If you rent your business premises, any improvements you make—such as interior remodeling—automatically become the landlord’s property. When these improvements and betterments are damaged in your restaurant or bar by fire or other insured catastrophe, who is responsible for replacing them? Since the improvements belong to the landlord, technically the tenant hasn’t lost any property. What the tenant has lost is the use of the improvements for the remainder of the lease.
Check lease wording to determine whether it permits you, as a tenant, to make improvements, whether it requires insurance for these improvements, and who must insure improvements. Since your improvements might be essential to your business operations, it’s important to determine who has responsibility for replacing them if they become damaged.
When The Tenant Is Responsible…
If the lease stipulates your business, as the tenant, is responsible for insuring improvements and betterments, you can take the following steps to transfer the risk of damage to improvements and betterments.
If the landlord assumes the responsibility of insuring the improvements, make sure that the lease also requires the landlord to repair or replace improvements (along with the building) if they are damaged or destroyed. If your lease doesn’t require this and you can’t renegotiate, you may want to buy insurance to protect what you have invested into your estabishment. Although designed primarily to protect tenants from losses suffered due to the cancellation of a favorable lease because of insured loss or damage to the building, it also covers your improvements and betterments.
Alternatively, you can buy insurance to cover your improvements or betterments. Your commercial property policy covers your “use interest as tenant in improvements and betterments.” However, the amount the policy will pay you for damage depends on how quickly you repair damages. If you repair them “promptly,” the insurer will pay their actual cash value.
When you don’t or can’t repair improvements promptly (as when the building is destroyed and not rebuilt or if you decide to move), the policy will pay the “unamortized” portion of the original cost of the improvements. For example, if you invested $20,000 in improvements at the beginning of a 10–year lease, and your building is destroyed at the end of the second year, you’ve lost 80 percent of your investment. In this case, the policy would pay you $16,000 (minus any deductibles), regardless of the actual cash value of the improvements when they were destroyed.
So before making an investment in improvements and betterments, protect yourself by reading your lease terms. Who has responsibility for repairing or replacing them in the event of a loss? If the lease makes your business responsible, you can transfer your risk of financial loss by buying insurance. For more information, contact your insurance broker.
If you have any questions or concerns, please email me.