Thomas Smith, Smith Buss & Jacobs

Ask any insurance broker what kind of claim occurs most frequently in co-ops and condos, and they will tell you leaks. While they would seem simple enough, sometimes these claims turn out to be anything but. You’ve got two clients with leak problems that illustrate this. Can you tell us about them?
 
One is a leak that emanated from an upstairs apartment where negligence of a contractor hired by the shareholder resulted in flooding that damaged several floors below. That scenario doesn't involve plumbing leaks that are the responsibility of the cooperative, but the cooperative unfortunately got inserted into the middle of the dispute, which happens very regularly in these kinds of cases. In most cases, if the proprietary lease and other policies require shareholders to have co-op apartment insurance, the owner of the apartment that was damaged can file a claim with their own carrier. The carrier will then take whatever action is appropriate to collect from the insurer of the apartment from which the flood came. However, there are times when, for whatever reason, either one of the shareholders does not have insurance or the insurance company disclaims coverage for some reason, which creates the kind of problem that we're confronting in this case.
    So for the shareholder whose apartment was damaged, the basic question is: What are the cooperative’s responsibilities? Most boards prefer to simply refer the shareholder who suffered the damage to the shareholder who caused it and let them solve it themselves, because it was the negligence of the shareholder and not the negligence of the cooperative that caused the problem. But in this particular case, for reasons that are not clear, the upstairs shareholder's insurance company has gone nine months and refused to adjust the claim. So the shareholder downstairs is saying to the cooperative, "Look, it's your tenant shareholder upstairs who created this problem. The fact that they are not rising to the occasion is not our problem. You're responsible as the co-op to repair my apartment, including all my personal property, and take whatever legal action is necessary against the shareholder upstairs. If they have insurance to cover them, good for them; but if they don't have insurance to cover them, that's not my problem."
 
Seems very logical to me.
 
It does seem logical. What complicates it further is that we've had the building's insurance adjuster come in, and unfortunately in this particular case it's not covered by the building's insurance policy, which is important. Most policies that cooperatives maintain will cover hazards. And so, if there was a burst pipe that was not the result of some contractor's negligence or a shareholder's negligence, then that would be covered under the cooperative's hazard insurance policy. But, clearly this was not a burst pipe and therefore it's not covered. So, there is no insurance for the cooperative to rely on to pay for these repairs and restorations. And, in this particular case, the shareholder has, in the cooperative’s view, an extraordinary opinion about the value of the improvements that were performed by them previously in the apartment. That renders it very difficult in this case for the cooperative to agree to go ahead and do the repairs and replacements, and then take recourse against the upstairs shareholder.
    But the important thing that I have found, much to my surprise, is how many boards and shareholders don't really understand the interaction between the kinds of coverage that cooperatives have and shareholders have, who the primary insurer is, and who is first required to step up and perform repairs and then seek reimbursement from other insurance companies or insured parties. So, this is an example of a case that really has all of those confusing aspects of insurance coverage involved.
 
I would imagine most boards, like most individuals, are perplexed by insurance. But what can a board do? I guess they can try to figure and understand it and maybe give a one-page memo to every resident that says, "Here's how it works: you get leaked on because somebody's tub overflowed or a pipe burst, and XYZ would happen." Is this what you need to do?
 
I think that's a very good idea. And we have done that for some clients who have asked us for that kind of outline. Also, the insurance broker that might be working with the cooperative usually gives that kind of guidance when requested. I think that's the kind of roadmap that would be really helpful to boards, who could then disseminate it or post it to shareholders to avoid confusion.
 
And without doing that, I assume that boards and shareholders will stay perpetually muddled.
 
Yes, to a degree. Obviously, the ideal thing is to avoid having everybody lawyer up, because then it gets even more confusing.
 
Are there other circumstances involving leaks where there is a lot of confusion?
 
Our other case is one that doesn't involve a shareholder's or contractor’s negligence. Under the typical proprietary lease, the lessor, meaning the apartment corporation, has an obligation to maintain the building as a first-class building. You have many buildings now that are 40, 50, 60 years old, which have aging risers, and are finding with increasing frequency that there are leaks from those risers. In many cases, they are insured because it's determined to be a burst-pipe incident, and therefore it's covered by the cooperative’s hazard insurance policy.

That creates secondary issues, though. Although the insurance company will restore the base building standard, the proprietary lease provides that the cooperative is not responsible for any improvements. So, in the hazard situation where a burst pipe is the cause of the damage, the building’s insurance company, subject to whatever deductible applies, will make the base building repairs and the shareholder would have to go to their own cooperative policy to cover the improvements. And unfortunately, if they don't have adequate insurance, nobody is negligent in that case. Generally speaking, they therefore have no recourse against anybody else, and have to fund any shortfall in terms of replacing their personal property or doing repairs to improvements from their own pocket.
 
I've also heard that in buildings where there are a lot of pipe leaks, the cost of the corporation's insurance policy increases.
 
Yes, for each claim. There is a claim history and that would be a factor in the premiums that the cooperative will be required to pay in the future. Further, where there is a long claim history of those kinds of riser-related leaks, we're finding with increasing frequency that insurance companies are either charging very substantial premiums or excluding redefining what constitutes a hazard to eliminate the kind of deferred maintenance and repair situation.
    That's also relevant in another case where a particular shareholder had experienced three prior floods as a result of riser leaks of the nature that we're describing, because it was an older system. After the second one, they were unable to obtain cooperative apartment owners’ insurance anymore because of the clear history of claims in this building. So, when the fourth leak occurred, the cooperative's insurance carrier still treated it as a hazard, but only paid for the base building repairs, subject to the $10,000 deductible. But this shareholder had spent hundreds of thousands of dollars doing improvements. And so, they had to fund over $150,000 of repairs and replacements as a result of the fourth incident.
    Their position now is that the cooperative has an obligation to maintain the building as a first class building, and where it becomes aware of a condition in the risers that causes these repetitive leak situations, the cooperative is in breach of the lease for failing to maintain the building. Continuing to Band-Aid riser leaks and not taking the steps necessary to avoid them in the future is a breach of the cooperative’s obligations under the lease.
 
Is that interpretation widespread?
 
I think it’s growing. And, I would say that based on the research we've done in that case, a court could find there's no black-and-white definition. In fact, under most leases, commercial or otherwise, courts have consistently held that the lessor is responsible for making the repairs, but the tenant can't dictate the ways and means by which those repairs are made. And so, if the cooperative moves in and does the riser repair to stop that leak, then under that legal theory, it has met its obligations. But there are cases we've seen where courts have held that that kind of repeated incident tilts past the point where it's just a reasonable decision on how to make the repair, and something more significant should be done as a result.
 
So I guess for boards, because riser repairs are expensive and disruptive and a very big deal, this comes down to a financial decision, an insurance decision and, I guess, somewhat of a legal decision.
 
And all of those involve financial aspects. It's not only the cost of the repairs and maintenance, it's the time that lawyers get drawn into the disputes. It's the claim history, which results in increased insurance premiums. And so, at a certain point, boards have to evaluate what the debt service would be on the loan necessary to fund the riser repair, versus the ongoing combination of those kinds of costs altogether. And more importantly, they have to evaluate the quality of life for individuals who have to live with concern that they're going to be the victim of the next flood.