IS INSURABLE?

PRESENTED BY

NEIL S. KESSLER SCOTT B. OSBORNE Troutman Sanders LLP Graham & Dunn PC Bank of America Center 33rd Floor 1111 East Main Street, 23rd Floor 1420 Fifth Avenue Richmond, Virginia 23219 Seattle, Washington 98101 (804) 697-1450 (206) 624-8300 [email protected] [email protected]

2002 AMERICAN COLLEGE OF REAL ESTATE LAWYERS MEETING MAUI, HAWAII MARCH 22, 2002

1 What Has Happened Since The Events of September 11, 2001?

· Approximately 22 buildings in and around the WTC were destroyed, damaged or made unusable

o 20% of the downtown Manhattan office market (15.5 million square feet of office space) destroyed o More than 29 million square feet of office space destroyed, damaged or made unusable (equal to total square footage of office space of Downtown Houston)

· Larry Silverstein headed a group that bought a 99-year lease on the WTC in August, 2001 (only 10 weeks before the attacks) from the Port Authority of New York and New Jersey for about $3.2 billion (reportedly including $100 million in cash as a deposit)

· Silverstein wants to collect $7 billion in property and casualty insurance, but that depends on whether the insurance carriers will be required to treat the attacks as two separate occurrences; if the attacks are found to be one occurrence for insurance purposes, Silverstein will only recover approximately $3.5 billion

o Swiss Re (which is obligated for 22% of the WTC insurance coverage) has filed for a declaratory judgment from the U.S. District Court for the Southern District of New York in Manhattan to determine if the planes crashing into the North and South Towers constituted one terrorist plot that destroyed two buildings or two separate incidents. At issue is whether the property policy limit of approximately $3.546 billion (with no aggregate limit) will be triggered once or twice. o Silverstein reportedly maintained business interruption coverage equal to three (3) years of rental income, or $1,105,935,000 o The WTC ground lease and the financing on the WTC complex require Silverstein to reconstruct the twin towers as two 110-story structures. Replacement cost insurance is payable only if the towers are reconstructed as two 110-story structures. CAN OR WILL THIS EVER BE DONE? o At the time of the 9/11 attack, certain insurance binders had been signed but policy wording had not yet been finalized and no policy had been issued. Among the wording not finalized was the definition of “occurrence”. One version of a specimen insurance form being considered, and the definition Swiss Re claims 2000 should apply (WilProp SM), makes “all losses or damages that are attributable directly or indirectly to one cause or to one series of similar causes … will be added together and the total amount of such losses will be treated as one occurrence irrespective of the period of time or area over which such losses occur ….” o But Silverstein claims that Swiss Re never formally committed to that policy wording. o The other specimen form being considered, and the one which Silverman claims is applicable, was a policy form issued by Travelers which did not define the term “occurrence”. o Swiss Re claims it never agreed to the terms of the Travelers policy claimed by Silverstein to be applicable.

2 Facts (and educated guesses) Relating to 9/11

o Although the litigation is ongoing, Swiss Re and 20 or so other insurers have reportedly paid Silverstein about $132 million in claims into a trust account to cover lost rents from tenants. o GMAC loaned Silverstein’s group about $563 million to take on the WTC lease, and has sued Silverstein in New York state court to clarify how the insurance money paid into the trust account should be split up. GMAC claims the insurance proceeds must be used to pay rents due to the Port Authority of New York and New Jersey and to pay interest to investors who bought bonds backed by repayments on GMAC’s loan to Silverstein. GMAC has asked the court to limit the amount of money going to Silverstein, who wants cash from the insurance proceeds to pay lobbying costs in Washington and management fees of more than $700,000 per month, “even though these properties have been destroyed.” o Silverstein and Boeing Co. (which manufactured the four planes) have been aggressively lobbying Congress for liability protection. Silverstein has told lawmakers that a flood of lawsuits from victims in and around the Twin Towers would prevent him from rebuilding on the site because he will be unable to obtain financing with a huge potential liability hanging over his head. The Wall Street Journal (October 25, 2001) quotes legal experts as estimating without a cap, Silverstein would be subjected to as much as $15 billion in claims, only $1 billion of which would be covered by insurance. The Port Authority faces similar claims and has only $650 million in coverage.

The Size and Scope of WTC Disaster and Attack on the Pentagon Will Have a Permanent Impact on the Insurance Industry

· Swiss Reinsurance Co. has recently estimated $90 billion in losses from damaged property and interrupted businesses resulting from attacks at WTC and the Pentagon. (12/20/01 The Wall Street Journal).

· For the first time in modern history, a man-made event short of war has created catastrophe losses that will approach those stemming from natural disasters. From the property/casualty insurance perspective, the events of 9/11 will be the largest catastrophe--manmade or natural.

· Only the 1995 earthquake in Kobe, Japan caused greater damage -- an estimated US $100 billion •BUT, ONLY ABOUT US $2.8 BILLION WAS INSURED

· This time the insurance industry is taking a bigger hit because the damages in New York were relatively well-covered.

· Estimates for all insurable losses range from $30 billion to $70 billion.

3 · Even so, insured commercial property and business interruption loss are estimated at $18.5 billion by Morgan Stanley Research (November 28, 2001) and $19 billion by Swiss Re (as reported in December 21, 2001 The Wall Street Journal).

WTC Losses Are Spread Across A Number Of Commercial Property And Casualty Lines; Property Losses Are Only One Piece Of The Pie

Aggregate WTC primary insurance losses by line*

Aggregate WTC primary insurance losses by line* Workers' comp

Aviation 14%

23% Business interruption 14%

Property Commercial 31% liablity and other

18%

*Does not include insurance industry payouts under life insurance policies; reinsurance losses could account for an additional $10.4BN; by-line reinsurance information is not available Source: Compilation of equity research reports estimating losses by line JPMorgan Investment Banking

4

History Shows That Catastrophes Are A “Growth Market”

JPMorgan Investment Banking

5 Putting WTC in the Context of the 20 Most Costly Insurance Losses

$billions, at 2000 prices

Insured Damage Date Event Country $25 - $35 2001 World Trade Center United States 19.6 1992 Hurricane Andrew United States 16.3 1994 Northridge Earthquake United States 7.1 1991 Typhoon Mireille Japan 6.1 1990 Winterstorm Daria France, Great Britain 6.0 1999 Winterstorm Lothar Western Europe 5.8 1989 Hurricane Hugo United States 4.6 1987 Storm & Floods Europe 4.2 1990 Winterstorm Vivian Western/Central Europe 4.2 1999 Typhoon Bart Japan 3.7 1998 Hurricane Georges United States 2.9 1988 Explosion on Platform Piper Alpha Great Britain 2.8 1995 Great Hanshin Earthquake in Kobe Japan 2.5 1999 Winterstorm Martin France, Spain 2.4 1999 Hurricane Floyd United States 2.4 1995 Hurricane Opal United States, Mexico 2.1 1993 Blizzard, Tornadoes United States 2.0 1992 Hurricane Iniki United States 1.8 1989 Explosion in a Petrochemical Plant United States 1.8 1979 Hurricane Frederic United States 1.8 1996 Hurricane Fran United States

JPMorgan Investment Banking

6 Other Catastrophic Events From Around the World Illuminate the Interplay of Private and Governmental Resources, Such As the Kobe Earthquake . . .

Description:

o The Great Hanshin Earthquake struck on January 17, 1995 at 5:46 a.m., with its epicenter at Akashi Strait, near Kobe. o Registering 7.2 on the Richter Scale, the quake lasted 14 seconds. o The devastation left 6,425 people dead, 28,000 injured and 300,000 homeless. In addition, 150,000 buildings were damaged or destroyed. o Total property damage was over US $100 billion, with only about US $2.8 billion insured. JPMorgan Investment Banking

… the serin gas attacks on the Tokyo subway ...

· Description

o Lethal serin gas attacks struck the Tokyo subway system on March 21, 1995 at around 8 a.m. o The gas was released from boxes that were placed in trains and on platforms. o The attack left 12 people dead and injured 5,500 others, while inconveniencing 1.1 million people.

JPMorgan Investment Banking

7 . . . and the L.A. riots

Description:

o L.A. riots lasted from April 29, 1992 through May 1, 1992. o Riots erupted after an all white jury returned a “not guilty” verdict in the Rodney King case. o Violence and destruction of property left more than 50 people dead, over 4,000 injured, 12,000 people arrested, and $1 billion in property damage. o The devastation and toll of the riots made them the worst civil unrest L.A. had experienced since the race riots of 1965.

JPMorgan Investment Banking

Catastrophes have also spawned more permanent governmental responses in the U.S., Including the formation of agencies, such as the CEA . . .

· California companies are required to write earthquake insurance as part of all homeowners’ policies. In the wake of the 1994 Northridge Earthquake many insurers, not wanting to expose themselves to losses from another earthquake, stopped writing homeowners’ policies altogether.

· The CEA was created to induce insurers to begin writing homeowners’ insurance once again. Under the CEA compromise, companies must still offer earthquake insurance with every homeowners’ policy, however, all earthquake-related premiums and risks are shifted to the CEA.

· The CEA assumes zero risk and commits no government money other than that needed for its own administration. Funding is provided entirely by CEA members (those selling homeowners’ policies), no state funds are available to cover losses incurred by CEA policyholders.

· The CEA currently has funds available to cover $7.2 billion in losses1. To date, the CEA has incurred only negligible losses related to earthquake claims.

1 Excludes 9% adjustment fee Source: Reuters, 01/09/01; ISO; Hawaii Office of the Governor JPMorgan Investment Banking

8 . . . the Hawaii Hurricane Relief Fund provides similar covers . . .

· Hawaii Hurricane Relief Fund (“Fund”) was established after Hurricane Iniki to provide hurricane insurance on residential properties in Hawaii.

JPMorgan Investment Banking

. . . and the National Flood Insurance Program (“NFIP”) provides federal coverage for water damage

· NFIP was enacted in response to the rising taxpayer costs for relief of flood victims due to the increasing amount of damage caused by floods.

· The NFIP makes federally backed flood insurance available in communities that agree to adopt and enforce floodplain management ordinances to reduce future flood damage. National Flood Insurance is available in more than 19,000 communities across the U.S. and its territories.

JPMorgan Investment Banking

Abroad, governmental responses have included such things as Pool Re in the UK . . .

· Pool Re is the mutual created by the UK government to reinsure terrorism risks following the 1992 IRA bombings in the City of London which destroyed much of the business district of Bishopsgate.

o Until 1992, terrorist damage was included in mainstream commercial property insurance

· In the event of a loss, the primary insurer is responsible for paying the entire terrorism claim. Once payment is made to the policyholder, the insurance company then seeks reimbursement from Pool Re.

· If claims resulting from a terrorist incident are more than the total pool of premiums collected by Pool Re, then the insurance companies who are members of the pool will

9 contribute an additional amount equal to 10% of the premiums that they have already contributed. If this additional money still does not cover the claim then the UK government steps in as reinsurer of last resort.

· Rates property risks in the UK according to a four-zone system with “Zone A” covering the highest risk areas - specifically, London and Westminster, while “Zone D” covers lowest risk rural areas.

· Since its inception, Pool Re has covered three major losses totaling US $15 billion.

· Pool Re’s members – the main insurance companies - sell terrorism insurance on terms set by Pool Re. In return, Pool Re carries most of the burden of large terrorism claims.

· Primary insurance companies are required to cover claims for damage caused by terrorist incidents up to the first US $250,000. Further coverage can be bought from insurers at Pool Re rates and the premiums are collected together by Pool Re after the insurer has received a 5% insurance commission.

JPMorgan Investment Banking

… and the Japan Earthquake Reinsurance Company

· Established in 1966, following the Niigata Earthquake which occurred on June 16, 1964. The earthquake measured 7.4 on the Richter Scale and killed 26 people, while destroying 3,018 and damaging 9,750 homes in Niigata.

· Reinsured by the central government, the scheme offers a limited earthquake endorsement to the basic fire policy (a fire following an earthquake is not covered under a basic fire policy, but requires the earthquake endorsement). The indemnity under the policy is limited to 15%-30% of the structure’s replacement value (depending upon the region) and capped at approximately US $100,000.

· Homeowners may purchase earthquake endorsement. However, nationally only about 7% of Japanese homeowners have purchased it with rates varying from 3% in Kobe in 16% in Tokyo.

· During the claims process the structure is determined to fall into one of three categories: “total loss,” “half loss,” or “significantly less than half loss.” If it is determined to be a “total loss,” then payment is for the total sum insured. If it is a “half loss,” then the indemnity is prorated at 50% of the total sum insured, with contents severely limited unless they are totally destroyed. Losses that fall under “significantly less than half loss” are not reimbursed. A minor allowance is made for incidentals.

10 · Earthquake premiums for this coverage are based on pure premium plus loading, with no profit for the earthquake cover. The pure premium is based on an estimation of annualized loss determined from a 500-year record of earthquakes. For example, typical premiums in the Tokyo area are about 0.5% of the Total Sum Insured (“TSI”).

· Total liability of the residential insurance scheme is limited to about US$18 billion, with about US $1 billion borne by the Japan Earthquake Reinsurance Company, about US $2 billion by the direct writers and the remainder, approximately US $15 billion or 85% by the government.

JPMorgan Investment Banking

What Will Be the U.S. Government’s Response?

· The federal government and Congress have “strongly encouraged” insurers not to invoke the act-of-war exclusion to avoid paying claims -- notwithstanding the statements of President Bush and Secretary of State Colin Powell referring to the attacks as “acts of war”.

· Major property and casualty insurers have made a point of saying they will not rely on the “acts of war” exclusion to avoid covering losses from 9/11 based on public policy considerations.

· But, the insurers probably would not have been legally be entitled to invoke the war exclusion anyway based on a U.S. Second Circuit Court of Appeals case, Pan American World Airways v. Aetna Casualty and Surety Co., 505 F.2d 989 (1974), holding that the insurance policy’s war risk exclusion (which is the exclusion commonly used today) does not include

“… a violent and senseless intercontinental hijacking carried out by an isolated band of political terrorists."

· TERRORISM - Prior to 9/11, standard commercial property insurance policies did not specifically exclude damage or loss resulting from terrorist acts or terrorism.

11 · Insurance Underwriters have testified before Congress that the insurance industry cannot offer coverage for future acts of terrorism and have strongly lobbied Congress to establish a government facility modeled after Pool Re in the UK.

· Widespread fears that such legislation was necessary to avert an economic crisis that would develop if companies were unable to get insurance against claims for future terrorism acts by December 31, 2001, when most commercial policies expired and had to be renewed.

· On November 29, 2001, the House of Representatives passed legislation (H.R. 3210) by a 226-193 margin aimed at ensuring the continued availability of terrorism risk insurance for U.S. businesses.

o The House bill requires the insurance industry to pay claims from any terrorist act causing losses under $1 billion. § If losses rose above $1 billion, the U.S. government will pick up 90% of all claims and insurers will have to repay this aid over time as their financial condition recovers. § Small insurers could get government loans if claims exceeded $100,000 and their own share of those losses exceeded a set percentage of their capital or premiums. § The plan would last for one year, with an option for two more.

o BUT, the House bill also (1) blocks victims of future terrorist acts on U.S. soil from collecting punitive damages from building or business owners even in cases where they may have been negligent; and (2) consolidate victim lawsuits in a single federal court and CAP attorneys’ fees at 20% of compensatory damages or court-approved settlement.

o However, to date, the Senate has not passed legislation. § Among other points of contention, Senate Democrats refuse to give Republicans and the Bush Administration a complete ban on punitive damage awards in terrorist-related claims. § The Senate’s sense of urgency to pass terrorist legislation before December 31, 2001 may have waned in light of what has happened in the commercial insurance market since January 1, 2002.

12 WHAT HAS HAPPENED SINCE JANUARY 1, 2002?

· TERRORISM POLICY EXCLUSIONS

o Following Congress’s failure to pass legislation before it adjourned, insurance companies approached state insurance regulators for approval to permit exclusions of terrorism risks in commercial insurance policies. o As of January 10, 2002, 47 states (not including New York, Connecticut and California) and two jurisdictions have approved some optional exclusions of terrorism risks in commercial policies. o There are at least two dozen forms of exclusion language being used for property and casualty coverage, but the following forms issued by ISO Properties, Inc. have been generally adopted by the industry.

13 IL 09 41 01 02 POLICY. PLEASE READ IT CAREFULLY.

EXCLUSION OF WAR, MILITARY ACTION AND TERRORISM

This endorsement modifies insurance provided under the following:

BOILER AND MACHINERY COVERAGE PART COMMERCIAL CRIME COVERAGE FORM COMMERCIAL CRIME POLICY COMMERCIAL INLAND MARINE COVERAGE PART COMMERCIAL PROPERTY COVERAGE PART FARM COVERAGE PART GOVERNMENT CRIME COVERAGE FORM GOVERNMENT CRIME POLICY STANDARD PROPERTY POLICY

A. The War And Military Action Exclusion is replaced B. Regardless of the amount of damage and losses, the by the following Exclusion. With respect to any Terrorism Exclusion applies to any incident of terrorism: Coverage Form to which the War And Military Action Exclusion does not apply, that Exclusion is hereby added 1. That involves the use, release or escape of nuclear as follows. materials, or that directly or indirectly results in nuclear reaction or radiation or radioactive WAR AND MILITARY ACTION EXCLUSION contamination; or

We will not pay for loss or damage caused directly or 2. That is carried out by means of the dispersal or indirectly by the following. Such loss or damage is application of pathogenic or poisonous biological or excluded regardless of any other cause or event that chemical materials; or contributes concurrently or in any sequence to the loss. 3. In which pathogenic or poisonous biological or 1. War, including undeclared or civil war; or chemical materials are released, and it appears that one purpose of the terrorism was to release such 2. Warlike action by a military force, including action materials. in hindering or defending against an actual or expected attack, by any government, sovereign or Except as provided in B.1., B.2. or B.3. above, the other authority using military personnel or other Terrorism Exclusion will only apply to an incident of agents; or terrorism in which the total of insured damage to all types of property in the United States, its territories and 3. Insurrection, , revolution, usurped power, or possessions, Puerto Rico and Canada exceeds action taken by governmental authority in hindering $25,000,000. In determining whether the $25,000,000 or defending against any of these. threshold is exceeded, we will include all insured damage sustained by property of all persons and entities With respect to any action that comes within the terms affected by the terrorism and business interruption losses of this exclusion and involves nuclear reaction or sustained by owners or occupants of the damaged radiation, or radioactive contamination, this War And property. For the purpose of this provision, insured Military Action Exclusion supersedes the Nuclear damage means damage that is covered by any insurance Hazard Exclusion. plus damage that would be covered by any insurance but for the application of any terrorism exclusions. Multiple incidents of terrorism which occur within a 72-hour period and appear to be carried out in concert or to have a related purpose or common leadership will be deemed to be one incident.

14 IL 09 41 01 02 © ISO Properties, Inc., 2001 Page 1 of 2

The preceding paragraph describes the threshold used to b. Commission or threat of a dangerous act; or measure the magnitude of an incident of terrorism and the circumstances in which the threshold will apply, for the c. Commission or threat of an act that interferes with purpose of determining whether the Terrorism Exclusion will or disrupts an electronic, communication, apply to that incident. When the Terrorism Exclusion applies information, or mechanical system; and to an incident of terrorism, there is no coverage under the insurance identified in this endorsement. 2. When one or both of the following applies:

In the event of any incident of terrorism that is not subject to a. The effect is to intimidate or coerce a government the Terrorism Exclusion, coverage does not apply to any or the civilian population or any segment thereof, element of loss or damage that is otherwise excluded under or to disrupt any segment of the economy; or the insurance identified in this endorsement. b. It appears that the intent is to intimidate or coerce a TERRORISM EXCLUSION government, or to further political, ideological, religious, social or economic objectives or to We will not pay for loss or damage caused directly or express (or express opposition to) a philosophy or indirectly by terrorism, including action in hindering or ideology. defending against an actual or expected incident of terrorism. Such loss or damage is excluded regardless of any other cause But with respect to any such activity that also comes within the or event that contributes concurrently or in any sequence to terms of the War And Military Action Exclusion, that exclusion the loss. supersedes this Terrorism Exclusion.

Terrorism means activities against persons, organizations or In the event of an incident of terrorism that involves nuclear property of any nature: reaction or radiation, or radioactive contamination, this Terrorism Exclusion supersedes the Nuclear Hazard Exclusion. 1. That involve the following or preparation for the following:

a. Use or threat of force or violence; or

Page 2 of 2 © ISO Properties, Inc., 2001 IL 09 41 01 02

15 COMMERCIAL GENERAL LIABILITY CG 21 69 01 02

THIS ENDORSEMENT CHANGES THE POLICY. PLEASE READ IT CAREFULLY.

WAR OR TERRORISM EXCLUSION

This endorsement modifies insurance provided under the following:

(1) The total of insured damage to all types of COMMERCIAL GENERAL LIABILITY COVERAGE PART property exceeds $25,000,000. In determining whether the $25,000,000 threshold is exceeded, A. Exclusion i. under Paragraph 2., Exclusions of Section 1 we will include all insured damage sustained by - Coverage A - Bodily Injury And Property Damage property of all persons and entities affected by the Liability is replaced by the following: “terrorism” and business interruption losses sustained by owners or occupants of the damaged 2. Exclusions property. For the purpose of this provision, This insurance does not apply to: insured damage means damage that is covered by any insurance plus damage that would be covered i. War Or Terrorism by any insurance but for the application of an terrorism exclusions; or “Bodily Injury” or “property damage” arising, directly or indirectly, out of: (2) Fifty or more persons sustain death or serious physical injury. For the purposes of this (1) War, including undeclared or civil war, or provision, serious physical injury means:

(2) Warlike action by a military force, including (a) Physical injury that involves a substantial risk action in hindering or defending against an of death; or actual or expected attack, by any (b) Protracted and obvious physical government, sovereign or other authority disfigurement; or using military personnel or other agents; or (c) Protracted loss of or impairment of the function of a bodily member or organ; or (3) Insurrection, rebellion, revolution, usurped power, or action taken by governmental (3) The “terrorism” involves the use, release or authority in hindering or defending against escape of nuclear materials, or directly or any of these; or indirectly results in nuclear reaction or radiation or radioactive contamination; or (4) “Terrorism” including any action taken in hindering or defending against an actual or (4) The “terrorism” is carried out by means of the expected incident of “terrorism” dispersal or application of pathogenic or poisonous biological or chemical materials; or regardless of any other cause or event that contributes concurrently or in any sequence to the injury or damage.

However, with respect to “terrorism”, this exclusion only applies if one or more of the following are attributable to an incident of “terrorism”:

16

(5) Pathogenic or poisonous biological or chemical (4) “Terrorism”, including any action taken in materials are released, and it appears that one hindering or defending against an actual or purpose of the “terrorism” was to release such expected incident or “terrorism” materials. regardless of any other cause or event that contributes Paragraphs (1) and (2), immediately preceding, concurrently or in any sequence to the injury. describe the thresholds used to measure the magnitude of an incident of “terrorism” and the However, with respect to “terrorism”, this exclusion circumstances in which the threshold will apply for only applies if one or more of the following are the purpose of determining whether the Terrorism attributable to an incident of “terrorism”: Exclusion will apply to that incident. When the Terrorism Exclusion applies to an incident of (1) The total of insured damage to all types of property “terrorism”, there is no coverage under this exceeds $25,000,000. In determining whether the Coverage Part. $25,000,000 threshold is exceeded, we will include all insured damage sustained by property of all In the event of any incident of “terrorism” that is persons and entities affected by the “terrorism” and not subject to the Terrorism Exclusion, coverage business interruption losses sustained by owners or does not apply to any loss or damage that is occupants of the damaged property. For the otherwise excluded under this Coverage Part. purpose of this provision, insured damage means damage that is covered by any insurance plus Multiple incidents of “terrorism” which occur damage that would be covered by any insurance within a seventy-two hour period and appear to be but for the application of any terrorism exclusions; carried out in concert or to have a related purpose or or common leadership shall be considered to be one incident. (2) Fifty or more persons sustain death or serious physical injury. For the purposes of this provision, B. The following exclusion is added to Paragraph 2, serious physical injury means: Exclusions of Section 1 - Coverage B - Personal And Advertising Injury Liability: (a) Physical injury that involves a substantial risk of death; or 2. Exclusions (b) Protracted and obvious physical disfigurement; This insurance does not apply to: or (c) Protracted loss of or impairment of the function War or Terrorism of a bodily member of organ; or

“Personal and advertising injury” arising, (3) The “terrorism” involves the use, release or escape directly or indirectly, out of: of nuclear materials, or indirectly or indirectly results in nuclear reaction or radiation or (1) War, including undeclared or civil radioactive contamination; or war, or (4) The “terrorism” is carried out by means of the (2) Warlike action by a military force, dispersal or application of pathogenic or poisonous including action in hindering or biological or chemical materials; or defending against an actual or expected attack, by any government, sovereign or other authority using military personnel or other agents; or

(3) Insurrection, rebellion, revolution, usurped power, or action taken by governmental authority in hindering or defending against any of these; or

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(5) Pathogenic or poisonous biological or chemical C. Exclusion h. under Paragraph 2., Exclusions of materials are released, and it appears that one Section 1 - Coverage C - Medical Payments does purpose of the “terrorism” was to release such not apply. materials. D. The following definition is added to the Paragraphs (1) and (2), immediately preceding, describe Definitions Section: the thresholds used to measure the magnitude of an incident of “terrorism” and the circumstances in which “Terrorism” means activities against persons, the threshold will apply for the purpose of determining organizations or property of any nature: whether the Terrorism Exclusion will apply to that incident. When the Terrorism Exclusion applies to an 1. That involve the following or preparation for incident of “terrorism”, there is no coverage under this the following: Coverage Part. a. Use or threat of force or violence; or In the event of any incident of “terrorism” that is not b. Commission or threat of a dangerous act; subject to the Terrorism Exclusion, coverage does not or apply to any loss or damage that is otherwise excluded c. Commission or threat of an act that under this Coverage Part. interferes with or disrupts an electronic, communication, information, or Multiple incidents of “terrorism” which occur within a mechanical system; and seventy-two hour period and appear to be carried out in concert or to have a related purpose or common 2. When one or both of the following applies: leadership shall be considered to be one incident. a. The effect is to intimidate or coerce a government or the civilian population or any segment thereof, or to disrupt any segment of the economy; or b. It appears that the intent is to intimidate or coerce a government, or to further political, ideological, religious, social or economic objectives or to express (or express opposition to) a philosophy or ideology.

18

· The ISO terrorism exclusion establishes a $25 million threshold for insured damage to all types of property (including business interruption losses) in the United States, its territories and possessions, Puerto Rico and Canada.

o This means that limited coverage may be given if the terrorist incident does not result in a total of $25 million of insured losses. o However, there is no coverage whatsoever if the terrorist incident involves the use of nuclear, chemical or biological materials. o “Multiple incidents of terrorism which occur within a 72-hour period and appear to be carried out in concert or to have a related purpose or common leadership will be deemed to be one incident.”

· The ISO terrorism exclusion endorsement for liability coverage provides an additional threshold for serious personal injury to 50 or more persons.

· Even though limited terrorism coverage is available, reinsurers, which are not regulated by states, have refused to provide unlimited terrorist coverage to retail insurance companies. However, new offshore reinsurers are being organized daily and coming into the market. Without prior losses from 9/11 and with high insurance rates for terrorism coverage being attainable, these new reinsurers have kept premiums for terrorism coverage from spiking as high as had been predicted.

· But, where available, terrorism coverage is very expensive, in many cases costing more than a company’s basic commercial coverage. Smaller, lower-profile business may be less affected. (The following examples have been provided by William Mason, Executive Vice President of Operations for the Rutherfoord Cos., a regional insurance broker and risk manager based in Richmond, Virginia).

o A Jewish Community Center in South Florida with $80 million in property and casualty insurance was quoted a $400,000 premium, plus quotes for $5 million of sabotage and terrorism coverage of between $65,000-$100,000 (1.3% of limit). o A preeminent office building in New York City received a quote for $100 million excess of $100 million set limit for $3 million (3% of limit). o A preeminent tower in Chicago received a quote for $1 billion excess of $1 billion set limit for $20 million (2% of limit). o A major international airport in the US is looking for a $200 million primary loss limit and was quoted a rate of $20 million (10% of limit). o And according to The Wall Street Journal (January 4, 2002), Gwinnett County, Georgia’s basic property insurance coverage for its jail, police headquarters, sewer plants and other public buildings climbed to $502,000 from $305,000 for $300 million of coverage, plus an additional $390,000 for $50 million of terrorism insurance (down from $300 million provided for free in 2001).

· As a result of the high premiums, many businesses are choosing to carry no terrorism coverage or low-level coverage, leaving them vulnerable in the event of future attacks.

19 · Even without the events of September 11, insurance premiums were hardening and businesses were expecting increases of at least 30% and in some cases as high as 200%, depending on the types and uses of the properties being insured. After September 11, without terrorism coverage, property insurance premiums have increased 70% to 80% on average. (The Wall Street Journal, January 30, 2002). Virginia’s 220-store Potomac Mills Shopping Center saw its 2002 property and casualty rates double, and the Giant Stadium at the Meadowlands Sports Complex in East Rutherford, New Jersey had its 2002 premiums hiked from $750,000 to $3.5 million, a 500% increase. (Media General News Service, December 17, 2001).

WHAT ARE LENDERS AND LANDLORDS REQUIRING?

· Y2K + 2?

· Terrorism insurance crisis has been replaced by crisis resulting from insurance industry’s unwillingness to issue surety bonds used as guaranties of various obligations in light of Enron and Kmart bankruptcies

· Doomsday scenarios predicted by many in the real estate and insurance industries have not yet come to pass, but …

· Lenders have been very cautious and are studying how they should react to current and prospective borrowers who cannot obtain terrorist coverage or for whom terrorist coverage is prohibitively expensive.

· Lenders are not pulling their financing for borrowers who lack terrorist coverage, as had been predicted. (The Wall Street Journal, January 4, 2002).

· Also, lenders generally have not changed their loan commitments or loan documents to specifically require terrorist coverage, relying instead on broad, catch-all language, such as “… and such other insurance coverage as Lender may require.” (See below for recommended insurance coverages in addition to terrorism coverage.) However, it is likely that lenders will require business interruption coverage to be maintained for longer periods of time.

· However, many lenders have initially required terrorist coverage, and when the borrower balks at the high cost, the difficulty of obtaining such coverage and/or the limitation of coverage (e.g., high deductibles and less coverage), lenders may treat this as an acceptable increased hazard if the borrower is willing to pay additional loan fees. (The Wall Street Journal, January 4, 2002).

· Some lenders have required that borrowers provide a certificate that the borrowers do not employ any persons on a terrorist list.

20 · Still, for “trophy” buildings located in high risk areas, even additional fees may not be enough. (See The Wall Street Journal, January 31, 2002. Billionaire Marvin Davis’ efforts to purchase a long-term lease on a 40-story office tower in New York City for $350 million is reportedly in jeopardy because of his inability to obtain sufficient terrorism insurance.) But, the same article reports that buyers of “trophy” properties in other cities (e.g., Frankfurt and Chicago) have successfully obtained terrorism coverage, some by covering the “trophy” properties under existing umbrella policies, which include terrorism coverage, on the rest of their real estate portfolios.

· Collateralized Mortgage Backed Securities will most likely be affected by the lack of terrorism coverage. Rating agency officials are reportedly working with investment bankers to figure out ways to finance “trophy” properties. One idea under consideration would be to carve large “trophy” loans into pieces that would be added to separate mortgage pools and thereby spread the risk enough so that portions of those pools could get investment-grade ratings. (The Wall Street Journal, January 11, 2002)

· Some landlords are requiring tenants to procure terrorist coverage, “if such coverage is commercially reasonably available,” with “commercially, reasonably available” being defined as where “a majority of similarly situated tenants” in that geographic area have gotten that coverage.

· Landlords are passing increased insurance premiums along to tenants, where possible. Combined with significant increases in costs for security and utilities, occupancy costs have risen and may continue to rise.

· Landlords may be required to absorb these increased costs

o if their leases tie tenants’ pass-through increases to the consumer price index or on increases to the Porter’s wage (the union pay scale for janitorial workers), or o if passing through all of the increases will adversely affect their ability to compete in the marketplace or cause their tenants to go out of business

· It is too early to know what affect this will have on the commercial rental markets.

· Lenders and Landlords are also requiring the study and implementation of increased security measures and new construction methods which might cause buildings to be less vulnerable to terrorist attacks

· Lenders and Landlords are requiring original or certified copies of insurance policies when documents are executed and on renewals, rather than depending on insurance certificates or binders.

· Businesses are being required to seek the services of sophisticated insurance consultants to assist in tailoring insurance needs and in procuring necessary insurance coverage.

21 · Real estate attorneys must review, analyze and draft appropriate loan and lease provisions to protect their clients. Real estate attorneys must be more knowledgeable and familiar with insurance and insurance coverages.

· CAVEAT - Since the insurance coverages are changing all the time and the needs of each insured are different, real estate attorneys are well-advised to require insurance and indemnity provisions to be reviewed by clients’ insurance agents and consultants and risk managers, and for files to be properly documented to evidence that this has been done and that comments have been incorporated.

· HOWEVER, many of the insurance agents, consultants and risk managers will often place the final responsibility on attorneys by responding “This provision is a legal, not an insurance matter” and real estate attorneys will have to be prepared to address these matters.

RECOMMENDED EXTENSIONS OF INSURANCE COVERAGES IN LIGHT OF 9/11

· James E. Branigan, President and CEO of Omega Risk Management LLC in a paper entitled, “Insurance Issues Resulting From The Attack On America - September 11, 2001,” prepared for the City of New York State Bar Association, Real Property Law Section Annual Meeting in New York City, January 24, 2002, recommends the following:

o Business Interruption Caused By Damage from Falling Debris - Buildings directly damaged will likely be covered for physical restoration expense (Replacement Cost) and resulting loss of Business Income/Rental Income until they are restored to a condition that existed prior to the loss. But those properties in the vicinity of Ground Zero not physically damaged and not able to be accessed because of the debris will likely be covered for loss of business with this coverage o Income by Prevention of Ingress and Egress and Act of Civil Authority coverage is found in most property insurance policies. But, this provides coverage up to a certain specified amount for only two weeks. Longer periods and higher sub-limits should be considered. o “Law and Ordinance”, also known as “D&ICC (Demolition and Increased Cost of Construction)”. This endorsement pays for increased construction costs due to the enforcement of a law that requires the building to be reconstructed to a higher standard than existed at the time of loss. (An unendorsed policy will not pay additional costs necessitated by legally imposed requirements needed to comply with more stringent building codes, e.g., ADA and sprinkler fire codes.) o Debris Removal - Most commercial property policies cover the expense of removing debris of covered property that is damaged by a covered loss. But, many policies contain a sub-limit for such coverage equal to 10% of the building replacement cost. Once the 10% limit is used up, the additional removal costs are

22 deducted from the available replacement cost insurance, which may result in a shortfall. Consider procuring an endorsement to increase this sub-limit. o Utility Interruption/Service Interruption Insurance - Consider adding an endorsement to the property policy to cover an interruption of utility service caused by a peril insured in the policy. This pays the resulting loss of income and the increased cost of continuing business by using other resources. o Also, Extra Expense coverage will make funds available to pay additional costs incurred to continue operations at another location. o Contingent Business Interruption - This endorsement to the Business Interruption coverage pays a loss arising from damage which prevents the insured from doing business because of a loss at a supplier or customer location. Service providers rarely purchase this type of coverage for losses due to decreased patronage; but nevertheless it should be explored. o Business and Rental Interruption Insurance - This endorsement provides coverage for lost net profit and continuing fixed expenses during the period from the insured occurrence until restored. o Extended Period of Indemnity - When the reconstruction is completed, the Business and Rental Interruption coverage ceases. Because most tenants of the building will have relocated following the occurrence, an Extended Period of Indemnity endorsement provides coverage after the property is restored and until the building is once again leased and occupied. This coverage is purchased in 30- day increments, usually for a 180 or 360-day indemnity period, although longer periods are available. o Self insurance and higher deductibles are becoming more prevalent.

#1029505.1

23 WHEN THE INSURED LOSS ISN’T

Almost immediately after September 11, the insurance industry began to quantify the potential loss. At the same time, the insurance industry began a two-pronged approach to make certain the industry is not be faced with losses on a similar scale in the future. The first prong was to seek federal legislation to have the United States government assume the role as the re- insurer of last resort. The second prong was to eliminate future exposure for terrorism by eliminating coverage for losses arising from terrorist acts. To date, the insurance industry has not been successful in its first endeavor. Congress adjourned at the end of 2001 without providing any legislative relief and there is no immediate prospect of legislation on the federal level. The second strategy has been more successful, however, since insurance companies have more control over the coverage afforded by their policies than the legislative process. As indicated above, endorsements have been prepared and approved by most states that exclude losses arising from terrorist acts. Anecdotal reports in the press indicate that insurance companies and re-insurers have added terrorism exclusions. As the existing policies expire and are replaced with new polices that exclude losses arising from terrorism, the insurance industry successfully reduces its exposure to future terrorist events. A Changing Market Place The change in the insurance market place has caused some disruptions. The cost of all insurance policies has increased. There are reports that lack of coverage for terrorist acts has impeded the completion of some transactions.1 From this anecdotal evidence, it is not clear that there have been difficulties in completing transactions outside of the New York City area or that do not involved very large, “trophy” properties. At a minimum, the discussion about terrorist coverage in the press guarantees that the issue receives more scrutiny in transactions. From informal inquiries of lenders, it appears that the requirement for terrorist coverage is something that is under study. Participants in transactions do not seem to have an absolute requirement for terrorist coverage and deals seem to be proceeding on a deal by deal basis. This situation if very similar to earthquake coverage, and it is possible that terrorist coverage will evolve in a similar fashion – participants in real estate transaction will assess the risks on a property-specific basis and then make a decision as to whether coverage against terrorist acts is required. That was the result in a recent transaction in which the lender had the following language included in the loan documents relating to insurance to be provided by the borrower: . . . and (ix) Borrower shall use commercially reasonable efforts, consistent with those of prudent owners of commercial real estate to maintain insurance against damage resulting from acts of terrorism, or an insurance policy without a

1 According to a February 4, 2002, report by BestWire Services, a news service published by A.M. Best Company, Inc., Deborah Beck, executive vice-president of the Real Estate Board of New York, in a speech gave several instances of transactions delayed as a result of problems with insurance coverage for terrorist acts. These included a 1 million-square-foot office building on the east side of midtown Manhattan that could not obtain sufficient coverage to satisfy a lender’s requirements, and the coverage that was available was quoted at $1 million to $1.5 million per year in premium cost; an acquisition of a $500 million midtown Manhattan building in trouble because the purchaser was unable to obtain more than $50 million to $100 million in commercial property coverage; and a refinance of a building in New Jersey that failed because the owner could not obtain more than $75 million of terrorist coverage, which was deemed inadequate by the lender. The report indicated that terrorist coverage was available from AIG, with a $150 million cap and a premium of 5% of value, and from Berkshire Hathaway with a $300 million cap and a premium of 2% of value.

24 terrorism exclusion, on terms consistent with the commercial property insurance policy required under subsection (i) above; provided, however, if such terrorism insurance is obtainable from any insurer or the United States of America or any agency or instrumentality thereof and the lack of such insurance in and of itself will result in a downgrade by any Rating Agency issuing any statistical rating in any secondary market transaction to the then current ratings assigned, or to be assigned, to the Securities or any class thereof in any applicable Securitization, Borrower shall obtain such insurance; and . . . 2

It is not possible to predict that this will be the standard approach followed in real estate lending transactions. The demands of the marketplace will depend upon the market-participants’ perception of risk. If terrorist events occur with a frequency experienced in Britain during the height of Irish Republican Army activity, it is difficult to conceive of market-participants willing to undertake significant transactions without the benefit of terrorist insurance coverage. If, on the other hand, participants in the market perceive that terrorist events will not occur more frequently than significant natural disasters, such as hurricanes or earthquakes, then the market might well adjust to limited coverage based upon an underwriting assessment of the probability of loss. Existing Relationships At the risk of oversimplification, the effect of the availability, or lack, of insurance coverage for new transactions is straightforward – participants in deals will either demand coverage or they won’t; if coverage is demanded, it must be provided or the deal will not get done. All the other discussion is just an allocation of the cost among the various participants in the marketplace – owners, tenants, buyers, sellers and lenders. A more interesting set of issues arises in the context of existing relationships. It is one thing to choose not to go forward with a purchase or loan based on the fact that insurance is not available to protect against an act of terrorism. It is an entirely different situation to be committed to a long-term loan or lease relationship that was entered into when the risk of a loss by terrorism was covered by insurance, and now find that the risk is not covered. At one level, transaction documents are nothing but elaborate risk allocation mechanisms. If every contractual obligation were performed according to its terms, and events transpired in the exact manner in which the contracting parties contemplated, there would be little need for elaborate agreements. Transaction documents allocate the risk that parties fail to perform and the risk that events will not occur as planned. Within the latter category of risks, are events such as the damage or destruction of the property that is leased, or which is the collateral for a loan; the inability to use the property; and injury to persons occurring on the property. The occurrence of these types of events is not planned in advance, but the parties to a transaction know that they might happen and the risk associated by these events is allocated in the transaction documents. Until September 11, the reasonable contemplation of parties to a loan or lease transaction was that loss arising from an act of terrorism was covered by property damage and commercial liability insurance. The risk of loss arising from a terrorist act may not have been specifically allocated in the documents under a heading entitled “Losses Arising from Terrorism,” but the

2 This language was provided by David S. Gordon, Reed Smith LLP, Princeton, New Jersey, and was used in a “securitized deal where the security is a suburban shopping center. Lender is a major investment banking entity and counsel is a prestigious NY law firm.”

25 parties did in fact allocate that risk in the transaction documents in the context of the expectation that insurance to cover the risk was available and would be obtained. After September 11, there is uncertainty whether insurance will be available to cover losses caused by terrorism. Unfortunately, the risk allocations in the transactional documents based on the assumption of availability of insurance will remain. It is reasonable to expect that when a loss arises from an event that was presumed to be insurable, but is actually uninsured, the party that was allocated the risk will seek to avoid, or minimize liability. Loan Document Issues At first blush, most loan documents are relatively straightforward in allocating risk of loss that might arise from terrorist act. As between the lender and borrower, the borrower bears the risk of damage to the property and any liability asserted by persons injured as a result of the terrorist act. Below is a typical provision included in documents in a loan intended to be part of a securitized pool of commercial mortgages: Restoration If the Property shall be damaged, destroyed or rendered unusable, in whole or in part, by fire or other casualty or become in need of repair or restoration because of any condemnation or similar proceeding, Borrower shall give prompt notice of such event to Lender and, subject to the following sentence, shall promptly commence and diligently prosecute the completion of the repair and restoration of the Property as nearly as possible to the condition the Property was in immediately prior to such casualty or condemnation (the “Restoration”), with such alterations as may be approved by Lender and otherwise in accordance with this Security Instrument. Borrower shall pay all costs of such Restoration whether or not such costs are covered by insurance proceeds or condemnation awards, except to the extent, but only to the extant, that Lender elects to apply the condemnation award or Net Proceeds, as the case may be, to reduce the Debt in accordance with the provisions of this Security Instrument. Indemnity Borrower shall, at its sole cost and expense, protect, defend, indemnify, release and hold harmless the Indemnified Parties from and against any and all claims, suits, liabilities (including, without limitation, strict liabilities), actions, proceedings, obligations, debts, damages, losses, costs, expenses, diminutions in value, fines, penalties, charges, fees, expenses, judgments, awards, amounts paid in settlement, punitive damages, foreseeable and unforeseeable consequential damages, of whatever kind or nature (including, without limitation, attorneys’ fees and other costs of defense) (collectively, “Losses”) imposed upon or incurred by or asserted against any Indemnified Parties and directly or indirectly arising out of or in any way relating to any one or more of the following: (a) ownership of this Security Instrument, the Property or any interest therein or receipt of any Rents; . . (d) any accident, injury to or death of persons or loss of or damage to property occurring in, on or about the Property or any part thereof or on the adjoining sidewalks, curbs, adjacent property or adjacent parking areas, streets or ways; (e) any use, nonuse or condition in, on or about the Property or any part thereof or on the adjoining sidewalks, curbs, adjacent property or adjacent parking areas, streets or ways; . . .

26 These provisions place the risk of loss on the borrower. From a practical standpoint, who suffers the risk of loss becomes less clear in the context of a non-recourse loan made to a special purpose, single asset, entity. If the sole asset of a single-asset entity is destroyed, the ability of the lender to enforce the obligation to rebuild is somewhat problematical. Non-recourse loans contain “carve-out” provisions that impose personal liability on the borrower for certain types of events. Consider the effect of the following language contained in a note used in non-recourse loan in the context of an uninsured terrorist loss: Notwithstanding the foregoing provisions of this paragraph [non-recourse language] or any other agreement, the undersigned shall be fully and personally liable for any and all: (1) liabilities, costs, losses, damages, expenses or claims (including without limitation, any reduction in the value of the Property or any other items, property or amounts which are collateral or security for the Loan) suffered or incurred by the holder hereof by reason of or in connection with . . . (e) any failure to maintain, repair or restore the Property in accordance with any Loan Document, to the extent not covered by insurance proceeds made available to the holder hereof; . . .

If only the single-purpose, single-asset borrower, is obligated under the “carve-out” provisions, a loss arising from an uninsured terrorist act will still incurred by the lender to the extent of its loan and the borrower to the extent of its equity in the property. If, however, a financially responsible party guarantees the “carve-outs,” the lender has successfully allocated the risk of uninsured terrorist losses to the borrower. “Carve-out” provisions vary from lender to lender. Not every non-recourse loan contains a “carve-out” for uninsured losses. If the universe of uninsured losses expands by terrorist exclusions from coverage, and lenders continue to provide non-recourse loans to single-asset entities, then lenders (and investors in CMBS pools) might well consider reviewing the carve-out provisions to make certain that the risk of loss of an uninsured event is allocated to a financially responsible party. As new insurance policies are issued with a terrorist exclusion, lenders will be faced with an enforcement issue arising from insurance covenants in existing loan documents. Below is an example of an insurance provision of an existing deed of trust granted in a securitized loan: (a) Borrower shall obtain and maintain, or cause to be maintained, insurance for Borrower and the Property providing at least the following coverages:

(1) Insurance against loss or damage by fire, casualty and other hazards as now are or subsequently may be covered by an “all risk” policy or a policy covering “special” causes of loss, with such endorsements as Lender may from time to time reasonably require and which are customarily required by institutional lenders of similar properties similarly situated, including, without limitation, building ordinance and law, lightning, windstorm, civil commotion, hail, riot, strike, water damage, sprinkler leakage, collapse, malicious mischief, explosion, smoke, aircraft, vehicles, vandalism, falling objects and weights of snow, ice or sleet, and covering the Improvements and Personal Property in an amount equal to one hundred percent (100%) of the full insurable

27 replacement value of the Improvements and Personal Property (exclusive of footings and foundations below the lowest basement floor) without deduction for depreciation.

. . . (8) Such other insurance coverages, in such amounts, and such other forms and endorsements, as may from time to lime be required by Lender and which are customarily required by institutional lenders to similar properties, similarly situated, including, without limitation, coverages against other insurable hazards (including, by way of example only, earthquake, sinkhole and mine subsidence), which at the time are commonly insured against and generally available. [Emphasis added] This provision falls somewhat short of an absolute requirement that the borrower maintain coverage against terrorist acts irrespective of the cost. The provision may or may not enable the lender to insist that the borrower maintain insurance policies that include losses from terrorist activities. If coverage for terrorist acts is not available, there is some question what remedy is really available to the lender. If the insurance is not available, there is some question whether the lender really benefits from declaring a default and foreclosing on the property. Arguably, by declaring a default, the lender ends up owning a property that is still uninsured for terrorist acts, so the lender’s risk has not changed, but now the lender must manage the property. A lender might conclude that declaring a default and charging a default rate of interest, but not pursuing a foreclosure, is the appropriate remedy for the increased risk incurred by the lender as a result of the absence of terrorist coverage. In the future, lenders may choose to specifically refer to the risk of loss from terrorism in the insurance clauses of their loan documents to avoid any argument whether the insurance is required. Reference to terrorist coverage should also be included in loan commitments issued by lenders if the lender intends to insist upon the coverage as a condition of loan funding. Leasing Issues The allocation of the risk of loss in a lease transaction is generally more complex than in a loan. Several sections of the lease have to be read together to obtain an accurate picture of relationship between the landlord and the tenant. These provisions include: 1. The provisions dealing with the requirement to maintain insurance;

2. The provisions relating to the requirement to repair following a damage or destruction of the premises;

3. The provisions dealing with rent abatement;

4. The indemnity provisions;

5. The provisions dealing with waiver of claims and waiver of subrogation rights; and

6. The provisions dealing with the condition of the premises upon termination of the lease.

28 These provisions should be coordinated to allocate risk of loss between the landlord and the tenant. Often, these clauses seek to allocate the risk of loss to an insurance company and then allocate the responsibility to maintain insurance to either the landlord or the tenant. An obvious problem arises if a risk that both the landlord and the tenant assumed would be covered by insurance becomes uninsurable. For example, the landlord and tenant agree that the landlord will rebuild the premises in the event of a damage or destruction. The tenant bargains for the landlord to rebuild the premises in the event the premises are damaged or destroyed. The landlord and tenant then allocate that risk to an insurance company; the landlord is obligated to maintain property insurance, but the landlord’s obligation to rebuild is limited to the proceeds of the insurance policy. The lease contains the following provisions: Landlord’s Insurance. Landlord shall obtain and maintain throughout the Term a policy or policies of fire and extended coverage with extended coverage endorsement in amounts and issued by companies as Landlord may from time to time reasonably deem appropriate, which shall insure the Building and all Improvements installed within the Premises against loss or damage from the perils covered in those policies. . . . In the event the Building and/or the Premises is damaged by fire or other perils Landlord shall: (i) In the event of total destruction, at Landlord’s option, as soon as reasonably possible thereafter, commence repair, reconstruction and restoration of the Building and/or the Premises and prosecute the same diligently to completion. . . . If damage is due to any cause other than fire or other peril covered by extended coverage insurance, Landlord may elect to terminate this Lease. To the extent that the tenant bargained for the reconstruction of the premises following a damage or destruction, these provisions create the risk to the tenant that a rebuilding will not occur if terrorist acts are not covered by insurance. In hindsight, the parties might have allocated this risk differently had they known that acts of terrorism would not be covered by insurance. On the other hand, landlords that agree to rebuild destroyed premises without limitations tied to insurance proceeds have increased exposure from uninsured terrorist damage. At the time the lease was negotiated, the landlord probably did not realize that it was retaining the risk of terrorist loss. In effect, the landlord has self-insured this risk. The potential liability to the tenant will vary depending upon the other terms of the lease. If the lease contains an exculpatory clause for the benefit of the landlord, the retention of the risk may not create a significant exposure to the landlord.3

Below is an indemnity provision from an existing office lease. This indemnity if coupled with a waiver clause that eliminates claims for property damage to the extent covered by property insurance maintained by the landlord, is not as broad in the scope of its liability as it appears.

3 The measure of damages for failure to obtain a policy of insurance is discussed at 64 ALR3rd 398 (1976).

29 Tenant, hereby agrees to defend, indemnify, and hold harmless Landlord against any and all claims, costs, and liabilities, including reasonable attorneys’ fees and costs (including costs and fees associated with any lawsuit or appeal), arising by reason of any injury or claim of injury to person or property, of any nature and howsoever caused, arising out of the use, occupation and control of the Premises, or from any breach of the terms of this Lease, or any violation of any governmental or insurance requirements by Tenant, its sublessees, assignees, invitees, agents, employees, contractors, or licensees, except to the extent as may arise out of the negligent act of Landlord or Landlord’s agents, employees or contractors.

If, however, the property damage coverage of the landlord does not insure against terrorist acts, and the tenant’s commercial general liability policy also excludes terrorism, the potential liability of the tenant under the indemnity has been expanded. This is particularly true if persons posing as the tenant’s customers initiate the terrorist event in the tenant’s premises. The failure by the landlord or the tenant to maintain required insurance is a default under the terms of the lease. The inability to obtain required insurance is probably not excused by the fact that the insurance is either unavailable or very expensive.4 If a party to a lease has agreed to provide insurance coverage, that party has assumed the risk that the policy might become unavailable or very expensive. Although not directly related to the allocation of risk, the increased cost of procuring terrorism insurance, the increase cost of insurance premiums in general and the increased security costs incurred by building owners since September 11 must be paid by someone. Landlords that have the ability to pass along increased operating costs can recover the increased operating costs from the tenant. In those instances in which the tenant has bargained for a limit on the amount of annual increase in operating expenses or the landlord does not have the ability to fully recover increased operating costs, the costs of increased risks of terrorism will be paid by the Landlord. The ability to change the terms of existing leases to address the problems created by a lack of insurance for terrorism is limited. The perception of the potential liability for the landlord and tenant will depend upon the overall perception of risk of continued losses as the result of terrorism. In the future, however, both landlords and the tenants may be more sensitive to the possibility of the lack of insurance coverage for risks that are currently insurable. In that case, it is likely that both parties will increasingly seek to limit their risk to those items that are actually covered by policies generally available in the marketplace, rather than undertaking the responsibility to cover specific risks or agree to open ended indemnities that extend beyond the scope of insurance that is available.

4 See Kel Krim Corp. v. Central Mkts, Inc., 70 N.Y.2d 900, 524 N.Y.S.2d 384, 519 N.E.2d 295 (1987) and Home Design Center-Joint Venture v. County Appliances, Inc., 563 So.2d 767 (Fla. App. 1990).

30