When a covered property is damaged, the insured may face a quintessential Catch-22—the insured cannot afford to proceed with costly repairs or replacement without insurance money, but until the repairs or replacements are finished, the insured cannot recover under the replacement cost provision of the liability policy. A recent court decision held a policyholder must actually repair or replace the damage in order to claim replacement cost value, but may recover a “conditional judgment” for replacement cost benefits and satisfy the condition after trial. Stephens & Stephens XII, LLC v. Fireman’s Fund Insurance Co., 2014 Cal. App. LEXIS 1073, 2014 WL 6679263 (Cal. App. 1st Dist. Nov. 24, 2014) (“Stephens”). Stephens fashions a pragmatic approach whereby insurers can condition payment on actual replacement, while policyholders preserve their rights to benefits after proving coverage.
The case involved a vacant, industrial warehouse owned by Stephens & Stephens XII, LLC (“Stephens XII”), which was covered under a commercial property insurance policy issued by Fireman’s Fund Insurance Co. (“Fireman’s Fund”). The insurance policy initially covered liability, and subsequently, Stephens XII added property damage coverage. The updated policy covered loss from property damage, including rent, and provided two different measures for reimbursement of covered damages: Stephens XII either could recover the replacement cost, or full cost of repairing the damage, so long as the repairs were actually made promptly or as soon as reasonably possible, or the actual cash value, or depreciated value of the damaged property.
Three days after the property damage coverage became effective, Stephens XII discovered large scale vandalism and theft by burglars who stripped all the electrical and conductive materials on the covered property, causing an estimated $1 million in repairs. Stephens XII filed a claim, but Fireman’s Fund delayed resolution of the claim, asserting that given the extensive scope of the vandalism, the damage must have occurred before the policy effective date. Stephens brought suit against Fireman’s Fund for breach of contract and breach of the implied covenant of good faith and fair dealing. Five years later, and one month before the trial, Fireman’s Fund denied coverage. As of the trial date, Stephens XII had yet to repair the damage. Regardless, in a special verdict, the jury awarded Stephens XII the “Replacement Cost,” plus over $2 million in lost “Business Income” for breach of contract, but denied damages for repair and lost profits and awarded $436,896 in “lost rents” as bad faith damages and awarding no damages for loss of rental value.
The trial court granted a judgment notwithstanding the verdict (“JNOV”), holding the terms of policy did not require Fireman’s Fund to pay replacement cost until the property damage was actually repaired or replaced, and such repairs had not been made. Replacement cost insurance, which typically places the insured in a better position than before the loss, creates a moral hazard that the insured will intentionally destroy property and recover under the policy. Therefore, replacement coverage typically requires as a condition to recovery that the insured actually repair or replace the damaged property before the insurer will pay the replacement cost. Generally, policies provide that the actual repair or replacement must occur as soon as possible.
The court noted that often, a policyholder with replacement cost coverage could claim an immediate payment based on the actual cash value to use as seed money to start the repairs. Here, claims discussions were in vain, with Stephens XII taking no steps to make repairs, and Fireman’s Fund never accepting coverage. Stephens XII did not ever seek the actual cost value to use as “seed money” to begin repairs and instead sought the replacement cost value with making any repairs, and sought its lost income. Because Stephens XII did not seek actual cost value and did not repair the damage, the trial court ruled that neither award was warranted. Next, the court rejected the jury award for lost business income. The policy contained a provision under which Fireman’s Fund agreed to pay for “actual loss of Business Income and Rental Value” sustained “due to the necessary suspension of operations during the period of restoration.” The court explained Stephens XII did not sustain losses because potential income lost from a failed property sale did not constitute “business income,” and Stephens XII did not suffer business losses as it did not conduct business at the property, as required by the policy.
On appeal, the Court of Appeal reversed, holding that Stephens XII was entitled to a conditional judgment awarding the replacement value, so long as the repairs were actually made. The court first confirmed that the trial court properly interpreted the contract as stating Stephens XII could claim either replacement cost, only if it actually repaired the damage, or actual cost value, which it did not claim. Further, there was no dispute that Stephens XII did not actually repair the damage, and therefore it was not entitled to replacement cost under the policy. The only issue to resolve was whether Stephens XII was excused from repairs based on Fireman’s Fund’s actions.
Stephens XII successfully argued its failure to repair was prevented by Fireman’s Fund’s failure to accept coverage. The court upheld the jury finding that there was significant evidence of Fireman’s Fund’s refusal to cover the loss which made it difficult for Stephens XII to repair the property. The court held that an insurer’s failure to pay a claim excused the procedural requirements (i.e., time restrictions), but not the insured’s underlying obligations (to repair the building) under the policy. However, the insured was entitled to a conditional judgment for replacement costs conditioned on the insured’s completion of repairs promptly after judgment. The Court of Appeal explained:
If coverage is ultimately resolved in favor of the insured, the insured should remain eligible to receive replacement cost, but only so long as the insured complies with other applicable policy terms, such as a repair requirement. In other words, a coverage dispute should not give the insured a benefit under the policy it never had in the absence of the dispute—such as the right to receive the replacement cost without actually repairing the damage.
The court rejected Stephens XII’s arguments that Fireman’s Fund waived, and was estopped from asserting, its right to demand compliance with the repair provision because it failed to communicate this demand in its correspondence. The court noted that California courts adhere to the general rule that waiver requires an insurer intentionally relinquish its right to deny coverage, and a failure to raise one basis for a denial in a denial letter may not reflect an intention to waive that reason. Here, Stephens XII did not provide sufficient evidence that Fireman’s Fund intended to waive the repair requirement.
Finally, the court upheld the jury’s verdict of $436,896 in “lost rents.”
Stephens identified a problematic issue in recovering replacement cost under a property damage policy and fashioned a rarely used judicial remedy by permitting a conditional judgment of award of replacement/repair costs. This solution seems appropriate and allows an insured to establish its right to coverage under a policy where the insurer denied coverage by requiring insurers to pay the replacement value once repairs are made.