Author: Jim Lobb, Best Lawyers© 2017 Real Estate “Lawyer of the Year” for Louisville.
This is the beginning of a multi-part series discussing Builder's Risk Insurance for real estate development.
Introduction: What is Builder's Risk Insurance?
Set out below are hypothetical contract provisions setting out the insurance obligations for a commercial construction project. For the sake of this hypothetical, assume that sophisticated landowner and developer clients are being represented by sophisticated real estate attorneys, in the negotiation of a ground lease, under which the ground lease tenant would construct an office building and lease the building to a subtenant. The parties recently agreed that the ground lease tenant would be required to provide insurance coverage during construction of the office building on the landlord’s property. The terms of that hypothetical agreement are set out below.
This author asks, and this series explores, the following questions: (i) whether the negotiators in the above transaction have adequately protected their respective clients’ interests in the event a casualty should occur during or as a result of construction of the building improvements; (ii) whether the respective clients’ lenders’ interests are protected in the event a casualty should occur during or as a result of construction of the building improvements; and (iii) if the clients’ or their lenders’ interests are not adequately protected here, what additional—or different—steps should the negotiators have taken to adequately protect those interests?
INSURANCE
1.1 Tenant’s Insurance. Tenant shall, at its expense, keep in full force and effect the following insurance policies during the Term and any extension thereof.
(a) Property. Commercial property insurance, insuring: (a) one hundred percent (100%) of the full replacement cost of the Leased Site Improvements (exclusive of foundations, footings and excavations), as well as Alterations made at Tenant’s expense or direction, and all other property owned or used by Tenant and located in the Premises; and (b) against all “special perils”.
(b) Liability. Commercial general liability (“CGL”) insurance and, if necessary, commercial umbrella insurance, with limits of at least Three Million Dollars ($3,000,000.00) per occurrence and Three Million Dollars ($3,000,000.00) in the aggregate. CGL insurance shall cover liability arising from premises, operations, independent contractors, products-completed operations, personal injury and advertising injury, and liability assumed under an insured contract, including without limitation this Lease.
(c) During Construction. During the construction of the Improvements and the performance of all Alterations, Tenant shall maintain or, at its option, cause Tenant’s contractor or subcontractor, as appropriate, performing such Alteration to maintain:
(i) Completed Value Builders Risk insurance which shall, at a minimum, cover “special perils” related to the Alteration and materials related thereto; (ii) Automobile liability and, if necessary, commercial umbrella liability insurance with a limit of not less than One Million Dollars ($1,000,000) each accident covering liability arising out of any auto (including owned, hired, and non-owned autos) used in connection with such Alteration; (iii) CGL insurance described above; and (iv) Workers compensation and employers liability insurance with employers liability limits of not less than One Million Dollars ($1,000,000) each accident for bodily injury by accident or One Million Dollars ($1,000,000) each employee for bodily injury by disease.
(text bolded for emphasis).
What IS Builder’s Risk Insurance?
Builder’s Risk Insurance is specifically designed to address a broad group of risks that can arise due to the nature of construction—the number of different contractors and subcontractors typically involved in the construction; the acquisition, on- and offsite staging and ultimate use of materials in the construction; the numerous different acts performed which collectively comprise the construction; the fluidity with which all these people, events, and materials come together in the construction of improvements; and the changing nature of the risks to the improvements and the participants as the construction proceeds toward the completed project.
Builder’s Risk Insurance, sometimes also known as “course of construction” insurance, covers real estate property improvements as they are being constructed.
Builder’s Risk Insurance will usually also cover damage to (i) materials onsite, waiting to be incorporated into the constructed improvements, (ii) materials while in transit to the site to be incorporated into the constructed improvements, (iii) materials offsite waiting to be transferred to the site for incorporation into the constructed improvements.
Builder’s Risk Insurance may also provide coverage for damage to equipment used in the construction project though that’s not usually the case unless you specifically acquire that coverage through a Contractor’s Equipment endorsement.
It may also provide coverage to the insured’s contractors, subcontractors and lenders.
There are important limitations to Builder’s Risk Insurance. It is usually applicable for only a short time after the improvements are completed. The length of that time can be negotiated, as can the definition of “completed construction”—but you must remember that the Builder’s Risk Insurance coverage WILL expire shortly after construction is completed (however that term is defined through negotiation) and that the insured parties must be insured after that, if at all, under a more traditional ISO type commercial property insurance policy.
Builder’s Risk Insurance may—or may not—cover or exclude a whole host of additional risks, conditions and circumstances depending on what you’ve included—or failed or forgotten to include—during your negotiation of the policy terms. Builder’s Risk Insurance is PROPERTY insurance—not liability insurance—though many coverages operate more like liability insurance. And the party seeking to recover under the Builder’s Risk Insurance policy must have an insurable interest in the property that has suffered the physical damage.