The dangers of varying the insurance covenant in a lease extension

Paul Robertson from 1st Sure explores some of the dangers of varying the insurance covenant when granting a lease extension.

It is fairly common that when a lease extension is being negotiated both parties may see this as an opportunity to update the insurance covenants. However both freeholder and lessee will have different agendas and there are many pitfalls for both sides to navigate.

One common request from solicitors acting for the lessee is to redefine the perils to be insured to a so called “more modern wording”. Typically this results in a request to include “and the usual comprehensive risks in accordance with the CML recommendations from time to time”. The Council of Mortgage Lenders (CML), annually publish a handbook outlining the requirements of mortgage lenders in respect of their requirements to be met when lending against a property and is used by conveyancing solicitors. On the face of it this appears to be a good idea, by ensuring the block policy complies with CML guidelines any prospective flat owner would be assured that the block insurance was acceptable to their lender. As ever with these matters life is not that simple.

The CML guidelines are updated annually and as such provide no certainty as to what the insurance requirements may be in future years. Also the phrase “CML recommendations” is rather fuzzy as there are three parts to the CML guidelines. Part 2 is specific to each lender and varies immensely between lenders.

Some lenders have requirements that whilst perfectly reasonable for a freehold house simply do not work for leasehold flats. A good example is where a lender wants to be a first loss payee. This is where that in the event of an insurance claim over a certain amount then the insurance monies are paid to the lender. Clearly in a block of flats this will frustrate the covenant in the lease which will require the insuring party to receive such monies and use them to reinstate. Potentially a mortgage lender could retain any insurance monies to offset any shortfalls in mortgage payments by the lessee.

Another common danger of rewriting insurance covenants is that it results in lessees with different insurance covenants which may not become compatible. Again inclusions that may be well intentioned can have disastrous results leaving all parties in worse position.

Recently I worked with a major client who had purchased a block of freeholds with leases that specifically required the freeholder to insure for fire, lightning, earthquake and explosion only and the lessee of each flat to obtain insurance for all other perils. This was proving very difficult for the lessees to obtain this cover.

They were purchasing top up cover from the previous freeholder’s broker at an outrageous cost. My client wanted to vary the leases to a more conventional and fairer form which the lessees readily embraced. This resulted in a fascinating meeting with three specialist solicitors agreeing with me a suitable insurance covenant going forward. The thing that really struck me was how much was left out as opposed to included, and how much relied on case law. One clause that we did however include was a provision to state that the freeholder would obtain certain perils subject to them being available in the market. In this circumstance this was entirely reasonable as the freeholder was taking on additional obligations to benefit the lessees. In many other cases a lessee may wish to resist the addition of such a wording as effectively it relives the freeholder of the financial implication of not being able to insure against a certain peril and moves the liability to the service charge account.

Ultimately there may be many occasions where updating the insurance covenant is desirable but the question remains as to which party, if any, does it really benefit?

Paul Robertson is Managing Director of 1st Sure Flats and Midway Insurance. 1st Sure pride themselves on providing the very best service at the very best price and will work with you to create cover that is perfectly tailored to your individual flat insurance needs.

Email: paul@midway.co.uk

Tel: 0345 370 2848

Reviewed: July 2019