February 2012

Leases: Damage and Destruction Clause

Violent storms, floods and tornadoes in recent months caused widespread damage and destruction to buildings around the nation. It is likely that many lessees read – perhaps for the first time – the damage and destruction (D&D) clause in their leases. Because it is not a “money” clause and deals with a contingency that is often not anticipated, the D&D clause simply may be copied from a standard form (or more likely) be part of the lessor’s printed form. This could turn out to be a serious mistake if the clause fails to reflect the particular circumstances of the parties.

The function of the D&D clause is to allocate the burden of loss in a manner acceptable to both parties. It is true that insurance coverage is available for all or most types of catastrophes, but even here the D&D clause plays an important role in determining which party will be responsible for obtaining and paying for the insurance.  Furthermore, insurance often is an incomplete remedy, and each party must weigh the risks it assumes in the event damage or destruction does occur.

Drafting the Clause
A D&D clause always should be included in a lease. In drafting the clause, the parties should be sure to coordinate it with related lease clauses—notably, the insurance clause and the repair/maintenance clause. As a general rule, the insurance clause should track the D&D clause. For example, after the clause allocates the repair or restoration obligations between lessor and lessee, the insurance provisions should require each party to carry sufficient insurance to perform its obligations. Similarly, if the D&D clause entitles the lessee to rent abatement in the event of damage or destruction, the lessor should obtain rent insurance (possibly requiring the lessee pay for the insurance as additional rent). On the other hand, if the lessee is not entitled to rent abatement, it is the lessee that should carry the insurance. With regard to the repair/maintenance clause, the parties usually do not intend that it be applicable when damage or destruction occurs because in that event, the provisions of the D&D clause are applicable. If this indeed is the intention of the parties, it should be specified.

The four major issues to be decided when parties are negotiating the D&D clause are:

• The definition of “damage and destruction"
• Obligation to restore
• Abatement of rent
• Lease termination

Definition of Damage and Destruction
Most leases make no attempt to define the term “damage and destruction,” except to the extent of saying “by fire or other casualty” or “by fire, explosion, earthquake, windstorm, flood, casualty or other cause.” Until recent
years, such a general definition was sufficient since damage and destruction were always thought of in terms of physical damage. With the advent of environmental concerns, however, it is not always clear whether environmental contamination fails within the term damage and destruction. For example, in New York City, a building became unusable because a utility’s steam pipe exploded and spewed asbestos throughout the building. A more subtle example of contamination is that involving indoor air quality that may make it difficult if not impossible to occupy the building.

Because of the difficulty of adequately defining the various causes that may trigger the provisions of the D&D clause, a better approach is to indicate when the clause becomes operative in terms of the consequences to the lessee. Examples of such language include:

• “When lessee cannot conduct normal business at the leased premises”
• “There is a material interference with the lessee’s business operation in the leased premises”
• “When the building is rendered unfit for use or occupancy”
• “When the premises are rendered substantially or wholly un-tenantable”

All of these phrases establish a standard that, while not self-evident, is capable of being determined by an impartial outsider, such as a mutually agreed-on building engineer.

This article was written by David Tevlin and originally appeared in BDO USA, LLP's "Real Estate Monitor" newsletter (Winter 2012). Copyright 2012 BDO USA, LLP. All rights reserved. www.bdo.com. Somerset is a member of the BDO Seidman Alliance, a nationwide association of independently owned accounting and consulting firms.