How to Avoid Extra Liability Posed by High-Risk Tenant

High-risk tenants, such as liquor and gun stores, pose potential dangers that typical retail businesses don't. But because alcohol and guns are available at limited locations, these high-risk tenants have a captive audience of customers that create a steady income stream, lessening the chances that they will default on rent or move out before the end of their lease terms.

However, the nature of these businesses increases the chances of an accident or property damage that you could be held liable for. We'll tell you how to protect yourself from liability for damage stemming from the nature of your high-risk tenants' businesses, and give you a Model Lease Clause: Require High-Risk Tenant to Get Comprehensive Insurance, which you can adapt and use in your leases.

Negotiate Insurance Procurement Clause

One of the most important protections you should include in your lease with a high-risk tenant is an insurance procurement clause. “With a liquor or gun store you need to require the tenant to have major insurance,” says Louisiana commercial real estate attorney Marie A. Moore. This includes general liability insurance naming you as either a “named insured” or an “additional insured” [Clause, par. 1]. Also, be aware that a specific kind of “dram” coverage applies to liquor stores in many areas. Find out whether you need to take that into account when negotiating insurance provisions with the tenant.

“I cannot stress enough the importance of insurance in high-risk cases,” says Moore. “Obviously, you will want to put in the typical provisions requiring the tenant to comply with applicable laws,” she adds. “But the insurance is of the utmost importance.”

Require Indemnification, Subrogation Waiver

By renting to a high-risk tenant, you are taking two risks. First, you might be found liable for not policing the tenant if it intentionally or negligently causes damage. Second, you could, depending on your state, be held responsible if a customer of the high-risk tenant causes an accident related to the items the tenant sold to it. For example, you could be partially liable for an accident caused by an intoxicated person to whom the tenant sold alcohol.

That's why indemnification provisions—a clause specifying whether, and for what amount of money, a tenant and owner must indemnify one another when they are sued—are crucial. Carve out your right in the lease for indemnification from the tenant for any claims for damage it causes, particularly liquor-related damage [Clause, par. 2].

Keep in mind that there are two specific kinds of potential injuries that you need to protect against—property damage and personal injury.

Property damage. You and the tenant should be required to insure your own tangible, personal property, and then to indemnify the other party for property loss or damage to that property. However, if the tenant's insurer must pay the tenant for its claim stemming from damage that you caused, the insurer may pursue a claim against you to recover the amount it paid to the tenant. In other words, it would have the right to “subrogation” from you. You can avoid this by negotiating with the tenant for a waiver of subrogation, essentially barring the insurer from filing a claim against you, even if you were at fault.

“To the extent that the tenant's insurance policy permits a waiver of subrogation, you would want your tenant to waive the insurer's right to subrogation,” notes Moore. But be aware that the tenant may ask you for a waiver of subrogation also, to prevent your insurer from coming after the tenant for damage it caused that your insurer had to pay you for. Think about agreeing that both you and the tenant will waive your insurer's subrogation rights against the other [Clause, par. 3].

Personal injury. Personal injury claims are more complicated than property damage claims. In some states, indemnification against the other party's sole negligence or possibly even to the extent of its negligence are not permitted; some states prohibit one party from indemnifying another party for its own negligence. You and your tenant need a different type of insurance—called commercial general liability insurance—for personal injuries.

With respect to naming the other party as an additional insured, some commercial general liability insurance policies are not as encompassing as an owner might want, so you need to look at the policy to make sure that anything that occurs on the property is covered by the tenant's insurance in states where indemnification is allowed—even if caused by the owner's own negligence, warns Moore. In states where an owner can't be indemnified for its own negligence, make sure that the policy protects you against claims for all incidents except those you caused.

Build Risk-Related Expenses into Rent

In addition to requiring a high-risk tenant to have insurance, you should always maintain your own insurance. “It's important to have your own back-up insurance because it's very hard to prove that the tenant has insurance,” says Moore. In fact, certificates of insurance say on their face that they can't be relied upon, she notes. Build the price of your own liability insurance into the rent. That way, you can make sure that you will be covered, with no added expense, if a tenant doesn't have insurance.

You can also include in the rent extra costs that you incur because of the tenant's nature as a high-risk business. “After all, you have assumed an increased risk by renting to that liquor store or gun shop than with other kinds of leases,” points out Moore.

But if you decide to charge the tenant more than a proportional share of common area maintenance (CAM) charges for the property, include this charge in the high-risk tenant's rent instead of specifying that it's a part of the CAM charges. Separating that charge from the rent can be complicated and could cost you more in accounting than it's worth. And you may not gain anything by charging a high-risk tenant's greater use of CAM services separately from its rent if the other tenants' leases state that their share of CAM charges will decrease according to any increases in other tenants' percentages.

PRACTICAL POINTER: Leases to dry cleaners and other businesses that generate hazardous materials are risky as well. One option is to specify that a dry cleaner tenant cannot perform any of its cleaning operations on site. Or, treat a dry cleaner that does cleaning on site the same way that you would treat a gas station. Make sure that you have a baseline for the way the property was prior to the lease term, so that you can show that the tenant, not you, caused any environmental issues. Say in the lease that any environmental issues that arise during the term that are different from your baseline are the tenant's responsibility. Also, require the tenant to restore the property at the end of the term to a “pristine condition” or “industrial condition” permitted by your state. It's up to you to choose which standard to use.

Use Experience, Business Judgment

Before renting to a lucrative high-risk tenant, remember that it will improve your bottom line only if you don't lose other tenants as a result. Tenants know that liquor stores are an issue because employees could sell to underage or already inebriated customers who later cause an alcohol-related accident, possibly on the property. And both liquor stores and gun stores attract potentially dangerous thieves who want the merchandise but can't obtain it legally. These people could pose a danger to nearby tenants and their customers.

And owners of certain types of retail property should be wary of renting to a high-risk tenant that could change the perception they want customers to have of their strip malls or shopping centers. If your tenants include a grocery store or pharmacy, or if you're running a family-style center, take that into account, says Moore. Ultimately, it's up to you to decide if the profit you'll make from a liquor store or firearms shop is worth the risks associated with these tenants.

“The owner should be able to use its experience and business judgment to know whether a high-risk tenant is appropriate for the property it owns,” says Moore.

Insider Source

Marie A. Moore, Esq.: Partner, Sher Garner Cahill Richter Klein & Hilbert, L.L.C., 909 Poydras St., 28th Fl., New Orleans, LA 70112; www.shergarner.com.

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