Seventh Circuit Says Replacement Cost Claim Survives Sale of Property

The Seventh Circuit Court of Appeals recently held that a claim for replacement costs under a property insurance policy survives the insured’s sale of the damaged property. In Edgewood Manor Apartment Homes, LLC v. RSUI Indem. Co., 2013 U.S. App. LEXIS 21939, the court determined that an insured, whose property had been damaged by a storm, could sell the unrepaired property and maintain a claim for the replacement cost proceeds. The decision offers an important ruling on replacement-cost coverage and policy interpretation.

The case arose after Hurricane Katrina severely damaged an apartment complex in Mississippi. The property insurance policy covered both the actual cash value, calculated as the actual market value of the property at the time of the loss, and replacement cost coverage, covering the additional cost to fully repair or replace the damaged property. Following the hurricane, the insurer paid the actual-cash-value insurance and began negotiating the additional replacement-cost coverage with the insured. According to the policy, the insurer would pay on a replacement cost basis only after the property was actually repaired or replaced. But before the property was repaired or the replacement-cost claim had been resolved, the insured sold the damaged property. Notably, the insured did not assign its rights under the policy to the buyer.

After the sale, the buyer repaired the property and, eventually, both the insured and the buyer sued the insurer for the replacement costs under the original policy.

Both the trial court and the circuit court agreed that the buyer lacked standing to recover the insurance proceeds. The insured never attempted to transfer its rights under the policy to the buyer and any such transfer or assignment to a third party would likely have been invalid under the policy’s “no transfer” provision. Without being a party to the contract and without assignment, the buyer lacked an interest in the policy and could not sue for the proceeds.

The question remained, however, whether the insured could still recover the replacement cost proceeds. The insurer argued that it had no obligation to pay because the insured sold the property in its unrepaired state and lost its insurable interest in the property after the sale.

The district court agreed with the insurer and dismissed the claim. The court said the purpose of replacement cost coverage is “to reimburse the insured for the additional costs to repair or replace the building above the depreciated value,” but where the insured expends nothing, nothing can be recovered. According to the court, the insured sold the property before satisfying the policy’s repair requirement and lost its insurable interest in the property after the sale. The court rejected the notion that the insured could retain an indefinite right to recover the replacement cost when a third party buys and repairs the property, as such a recovery would violate insurance law by allowing the insured to profit from the policy.

The insured appealed the trial court’s dismissal, arguing that its right to recover survived the transfer of the property and that the policy did not require that it make the repairs to the property, only that repairs be made. The Seventh Circuit Court of Appeals agreed, reversing the district court’s dismissal of the case. The court acknowledged that an insured must have an insurable interest in the property “to prevent the coverage from becoming a wagering contract contrary to public policy” and to remove “economic incentives in such persons to cause loss,” but ruled that Mississippi law requires an insurable interest in the property only at the time of the contract formation, i.e., when the policy was issued, and does not require the insured to maintain that interest while a claim is being negotiated or through litigation. Here, the insured had an insurable interest in the property both when it procured the policy and at the time of the loss, satisfying the legal requirement.

The court also held that the insurance policy did not require the insured to have made the repairs itself, only that the repairs be made. Although other courts interpreting similar provisions have implied a “repair it yourself” requirement to prevent the insured from selling unrepaired property and profiting from a replacement cost claim, the Seventh Circuit rejected their reasoning. The court stated that replacement-cost insurance is supposed to be more than an indemnity policy—it is designed to put the insured in a better position than he was before the loss by compensating the insured for depreciation. In the court’s view, the repair requirement is not intended to prevent a windfall, but rather to ensure that the replacement cost is valued accurately. The court added that if the insurer intended a “repair it yourself” restriction, it was free to draft the policy language accordingly.

The court’s decision resolves an interesting and important question, allowing an insured’s claim for replacement costs to survive its sale of unrepaired property. The insured had an insurable interest at the time the policy was issued and the property was repaired, albeit by the buyer and after the sale, according to the policy requirement. As the court noted, recovery for the insured remains subject to further proceedings at the trial court level and may yet be precluded by a provision in the policy requiring repairs to be made within a reasonable time. Nevertheless, the decision, while factually unique, could have implications for insurers and insureds where replacement cost proceeds are potentially available and property is transferred.

The Seventh Circuit read the replacement cost provision generously for the insured and was unwilling to impose implied restrictions on coverage. Insurers and insureds should be aware of the court’s application of the replacement cost provision allowing an insured’s rights to survive a transfer of unrepaired property.