What is Subrogation and How Does it Affect You?
If you are involved in any aspect of the real estate business, sooner or later you will come across the term, "subrogation." Most often it appears in leases, but you may also find it in mortgages, insurance policies, guarantees and other agreements. The phrase may appear in a document where a party agrees to "waive his right of subrogation," or where it is stated that one party is "subrogated to the claims of another."
What is the right of subrogation, anyway, and what does it mean to waive it?
Simply stated, the right of subrogation is the right to pursue someone else's claim. If you are subrogated to someone's claim, it sounds as though you are somehow subordinated to it -- but that's not what it means. It means that you may pursue it as though it were your own. It can arise by the express agreement of the parties, or automatically by operation of law.
Let's look at a few examples.
- Insurance. Suppose you own a building which burns down due to the negligence of a third party. Normally you could sue the negligent third party for causing your building to burn down. If your fire insurance company pays off your claim, however, the insurance company is then subrogated to your claim against the negligent third party. This means your claim against the negligent third party is treated as having been assigned to the insurance company, which may sue him to recover the amount it paid you on account of the fire loss.
- Guarantees. Suppose you guarantee your brother-in-law's loan so that he can buy an apartment building. If you are forced to make good on the load, you are subrogated to the lender's claim against your brother-in-law. This means that you may foreclose on the apartment building to the same extent the lender could do so, or you may sue on the lender's note. You are in essentially the same position as if you purchased the lender's note.
- Interest in Real Property. Suppose you hold an interest in someone else's real property. It might be an easement, a leasehold estate or a lien or encumbrance of some sort. If the fee owner allows the property taxes to go into default, you might decide to pay the taxes in order to protect your own interest from a tax foreclosure. By doing so, however, you also protect the interest of the fee owner by paying off an obligation the owner should be paying. In this situation, you are subrogated to the rights of the taxing authority and may proceed against the fee owner in order to obtain reimbursement for the taxes you paid.
- Assumptions. Suppose you sell some property, and the buyer assumes the existing note and mortgages; however, in typical fashion, you are not released and remain liable along with the buyer. If the buyer defaults and you pay off the note to avoid being sued, you are subrogated to the rights of the noteholder and may recover from the buyer who assumed the note.
From the above examples it becomes apparent that subrogation most often arises when someone reimburses another's loss or pays another's obligation. To achieve fairness, the law assigns the claim to the party who made the payment so that he can pursue it in order to make himself whole.
Waiver of Subrogation. There are certain situations where it makes sense to waive the right of subrogation. Leases, for example, frequently contain a provision stating that the landlord and tenant waive rights of recovery against one another to the extent the loss is covered by insurance, or agree to obtain insurance policies in which the insurance company waives any rights of subrogation it may have against either the landlord or the tenant. These are two ways to reach the same result -- namely, to make sure the insurance company doesn't have a right of subrogation with respect to either the landlord or the tenant.
These are useful provisions and normally should be contained in all leases. To see why, assume the landlord's building burns down due to the negligence of one of the tenant's employees. Without a waiver of the right of subrogation, the insurance company could pay the landlord for the value of the building, and then sue the tenant to recover the amount it paid because (a) it would be subrogated to the landlord's claim against the negligent employee of the tenant, and (b) the tenant becomes responsible for its employee's negligent acts under the doctrine of respondent superior. The net result is that the tenant is not protected by the insurance policy and ends up having to pay the insurance company for the fire loss, which is not what the parties intended.
A similar situation can arise under liability insurance policies where someone suffers a personal injury due to someone's negligent acts. The parties intend the policy to protect both the landlord and tenant, but unless the right of subrogation is precluded, the result might be quite different. Consequently, most leases should contain provisions precluding the insurance company's rights of subrogation for claims arising under either liability or hazard insurance policies.
Before you sign a lease or other agreement containing a waiver of subrogation, check with your insurance agent to be sure that you are not violating any of the terms of your insurance policy. If your policy will not permit a waiver, you may be in danger of losing your insurance coverage, leaving you without policy proceeds or a cause of action against the other party. If the insurance company does permit a waiver of subrogation, it may be necessary to obtain an endorsement to the policy and, in some cases, pay an additional premium.
Conclusion. Once you understand the meaning of the "right of subrogation" and become familiar with the situations in which it is normally applied, it becomes much easier to intelligently analyze and understand documents containing the term and to decide when it is in your best interest to provide for the waiver of these rights.