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February 2013

Policy Exclusion Precludes Coverage for Home Demolished By City Order

The California Court of Appeal for the Fourth Appellate District recently held that a policy’s “law or ordinance” exclusion precluded coverage for a partially remodeled home that violated flood plain regulations and was demolished pursuant to an order of the city of Huntington Beach. In Reichert v. State Farm General Insurance Co., the appellate court affirmed the trial court’s order, which granted summary judgment in favor of the defendant insurer.

In September 2007, Eric and Liz Reichert purchased a two-story home in Huntington Beach, which was located in a flood zone.  The Reicherts hired an architect and contractor to remodel the home and submitted several plans to the city.  In the first set of plans, the overall value of the home was to increase more than 50 percent and more than 50 percent of its existing walls were to be modified.  This plan triggered a city “in fill” requirement so neighbors would have to sign-off on the placement of windows and a federal FEMA requirement so the ground floor would have to be raised because the property was located in a flood plain. 

As a result, the Reicherts submitted a second set of plans that left several existing walls in place to avoid the city’s “in-fill” requirement, which meant the property value would have increased by just under 50 percent and the FEMA requirement would have been avoided.  The city approved the plans and the Reicherts began the remodel.  During construction, however, the project manager discovered that the existing 8-foot walls, which were supposed to be left in place, could not support the permitted 10-foot ceilings.  The project manager reported the oversight to the architect and contractor, and was instructed to tear down all the walls, including the walls designated to remain as part of the approved plans.  

During the next city inspection, it was discovered that the Reicherts exceeded the scope of the permit and that the addition of all new walls and the corresponding increase in the overall value of the home would trigger the city and FEMA requirements.  A “stop work” order was immediately issued.  The Reicherts sued the contractor and architect and made a claim for insurance benefits under their homeowners policy to State Farm General Insurance Co.  The home was later completely demolished by order of the city.  

The trial court granted summary judgment in favor of State Farm finding that the demolition could not be an accidental loss under the insurance contract, and the exclusion of losses for enforcement of any ordinance or law was “fairly obvious.”  The Reicherts appealed.

In its Dec. 28, 2012, opinion, the Court of Appeal did not address whether there was an “accidental direct physical loss” as required by the policy, but instead focused entirely on whether the law or ordinance exclusion applied.  The “law or ordinance” exclusion provided, “We do not insure under any coverage for any loss which is caused by one or more of the items below, regardless of whether the event occurs suddenly or gradually, involves isolated or widespread damage, arises from natural or external forces, or occurs as a result of any combination of these [¶] a. Ordinance or Law, meaning enforcement of any ordinance or law regulating the construction, repair or demolition of a building or other structure.” 

The Court of Appeal first discussed the fact that there was a split among California courts as to whether, after a loss from a covered peril, a first-party property insurer is required to pay for code upgrades to replace the lost or damaged property, even if the insured ultimately receives something better than they had.  The two camps are divided into “anti-windfall” and “pro-compliant”.  The appellate court stated the split was not directly relevant because the Reicherts’ loss was not caused by a covered peril.  However, the court found the cases instructive because they establish that “the clear intent of the law or ordinance exclusion is to exclude loss when it is the law or ordinance itself – as distinct from, say a fire – that is the cause of the loss.”  As a result, the court found that the “law or ordinance” exclusion clearly applied because the undisputed facts showed the property was demolished pursuant to the city’s proper enforcement of FEMA floodplain regulations.

The appellate court rejected the Reicherts’ contention that Option OL of their policy provided coverage for their loss.  Instead, the court found that Option OL provides an insured with additional amounts under the policy to cover replacement costs for required code upgrades, only where there already is a loss from a covered peril.  Since the Reicherts’ loss was not from a covered peril, Option OL did not apply.  The court found its conclusion was consistent with the limited case law discussing Option OL.

The court also rejected the Reicherts’ contention that the cause of their loss was not the governmental enforcement action, but the third-party negligence of their architect or contractor.  The court relied on the language of the policy, which stated the insurer does not insure for loss in its listed exclusions regardless of whether there was “defect, weakness, inadequacy, fault or unsoundness in (1) [¶] planning . . . [¶] (2) design, specification . . . [¶] of any property” that directly or indirectly caused, contributed to or aggravated the loss or occurred before, or at the same time or after the loss of any other cause of the cause. Therefore, the court concluded that even if third-party negligence was a cause of the loss, the policy still excluded the loss.
Accordingly, the Court of Appeal affirmed the judgment of the trial court.

Click here for the opinion. 

The opinion in Reichert v. State Farm General Insurance Co., 212 Cal.App.4th 1543, is not final. It may be withdrawn from publication, modified on rehearing, or review may be granted by the California Supreme Court. These events would render the opinion unavailable for use as legal authority.

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Jordan S. Altura
Aaron P. Rudin