The Espresso Machine Fire: Subrogation, Insurable Interest, and Indemnity
Larry owns a four-unit apartment building in Bangor insured under a commercial property policy on a replacement cost basis (building RC $600,000; ACV $420,000) with a $5,000 deductible. His lease with tenant Tina requires her to carry $300,000 of liability insurance and contains this clause: "Landlord and Tenant each waive all rights of recovery against the other for loss by fire, regardless of cause." Last month a cord on Tina's espresso machine ignited a fire causing $150,000 of building damage. Larry's carrier paid the claim and now demands reimbursement from Tina. Tina's carrier has refused and pointed to the lease. Larry has decided not to rebuild - he will sell the vacant lot.
1. Can Larry's insurer recover the $150,000 from Tina? Walk through the competing considerations and identify what you would verify before answering the insured.
Read the worked answer
Start with the nature of subrogation. Subrogation is derivative: after paying a loss, the insurer steps into the insured's shoes and acquires only the rights Larry himself had against the party who caused the loss. It cannot create rights Larry contractually gave away.
Apply it. The lease is a mutual, pre-loss waiver covering fire "regardless of cause" - including Tina's negligence. Larry therefore had no claim against Tina when the fire occurred, so his insurer acquired none. The demand should be withdrawn.
But verify two things before committing:
- The policy's subrogation condition. Many commercial property forms permit the insured to waive recovery rights in writing before a loss; others require the insurer's written consent first. If Larry's form requires consent and he never obtained it, the insurer may have a contractual argument against Larry (not against Tina) - but it cannot manufacture a claim against a party Larry released.
- Scope of the waiver. Confirm it is truly mutual and covers the tenant's negligence, not merely losses Larry causes. A one-way waiver favoring only the landlord leaves the insurer free to pursue Tina.
Practical point: the carrier's remedy is prospective - underwriting the risk with a known waiver and pricing or endorsing accordingly. Tina's $300,000 liability policy, required by the lease, would otherwise have responded to Larry's claim.
2. Identify each party's insurable interest and what each policy should cover if the building is repaired.
Read the worked answer
Insurable interest is measured at the time of loss and is limited to the economic loss the party would actually suffer.
| Party | Interest | Proper coverage |
|---|---|---|
| Larry (owner) | Entire structure; he bears the loss of the building itself | Commercial property, building, replacement cost $600,000 |
| Tina (tenant) | Her business personal property - espresso machine, furniture, inventory - and any improvements she installed | BPP limit plus, if the lease obligates her to restore improvements, an improvements-and-betterments limit |
| Tina (as occupant) | Third-party claims from customers or visitors | $300,000 liability, as the lease requires (contractual liability may also be triggered by an indemnity clause) |
Two traps the exam likes:
- A tenant has no insurable interest in the landlord's building merely because the lease requires her to return the premises in good condition - she insures improvements and betterments, not the shell.
- The indemnity principle prevents double recovery. Larry cannot collect the full RC from his insurer and the sale proceeds for a building he never replaced; his recovery is capped by his actual loss.
3. Ignoring the subrogation question entirely, how much should Larry's insurer pay if he does not rebuild?
Read the worked answer
Replacement cost coverage is a two-step payment. The policy pays actual cash value at the time of loss, then holds back the depreciation until the insured actually repairs or replaces, within the policy's time limit (commonly 180 days to two years).
Computing it:
- Building ACV: $420,000
- Less deductible: $5,000
- Initial payment: $415,000
- Depreciation held back: $600,000 − $420,000 = $180,000, recoverable only if he rebuilds within the deadline
Reasoning: RC coverage exists to make the insured whole, not to create a profit. Selling a vacant lot means Larry suffers the depreciated value of a building he chose not to replace. Advise him in writing of the deadline - insureds frequently sell the lot months later and then claim they intended to rebuild.
If the loss had exceeded the $600,000 limit, the limit caps the payment; the deductible is then applied against that limit per the policy's loss payment clause.