Actual Cash Value and Contractor Fees

The Arizona Court of Appeals finds that, if a general contractor may be needed for repairs or replacement, payments to the insured should include contractor overhead and profit fees – even if no contractor is used

In the summer of 1998, the home of Mr. & Mrs. Tritschler was damaged by rain. They filed a claim under their homeowners policy from Allstate Insurance, and Allstate hired a general contractor – we’ll call it “XYZ Construction” – to perform the needed repairs.

XYZ Construction provided to Allstate a written estimate that totaled about $44,000, an amount that included a 10% profit and 10% overhead charges for XYZ.

The Tritschlers assigned payment of their insurance proceeds to XYZ, and XYZ began work to repair the home. However, before the repairs were completed, the Tritschlers became dissatisfied with the quality of the work. After XYZ left the job, the Tritschlers informed Allstate that they planned to make the remaining repairs themselves.

When Allstate offered to “cash out” the repair claim, the Tritschlers accepted. Without investigating whether XYZ’s work was truly substandard, Allstate paid XYZ $26,200 for the work it had performed. In addition, Allstate paid the Tritschlers $11,500 – an amount equal to the difference between XYZ’s estimate and the amount paid to XYZ, less the overhead and profit charges contained in the estimate.

Allstate’s $11,500 payment to the Tritschlers was accompanied by a letter that stated, “If you decide to use a general contractor, please submit signed contract or paid bill and [Allstate] will reimburse the contractor overhead and profit.”

After the house was repaired, the Tritschlers submitted to Allstate an actual cash value proof of loss and a demand for $36,000. That amount included $8,000 for general contractor’s overhead and profit, even though the Tritschlers did not use a general contractor.

In reimbursing the Tritschlers, Allstate paid the entire amount of the claim, plus $5,000 (based on Allstate’s estimate of remaining repairs), but deducted the overhead and profit portion of the claim.

Lawsuit. The Tritschlers sued Allstate, claiming that Allstate had breached its contract by failing to pay the general contractor’s overhead and profit. There were other allegations as well – concerning alleged bad faith, collaboration with XYZ to make substandard repairs, etc., and a claim for punitive damages – but much of the attention focused on whether the Tritschlers’ decision not to use a general contractor excused Allstate from paying the overhead and profit portion of the claim. (XYZ was also named in the suit, but the claims against the contractor were not pertinent to the central theme of this article.)

In Superior Court, Allstate filed a motion for summary judgment on all elements of the Tritschlers’ complaint. The trial court granted Allstate’s motion, and the Tritschlers appealed.

Appeal. The Tritschlers argued, in Superior Court and again in their appeal, that the actual cash value coverage (as provided in their policy under a subsection [b]) included the contractor’s overhead and profit, and, thus, they were entitled to receive those amounts regardless of whether they used a general contractor.

Allstate countered that the provision cited by the Tritschlers applied only to insureds who choose not to repair their properties. Allstate repeated its successful trial court argument that, since the Tritschlers did repair their property, Allstate was obliged to pay only for coverage pertaining to the building structure reimbursement provision (a subsection [c]) of the policy, which provided not for contractor overhead and profit but, rather, “the amount actually and necessarily spent” to repair or replace the damaged property.

Findings. The Court of Appeals did not view this issue with the same degree of clarity as did the trial judge in granting Allstate’s motion for summary judgment:

“[T]he trial court erred in finding as a matter of law that Tritschler was not entitled to receive the actual cash value under subsection (b) and that his claim was governed solely by subsection (c). Nevertheless, we may still uphold the trial court’s grant of summary judgment to Allstate on the issue of contractor fees if it is correct for any reason.”

The Court then sought to determine whether the “actual cash value” in the Allstate policy included general contractor overhead and profit when no contractor is used. The Court noted that, while an endorsement attached to the policy defined “actual cash value” as “the current cost to repair or replace covered property with new material of like kind and quality less a deduction for physical deterioration and depreciation, including obsolescence,” the policy did not specify how Allstate calculated the “cost to repair or replace covered property” or whether the value included contractor overhead and profit fees.

Finding no binding judicial precedent in Arizona, the Court looked to other states for persuasive guidance.

• A 1987 Kentucky case, Snellen v. State Farm Fire & Casualty Co., supported Allstate’s position. The court in that case determined that “since the goal is to arrive at the actual cash value of the damage, non-damage factors … such as clean-up, profit, overhead, and permits, were properly deducted.”

• Conversely, a 1994 Pennsylvania case, Gilderman v. State Farm Insurance Co., favored the Tritschlers’ position. In that case, the court noted that “there are types of property damage where … there is extensive damage to a home requiring the use of more than one trade specialist.” That court found that, in such instances, an insurance company may not deduct contractor fees from the actual cash value when such fees are reasonably expected to occur.

• Similarly, in a 1998 Michigan case, Salesin v. State Farm Fire & Casualty Co., the court found that “the expense of a general contractor cannot be deducted … unless such services are not likely to be required.” The homeowner in that case, like the Tritschlers, had made his own repairs and did not incur any contractor fees. That fact did not affect the court’s holding that it was improper for the insurance company to automatically deduct contractor overhead and profit from the actual cash value payment.

The Arizona court noted that “several other jurisdictions have since followed the reasoning in Gilderman and Salesin and ruled that an insurer may not automatically deduct a contractor’s overhead and profit from an actual cash value payment.”

Conclusion. In the end, the Court vacated the trial court’s granting of Allstate’s motion for summary judgment and sent the case back to Superior Court.

While that ruling does not provide ironclad direction to insurance companies regarding comparable claims, insurers would be wise to note the Court’s holding on the issue of actual cash value and contractor fees:

“Based on the foregoing analysis, we hold that under this policy actual cash value in adjusting a property loss includes any cost that an insured would be reasonably likely to incur in repairing or replacing a covered loss[.] … And, if the cost to repair or replace the damaged property would likely require the services of a general contractor, the contractor’s overhead and profit fees should be included in determining actual cash value, even when an insured ultimately elects to complete personally the needed repairs.”

Lang & Baker attorney Bill Klain contributed to this article.

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