Read The Lease!

In its natural state, the relationship between the landlord (lessee) and tenant (lessor) is relatively straightforward. If either the lessee or lessor negligently causes damage to the leased premises, there would be a right to sue for losses arising from the negligence. Modern leases have modified this natural position, often by including “covenants to insure” requiring either the lessee or lessor to obtain insurance coverage for the benefit of both parties. This nexus of contract and insurance law has been subject to judicial scrutiny over the years, so the recent New Brunswick Court of Appeal decision of Pharmacie Acadienne de Beresford Ltev. Beresford Shopping Centre Ltd./Lte1 should be of great interest to insurers.

It is trite law that the right of an insurer cannot be greater than the right of action of its insured because subrogation is the same as substitution: An insurer cannot succeed where an insured cannot succeed. If the insured lessee has contractually insulated its lessor from liability claims, then its insurer will also be foreclosed upon when attempting to attach liability to the lessor. It follows from this premise that much attention is focused on the exact words used by the contracting parties to limit liability, and more importantly, the context in which those words are used.

Any discussion on landlord and tenant covenants to insure should begin with four Supreme Court of Canada cases: Agnew-Surpass Shoe Store Limitedv. Cummer-Yonge Investments Ltd. 2; Ross Southwood Tire Ltd. v. Pyrotech Products Ltd. 3; T. Eaton Company v. Smith4; and Greenwood Shopping Plazav. Beatty5. In these cases the Supreme Court laid down several principles regarding such clauses⁶:

• a landlord’s covenant to insure the leased premises is a covenant for the benefit of the tenant and immunizes the latter against any claims by the landlord (or its subrogated insurer) for covered losses;

• a lessee’s covenant to pay insurance premiums transfers the risk of loss under the insured perils to the landlord and immunizes the tenant against subrogated or landlord claims for such losses; and

• in certain circumstances, privity of contract may exist between the lessor’s employee and the lessee, thereby insulating them from liability.

Most recently, the New Brunswick Court of Appeal has held that a tenant’s covenant to insure may insulate the landlord from subrogated or other claims⁷.

In Pharmacie Acadienne, some of Pharmacie’s leasehold improvements, inventory and office equipment were damaged due to water escaping from a frozen sprinkler pipe, allegedly due to Beresford’s negligence. Pharmacie’s insurer paid its claim and brought a subrogated claim against Beresford. Beresford then brought a third party action in negligence against the law firm that drafted the lease for failing to insulate it against subrogated claims. The trial judge decided in favour of Pharmacie and the law firm appealed.

Determining the intention of the parties is the touchstone for interpreting the covenant to insure and therefore the courts will look at all admissible and relevant indicators and not just the words themselves when construing a contract. The doctrine of contra proferentem, a rule by which any ambiguities in the language will be construed against the drafter, may also be employed. Two of the disputed clauses were taken directly from the Standard Forms of Conveyances Act⁸. In particular, clause 24 of the contract (Covenant 38) was essentially intended to insulate the lessor from any liability for personal or property damage resulting from its negligence. The disputed parts of Clause 28 (Covenant 42) are:

All lessee’s insurance policies shall contain a waiver of subrogation.

All policies of insurance placed by the lessee shall contain a waiver or waivers of subrogation against the lessor and the lessee waives, releases and discharges all rights, claims and demands whatsoever which the lessee might have or acquire against the lessor arising out of damage to or destruction of the building or any part thereof occasioned by any of the perils insured against by the lessee or which the lessee has agreed to insure against, whether or not such rights, claims and demands shall arise through the negligence or other fault of the lessor, his servants, agents or contractors.

Pharmacie offered two arguments: First, it did not covenant to insure the property for the benefit of Beresford and second, that even if it did, the second paragraph of Clause 28 restricts the operation of the first. The judge was not impressed with the first argument, given that Clause 28 is designed to apply whether or not an explicit covenant exists, “any of the perils insured against by the lessee or which the lessee has agreed to insure against”. The Court was more interested in Pharmacie’s second argument and since the contract was drafted by Beresford’s lawyers, contra proferentem would dictate an interpretation favourable to Pharmacie. The appellant took the position the first part of Clause 28 was an unlimited and independent covenant that is not restricted by the second part.

While the trial judge agreed with Pharmacie, the Court of Appeal found the lower court’s interpretation of the contract incorrect. The trial judge interpreted the emphasized words, “arising out of” in Clause 28 as meaning “for damage to the building.” However, the appellate Court noted the only claim the lessee could advance would be for integrated leasehold improvement because it lacked a proprietary interest in anything else. Following this logic, if the sole purpose of the clause was to insulate the lessor from claims for damage to integrated leasehold improvements, why did it not just say so? The Court concluded a more rational interpretation would be that the intention of the parties was to release all claims “loosely traceable to the occurrence of damage to the building” with the only condition being that the type of damage arise from an insured peril. The Court also found it significant that Clause 28 used very broad wording and the plural for both “claim” and “policy” (all policies . . . all claims). The Court also decided that contra proferentem did not apply as neither party had drafted the clause in question (or its underlying statute).

The Court ruled that Clauses 24 and 28 of the lease operated together to create a coherent loss bearing scheme that limited the lessor’s liability to claims in negligence for uninsured property damage and which disallowed subrogated claims in negligence arising out of property damage falling within (at the very least) the class described in the second part of Clause 28. The object of Clause 28 was to favour the lessor’s insurer in relation to any loss-bearing obligations.

Commercial lease arrangements are variable, as the landlord and tenant may use statutory language like in this case, or may outline their respective obligations via personalized language. Regardless of the form it takes, if the Court determines its essence is to shield either party from liability, it will affect some or all of their insurer’s subrogation rights. As the New Brunswick Court of Appeal said in Pharmacie Acadienne, ” . . . if the ability to successfully prosecute a subrogated action is truly valued as a payout recovery option, a close inspection of the lease is an absolute must.”

Monika M. L. Zauhar is a partner with Cox & Palmer in the Fredericton, N. B. office. She specialises in commercial and insurance litigation.

Matthew R. Hiltz, is an articling student at Cox & Palmer, Barristers & Solicitors in Fredericton, N. B. He is currently studying law at the University of New Brunswick.

Cox & Palmer is a member firm of the Risk Management Counsel of Canada.

1 2008 NBCA 12.

2 [1976] 2 S. C. R. 221.

3 [1976] 2 S. C. R. 35.

4 [1978] 2 S. C. R. 749.

5 [1980] 2 S. C. R. 228.

6 As summarized in “Tort Immunity: Covenants to Insure and Waivers of Subrogation” by Nigel Kent, Clark Wilson LLP at p. 13.

7 Atlantic Shopping Centres v. CNR (1985), 40 R. P. R. 185 (N. B. C. A.).

8 S. N. B. 1980, c. S-12.2.