Indemnity and Reinstatement

Will J:

‘In the instant case, when the subject building was destroyed on May 1, 1972, it was an economically useless building. It was empty, secured and boarded. It had been gutted by a previous fire. It was not being used in any way.

Here, as in Aetna State Bank v Maryland Casualty Co, 345 F Supp 903 (ND Ill 1972), it would be ludicrous to allow the plaintiff to recover a substantial amount of money representing the replacement cost less depreciation of a building that was for all practical purposes non-existent. It would be grossly inequitable for plaintiff’s beneficiary to recover $43,000 for a building which less than one month prior to its destruction she had purchased for $4,000 in what appears to have been an arm’s length transaction and in which building she had made absolutely no additional investment or improvements.

We hold that the Smith v Allemannia Fire Ins Co, [219 Ill App 506 (1920)] doctrine of rigidly defining actual cash value of a building as its reproduction costs minus depreciation is limited in application to those buildings which are being economically utilised at the time of their damage or destruction. Such a limitation may be implied from the facts of those cases which have purported to follow Smith. Despite the language in the various opinions, Illinois had not allowed such windfalls as plaintiff here seeks.

Illustrative of this is the recent case of Lieberman v Hartford Ins Co, 6 Ill App 3d 948, 287 NE 2d 38 (1st Dist 1972), in which the Appellate Court of Illinois went a step further than Judge Marovitz in Aetna State Bank and held that, where a contract for demolition exists on the subject building, the plaintiff has no “insurable interest” in the building since there is no economic value to the building. Judgment was entered for the defendant in that case despite clear liability under the policy.

In the instant case, the building was economically useless at the time of the fire. While we would prefer a more flexible standard of insurable “actual cash value” than the Illinois courts have adopted so that, in cases like the instant one, an insurable interest having some relationship to the actual value, even though nominal, could be found, we conclude that under all the precedents, there was no insurable interest in the building at the time of the fire on 1 May 1972.

In cases such as the instant one, where the building is vacant, boarded up and under a court order prohibiting repair of its heating system, and, therefore, cannot be economically utilised, reproduction cost new less depreciation has little or no relationship to actual value. Other factors, such as market value or salvage value, should be considered in establishing any insurable interest of the building owner. In their present posture, however, the Illinois cases preclude consideration of such factors. They do, however, permit a finding that where, as here, a building is economically useless and was obviously purchased for its scrap or salvage value, there is no insurable interest. This is such a case…’

Mackinnon J:

‘[a valued policy is] not a contract of indemnity ideally, but of an indemnity according to the conventional terms of the bargain. When a loss has happened the question is hardly ever: How much is the assured out of pocket? That might be the proper question if the object of the contract was to provide an ideal indemnity. The real question in any case is: What is the measure of indemnity that by the convention of the parties has been promised to the assured?’

“In the event of partial loss or damage…the amount of the loss shall be the cost and expense of restoration plus any resulting depreciation in value. Underwriters’ liability shall be limited to that proportion of such loss or damage which the sum insured bears to the market value of the item immediately prior to the loss and in no event shall underwriters be liable for more than the insured value of the Item.”

Thomas J:

‘Issue (1): Was the policy a valued policy? It was also common ground that I should construe the policy as a whole (including both the endorsements) in the light of the principles applicable. In Kyzuna Investments Ltd v Ocean Marine Mutual Insurance Association (Europe), [2000] 1 Lloyd’s Rep 505, I endeavoured to summarise at p 508 the principles applicable to determining whether a policy of marine insurance was a valued or unvalued policy. Those principles are also generally applicable to non marine insurance; in para (5) of my summary in Kyzuna, I referred to the fact that it is common for a policy of marine insurance to be a valued policy and set out the reasons for that. As regards non-marine insurance, a passage at paras 28–7 of Professor Clarke’s The Law of Insurance Contracts (1999 edition) is helpful.

However it is important to bear in mind that there is an accepted and well known distinction between an insured value and a sum insured: The use of the term “sum insured” will normally indicate the amount for which the subject matter is insured and will not be read as an agreed value. There are a number of authorities that make this clear. (See Kyzuna at p 509)…

Although the clause relating to La Danse Grecque refers to the sum of US $5.3 m., it does not do so in terms of value. Although I see the force of the argument made by the claimant that one would ordinarily have expected the parties to agree a value for a work of the importance and value of La Danse Grecque, the parties did not do so. Although they did not use the words “valued at”, that is clearly not decisive as any language can be used. However, they expressly used the words “in addition to the policy limits hereon, including while anywhere within the geographic limits of this policy”. It seems to me clear that they were adding this picture as an additional work with a further policy limit, though expressed in dollars…There are no words that stipulate that this is an agreed value. Furthermore the words of cover in the policy are expressed in terms of “up to the amounts stated”; the clause adding La Danse Grecque did not use any words to modify that basic provision.

The endorsement agreed on 17 January 1992 applied from inception. Although therefore as a matter of context and timing, it was agreed after the loss, it was to apply from inception. It was therefore common ground that I should construe it as if it had always been part of the policy. The clause was, however, ambiguous and contained a clear contradiction in the terms used in the second sentence. This is somewhat remarkable, given the fact that it was agreed after the loss and was intended to deal with it.

The first sentence was clear; the amount recoverable was the cost of restoration and the resulting depreciation in value. The second sentence then purported to limit the recovery by reference first to the proportion the “sum insured” bore to the market value immediately prior to the loss, with a cap of the “insured value” of the item. Both parties contended that in the second sentence, the parties could not sensibly have intended to refer to both the sum insured and the insured value; both references must have been either to the one or the other. The claimant contended that both references must be read as being to insured value…

It is unfortunate that after the loss the parties should have agreed a clause that is so unclear. On the claimant’s submissions this partial loss clause had the effect of confirming the policy as a valued policy after the loss; on the underwriters’ case it introduced an average clause of a most unusual kind at that point in time. However, as I have said, it is common ground that I must construe the clause as if it had always been part of the policy.

Approaching the policy as a whole, including the partial loss clause, I do not consider it to be a valued policy. I have already considered the other terms of the policy. The first sentence of the partial loss clause is the primary measure of recovery; on its ordinary language, it is to be read as referring to depreciation in value in terms of market value. This sentence therefore does not point to the policy being a valued policy, though it is not inconsistent with it being a valued policy. Thus the second sentence is crucial to the claimant’s argument; the difficulty is that the operative words that would apply the principles of a valued policy are expressed in terms of “the sum insured” and if I were to read those words as “insured value of the item”, I would not only be making a major interpolation, but the last phrase in that sentence would have no purpose. Furthermore the terms of the partial loss clause would not obviate the need for an enquiry into the market value; it would be a little unusual to find therefore the decisive terminology in such a clause. In my view, less violence is done to the language and a greater consistency is achieved by reading “sum insured” to mean, as it says, sum insured. The clause would then operate as an average clause. However this leaves the difficulty that it would operate, on its literal language to reduce the recovery if the market value had fallen below the sum insured; this was not a result for which underwriters contended and it is wholly so uncommercial that the result cannot have been intended…the second sentence of the partial loss clause was plainly intended to operate only where the market value had risen and had no application where it had fallen.

In the result therefore I have concluded that this was not a valued policy.

Issue (2) What damage did the pastel sustain which is recoverable under the policy? [This was an issue of expert evidence.] Underwriters contended that apart from the paper tears and bowing of the board (which they accepted to be direct physical damage), there was no other direct physical damage.

I do not agree with that submission on the facts of this case as I have found them to be. I accept that depreciation in value because of the suspicion of possible physical damage is not covered; I also accept that indirect physical damage is not covered. However, I have found that there was sub- molecular damage to the pastel caused by the fire; that was, in my view, damage to the picture. In my view such damage is clearly direct physical damage resulting from the fire, even though it might not be visible and its extent could not be determined without testing which could not be carried out because of its effects on the pastel…

The sub-molecular change gives rise to the shortening of the life of the pastel and the risk of deterioration. As time passes and no deterioration occurs, the risk must become less, but I have to assess that risk at the time the damaged value has to be ascertained immediately after the fire.

Furthermore it seems to me clear that in assessing the diminution in value of the picture, I must take into account the view which the market would take of the value of the picture with the physical damage I have found existed. It may well be that the market attributes to such damage a much greater monetary effect than a detached and rational analysis might suggest; however, it is common place that in the case of more prosaic goods that have suffered minor damage (such as damaged cargo), the diminution in value might in consequence be greater than might at first sight be assumed, because of the view taken by the market of such goods. That is a function of the market’s view of the value of goods which have suffered damage as a result of an insured peril; it is not a separate element of “stigma”.

Issue (3): The value before and after the fire There was very little authority that Counsel could find, despite extensive research, on the approach to the valuation of a work such as La Danse Grecque.

I consider that the task of the Court is to ascertain the price that could be achieved between a willing seller and a willing buyer within a reasonable period of time in the relevant market or markets; if there is an open market price, that should be ascertained. That test is, it seems to me, consistent with the approach taken in relation to the sale of goods…the approach to valuation under many statutes (such as s 160 of the Inheritance Tax Act and corresponding provisions of other revenue statutes, s 9 of the Leasehold Reform Act, 1967 and s 459 of the Companies Act, 1985), the observation of Colman J at p 24 of his judgment in The Timbuktu [2001] 1 Lloyd’s Rep 739 and the general guidance by the Royal Institute of Chartered Surveyors as to the basis for valuations conducted by them.

In assessing the value, I should take into account whatever evidence is available: see Professor Clarke’s The Law of Insurance para 28–3B. That will include evidence of prices obtained at auctions: see Luxmoore-May v Messenger May Baverstock [1990] 1 WLR 1010 at pp 1026–1027…

On the basis of [the] authorities [three tax cases: Holden v IRC [1974] 2 All ER 819; Holt v IRC [1947] 1 All ER 148; and Mouat v Betts Motors [1959] AC 71] it seems to me that I ought to have regard to the market where it was likely that the higher price would be obtained — the dealers’ market. Furthermore that was the market where the claimant was more likely to sell the picture and therefore it more accurately reflected the loss against which the claimant is entitled to be indemnified. If, on the facts, it was clear that the claimant would have used the market where the price was likely to be lower, the position might be different, but on the facts of this case, I am satisfied that in October, 1991 the claimant…were going to sell on the dealers’ market. However the dealers’ market and the auction market did not operate in isolation and it is relevant to take into account the available evidence in relation to both.

The commissions in the market for works of art of this value are very large indeed — whether the sale is by auction or through a dealer. Should they be taken into account? In my view they should not be. Commissions are not normally taken into account in valuations and I see no reason to do so in this market.

It was common ground that there was no market for the damaged pastel. In the circumstances, I will follow the approach suggested by Devlin J in Biggin & Co v Permanite Ltd [1951] 1 KB 422…He observed that one could rarely arrive at an accurate figure of damaged value; in the absence of precise evidence “the court must do the best it can” [taking into account expert evidence]…

I am quite satisfied that the picture had a value in excess of US $3 m. but not greater than US $4 m. in the sense of the price likely or reasonably expected to be obtained between a willing seller and a willing buyer.

Doing the best I can in what is a very difficult area of assessing value, I consider that the value was towards the higher end of that bracket; for example a prospective buyer was unlikely to have indicated an offer in the region of US $3 m. if he was not willing to go higher. In my assessment, taking all these factors into account, I have come to the conclusion that the value was US $3.6 m on the dealers’ market immediately preceding the fire.

The damaged value after the fire

Mr Roundell assessed the depreciation as 20 per cent; Mr Dauberville at 80 per cent. if assessed immediately and 55 per cent. if assessed in March, 1992. The difference between them was large and no doubt reflected the difficulty of assessing the depreciated value and their lack of experience in selling works of this value that were damaged…

I am also satisfied that the range of those interested in the picture in its damaged state would have been fewer; although there were dealers who would have been prepared to market it, a large number would not. Furthermore, the number of museums and serious collectors likely to be interested would have been few; I consider the evidence of Mr Dauberville was correct on this point.

In valuing the picture after the fire, I must look at the risks of further deterioration as they might have been assessed at the time (on the assumption that restoration work had been carried out). Even allowing for the few months that had elapsed by the end of that, it would have been difficult to assess what long term effect the sub-molecular damage might have had.

On the other hand, I have to treat Mr Dauberville’s figures of 80 per cent. (if put on the market in 1991) and 55 per cent. (given in April, 1992) with some caution. He plainly had no actual experience of selling such works in a damaged state…

Doing the best I can and taking into account the fact that I am dealing with a work of very high value, considering that the uncertainty present in October 1991 (allowing a few months for conservation and thus time to see if any of the sub-molecular damage had manifested itself) and taking into account that Mr Dauberville’s figure was given in April, 1992, I consider that its value in its damaged state would have been US $2.2 m.

Conclusion I therefore conclude that the claimant is entitled to recover US$1.4 m under the policy of insurance.’

Forbes J:

‘The classic statement of the basis of the assured’s right to indemnity is to be found in the judgment of Brett LJ (as he then was) in Castellain v Preston, (1883) 11 QBD 380 at p 386:

Mr Wilmers [counsel for defendant insurers] also relied strongly on a passage from the judgment of O’Connor LJ in Murphy v Wexford County Council (1921) 2 IR 230 at p 240:

Now Murphy’s case arose not under an insurance policy but under a statute giving compensation, to persons whose property had suffered malicious damage. The Court in that case was equating the measure of compensation with the measure of damages in ordinary civil cases:

A similar broad principle is apparent in the English law of compensation for compulsory acquisition:

But these are all broad principles — you are not to enrich or impoverish: the difficulty lies in deciding whether the award of a particular sum amounts to enrichment or impoverishment. This question cannot depend in my view on an automatic or inevitable assumption that market value is the appropriate measure of the loss. Indeed in many, perhaps most cases, market value seems singularly inept, as its choice subsumes the proposition that the assured can be forced to go into the market (if there is one) and buy a replacement. But buildings are not like tons of coffee or bales of cloth or other commodities unless perhaps the owner is one who deals in real property. To force an owner who is not a property dealer to accept market value if he has no desire to go to market seems to me a conclusion to which one should not easily arrive. There must be many circumstances in which an assured should be entitled to say that he does not wish to go elsewhere and hence that his indemnity is not complete unless he is paid the reasonable cost of rebuilding the premises in situ. At the same time the cost of reinstatement cannot be taken as inevitably the proper measure of indemnity. There must be cases where no one in his right mind would contemplate rebuilding if he could re-establish himself elsewhere. The question of the proper measure of indemnity thus becomes a matter of fact and degree to be decided on the circumstances of each case.

At this juncture it seems important to me to consider what in fact is; and was, the attitude of the plaintiff towards this building. Having seen them both in the witness box and heard not only their own evidence but other evidence too, I have reached certain firm conclusions on this matter. I am satisfied that they fully intended to use the maltings as a grain store and for the production of cattle feed. They were going to start in a small way and hoped to build up a business in time…They had bought an outstanding bargain when they secured the maltings for £16,000. I am quite satisfied that had they been faced with paying something over £50,000 for the maltings they would in all probability not have bought them; they would almost certainly have preferred a new Boulton and Paul building and the land to put it on at the same price. At the same time I am quite satisfied that having bought them they not only intended using them for the purposes I have just described; they still so intend if the maltings are reconstructed. Further I feel satisfied that they genuinely intend to reconstruct the maltings if they receive a sum adequate to cover the cost of reasonable reconstruction. I am satisfied too, from their answers in evidence, that they could between them raise sufficient money to reconstruct even without the insurance moneys. I am not at all satisfied however that they would ever be sufficiently unwise to attempt to do so and certainly not to the old design and with the old type of material. They are both shrewd men of large resources. They could employ £¼ million more profitably than in rebuilding Stonham mattings. But they feel that, having insured the property for a very large sum on the advice of the insurers, they should be entitled to rebuild at the insurers’ expense, and not be forced to rebuild a replacement building elsewhere.

Now Mr Wilmers argues that even if the plaintiffs have a genuine intention to reinstate you have to consider whether such an intention could be regarded as reasonable or merely eccentric. One can, I think, without doing him an injustice, expand this argument in this way, having regard to the views I have just expressed about the plaintiffs’ attitudes: if the plaintiffs were prepared to expend their own money on rebuilding it might be said that it had been shown that they were not being merely eccentric; but if they are only prepared to reconstruct if they get the insurance money to cover the cost then this demonstrates that the intention to rebuild, while genuine, is not that of a reasonable commercial person and therefore reconstruction is not the measure of indemnity…Now Mr Wilmers’ favourite case — Murphy — was a case of compensation where the owner was not being dispossessed, and the true view in such cases was expressed by O’Connor LJ in these terms:

The upshot is that I am satisfied that the plaintiffs do have the genuine intention to reinstate if given the insurance moneys; that this is not a mere eccentricity but arises from the fact, as I find, that they will not be properly indemnified unless they are given the means to reinstate the building substantially as it was before the fire but with appropriate economies in the use of materials. I am fortified in this conclusion by the fact that throughout the considerable correspondence and negotiations which preceded this action…every one on the defendants’ side appears to have been ready to accept that, so long as the plaintiffs intended, to reinstate, the true measure of indemnity was the cost of reinstatement. No one suggested that this was a mark of eccentricity; it appears to have been accepted that it was not an unreasonable course to pursue. On the basis of reinstatement therefore I consider that the plaintiffs are entitled to £246,883, the figure produced by Haymills [building contractors instructed by the insurers’ adjusters]. This figure, however, takes no architects’ fees or VAT at 8 per cent. and architects’ and surveyors’ fees 12½ per cent. should therefore be added to that figure…

It follows that I am not satisfied that the indemnity required would be any more than the £55,000 necessary to buy and erect a suitable building of modern steel, and asbestos construction and the land on which to erect it…

Two points however, remain. The first is betterment. Now the principle of betterment t is too well established in the law of insurance to be departed from at this stage even though it may sometimes work hardship on the assured. It is simply that an allowance must be made because the assured is getting something new for something old. But in this class of insurance there is no automatic or accepted percentage deduction. In some of the calculations put before me an attempt was made to establish a figure of 13.3 per cent as the appropriate reduction for betterment. This figure has no validity. It happens to be, mathematically, the result of stating as a percentage the figure agreed as a deduction for betterment between assessors and adjusters…But this deduction itself was clearly not the result of applying a percentage, and particularly not one as unlikely as 13.3 per cent. The figure was one which, when deducted from the adjusted Haymills’ figure left a convenient round sum. I have had no acceptable evidence on what would be the proper deduction for betterment on the basis that Haymills…is the estimate to be adopted, and I must do the best I can in the circumstances. When I consider that this estimate already takes into account the reuse of a great deal of second-hand material and, where it does not; accepts in many cases the substitution of inferior substances I think that betterment must very largely have been absorbed in the reduced estimate. There may well be some instances in which some new for old exchange can be detected, but they must be minimal and in any event the defendants have not adduced any satisfactory evidence which could enable me to make any confident further reduction, if reinstatement costs are to be taken. If the alternative of market-value is to be adopted, betterment must be applied to this. The hypothesis on which this value falls to be chosen is severely commercial so that betterment has considerable logical validity. Taking a broad view on the evidence I have heard, the figure for deduction probably lies between a third and a quarter of the total. On building costs of £35,000, a deduction of £10,000 would I think be fair to both sides. The total figure, including land, would then be £45,000.’

Megaw LJ:

‘Ever since the decision of this court in Castellain v Preston (1883) 11 QBD 380, the general principle has been beyond dispute. Indeed I think it was beyond dispute long before Castellain v Preston. The insured may recover his actual loss, subject, of course, to any provision in the policy as to the maximum amount recoverable. The insured may not recover more than his actual loss. As it was put by Brett LJ in Castellain v Preston…

…What the insurers have agreed to do is to indemnify the insured in respect of loss or damage caused by fire. The “full value” the cost of replacement. That defines the maximum amount recoverable under the policy. The amount recoverable cannot exceed the cost of replacement. But it does not say that that maximum is recoverable if it exceeds the actual loss. There is nothing in the wording of the policy, including the declaration which is incorporated therein, which expressly or by any legitimate inference provides that the loss which is to be indemnified is agreed to be, or is to be deemed to be, the cost of reinstatement, the “full value,” even though the cost of reinstatement is greater than the actual loss. The plaintiff is entitled to recover his real loss, his actual loss, not exceeding the cost of replacement.

There remains the second question. Was the plaintiff’s actual loss the cost of the reinstatement of the cottage? Or was it, as the defendants contend, the market value of the property as it was at the time of the fire? The defendants do not rely upon any general principle in support of their submission. They say, rightly in my judgment, that this is a question of fact, and that one must look at all the relevant facts of the particular case to ascertain the actual value of the loss at the relevant date. Of course, one is entitled to look to the future so as to bring in relevant factors which would have been foreseen at the relevant date as being likely to affect the value of the thing insured in one way or the other, if the loss of it had not occurred on that date. But on the evidence in this case, and the judge’s statement of the relevant facts in the passages from his judgment which I have read earlier, it is beyond dispute that the plaintiff himself, at the relevant date, wished to sell the house, and was ready and willing to sell it for £4,500 — indeed, on his own evidence, for less. [Counsel for the claimant] submits that he was not bound to sell it. Of course not. He might thereafter, if the loss had not occurred, have changed his mind. The value of the property might have increased or it might have decreased. But there is no getting away from the reality of the case: “It was” (I am quoting again from the judgment) “an empty cottage that he had for the purpose of sale.” The judge says:

With very great respect, I am unable to see why not. If the plaintiff himself was ready and willing, as he plainly was, to sell the property for £4,500, or less, on 25 October 1978, just before the fire, how can it be said that that was not its actual value at that time: unless, indeed, some reason could be shown why the plaintiff himself should have made a mistake about, or underestimated, its real value. No basis is shown for any such suggestion. The amount of the loss here, in my judgment, is shown by the facts to have been the figure agreed, hypothetically, on this basis, as £3,000…’

Evans LJ:

‘In my judgment the position which arose when the defendants dealt with this matter in the way they did (that is to say, by denying liability, even on a ground which subsequently they have not sought to uphold) placed the plaintiff in a position where he was entitled and, indeed, bound to proceed as if he was uninsured. In other words, he could proceed to reinstate or repair the damaged property if he was so advised. If he decided to do so and then subsequently claimed against the defendants under the policy, it seems to me that the defendants would not then be in a position to allege by way of defence that there had been a breach of condition (6) [of the policy]; in other words, they would have disqualified themselves from saying that, the repairs having been carried out without their consent, the plaintiff was not entitled to recover the promised indemnity under the policy.