In Xu v IAG New Zealand Limited(1) the Supreme Court dismissed an appeal by a three-to-two majority, holding that the right to replacement under an insurance policy cannot be assigned where the insured party has not incurred the reinstatement costs.
The Barlows' Christchurch home was damaged in the Canterbury earthquakes on 4 September 2010 and 22 February 2011. The home was insured under a standard replacement policy underwritten by IAG New Zealand Ltd, which provided that the insured could elect between:
- recovery of 'replacement benefits', being the actual costs on a new-for-old basis of repair where the insured had reinstated the property; or
- if the insured does not reinstate the property, an indemnity payment for the economic loss suffered by the insured, being the lesser of the diminution in value of the insured property and the cost of restoring it to its pre-event condition.
The policy also stated in Condition 2, under the heading "Insurance during sale and purchase", that:
[w]here a contract of sale and purchase of your Home has been entered into the purchaser shall be entitled to the benefit of this Section but to get this benefit the purchaser must (a) comply with all the Conditions of the Policy, and (b) claim under any other insurance that has been arranged before claiming under this Policy.
Following the earthquakes, the Barlows made a claim with IAG for the damage to their home. However, the claim remained unresolved some three years later when the Barlows sold the property to the appellants. As part of that transaction, the Barlows assigned their rights in respect of their claim under the policy to the appellants. At the date of assignment, the Barlows had not incurred any actual reinstatement costs.
All parties accepted that the assignment to the appellants meant that they were entitled to an indemnity payment under the policy, but IAG denied the appellants' claim to be entitled to recover replacement benefits if they reinstated the house. The appellants also claimed that Condition 2 of the policy entitled them to reinstate and be reimbursed.
The appellants' claims failed in the High Court(2) and the Court of Appeal.(3) The High Court considered that it was bound by an earlier Court of Appeal case, Bryant v Primary Industries Insurance Co Ltd,(4) which held that entitlement to replacement benefits cannot be assigned. Accordingly, the primary focus of the argument in the High Court was whether Condition 2 of the policy entitled the appellants to recover replacement benefits, irrespective of Bryant. The High Court concluded that it did not, finding that Condition 2 applies only to situations where the insured event occurs between the entering into of an unconditional contract for sale of the insured item and settlement, consistent with the legislative context provided by Section 13 of the Insurance Law Reform Act 1985. The Court of Appeal agreed with this interpretation of Condition 2 (although it saw the statutory provision's existence as a neutral factor) and also declined to overrule or distinguish Bryant.
The Supreme Court granted leave to appeal on whether the Court of Appeal had been correct to dismiss the appellants' appeal against the High Court judgment.
A majority of the Supreme Court (Justices William Young, O'Regan and Ellen France) dismissed the appeal.
The majority discussed Bryant, noting that it had been decided on the basis that, in the context of the policy wording:
- assignability of the right to the replacement benefit would infringe the indemnity principle (that insurance covers only losses suffered by the insured) and thus will not cover a loss suffered by an assignee; and
- the entitlement to reinstate and be reimbursed for the cost was personal to the insured.
The majority noted that replacement insurance is usually issued on the standard basis that the entitlement to replacement benefits is:
- subject to the insured reinstating the property; and
- limited to the amount actually expended in replacing the property.
In Bryant Cooke P had rationalised that such conditions enabled replacement insurance to be reconciled with the indemnity principle. The majority considered this rationalisation to be contestable because replacement insurance entails the recovery of expenses incurred, the reimbursement of which may result in a gain in the insured's net worth, meaning that it may be better to accept that replacement insurance is an exception to the indemnity principle. A more convincing reason for limiting reimbursement to actually incurred reinstatement costs is that it limits (although it does not eliminate) the moral hazard of fraudulent behaviour which replacement insurance creates. However, the majority considered that Bryant correctly stood for the proposition that entitlement to replacement benefits conditional on reinstatement by the insured cannot be assigned where no such reinstatement has occurred.
The majority considered several North American decisions (Ruter v Northwestern Fire,(5) Paluszek v Safeco Insurance Co of America(6) and Edgewood Manor Apartment Homes LLC v RSUI Indemnity Co(7)), where the relevant policies provided for reinstatement as a pre-condition to recovering replacement benefits but with no explicit requirement for such reinstatement to be effected by the insured. In each of the three cases, the plaintiff was the original insured, the property had been sold on a 'as is where is' basis and reinstatement was effected by the purchaser. In all three cases the insurers argued that it was implicit in the policies that reinstatement was to be effected by the insured. That argument was accepted in Paluszek but rejected in Ruter and Edgewood Manor, the latter of which proceeded on the basis that, on the policy wording, reinstatement by the insured was not a prerequisite to entitlement to replacement benefits. The majority held that, if the policy wording in the current case could be construed in the same way, they would have had no difficulty accepting that the appeal should be allowed, despite the apparent inconsistency with the indemnity principle.
The appellants sought to rely on several assignment cases in which vicarious performance was held to be possible where the obligee had or should have been indifferent to whether the obligations were performed by the assignor or a third party (eg, an assignee) and in which performance was in accordance with the contract's terms. The appellants argued that a similar approach should be applied because IAG should be indifferent to whether reinstatement was effected by the Barlows or the appellants. The majority considered the cases of CP Peacocke Land Co v Hamilton Milk Producers Co Ltd(8) and British Waggon Co v Lea(9) but held that neither case assisted the appellants because, in both instances:
- the assignor was still in contract with the obligee; and
- the assignee was acting, in a sense, on behalf of the assignor in discharging its obligations.
The majority held that, in the present case, it could not sensibly be said that the appellants' restoration of the house would be on the Barlows' behalf.
The majority acknowledged that, if replacement benefits are lost on the sale of an insured property, delays in claims handling could mean that claimants may have little choice but to sell on an as is where is basis and thus be unable practically to insist on their contractual entitlements. However, the majority held that, on the most obvious reading of the policy, entitlement to replacement benefits is conditional on reinstatement by the insured and that given the moral hazard associated with replacement insurance, insurers' insistence on this is rational. The majority noted that this was the approach adopted in Bryant, which remains correct to the extent that it stands for the proposition that entitlement to replacement benefits which is conditional on reinstatement by the insured cannot be assigned where no such reinstatement has occurred. As Bryant has been recognised as the leading decision and must have been influential on the terms on which insurers have offered replacement insurance in New Zealand over the past three decades, the majority considered that the destabilising effect of overruling Bryant would be "of paramount significance" and declined to do so.
As to Condition 2, the majority held that it clearly extended cover only to events occurring before settlement because, on settlement, a vendor no longer has an insurable interest. The text of Condition 2 and particularly its heading ("Insurance during sale and purchase") also confined coverage for a purchaser to events which occur after the entering into of the sale and purchase agreement. The majority saw Section 13 of the Insurance Law Reform Act, which provides protection to purchasers for loss suffered during the period between when a sale and purchase agreement is entered into and settlement, as identifying the problem that Condition 2 aimed to address.
Justices Glazebrook and Arnold dissented and would have allowed the appeal.
The minority found that the Barlows had an accrued right to the replacement benefits from the time that the property was damaged in the 2010 and 2011 earthquakes. Right to payment for that loss arose at that time, even though the basis for calculating that payment depended on whether the property was reinstated. Restoration would merely quantify IAG's payment obligation in respect of the loss.
The minority considered there to be no reason why the already accrued right to replacement benefit should not be assignable. They did not accept that the Barlows must restore the property personally under the policy – if the rights are assignable, the contract will be interpreted as if the named parties included assignees. There was nothing so obviously personal in the restoration condition that meant that it had to be inferred that it could be discharged only by the Barlows. The policy did not require that the Barlows do the restoration work personally rather than employ contractors and it is common industry practice for insurers to contract third parties to carry out reinstatement and to pay contractors directly. An insured would have a limited role to play.
The minority also considered that moral hazard arguments were addressed in the policy by providing that replacement costs are not paid until they are actually incurred, by limiting the costs to those necessary for reinstatement and by practical measures, such as payment directly to contractors. These moral hazard protections all continue to apply where there is an assignment. As to arguments that the insurer may end up dealing with a person who acquires a property to make a quick profit, acts dishonestly or is difficult or litigious, the minority pointed out that substantially the same risk would apply to the assignment of an already accrued indemnity claim. They found the moral hazard arguments to be unconvincing.
The minority agreed that Bryant could not be distinguished but considered that it had been wrongly decided. Bryant had been decided on the basis that assignment of replacement benefit ran counter to the principle of personal indemnity and applied Castellain v Preston(10) from the Court of Appeal of England and Wales and Ziel Nominees Pty Ltd v VACC Insurance Co Ltd(11) from the High Court of Australia. The minority noted that both Castellain and Ziel were indemnity cases rather than replacement cases and, in both, the risk had passed to the purchasers before the insured event had occurred, meaning that the purported assignment could only have been an attempt to assign the whole policy, contrary to the principle of personal indemnity. No benefit under the policy accrued before the sale and purchase agreements had been entered into. Nor was there any loss as the full purchase price had been received in settlement. In contrast, in Bryant the insured event had occurred before the sale and purchase agreement was entered into and while the risk remained with the insured vendors, meaning rights to the indemnity sum and to replacement benefit had already accrued before the assignment of the insurance claim, albeit being conditional on restoration in the latter case. This meant that the personal indemnity principle did not apply.
The minority did not consider that insurers would be disadvantaged if Bryant was overruled. While insurers may have been able to explicitly provide that replacement benefits were not assignable if Bryant had been decided differently, it should not matter to the insurer who restores the home. The minority also saw force in the appellants' submission that Bryant could force homeowners to accept an indemnity sum because of delays in resolution of claims, which would mean that, despite having received premiums for replacement cover, the insurer would have to pay only the indemnity sum. The minority held that there was no reason why, if an indemnity claim is assignable, a replacement claim should not likewise be assignable. It did not consider that Bryant should continue to perpetuate a harsh outcome for insureds and a windfall to insurers, given that insurers will likely be in the same position whether or not there is an assignment of the replacement sum. The minority would overrule Bryant.
As to Condition 2, the minority noted that if there was any ambiguity in the wording, it would be construed against the drafter IAG, applying the principle of contra proferentem. However, while the condition could have been drafted more clearly to indicate that it is intended to cover any loss that occurs while the sale and purchase agreement is in force, it is difficult to read the clause and its heading ("Insurance during sale and purchase") otherwise.
Xu confirms the Bryant position and will be welcomed by insurers. The effect of Xu is to limit purchasers solely to indemnity claims where the policy imposes a personal obligation on the insured to restore the property.
While Xu provides clarity, even the majority recognised the potential for unfairness. Delay in claims handling (whether deliberate or as a result of inadequate resourcing in the case of a natural disaster) may mean that insureds lack the time or money to reinstate first and sue later and may be left with little choice but to sell without being able to assign the full benefits of the policy to the purchaser, with a comparatively negative effect on the sale price and a resulting windfall for the delaying insurer. As the minority noted, in the case on appeal, because indemnity value would not exceed the amount to be paid by the Earthquake Commission, IAG would have nothing to pay under the policy, despite having received premiums from the Barlows for replacement cover.
There may be opportunities for insureds under pressure and faced with claim handling delays to use litigation funding to ensure that their rights to full recovery are preserved (and not lost to their insurers' benefit).
Although the majority specifically recognised that replacement policies could provide expressly for assignability of replacement benefits, the extent to which policies are offered on such terms will depend on the insurance markets. The effect of Xu should be considered by homeowners and their brokers when choosing a replacement home insurance policy and by purchasers and their advisers if assignment of claims is in prospect.
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