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Preparing for Hurricanes and Other Natural Disasters
Lifelong Florida residents will tell you that there have been some bad hurricanes to hit the state, and can name them by heart: Miami 1926, Labor Day 1935, Donna 1960, Andrew 1992. But for the most part, life on the peninsula has been balmy and beautiful, with plenty of sunshine, and with summertime heat and thunderstorms being the only real weather-related annoyances.
But say that to the people of Polk County, Florida, and you will get an argument. In 2004, three different powerful hurricanes -- Charley, Frances and Jeanne -- had their common point of convergence in Polk County, located in the center of the Florida peninsula, and the following year many long-standing storm records were shattered by Hurricanes Dennis, Katrina, Rita and Wilma, which impacted nearly every Floridian in some significant way. Notably, each sibling in this latest family of storms was relatively minor at Florida landfall but still caused major damage, weeks of power outages and gas shortages, and significant displacement of businesses and residents alike.
An historical study of hurricane incidence in Florida, from the beginning of recordkeeping in 1853, demonstrates that the state is prone to tropical cyclone activity. Two features of Florida's hurricane history stand out. First, there was, in fact, a relative lull in storm activity during the 1970s and 1980s. Second, during this same period of inactivity, some of the areas of Florida most vulnerable to storm activity experienced very large population gains, with new development of oceanfront, waterfront and inland areas on lands that had been vacant for centuries or had been left alone because of a prior history of storm impacts. Indeed, Florida is not alone in this phenomenon; many primary and secondary cities along the East Coast and Gulf Coast have experienced significant growth during the last 30 years, and more recently, have begun to experience increasingly frequent and severe weather systems that have resulted in extensive flooding, wind damage and loss of basic utility services, in some cases lasting for weeks or months.
Today, with conventional wisdom now recognizing long-term weather patterns, rather than unfounded reliance on deceptively calm but short periods in the Southeast's recent history, it is time to re-examine the expectations and rules of "hurricane law." Unfortunately not taught in law schools but learned through sometimes bitter experience, "hurricane law" is the bundle of legal issues and concepts that take on primary importance in the aftermath of a hurricane or tropical storm, encompassing insurance law, contract law, commercial and residential lease law, construction law, and land use and zoning law. Businesses need not wait until the next storm hits to become well versed in hurricane law. Rather, lessons learned in the open-air hurricane law classroom over the past few years should be implemented immediately, so that businesses and residents can rest assured that when the next one hits, they will have adequate legal protection to weather the storm.
Business and Property Due Diligence
Anticipation of a threat and the resultant ability to act to reduce or prevent vulnerability is a far better way of dealing with hurricanes than reacting to an imminent danger without understanding such vulnerabilities. Business and real estate interests can apply Threat and Vulnerability Assessment Tools (TVATs) to study their physical and financial vulnerabilities given a variety of circumstances -- among these, the impact of tropical weather systems on property, transportation, communication and production. A TVAT will assess the full spectrum of potential risks, which may include human acts, accidents and natural events for a given facility or location, along with an evaluation of the likelihood of occurrence for such risk. For example, historical data are used to estimate the potential frequency of occurrence for severe storms, hurricanes or floods to establish whether a given risk is probable, possible or not likely. Credible risk data are further evaluated to establish the vulnerability of the specific facility or location and the potential impacts of such threats in the event of a risk occurrence. Under the TVAT model, impact of an event is measured by the degree to which the physical plant and business operations at the location may be impaired by a given risk occurrence. To accomplish this, the TVAT study will evaluate demographics of the physical location, access to the location, environmental factors associated with the location, information technology and business process issues at the location, and a risk-ranking formula that compares vulnerability as measured by probability of the threat occurring against the impact of an actual risk event.
TVATs are required under the Sarbanes-Oxley Act of 2002 for publicly traded companies and often are focused on human-sourced threats such as terrorism and workplace security. But this does not mean that TVATs are exclusively the domain of big business or should be ignored for use in assessing weather-related risks. All businesses and commercial property owners can benefit from a TVAT study tailored to each enterprise's particular circumstances and locations. Just as a property inspection, environmental site assessment, title insurance and survey have become ubiquitous in purchase and sale and leasing transactions, the TVAT or its functional equivalent eventually should become an essential element of real property due diligence and a prudent step in any comprehensive business plan, particularly when a business or landowner has widespread interests in any region that has the potential for adverse geological or atmospheric patterns. Although tropical cyclones are the most significant natural threat to the Southeast, other parts of the United States are vulnerable to earthquakes, tornadoes, blizzards, seasonal flooding, fires and volcanoes, each of which should justify a TVAT study for the protection and preservation of commercial interests that could be directly or indirectly impacted by a widespread natural disaster.
TVAT guidelines and programs are available through a variety of public and private sources. The National Oceanic and Atmospheric Administration (NOAA) maintains a Risk and Vulnerability Assessment Tool (RVAT) through its Coastal Storms Program, which in turn has been adopted in Brevard and Volusia Counties in Florida. NOAA's RVAT Internet site contains instructions and further information on threat identification and assessment, including hazard identification; critical facilities; societal, economic and environmental vulnerability; and mitigation opportunities. NOAA's RVAT as adopted in New Hanover County, North Carolina is available as a case study, which includes a tutorial, CD-ROM, case study materials and data tools. NOAA also maintains a Coastal Risk Atlas that includes a Vulnerability Assessment Interactive Mapping function covering most of Florida and a Multi-Hazard Vulnerability Assessment Tool to evaluate the impacts of storm surge, flooding and wind speeds. Relatively inexpensive TVAT software for self-evaluation can be purchased through a variety of software dealers, such as Janco Associates, Inc. Private companies like ABS Consulting offer resources for identifying, evaluating and managing the risks posed by severe storms, which resources extend beyond the basic self-administered TVAT evaluation to in-depth consulting for property owners and businesses to identify, evaluate, manage and mitigate risks as part of an overall business model.
Purchase Contract Casualty Clauses
Lessons learned in the open-air hurricane law classroom should be implemented immediately, so that businesses and residents can rest assured that when the next one hits, they will have adequate legal protection to weather the storm. The TVAT or its functional equivalent eventually should become an essential element of real property due diligence and a prudent step in any comprehensive business plan.
Armed with a comprehensive understanding of the risks and vulnerabilities of a particular facility or location, owners and tenants should next pay particular attention to the casualty and insurance clauses in purchase and sale agreements, leases and other contracts. Sometimes given perfunctory treatment based on perceptions of the relatively low risk of a casualty loss, these clauses take on new significance for six months every year during hurricane season, when considered in light of the worst-case scenarios painted by the TVAT. Purchase and sale contract casualty clauses often will provide that the seller will bear the risk of a loss to the property until closing, at which time the risk shifts to the buyer. However, many commercial closings are conducted by use of document and funding escrows, and there have been actual incidents where a hurricane loss occurs during the closing escrow, after all conditions to closing have been satisfied but before the escrow agent actually has released the closing documents and funds for legal delivery. Has the risk of loss shifted to the buyer? Did the buyer have its insurance in place to cover the loss? Does the buyer's insurance policy cover the loss before the property is actually titled in the buyer? Questions like these can be avoided by careful drafting and negotiating to clarify, for example, that risk of loss will not shift from the seller to the buyer until the moment of legal delivery of closing documents and funds.
Similarly, purchase contract casualty clauses sometimes allow the buyer, upon an event of loss, to elect either to terminate the contract or proceed to closing with an assignment of the insurance proceeds. Alternatively, some contract casualty clauses will require the buyer to proceed with closing, with an assignment of the insurance proceeds and purchase price credit for the deductible. Again, such provisions may appear straightforward on their face, but given the potential difficulties created by a hurricane strike, further questions arise: is a long-term loss of electric power or other utilities caused by a storm event considered a casualty that would entitle the buyer to terminate the contract? Is insurance coverage available for the loss, and, if so, is the insurer prepared to pay on the policy without challenge or undue delay? Is the buyer obligated to close if the availability or amount of insurance coverage is at issue, and, if so, is the seller obligated to assist the buyer in pursuing an action against the insurer? Proper attention should be given to these kinds of questions in negotiating any real estate or business purchase and sale agreement.
Lease Casualty and Insurance Clauses
As contracts between a landlord and tenant, real property leases contain similar pitfalls relating to casualty and insurance coverage. During Smith, Gambrell & Russell's active involvement with a regional retail client in the aftermath of Hurricanes Katrina and Wilma, the firm encountered many lease provisions that gave rise to more questions than answers. SGR real estate attorney Keith Daw played a key role in assisting the client to navigate these issues. "Our client was fully insured and knew in advance that it could recover from the devastating effects of these hurricanes, but it did not have a full understanding of how its store leases worked under these circumstances to either create or protect it from liability," Daw recalls. Before the storms had finished moving through some of the affected areas, SGR had stepped in on an emergency basis to audit each store lease to identify the relevant casualty and insurance provisions and provide recommendations on how these provisions would affect the client's recovery efforts. As Daw explains, "This working tool provided the company's in-house counsel, real estate, construction and risk management advisors and decision makers with the information they needed to react quickly, plan for recovery and reopen its stores. Some of our findings came as surprises to the company, showing how important it is to know your leases."
It is essential to both the landlord's and tenant's interests for each party to confirm that their lease provides absolute clarity regarding insurance obligations and casualty rights and obligations. Critical questions raised in the hurricane law "classroom" provide guidance for revisiting existing leases and for evaluating the terms of new leases:
(a) Does the tenant have a right to abate its rent or terminate the lease following a potentially long-term casualty, and, if so, can certain events that prevent use of the premises -- loss of electric power, loss of transportation infrastructure or other indirect impact -- be treated as a "casualty" that would allow such rent abatement or termination? Under Florida lease law, rent abatement and termination rights are not available unless the terms of the lease specifically provide such rights. Even then, most rent abatement and lease termination provisions in effect today fail to address details that are crucial in a catastrophic storm event. For example, if the leased premises are not damaged or directly impacted by the storm, can destruction of the surrounding neighborhood or region in which the tenant's customers live be treated as a "casualty" that would allow the tenant to abate or terminate?
(b) Is the landlord or the tenant responsible for carrying and paying for casualty insurance coverage, and which party (regardless of who carries insurance coverage) is obligated to rebuild the premises following a casualty? Particular attention should be paid to the distinction between the obligation to carry casualty insurance coverage and the obligation to restore the premises following the casualty. Hint: they are not always the same party. Also, the distinction between a "repair" obligation and a "restoration" obligation is important and sometimes misunderstood. It is not uncommon for a lease to obligate one party to make repairs but the other party to restore following a casualty. The insurance, repair and restoration provisions usually are set forth in three different sections of the lease, so one should not be overlooked upon finding the others when evaluating these obligations.
(c) If there is a rebuilding obligation, is the obligated party excused from performance under the typical "force majeure" clause, or if the availability or amount of insurance coverage is at issue? Severe storms are considered acts of nature under force majeure clauses that will excuse performance that is rendered difficult or impossible by the force majeure event. But when the act of nature causes damage to the premises and gives rise to a restoration obligation, it may not be clear whether the lease's restoration provision or force majeure provision will be controlling. Similarly, force majeure clauses often list unavailability of services or materials, moratorium, and other causes beyond control of the parties as qualifying circumstances. An insurer's denial or delay of payment on an insured loss typically is not considered a force majeure event, but under many common definitions, this outcome is not so clear.
(d) Is the required insurance coverage (kinds of losses insured, coverage amounts, deductibles) adequate to allow the obligated party to perform its rebuilding obligations? We have now seen that insurers will refuse to cover damage resulting from hurricane-driven storm surge because it is considered a "flood," thus making flood insurance a must-have for properties that may be vulnerable to the risk of storm surge, even though the properties may not lie within a flood zone. Insurance policies should be reevaluated to confirm that desired coverage is in fact provided, that the coverage amounts are sufficient to restore the premises following a catastrophic loss, and that the deductibles and other conditions to claims payment are not so substantial as to result in an essentially "self-insured" situation where this is not the intended result.
(e) Does the insurer have the financial capability to pay all insurance claims under its policies when state or regional losses are catastrophic? A.M. Best Company publishes an annual report of insurance company financial status and issues ratings from A++ (Superior) to F (in liquidation) as a gauge of how A.M. Best views an insurance company's ability to meet its obligations to policyholders. According to Best, it bases its ratings on an in-depth evaluation of the insurer's balance sheet strength, operating performance and business profile. Generally, a Best's rating of at least A- (Excellent) is recommended for commercial property insurance coverage. Companies rated B (Fair) and below are considered financially vulnerable to adverse changes in underwriting and economic conditions. However, even the most secure insurer may have difficulty meeting its obligations following a single catastrophic event involving tens of thousands of claims and perhaps billions of dollars in losses.
Lessons Learned in the Hurricane Law Classroom
With lessons learned from the real-life hurricane law classroom, business and real estate interests in Florida and other event-prone regions must look at their properties and transactions with an eye toward the rising storm. Threat and Vulnerability Assessment Tools are essential in developing policies for enhancing storm preparedness and potentially mitigating business or property loss in a storm event. Due diligence investigations incorporating TVAT studies for buyers or prospective tenants may identify risks and vulnerabilities that are so significant that the transaction is abandoned or at least is carefully reconsidered before the parties proceed with a deal. Given the risks identified, if the parties to a transaction decide to enter into a contract or lease, then the terms of the documents must be tailored carefully and specifically to TVAT results and other risk vulnerability observations. Contract and lease provisions that often are considered "boilerplate" thus take on new significance and should be drafted and negotiated with the same attention to detail that purchase price or rent provisions are given.
Florida is at the center of the tropical weather phenomenon, but the potential impacts of natural disasters are not limited to the Sunshine State. Every coastal city from Brownsville, Texas, to Portland, Maine is vulnerable to tropical cyclone impacts of wind damage, tidal surge and flooding. Inland cities may have just as much to worry about, with storm impacts often manifested by flooding and tornadoes. Even the West Coast is not worry-free, with its tendency toward mudslides, earthquakes and other severe geological events. Businesses and property owners who identify the threats, understand the impacts, plan ahead for adverse events, and are prepared to implement those plans when necessary will get an "A" in the hurricane law classroom. When the storm hits, any other grade will be considered failing.
Sources and Recommended Reading
- RVAT Resources: www.csc.noaa.gov/rvat
- Sarbanes-Oxley Act of 2002, Section 404
- Coastal Risk Atlas Resources: www.ncddc.noaa.gov/cra
- A.M. Best Company: www.ambest.com/ratings
- ABS Consulting: www.absconsulting.com
- Janus Associates, Inc.: www.e-janco.com
- Christopher W. Martin and Karin Crump, "After the Storm: Katrina and Rita Present Challenging Insurance Coverage Questions," Texas Bar Journal, January 2006.