If the improvements can be used for the agreed period of time, all should be well. The tenant has received that for which he bargained; but suppose the improvements are damaged by fire or some other insurable peril before the lease expires. The tenant has lost no property. The improvements belong to the landlord. What the tenant has lost is the use of the property, and it is the right of use for the term of the lease that creates the tenant's insurable interest in the improvements. Or, put another way, it is the possible loss of use of the improvements in which the tenant has invested that represents the tenant's exposure.

Topics Covered: Methods of treating improvements and betterments exposure

What are "improvements and betterments"?

Trade fixtures

Rules and agreements

Methods for determining recovery

Basis of recovery

Options to purchase

Insurable interest of sublessee

Methods of Treating Improvements and Betterments Exposure

 Improvements and betterments insurance is the vehicle through which the tenant transfers the exposure to the insurance company. An alternative risk management technique is to transfer the risk to the landlord. As said, once the improvements are made, they become the property of the landlord. The landlord must either increase the amount of building insurance to account for the added value or have the insurance on the building endorsed to exclude the additional value stemming from the improvements. If the landlord does neither, the amount of building insurance may not be adequate to meet the requirements of the coinsurance clause (see Coinsurance), which is probably a feature of the policy covering the building.

 Thus, when negotiating the matter of improvements the tenant should seek to arrange for the landlord to assume responsibility for improvements along with their ownership. If the tenant can be assured that the building owner will replace the improvements should they be damaged or destroyed during term of the lease, the tenant has no need for improvements and betterments insurance. The tenant's assurance might come by way of a specific agreement with the landlord or by way of having the landlord's insurance on the building amended to cover the interest of the tenant in the improvements. The tenant's attorney is the proper source for counsel on this point.

 Even if the tenant has purchased improvements and betterments insurance or is covered under the landlord's building policy, the tenant may still need leasehold interest insurance. Leasehold interest coverage (see Leasehold Interest Coverage) protects the tenant against the termination of a favorable lease by fire or other peril. That exposure is often broader and farther reaching than the loss of an investment in improvements and betterments.

 Suppose, for example, that the lease between a tenant and landlord provides that the contract is broken if the building is damaged in excess of 50 percent of its value. Suppose, further, that such an event happens, but with minimal damage to the improvements installed by the tenant. The landlord may negotiate for higher rents or even tell the tenant to move on, but the improvements and betterments insurance provides very little recovery for the tenant. Improvements and betterments insurance does not respond to the higher rent if the tenant decides to stay; if the tenant vacates, the improvements and betterments recovery is limited to a portion of the original cost of the damaged or destroyed improvements which, in this example, has been negligible.

 What Are "Improvements and Betterments"?

 The term "improvements and betterments" is one of elasticity and implies a substantial alteration, addition, or change to real property that enhances its value. The coverage form itself, CP 00 10 06 07, defines improvements and betterments as fixtures, alterations, installations, or additions that are made a part of the building that is occupied but not owned by the named insured, and that the named insured acquires or makes at his expense but cannot legally remove.

 The improvements and betterments insuring agreement is found in the business personal property section of CP 00 10, the building and personal property coverage form. Coverage is automatic if the insured has an improvements and betterments exposure since business personal property is said to consist of, among other things, the named insured's "use interest" as tenant in improvements and betterments. As is noted later, automatic coverage in a form calls for caution when coinsurance is a consideration.

 The definition of "improvements and betterments" is broad and generalized. Questions can and do arise as to whether, under given circumstances, particular work paid for by the tenant falls within its meaning.

 For example, do repairs made on a permanent part of the building by the tenant constitute improvements and betterments? The answer seems to be no. Modern Music Shop v. Concordia Fire Ins. Co., 226 N.Y.S. 630 (1927) provides a guide though it involved an older form that referred simply to "the insured's interest in improvements and betterments." The court said: "These words imply and mean a substantial or fairly substantial alteration, addition, or change to the premises used and occupied by the insured, rising above and beyond and amounting to something more than a simple or minor repair."

 In another case, U.S. Fire Ins. Co. v. Martin, 282 S.E.2d 2 (Va. 1981), the Virginia Supreme Court decided that air conditioners that the insured tenant had repaired but not installed were not within the meaning of "improvements and betterments." The court reasoned that the tenant had not made the original expenditures for the air conditioners, that the expenditures were not later acquired by the tenant, and the expenses put out by the tenant were for repair only; therefore, there was no coverage under the terms of the policy.

 The present definition and the court decisions in these two cases imply that an improvement must substantially change the building. A minor maintenance or repair task, such as painting the building or installing new locks on doors is not an improvement in the insurance meaning of the word. Tenants often agree to maintain the building or to undertake repairs or do these things voluntarily because the landlord refuses to do so. Such expense should probably be considered additional rent rather than an investment in improvements.

 Trade Fixtures

 An important distinction is that between improvements and trade fixtures. The latter are installed by the tenant, often in such a way that they become a part of the building, but—either by express provision in the lease or by established custom—they are taken away by the vacating tenant; trade fixtures retain the character of personal property. Taking a store as an example, a new front installed by the tenant is an improvement, but counters, no matter how firmly they are attached to the building, are usually trade fixtures. Machinery and other apparatus, even though heavy and cumbersome, are usually also in this class. If a tenant has any doubt as to the status of certain equipment—whether it can be removed or if it must stay—the tenant should be advised to consult an attorney since the lease between the tenant and the landlord governs the rights and duties of both parties. Trade fixtures generally are legally subject to removal by their owner and, as such, are not considered a subject of improvements and betterments insurance.

 As discussed in a federal Second Circuit appeals court decision that applied New York law, C-Suzanne Beauty Salon, Ltd. v. General Ins. Co., 574 F.2d 106 (1978), if an insured can only prove that fixtures were added at his own expense, they will be treated as improvements and betterments and not as trade fixtures. In order to recover for trade fixtures (valued at actual cash value), insureds must also show that they had the legal right to remove the fixtures. When items are treated as improvements and betterments, the insured will receive a more limited recovery than actual cash value if the fixtures are not repaired or replaced promptly, as discussed later.

 However, the court in Lumbermens Mutual Ins. Co. v. Cantex Mfg. Co., 262 F.2d 63 (5th Cir. 1958) (applying Georgia law) held that a fire policy covered certain property installed by the insured as improvements and betterments, even if the insured had the right to remove them at the end of the lease term. The insured leased a building for use as a corduroy factory and had installed boilers, water coolers, lint removal and ventilation systems which were destroyed in a fire. Apparently, the policy limits applicable to trade fixtures were exhausted, and the only way that the insured could recover for the installations was if they were found to be "improvements and betterments." The insured's lease agreement provided that the tenant could "remove all machinery, machinery and equipment installed…in said building, other than equipment or improvements which have become a part of the basic building structure." The insured's declarations page apparently showed a separate limit for "improvements and betterments," although the printed portion of the policy itself did not use this term. Finding that the insured could recover for these items under its improvements and betterments coverage, the court held that "the insured's right to remove property is irrelevant where, as here, the property has been annexed to the realty in a substantial way, even though it may not have been made an integral part of the realty or otherwise lost its identity."

 The policy did not contain explicit provisions relating to the definition and treatment of "improvements and betterments," leaving open this avenue of reasoning. This may account for the difference between the Lumbermens case and the ruling in C-Suzanne. The Second Circuit Court of Appeals was careful to point out the explicit provisions in the policy that pertained to "improvements and betterments" (including the definition that appears in the current standard policy) and the fact that the provisions were adhered to in reaching the decision. So, it appears that where a policy contains specific provisions concerning the coverage of improvements and betterments, the terms of the policy will be followed.

Obviously, whenever the status of trade fixtures is in doubt, the better course is to secure the agreement of all parties at the outset as to their classification as "improvements to the building" or "tenant's contents" and insure them accordingly.

 Rules and Agreements

 Improvements and betterments coverage is written to protect a tenant's use interest in improvements and betterments that may be destroyed by a covered cause of loss. The building owner obviously also has an interest in the improvements since they become a part of the building. The value of the improvements should be added to the amount of insurance covering the building since failure to do so could result in a coinsurance deficiency.  It is not permissible to write improvements and betterments coverage in the names of the building owner and the tenant jointly. If joint coverage is desired, it must be written as building insurance, with division of cost or proceeds of a loss payment being a matter of private agreement between the building owner and the tenant. Improvements and betterments may be excluded from the building coverage of CP 00 10 by use of the additional property not covered endorsement, CP 14 20 11 91.

 With reference to coinsurance, the current property coverage form covers improvements and betterments automatically as business personal property whenever a tenant has an interest in such. Improvements and betterments values, consequently, must be taken into account when considering the amount of business personal property insurance necessary for coinsurance purposes.

 Finally, improvements and betterments may be written as a separate policy, a separate item, or as part of an item also covering personal property under a blanket amount.

 Methods for Determining Recovery

 CP 00 10 spells out three methods for determining recovery when the improvements are damaged or destroyed by an insured peril.

 (1) If the improvements are restored at the expense of the insured (not by the landlord), recovery is the actual cash value of the damaged improvements, just as though the insured owned them. Repairs must be made promptly.

 At least one court has held that the amount recoverable by the tenant for improvements is reduced by any amount that the tenant is reimbursed by the owner for the cost of the improvements. In Atlanta Eye Care, Inc. v. Aetna Casualty and Surety Co., 364 S.E.2d 634 (Ga. App. 1988), the insured was covered under a businessowners policy for improvements and betterments. The insured made improvements costing $19,015.55 to the leased property. The lease agreement, however, provided that the owner would reimburse the tenant $8,000, and this was done. After the property suffered a loss, the insurer paid all but $8,000 of the tenant's claim for improvements and betterments. Ruling in the insurer's favor, the court found that the coverage was correctly limited to those improvements for which the tenant had not been reimbursed.

 (2) If the improvements are restored at the expense of others (usually the landlord) for the use of the insured, there is no recovery. In this situation, the insured has suffered no loss and consequently should not recover anything. Where the insured has suffered temporary loss of business because of the damage to the improvements, the loss should be covered by business income coverage.

 (3) If the improvements are not repaired or replaced promptly, the insured (tenant) recovers a proportion of the original cost of the damaged improvements. The insurer determines the proportionate value by multiplying the original cost of the improvements by the number of days from the loss or damage to the expiration of the lease. Then, this amount is divided by the number of days from the installation of improvements to the expiration of the lease. Also, if the insured's lease contains a renewal option, the expiration of the renewal option period will replace the expiration of the lease in determining the amount recoverable. The lease option provision does not require that the tenant give notice to the owner, either verbally or in writing, of an intent to exercise the option. However, if the insured has an option to purchase, his insurable interest in improvements and betterments is still bound by the unexpired term of the lease. Once the option to purchase is exercised, the improvements and betterments are transformed into building property in which the insured has an absolute interest, not merely a use interest.

 The third situation is the one which most often presents difficulties. If neither the insured nor the landlord repairs or replaces the improvements promptly (and there is no definition of the word "promptly"), recovery is based on what is generally referred to as the "unamortized" portion of the investment. However, where the insured owns the damaged property, the insured has an interest in the full value of the property which cannot be diminished merely because portions of the property were tenant-occupied at the time of loss. Foley v. Manufacturers' & Builders' Fire Ins. Co. of New York, 46 N.E. 318 (1987) and Conway v. Farmers Home Mut. Ins. Co., 31 Cal.Rptr.2d 883 (1994).The simplest example of recovery under this situation is a tenant who has invested $10,000 in improvements at the beginning of a ten year lease. In effect, the tenant has bought the use of these improvements for ten years for $10,000. If they are destroyed at the end of five years, the tenant has lost half of the investment. If they are not replaced, the third provision sets up the machinery for recovery of that lost half. Of course, when this third provision takes effect is open to question due to the lack of a time schedule. Does "promptly" mean sixty days, ninety days, 180 days, or depend on the particular circumstances surrounding the loss and its aftermath?

 Basis of Recovery

 The basis of recovery, when the damaged improvements are not repaired or replaced promptly, is the original cost of the improvements—the amount the tenant had invested. Depreciation makes no difference. Neither does it matter whether those improvements would cost more or less to replace at the time of loss than they actually cost to install. Actual cost of installation is the insured's investment—and that investment is what is lost—wholly or partially—if the improvements are destroyed and not restored promptly.

Suppose an insured spent $10,000 on improvements at the beginning of November 2009, under a lease running to the end of 2023. At the beginning of February 2011, the improvements are destroyed and not replaced at all.

 Under the formula for recovery of the loss in CP 00 10, the $10,000 is multiplied by 155 months since that is the amount of time from the loss to the expiration of the lease.  The resulting amount, $1,550,000, is divided by 170 or the amount of time from the installation of the improvements to the expiration of the lease. The answer is $9,117.65.

 The original cost may be greater than the actual cash value of the improvements. If the insured is compelled to tear out a portion of the building in making the alterations or improvements, the original investment is the cost of the improvements plus the amount expended getting ready for them. For example, assume that the insured (tenant) spent $10,000 for improvements. But before these improvements could be made it was necessary to spend an additional $4,000 to remove the building front and inside wall. The total investment in improvements is $14,000, not $10,000. Should the improvements be totally destroyed and the tenant replace them (improbable in case of a total loss) it obviously would not be necessary to redo the demolition work. Hence, this cost would be ignored and the insured's recovery, assuming adequate insurance, would be the actual cash value of the improvements—replacement cost less depreciation, which might be more or less than $10,000. On the other hand, if the improvements were not replaced, the insured's recovery would be based on the total original cost—$14,000, the cost of the demolition work plus the original cost of the improvements.

 In case a loss occurs under a month-to-month lease, recovery is still based on the provisions as set forth in the form. However, the tenant has very little enforceable time of tenancy. If the improvements are replaced, the insured will recover their actual cash value, just as if under a lease with a long time to run. But if they are not replaced the tenant will recover very little, since the fraction arrived at by the procedure for the third situation will reflect only a small portion of the cost of the improvements.

 Such was the situation presented to the New Hampshire Supreme Court in Magulas v. Travelers Ins. Co., 327 A.2d 608 (N.H. 1974). The insured had a two-year verbal lease, but he knew that as a tenant-at-will his legally enforceable tenancy was limited to thirty days. The owner had told him that the building, which he leased to use as a restaurant, might be demolished, but that it would not be demolished for at least two years. The insured relied on the likelihood of staying in the building for two years and made improvements of $20,000. Two months after the restaurant opened, it suffered a fire loss and the owner refused to rebuild. The insurer argued that the insured's interest in the improvements and betterments was limited to his legally enforceable right to have thirty days' notice before tenancy could be terminated. The court found that the insured's insurable interest in the improvements and betterments was not so limited, stating: "[The insured] expected to use the improvements for two years and should recover on the basis of that expectation despite the fact that his legally enforceable rental term was limited to thirty days."

 Options to Purchase

 As stated earlier, an option to purchase does not increase the amount recoverable for improvements or betterments. This view was adopted in Vendriesco v. Aetna Casualty and Surety Co., 414 N.Y.S. 2d 64 (1979). The case involved an insured who operated a motel and restaurant under a lease running from September 3, 1975, to September 30, 1976, with an option to purchase if the option was exercised in writing prior to the expiration date of the lease. During the term of the lease the insureds made improvements in the sum of approximately $15,000 and purchased a fire insurance policy covering "betterments and improvements." The policy contained a provision that in the event the improvements and betterments were not repaired or replaced, the insureds' recovery would be limited as described in the third situation above. That is, the insureds could collect only that portion of the original cost of the damaged or destroyed items which the unexpired term of the lease at the time of the loss bore to the period from the date of the betterments and improvements to the termination date of the lease.

 On September 7, 1976, a fire substantially destroyed the leased premises. Neither the lessee nor the landlord repaired or replaced any of the betterments after the fire. Accordingly, the insurer applied the formula contained in the policy and contended that since the lease had only twenty-three days to run, any recovery for improvements and betterments must be limited to 23/365 of their original cost.

 The insureds argued that as lessees with an option to purchase they should be considered as contract purchasers in possession with a full insurable interest. The court, however, stated that the language of the policy providing for the limiting formula was clear and unambiguous. The court held that at the time of the loss, the insureds had no rights other than those of a lessee in possession with an unexercised right to purchase. Thus, their recovery was limited to their unexpired "use interest" in the betterments and improvements. As lessees with an unexercised option to purchase, they never achieved the status of a contract vendee or any other that would place them beyond the reach of the contractual limitation.

 A North Carolina appeals court case involving a homeowners policy, Harris v. N.C. Farm Bureau Mut. Ins., 370 S.E.2d 700 (N.C. App. 1988), also addressed the issue of recovery for improvements and betterments under an agreement with an option to purchase. The insured had a two year lease on the home, with an option to purchase. Nine months into the lease, the house was destroyed by fire. The insured had spent about $17,724 on repairs. The court did not discuss the distinction between repairs and improvements, and treated the repairs as improvements for purposes of determining insurance coverage. The insured argued that his recovery for the "improvements" should be based on the length of the unexpired term of the lease, the option to purchase the property, and the improvements made. The court found that the "unexercised option to purchase was a mere expectancy and [did] not qualify as an insurable interest."  An insurable interest in an option to purchase exists only where the insured had equity in the property which was the subject of the option. A party's insurable interest in the property is consistent with its personal stake in the property such that the insured incurs benefits from its existence or losses from its damage. Belton v. Cincinnati Ins. Co., 602 S.E.2d 389 (2004) citing Benton & Rhodes, Inc., v. Boden, 426 S.E.2d 823 (Ct.App. 1993). The trial court had set the insured's recovery at the exact amount expended for repairs, but the appeals court held that if the issue of damages was reached when the case was sent back to the trial court, recovery was to be limited to the value of the loss of use of the house and its improvements for the remainder of the lease term.

 Insurable Interest of Sublessee

 If a tenant secures the use of improvements and betterments without expense—perhaps in a sublease—that tenant is thought to have no insurable interest and, consequently, no need for improvements and betterments insurance. Indeed, ISO commercial property form CP 00 10 does not allow a tenant to cover improvements and betterments acquired for use by the tenant at no cost other than rent. However, the concept of "insurable interest" is not so rigid as to preclude the possibility of insurance under a nonstandard form or endorsement for a tenant who can demonstrate a genuine need. Though acquired "for free," it is conceivable that certain improvements could be vital to the tenant's occupancy and the need to replace or restore them following loss every bit as imperative. Consequently, the tenant's use interest may be compelling in spite of the fact that the original investment was made by another, and insuring that interest violates no fundamental insurance tradition.