Intention, adaptation and annexation

Rough Notes, Apr 2003 by Utschig, LeRoy H

Although improvements and betterments is a very common exposure, many agents do not fully understand the implications for the building owner or the tenant.

Although improvements and betterments is a very common exposure, many agents do not fully understand the implications for the building owner or the tenant. A key concern is determining whether the landlord or the tenant is responsible for covering improvements and betterments. Another important consideration is the contract wording. An insurance contract will pay a decreasing amount for improvements and betterments. There is no one answer that fits all situations. In this article, my intention is to aid you in understanding all of the possible scenarios.

Bath Boutique, LLC (Bath), was going to be the first tenant in a space located in Mall, Inc.'s, brand new shopping mall. When Bath first moved in, it occupied a large room with nothing in it. Bath put in such items as electrical wiring and fixtures, a complete ceiling, wall coverings and floor covering. All of these items were attached to the building and owned by Mall. Bath's $500,000 worth of material and labor was now a part of Mall's building.

A fire damaged Bath's area, as well as several stores on both sides of its space. Bath's items permanently attached to the building were totally destroyed. There was no provision in the lease specifying whether the building owner or the tenant was to replace the damaged improvements and betterments. When Bath approached Mall regarding the replacement of all of the items that had been installed by Bath, Mall replied that it did not plan on replacing any of those items.

Mall's owner protested when he received a coinsurance penalty for all of the value tenants had put into the building, saying that he would not be replacing any of those building items. The insurer replied that those items were part of the building and would be considered when calculating Mall's coinsurance penalty. Mall's building insurance automatically covered the improvements and betterments installed by all of the tenants. Had the owner not wanted to insure those values, he could have added an endorsement to specifically exclude all of the improvements and betterments.

Bath's policy also automatically insured improvements and betterments. However, when it put in a claim for those improvements and betterments, the claim was turned down because Bath had already used up its full limit of insurance. Bath should have added the values for stock, furniture, fixtures, and improvements and betterments when considering the amount of insurance it purchased.

What constitutes improvements and betterments?

Many times there are questions regarding whether or not items installed by a tenant are furniture and fixtures (which belong to the tenant) or whether they have become a part of the real estate. Rules, laws and court decisions come into play to resolve these issues. Different decisions will be made in different states. Instead of discussing a few specific instances, we will provide some overall rules or guidelines that have applied for more than 40 years. These points will not answer every question. But, they will act as working guidelines, which can aid an insured in presenting a claim.

One "rule" can be answered by the question: Can the tenant remove the item without damaging the building? Bath had installed wall coverings and flooring that were attached to the structure. Only by damaging the building could these items be removed. Hence, they were considered part of the real estate. They were improvements and betterments from Bath's standpoint.

Intention is another factor to consider. Did Bath plan on taking these items when its lease expired? As the items were all permanently fastened to the building and could not be removed without damaging the structure, the most common answer is that Bath did not plan to take them. This is another indication that Bath had installed improvements and betterments.

Annexation is another concept to consider. Do the items installed by Bath fit in with the overall building? The answer is yes. Everything installed by Bath fit into the overall mall. There was nothing that would cause anyone to state that the improvements and betterments were an eyesore or did not fit in with the overall purpose of the mall. Thus, those items would be considered part of the real estate and owned by Mall. This is another indication that Bath had installed improvements and betterments.

Adaptation is another concept to consider. Essentially, this addresses the issue of whether the items installed by the tenant fit into the overall real estate pattern.

The terms intention, annexation and adaptation are typically always used together. You probably noticed that there was not much difference in the explanations given for the three words. Using just one of the three words can lead to misunderstanding. When the three words are used together, there is much less chance for someone to get an incorrect idea. Hence, the three words are used even though the meaning of any one of them is enough to give an acceptable idea to many people.