The French Fry Story Redux
Holy cow, it’s the “French Fry Story!” we both remarked as we read the paradigm-shifting Court of Appeal decision in Royal Host GP Inc. v 1842259 Ontario Ltd.
There’s a backstory to this. Nearly two decades ago, the senior author of this article decided that it would be cool to make french fries at home using a large, open vat of cooking oil — old school! Fast forward an hour or so, and the junior author of this article, for whom the french fries were intended, asked her father why the french fries were on fire! Needless to say, the Lem family quickly discovered the dangers of open-vat deep-frying, and how fire insurance actually works.
Here’s where the law of insurance come to play. It was obvious that the senior author was negligent in not shutting off the heat source even after those golden fries had been plated and served. As the fire fighters glibly said after the fire was extinguished, “the house didn’t burn itself down!” Fire insurance pays for the fire damage, even if it is clear that the insured had contributed to his or her loss by negligence (the same is not true in the case of deliberate arson, but, luckily for these authors, that was not the case with the Lem family french fry fire).
Think about it, why do businesses take out insurance? It is really to indemnify against the risk of accidents, including accidents that may have been caused by, yes, negligence. Fire insurance covers loss against accidental fires, even those accidental fires started by the negligence of the insured. Much to the relief of the Lem family that fateful afternoon two decades ago, the insurance company does not pay for the fire damage only to then turn around and sue the homeowner for negligent french frying.
Now, think about the typical commercial lease. In almost all commercial tenancies, the landlord takes out the fire insurance, and each of the tenants contribute to the cost of the premiums in a shared ratio (typically proportionate share based on area, but the formulas all vary slightly). This is both common and common sense. Having each tenant insure the entire building would be a ridiculous multiple insurance of essentially the same overall risk (imagine your local regional shopping centre or mega-office tower with dozens of tenants each having to insure a building worth hundreds of millions of dollars). It makes total commercial sense for the landlord, as owner, to take out the fire insurance and for each of the tenants to then contribute proportionately to the premiums.
Now, apply the french fry scenario to a typical commercial tenancy. Imagine, for instance, fire damage to the whole building caused by the negligence of one tenant (a not uncommon scenario). The tenant, having regularly contributed proportionately to the fire insurance premiums as part of its annual additional rent payments, might think that it, like the Lem family, would be immune from being sued by the insurance company, even if its negligence is shown to have been the cause of fire damage.
Not necessarily so, said the Ontario Court of Appeal in the recent Royal Host fire case. According to the Court of Appeal, the actual insured was the landlord (not the tenant), and once the insurance company had properly paid out the landlord for the fire damage, the insurance company was free then sue anybody who might have negligently started the fire — in particular, the negligent tenant. Pretty much the same facts as the Lem french fire story (i.e. occupant negligently burns down building), but totally different legal results where the tenant was not the legal insured party and merely a proportionate share contributor to the fire insurance policy premiums.
This case turns on its head decades of common understanding in the commercial leasing world about the relationship between the tenant and the insurance company. Since the mid-1970s, there was thought to have been a “general rule,” based on a trilogy of Supreme Court of Canada cases, which stipulates that the tenant gets the benefit of insurance taken out in this manner as if the tenant was the legal insured. In other words, for the past 40 years or so, it has been generally understood in the industry that, if the landlord takes out the insurance, and the tenants collectively pay for the premiums, then, for all intents and purposes, the tenants become the insured and can’t be sued by the insurance company for fire damage, even if the tenants negligently caused the fire.
This is no longer the law. More accurately, this was probably never really the law. According to the Court of Appeal in Royal Host, there has never really been a “general rule” regarding this kind of insurance scheme. Instead, tenant liability has always depended on the exact details in the lease. If the lease expressly says that the tenant cannot be liable at the hands of the insurance company, then the tenant gets the benefit of the Lem french fry story. If the lease does not provide that necessary exculpatory wording, then the tenant might still be liable for fire damage that it causes, even though it has paid its fair share of the premiums all along.
For those in the commercial leasing space, that means that more lawyers will be spending more time on the insurance and liability sections of commercial leases (oh joy!). The paradigm of the past 40 years or so has just been shattered, and, just to be safe, the Lem family now bakes its french fries!