Matter of Precaution
Question: An owner carelessly started a fire in his unit that caused extensive damage to common areas. The association’s master policy will cover the repair costs, but the claim will almost certainly affect our premium. The board, of which I’m a member, thinks our insurance company should seek compensation from the owner who caused the damage. Our view: Let the owner’s insurance company pay the claim and let the owner pay any premium penalty on his insurance, instead of putting that financial burden on the whole community. We think this makes sense, but our insurance company rejected the idea. Can you explain why?
Answer: The one-word answer is, “subrogation.” Condominium documents require a “waiver of subrogation” in the association’s master policy. This means the insurer agrees not to pursue specified third parties (typically other owners, trustees and the manager) to recover payments for a master policy claim. Secondary market rules established by Fannie Mae and Freddie Mac require this provision to reduce default risks on the mortgages they purchase. Their concern, Stephen Marcus, a partner in Marcus, Errico, Emmer & Brooks, LLC, explains, is that if the association’s insurer successfully sued a borrower to recover a large damage claim, the borrower might not be able to meet other financial obligations – specifically, his/her mortgage payments.
Marcus says he understands the board’s position: “You have every right to be angry with the owner who caused the damage. But you can’t change the policy language.” Under the terms of the subrogation waiver, “the insurer can’t chase the owner.”
HO6 and Tenant Policy Waivers
The subrogation language Fannie and Freddie require protects lenders, Marcus notes. It is equally important, he says, for condominium associations to require subrogation waivers in the HO6 policies owners obtain to insure their units. Without this waiver, he explains, an HO6 insurer could pay an owner’s damage claim and then turn around and sue the association or sue its trustees and manager individually, asserting that they are responsible for causing the damage or were somehow negligent for not preventing it. As an additional precaution, he suggests, the waiver language should require owners “to defend the association, its trustees and its manager against any effort by the owner’s HO6 carrier to pursue subrogation against them.”
Marcus advises associations to instruct owners who rent their units to require subrogation waivers in tenant insurance policies for the same reason – to prevent the tenant’s insurer from subrogating against the association, its board or its manager.
What happens if tenants or owners fail to obtain a subrogation waiver, even though the condo documents require it? Marcus thinks the association could sue the owner for failing to obtain – or make sure a tenant obtained - the required coverage. But he also thinks “there’s a strong argument to be made” that the insurer had “constructive notice” of the subrogation waiver requirement, even if the owner or tenant didn’t request it. Condominium documents are public records, he points out, and the insurer or the insurance agent should review them to verify the association’s requirements before issuing a policy. Because the documents provide notice of the subrogation waiver requirement, he contends, insurers arguably should be bound by it, even if the policy doesn’t include it.