Economic Obsolescence Not Considered in Calculating Actual Cash Value

On June 17, 2014, the U.S. Court of Appeals for the Sixth Circuit addressed the meaning of the term “obsolescence” as used in an insurance policy in the context of determining the “actual cash value” of a fire loss in the case titled Whitehouse Condo. Group., LLC v. The Cincinnati Ins. Co., — Fed.Appx. —, 2014 WL 2743480 (6th Cir. 2014) whether the term “obsolescence” in the definition of “actual cash value” in a fire insurance policy accounts for external changes in market value through the concept of “economic obsolescence.”  After surveying use of the terms the court determined that the commonly understood meaning of obsolescence did not account for market value decline.

The insured’s condominium building located in Flint, Michigan, was destroyed in a fire.  The insurance company that covered the building admitted that it owed the insured.  The dispute was how much it owed.  The policy required the insurance company to pay the insured the “actual cash value,” which was defined as “replacement cost less a deduction that reflects depreciation, age, condition and obsolescence.”  The insurance company argued for a broad interpretation of obsolescence which would include economic obsolescence—decrease in market value—in which case the actual cash value would be $1,187,660.  The insured, on the other hand, argued for a more narrow interpretation of the term that would only include functional obsolescence, which would mean the actual cash value would be $2,767,730.  The court summed up the dispute as whether the insurance company was to receive the benefit of a decrease in market values in Flint, Michigan.

The federal district court in Michigan determined that the term obsolescence was unambiguous as used in the policy, and that it did not include economic obsolescence.  The court there considered case law from the Southern District of New York in concluding that nothing in the insurance contract indicating the parties intended to take into account market prices when determining actual cash value.  Specifically, found persuasive (1) the fact that the contract did not require consideration of all pertinent evidence—unlike the court-created “broad evidence rule” which has been adopted in Michigan in cases where actual cash value is not defined; (2) the use of the term “deduction” suggested that market factors should not be taken into account because they can also increase; and (3) the parties could have used the term “market value” if they intended it to be considered.  The insurance company appealed.

The Court of Appeals began its analysis by considering the general definitions of the terms: “functional obsolescence means a loss in value due to something inherent to the building itself such as old technology (think an electrical panel that is no longer acceptable under current codes) or bad design (think a five bedroom house that only has one bathroom). … Economic obsolescence means a reduction in value due to market factors entirely external to the building, such as neighborhood factors (this might occur if the neighborhood were suddenly under a noisy flight path) or the general market (the real estate market crash appears to be the factor in this case).”  The court then considered the various dictionary definitions advocated by the parties and determined they did not resolve the issue.  It next turned to case law on the subject, which supported the conclusion that economic obsolescence is treated as a specialized term not used in the commonly understood meaning of obsolescence.  The court also found persuasive the fact that the other factors used in the definition—depreciation, age, and condition—all related to something inherent in the building rather than an external market condition, suggesting that the term obsolescence should likewise be limited to functional considerations.  Based on those considerations, the Court of Appeals upheld the district court’s ruling in favor of the insured, determining that the insurance contract did not support the insurance company’s use of economic obsolescence in determining actual cash value.

Maloney Lauersdorf Reiner regularly litigates property loss insurance cases involving issues of actual cash value.  Please contact us with any questions about this case or any other issue you see addressed in the Insurance Coverage Blog.

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