In Avonside Holdings Ltd v Southern Response Earthquake Services Ltd  NZCA 483 the Court of Appeal faced a difficult question regarding an insurer’s liability for a contingency sum for rebuilding works which by definition were never going to occur.
The insurer, AMI (now Southern Response) insured the policyholder’s (Avonside) residential dwelling in Christchurch. As a result of the Canterbury earthquakes, the property was damaged beyond economic repair. The policyholder sold the land to the Crown in accordance with a government scheme.
A relevant provision of the policy stated:
c. If your rental house is damaged beyond economic repair you can choose any one of the following options:
i to rebuild on the same site. We will pay the full replacement cost of rebuilding your rental house.
ii to buy another house. We will pay the cost of buying another house, including necessary legal and associated fees. This cost must not be greater than rebuilding your rental house on its present site.
iii a cash payment. We will pay the market value of your rental house at the time of the loss.
“Full replacement cost” meant “replacement with a new item, or repairing to an ‘as new’ condition”.
The policyholder elected to purchase another property.
In this case the rebuilding cost, as envisaged in the “buy another house” option was inevitably hypothetical because the land had already been sold and the property would never be rebuilt on the same site.
In the High Court, the parties disagreed about whether a contingency sum and professional fees should be included in calculating the notional rebuilding cost. They also disagreed about how the sum apportioned for external works should be calculated. In this note the focus is on the contingency sum issue only.
At trial, the policyholder’s quantity surveyor expert witness apportioned a sum of money for contingency fees, whereas the insurer’s expert did not apportion anything on the basis that there should be no allowance at all.
The High Court held that there should be no allowance for contingencies in the calculation of the cost of rebuilding the property. MacKenzie J held that, in a notional rebuild, there could by definition be no unexpected items for which a contingency allowance would be provided in a contract. What was required was the best assessment of the cost of rebuilding, based on all known circumstances. As there would be no actual rebuild, that assessment would never be put to the test. So, there was no need to add a contingency sum to reflect possible contingencies which would never be encountered.
In the Court of Appeal, the policyholder contended that it was necessary to assume hypothetically that the rebuild would occur. Costs could not be excluded from the estimate of the rebuild cost just because the rebuild was not going to happen and costs would not be incurred. If that approach were taken, it was difficult to see what costs would ever be included in the estimate, it submitted.
The insurer contended that no allowance for contingencies was needed because, given the nature of the notional exercise involved in estimating the rebuild costs, all relevant risks were already known. Rather, what needed to be worked out was the cost of duplicating the construction of the property as provided for in its original plans. Where contingencies did arise they could be dealt with under a provision of the policy which provided for cover for additional costs.
The Court of Appeal therefore had a clear choice between ordering that something, or nothing at all, be paid for contingencies.
It analysed the insurer’s position this way at paragraph 49:
The approach contended for by Southern Response means that costs for contingencies and professional fees that would be incurred where the rental house was actually rebuilt on the same site, whether as part of “the full replacement cost” or as part of “additional costs”, are excluded from the calculation of the cost of rebuilding under the “to buy another house” option. The rationale for that exclusion is that because the exercise is a notional and not an actual one, contingencies that would as a result not be incurred need not be included. Southern Response argues this is the correct interpretation of the Policy.
With regards to this, the Court held at paragraph 51:
The cost of rebuilding the rental house on its present site involves both the full replacement cost and additional costs, encompassing contingencies and professional fees. That is the amount the insurer would be liable for where the insured chose the “to rebuild on the same site” option. We are satisfied, therefore that it is an amount equivalent to the sum of both of replacement and additional costs, and not the lesser amount of solely “the full replacement cost”, that is to be paid by the insurer to the insured when the insured elects the “to buy another house” option. In our view, if the Policy had intended any limit to “the full replacement cost” to apply in cl (c)(ii), it would have said so.
(Italics added for emphasis).
This line of reasoning can be broken down this way: an election to buy another house under clause (c)(ii) was referable to the cost of rebuilding the property on the same site under clause (c)(i), which was limited to the “full replacement cost.” Ordinarily, the full replacement cost for an actual rebuild would include a contingency sum. If the insurer had wanted the “full replacement cost” to be net of a contingency sum for the purposes of clause (c)(ii), the Court of Appeal reasoned, then it needed to say so.
This reasoning, as in other Canterbury earthquake cases, involved an assessment of where the risk should lie where the policy is capable of different reasonable meanings. The insurer’s contention that it should never be liable for costs which, by definition, could never be incurred, is attractive. This is instinctively the correct position as a matter of logic. However, contract interpretation is concerned with more than logic; it is concerned with meaning. Clauses (c)(i) and (ii) used the concept of rebuilding the property on the same site as common concept and without any distinction between an actual rebuild (clause (c)(i)) or a notional rebuild (clause (c)(ii)). So, the insurer’s argument, as attractive as it is, can only be regarded as implicit in the wording, rather than explicit. Viewed this way, it is fair for the insurer to bear the risk because clearly it has the ability to control the way the policy is worded in a way that the policyholder does not. Simply put, if it wanted contingencies to be excluded where the policyholder elected to buy another property, then it needed to say so clearly and unequivocally.
Further, this is not a case where such an outcome is inconsistent with commercial common sense or anything like it, which may justify the provision being read down. As I have commented previously, replacement insurance is consciously different to indemnity insurance. It is new for old. It is a permissible windfall on the behalf of the policyholder. An economist will tell you it is what the insurer promised to provide in the event of accidental damage, and what the policyholder believed it was paying for. So, while this outcome will put the policyholder in an advantageous position when it goes to buy a new house, this is an eventuality that was contemplated by the policy, based on a reasonable interpretation of it.
13 October 2014
This case note is not subject to copyright. I assert my moral rights to be identified as the author. Microsoft Word version available on request.