Leaseholder insurance: Managing the risk of uninsured loss

This isn’t a story about cladding. But it reveals a set of circumstances where a leaseholder can find itself with an uninsured loss. This might not be such a problem where there has been a burst pipe or minor malicious damage, but it is a different matter if the leaseholder flat has been destroyed by fire.

Let us first consider what can go wrong and then look at what remedies might be available.

ABC (a limited company) is a property owner. In January 2019, ABC purchased the freehold of 12 flats. ABC planned to refurbish the flats and then sell the leases for an enhanced value. To achieve this, ABC largely funded the purchase through borrowings secured on the leases. The leaseholder arrangements were not without complication.

The chain was:

• a. The freeholder is the XYZ Property Group as evidenced by a head lease;
• b. The freeholder granted a long lease to Mr Jones, with permission to sub-let;
• c. Mr Jones, in turn, granted a long lease to ABC which also has permission to sub-let to individual tenants.

The lease granted to ABC by Mr Jones (the superior landlord) made ABC responsible for its share of the insurance premium for the comprehensive policy covering the whole.

The underlease obliges the superior landlord to arrange insurance for the buildings and to ensure the buildings are maintained in a good and tenantable condition. In fact, the main buildings insurance policy covering the whole block had been effected by the freeholder, XYZ.

There was a fire just a few days following ABC’s acquisition of the leases. ABC confidently submitted its claim for the damage caused to its flats and met the loss adjuster on site to get the ball rolling. ABC put the initial delays down to plain inefficiency, but it eventually became clear that the insurers were not going to cooperate. To make matters worse, the insurers simply stated they were not willing to deal with ABC anymore because ABC was not the policyholder. 

ABC was not able to read between the lines, but an insurance expert was eventually able to explain the sad fact that the buildings insurers were not going to indemnify its policyholder, XYZ, for reasons that were not disclosed. This placed ABC under considerable financial pressure because the tenants had immediately vacated the flats and there was no income to support the finance payments.

Before long, the lender was threatening action to take possession of the leases and ABC’s directors were being called on in relation to personal guarantees. It later became apparent that the freeholder, XYZ, had failed to make a fair presentation of the risk to the insurer at the policy’s last renewal with the result that the policy was voided.

An insolvency solicitor was instructed to: (i) take necessary steps to protect the solvency of ABC and, if necessary, to appoint administrators to deal with the time during which repairs to the flats could not be completed, and (ii) commence legal action against the superior landlord (who, in turn, would likely need to issue proceedings against the freeholder, XYZ).

The solicitors soon established that both the superior landlord and XYZ had sufficient assets from which any judgment obtained in favour of ABC could be satisfied and a full recovery was expected.

Lessons to learn

How could the interests of ABC have been better protected? Just like most leaseholders, ABC put its faith in the freeholder’s block policy and dutifully paid its proportion of the premium. But, in so doing, ABC did not appreciate that: (i) ABC has no direct right of access to the block policy, and (ii) the effectiveness of the block policy, and the extent to which the freeholder is diligent in transacting that insurance, is entirely outside of ABC’s control.

Possible reasons for insurance failure

Freeholders come in all shapes and sizes, with some being less than reliable. There are many reasons why an insurance policy might prove defective. The landlord might be responsible for:

·       Failing to make a fair presentation of the risk, at inception or renewal, as required under the Insurance Act 2015. This might involve failing to disclose past insolvency events, previous claims, or anything else that might represent an increase in risk that should have been notified;

·       A breach in policy condition, such as an agreed provision of fire precautions, late notification of claim, or failure to observe a requirement to ensure the property remains in good condition;

·       Failing to pay the premium.

In effect, a leaseholder is handing over the security of its investment in the lease to third parties over which it has no control. That is no way to manage risk.

Contingent buildings insurance

One solution is for the conveyancer to recommend the arrangement of contingent buildings insurance in the leaseholder’s name. Conveyancing solicitors will often recommend this, frequently only in cases where they have reason to doubt the suitability of the freeholder’s insurance. But that is the problem. It is rarely going to be possible to foresee whether or not a freeholder is going to exercise sufficient care to ensure the buildings insurance operates properly. In the case of ABC, it had been established that the freeholder had effected a comprehensive cover with an insurer of good repute, so there was no obvious cause for concern. As a consequence, contingent insurance had not been considered.

In this case, ABC was able to pursue the superior landlord, but not before the company was placed in administration, with the directors facing claims under the personal guarantees. It would have been much better had there been contingent insurance in place if only to speed up the recovery process and fund any required legal action.

A one-off indemnity premium may well be a cost effective way of removing this danger, even in cases where the insurance arrangements seem perfectly suitable. If your client does not take up the offer, a copy email or file note to this effect would be welcomed by your PII insurers.

Another way to cater for this unusual, but catastrophic, problem would be to encourage the leaseholder to insure their contents and fixtures and fittings under a policy that offers a contingent insurance extension. Such policies are available, although they are far from common. 

Countrywide Legal Indemnities (cli.co.uk) offers a one-off indemnity cover (lasting for the duration of the lease or mortgage) for contingent buildings insurance, as do other indemnity providers. If advising a client to effect such cover, it is important to review the policy’s conditions, as they might, for example, include a requirement that your client seeks annual confirmation that the freeholder has renewed the block policy.

And, in the event of damage occurring that should be covered by the buildings policy, your client would be well advised to seek confirmation from the freeholder that timely steps are being taken to claim for the damage, as failure to progress matters might compromise the contingent cover.

Liability cover

Leaseholders should also consider if their legal liabilities have been insured. Insurance brokers, Boswell (alanboswell.com), specialise in insurances for leasehold property. As well as advising on the best way for leaseholders to protect their interests in the property, they also offer a package of contents and fixtures and fittings cover, arranged in such a way that the leaseholder’s legal liabilities, by reference to the terms of the lease, are properly allowed for.

Many leaseholders see no need to insure for contents if the value is modest, but effecting contents insurance is often the easiest and most cost effective way of securing the required public liability cover.

Michael J Wilson is regional director for Flaxmans, insurance claims advocates flaxmanpartners.co.uk