Policy language holds the key to loss-of-rents coverage; a look at Folksamerica Reinsurance and the clarity it brings to this issue
Commercial-property owners have coverage for physical damage to their building, but what if the time to repair that physical damage results in a tenant who moves out or who refuses to pay rent, or what if the building was in the process of being rented at the time of the loss?
It all comes down to the policy language of course, but some policies are unclear on when loss-of-rents coverage is triggered. Under a homeowner’s policy, if a covered physical loss to the property occurs, and the repairs (or the damage itself) force the insureds to move out, coverage is usually pretty clear. The insurance company must pay up to the policy limits for the time the insureds have to relocate in a monthly amount that is commensurate with the insured property. The only issue that arises here is if the insurer takes an unreasonable amount of time to adjust and pay the claim for the property damage. Then, the limits may be suspended for the period of time that is an unreasonable delay.
For commercial property, the situation can be quite different. What is insured is not the right of the insured to live in a place similar to their insured residence. Instead, what is commonly being insured is the right of the building owner to collect rent from a third-party occupant of the property. If the renter must move out because of covered damages, then the rent that was being paid by that tenant is recoverable under most commercial insurance policies. If, however, the building is vacant at the time of the loss – say when it is in between tenants – then what? Under most policies, the coverage still exists, even though there is no rent being paid that is to be reimbursed. The reason why there is still coverage is because of the economic concept of “opportunity cost.” If, for example, it takes a year to repair the property, then that is one year when the property could not be rented, and coverage should be afforded for that loss.
The California Court of Appeal ruled in 2013 that when the policy promises to pay the insured for “loss of rents,” but goes into no further detail regarding the actual presence of a tenant at the time of the loss, the claim is covered even if the building is vacant at the time of the loss.
Ventura Kester, LLC, v. Folksamerica Reinsurance Co.
In Ventura Kester, LLC, v. Folksamerica Reinsurance Co. (2013) 219 Cal.App.4th 633, the Court of Appeal found that lost rents are covered even when there is no tenant: “Since the owner’s need for rental income and loss of rental income did not depend on having a tenant in place at the time of the covered incident, it was reasonable for the policyholder to expect the policy covered the owner’s actual lost rent as a result of the damage and did not depend on the fortuity of having a tenant in place when the damage occurred.” (Id. at 642.)
•The Folksamerica policy language and the ISO form
The Folksamerica policy is not an Insurance Services Office (“ISO”) policy. It is drafted by Folksamerica itself and differs somewhat from the ISO form used by the majority of property and casualty insurers.
The ISO form states:
(2) “Rental Value”
If the necessary “suspension” of your “operations” produces a “Rental Value” loss payable under this policy, we will pay for the actual loss of “Rental Value” you incur during the period that:
(a) Begins on the date property is actually repaired, rebuilt or replaced and tenantability is restored; and
(b) Ends on the earlier of:
(i) The date you could restore tenant occupancy, with reasonable speed, to the level which would generate the “Rental Value” that would have existed if no direct physical loss or damage had occurred; or
(ii) 30 consecutive days after the date determined in (2)(a) above.
Under this language, loss of rents is covered until “tenantability is restored.” The coverage also requires an “actual loss” of “rental value.” Some insurers argue that if there is no tenant at the time of the loss, then there is no “actual loss.” Ventura Kester eliminates this argument as a defense against coverage in those circumstances.
The Folksamerica policy defines whether the loss of rents claim is covered in two areas of the policy. The first is in the grant of coverage:
Subject to the terms, conditions and limitations of this policy, we insure you against financial loss resulting from:
. . . .
(3) rents including accrued rents which become uncollectible, and extra expense incurred to prevent loss of rents, because of damage to or destruction of covered structures caused by an accident.
All that is required for the loss of rents coverage to apply is (1) A financial loss, (2) resulting from rents (inclusive of accrued rents) or extra expense, (3) be-cause of damage to covered structures. In other words, if there is “damage to . . . covered structures caused by an accident,” then there is loss of rents coverage.
The first element was present in Ventura Kester. Ventura Kester suffered a financial loss of approximately $3.8 million in lost rents as a result of a vandalism claim. Certainly the fact that the building was vandalized and needed time to repair would prevent Ventura Kester from collecting rent from a tenant. Even Folksamerica conceded that the damages would take nearly a million dollars to repair; that was certainly not a repair that could take place in an afternoon. Ventura Kester’s expert opined that it would take approximately a year to complete the work. If there had been no vandalism, Ventura Kester could simply have completed the lease that it was negotiating with OfficeMax prior to the loss and rented the building. It could not be seriously contended that Ventura Kester suffered no “financial loss” as a result of not being able to rent the building. Although the parties might disagree as to the amount of the damages, there can be no dispute that there was some financial loss.
The second element is that the financial loss must result from rents or extra expense incurred to prevent loss of rents. Here, because the building was vandalized and had to be repaired, it could not be rented, so there was a loss of rents. Ventura Kester also incurred significant extra expenses in attempting to avoid a loss of rents by hiring attorneys, designers, and architects to attempt to get the building back into a state where it could be rented. Ventura Kester also had to pay for taxes and insurance, which normally would have been paid by the tenant.
The third element was undisputed. Folksamerica paid $927,424.03 on the building portion of the claim.
•These policies provide “all risk” loss of rents coverage.
Since this kind of policy is ordinarily an “all risk” policy, every risk of loss is covered unless specifically excluded. Such a policy does not cover, for example, only losses as a result of the risk of earthquake, and instead covers all risks not specifically excluded.
Under an “all risk” policy, the limits of coverage are defined by the exclusions. (Garvey v. State Farm Fire & Cas. Co. (1989) 48 Cal.3d 395, 406.) The insurer has the burden of proof that an exclusion applies. (Waller v. Truck Ins. Exchange, Inc. (1995) 11 Cal.4th 1, 16.)
•The Folksamerica policy provides three different coverages under this provision.
The second portion of the Folksamerica policy that describes if loss of rents claims are payable states as follows:
Basis of loss payment
Subject to the provisions contained in the limit of insurance section and subject to all other terms and conditions of this policy the amount we will pay is calculated as follows:
. . . .
We will pay:
your net loss of rental income; and rents accrued but rendered uncollectible by reason of a covered loss at a location described on the Declarations Page; and your extra expenses necessarily incurred to minimize your rental income loss, but only to the extent that the rental income loss we would otherwise pay is reduced.
There was coverage in its coverage in Ventura Kester under subsections (a) and (c). Ventura Kester agreed that there was no coverage under subsection (b).
Loss of rents coverage
Under (a), a loss of rental income is covered. In Ventura Kester, the insured lost the ability to collect rent because there was a vandalism claim that caused the building to need nearly a million dollars in repairs that would take a year to complete. Because of the vandalism, Ventura Kester suffered a loss of rental income.
Loss of accrued rents coverage
Under (b), there is coverage for rents that have “accrued” but are uncollectible due to a loss. This scenario does not apply here.
This coverage applies when there is a tenant, but the tenant is not paying rent because of damage to the building. This language proves that subsection (a) applied in Ventura Kester. Ventura Kester’s building was damaged, so Ventura Kester lost the ability to make money by renting it. If subsection (a) only applies when there is a tenant at the time of the loss that has stopped paying rent, then what is the need for (b)? Folksamerica argued that subsection (a) applies when the rent is being paid by the tenant and subsection (b) applies when rent is not being paid by the tenant. The problem with this interpretation is that if the rent is being paid, then there is no loss. Such an interpretation would therefore make subsection (a) totally superfluous.
Any interpretation that would render some language of the Policy meaningless establishes that that interpretation is wrong by definition: “We must give significance to every word of a contract, when possible, and avoid an interpretation that renders a word surplusage.” (Advanced Network, Inc., v. Peerless Ins. Co. (2010) 190 Cal.App.4th 1054, 1063.)
Extra expense coverage
Under subsection (c), there is coverage for extra expenses incurred by the insured to reduce rental income loss. In Ventura Kester, the insured spent money on attorneys, designers, and architects in order to attempt to reduce the rental income loss by getting the building fixed as soon as possible.
Since Ventura Kester spent money in order to get the property ready to rent after the vandalism loss, this portion of the claim should be covered. There are no grounds to state Ventura Kester did not spend money to reduce a loss of rental income.
Ventura Kester suffered a “financial loss” under the policy
The Folksamerica policy only provides loss of rents coverage if there is a “financial loss.” Folksamerica argued that there was no “financial loss” in Ventura Kester because the building was not rented when it was vandalized. Yet, clearly if it was going to take one year to repair the building, then there is an entire year where Ventura Kester did not have the opportunity to rent the building, suffering the financial loss that it had to spend a year repairing the building before it could be rented.
In Nebo, Inc., v. Transamerica Title Insurance Co. (1971) 21 Cal.App.3d 222, 228, a title insurance policy covered loss of rents due to a defect in title. Because of a title defect, the insured had to pay its mortgage and other expenses but could not rent the building. The court held that it had therefore suffered a financial loss of rents.
An opportunity cost is a financial loss
“An opportunity cost is ‘the benefit forgone by employing a resource in a way that’ prevents it from being put to another use.” (Meyer v. Sprint Spectrum L.P. (2009) 45 Cal.4th 634, 640 n.1.)
The opportunity cost of not being able to rent a building for a year while repairs are made is obvious: when the building is being repaired, it cannot be rented. Such a cost is a real financial loss to the insured. The opportunity cost of repairing the building is forgoing the ability to rent the building. The cost of taking one action is the loss of opportunity to take another.
Separate coverage for “accrued” lost rents proves that there is coverage for lost rents that have not accrued
Under the Folksamerica policy, there is coverage for accrued loss of rents as well as loss of rents. Thus, the Folksamerica policy deems these two losses to be different.
An “accrued loss of rents” is easily understood: when a building is damaged so that a tenant stops paying rent, then that loss of income can be claimed under this coverage.
“Loss of rents” then is where no rent is being received and no tenant owes rent. This situation could only occur where there is no tenant. If there was a tenant, and it was paying rent, then there would be no loss. If there was a tenant, and it was not paying rent, then there would be a claim for “accrued loss of rents.” Thus the only “financial loss” that could occur as a “loss of rents” that is not an “accrued loss of rents” is where the building is vacant, becomes damaged due to a covered loss and thereafter cannot be rented until repaired. There is no other way to ever trigger this coverage.
There were no applicable exclusions in the Folksamerica policy
In the trial court, Folksamerica agreed that no exclusion applied. Folksamerica argued at the Court of Appeal that because it was not relying on an exclusion to deny coverage, its limitation on coverage need not be “conspicuous, plain, and clear.” Yet, any restriction on coverage – such as Folksamerica’s desire to restrict coverage to non-vacant properties – must be clear. This rule applies not just to exclusions, but to any limitations on coverage:
Hence the policy contains its own seeds of uncertainty; the insurer has held out a promise that by its very nature is ambiguous. Although this uncertainty in the performance of the duty to defend could have been clarified by the language of the policy we find no such specificity here. An examination of the policy discloses that the broadly stated promise to defend is not conspicuously or clearly conditioned solely on a nonintentional bodily injury; instead, the insured could reasonably expect such protection.
(Gray v. Zurich Ins. Co. (1966), 65 Cal.2d 263, 272.)
(1) There was no vacancy exclusion
There is no exclusion for vacancy in the Folksamerica policy. Many policies only provide coverage for building loss – especially vandalism claims – if the building is occupied at the time of the loss. The Folksamerica policy did not have such an exclusion. (See, generally, TRB Investments, Inc. v. Fireman’s Fund Ins. Co. (2006) 40 Cal.4th 19, 30; Belgrade v. National Am. Ins. Co., (1962) 204 Cal.App.2d 44, 47.)
(2) There was no “signed lease” exclusion
The person designated by Folksamerica to make the ultimate decision on coverage in Ventura Kester testified that, in order for there to be coverage for loss of rents, there must be a signed lease with a tenant before the loss. But this requirement is not stated anywhere in the policy.
Of course, the test for whether Ventura Kester’s claim is covered is neither a claims person’s ideas nor the denial letter: the sole source of the rules for whether Ventura Kester’s claim was covered was the language of the Folksamerica policy. That policy does not state that a signed lease is required for coverage. It states that there must be a loss of rents as a result of physical damage to the building.
Interpretation of policy language
If a court finds that a policy is clear, then the plain meaning controls. (Bank of the West v. Superior Court (1992) 2 Cal.4th 1254, 1264-65.) If it is in any way uncertain whether or not there is coverage, then the court must look to the objectively reasonable expectations of the insured. (Ibid.) If that analysis does not resolve the question, then the court will construe the language against the drafter, the insurer.
The fundamental goal of contractual interpretation is to give effect to the mutual intention of the parties. If contractual language is clear and explicit, it governs. On the other hand, “if the terms of a promise are in any respect ambiguous or uncertain, it must be interpreted in the sense in which the promisor believed, at the time of making it, that the promisee understood it.” This rule, as applied to a promise of coverage in an insurance policy, protects not the subjective beliefs of the insurer but, rather, “the objectively reasonable expectations of the insured.” Only if this rule does not resolve the ambiguity do we then resolve it against the insurer. (Ibid.)
• The plain meaning of the policy establishes coverage
In interpreting an insurance policy, courts first look to the plain meaning of the policy. Bank of the West, 2 Cal.4th at pp. 1264-65.) If it is clear, it controls. (Ibid.) Words in an insurance policy should be construed as a layperson would read them. If, for example, an insured cannot rent a property due to covered physical damage, then the insured has suffered a “loss”: “Absent any indication that the parties intended some special or legalistic meaning to be given to the definition of ‘Loss,’ it is settled that we must determine its meaning by interpreting the phrase as a reasonable layperson, not as an attorney or an insurance expert, would construe it.” (Executive Risk Indem., Inc., v. Jones (2009) 171 Cal.App.4th 319, 329.)
• The objectively reasonable interpretations of the insured results in coverage
If, after reading policy language, a court is not certain whether or not there is coverage, then the objectively reasonable interpretation of a layperson controls. (Bank of the West, 2 Cal.4th at 1264-65.) In Ventura Kester, the court concluded that an objectively reasonable layperson would consider that a policy that has a loss of rents provision would provide coverage if the building is damaged and cannot be rented.
• If neither the plain meaning nor the expectations of the insured answer the coverage issue, then it is automatically construed against the insurer
Finally, if the court finds that the policy language is still unclear after taking into account the objectively reasonable layperson’s interpretation, then the language is automatically interpreted in favor of the insured. (Ibid.)
• Restrictions on coverage are narrowly construed
E.M.M.I. Inc. v. Zurich American Ins. Co. (2004) 32 Cal.4th 465, 470-71, held that in interpreting an insurance policy, limitations on coverage are to be strictly construed against the insurer:
Furthermore, policy exclusions are strictly construed, while exceptions to exclusions are broadly construed in favor of the insured. “‘An insurer cannot escape its basic duty to insure by means of an exclusionary clause that is unclear. As we have declared time and again “any exception to the performance of the basic underlying obligation must be so stated as clearly to aprise the insured of its effect.” Thus, “the burden rests upon the insurer to phrase exceptions and exclusions in clear and unmistakable language.” The exclusionary clause “must be conspicuous, plain and clear.”’ This rule applies with particular force when the coverage portion of the insurance policy would lead an insured to reasonably expect coverage for the claim purportedly excluded.
If the court in evaluating policy language considers the issue to be a “close call,” then the limitations must be construed against the insurer. It does not create a triable issue of fact, because the issue of policy interpretation is not a factual issue. It is a legal issue to be decided by the Court. (Waller v. Truck Ins. Exchange, Inc. (1995) 11 Cal.4th 1, 18.) Any uncertainty as to the enforceability of an insurance company’s claimed restrictions on coverage must result in a finding against its enforceability.
If Folksamerica had wanted to limit coverage in its policy for loss of rents only to those situations where there is a signed lease with a tenant in effect at the time of the loss, then the policy should have stated that loss of rents and other expense is excluded unless the insured has entered into a written lease with a tenant prior to the date of the physical loss to the building. The policy did not contain that language.
Loss of rents provisions provide coverage when a commercial building can no longer be rented due to covered physical damage to the building – even if (a) there is no tenant in the building at the time of the loss, or (b) the building is not currently lease to anyone. The loss of the opportunity to lease the building is enough for coverage.
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