Requirement to Repair or Replace

Jun 10, 2013 | andracki | Articles | No Comments

“Requirement to Repair or Replace”

Introduction

This paper was designed to provide an informative analysis of the current trends in the law regarding replacement cost policy language referencing the insured’s requirement to repair or replace and the prerequisites for satisfying this policy provision; methods employed in valuating loss pursuant to policy provisions, and an examination of the rights and duties of an insurer electing its option to repair or replace under a policy of insurance.

Further, this paper will highlight significant case law across the country on certain issues relating to repairing and/or replacement pursuant to policy provisions.

 

I. Insured’s Requirement to Repair of Replace

Most general property insurance policies provide that upon a loss the insurer will pay the actual cash value of the loss unless the insured actually completes repairs, at which time the insured may obtain the additional replacement cost proceeds afforded under his or her policy of insurance.  Specifically, the Insurance Service Office Homeowner’s Form provides as follows[1]:

(1)   If, at the time of loss, the amount of insurance in this policy on the damaged building is 80% or more of the full replacement cost of the building immediately before the loss, we will pay the cost to repair or replace, after application of deductible and without deduction for depreciation, but not more than the least of the following amounts:

(a)  The limit of liability under this policy that applies to the building;

(b)  The replacement cost of that part of the building damaged for like construction and use on the same premises; or

(c)    The necessary amount actually spent to repair or replace the damaged building.

 (2)   If, at the time of loss, the amount of insurance in this policy on the damaged building is less than 80% of the full replacement cost of the building immediately before the loss, we will pay the greater of the following amounts, but not more than the limit of liability under this policy that applies to the building;

(a)  The actual cash value of that part of the building damaged; or

(b)  That proportion of the cost to repair or replace, after application of deductible and without deduction for depreciation, that part of the building damaged, which the total amount of insurance in this policy on the damaged building bears to 80% of the replacement cost of the building.

(3)   We will pay no more than the actual cash value of the damage until actual repair or replacement is complete.  Once actual repair or replacement is complete, we will settle the loss according to the provisions of b. (1) and b. (2) above.

 This is one of the most important limitations on replacement cost coverage because the carrier has limited its liability to instances where the insured actually completes repairs or replacement.  Similar ISO Replacement Forms state that liability under the replacement cost coverage does not exist “unless and until the damaged or destroyed property is actually repaired or replaced by the insured with due diligence and dispatch.”[2]

The general trend in the law across the United States is that to obtain replacement cost

proceeds in lieu of actual cash value, the insured must actually begin the process of repairing or replacing the building and/or structure.[3]  An insured’s intention to repair or replace the damaged structure is not enough to trigger the carrier’s obligation to pay.[4]  The purpose of this limitation is to prevent the insured from gaining a potential windfall through the receipt of cash funds beyond the actual cash value of the loss.  Further, this replacement cost limitation forces the insured to commence rebuilding prior to procuring the depreciation amounts withheld by the insurer, pursuant to depreciation holdback provisions within a policy.

Insureds have attempted to recover replacement cost proceeds without complying with the requirement to actually complete the repair or replacement.  Many times the deciding factor for the courts in determining whether to allow recovery of replacement cost proceeds prior to commencement of repairs depends on the conduct of the insurer in handling and/or adjusting the initial claim of the insured.

In National Tea Co. v. Commerce & Indus. Ins. Co., [5] the court dealt with the issue of an insured who sued his carrier alleging that his intent to rebuild the damaged property was sufficient to satisfy the requisites of his policy, and thus, he should have been afforded replacement cost proceeds pursuant to his policy of insurance.[6]

The court declined to accept the insured’s argument, holding that:

“It is undisputed that the building in question has not been repaired or replaced, and we see nothing in the language which indicates that it is sufficient that the owners intended to repair or replace the structure…”[7]

Additionally, the court addressed the insured’s argument that the insurance company made the condition precedent to obtaining replacement cost proceeds, virtually impossible, by deliberately failing to pay replacement cost and instead, offering actual cash value while maintaining knowledge of the insured’s intent to repair or replace.  The insured argued that these actions precluded him from the possibility of repairing, rebuilding, or replacing the structure.[8]

The National Tea court found for the insurer, holding that there was no reason to excuse the condition precedent of completing repairs or replacement prior to receiving replacement cost benefits.[9]  In reaching its conclusion, the National Tea court examined a case where the condition precedent of repairing or replacing was excused, and likewise distinguished the case based upon the facts.

Zaitchick v. American Motorist Insurance Co., [10] was a case where the court allowed recovery of replacement proceeds despite the fact that the risk had not been rebuilt.  In the case, the insurer denied the insured’s claim on the basis of arson.  The trial court found the evidence insufficient to support the insurer’s denial and determined that the insureds were entitled to recover.  However, the insurer argued that the insureds had not completed rebuilding, which was a condition precedent to collection of replacement cost proceeds, and therefore, the insureds should be limited to the actual cash value of the structure.[11]

The insureds, to the contrary, argued that they should be entitled to replacement cost benefits because the insurer specifically made replacement of the home impossible.  The court sided with the insured, reasoning that the insureds’ age, limited income, the fact that insurance was on residential rather than on commercial property, and the likelihood that the insureds could not obtain outside financing to begin rebuilding, coupled with the insurer’s denial of liability, evidenced that replacement cost proceeds were warranted in this instance.[12]

Obviously, the fact that the insurer completely denied liability was a critical distinction in the Zaitchick case, and was a fact noted by the National Tea court in rendering their decision.  Interestingly though, there are cases where courts have still stringently enforced the replacement cost provisions of the policy even in cases like Zaitchick, where the insurer denied liability.[13]  However, this principle is not followed in a majority of jurisdictions.

An insured may also be able to recover replacement cost proceeds in lieu of actual repair or replacement based upon a court’s determination that replacement cost policy provisions are unconscionable.

In Ferguson v. Lakeland Mut. Ins. Co., [14] the Superior Court of Pennsylvania found that the replacement cost provision of the insureds’ homeowner’s policy was oppressive and unfair since it required them to expend a large sum of money prior to a liability determination.[15]

In the case, the insureds’ sought to collect when lightning struck an organ inside their mobile home.  The carrier disputed the claim and the parties proceeded to court.  Thereafter, the trial court in instructing the jury informed the jury to disregard the replacement cost provision found in the insureds’ policy provisions.[16]

The Superior Court affirmed the trial court holding that since the insurer denied liability, the insureds’ were faced with the unsavory choice of either accepting the lower actual cash value of the organ or expending a large sum of money in replacement costs without a guarantee of reimbursement.[17]  Therefore, the court ultimately held that the replacement requirement was unconscionable despite the clear and unambiguous language of the policy.  Furthermore, the court held the insurance contract was one of adhesion, and as such, the replacement cost provision was void and unconscionable.

Although insureds continually attack such provisions as being unconscionable, unfair, and/or contrary to public policy, the vast majority of courts across the country have not hesitated to enforce these policy prerequisites to replacement cost recovery.  A recent Missouri Court of Appeals opinion found that despite replacement cost language potentially frustrating the reasonable expectations of the insured, policy provisions should not be held ambiguous on that basis alone.[18]

Still, other cases have permitted an insured to recover replacement cost proceeds based solely upon the actions of the insurer in handling the insured’s claim from its inceptions.  In Pollock v. Fire Ins. Exchange, [19] the insured attempted to recover replacement cost benefits under a homeowner’s policy without actually replacing, or repairing a home, which was destroyed by fire.  The facts of the case were of the utmost importance in the Court’s decision to permit the insured to recover replacement cost benefits absent the commencement of repairs or replacement.

In Pollock, subsequent to the fire, the insured filed a claim of loss with the carrier.  Thereafter, the insurer denied the claim, and additionally, refused to appoint an appraiser, which ultimately lead the insured to file suit.[20]  Twenty-five months after the insured filed suit under her claim, the insurer paid the insured $30,000 for structure and contents.  The replacement cost of the house was appraised at $52,445.  The insured sought replacement cost value even though she had not repaired, replaced, or rebuilt her house.  The insurer argued that the insured’s policy specifically required that the house be actually repaired or replaced before replacement cost benefits were paid.  The Court ultimately held that the insurer’s lack of good faith in processing the claim hindered the insured from complying with the condition of repairing or replacing the residence, and under the circumstances, the insurer was precluded from asserting the policy condition as a defense to payment of replacement cost.[21]

Subsequent to the Michigan Appellate Court’s decision in Pollock, this same court examined a similar case and reached the opposite conclusion while distinguishing the factual scenario of Pollock

In Burnett v. Citizens Ins. Co. of America, Mich. App. 2000, (2000), the court specifically limited its holding in the previously decided Pollock case to the specific facts of that case.  The Burnett court found that the insured presented no evidence that the insurer hindered or prevented the insured’s from repairing, replacing, or rebuilding their cabin.  Further, the court noted that in the Pollock opinion, the court stated that, “had the insurer worked with the insured to allow them to repair or replace the building, rather than attempting to hinder any payment of the claim, a different result might be called for.”[22]  Moreover, the Burnett court looked to the Michigan Supreme Court’s previous holdings relative to the requirements of repairing or replacing prior to collections of replacement cost benefits,[23] finding that replacement cost proceeds were not warranted in the instant case until repair or replacement is completed pursuant to the policy.

Even if the insurer acts in good faith toward its insured, some courts in various jurisdictions have held that the insured is not required to commence repairing or replacing unless the policy language specifically evidences this requirement, however, the case evidencing this proposition stated this conclusion in dicta.[24]  Conversely, it has been held that despite the failure to specifically include the requirement to actually repair or replace, the court can infer this requirement after a reading of the policy as a whole.[25]

Some courts have permitted an insured to recover replacement cost proceeds prior to actual repair or replacement based upon the notion that certain acts may satisfy the literal requisites of these requirements.[26]

In Northrop v. Allstate Insurance Company,[27] the Supreme Court of Connecticut affirmed a lower court holding which held that the policy language requiring that the homeowner had “spent” the money was broad enough to encompass the incurring of a valid debt, and permitted the insured to recover replacement cost proceeds prior to the insured lifting a finger to repair.

William Northrop’s homeowner’s policy provided that replacement cost “will not exceed the smallest of the following amounts: 1) the replacement cost of that part of the building structure damaged for equivalent construction and use on the same premises; 2) the amount actually and necessarily spent to repair or replace the damaged building structure; or 3) the limit of liability applicable to the building structure.[28]

Subsequent to his loss, Mr. Northrop, after receiving his actual cash value proceeds, contracted with a repairmen and paid him to fix a portion of his residence.  The carrier refused to pay the withheld depreciation arguing that the insured must have actually “spent” the money to repair or replace the loss.  Further the insurer asserted that nothing was spent in the case because neither the insured nor the contractor believed the contract had any legal affect.

The court noted that although “spend” means to actually pay money, it could also refer to incurring an obligation through a purchase, as when a person “spends” $100 for a coat that is actually bought on credit.  Therefore, the word “spend” as used in the insurance policy provision at issue, included the action taken by the insureds’ and thus, they were entitled to replacement cost proceeds.[29]

A final noteworthy case on the insured’s requirement to repair or replace was handed down by the Minnesota Appellate Court in Cornelius v. Badger Mut. Ins. Co., [30] whereby the insureds brought suit against their carrier to recover insurance proceeds for damages sustained during a storm.  The insurer argued that damages could not be measured under the policy due to the replacement cost provisional language requiring the insureds to actually replace or repair prior to being entitled to replacement proceeds.[31]

The court reasoned that one of the inherent purposes of the replacement cost provision was to protect the insurer from paying on bids higher than the actual cost of repair or replacement, but regardless, this protection was being afforded to the insurer at the trial of the case.  The court reasoned that at trial, the insurer could present its own estimates, and cross-examine on the issue of certain estimates offered into evidence by the policyholders in protecting its interests under the policy.[32]  Therefore, the court concluded that the replacement cost provision had no effect since the case was at trial before a neutral fact-finder.[33]

While the general requirements of repairing or replacement are enforced by most courts, some jurisdictions will disregard policy language and permit an insured to recover replacement proceeds despite failure to repair or replace.  The importance of clear and concise replacement cost policy language coupled with an insurer’s diligence and promptness in handling a claim seem to be the most significant factors viewed by the courts in determining whether to enforce replacement cost policy provisions as stated.[34]

 

B. How Long Does The Insured Have to Repair or Rebuild?

Generally, the replacement cost provisions of a policy of insurance do not contain language indicating when the insured must complete repair or replacement of the damaged or destroyed property.  However, the provision does permit the insured to make a claim within a certain amount of days after the loss, so as to secure replacement cost proceeds.  The typical replacement cost provision provides that:

(5)  You may disregard the replacement cost loss settlement provisions and make claim under this policy for loss or damage to buildings on an actual cash value basis.  You may then make claim within 180 days after a loss for any additional liability according to the provisions of this Condition 3. Loss Settlement.[35]

Some replacement cost provisions contain no specific time requirement for the insured to make his or her claim for replacement proceeds.  In this type of case, if litigation ensues, the court usually will set a time frame for the insured to comply with this requirement.[36]

Given the potential ambiguity as to when the insured must complete repair or replacement, some insurers have set forth the argument that the insured should be required to complete his requirement to repair or replace with the 180 day time period provided in the policy.  This proposition has been looked upon unfavorably by most courts addressing this issue.

In Bourrie v. Untied States Fidelity & Insurance Co., [37] the insurer denied replacement cost benefits to an insured who commenced repairs on his residence subsequent to his loss, but did not complete the repairs within 180 days of his loss.  The lower court agreed with the insurer’s position and permitted denial of the replacement cost proceeds.  Thereafter, the Court of Appeals reversed, holding that the 180 day period was the time frame given for the insured to notice the carrier of his loss and intent to rebuild.  Since the policy did not specify when the repairs had to be completed, the court permitted the insured a reasonable time to complete repairs.[38]

The reasoning of the court was that if the insurer originally intended all repairs to be complete by the 180 day period expressed in the policy, it could have simply done so via clear and concise policy language.[39]

 

C. Can An Insured Comport With Requirements Of Replacement Cost Coverage By Replacing On a Different Site?

An issue that still attracts much attention with respect to the insured’s requirement to replace or repair, is whether replacement of the insured risk on a different location will satisfy the requirements of policy provisions.  Many property insurance policies specifically provide for replacement on the same premises or location:

(1)  Buildings under Coverage A or B at replacement cost without deduction for depreciation, subject to the following:

(b) The replacement cost of that part of the building damaged for like construction and use on the same premises;[40]

 However, this requirement has dropped out of many replacement policies, but yet

insurers are still trying to enforce this provision as a prerequisite to collection of replacement cost proceeds.[41]  A majority of jurisdictions hold that the failure to include the “same premises” requirement precludes the insurer from later withholding replacement cost benefits from an insured who replaces on a different site.

In Blanchette v. York Mutual Insurance Co., [42] the Supreme Court of Maine addressed this very issue.  In Blanchette, the insured informed the adjuster that he intended to claim replacement cost proceeds by replacing his building.  Due to the upcoming winter, the insured requested and was granted by the adjuster an additional 90 day extension in filing for these benefits.  Subsequently, the insured was informed that local ordinances pertaining to sewerage treatment would bar him from replacing his home on the same site as before.  Thereafter, he constructed his new home on a different lot and made a claim for replacement cost benefits, which was ultimately denied by his carrier.  The insured file suit after being denied these benefits.[43]

The insurer defended its actions arguing that a provision of the insured’s policy referenced the language “same premises”.[44]  The court in a relatively short opinion dismissed the carrier’s argument, and held that the express language of its policy refutes such an assertion and no rule of construction supports such a reading of the contract.[45]

Additionally, the Supreme Court of Connecticut reached a similar conclusions regarding replacement cost coverage for repairing or replacing on a different premises, however, the policy provisions at issue in the case did not specifically reference and/or limit the insured’s ability to repair or replace on the same premises.

In S and S Tobacco and Candy Co. Inc., v. Greater New Mutual, [46] an insurer denied replacement cost proceeds in lieu of the insured actually repairing or replacing on the basis that the policy prescribed that the insured had to repair or replace with due diligence and dispatch and upon the same premises as required under the policy.[47]  The insurer argued that the trial court misconstrued the policy and mistakenly found that the plaintiffs had acted with due diligence.[48]

The court found in favor of the insured, asserting that the provision of the policy referencing due diligence and dispatch defined the scope of the coverage, and not the subsequent provision referencing “same premises”, which the court interpreted as addressing liability rather than the conditions precedent for the entitlement of coverage.  Further, the court found that the provision addressing the scope of coverage limited coverage to instances which “the damaged property is actually repaired or replaced,” but did not expressly require a replacement on the same premises.  The court found the common usage of the term replaced included “substituted”, and given the provisional language, a substituted building may be located on a different site, thus, the insured was entitled to replacement cost proceeds per policy provisions.[49]

Most jurisdictions are of the opinion that unless there is clear and unequivocal language restricting repair or replacement to the same site, replacement on a different site will satisfy as “replacement” per policy provisions, and the insured may thereafter collect replacement cost proceeds pursuant to his or her policy.[50]

II. Is an Insured Who Sustains a Partial Loss Being Granted Replacement Cost Coverage Without Paying Premiums?

One of the issues arising more frequently when paying covered claims, is the assertion by insureds that carriers may not take depreciation deductions when the insured has suffered a partial loss.  The rationale for not including a depreciation allowance in the computation of actual cash value is that if depreciation is deducted, the insured will not receive a sum sufficient to pay for repairing the property at the time of the loss and consequently will be unable to make repairs.  Further, the insured argues that where the actual cost of new material, with deduction for depreciation, is not sufficient to replace the building as nearly as it could be as of the date of the loss, the policy does not fulfill its ultimate goal of indemnification.  Conversely, from the insurers point of view, when a partial loss occurs and depreciation is not deducted in reaching actual cash value, the insured in a sense gains replacement cost coverage without specifically requesting and/or paying premiums for such coverage.

Generally, a property policy of insurance limits recovery of a loss to “actual cash value”, but provides that if the insured repairs or replaces the property, replacement cost proceeds may be collected by the insured.  The obvious first question is the proper method to use in determining computation of actual cash value.

There is a split of authority relating to which method of valuation is the most appropriate and most capable of truly calculating actual cash value.  The first method of calculating actual cash value is the use of a formula requiring replacement costs to be calculated and then to subtract depreciation from that amount to arrive at an actual cash value figure.  This standard is also known as the Pennsylvania Rule.[51]  Despite some acceptance in the industry, there are also two other methods used in various jurisdictions in determining actual cash value: the fair market value test (also known as the California Rule), and the broad evidence rule (also known as the New York Rule).

The fair market value rule has been defined to include the price that a willing buyer would pay a willing seller, neither being under any compulsion to sell or buy.[52]  On the other hand, the broad evidence rule, which was first created and implemented in the New York Court of Appeals in McAnarney v. Newark Fire Insurance Company, [53] permits the trier of fact to consider every fact and circumstance which would logically tend to the formation of correct estimate of the loss in calculating actual cash value.[54]

The issue that arises with the above methods of valuation is how to implement them when the insured suffers a partial instead of a total loss.  The broad evidence test and market value rule are both equally applicable to both total and partial losses.  However, a minority of courts have indicated that the replacement cost minus depreciation test should be altered in a partial loss situation, thereby prohibiting the insurer from deducting depreciation.

The majority of jurisdictions across the country permit an insurer to deduct depreciation in computing actual cash value for a partial loss.  Again, the rationale is that if no depreciation is deducted then the insured is provided with replacement cost coverage without paying for it.  One of the more notable cases where depreciation was taken and subsequently authorized by the court on a partial loss is Braddock v. Memphis Fire Insurance Corp. [55]

In the case, the insured suffered damage to his fifteen year old roof in the amount of $275 dollars, and after application of the deductible and depreciation deduction, the insurance company offered him $11.75, which was obviously not enough to repair his roof to its original condition.  The court noted the concept of indemnity was to restore the insured to as near identical position prior to the loss, but yet held that the application of replacement cost less depreciation rule would best accomplish this result because if the actual cash value was the same as replacement cost, the insured would receive a windfall.[56]

The court’s rationale in reaching this conclusion was that the insured would make a substantial profit on his loss if he was permitted to recover the cost of putting on a new roof when prior to the loss all he had was a fifteen year old roof, and in such a case, “the ends of indemnity would not be served.”[57]  This court is in the majority of jurisdictions which still hold that depreciation deductions may be taken in account when calculating payments for actual cash value in partial loss situations.[58]

The minority rule regarding depreciation deductions of a partial loss is most adamantly expressed by the courts of the Commonwealth of Pennsylvania.  A review of the Pennsylvania Supreme Court cases of Fedas [59] and Farber,[60] establishes that in the absence of language to the contrary, an actual cash value policy does not allow an insurer to deduct depreciation from compensation for repairs in the event of a partial loss.

The Fedas court was one of the first to recognize a distinction between depreciation of total and partial losses.  The court stated that:

“Where a building is entirely destroyed, the application of the rule is simple;  where a building is partially destroyed, it may be difficult to arrive at actual cash value, less depreciation, if it is to be considered; but difficulties cannot prevent the right to compensation.”[61]

The Fedas court basically disregarded the policy definition of actual cash value[62] based upon the reasoning that if depreciation was applied to the loss calculation, the insured’s building would not be sufficiently replaced as nearly as it could be as of the date of the fire.  Specifically, in the court’s opinion, it would not make the insured whole again.  In concluding its opinion, the court stated:

“To sum up, actual cash value means the actual cash value expressed in terms of money of the thing for the purpose for which it was used, in other words, the real value to replace.  The rule established by our decisions seeks a result which will enable the parties to restore the property as it was at the time of the fire, or pay for it in cash; that was the loss insured against.”[63]

The Farber court was given the task of determining whether the loss determined by reproduction cost new of the restoration should be depreciated by the percentage of depreciation applicable to the building as a whole in determining the actual cash value immediately prior to the fire.[64] The court applied similar reasoning found in Fedas in concluding that depreciation was not proper to the building as a whole in determining its actual cash value immediately prior to the fire, finding that the cost of new material, with a deduction for depreciation, does not comply with the policy provision.[65]

Many insureds cite these two Pennsylvania Supreme Court cases as authority for their position that an insurer may not deduct depreciation for a partial loss.  However, some believe these cases have been construed not to stand for the proposition that an appraiser may not depreciate a partial loss, but instead, for the theory that “the blanket rate of depreciation taken for purposes of determining actual cash value of the insured structure may not be applied on a blanket basis to such a loss.”[66]

While both Pennsylvania Supreme Court cases expressly enunciated the rule in the Commonwealth as to depreciation deductions taken on a partial loss, the Farber court did include language in its opinion which provided the insurer with a course of action, whereby the court would possibly permit depreciation deductions on a partial loss.  The Farber court stated that, “If the defendants, (insurer) wish to bring about a different result under the circumstances to those present here, they will have to change the terms of their policies in order to achieve this end.”[67]

A case that provided some hope to insurers whose jurisdictions follow the Pennsylvania Rule on partial loss depreciation, was handed down by the Superior Court of Pennsylvania in 1997.  London v. Insurance Placement Facility of Pennsylvania [68] was a case where the insurer provided a statutorily mandated Fair Plan Policy to the insured, and ultimately deducted depreciation from repair costs while adjusting the insured’s partial fire loss.  The insured’s argued that under existing Pennsylvania precedent, that the insurer was prohibited from making depreciation deductions.

The court ultimately held that the Fair Plan Policy was inherently different from a standard fire policy, being that the Fair Plan was designed to insure high-risk individuals, and since the result proposed by the insured’s would provide them replacement cost protection when they only were provided with basic insurance, this failed to comport with intrinsic ideas of fairness.[69]

Despite this holding, the Superior Court exclusively limited the ability to deduct depreciation for partial losses to Fair Plan policies due to the high risk insurer involved in these types of policies.

Currently in Pennsylvania the case law is clear that an insurer is precluded from taking depreciation on partial losses, thus giving replacement cost coverage to an insured who only procured an actual cash value policy of insurance.  Even under the Pennsylvania Superior Court’s holding in London that it is unfair to allow an insured to receive replacement cost protection when the insured did not pay for it, the courts have failed to extend this principle outside of Fair Plan polices, and thus the precedent set in Fedas and Farber still controls in Pennsylvania, and is recognized in a minority of jurisdictions.

 III.  Insureds Attempt to Procure Enhanced Building or Structure.

An interesting issue that is continually litigated throughout the country involves whether an insured who makes a claim for replacement cost coverage, can and will be afforded replacement cost proceeds for code upgrades, structural enhancements, and/or foundational requirements under a policy of insurance, pursuant to replacement cost coverage provisions.

Under the principle of indemnity, an insured should receive only that amount that will indemnify actual loss, not an additional windfall above this amount.[70]  However, in many of the cases examining the issue of whether replacement costs include building enhancements, the courts have analyzed the specific policy language in reaching their conclusions, and found that a better building may be required under provisional language.

Typically, an insurer who wishes to dispute an insured’s claim for replacement cost proceeds under a policy for code upgrades, will attempt to take advantage of two provisions within the policy of insurance.  The first provision usually limits coverage in that the insurer will pay the cost of repair or replacement, but not exceeding the replacement cost of that part of the building damaged, for “like construction” and “use on the same premises.”  An additional provision relied upon by insurers when there are extensive building upgrades needed on an insured premises, is the “Ordinance or Law Exclusion” found within many policies.[71]

An insurer arguing against the distribution of replacement cost proceeds to cover an insured’s potential code upgrades will consistently argue that the insured would clearly receive a windfall in that they would get an enhanced building, which replacement cost coverage does not and should not provide.  Instead, the replacement cost coverage should provide the insured with a functional equivalent of what they originally had.  Despite this school of thought, many insurers have been required to provided replacement cost benefits to insureds who are required to  upgrade their homes or buildings.

The Supreme Court of Alaska handed down a well known opinion whereby the insurer was required to provide coverage under its replacement cost coverage provisions for a school’s update of its building codes.[72]  In the case, a school was destroyed by fire, and by the time of the fire, building code requirements had changed to the extent that for the school to rebuild in compliance with current school codes, an additional $206,466 had to be expended.[73]  The insurance company refused to pay this outrageous figure and litigation subsequently ensued.

The court initially had to assess the specific policy language prior to rendering an opinion.[74]  The school district’s argument was that the insurance policy is a replacement cost policy which was intended to cover the cost to reconstruct a building so that a new building would be able to replace in function the building which was destroyed.[75]  Conversely, the insurance company specifically relied on two provisions found with the policy of insurance: (1) the civil authority provision; and (2) the “like kind and quality” provision, [76] arguing that the provision must be enforced.

The court held for the insured under the rationale that the exclusions relied upon by the insurer were ambiguous, that they can be reasonably construed not to preclude coverage, and that they fall well short of negating an insured’s expectation of coverage.[77]  In ultimately reaching this conclusion, the Supreme Court relied upon similar case law outside the jurisdiction.[78]  It should be noted that the majority opinion was not unanimous.[79]

Subsequent to the Bering Straight School District case, the Washington Appellate Court decided similar issues and reached different conclusions in holding that building code expenses were not recoverable under a policy where the phrases “like kind and quality,” and “like construction,” were specifically mandated in the policy provisions.[80]

California is among jurisdictions which will not hold an insurer liable to compensate an insured for building and/or structural improvements to meet building codes pursuant to replacement cost policy provisions.[81]

In McCorkle, an insured’s garage was destroyed by fire and an ordinance required the insured to reconstruct the garage with a cement floor, which would have cost twice as much as the previous wooden floor.  The court looked to California’s Standard Form Fire Insurance Policy and its limitation that recovery may not exceed the amount which it would cost to repair or replace the property with material of like kind and quality.  The court held that the provision does not require an insurer to provide the insured with a structurally more valuable building than was destroyed, even if the structural improvements are required to bring the replacement structure into compliance with changed building codes.[82]

Besides the “like kind and quality” and “like construction” provisions found in many replacement cost provisions, insurers in many instances will look to the “ordinance or law” exclusion when an insured claims that local ordinances or building codes require updating which is covered under replacement cost coverage.  The typical purpose of the “ordinance or law” exclusion is to prevent an insured from receiving a windfall through the enforcement of a local or state ordinance or law.

In Throgs Neck Bagels, Inc. v. GA Insurance Company of New York, 671 N.Y.S.2d 66 (1998), the court held that an “ordinance or law exclusion” in a business owners policy covering property damage due to fire or explosion did not apply to bar coverage where the insured was ordered by the city to vacate the premises after the fire.[83]  The court’s rationale was that the efficient cause of the loss was the fire, and that all losses which followed from the occurrence of the fire created liability in the insurer based upon the policy.

The conclusions reached throughout the country on whether the “ordinance or law exclusion” should be given affect when building codes and/or ordinances require additional costs to repair vary from jurisdiction to jurisdiction.

Florida is a jurisdiction that has examined the “ordinance or law exclusion” exclusively, due in large part to the fact that after a hurricane devastated areas of the state, many insureds attempted to collect replacement cost proceeds in making structural improvements to bring them in compliance with building codes.

A significant case was that of State Farm Fire & Cas. Co. v. Metropolitan Dade County[84], where the County brought a declaratory judgment action against an insurer arguing for coverage of structural improvements by insureds to bring homes up to code pursuant to the insurer’s replacement cost coverage language.  The lower circuit court found in favor of the county on the basis that the policy language was ambiguous and therefore, coverage was to be provided.

The Florida District Court of Appeals overturned the lower court decision, holding that the “ordinance or law exclusion” and the “increased loss limitation” contained in a homeowner’s policy was not ambiguous, and barred the insurer from having to distribute replacement cost proceeds to cover costs of code upgrades and home elevation alterations.[85]

Further, the court opinioned that even though the policies failed to define language such as “enforcement” and “increased costs”, the policy language[86] was unambiguous and was to be enforced.[87]

In a recently decided, unpublished Colorado Appellate Court opinion, the court held that a definition of replacement cost in a property insurance policy as to the “cost to repair, rebuild or replace the damaged or destroyed part(s) of the building(s) without deduction for depreciation” did not limit owner’s recovery to the cost of restoring her house to its pre-fire condition, which would have made the building uninhabitable due to changed building codes.[88]

In the opinion, the court looked to common definitions for words that were found in the replacement cost limitation due to the fact that they were not expressly defined in the policy and/or definitional section.  Thus, the court held that no other language in the policy would negate the reasonableness of interpreting the “equivalent construction of similar use” limitation as contemplating similar functional utility and therefore, to include the cost of complying with regulations necessary to render the insured’s house habitable.

There are differing opinions throughout the country as to whether code upgrades should be covered with replacement cost proceeds.  There is no guarantee that even with clear policy language and definitional language, that courts will enforce these provisions because it may inherently go against the concept of indemnity.  However, an insurer who clearly provides provisional language and defines word usage does stand to be in the best position possible when arguing for enforcement of policy provisions.

IV. Insurer’s Option to Repair or Replace 

A. Insurer precluded from exercising its option to repair or replace.

There are some situations where the case law has held that despite an insurer’s reservation of an option to repair or replace in the policy with its insured, this option is not feasible and will not be permitted by the courts.

This type of scenario usually arises when either an ordinance or municipal order refuses to allow a structure to be repaired or replaced, thus turning what may have been a partial loss into a total loss.  Additionally, this type of situation plays even greater importance in states that have enacted valued policy laws.[89]

In Northbrook Property & Cas. Ins. Co. v. R & J Crane Service, [90] an insurer attempted to exercise its option to repair a crane that it insured, which was damaged by high winds.  The insurer was precluded from exercising this option based upon OSHA regulations requiring that the crane be replaced.  The insurer argued that the policy expressly allowed it to repair the crane rather than replace it, and the OSHA regulations should not apply to the insurer’s contractual obligations to insure the product.

The court viewed prior case law concerning the issue of requiring the insurer to replace rather than repair,[91] holding that the OSHA regulation should be construed as part of the insurance contract, and that the insurer is bound by such regulations.[92]

Furthermore, the court rejected the insurer’s argument that exclusionary language should be read to exclude replacement arising from losses caused by the enforcement of ordinances or laws because the policy language did not explicitly include this exclusion, as was the Northbrook case decided by this same court.[93]

In some states where the standard policy contains an optional repair or replacement clause and the legislature also has enacted a valued policy law, it is held that the statutes must be construed together, and are regarded as not in conflict, so that the insurer has the option provided for.[94]

On the other hand, other courts have held that a provision giving an option to repair or rebuild is void as an attempt to supersede a statutory provision requiring the full amount of the policy to be paid in case of total loss.[95]

A middle ground is taken in some jurisdictions wherein it is held that a provision in a valued policy limiting recovery to the cost of repairs or replacement applies only in the case of a partial loss.[96] For example, it has been stated that by virtue of the valued policy law, a provision of a policy giving the insurer the right to repair or rebuild within a reasonable time on giving notice of its intention so to do is applicable only where the building insured has not been totally destroyed.[97]  Where the building is totally destroyed, the valued policy law controls, and insured is entitled to the face amount of the policy.[98]\

Many jurisdictions have valued policies specifically applying to partial losses, and in those jurisdictions, depreciation cannot be deducted when repairs are undertaken after a partial loss.[99]  Also, there is case law evidencing that if repairs are undertaken they must be to code, despite specific “ordinance and law” exclusions.[100]
B. Sufficiency of insurer’s exercising of policy options to repair or replace.

The cases agree that a specific provision in an insurance policy authorizing the insurer to rebuild, repair, or replace insured property within a certain time stated, whether a certain number of days after receipt of proofs of loss or after receipt of the required proof, imposes a duty upon the insurer to exercise its election within the time specified if it wishes to take advantage of the option.[101]  If the election to replace or repair the property is not made within the period fixed by the express terms of the policy, and notice given, the right of action becomes complete in the insured, and no subsequent election on the part of the company not assented to by the insured will divest that right of action.[102]  If no time is expressed in the policy, the courts agree that the insurer’s election to rebuild, repair, or replace the insured property must be made within a reasonable time.[103]

Various courts have considered what constitutes sufficient notice by an insurer of an election to repair or replace damaged property.  Factors of significance to the courts involve the course of action taken by the insurer in exercising the option, and the individuals who were provided with such notice.[104]

In German Ins. Co. v. Hazard Bank, [105] the insured brought suit to recover an amount determined by appraisers to be the loss sustained when the insured bank building was partially destroyed by fire.  The insurer argued that it gave the insured notice of intention to exercise its option to repair the building, and sent out a mechanic to make the necessary repairs.  The bank subsequently refused to allow the insurer to make the repairs, and at trial the insurer argued that under the terms of the policy it had the right to restore the building to its former condition in lieu of paying the award which was made.[106]

The court held that the option to repair was not appropriately exercised by the insurer because the letter of notice of intention to repair was coupled with additional propositions to be accepted by the insured in lieu of the exercise of the given right.  Further, the court held that the right should have been exercised by giving a plain unambiguous notice of the insurer’s intention, and the company should not have undertaken to use the privilege of rebuilding as a means to force the insured to accept the compromise.[107]

The cases addressing the issue of what constitutes sufficient notice to appropriately inform the insured of the insurer’s option to repair or replace seemingly indicate the notice must be clear and decisive, a standard which the courts will likely judge on a case by case basis.[108]

 

C. Consequences of Insurer’s Option to Repair or Replace

There are some very interesting issues that arise after an insurer successfully effectuates the option to repair or replace as provided in a policy of insurance.   

In Abbottsford Bldg. & Loan Ass’n v. William Penn Fire Ins. Co. [109] a mortgagee brought suit to recover the loss alleged to have been suffered by it as the result of damage caused by fire to the building on the mortgaged real estate.  The action was based on the mortgagee clause[110] attached to two standard fire insurance policies issued by the defendant to the mortgagor owner.  The policies contained a clause providing the insurer with an option to repair and/or replace damaged or destroyed property.[111]

Subsequent to the loss, the insurer appropriately exercised its option to repair the damaged property.  Thereafter, Plaintiff, (mortgagee) demanded payment of the loss directly to it asserting that the mortgagee clause created a separate contract between the insurer and itself, and therefore, the insurer could not exercise its option to repair or rebuild.[112]

In reaching its conclusion, the court reasoned that the option to repair is of course for the benefit and protection of the insurer, and is one of two ways of discharging its obligations under the policies of insurance.  The mortgagee clause refers specifically to “loss or damage, if any, under this policy.”  The only loss the insurer agreed to pay to for loss under the policy as a result of the fire.  There was no loss to the mortgagee in the sense of a right to money damages, if, in accordance with the terms of the policies, the insurer elects to, and does fully, repair, rebuild, or replace the property.[113]

Therefore, the court held that purpose of the insurance was effectuated by complete repair and restoration of the damaged property, and the mortgagee’s interest was properly protected.  The option to repair was applicable to the mortagee clause and the mortgagee’s interest, and was binding upon it.[114]

The duties and responsibilities of the insurer after electing the option to repair or replace is an issue that must always be contemplated by an insurer.  This is especially true, when the insured is uncooperative initially, and his or her actions evidence that they could present a problem after the insurer exercises its option to repair or replace.

As a general rule, if the insurer, after a loss, elects to rebuild, the contract of insurance is converted into a building contract which can only be discharged by its performance or execution; and if the insured premises is improperly or incompletely rebuilt, repaired, or replaced, the remedy is upon the new building contract, and not the original policy of insurance.[115]

In Wynkoop v. Niagra Fire Ins. Co., [116] the plaintiff, (insured) sought damages for improper performance by the insurer in making repairs to a building damaged by fire and served the usual proofs of loss.  The insured thereafter demanded an arbitration of the question of damages under the policy.  This request was refused by the court under the rationale that the contract for insurance was out of the case with its provision for arbitration, and that the measure of damages for breach of the undertaking to rebuild did not depend upon damages inflicted by the peril insured against.[117]

Additional case law has confirmed the opinion that an election to rebuild by the insurer transforms a contract for the payment of insurance proceeds into a construction contract, which indicates the insurer will be liable at law for any and all damages recoverable under breach of a construction contract if sued by an insured after exercising the option to repair or replace.[118]  Furthermore, by the insurer undertaking this option to repair, if they are found to be guilty of unreasonable delay, they may be liable for loss of any rents attributable to the property if applicable.[119]

The insurer must clearly and consciously know and appreciate the situation and risk involved prior to exercising an option to repair or replace given the fact that the courts permit recovery of any and all damages associated under a breach of contract action.  The insurer must be aware that upon exercising this option, the former policy is transformed into a construction contract with the insured, whereby they must fulfill all requirements and responsibilities of a contractor when constructing a new building or repairing part of a building.

 V. Conclusion

This paper has traced some of the developments triggered with insurance policy requirements and options to repair or replace, and valuation methods in determining the appropriate amount of losses pursuant to policy provisions.

As can be seen from the decisional law, many times, clear and concise policy language will serve as a solid defense to many of the lawsuits filed by insureds.  However, even with clear policy language, the insurer still faces exposure when a court views requirements and options to repair or replace, and/or the valuation method implemented under the policy.  The insurer must be aware of how the courts are addressing these issues and handling the everyday occurrences associated with interpretation of policy language and adjustment and/or valuation of loss.