It Was the Best of Times, it Was the Worst of Times

AlligatorWhen was the last time you read your insurance policy?






I don’t blame you. Reading an insurance policy can be like death by a thousand cuts, often done best by those with thick skins, like alligators or lawyers.

A recent case, Reichert v. State Farm General Insurance Company, Case No. G046582 (January 24, 2013), shows what can happen when you don’t know what your insurance policy covers and doesn’t cover. In Reichert, the California Court of Appeals for the Fourth District held that a pair of homeowners were not entitled to coverage under the “clear” language of their insurance policy even though the negligence of their architect and contractor resulted in their house being demolished by the city.

A Tale of Two Homeowners

Reichert reads like the opening of Charles Dicken’s A Tale of Two Cities – “It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness . . . “

Eric and Liz Reichert purchased a home in Huntington Beach, California. It may not have been exactly to their tastes, and it just so happened to be located in a federal flood zone, but the Reicherts were going to remodel their home to make it perfect. In short, it was the best of times.

The Reicherts did everything right. Architect. Check. Contractor. Check. Even a project manager. Check.

Because the project was located in a flood zone it was subject to the Federal Emergency Management Agency’s (“FEMA”) “50% Rule.” The 50% Rule requires that a building be elevated above the flood plain and comply with other FEMA building requirements if improvements are valued at 50% or more of the current value of the building.

The Reicherts, always on top of things, submitted plans that avoided the 50% Rule. In fact, they just barely avoided the 50% Rule, with plans with an improvement value of 49.93% of the current value of their home. It was the age of wisdom.

But somehow things went terribly wrong.

During the demolition phase of the project, the Reichert’s project manager discovered that the walls of the house were 8-feet high. Not a problem in and of itself, except that the approved plans called for 10 foot high ceilings and the building permit did not allow the existing walls to be torn down.

Faced with this dilemma – how to build 10 foot ceilings when you only have 8 foot walls – the project manager brought it to the attention of the architect and the contractor. No problem they said, if you want to build 10 foot ceilings, and you only have 8 foot walls, then you need to rebuild the 8 foot walls.

While imminently practical, it ignored the scope of the building permit. I won’t say that it was the age of foolishness since that seems a bit harsh, but it wasn’t the best idea, and unbeknownst to the Reicherts, this decision would cause problems of monumental proportions.

When the city inspected the building, it found that the walls had been torn down, and determined that the project exceeded the scope of the building permit. But, what’s more, by tearing down the walls, the cost to construct the project increased, which in turn caused the value of the improvements (which were already at 49.93% of the current value of the home) to exceed the 50% Rule which would require that the property comply with all of FEMA’s extensive building requirements.

Thereafter, the Reicherts filed suit against their architect and contractor, made a claim against their homeowner’s insurance carrier, and their home was later bulldozed by the city.

It was the worst of times. But it was going to get worse.

Reichert v. State Farm

In their case against their carrier, State Farm General Insurance Company (“State Farm”), State Farm successfully argued to the trial court that because its policy contained a “law or ordinance exclusion,” and the house was demolished for not complying with FEMA regulations, that no coverage existed.

The Court of Appeals agreed.

In response, the Reicherts made two arguments. First, they contended that there was an “Option OL” in their policy, which provides additional coverage for increased costs caused by the enforcement of laws or ordinances. Second, they argued that the “law or ordinance exclusion” was inapplicable because the true cause of their damage was not the enforcement of laws or ordinances, but rather, the negligence of their architect and contractor who authorized the walls to be torn down.

The Court of Appeals disagreed.

As to the Reichert’s “Option OL” argument, the Court explained that while Option OL does indeed provide additional coverage should there be increased costs caused by the enforcement of laws or ordinances – say, for example, your older house is burned down and due to changes in the building codes there are increased costs to rebuild your house – it does not change the requirement that their first be a covered peril. And, explained the Court, under the “law or ordinance exclusion,” there is no coverage when enforcement of a law or ordinance is the peril. In other words, Option OL does not restore coverage when the “law or ordinance exclusion” provided no coverage to begin with.

As to the Reichert’s builder’s negligence argument, the Court acknowledged that negligent conduct by third-parties “has bedeviled insurance law in California courts for over a hundred years since the 1906 San Francisco earthquake.” “But,” explained the Court, “actions can generate reactions,” and in response to courts holding that the negligence of a third-party can be a covered peril, insurance companies added “broad language to their policies excluding losses from third-party negligent conduct.” And, here, State Farm had done exactly that.

For the Reicherts, it was definitely the worst of times. They lost their home, and although the case doesn’t discuss what happened to the architect and engineer, it can be inferred that the architect and contractor were likely judgment proof, and at the end of the day they also could not recover under their homeowner’s insurance policy.

Reichert, however, provides an important lesson for property owners, whether you are an owner of residential, commercial, or publicly-owned property.

Why Insurance is so Important

As a property owner there is always a risk that the person you contracted with, whether it be your architect or contractor, may not be around if everything goes to hell and a handbasket. That’s why insurance is so important. All of the contractual protections including indemnity provisions in the world won’t help you if the person giving the indemnity is judgment proof.

While there are various types of insurance available on construction projects including commercial general liability insurance, builder’s risk insurance, design professional errors and omissions insurance, and owner and contractor controlled insurance programs (OCIPs and CCIPs), which are beyond the scope of this post (I’ll have to ask my colleague Peter Laufenberg who is an expert on insurance issues to write an article), it is important to know what types of insurance are available, what they protect and don’t protect, and to make sure you have them in place.

Although it is of little solace to the Reicherts, if their architect had design professional errors and omissions insurance, they could have made a claim against their architect’s errors and omissions policy.

And so ends our sad tale of two homeowners.

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