Court Clarifies Insurers’ Replacement-Cost Obligations

by Zelle LLP
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Amid the onslaught of Texas hail claims litigation,[1] one Texas federal district court recently confirmed that in order for an insured to receive any portion of a replacement-cost holdback under a property insurance policy, it must actually incur costs above and beyond the actual-cash-value payments tendered by the insurance carrier. The federal district court also reiterated that general contractor overhead and profit is only applicable to a property insurance claim when it is reasonably necessary to repair or replace the damaged property.

In Central Mutual Insurance Co. v. White Stone Properties Ltd.,[2] the insured owned and managed a commercial property located in Austin, Texas. The property sustained hailstorm damage on or about May 25, 2009. The insured submitted a claim to its insurance carrier under a property insurance policy with a replacement-cost provision. The provision provided in pertinent part as follows:

a. Replacement cost (without deduction for depreciation replaces actual cash value in the loss condition, valuation, of this coverage form.) 

*** 

c. You may make a claim for loss or damage covered by this insurance on an actual-cash-value basis instead of on a replacement-cost basis. In the event you elect to have loss or damage settled on an actual-cash-value basis, you may still make a claim for the additional coverage this optional coverage provides if you notify us of your intent to do so within 180 days after the loss or damage.

d. We will not pay on a replacement-cost basis for any loss or damage:

1) Until the lost or damaged property is actually repaired or replaced; and

2) Unless the repairs or replacement are made as soon as reasonably possible after the loss or damage.

e. We will not pay more for loss or damage on a replacement-cost basis than the least of 1), 2), or 3) subject to f. below:

1) The limit of insurance applicable to the lost or damaged property;

2) The cost to replace the lost or damaged property with other property:

a) Of comparable material and quality; and 

b) Used for the same purpose; or

3) The amount actually spent that is necessary to repair or replace the lost or damaged property.[3]

During the course of the adjustment, the insurance carrier determined that that the modified bitumen roof at the property required replacement. Therefore, the insurance carrier retained Lon Smith Roofing to provide an estimate to replace the roof. The estimate totaled $1,768,052.19 on a replacement-cost basis and $1,238,863.85 on an actual-cash-value basis.

The Lon Smith Roofing estimate did not include general contractor overhead and profit, in that overhead and profit was apparently not reasonably necessary for the replacement of the roof. Based on the Lon Smith Roofing estimate, the insurance carrier tendered an actual-cash-value payment totaling $1,444,230.89.[4] The insurance carrier also advised the insured that it was eligible to receive up to an additional $482,690.60 in replacement-cost holdback under the terms and conditions of the policy.

After receiving the actual-cash-value payment, the insured contracted with a purported “general contractor,” Laurent Enterprises LLC, to complete all necessary repairs due to the hailstorm. The contract amount was $2,450,450.02. Laurent arrived at this figure by taking the Lon Smith estimate and adding tax, 10 percent overhead and 10 percent profit.

Interestingly, the contract between the insured and Laurent also stated that the contract amount was limited to the “insurance proceeds received only.” Therefore, the insured knew it would have no liability to Laurent beyond the total amount received from the insurance carrier.[5]

Laurent retained CEI Roofing Texas on behalf of the insured to replace the roof, repair the lighting protection and repair the interior. CEI charged $816,852.00 for what it described as a “turnkey job.”[6] In fact, CEI paid for all the materials, obtained all of the necessary insurance for the project, paid for the permit, provided all of the workers, and oversaw all of the safety measures for the project. No other contractors were involved in the repairs, and Laurent’s only noticeable role involved advising the property’s tenants when CEI would be completing the work.

After CEI completed all of the repair work associated with the hailstorm, the insured, Laurent and the insured’s public adjuster, Eric Raisman, submitted a packet of information requesting a replacement-cost payment totaling $2,045,450.02, less the previous actual-cash-value payment totaling $1,444,230.89. This was the amount of Laurent’s contract with the insured.

They made this request despite the fact that the work had been completed by CEI for $816,852.00, a figure well below the actual-cash-value amount previously tendered by the insurance carrier. The $816,852.00 CEI invoice, which was the only evidence of any amount actually spent, was in the packet of information provided to the insurance carrier. Because the amount actually spent was less than the prior payments, the insurance carrier took the position that no additional proceeds were due. The insured, its purported general contractor and its public adjuster disagreed.

Faced with this dispute, the insurance carrier filed a declaratory judgment action seeking a determination that it had no further liability to the insured under the policy’s replacement-cost provisions. The insured, believing it was entitled to additional replacement-cost proceeds, filed counterclaims for breach of contract, breach of the common law duty of good faith and fair dealing, and violations under the Texas Insurance Code.

The federal district court held a bench trial on the various causes of action. The court held that the replacement-cost provisions on their face were unambiguous and that an insured is not entitled to replacement-cost coverage until: 1) the insured actually repairs or replaces the damaged property; and 2) the amount actually spent by the insured exceeds the actual-cash-value amount tendered by the insurance carrier.[7] Through the course of the trial, the court also determined that:

  • No party could explain what Laurent actually did to effectuate the repairs as the purported general contractor.[8]
  • Laurent’s experience in the construction field was extremely limited.[9]
  • Laurent had “absolutely zero experience” with roofing work.[10]
  • Laurent could not explain, or even attempt to explain, why it was entitled to $2.45 million under its contract and therefore, that contract amount was “baseless.”[11]
  • The contract between the insured and Laurent was a “sham,” apparently designed to extort additional money from the insurance carrier.[12]
  • The $816,852 figure charged by CEI best describes “the amount actually spent that     is necessary to repair or replace the lost or damaged property.”[13]
  • And because Laurent had no apparent involvement in the repairs with no apparent experience in making such repairs, and CEI did not charge overhead and profit, the court questioned whether overhead and profit was reasonably necessary for this project.[14]

The court acknowledged that the purpose of replacement cost coverage is to place “the insured in a better position than he or she was in before the loss” and “any purported windfall to an insured who purchases replacement cost insurance is precisely what the insured contracted to receive in the event of a loss.”[15] This logic explains why an insured receives the actual-cash-value payment before it effectuates repairs.

If after the repairs are complete, the amount actually spent to repair covered damages exceeds the actual cash value, the insured may be entitled to the replacement-cost holdback. But, if the amount actually spent is less than the actual-cash-value payment, then the insured gets to keep the full amount of the actual cash value and the insurer owes nothing more.

In this case, the insurance carrier paid $1,444,230.89 as its actual-cash-value measure. The insured actually spent $816,852 to effectuate the repairs, which was far less than the actual-cash-value amount tendered. Therefore, the insurance carrier had satisfied its obligations under the replacement-cost provisions of the policy and no further insurance proceeds were due.

This is the right result under the clear and unambiguous terms of any replacement-cost provision. The provision does not state that the insurer owes the largest dollar amount the public adjuster or contractor can obtain a quote for (or squeeze out of an estimating program) whether realistic or not. Instead, the provision plainly states that the insurer owes the amount actually spent in completing the repairs. The best evidence of the amount actually spent is what the contractor actually charged — and the insured actually paid — to complete the work.

Finally, it is worth noting that the Texas federal court questioned whether general contractor overhead and profit were reasonably necessary given the extremely limited involvement and vast inexperience of the purported general contractor. In making this observation, the court made no mention of the “three trades rule” often quoted as the benchmark in determining whether it is appropriate to include general contractor overhead and profit.

Rather, the court used the appropriate rule under Texas law, which is whether the involvement of a general contractor was reasonably necessary and, for replacement-cost purposes, whether the cost of a general contractor was actually incurred.[16] Conversely, there is no basis for such a payment when the general contractor involved in the project is not a “legitimate roofing company,” lacks “experience in the industry,” and has no “competent, professional employees.”

With his strongly worded opinion, Judge Sam Sparks clearly intended to send a strong message to contractors performing insurance restoration work — quite simply, you had better be a real contractor and your pricing had better reflect the real cost to perform the restoration work.[17]

—By Todd M. Tippett, Zelle Hofmann Voelbel & Mason LLP

Todd Tippett is a partner in Zelle Hofmann's Dallas office.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] Steven J. Badger, “What The Hail Is Going On In Texas?” Law360, December 19, 2013.

[2] Civ. Action No. A-12-CA-275-SS, 2014 WL 1092121 (W.D. Tex. March 19, 2014).

[3] Id. at *5, 6 and 7 (emphasis added).

[4] This amount included additional funding for repairs to lighting protection, ISO Board and other interior damage.

[5] 2014 WL 1092121 at *2.

[6] Id. at *3.

[7] Id. at *6 and 7,

[8] Id. at *4.

[9] Id.

[10] Id.

[11] Id. at *8

[12] Id.

[13] Id.

[14] See id. at *9.

[15] Id. at *10.

[16] Todd M. Tippett, “A Guide To Making O&P Payments On Texas Roof Repairs,” Texas Law360, December 2, 2013.

[17] Todd M. Tippett, “Roofing Contractors, Don’t Mess With Texas Insureds!” Texas Law360, November 15, 2013.

Texas Law360 - June 18, 2014

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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