Protective Safeguards Endorsements to Property Insurance Policies May Pose Unanticipated Risks for Landlords, Tenants and Others

One would expect a building equipped with an automatic sprinkler system, central station fire alarm system or other high-tech fire detection or suppression system to be less likely to suffer severe fire damage than a building that lacked such systems. It also stands to reason that properties with such systems should qualify for a break on their property insurance premiums. But what happens if there is a fire and the system fails to function as intended?

For the unwary property owner—or tenant—the result can be disastrous: denial of insurance coverage as a result of what might seem to be a relatively innocuous mistake. In one prominent case, for example, an insurer successfully denied coverage because the owner of an industrial building had capped fewer than 20 of 600 sprinkler heads. Another insured was denied coverage for failing to maintain a contract with a duct cleaning service. For those who purchase property insurance, the lesson is clear: Know what the policy says, and adhere to its requirements pertaining to automatic sprinklers and other protective systems.

Duties of Insureds Under a Protective Safeguards Endorsement

In many states, a premium discount or credit may be given—or otherwise uninsurable property may qualify for insurance—if the property insurance policy includes a "protective safeguards endorsement" (ISO Form IL 04 15 04 98 or the local equivalent). This endorsement calls for a description of the particular type of protective safeguard devices or services that are installed in or applicable to each property covered by the policy. A protective safeguard may be in the form of a service contract with, for example, a security company or private fire department, or it may consist of or be supplemented by a mechanical or electronic system.

After identifying particular protective safeguards, the endorsement form states: "As a condition of this insurance, you [the insured] are required to maintain the protective devices or services listed in [this endorsement]." This point is emphasized with additional language in the endorsement:

"We will not pay for loss or damage caused by or resulting from fire if, prior to the fire, you:

"1. Knew of any suspension or impairment in any protective safeguard listed in [this endorsement] and failed to notify us of that fact; or

"2. Failed to maintain any protective safeguard listed in [this endorsement], and over which you had control, in complete working order."

In other words, each insured under the property insurance policy has at least two additional duties if the policy includes a protective safeguards endorsement: the duty to notify the insurer if the insured learns of any "suspension or impairment" of any device or service listed in the endorsement, and the duty to "maintain…in complete working order" any device or service that is listed in the endorsement and over which the insured has control.

Failure to Comply With Provisions

If the language of the endorsement is read literally, there is (with one exception mentioned below) no leeway for any delay in notifying the insurer once the insured becomes aware of any suspension or impairment, nor is it sufficient to use reasonable—or even extraordinary—efforts to maintain devices or services if in fact they fail due to a maintenance shortcoming.

Some failures to comply with policy provisions affect coverage only to the extent the insurer's rights are prejudiced by the insured's noncompliance. But based on the language of the endorsement, failure by an insured to perform these duties can be a basis for the insurer to deny all coverage for a loss by fire—whether or not the loss was caused or exacerbated by that failure.

Case Law Examples

Reported cases include a number of situations where insurers successfully denied coverage based on the insured's noncompliance with protective safeguards endorsement provisions:

• In Burmac Metal Finishing Co. v. West Bend Mutual Insurance Co., an Illinois appellate court said in 2005 that a property owner's intentional capping of between three and 19 automatic sprinkler system heads out of 600 in an industrial building, without notice to the insurer, constituted failure to maintain the system and justified a denial of coverage for a fire and explosion.

• In Goldstein v. Fidelity & Guaranty Insurance Underwriters, the Seventh U.S. Circuit Court of Appeals ruled in 1996 that although an insurer was obligated to pay for fire loss that occurred during a period when the protective safeguards endorsement had been waived due to an error by the insurer's agent, the insurer was justified in denying coverage for subsequent loss due to the owner's failure to restore a nonfunctioning sprinkler system, as required by the endorsement.

• A California appeals court said, in a 2006 case known as Y2K Textile, Inc. v. Lexington Insurance Co., that the insurer had properly denied coverage for fire loss where the protective safeguards endorsement required the insured to maintain a contract with a duct cleaning service and the insured never obtained such a contract.

Partial Safe Harbor

Subsequent language in the protective safeguards endorsement form provides a partial safe harbor: "If part of an Automatic Sprinkler System is shut off due to breakage, leakage, freezing conditions or opening of sprinkler heads, notification to us will not be necessary if you can restore full protection within 48 hours." Significantly, however, this safe harbor applies only to sprinkler systems, not to any other kind of device or service, and only if "part of" the system, rather than the entire system, is affected. And, it applies only to the notification requirement, not to the duty to maintain all devices and services in complete working order.

Practical Considerations

What is a property owner to do with this information? Although a brief article cannot offer advice that is sound in all circumstances and all jurisdictions, here are some practical considerations:

Identify and understand applicable endorsements. Property owners (and this term is used to include tenants whose leases give them equivalent risks and obligations) should make sure they know whether the applicable insurance policy includes a protective safeguards endorsement. If it does, they should also be sure they have an accurate understanding of what is required by the terms of the endorsement. A Missouri case, Insurance Corporation of Hannover v. Vantage Property Management, involved a hotel owner who did not understand the requirement for an automatic fire alarm that was "connected to a central station" and "report[ed] to a public or private fire alarm station." After prolonged litigation, the owner ultimately overcame the insurer's denial of coverage for a fire loss because those terms were not defined in the endorsement and were not generally understood by people outside the fire alarm industry. Without further definition, the court found, the owner reasonably believed its central alarm panel in the basement was a "central station," although the insurer argued that "central station" meant an off-site monitoring facility.


Weigh savings against risk. If the existing property insurance policy includes a protective safeguards endorsement, the party responsible for obtaining or maintaining that policy should investigate the premium savings provided by that endorsement. Affected parties should weigh the savings against the potential risk that a claim for fire loss may be denied if the particular safeguards do not function properly. Doing without the endorsement, of course, is not an option if prospective insurers are unwilling to insure a property without protective safeguards.


Be prepared to give required notices promptly. Insureds under property insurance policies with protective safeguards endorsements should review the notice provisions of their policies to determine how and to what address notices are to be given. Insureds should make sure this information is communicated to those with operational responsibility for each insured property so notice can be given, when appropriate, without delay.


Be clear about notification and maintenance responsibility. Landlords should be sure their leases—and property management agreements—are clear as to which party is responsible for the notification and maintenance duties described above. In some instances, especially in single-tenant buildings, the landlord may reasonably insist that the tenant take responsibility for maintaining systems, devices and contracts. The landlord may not want the tenant to give unapproved notices to the insurer, given the impact any notice may have on property insurance premiums.


Keep detailed maintenance records. Anyone with contractual or practical responsibility for maintaining systems, devices and contracts should keep detailed records of the nature, timing and results of maintenance activities. As noted earlier, it is not clear that maintenance efforts will be sufficient to satisfy requirements of a protective safeguards endorsement if a maintenance failure on a single, critical occasion leads to a failure of a system or device, but an insured is clearly on stronger ground if it can show a consistent pattern of maintenance.


Consider how listed systems might become impaired. Recalling that "impairment" as well as "suspension" of a device or service may require notice to the insurer, any party with an interest in the availability of fire insurance coverage should consider how, as a practical matter, each listed system, device or service might be impaired, and how non-impairment may be demonstrated. These practical considerations may require consultation with system vendors, independent engineers or contractors or other third parties.


Review criteria for permitting alterations. Landlords should think carefully about their criteria and procedures for granting consent to proposed tenant alterations. They should also consider whether it is appropriate for leases to permit any tenant to make alterations that are merely characterized as "nonstructural" or in some other nonspecific manner. Even where the tenant is given broad discretion to make alterations, it may be appropriate for the landlord to require some kind of expert certification that the alterations will not "impair" any facilities listed in a protective safeguards endorsement.


Avoid indemnification risks. Tenants should also consider how they would be able to demonstrate that a seemingly permitted alteration did not impair such facilities, because most leases—even those that grant the tenant broad freedom to make alterations—prohibit the tenant from doing anything that would affect, or increase the cost of, property insurance coverage. An alteration that impaired the functioning of a listed system or device might therefore be a breach of the lease and expose the tenant to serious liability under a typical indemnification clause.


Watch for analogous requirements. This article has focused on protective safeguards endorsements as they affect fire insurance coverage. Protective safeguards endorsements are sometimes issued with respect to risks other than fire, including burglary, theft and damage to construction work in progress. Those endorsements contain similar language and may present similar risks to insureds. They deserve similar thoughtful attention.

Conclusion

Anyone with concerns relating to insurance issues may wish to consult a risk management consultant or an attorney with substantial expertise in the specific kind of coverage involved. While insurance agents are often good sources of practical, front-line suggestions, they generally have no authority to waive or modify policy provisions. For this reason, any assurance that a policy provision or endorsement doesn't mean what it appears to say should be confirmed in writing with the insurer.