Over the next two weeks we are going to take a look at some of the issues that commonly arise in relation to the negotiation of insurance requirements on transactions. This week we are giving our top five jargon busters to help you understand the complex world of insurance.
1. Noting interest
It used to be the norm that lenders would require borrowers to note them on their insurance policies. It is often assumed that noting a lender’s interest on a policy provides the lender with the right to any insurance proceeds paid out by an insurer when a claim is made.
However, noting an interest does not make the lender a party to the insurance policy and the lender therefore has no ability to make any claim and/or enforce any rights provided by the policy itself, including the right to receive any proceeds. Furthermore, since the Association of British Insurers withdrew from the 1992 agreement with the British Banking Association, lenders are no longer automatically notified of any cancellation or alteration in cover.
Noting a lender on an insurance policy offers little or no protection and ought to be avoided as sole protection.
2. Joint insurance
Some insurance policies refer to ‘joint insurance’. Lenders and borrowers are not true joint insureds, because they have different interests insured under the policy. Lenders should not ask to be named as joint insured. They need to be named as ‘composite insured’ or ‘co-insured’.
3. Co-insured/Composite insured
Either of these terms can be used. They effectively have the same meaning. Lenders need to be named as ‘composite insured’ or ‘co-insured’ (as shorthand for ‘co-insured on a composite basis’), not as joint insured. Co-insureds are insured ‘for their respective rights and interests.’
Subject to any words to the contrary in the policy, the legal effect of co-insurance is that the rights of each co-insured are separate. This means that, if one co-insured does something which vitiates (invalidates) its cover under the policy, this does not vitiate the other co-insured’s cover as well. Property insurance policies commonly contain a non-vitiation clause that prevents (to a varying extent) the actions of the borrower resulting in the policy being invalidated for the benefit of the lender. It is worthwhile for lenders to negotiate for the broadest possible wording of such a clause.
4. First loss payee
A first loss payee clause requires an insurer to pay any proceeds to the person named in that particular clause. Lenders request such a clause for obvious reasons but it is important to note that in order to obtain maximum protection the lender should request that it is first loss payee as well as being an insured party on the policy.
An insurer who pays a claim is subrogated to the insured’s rights. This means that the insurer has the right, acting in the insured’s name, to proceed against a third party responsible for causing the loss, in order to recover sums paid out by the insurer to the insured.
If insurers agree to a waiver of subrogation rights, this means that insurers cannot recover their outlay from those responsible for the loss.
Finance documents commonly require that a policy contains a waiver of rights of subrogation against the insured (borrower), the tenants and the lender (as composite insured). Except in relation to tenants, this requirement is difficult to justify to insurers. Insurers generally cannot sue their own insureds. They do not have subrogation rights against their insureds or composite insureds, so there is strictly nothing to waive against them. However, most insurers can be persuaded to agree to the waiver. It is important to get a waiver of subrogation rights against tenants, if tenants are not composite insureds under the policy. However, there are circumstances in which the landlord’s insurers have no subrogation rights against the tenant, even where the tenant is not a composite insured under the policy.
Next week we will look at common sticking points when negotiating.