First published on Law360
The 2017 hurricane season has left the southeastern and southwestern portions of the United States reeling from hundreds of millions of dollars in property damage. As insurers assess the resulting insurance claims, Georgia presents a unique wrinkle in the claims adjustment process.
In 2012, the Georgia Supreme Court held that policyholders may recover post-repair diminution in value as part of their property damage claims. Insurers who fail to recognize this development in the state's law could expose themselves to litigation. In Royal Capital Development LLC v. Maryland Casualty Co., the Eleventh Circuit certified the following question to the Georgia Supreme Court:
For an insurance contract providing coverage for "direct physical loss of or damage to" a building that allows the insurer the option of paying either, "the cost of repairing the building" or "the loss of value," if the insurer elects to repair the building, must it also compensate the insured for the diminution in value of the property resulting from stigma due to its having been physically damaged?
728 S.E.2d 234, 235 (Ga. 2012).
The court answered the question affirmatively. Id. at 238. In doing so, the court extended the Mabry rule — the requirement that an insurer compensate a policyholder for his vehicle's diminished value resulting from an automobile accident in addition to the actual cost of the repairs — to property insurance.1 The basis for the court's holding is the principle that the measure of damages is intended to place the injured party in the same position it would have been in if the injury had never occurred, and the stigma associated with previously damaged property may result in diminished fair market value. Id. at 236-237.
Since Royal Capital, Georgia policyholders have successfully asserted breach of contract claims when insurers failed to consider diminution in value when measuring property losses. For example, the plaintiff in Anderson v. American Family Insurance Company filed an action alleging "[d]efendants breached their insurance contract with him by (1) failing to assess his property for diminution in value resulting from water damage and (2) failing to pay him for such diminution in value." No. 5:15-CV-475 (MTT), 2016 WL 3633349, at *1 (M.D. Ga. June 29, 2016).
One of the defendant insurers argued the plaintiff's recovery was limited to actual repair costs because the policy stated that the insurer would pay "the amount [the plaintiff] actually and necessarily spent to repair or replace the damaged portion of the property with materials of like construction." Id. at *4. The court found that in light of Royal Capital, the fact that the policy stated the insurer would only pay for actual repair costs did not eliminate the insurer's obligation to compensate for diminished value. Id. See also Thompson v. State Farm Fire and Cas. Co., No. 5:14-CV-32 (MTT), 2017 WL 3776704, at *4-*5 (M.D. Ga. Aug. 31, 2017) (holding plaintiff's insurance policies covered diminished value because they did not contain language explicitly excluding such coverage).
Interestingly, despite the precedent set by Royal Capital the Eleventh Circuit has rejected an attempt to recover diminution in value in the absence of physical property damage. O'Dell v. Pacific Indem. Co., 619 Fed. App'x 828, 832 (11th Cir. 2015). In O'Dell, the plaintiff was a home buyer who accused the sellers of misrepresentations due to their failure to disclose previous flood damage. The plaintiff filed an action against the sellers and eventually settled, and then he filed an action against the sellers' property insurer to recover for the alleged bad faith refusal to defend and indemnify the sellers. Id. at 830-831. The plaintiff argued the policy provided coverage for diminution in value, but the court held that purely economic loss was not covered "property damage." The policy defined property damage as "physical injury to or destruction of tangible property, including the loss of its use." Id. at 831. The court found that even assuming the diminution in value occurred during the sellers' policy period, it did not involve any physical injury to or destruction of property and consequently, the policy did not provide coverage. Id. at 831-832.
When the O'Dell holding is read in conjunction with Royal Capital, it appears that courts may draw a distinction between a claim for only diminution in value, a purely economic loss, and a claim for the cost of repair and diminution in value. However, the duty to compensate a policyholder for diminution in value as part of a physical property loss is clear.
Georgia has taken what appears to be a minority position. Other states have explicitly rejected diminution in value coverage. For example, California courts have stated there is no coverage under a property policy for diminution in value because diminution in value is a method of measuring loss, not a cause of loss that may be covered. In State Farm Fire & Casualty Co. v. Superior Court, the plaintiff sought coverage for repairs the condominium association was forced to make in order to bring a building up to current code requirements. 215 Cal. App. 3d 1435 (Cal. Dist. Ct. App. 1989). The claims were denied based upon policy exclusions for latent defects, faulty workmanship and construction code violations. The plaintiff argued that the actual loss was the diminished value of the building, which was a nonexcluded ensuing loss. Id. at 1439.
The court determined the key question was whether the plaintiff's losses were caused by a covered peril. Under this approach, the court found the efficient cause of the plaintiff's losses was one of the excluded perils, not diminution in market value. Id. at 1444. The court went on to note "[t]he policy here states it insures against 'direct physical loss' except when due to certain enumerated causes; diminution of market value is not specifically excluded because it is not a 'cause' of loss; it is the measure of a loss caused by something else." Id. at 1445.
While Georgia has created a unique rule regarding the measurement of property losses, insurers will expose themselves to litigation if they do not appropriately respond to Royal Capital. Essentially, insurers have two options. First, insurers can fulfill their obligation to assess diminished value as an element of loss when a policyholder makes a claim. And unless the policy requires the policyholder to assert a right to recover each particular element of damage, it is not necessary for the policyholder to specifically claim diminished value. Rather, the insurer has an affirmative duty to assess and adjust each element of the covered loss, including diminished value. Mabry, 556 S.E.2d at 123. The insurer may develop its only methodology for assessing diminished value, rather than engaging licensed real estate professionals to conduct formal appraisals. Thompson, 2017 WL 3776704, at *13.
Alternatively, insurers may avoid this issue altogether by revising their policies to exclude coverage for diminished value. In Thompson, the court found that the following policy language effectively barred coverage for diminished value:
Diminution in Value Loss Restriction
When used in Section I of this policy, loss does not include diminution in value. This does not preclude payments as described in the Section I loss settlement provisions of this policy.
The cost to repair or replace does not include any reduction in the value of any covered property prior to or following repair, rebuilding or replacement as compared to the value before the loss.
Id. at *5.
Royal Capital's impact on Georgia insurance law cannot go unnoticed. Whether insurers choose to change their claims handling processes to include assessing diminished value or revise their policies to exclude this coverage, it is imperative that insurers develop effective responses to this change in Georgia law.