Insurance issues

Have you read your lease lately? Have you read it at all? I know someone who has – your landlord’s lawyer. It’s you versus a college degree, four years of law school and the disposition of a pit bull.

Leases are a part of our everyday business life. We sign leases of premises; equipment leases, and some of us even sign employee leases. Because leases are so common to businesses, some really important things slip by unnoticed.

Now, there is more to this subject than I can possibly deal with here. There are entire books written about it. What I’m going to do is give you my insurance view of two of the lease agreements you usually see. Remember – this is NOT legal advice – I’m only talking about insurance here. The leases I’ll talk about are lease of premises and lease of equipment. Lease of employees does not seem to be too popular in the pizza industry, so I’ll leave that one alone for now.

LEASE OF PREMISES

When you leased your premises it was a major event. It was big enough for the landlord to hire a real estate lawyer to handle their side. You see, the landlord knows what’s at stake. I hope you do, too.

The basics of a lease of premises are this—the landlord gives up the use and control of the premises for a period of time in exchange for your payment of money in a specified amount for a specified time.

The devil is in the details. That agreement is a contract, whether it’s in writing or not—legally binding and enforceable for both parties. We are going to assume you had the good sense to get it in writing. In theory, everything in a lease is negotiable. Now, we both know that according to the old adage, “He who has the gold makes the rules,” whoever has the greater need will be forced to make greater concessions. But, in theory everything is negotiable.

Here are some points to pay attention to:

  • Condition of premises: Some leases still contain old wording that requires you to “return the premises in the same condition in which you received it.” That wording could make you responsible for normal wear and tear after your lease term!
  • Improvements to the premises: Big problem– pay big attention! Almost every lease has a section that deals with “alterations, additions and improvements” made to the premises. In most leases, these are things that become the property of the landlord. You spend the money for them, but they become the landlord’s property. These conditions vary so widely that even the pizza oven you buy and install could become the property of the landlord!
  • Termination in the event of destruction or damage: Most leases address the issue of destruction of the premises during the lease term and what happens to the lease. You will usually see the landlord having the right to terminate the lease if they decide not to rebuild. If you just spent some serious money for “build out” of the premises to suit your needs, what happens to that money?

Who actually owns the improvements and who gets paid by which insurance policy?

From my insurance point of view, there are some things you really should do to make sure you aren’t “burned.”

  • Condition of the premises: I don’t know of any insurance that’s going to pick up this one. Wear and tear just is not covered – and I don’t think it should be! If you see this wording, get it out or get it modified. Your lawyer will know how.
  • Improvements to the premises: Spell out just what is and what is not an improvement to the premises. It may sound dumb, but if you don’t want trade fixtures considered part of ‘premises improvement’ then say so in the lease. If you don’t, it’s all up for interpretation at the time of a loss – the wrong time to interpret anything! Spell out as much as you can in advance in plain and simple language—when the money’s at stake, memories grow dim. Once you separate out what’s yours and what’s not, make sure you tell your insurance agent just what’s been decided. I know some really good insurance people, but I’ve yet to meet one that could read your mind. If you keep it a secret, you probably won’t have the right insurance! With the right information, your insurance can be tailored to follow your lease terms.
  • Termination in the event of destruction or damage: Again, these provisions are up for grabs, but the power will lie with the guy who has the “gold.” Have your lawyer go over this one with a “fine tooth comb.” This one is never important – until it’s important. Think about it – you lease a “bare box” in a strip mall and spend $100K to build it out – HVAC, plumbing, electrical, flooring, dropped ceiling etc. You do it because you just signed a 10-year lease so you expect to get a good return on your investment. Six months later lightning hits the building and in about 90 minutes flat, the whole place is gone. This is NOT the time to find out that all of that $100K became the landlords property right after you finished the job and you are not getting paid for ANY of it – even if you thought you bought enough insurance to cover it.

Important Point: Your insurance company will follow two agreements when they look at this kind of loss-

  1. The insurance policy.
  2. The lease agreement.

If the lease agreement makes the $100K you spent the landlord’s property, you just lost your “insurable interest” under the policy. (Insurable Interest is an insurance term—it’s the thing that allows you to buy insurance in the first place. You can’t insure my house because you have no insurable interest in it, like an ownership or a security interest, like a loan or a lease.) With that, you also lost your insurance coverage.

Worse yet, it is possible that the lease can make you responsible for insuring that $100K and your policy can be made to pay the landlord! Ouch.

LEASE OF EQUIPMENT

Equipment leasing is a popular way to leverage capital and get the tools you need to grow your business. With little (or none) of your money up front, you can get literally hundreds of thousands of dollars worth of equipment with little more than a signature.

Since the leasing company has all the money, and you want the equipment using little or none of yours, you usually don’t have much negotiating room. So, pay careful attention to the lease terms. Read and re-read them. The insurance implications of an equipment lease can be profound if not handled with care. Usually, you are going to be responsible for what happens to the leased equipment. The lease company is going to tell you what to insure, how much to insure it for and even what policy form to use the so-called “special form.”

They will even tell you just how they want you to structure your insurance to give them the maximum benefit under your policy! What they won’t tell you is how to adjust your policy to protect yourself. Be careful—I’ve seen equipment lease language that can put the leasing company ahead of you at the time of loss. If you follow the steps the leasing company gives you, you’ve taken care of the leasing company – NOT yourself.

Look at this example: You lease a $50,000 equipment package including a walk-in cooler, mixer and new compressors. You follow the leasing company’s instructions and add them as loss payee, additional insured, arrange for them to have notice if you don’t pay the insurance bills and include the lease as an “insured contract” under your policy. You’re done, right? No, your not!

What you just did was to give the leasing company first ‘dibs’ on $50,000 of your insurance. If there’s a claim, they can go to the front of line and have the insurance company pay them first while you watch slack-jawed, scratching your head. Then you get the remainders. What you should have done is increase your insurance to match the value of the equipment you leased. Watch the world VALUE—it’s used in the lease and can have different meanings depending on who uses it! Get the lease terms in the hands of your insurance agent quickly. If your agent knows what to do, they will ask you about the “value” of the equipment. If they don’t, consider looking for a new agent.

Caution Point—Some leases will “include” insurance in the lease payment. This is not generosity on the part of the leasing company. You are paying for the use of the leasing company’s money. The more of it you use, the more they charge. So, if they can load your lease with an insurance premium, you pay for that too. AND, it’s been my experience that the cost of insurance from a leasing company can be as much as 100 percent more than the cost under your own policy. Look out for this and check the price—if it’s not in your interest, get it out.

Final point—Once you make it to the end of the lease you may think you can drop the insurance on the leased equipment. Wrong. If you exercised the purchase option, you now own this stuff. Now is the worst time to drop insurance. What you really need to do is to review all your property and get a good handle on just what you have at risk. Then, make some intelligent choices about what insurance you want to buy.

One note of caution—Because of space limitations, I haven’t touched the subject of “leasehold interest” and the loss involved there. I’ll deal with that in a later “Special Report.” I’ll also talk about leasing and insurance at the upcoming New York Pizza Show, November 2, 2004. We’ll cover all the basics of insuring your pizzeria from leasing to Worker’s Comp audits to what your agent may not know. Go to www.newyorkpizzashow.com for more information and to get registered. If you want a copy of the report, go to our website www.pizzasure.com and use the email form to request your advance copy. My standing offer: If you have any questions, I invite you to call me at 201-945-3100.