Insurance, Broker's Letters and Due Diligence - A battle of the forms?
Insurance is always a critical piece of a commercial real estate finance (REF) transaction, after all, most deals are limited recourse (the properties usually being owned by special purpose entities with no other assets), and understandably, the lenders are in trouble if the assets are destroyed, damaged, or other events occur that could affect value or the income stream.
This blog has been co-authored with the help of Sarah Roberts a President of Intech Risk Management GmbH and Corey Tidey a Risk Analyst of Intech Risk Management GmbH.
We have taken into account in this blog that fact that today, 10th February 2016, the Loan Market Association (LMA) released a template form of Insurance Broker Letter for use in real estate finance transactions.
The Security Agent, as agent and security trustee on behalf of the lenders, will want to ensure that the interests of the lenders are adequately protected via the Insurance Conditions precedent (CP’s) in the Facility Agreement (FA). Please note, where we use lender in this blog (for brevity), it applies to all finance parties.
Some examples of protection are:
- Naming the Security Agent as Composite Insured or Co-insured and First or sole loss payee on the policy giving it same legal rights as the borrower without the liability to be responsible for premiums;
- Adding a Waiver of Subrogation to protect the Security Agent;
- Non-Vitiation and Non-invalidation clauses to ensure non-disclosure by one of the insureds does not vitiate the insurance cover;
- Notice of Cancellation given to the Security Agent to ensure they are aware of any non-payment of premiums by the borrower.
The LMA template real estate finance facility agreements contain a model clause, designed to protect the interests of the lenders in respect of the issues mentioned above. The LMA insurance clause is long established now, and rarely heavily negotiated, once it has been adapted to suit the particular factual circumstances of a given transaction. This non-exhaustive list demonstrates what can be included in the insurance policies of a borrower to ensure the lender’s interests are protected.
The insurance clause in the FA is of course one way of protecting the interests of the lenders. But it is usual not to rely simply on that covenant in the FA, but to carry out due diligence to ensure that the insurance policies do, in practice, comply with the terms of the FA.
There are two principal ways of carrying out such due diligence.
- Requiring an insurance broker's letter; or
- Dealing direct with the insurance company providing the insurances to obtain the comfort required.
Brokers Letter
This is a letter from the borrower’s insurance broker confirming the borrower has put in place insurance which complies with the terms of the FA. It may outline the policies in place, confirm premiums are paid and up-to-date and that the insurance is usual for a company carrying on the same business as the borrower.
However, negotiating the specific wording of the undertakings to be given by the broker often takes some time and can hold up transactions. Usually, the broker letter will contain language which gives no reliance to the lender and no mention the requested endorsements have been included.
The LMA form of Insurance Broker's letter has been prepared to try and address some of the matters above. In line with market practice to date, we are expecting law firms and lenders to adopt this quickly as their template, albeit some lenders will require their own specific amendments or alterations.
What remains to be seen, is to what extent the insurance broker's will negotiate the letter. What is certain, is that the insurance broker's legal teams will have their own views on the letter.
Specifically:
- If a broker is asked to give a positive confirmation on the details of the insurance cover, limitations and exclusions, this will involve due diligence by the broker itself.
- The terms of engagement of the broker and its attitude to risk will determine whether it is prepared to give a confirmation that the risks insured are "as we would advise and recommend to a prudent company or other persons in the same business as the [borrower] to insure".
- Whether the insurance broker's will require their own standard clauses and carve outs to the LMA template.
This blog deliberately does not go into detail on the insurance law issues the broker's letter is designed to protect against. The LMA template comes with a useful guidance note and we would be happy to take any technical questions on request.
Dealing direct with the insurance company
This creates an additional burden on the lender (or its consultant) to review the terms and conditions of the relevant insurances and, if necessary, require amendments or endorsements.
Policy Endorsements
These are additional insurance forms that are attached to the original insurance policy and modify it in some way, in this case to specifically add the Security Agent endorsements. A signed endorsement from the Insurer ensures that the particular FA requirements are now material to the policy and have been accepted by the leading Insurer. This provides reliance to any lender that its best interests have been protected and that the insurance CP’s in the FA are satisfied. Evidence the endorsements have been met can be a safer option for the acting broker as the reliance falls back on the placing insurer who holds the policy thus, providing an even stronger case to the benefits of this type of compliance.
An Insurance Consultants role
Independent Insurance Consultants (IIC) are well versed in the particulars of insurance policies and contracts and are used as intermediaries by lenders to negotiate and draft FA insurance language and liaise directly with the borrower/broker. Furthermore, lenders should be aware that borrowers may have existing policies in place which they are committed to until expiry. Utilisation of an IIC can help ensure existing policies held by the borrower are amended to suit the requirements. Reputable IIC’s will have no affiliations with Insurers or Brokers and will usually work on a fee for service basis.
The way forward?
There do seem to be two clear paths:
- The insurance broker's letter, with the help of the new LMA template, and the inevitable discussions/negotiations with the broker;
- Due diligence on the insurance policies, and requesting specific amendments/endorsements to the policies, either by the lender direct, or with the help of an IIC.
Our friends at Intech will argue that lenders who want to ensure Insurance CP’s are satisfied in a comprehensive and timely manner are best advised to procure an IIC. They are best placed to negotiate the insurance minefield, and ensure lenders interests are always protected. IIC’s know the value of requesting Policy endorsements over broker letters to complete insurance transactions and therefore the lenders can rest assure their particular interests are agreed to and the Insurance CP’s are always in compliance at time of financial close.
Other lenders, particularly the specialist real estate banks and funds, may decide that they have the requisite resource and expertise in house.
Like most aspects of REF, the way to go will depend on risk allocation, resourcing, and time management - and the key point is actually a simple one - deal with insurance as early as possible in a transaction, and ensure the right people are talking to each other as soon as possible to ensure an efficient solution.