Are pandemics the new terrorism in commercial leasing?

The current impact of Covid-19 on our daily lives could not have been imagined, yet alone foreseen, only months ago. Its effect on commercial landlords and tenants means that how the risk of pandemics should be dealt with in commercial leasing is, and will continue to be, the subject of much debate. As commercial property forms an indirect but core part of most people’s pension, the importance of ensuring that commercial property continues to provide an attractive and solid investment is of wider interest than to just property professionals.

The foundation of commercial leasing and institutionally acceptable leases is that a landlord has a secure stream of rental income from a property, with the costs of repairing and maintaining the property being met by tenants.

Back in the late nineties / early noughties, how the risk of terrorist damage should be treated in commercial leases was the subject of much debate. The risk was fairly remote, but tragic events in the UK and abroad at that time meant that it was a risk that remained in our collective minds and became the subject of much debate in lease negotiations. While today insurance for terrorism is commonly available at reasonable rates and therefore generally forms an “insured risk” entitling a tenant to an abatement of the rent, that was not always the case. As such, 15 or 20 years ago whether it was the landlord or the tenant that should bear the risk of terrorist damage was a thorny issue in negotiations and positions changed over time, depending on whether it was a landlord or a tenant market. The risk of terrorism was a catalyst for the widespread adoption and development of the concept of “uninsured risks” - identified risks (e.g. terrorism or in certain areas flooding) that cannot be insured against at the time of damage/destruction because of the unavailability of cover or unreasonable cost of maintaining cover. Uninsured risks are now a standard provision in leases and entitle a tenant to an abatement of rent during the period that the property is unavailable for use, while allowing a landlord to elect whether or not to reinstate the damage – thus, while the landlord would have to meet the cost of making good such damage/destruction, the landlord has control over that decision.

A pandemic (unlike insured or uninsured risks) is not damaging or destroying the property; but as we can see today, it is temporarily halting the ability of a tenant to occupy it. While to a degree tenants seeking rent abatements during this period is understandable, commercial landlords and their investors (which include, indirectly, the vast majority of our population through pension investments) have based their business model on a secure and steady flow of rental income.

As such, as with terrorism (and other more established risks such as fire), could it be that insurance offers the best option to cover the risk of future pandemics? Depending on how the insurance market responds in the months and years to come, pandemics could be commonly adopted as a risk for a landlord to insure against as part of maintaining loss of rent insurance (paid for by tenants as is standard for loss of rent, but allowing tenants an abatement of the rent during necessary periods of closure due to pandemics, during which the landlord would continue to receive the rental income from the insurer). Or it could be a risk for tenants to insure against as part of their business interruption insurance (as some tenants had already done and particularly given that the costs of closure are of course far wider than just rent). It will likely be the insurance industry that is best placed to direct landlords and tenants regarding which party will be able to maintain such insurance at reasonable rates, although this may take time given that insurers are currently facing the biggest level of claims since the 9/11 attacks. The availability of such insurance may also depend on how the reinsurance market can deal with the risk of pandemics, which as we are currently seeing can have a global, systemic and longer-term impact than other insured risks. Perhaps this would require something similar to Pool Re, the reinsurer whose members comprise the majority of insurers providing commercial property insurance in the UK. Pool Re was set up following the Provisional IRA bombings of the early nineties, after which insurers would not provide insurance for terrorism, which the property industry and government recognised was not in the public interest. As such, the scheme was set up and operates by all members paying a percentage of their premiums into the pool as a levy. The pool is backed up by the government, who in return receive a premium and would be repaid from future income if they ever had to step in if the pool was insufficient to meet claims.

The hope is that severe pandemics such as we are currently facing are, like the Spanish flu of 1918, events that only occur once every few generations. As such, while the human and economic cost of such events is high, hopefully the risk of repeat global outbreaks will remain low. Nevertheless, given the unprecedented impact of Covid-19 it is likely to be a risk that parties will want to cover, and as such the availability of insurance for pandemics may, as happened with terrorism years ago, evolve and inform how commercial leasing develops.