Insuring Rental Equipment

August 30 2019 | Committees

 

It’s common for certain businesses (especially oil and gas producers, refineries, chemical companies, restaurants, manufacturers, and construction contractors) to rent principal equipment required for their day-to-day operations. Such rental equipment includes compressors, generators, specialty tools, motors, refrigeration units, cranes, and specialized equipment. The reasons for renting such equipment (as opposed to purchasing it) are based on custom and tradition, the desire to avoid capital expenditures, and the third-party expertise available to maintain the equipment and advise on its use.

A common aspect of such rental agreements is that the lessee is responsible for damage to the equipment during the rental period, regardless of fault. Here is one common formulation:

Notwithstanding anything to the contrary, Company shall be liable to Contractor for any Losses due to damage to or loss of Contractor’s Equipment, regardless whether caused or contributed to by the sole, joint or concurrent negligence, strict liability, imperfection of material, defect or failure of equipment, breach of representation or warranty (express or implied), ultrahazardous activity, tort, breach of contract, violation of law, breach of any safety requirement or regulation, or other fault of Contractor Group, or a preexisting condition (patent or latent). 

Such arrangements present a challenge from an insurance standpoint: where is the insurance coverage for the lessee’s obligation to make good on damage to the rental equipment? One might instinctively look to the lessee’s commercial general liability policy for such protection; after all, a claim for damage to rented equipment would seem to fall within the GL policy’s insuring agreement (coverage grant) as one seeking “damages” “because of” third party “property damage.” But there’s a significant challenge in relying on a GL policy for such liability under a lease.

First, there is the “care, custody, and control” Exclusion j(4) in most GL policies. Exclusion j(4) excludes coverage for property damage to “personal property [i.e., not real property] in the care, custody or control of the insured.” So, depending on the terms of the lease, the particular use made of the rental equipment, and the circumstances of the loss, coverage for damage to leased equipment may well be barred under Exclusion j(4) (despite a loss to third-party property normally falling within the GL policy’s coverage grant).

Second, even if not excluded under Exclusion j(4), the policyholder’s responsibility for a loss to rental equipment may not be covered as contractual liability. Contractual liability is initially excluded in the GL policy, but there is an exception for liability that is assumed in an “insured contract”:

Insured contract means … that part of any other contract or agreement pertaining to your business (including an indemnification of a municipality in connection with work performed for a municipality) under which you assume the tort liability of another party to pay for “bodily injury” or “property damage” to a third person or organization. Tort liability means a liability that would be imposed by law in the absence of any contract or agreement.

The above language could be read as requiring a three-party relationship: the policyholder indemnifies its contractual counter-party for the counter-party’s tort liability to a third party. But in many equipment lease scenarios, this three-party situation is not contemplated. For example, if the lessee is liable to the lessor for loss to rented equipment (regardless of fault), and the equipment is destroyed by a lightning strike or other Act of God, there is no tort liability to a third party to address. Instead, the lessee is liable – regardless of fault – directly to the lessor for damage to the equipment; that is a two-party relationship.

In light of the above challenges, the best practice is for the lessee not to rely on GL coverage for its lease obligations with respect to rental equipment. Instead, equipment lessees should consider the following options:

  • Amendment to the GL Policy: Attempt to negotiate the deletion of Exclusion j(4) from the GL policy (more of an option for lessees in the construction business).
  • Inland Marine Policies: Probably the best approach is to rely on an “equipment floater” (or a contractor’s equipment policy), which may not require scheduling or declaring the equipment. Long-term rentals should be scheduled under such policies.
  • Oil and Gas Specialty Policies:
  • Lost In Hole insurance (which may take the form of a mere waiver from the lessor or a formal first-party insurance policy);
  • “Care, Custody, and Control” coverage for a limited set of equipment under certain circumstances under a Control of Well policy; and/or
  • Oil Lease Property Coverage.

The four important takeaways here are that:

  1. Relying on GL coverage for the lessee’s responsibility for “big ticket” rental equipment is not a best practice;
  2. There are several uncomplicated “first party” options available to obtain coverage for contractually assumed lease obligations;
  3. One should take careful note of the effect of the rental contract itself and its interaction with the policyholder’s insurance program; and
  4. This process requires two things: the policyholder’s lawyer or contract manager must first notice the issue, and then coordinate with the insurance broker to find the best solution for insuring this risk, taking into consideration the value of the rented equipment, the lease terms, and the policyholder’s obligations with respect to other leased equipment.

Recognizing these issues and taking basic precautions can help avoid unpleasant surprises and uninsured liability.

 

 

Authored by Harold J. Flanagan,
Flanagan Partners LLP
Insurance Law Committee Chair

                               
   



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