Commercial Triple Net Leases: Allocating Insurance Costs

At the very least, tenants are responsible for paying the rent in a commercial lease. But depending on the type of lease—a net lease or gross lease—a tenant might be responsible for additional expenses. In a gross lease, tenants pay one flat fee for rent that indirectly covers the landlord's operating expenses. In a net lease, tenants pay rent plus their share of three kinds of operating expenses depending on the type of net lease: single, double, or triple.

Specifically, tenants will be responsible for all or a portion of the landlord's insurance premiums in a double net or triple net lease.

What Is a Triple Net Lease?

A triple net lease is a kind of net lease where the tenant pays for all three types of operating expenses:

• property taxes
• property and liability insurance, and
• maintenance costs.

Typically, the tenant's payment will consist of the rent (which is usually lower than it would be in a gross lease) and then additional allocated costs for the three separate operating expenses. You can also have a single net or double net lease. In a single net lease, the tenant pays for the property taxes. In a double net lease, the tenant pays for some portion of the property taxes and the property and liability insurance. So whether you have a double net lease or a triple net lease, you'll be responsible for paying your share of the landlord's insurance premiums.

Before signing a lease, make sure you know much the insurance premiums are, what the policy or policies cover, and who's covered under the policy.

Common Insurance Policies Under Commercial Leases

Typically, at the very least, the landlord will have or require you to have:

• property and casualty insurance, and
• commercial general liability insurance (also known as "third-party insurance").

The landlord might already have these two policies in place. If this is the case, then expect to pay a portion of the landlord's premium payments. If the landlord doesn't have one or both of these policies, then they'll likely require you to obtain them. A common scenario is that the landlord will have their own property and casualty insurance and expect you to pay a share of their premiums but require you to get your own liability insurance.

If your landlord requires you to have one of these policies, they'll likely want to be named as one of the insured under the policy and they'll have requirements regarding minimum coverage. For example, your landlord might require you to hold a general liability insurance policy with at least a $1 million occurrence limit and a $2 million aggregate limit.

While property and general liability insurance are the two most basic insurance types for commercial leases, you might want to consider other types of insurance for your small business. Your landlord can even require these additional coverages. Some other types of insurance are:

• insurance for your trade fixtures and inventory
• rental interruption insurance
• business interruption insurance, and
• leasehold insurance.

Before heading into lease negotiations, be sure you understand other important aspects of the two most popular types of insurance: property and general liability.

Property and Casualty Insurance for Commercial Properties

Property and casualty insurance covers the building for fire, smoke damage, explosions, and other disasters or "perils." The policy won't cover perils that it specifically excludes, such as damage from floods. But if a peril isn't listed as an exclusion, the insurance policy will generally cover it.

What Parts of the Building Are Covered?

Property and casualty insurance will protect the building and include:

• the roof
• interior and exterior walls
• stairwells, and
• parking structures.

But what about the items inside the building? Although some contents are covered, the policy will by no means cover damage or destruction to everything inside.

The landlord's own business property, such as maintenance equipment, office supplies, and furnishings, are "contents" covered by the landlord's policy. But you'll need to purchase separate insurance to cover your own business property.

What Parts of the Building Aren't Covered?

In addition to specific exclusions (such as damage from earthquakes), damage or destruction to the building's vital systems—heating, ventilation, and so on—aren't included in property and casualty insurance. You or the landlord must purchase separate policies for them.

Your own business property—your trade fixtures, inventory, and other personal property—are also not covered by this policy. Your landlord could insist, in the lease, that you insure these items.

Finally, many monetary consequences of a fire or other casualty aren't included in this coverage. For example, if the building is damaged or destroyed, your lost profits and the landlord's lost rents won't be compensated by the property and casualty policy. If you want coverage for these losses, you'll have to request an endorsement from your broker, which adds this coverage to the policy. Or, you might need separate policies for this coverage.

Are Tenant Improvements Covered Under Property and Casualty Insurance?

Improvements to the property that were added to customize the space for your needs will normally be covered because, unless you and the owner have decided otherwise, improvements are by law the landlord's property.

Sometimes landlords and tenants agree that an improvement will not become the landlord's property. For example, if you want to take the improvement with you when you leave—such as an expensive server for your computer network—you'll need to bargain for the right to remove it. In this event, the improvement isn't covered under the property and casualty policy. Instead, you'll have to insure it as you would a trade fixture.

What Events Aren't Covered Under Property and Casualty Insurance?

Typically, property and casualty insurance will exclude some events from its coverage, including damage caused by:

• floods
• earthquakes
• pollution, and
• civil riots.

Sometimes, you can purchase separate policies to cover these exclusions—earthquake insurance, for example, is available in areas with known seismic activity. The federal government offers flood insurance for some properties on a flood plain. In addition, environmental contamination policies, covering claims arising from asbestos, lead paint, and indoor air problems are increasingly available.

Commercial General Liability Insurance

If someone is injured on the landlord's property, you and the landlord can be sued. Or, if you or the landlord accidentally damage or destroy someone else's property while it's on the rented premises, the owner can sue you over its loss.

Under general liability insurance coverage, the insurance company will provide both:

• the lawyers to represent you, and
• the money to pay a settlement or verdict.

This type of insurance is known as "third-party" insurance because it protects you and the landlord from claims by others. Knowing that lawsuits by third parties can ruin even the best of businesses, it's in everyone's interest to have an adequate commercial general liability policy protecting you and the landlord.

Who Is Covered Under a Liability Insurance Policy?

When you take out a car insurance policy, you'll list the drivers of the vehicle that you want covered under that insurance. For example, if you list yourself and your spouse as drivers, then insurance will cover the costs related to any accident where you or your spouse are behind the wheel. But it won't pick up the bill if your brother-in-law was behind the wheel because they weren't listed under the policy. General liability insurance policies work in the same way.

The liability insurance will cover anyone who's named as one of the insureds. Many leases prepared by landlords require you to obtain liability insurance and add the landlord as an additional insured. With both of you covered under the policy, the insurance company will represent the landlord as well as you if you're both named as defendants in a lawsuit.

If money needs to be paid out in a settlement or a judgment, the insurance company will pay that, too. In this situation, you won't be able to share the premium costs with other tenants. Unfortunately for all tenants, they might be buying their own policies too, as well as adding the landlord to them. The landlord ends up being covered by several policies, each taken out by separate tenants. The only winners here are the insurance companies.

What Damages and Losses Aren't Covered?

It's important to understand that commercial general liability policies won't cover damage to or loss of property that you or the landlord own or for which you might be responsible (such as rented equipment). You'll need property and casualty insurance for that.

You and the landlord will also not be covered if the third party's loss is the result of deliberate action or inaction, rather than a mistake or accident. Most of the time, there'll be no question that the loss or injury—for instance, damage to a piece of rented equipment or injury to a customer—was unintended. But things get trickier when it comes to claims involving personal, nonphysical injuries such as slander and emotional distress. If an insurance company thinks that you or the landlord intended to cause the damage you did, it might balk at covering you.

If the landlord already has the general liability coverage, you'll be added as an additional insured and charged for a portion of the landlord's premium.

Allocating Insurance Costs Between Tenants and Landlord

Hammering out who pays the insurance premiums is no different from negotiating who will pay for improvements. Your expected share will be a point of negotiation and depend on:

• your negotiating power
• your expertise, and
• the existence of other tenants.

Don't get sidetracked by thoughts that because the landlord owns the building, the landlord ought to pay to insure it. Instead, recognize that adequately insuring the building will benefit both of you. Now, decide whether you'll use your bargaining power to attempt to modify the extent of your share of the cost or, instead, agree to pay what the landlord has assigned to you and save your bargaining might for another lease clause.

Dividing Property Insurance Premiums

If you're the only tenant in the building, the landlord will likely have you pay for the full premium. But they might also split the cost with you if you negotiate for it.

If there are other tenants in the building, the landlord will usually split the costs among the tenants and pay no share of their own. Typically, the landlord will split the costs depending on how much square footage each tenant occupies. For example, suppose there are three tenants in a building:

• Tenant A occupies 50% of the building
• Tenant B occupies 30% of the building, and
• Tenant C occupies 20% of the building.

In this case, the landlord would have Tenant A pay for 50% of the premium, Tenant B 30% of the premium, and Tenant C 20% of the premium.

But your landlord might also split the cost evenly among tenants regardless of the square foot each occupies. If you occupy less square footage than your neighbor but the insurance cost is split evenly among the tenants, you should negotiate for your share to be based on the square footage. Your landlord might be locked into this allocation system in their lease with the other tenants. But you're in a good position to argue that your share of the property insurance premiums should be divided based on your share of the property.

Dividing Liability Insurance Premiums

The landlord might require you to have your own liability insurance policy, in which case, you'll be responsible for paying the full premium.

Alternatively, your landlord might already have a liability insurance policy in place. If your landlord already has a policy, then they'll likely have you pay a share based on either the size of your rental space or the cost of adding you as an insured to their policy.

When Different Types of Businesses Occupy the Same Building

The process of dividing up the insurance costs gets complicated when you consider that insurance companies take into account risk factors when setting their price and coverage. For example, an insurance company would likely find a restaurant riskier than an accounting firm because restaurants are more susceptible to fires, customer injuries, and other accidents. As a result, the insurance company would assign a higher premium to the restaurant.

Now suppose that your accounting firm and the restaurant are the only two tenants in the building and you each take up 50% of the space. The landlord divides the insurance premiums 50/50 between you and the restaurant owner. While the landlord might think this is the fairest apportionment because the division is based on both your share of square footage and the number of tenants, you might disagree. You're, in effect, paying a higher cost than your share because your fellow tenant has what insurance companies view as a riskier enterprise.

While it might be true that you're paying more than your fair share, this point will be difficult to bargain for. Your landlord likely already has a signed lease with the restaurant tenant where both parties agree to this allocation method. The landlord would have to get the restaurant tenant to agree to a higher premium or absorb the cost themselves—neither of which are attractive prospects for the landlord. Instead, your best option is to use this point to argue for more favorable terms in other parts of your lease.

Consulting a Commercial Lease Attorney

When deciding how to protect your business and negotiate the best terms under your lease, you might already be well-versed in the subjects. If you've owned your business for a while or have experience with insurance policies, you might know what kind of coverage you need and what's fair to pay.

But if you're a new business owner or the liability insurance terms in your lease are complicated or seem unfair, talk to a commercial lease attorney. They can walk you through the pros and cons of each valuation method and help you and the other side reach a fair agreement. They can also advise you on which insurance policies will benefit your business and which aren't worth the cost. You can also hire a commercial real estate broker to help you understand the terms of your lease and negotiate for better ones.