Based on the specialist advice of lending expert John Bridge, partner Angela Robinson looks at insurance clauses which are commonly found in residential leases, whereby the landlord is only obliged to reinstate the property insofar as the Insurance Company pays out under the Policy. She analyses the level of cover they provide, the exclusions they contain or may imply, and their acceptability to "reasonably competent" mortgage lenders.

It is an obvious requirement of domestic mortgage lenders that the property securing the loan is and remains adequately insured.

Most mortgage lenders provide their own "block policy", therefore ensuring that all their mortgaged properties are comprehensively covered, and add monthly insurance premiums to the borrowers' repayments.

Over the last 10 years, with the intervention of the Office of Fair Trading, lenders have allowed borrowers to arrange their own insurance. In practice in residential leases this is usually a requirement of the landlord who arranges his own insurance for the building.

In those circumstances, mortgage lenders should nevertheless ensure that the insurance taken out is at least as comprehensive as their own "block policy".

Example 1

"That if and when during the term:-

The demised premises are damaged or destroyed by a risk against which the landlord is required to insure under the terms of this lease and the payment of the insurance monies is not refused in whole or in part by reason of any act or default of the tenant or anyone at or near the demised premises …the landlord will … lay out all monies received in respect in such insurance in rebuilding or reinstating the buildings including the demised premises so destroyed or damaged."

A mortgage lender may be concerned that where the insurance monies are refused "by reason of any act or default of the tenant or anyone at or near the demised premises", the landlord would have no obligation to reinstate the property.

However, irrespective of the wording used in this clause of the lease to describe circumstances in which the insurance company may refuse to pay out, the actual conditions which may allow the insurance company to refuse payment are not governed by the lease but by the insurance policy itself. Those conditions would have to appear under an express clause of the policy for the insurance company to be entitled to deny cover.

A mortgage lender should review the policy proposed by the landlord to ensure that the extent of coverage provided is at least as comprehensive and the exclusions are no wider than those contained in its "block policy". The lender should also ensure that its interest is specifically noted on the policy. If the Landlord then changed its insurers or allowed the policy to lapse during the term of the loan the insurer would be bound to notify the lender. Once the mortgage lender has taken these precautions, there should be no reason why such insurance clause appearing in the lease would not be acceptable.

Example 2

The Landlord covenants

"At all times hereafter to keep insured the building and all other buildings which are now or may at any time hereafter be erected on the estate and for the insurance of which the management company is or will become responsible in the names of (inter alia) the management company and the lessor… in a sum which in the opinion of the lessor requires the full reinstatement costs thereof … AND in case the premises herein before this clause referred to or any part thereof shall at any time hereafter be destroyed or damaged by fire or other perils … lay out all monies received in respect of such insurance in rebuilding repairing or otherwise reinstating the same… and in case the monies received in respect of the said insurance shall be insufficient for the purpose to make good the deficiency out of the management companies own monies."

This clause requires that any shortfall in insurance monies received should be made up by the management company. However, it may also construed to imply that if the insurance monies are refused, the landlord would have no obligation to reinstate the property.

The lender would have no grounds on which to require that the landlord reinstated the property out of its own monies. Its only remedy would probably be against the borrower, by enforcing the borrower's personal covenant, as if the loan were unsecured.

It may also be that whilst the insurance company denied the landlord the benefit of payments under the policy (in a case where, for instance, the landlord's negligence caused the damage), it would agree to pay the lender, provided that the lender's interest in the property had been noted on the policy.

In any case, it is again to be assumed that the lender would have reviewed the policy before agreeing the terms of the lease: he would therefore have ensured that exclusions in the insurance policy arranged by the landlord are no wider than those contained in the lender's "block policy" - in which case this insurance clause in the lease would be acceptable to the lender.

Derek Williams Partner / Head of Department 020 7544 5653 derekw@sghlaw.com