Under the “Loss Settlement” provision in the typical homeowners property insurance policy, the insurer is not obligated to pay replacement cost benefits unless and until “actual repair or replacement is complete.” The “Loss Settlement” provision also limits the insurer’s replacement cost payment to the lesser of:
- the limit of liability that applies to the building,
- the replacement cost of that part of the building damaged for like construction and use on the same premises, or
- the necessary amount actually spent to repair or replace the damaged building.1
In Batton-Jajuga v. Farm Bureau General Insurance Company of Michigan,2 the Michigan Court of Appeals recently addressed the issue whether entering into a land contract for replacement property satisfies the “actual and complete replacement” and the “amount actually spent” requirements for replacement cost benefits. There, a fire destroyed the insured’s real property. The parties agreed that the replacement cost value of the loss was $179,811.23. Farm Bureau promptly paid $93,000, representing the actual cash value of the destroyed property minus a $1,000 deductible. The insured subsequently located a replacement property. She purchased the property by land contract for $200,000, with $40,000 paid immediately as a down payment and the remaining balance to be paid with monthly installments over 15 years. She then submitted a claim with Farm Bureau for the recoverable depreciation. After Farm Bureau refused to pay additional monies, the insured sued for breach of contract. Ultimately, the trial court ruled in favor of the insured. On appeal, Farm Bureau advanced two arguments as to why the insured was not entitled to replacement cost benefits.
First, Farm Bureau argued that the property interest conveyed by the land contract was not a “complete replacement” for the insured’s fee simple in the destroyed property. The Court of Appeals disagreed. It concluded that the insured had made a complete replacement of her destroyed property when she acquired the replacement property by land contract, which was binding and unconditional upon execution, as opposed to a mere option to buy upon the satisfaction of a future condition. She gave real consideration to the vendor, both in a $40,000 down payment and an unconditional promise to pay the remaining balance in future monthly installments. Under Michigan law, the insured obtained equitable title to the property and, thus, she could sell, devise, or encumber the property as she saw fit.3 The appellate court also stated had Farm Bureau intended that, for a replacement to be complete under its insurance contract, the insured must obtain both equitable and legal title at the time of purchase, then it could have explicitly said so.
Second, Farm Bureau argued that the insured had no compensable replacement costs because her out-of-pocket payment for the replacement property was less than what she received as the actual cash value of her destroyed property. The appellate court also rejected this argument, reasoning that, under Michigan law, the sale of real property under a land contract operates as an equitable conversion, meaning equity treats the sale as actually taking place when the land contract becomes effective. When the land contract became effective, the insured became the equitable owner of the replacement property and the vendor became the equitable owner of the $200,000 purchase money. Under the doctrine of equitable conversion, because the land contract was unconditional and effective, the insured had “actually spent” the $200,000 in purchase money before she made her claim with Farm Bureau. This amount exceeded the replacement cost value of the loss, entitling her to the full replacement cost benefits.
Although it did not involve a land contract, the Supreme Court of Connecticut concluded in Northrop v. Allstate Insurance Company,4 that by entering into a construction contract for repairing a damaged building structure, the insured met the “amount actually spent” requirement for replacement cost benefits. The court rejected Allstate’s argument that the insured actually had to pay out the money first, reasoning that the dictionary meaning of the word “spent” included the situation in which an insured incurs a valid debt for repair or replacement, which he did by entering into the construction contract.
1 See ISO Homeowners 3-Special Form HO 00 03 05 11 at pages 14 and 15 of 24.
2 Batton-Jajuga v. Farm Bureau Gen. Ins. Co. of Mich., No. 334130, 2017 WL 6542781 (Mich App. December 21, 2017).
3 The Supreme Court of Iowa reached a similar result 20 years earlier in Pierce v. Farm Bureau Mut. Ins. Co., 548 N.W.2d 551 (Iowa 1996), which decision the Michigan Court of Appeals found to be thoughtful and in line with relevant Michigan law.
4 Northrop v. Allstate Ins. Co., 720 A.2d 879 (Conn. 1998).