When the Lease or Building Stays in the Seller's Name: Who Insures What

When the seller keeps the building and becomes your landlord, treat it like a lease with a stranger. The seller's real estate company usually insures the building, your business insures its contents, equipment and the improvements the lease makes yours, and a written lease sets limits, additional insured status and a mutual waiver of subrogation. The trap is that one owner used to control both sides, so the old insurance often blurred them. A business policy may insure a building the business never owned, or the real estate company may have no policy at all. This guide is for new owners who rent their space from the seller or the seller's family.

Why is a lease with the seller different from any other lease?

Many owner-operators hold their building in a separate real estate company and keep it when they sell the business. The business then rents from its former owner. That is common and can work well, but it changes the insurance picture in three ways.

• The old setup was informal. When one person owned both companies, there was often no written lease, or a one-page lease that said nothing about insurance, and one policy covered everything.
• Interests now differ. After closing, a fire is no longer one owner's problem. The seller wants the building rebuilt and the rent paid; you want your equipment replaced and your business reopened fast.
• The seller may wear several hats. Landlord, seller note holder, consultant and indemnitor all at once. A dispute in one role can spill into the others.

The general lease clauses most tenants face, such as limits, plate glass and business income, are covered in lease insurance requirements most new owners have never read. This guide focuses on what changes when the landlord is the seller. If your space is leased from an outside landlord and the lease is still in the seller's company's name because it has not been assigned yet, the seller is still the tenant, and the assignment, consent and insurance steps are covered in that guide. If you are only sharing the seller's space for a few months under a transition services agreement, see transition services agreements and insurance.

Who insures the building, contents and improvements?

This is how the split usually works in a single-tenant building owned by the seller's real estate company. If the seller owns the building personally or through a trust, the same split applies; the landlord's policy should name whoever actually holds title. The lease controls, so confirm each line against yours.

Improvements need extra care in a seller-landlord deal. The standard commercial property form covers a tenant's improvements to a building it does not own, but only those it "acquired or made at your expense" (and cannot legally remove). If the seller's old business paid for the build-out, ask your deal counsel whether your company acquired that interest in the asset purchase. Then make the lease say who insures and rebuilds it.

How the form pays matters too. If you do not repair the improvements promptly, you may receive only a share of their original cost based on the time left on your lease, and nothing if someone else pays to repair them for your use. Match the lease term and the rebuilding clause to your coverage.

What in the old insurance setup no longer fits after the sale?

Owner-run insurance programs often reflected who owned everything, not which company owned what. Look for these patterns when you review what you inherited:

• The business's property policy insures the building, even though the real estate company owns it. Your business may have no insurable interest in the structure, and the true owner may not be on the policy.
• The seller's mortgage lender is listed on the business's policy rather than on the owner's.
• The real estate company has no liability policy of its own and relied on the business's general liability.
• In an asset deal, the seller cancels the old operating company's policies at closing, and the building is suddenly uninsured.
• In a stock deal, the company you bought keeps paying to insure a building it does not own.

A hypothetical example. A buyer acquires a machine shop in a stock deal. The seller keeps the building in his real estate company and signs a five-year lease at closing. The shop's inherited property policy still insures the building for $2,000,000, names only the operating company, and lists the seller's bank as mortgagee. Nobody changes it. A year later, a roof collapse damages the building and the shop's equipment. The carrier pays the equipment claim but questions the building claim, because the named insured does not own the building. The bank's position as mortgagee may be protected, but the seller's own equity and the rebuild are not. The seller argues the shop should have kept insuring it, and the lease is silent. A lease that assigned the building to the landlord's own policy, with the shop insuring its equipment and improvements, would likely have avoided most of the dispute. The numbers are illustrative.

Should you and the seller waive subrogation against each other?

Usually, yes, and both sides should do it on purpose, with your deal counsel drafting the clause. Subrogation is an insurer's right, after paying a claim, to pursue whoever caused the loss. Without a waiver, if your employee's welding torch starts a fire, the seller's insurer can pay the seller for the building and then sue your business to get its money back, even though you and the seller are on good terms.

Your general liability policy may not cover much of that bill. The standard form excludes damage to premises you rent. It gives back only fire damage, under a separate "damage to premises rented to you" limit that is often far below a building's value. Damage your business causes by other means, such as a burst pipe or a collapse, may have little or no liability coverage. Check that limit on your declarations page and compare it with the building's value. Some carriers offer an endorsement that extends this coverage to other causes, such as water damage or explosion, and raises the limit, so ask your broker what is available.

A mutual waiver of subrogation in the lease means each side looks to its own insurance for its own property. Two points matter:

• Both policies must allow it. That includes the seller's real estate company's property policy, whose mortgage lender may also have a say. The general rules are in lease insurance requirements; ask your broker to confirm in writing that your policies support the waiver.
• Sign it before closing or at closing. A waiver negotiated after a fire is too late.

With a seller-landlord, the waiver also keeps an insurance fight from turning into a fight over your seller note or earnout. See waiver of subrogation.

What insurance terms should the lease with the seller include?

Ask your deal counsel to cover these points. The friendlier the seller, the more tempting it is to skip them, and the more awkward a claim becomes if you do.

Keep the rent and terms close to what an unrelated landlord would charge. Below-market rent can flatter earnings and create questions later, and above-market rent can look like extra purchase price. Your accountant can advise on the numbers. For the certificate a landlord typically asks for, see certificates for a landlord.

What should you fix in the first month?

1. Get a signed, written lease if you do not have one, with the insurance terms above.
2. Confirm the seller's real estate company has its own building and liability coverage in force, and ask for evidence.
3. Take the building off your property policy unless the lease requires you to insure it, and if it does, name the correct owner and lender.
4. Update your property limits for contents, equipment and improvements at today's replacement cost. See the commercial property review.
5. Check your business income limit against how long a rebuild of this building could take. See the business income review.
6. Add the landlord entity as additional insured on your general liability if the lease requires it, with the right endorsement.
7. Calendar certificate exchanges and the lease renewal date.

A Morrow review can read your lease with the seller alongside both sides' policies and flag the places where the coverage and the lease do not match.

Keep reading

• Lease Insurance Requirements Most New Owners Have Never Read
• New Owner Review: Commercial Property
• Do Your Policies Still List the Seller? What to Fix
• New Owner Review: Business Income and Extra Expense
• Seller Notes, Earnouts and a Big Uninsured Loss in Year One
• All guides for new business owners

Frequently asked questions

Who should insure the building if I rent it from the seller?

Usually the seller's real estate company, as the owner, on its own property policy. Some net leases make the tenant buy building coverage instead. Either way, the lease should say so, and the policy should name the actual owner and its lender.

My inherited policy still insures the seller's building. Is that a problem?

It can be. If your company does not own the building, it may have no insurable interest in the structure, and the real owner may not be on the policy. Fix it at closing: move the building to the owner's policy unless the lease requires you to insure it.

Do I need a written lease if the seller and I get along?

In almost every case, yes. A written lease protects both of you if there is a fire, an injury or a dispute over your seller note. It also helps your lender and your accountant. Ask your deal counsel to draft it.

What is a mutual waiver of subrogation in a lease?

It is a clause in which you and the landlord each give up claims against the other for property losses covered by insurance, so neither insurer can pursue the other side after paying. Each side relies on its own insurance. Confirm your policies allow it, and put it in place before any loss.

What happens if the seller sells the building later?

That depends on your lease terms and your state's law, so ask your attorney; many leases continue with the new owner. Update the landlord's name on your additional insured endorsements and certificates, and check whether the new owner wants different insurance terms at renewal.

References

• ISO: Building and Personal Property Coverage Form CP 00 10 04 02 (carrier-hosted copy)
• ISO: Commercial General Liability Coverage Form CG 00 01 12 07 (carrier-hosted copy)
• IRMI: Insurable interest (definition)
• IRMI: Waiver of subrogation (definition)

This article is general information, not legal, tax or financial advice, and not a coverage determination. Coverage depends on the actual policy wording, carrier underwriting, your purchase agreement and your contracts. Ask your attorney and accountant about deal and legal questions.