Property Insurers Put to the Test

The hurricanes of the 2004 and 2005 seasons inflicted massive damage on real estate along the Gulf Coast. There are still hundreds of pending commercial property insurance claims from these hurricanes slowly winding their way toward resolution. The 2006 hurricane season, which began June 1, is expected to be punishing, and could produce hundreds of more commercial property insurance claims.

Meanwhile, there is a tremendously active market in the sale and purchase of real estate, especially income-producing properties such as hotels and retail outlets. Sellers and purchasers of commercial properties recently have confronted — or may soon confront — the issue of what happens to an insurance claim when a commercial property is sold.

Insurer obligations

Hurricane damage is sometimes a catalyst for an owner to sell real estate to a developer who wants to demolish the damaged structure and rebuild beachfront condominiums. During such fast-moving events, sellers and purchasers invariably have questions about the continuing rights to insurance recovery under the seller's insurance policy.

For example, can the insurance rights be assigned? If so, are they limited by the sale? Insurers look for an opportunity to slash their obligations to pay for repairs or lost business income. One must always carefully consider the language of the policy, but under the language of most property policies, there are three simple rules for resolving this issue:

  1. Following a sale, the policyholder/seller can still collect business interruption proceeds beyond the sale date and through what would have otherwise been the end of the “business interruption” period caused by the hurricane. Most commercial policies insure lost business income during the period of business interruption caused by the hurricane or other covered peril.

    This period of interruption is said to be “theoretical” — the amount of time it ought to take to complete all repairs with “all due diligence and dispatch.” The sale of a property in the middle of a business interruption period does not cut off and limit the business interruption insurance recovery. This rule is consistent with a very well settled line of legal cases holding that a policyholder is always entitled to collect business interruption based upon the full “theoretical” interruption period.

  2. The policyholder/seller can also collect repair or replacement costs estimated, but not actually spent, at the damaged property as of the sale date. Oftentimes when a sale is made in the middle of a claim, the actual repairs are partially completed. A seller can elect to retain the insurance rights, and for uncompleted repairs still collect the full repair or replacement cost value from the insurer even though those costs are not spent.

    For example, if a hurricane damaged a façade and it must be replaced, the policyholder can still collect the repair costs without actually completing the repairs to the façade. Usually, this requires a choice by the seller to apply such proceeds to another insured location, or to “other capital expenditures” unplanned as of the date of the loss. In the absence of such a choice, the adjustment reverts to recovery on an actual cash-value basis.

  3. All or part of a claim can be assigned to a purchaser. In Florida, Louisiana, Mississippi, and most other states, any and all parts of an insurance claim are assignable. The “anti-assignment” clause in a typical insurance policy means only that the policy itself cannot be assigned without consent, but if the hurricane or peril is past, a claim itself is assignable. Thus, if the deal so warrants, a seller can simply assign all or part of a pending claim for property repairs or business interruption loss. The scope and nature of an assignment is negotiable between the seller and purchaser.

Hold insurers accountable

In short, the sale of a damaged property in the middle of a claim does not create a windfall opening for the insurer to escape from some or all of its insurance obligations, no matter how rights to insurance proceeds are negotiated and allocated between the seller and purchaser in their agreement.

Insurers may circle like sharks, sensing the opportunity to blunt their obligations. But there is nothing about the sale of a property that provides an insurer with the opportunity to sidestep its duty to pay. Policyholders should insist that insurers adhere to their obligations. Policyholders should carefully address assignment or other insurance-related language in purchase and sale agreements, loan documents, and other writings related to the transaction.

Gary Thompson is a partner with the law firm of Reed Smith LLP in Washington, D.C. He can be contacted at [email protected].

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