Savvy commercial real estate owners, developers, investors and property managers know that contractual risk transfer (CRT) is a key tool in managing commercial real estate operations and plays a substantial role in managing the total cost of risk.
Contractual risk transfer assigns liability and financial burden of a loss to the party best able to control or prevent the incident resulting in injury or damage. The contract offers protection by indemnifying and holding harmless a non-participating or supervising party (often referred to as “upper tier,” e.g. Property Manager, General Contractor) for actions of a third party (often referred to as “lower tier,” e.g., Tenants, Subcontractors).
This form of risk transfer accomplishes both risk financing, assigning a source to pay the cost of a claim, and risk control, developing a means to avoid or lessen the cost of a loss. When utilizing contractual risk transfer agreements, tenants and service providers have extra reason to follow safe operating practices since they will be the first party held financially responsible in the event of an accident or claim.
For the building owner or manager, contracts with numerous entities are a normal part of the business process. Some common contracts related to real estate include property management, elevators, escalators, snow removal, janitorial and general maintenance, lease agreements (owner and tenant), security, landscaping, pool service/maintenance, and fitness center service/maintenance.
Tiers and Levels of Liability
Owners and general contractors hold a position with a certain amount of control over and responsibility for the actions of subcontractors. This control leaves them vulnerable to being held vicariously liable for the actions of lower-level entities. Every state allows vicarious liability to be transferred back to the at-fault lower-tier contractor.
Joint liability is injury or damage caused by or attributable to both the upper-tier and lower-tier contractor. The term does not consider the percentage of fault assignable to each party, only that the actions of both parties resulted in the injury or damage. Approximately 19 states allow the upper-tier contractor to contractually transfer joint negligence back to the jointly liable lower-tier contractor.
Sole negligence and liability exists when only the upper tier is found to be negligent and legally liable for the injury or damage. In sole negligence situations, there is no assignable negligence or legal liability to the lower-tier contractor. According to the International Risk Management Institute (IRMI), only 10 states allow the contractual transfer of sole negligence from the upper tier to the lower tier. However, there are strict guidelines for such broad transfer in the states that allow this level.
Common Applications of CRT: Landlord/Tenant, Landlord/Contractors
Landlord-favorable insurance risk transference requirements include obligating each tenant’s insurance policy to respond in a primary and non-contributory fashion with a waiver of subrogation, naming the landlord as an additional insured. The same waiver of subrogation terms should be required from all general contractors or subcontractors within their contractual agreements prior to performance of any work. When it comes to general contractors or subcontractors, a landlord should also obligate them to provide completed operations protections that extend past the point of the completion of their work. By designating the tenant’s insurance as primary and noncontributory, with a waiver of subrogation, their insurance will respond first, and the landlord’s insurance usually will not be needed.
Claim Example
During a building renovation process, an elevator maintenance company is brought in to repair the elevator. The repair requires a scaffold to be built inside the elevator shaft to support two workers who are completing the repair. During the repair, the scaffold collapses and both workers fall approximately 30 feet to the bottom of the shaft. One worker dies from his injuries, and the other is severely injured, including brain injuries. Both families of the workers sue the building owner, the contractor and the company that provided the lumber for the scaffold. The final settlement totaled $17.5 million, with the building owner’s insurance only paying $2 million of that loss since the building owner took the careful step (prior to the loss) when executing the work contracts to contractually require both the contractor and scaffold company’s general liability insurance to respond as primary and non-contributory, with a waiver of subrogation. [*Example provided by Chubb, the world’s largest publicly traded property and casualty insurer.]
Manage Your Risk and Your Agreements
Effective risk transfer can lower your overall cost of risk. Commercial real estate enterprises can be party to a number of contractual relationships. Through contractual risk transfer, you manage your risk by having others contractually assume their proportionate share of the liability.
This strategic arrangement must be managed by collecting certificates of insurance from each tenant, every year, confirming and memorializing that the tenant has agreed that their insurance policies will respond to any claims first. Many commercial property management software programs today have a certificate monitoring capability which provides property managers with calendar reminders so they can easily follow up with tenants for their updated certificates of insurance.
As key advisers to your management team, your insurance broker and legal advisers can work together on your behalf to identify and implement risk management protocols. As this article outlines, contractual risk transfer is an effective aspect of a total risk management program.