & Cas. Co. (1989) 48 Cal.3d 395, 406.) The insurer has the burden of proving that an exclusion applies. (waller v. truck ins. exchange, inc. (1995) 11 cal.4th 1, 16.)
•folksamerica’s policy provides three different coverages under this provision.
The second part of folksamerica’s policy describing whether claims for lost rentals are payable states the following:
loss payment basis
subject to the provisions contained in the insurance limit section and subject to all other terms and conditions of this policy, the amount we will pay is calculated as follows:
. . . .
we will pay:
your net loss of rental income; and rents accrued but become uncollectible due to a covered loss at a location described on the declarations page; and your additional expenses necessarily incurred to minimize your loss of rental income, but only to the extent that it reduces the loss of rental income that we would otherwise pay.
There was coverage in your coverage at Ventura Kester under items (a) and (c). Ventura Kester agreed that there was no coverage under subsection (b).
rental loss coverage
Under (a), a loss of rental income is covered. In Ventura Kester, the insured lost the ability to collect rent because there was a vandalism claim that caused the building to require nearly a million dollars in repairs that would take a year to complete. Due to vandalism, Ventura Kester suffered a loss of rental income.
loss of accrued rent coverage
Under (b), there is coverage for rent that has been “accrued” but is uncollectible due to a loss. this scenario does not apply here.
This coverage applies when there is a tenant, but the tenant does not pay rent due to damage to the building. This language proves that subsection (a) applied in Ventura Kester. Ventura Kester’s building was damaged, causing Ventura Kester to lose the ability to earn money by renting it. If subsection (a) only applies when there is a tenant at the time of the loss who has stopped paying rent, then what is the need for (b)? folksamerica argued that subsection (a) applies when the tenant pays rent and subsection (b) applies when the tenant fails to pay rent. The problem with this interpretation is that if the rent is paid, then there is no loss. such an interpretation would therefore make subsection (a) entirely superfluous.
Any interpretation that would render any policy language meaningless states that such interpretation is incorrect by definition: “we must give meaning to every word of a contract, where possible, and avoid an interpretation that makes a word redundant” . (Advanced Network, Inc., v. Peerless Ins. Co. (2010) 190 Cal.App.4th 1054, 1063.)
coverage of extra expenses
Under subsection (c), there is coverage for additional expenses incurred by the insured to reduce loss of rental income. In Ventura Kester, the insured spent money on lawyers, designers, and architects to try to reduce the loss of rental income by repairing the building as quickly as possible.
since ventura kester spent money to get the property ready for rent after the vandalism loss, this part of the claim should be covered. there is no reason to say that ventura kester did not spend money to reduce the loss of rental income.
ventura kester suffered a “financial loss” under the policy
folksamerica’s policy only provides rental loss coverage if there is a “financial loss”. FolksAmerica argued that there was no “financial loss” at Ventura Kester because the building was not rented when it was vandalized. however, clearly if it was going to take a year to repair the building, then there is a whole year where ventura kester did not have the opportunity to rent the building, suffering the financial loss that he had to spend a year repairing the building before it can be rented .
in nebo, inc., v. transamerica title insurance co. (1971) 21 cal.app.3d 222, 228, a title insurance policy covered loss of rentals due to a title defect. Due to a title defect, the insured had to pay his mortgage and other expenses but was unable to rent the building. the court held that he had therefore suffered a financial loss of rentals.
an opportunity cost is a financial loss
“an opportunity cost is ‘the lost benefit of using a resource in a way that’ prevents it from being used otherwise”. (meyer v. sprint spectrum l.p. (2009) 45 cal.4th 634, 640 n.1.)
The opportunity cost of not being able to rent a building for a year while repairs are being made is obvious: when the building is under repair, it cannot be rented. said cost is a real financial loss for the insured. the opportunity cost of repairing the building is giving up the possibility of renting the building. the cost of performing one action is the loss of the opportunity to perform another.
separate coverage for “accumulated” lost rentals proves that there is coverage for lost rentals that have not been accumulated
Under folksamerica’s policy, there is coverage for accumulated rental loss as well as rental loss. therefore, folksamerica’s policy considers these two losses to be different.
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An “accrued rental loss” is easily understood: when a building is damaged such that a tenant stops paying rent, then that loss of income can be claimed under this coverage.
“rent loss” is when no rent is received and no tenant owes rent. this situation could only occur when there is no tenant. if there was a tenant, and he was paying rent, then there would be no loss. if there was a tenant, and they were not paying rent, then there would be a claim for “accrued loss of rents”. therefore, the only “financial loss” that could occur as a “rental loss” that is not an “accrued rent loss” is when the building is vacant, is damaged due to a covered loss, and then becomes unrentable until it is fixed. there is no other way to activate this coverage.
there were no applicable exclusions in folksamerica’s policy
In the trial court, folksamerica agreed that no exclusion applied. folksamerica argued in appellate court that because it did not rely on an exclusion to deny coverage, its limitation on coverage did not need to be “conspicuous, simple, and clear.” however, any restrictions on coverage – such as folksamerica’s desire to restrict coverage to non-vacant properties – must be made clear. this rule applies not only to exclusions, but also to any limitations on coverage:
therefore, politics contains its own seeds of uncertainty; the insurer has made a promise that is by its very nature ambiguous. Although this uncertainty in the fulfillment of the defense duty could have been clarified by the language of the policy, we do not find such specificity here. an examination of the policy reveals that the promise to defend, stated in general terms, is not clearly or conspicuously conditioned solely on unintentional bodily injury; instead, the insured could reasonably expect such protection.
(gray v. zurich ins. co. (1966), 65 cal.2d 263, 272.)
(1) there was no vacancy exclusion
There is no vacancy exclusion in the folksamerica policy. Many policies only provide coverage for building losses, especially vandalism claims, if the building is occupied at the time of the loss. folksamerica politics had no such exclusion. (see generally trb investments, inc. v. fireman’s fund ins. co. (2006) 40 cal.4th 19, 30; belgrade v. national am. ins. co., (1962) 204 cal.app.2d 44 , 47.)
(2) there was no “signed lease” exclusion
FolksAmerica’s appointee to make the final coverage decision at Ventura Kester testified that in order for there to be coverage for rental loss, there must be a signed lease agreement with a tenant prior to the loss. but this requirement is not stated anywhere in the policy.
of course, the test to determine if the ventura kester claim is covered is not the ideas of the person in charge of the claim nor the denial letter: the only source of the rules to determine if the ventura kester claim was covered was the language of folksamerica policy. that policy does not state that a signed lease is required for coverage. states that there must be a loss of rent as a result of physical damage to the building.
interpretation of the language of politics
If a court determines that a policy is clear, then the plain meaning prevails. (Bank of the West v. Superior Court (1992) 2 Cal. 4th 1254, 1264-65.) If it is in some way unclear whether or not there is coverage, then the court must consider the objectively reasonable expectations of the insured. (ibid.) If that analysis does not resolve the issue, then the court will interpret the language against the writer, the insurer.
The fundamental objective of contractual interpretation is to make effective the mutual intention of the parties. if the contractual language is clear and explicit, it governs. on the other hand, “if the terms of a promise are in any respect ambiguous or uncertain, it must be interpreted in the sense in which the promisor believed, at the time of making it, that the promisee understood it”. this rule, applied to a promise of coverage in an insurance policy, protects not the subjective beliefs of the insurer but, rather, “the objectively reasonable expectations of the insured.” only if this rule does not resolve the ambiguity do we resolve it against the insurer. (ibid.)
• the simple meaning of the policy establishes the coverage
When interpreting an insurance policy, courts first look at the plain meaning of the policy. western bank, 2 cal.4th to pp. 1264-65.) if clear, check. (ibid.) The words in an insurance policy should be interpreted as a layman would read them. if, for example, an insured is unable to rent a property due to covered physical damage, then the insured has suffered a “loss”: “in the absence of any indication that the parties intended to give any special or legalistic meaning to the definition of ‘loss,’ it is stated that we must determine its meaning by interpreting the phrase as a reasonable layperson would interpret it, not as an attorney or insurance expert.” (Executive Risk Indem., Inc., v. Jones (2009) 171 Cal .app.4th 319, 329.)
• the objectively reasonable interpretations of the insured results in the coverage
if, after reading the language of the policy, a court is unsure whether or not there is coverage, then a layman’s objectively reasonable interpretation controls. (Bank of the West, 2 Cal.4th at 1264-65.) In Ventura Kester, the court concluded that an objectively reasonable layman would consider that a policy that has a loss of rentals provision would provide coverage if the building is damaged and cannot be rented.
• If neither the clear meaning nor the insured’s expectations respond to the coverage problem, then it is automatically interpreted against the insurer
Finally, if the court determines that the language of the policy remains unclear after taking into account the objectively reasonable interpretation of the layman, then the language is automatically interpreted in favor of the insured. (ibid.)
• Coverage restrictions are narrowly construed
e.m.m.i. Inc. v. zurich american ins. co. (2004) 32 cal.4th 465, 470-71, held that when interpreting an insurance policy, limitations on coverage should be construed strictly against the insurer:
Furthermore, policy exclusions are narrowly construed, while exceptions to exclusions are construed broadly in favor of the insured. “‘An insurer cannot avoid its basic duty to insure by means of an exclusion clause that is not clear. as we have stated time and time again, “any exception to the underlying basic obligation must be stated in such a way as to clearly inform the insured of its effect”. therefore, “the burden is on the insurer to write the exceptions and exclusions in clear and unambiguous language”. the exclusion clause “must be conspicuous, simple and clear”. this rule applies with particular force when the coverage portion of the insurance policy would lead an insured to reasonably expect coverage of the allegedly excluded claim.
if the court, in evaluating the language of the policy, finds the matter to be a “close call”, then the limitations must be construed against the insurer. it does not create a judicious question of fact, because the question of policy interpretation is not a question of fact. it is a legal question for the court to decide. (waller v. truck ins. exchange, inc. (1995) 11 cal.4th 1, 18.) any uncertainty as to the enforceability of coverage restrictions claimed by an insurance company should give rise to a judgment against its enforceability.
if folksamerica had wanted to limit the coverage in its policy for loss of rentals to only those situations where there is a signed lease agreement with a current tenant at the time of the loss, then the policy should have stated that the loss of rents and other expenses are excluded unless the insured entered into a written lease with a tenant prior to the date of physical loss to the building. the policy did not contain that language.
loss of rent clauses provide coverage when a commercial building can no longer be rented due to covered physical damage to the building, even if (a) there is no tenant in the building at the time of the loss, or (b) the building is currently not rented to anyone. the loss of the opportunity to lease the building is sufficient for coverage.