Recent Fires Serve as Reminder That Casualty Will Always be a Hot Issue

by Mark E. Ellinghouse, Kenneth J. Conlan

Fires have played a major role in the history of California. Not only have these disasters repeatedly left a trail of devastation through the State’s forests and other natural areas, but recent fires have been noteworthy in their damage to developed areas such as Paradise and South Lake Tahoe. The impacts will be felt for years, as families struggle to rebuild their homes and charred trees litter freeways and hiking trails. These effects are a good reminder to make disaster plans, including identifying key heirlooms and records and reviewing insurance policies for adequacy and comprehensiveness.

I recommend that my clients address these potential circumstances in their real estate transaction documents, often to their chagrin. Whether this involves determining if a property purchase must proceed if a casualty occurs or outlining the parties’ obligation to rebuild a damaged space, these infrequent occurrences pose such extreme risk of damage that they must be considered. Clients who overlook these situations risk unexpectedly bearing the cost of the damage over which they had no control. To underscore how important these terms can be, I thought it would be helpful to explain how California law applies in these settings.

In the leasing context, California Civil Code Sections 1932 and 1933 provide that, as long as the tenant does not cause the damage and subject to certain other conditions, Section 1932(2) allows a tenant to terminate a lease if the “greater part of the thing hired” (i.e., the leased premises) is destroyed. This means that if a landlord’s building is destroyed, the landlord dealing with insurance claims and rebuilding may also face the prospect of having to find new tenants as well.  The economic damages from the casualty could end up being worse than the physical damage to the building.

Damage does not have to be total. Destruction can be deemed to occur if all or part of the premises suffers damage or if the portion destroyed was a “material inducement” for the tenant to enter into the lease. California courts generally interpret partial destruction narrowly, but that determination is often the source of dispute after a casualty event.

In the purchase setting, California Civil Code Section 1662 allows a purchaser to terminate a pending acquisition contract so long as the right of termination is not waived in the contract and the purchaser is not in possession of the property. In these cases, a buyer may no longer want to proceed with its acquisition and, relying on California Civil Code, terminate its contract. This may be a fair outcome for the buyer, but the seller is now stuck with a potentially less marketable property on top of dealing with rebuilding its property. And if the market shifts while the repairs occur, the seller may never recover.

It is critical for all parties to consider how a casualty event should affect their transactions. In a lease, this means outlining who will pay for the repairs, who will be responsible for completing them, and who controls the insurance proceeds. In a purchase, parties can not only determine whether the parties are obligated to complete the transaction following the destruction but what level of damage can be sufficient to trigger a termination right. All of the parties should be obligated to provide prompt notice of any damages that may be deemed a casualty.

While insurance is the best weapon to fight these uncontrollable disasters, numerous other issues can arise in the casualty context. For individuals affected by the ongoing fires in 2021, these issues are now front-and-center. For those in the real estate industry, these events are good reminders that the chance of destruction is real and must be considered in all transactions regardless of how the risks are ultimately assigned.