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When a tenant pays his or her rent, what does the tenant suppose the landlord does with that rent? Unless the lease is triple net, the tenant expects the landlord to use the rent, among other things, to maintain the building and pay utilities, taxes and insurance. So, having contributed toward the payment of these costs, what are the tenant’s expectations in the event there is a fire in the building – maybe even one caused by the tenant? Many tenants, especially residential tenants, never think about this issue but, if pressed, would likely reply that the landlord’s insurance will cover the loss. Isn’t that why the landlord has insurance? The tenant would be correct but perhaps only to a point. The landlord will clearly look to its insurer, but that may not resolve the issue of the tenant’s exposure for the loss. This is because after the insurer pays the landlord, the insurer has the opportunity, under the equitable doctrine of subrogation, to step into the shoes of its insured and pursue a claim for compensation against the party who caused the loss: the tenant. The idea behind the right of subrogation is to shift the burden for the loss onto the party responsible for its occurrence. This is a question of fairness, and consequently, application of the doctrine is not considered appropriate in all cases but rather only in those cases where its application will lead to a more equitable result under the particular facts and circumstances. An insurer has no right of subrogation against its own insured. This is because the insured paid for the insurance, and the acts of the insured are a factor considered in determining the insurance premiums to be paid. This principle is extended to acts of any co-insureds because, again, the insurer’s contractual obligation is to bear this loss. Whether a tenant will be protected from a subrogation claim will be determined, as an initial matter, by the terms of the lease. If the lease contains a properly drafted release and waiver of the subrogation provision, this will be enforced and serve to protect the tenant. The tenant should review this provision with care to ensure that it does not exclude “casualties caused by the negligence of the tenant.” After all, most fires are someone’s accident. However, if the lease terms do not clearly protect the tenant, either by requiring the landlord to name him or her as co-insured (unlikely) or through a release and waiver of the subrogation provision, does the tenant have any defense? One possibility is for the court to deem the tenant to be an “implied co-insured,” in which event the tenant will benefit from an “implied waiver” of the insurer’s subrogation rights. American courts considering this possibility have produced a variety of decisions, generally applying one of three vastly different approaches to justify their conclusions. And interestingly, the courts in Pennsylvania, New Jersey and Delaware have each chosen to follow a different line. Helpful hint: If you are a tenant in New Jersey, be extra careful. Most modern courts facing this question have tended to adopt what is referred to as the “Sutton Approach” (so called after an Oklahoma case of that name), which holds that the tenant is presumptively entitled to the benefits of an implied waiver of subrogation unless particular circumstances clearly demand a different result. The tenant in such cases is deemed a co-insured only for purposes of inferring waiver of subrogation and is therefore not entitled to insurance proceeds (unless actually named a co-insured in landlord’s policies) but is nonetheless protected against subrogation claims by the insurer. The public policy arguments for this approach are that it can be assumed that the landlord purchased insurance to protect against tenant’s acts and that the parties likely presumed such co-insured status even if the insurance policy is silent; the insurer doubtlessly factored the risk of the tenant’s occupancy into the determination of premium levels; the tenant is presumably paying for the insurance through his or her rent; and it would be wasteful to require both tenant and landlord to carry insurance. The Sutton Approach is intended to create certainty in risk allocation and protect tenants from unexpected liability. The converse method of the Sutton Approach is generally referred to as the “Anti-Sutton Approach.” This position, explicitly adopted by a handful of states, is based upon the common law expectation that a tenant should bear full responsibility for his or her own negligence, both to his or her landlord and, if applicable, his or her landlord’s insurer. In these states, the insurers are entitled to subrogation rights in all cases, except where those rights are explicitly disclaimed by contract, so as to impose the cost of the tenant’s negligence upon the tenant him or herself. Unlike Sutton courts, the Anti-Sutton courts will not allow inferences of waiver of subrogation to be drawn from lease language such as the commitment of the landlord to maintain insurance or the obligation of the tenant to pay for insurance. In such states, waiver of subrogation must be express to be enforceable. The third approach is typically called the “intermediate” or “middle” approach. Courts applying this approach are open to finding implied waiver of subrogation but attempt to resolve the question by analyzing what they see as the reasonable expectations of the parties based upon lease language and other relevant facts and circumstances. These courts eschew the broad predispositions of the Sutton and Anti-Sutton courts and instead determine whether tenants are entitled to an implied co-insured status on a case-by-case basis. While attempting to be the most equitable of the equitable remedies, this approach has been criticized as providing no guidance (and thus no predictability) at all. As noted, the courts of Pennsylvania, Delaware and New Jersey have each adopted a different approach to this issue, providing three useful illustrations. Delaware courts have adopted the Sutton Approach, at least in the residential context. The case of Lexington Insurance Company v. Brian Raboin occurred as a result of a fire after a tenant improperly installed a ceiling fan in violation of his lease. The insurer paid the landlord and then sought to subrogate its loss by bringing an action against the tenant. The court confirmed the vitality of the right of subrogation as against third parties who cause damage to an insured, however noted that such causes cannot be pursued against an insured, a co-insured or where the wrongdoer is otherwise covered by the insurance. The Lexington court reviewed the lease and noted that the landlord had the obligation to insure the building. As is common in Sutton cases, the court cited language that the tenant was required to return the premises, upon surrender, in good condition, “damage . . . by fire excepted.” As a result, the landlord was found to have assumed the risk of loss. As to the question of whether an insurer could maintain a subrogation claim under such circumstances, the court chose to follow the “modern” trend that the fire insurance is for the benefit of both the landlord and the tenant, based upon the general expectations of those parties, the practical realities of who can and cannot insure the building, and the recognition that the landlord is insuring primarily, if not exclusively, to protect against the dangers of tenant negligence. Thus, the court held, in the absence of an express disclaimer of the waiver of subrogation or other provision whereby the tenant undertakes to assume this risk, a landlord’s insurer cannot obtain subrogation against a residential tenant. The court did distinguish commercial cases, where, it stated, the presence or lack of waiver of subrogation language may be indicative of particular intentions of the parties. The leading New Jersey case on this question is Zoppi v. Traurig, which was decided in 1990 and illustrates the polar opposite approach taken by an Anti-Sutton court. The Zoppi facts were similar to Lexington, in that a residential apartment dweller was alleged to have caused a fire and then asserted that the landlord’s insurance company had no right of subrogation. The court reacted strongly in rejecting this proposition: “I find no binding case law or reason in common sense that would hold that where the landlord would have had a claim against the tenant, the existence of insurance obtained by the landlord, paid for by landlord from landlord’s own unrestricted funds, and for the benefit of the landlord should exculpate the tenant from the consequences of negligent conduct absent an express agreement to that effect.” The court stated that this would undermine the public policy of “holding one responsible” for one’s actions and would impermissibly rewrite landlord-tenant relationships across the state. Finally, Pennsylvania has been categorized by some as an “intermediate” state. This is based upon the Pennsylvania case of Remy v. Michael D’s Carpet Outlets. Remy arose after a carpet seller negligently stored carpets too close to a light, which set off a fire and severely damaged a strip center. In analyzing whether the tenant, Michael D’s, was entitled to be deemed a co-insured, the court looked to the terms of the lease, which did not explicitly require the landlord to carry insurance and which required Michael D’s to carry liability insurance, including coverage for property damage. Moreover, the lease expressly provided that the tenant would be excused from liability for damage by “unavoidable casualty,” and this distinction was held to prejudice the tenant in this case, where the court found the fire to be “avoidable.” Thus, though apparently open to the possibility, the court rejected a finding that the tenant was an implied co-insured in this case, and the insurer’s subrogation claim was permitted to proceed. For further information, it should be noted that the 2007 Tennessee case of Dattel Family Limited Partnership v. Wintz provides an excellent review of the three approaches and their recent application in a variety of jurisdictions. In that case, the court weighed each theory and expressly adopted the Sutton Approach. Not surprisingly, the lesson from these cases is that landlords and tenants should make sure that their leases accurately and completely reflect their intentions on this very important issue. The risk to a tenant of ignoring this issue can be overwhelming, relative to the size of the leasehold obligation. The landlord, while risking less, should also strive to avoid creating uncertainty and openings for disputes by leaving issues unaddressed. This is not to suggest that landlords should respond by rejecting release and waiver of subrogation language, since such language frequently reflects the most reasonable and defensible allocation of risk and does not typically result in any increased insurance costs or practical complications. MARTIN DOYLE and DAVID FELDER are members of Saul Ewing’s real estate department in the firm’s Philadelphia office. Both have worked on a number of major real estate transactions and have been involved in all aspects of real estate development, sales, finance and leasing. Doyle received a law degree, cum laude, from the University of Pennsylvania Law School. Felder received his J.D. degree, cum laude, from Harvard Law School.

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