How many times have you heard someone in our industry say something like: ‘The commercial units at the bottom? Oh they’re nothing to do with us – just leave them out’. As providers of RCAs, we hear it all the time. When it comes to mixed-use developments, though, it’s vital to understand the effect any commercial units will have on the building’s overall insurance.
Take the classic scenario: a four-storey block of flats with, say, 20 units. Maybe it’s on a street corner in a busy town centre. On the ground floor, there’s a hot food takeaway on one side and retail premises like a newsagents on the other. The commercial tenants keep themselves to themselves, never need to access the internal common parts, and – other than maybe sharing the bin stores at the back with the residential leaseholders – no one’s paths ever cross. The residential block manager has nothing to do with the commercial unit stakeholders on a day-to-day basis, and given their job title, why would they think anything about the commercial units ought to concern them?
The issue is, of course, that all tenants – commercial and residential – share the same freeholder. And this is where the two worlds collide.
Whose responsibility is it to insure the building, and who should be commissioning an RCA? The leases in place will determine those responsibilities. It might be the freeholder, but often they delegate this responsibility to the managing agent. Whoever is in charge of organising this, though, they need to decide how the commercial units should be approached. So, should a commercial tenant be insuring their own premises? And if so, will they deal with their own RCAs? It will depend on the lease wording. Generally lease insurance terms will result in the insurance split falling into four categories.
The classic FRI
The first is the landlord or freeholder insuring nothing, which means the tenant must take out insurance to the full CAT-B reinstatement. This is the classic FRI (fully repairing and insuring) lease situation, designed with higher fire risk commercial operations taking place, where residential neighbours within the same building or estate do not wish to be saddled with the elevated insurance premium associated with a higher risk commercial property type. FRI leases are popular with factories, detached pubs, restaurants and takeaways with private flats built above, and detached freestanding buildings that have a commercial element. The commercial occupiers are entirely responsible for insuring all areas of their demise, including the external envelope of their premises and their interior fit-out. The lease may compel commercial occupiers to demonstrate to their freeholder or head lessee that they are adequately insuring in this situation, and this may include the sharing of up-to-date RCAs.
Shell-and-core only
The second scenario is the landlord or freeholder insuring to shell-and-core only. That leaves the tenant to insure all interior fit-out. This lease set-up is popular with high street shops with flats built above. The lease will emphasise that the landlord or freeholder should only insure the external building envelope, and is not responsible for commercial premises insurance. If you’re struggling to interpret the lease clauses on this, or if your commercial occupier disagrees with your interpretation, you should always seek legal advice
CAT-A and CAT-B
The third scenario is the landlord or freeholder insuring to CAT-A, and the tenant to CAT-B. This set-up is popular on industrial estates, multi-tenanted office buildings and modern, residential-led schemes where there are ground floor commercial units. The commercial occupiers are responsible for insuring the final fit-out of their premises in terms of built partitions and any personal or corporate branding, but certain other aspects are controlled and insured by the freeholder or landlord. These might include district heating, the external building envelope (including the shop front window at times), rear loading bays, bin stores, fire escape stairs, corridors, and services up to the main intake point for the premises.
Landlord insures and bills back
The fourth and perhaps least common scenario, although it is getting more common, is the commercial tenant insuring nothing directly. This means the landlord or freeholder insures to full CAT-B reinstatement and then quite often bills this back to the tenant (or at least includes it somehow within the price of the rent). This is prevalent on listed buildings and very high-specification modern buildings where tenants may not be trusted to procure the correct insurance, or insure to the right level. It also happens where the freeholder has a stronger than usual interest in ensuring the commercial units are adequately insured. Nearly every commercial premises inside an airport or a major train station is insured on this basis, and some small commercial units in modern shopping centres as well.
So, next time you hear something to the effect of, ‘just leave the commercial units out,’ bear in mind the building insurance situation. Part of the more joined-up approach the golden thread is harnessing as the industry steps out of silo-mode is for all of us to become holistically aware of what other specialisms and stakeholders are doing. Whichever insurance split applies, don’t leave it to chance. There’s no harm in making a friendly call to your commercial neighbours and ensuring they are aligned on their – and your – insurance obligations.
