Risky Business: Covenants To Insure In Commercial Leases
Article by Jamie Spotswood
Covenants to insure in commercial leases are special. They obligate a party to obtain insurance. But what makes them special is that they are interpreted to relieve the other party of liability for breaches of that party’s obligations under a lease that relate to the risk being insured against. While it is true that a covenant to insure is one of several clauses in a lease that allocates risk between the landlord and tenant, the covenant often trumps the other clauses that are intended to assign risk when it is engaged.
The law is settled that in a landlord and tenant relationship a covenant to insure prevents the party who agreed to obtain insurance from successfully suing the other party for damages caused by the risk being insured against even if the other party would otherwise be liable for the loss. Subrogated claims in this regard are also barred. The commercial rationale for the immunity is that the party who obtains the insurance assumes the risk of the loss covered by the insurance. The insuring party must deal with its insurer for the loss not the other party to the lease.
The broad scope of the immunity is limited by the terms of the lease. Claims that can be characterized as being unrelated to the obligations in the lease may prevail even if the loss that is the subject of the claim flows directly from the risk of peril that the insurance was intended to cover. This is because the covenant to insure in a commercial lease operates as a matter of contractual law not insurance law, as the Court of Appeal for Ontario emphasized in Madison Developments Limited et al v. Plan Electric Co.,  O.J. No. 4249.
By way of example, a tenant’s claim against a landlord for breach of quiet enjoyment pursuant to a lease following a fire loss would be barred by a covenant to insure against the risk of fire. On the other hand, a claim based on a pre-contractual representation that arises out of the same fire loss may prevail notwithstanding the presence of a covenant to insure in the lease. The misrepresentation claim may proceed to the extent that the alleged misrepresentation does not engage the terms of the lease.
The Court of Appeal for Ontario recently considered this issue and the scope of a covenant to insure on an appeal from a motion to strike in D.L.G. & Associates Ltd. v. Minto Properties Inc.,  O.J. No. 5494. The tenant, D.L.G. & Associates Ltd., had covenanted to obtain “all risk” insurance which included the risk of sewer back-up. The tenant alleged that during the lease negotiations the landlord represented to it that the plumbing was in good order and it relied on these representations to its detriment. After a sewer back-up occurred, the landlord represented that the plumbing was in good repair going forward and that it carried out the necessary repairs, when in fact it had not done so. A second sewer back-up occurred. The tenant sued the landlord.
The tenant advanced claims in breach of contract, negligence, and negligent and fraudulent misrepresentation. The landlord moved to strike the claims, in part, on the strength of the covenant to insure. The motion judge held that it was plain and obvious that the tenant’s claims in breach of contract, negligence, and negligent misrepresentation were barred by the covenant to insure. It was not plain and obvious that the fraudulent misrepresentation claim could not succeed. The tenant appealed.
The Court of Appeal allowed the appeal in part, holding that the motion judge erred in striking the negligent misrepresentation claim. Writing for the Court, Justice Doherty stated that the “covenant to insure was intended to assign risk within the operation of the contractual relationship between D.L.G. and Minto. The alleged tortious conduct, be it fraudulent or negligent, occurred outside of that relationship.” Thus, it was not plain and obvious that the negligent and fraudulent misrepresentation claims must fail.
It is somewhat counter-intuitive to think that the result may have been different if the lease contained a specific representation or warranty from the landlord that the plumbing was in good working order and had been repaired. Of course, the intent of such a representation would be to assign the risk of a faulty sewer system to the landlord. Had such a representation been included in the lease, the alleged misrepresentation claim would arguably come within the ambit of the contractual relationship and would be barred by the covenant to insure as a result.
D.L.G. Associates Ltd. underscores the importance of reading covenants to insure together with other clauses in the lease to fully understand how the parties to the lease intended to allocate risk as between them when litigation arises.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.