Southern Response Earthquake Services Limited v Shirley Investments Limited
[2017] NZHC 3190
•18 December 2017
IN THE HIGH COURT OF NEW ZEALAND CHRISTCHURCH REGISTRY
I TE KŌTI MATUA O AOTEAROA ŌTAUTAHI ROHE
CIV-2016-409-1230 [2017] NZHC 3190
UNDER the Declaratory Judgments Act 1908 and
Part 18 of the High Court Rules
BETWEEN
SOUTHERN RESPONSE EARTHQUAKE SERVICES LIMITED Plaintiff
AND
SHIRLEY INVESTMENTS LIMITED Defendant
Hearing: 30 October 2017 Counsel:
D J Friar and O M de Pont for Plaintiff
N R Campbell QC and K J M Robinson for DefendantJudgment:
18 December 2017
JUDGMENT OF THOMAS J
Table of contents
Introduction ............................................................................................................. [1] Background.............................................................................................................. [3] The proceedings..................................................................................................... [11] The Policy............................................................................................................... [16] Prior decisions ....................................................................................................... [18] Turvey Trustee v Southern Response ................................................................... [21] Avonside v Southern Response ............................................................................ [33] Tower Insurance Ltd v Skyward Aviation 2008 Ltd............................................. [66] Submissions............................................................................................................ [81]
First declaration – are the costs of Enhanced Foundations and demolition included in the calculation of an insured’s entitlement under the buy
another house option?........................................................................................... [85]
Is there any difference between the cost to be paid by Southern Response for
SOUTHERN RESPONSE EARTHQUAKE SERVICES LIMITED v SHIRLEY INVESTMENTS LIMITED [2017] NZHC 3190 [18 December 2017]
the rebuild option as against the buy another house option? ............................. [89] Does this interpretation accord with the purpose of the Policy? ...................... [107] (a) Windfall argument ................................................................................. [110] (b) The Policy does not cover land ............................................................. [116] (c) Impact on other policies ....................................................................... [118] Demolition costs................................................................................................ [120]
Second declaration – does the buy another house option include the cost of buying the land on which the house is situated? .............................................. [122] Result .................................................................................................................... [131]
Introduction
[1] The defendant, Shirley Investments Ltd, owns a house which was damaged beyond economic repair in the Canterbury earthquakes in 2010 and 2011. Shirley Investments has made a claim under the insurance policy which covered the house at the time of damage. It has elected to buy another house but the liable insurer, now the plaintiff, Southern Response Earthquake Services Ltd (Southern Response), and Shirley Investments cannot agree on how the price for the replacement house is to be calculated under the policy.
[2] Southern Response, noting that this issue affects a number of insureds, seeks the following declarations:
Declaration
Southern Response seeks by way of relief, declarations under section 3 of the
Declaratory Judgments Act 1908 that:
(a) the cost of rebuilding Shirley Investments’ rental house on its present site under the buy another house option includes the cost of rebuilding the existing foundations but does not include:
(i) the cost of additional foundation work that is required to ensure that rebuilding the rental house complies with the building code; and
(ii) the cost of demolishing the existing house.
(b) the amount payable by Southern Response to Shirley Investments under the buy another house option can be no greater than the cost of Shirley Investments buying another house and does not include the cost of buying the land on which the house is situated.
Background
[3] The property at 560 Madras Street, St Albans, Christchurch (the Property) was owned by Jason Stapley at the time of the series of earthquakes which badly affected Christchurch in September 2010, and February and June 2011.
[4] At the time of the damage, the house on the Property (the House) was insured by AMI Insurance Ltd under an AMI Premier Rental Property Policy (the Policy). Southern Response is now responsible for settling earthquake claims lodged by AMI policy holders for damage which occurred in the Canterbury earthquakes before 5
April 2012.
[5] In March 2011, Mr Stapley made a claim under the Policy for damage to the House and on 20 December 2011 Southern Response informed him it considered it uneconomic to repair the House. In March 2013, Mr Stapley made an election under the Policy to rebuild the House on the same site.
[6] Following a geotechnical investigation and assessment of the Property, the land was assessed as having a predicted future land performance consistent with what is known as Technical Category 3 (TC3 land). Geotechnical engineers therefore recommended that, to comply with the building code, one of the enhanced foundation options for TC3 land would need to be used if the House were rebuilt, as set out in the guidance issued by the Ministry of Business, Innovation & Employment: Repairing and rebuilding houses affected by the Canterbury earthquakes. The assessment identified a number of viable enhanced foundation solutions for the Property, including deep site ground improvement with a TC2 surface structure (such as a waffle slab).
[7] It is not in dispute that, if the House is rebuilt on the Property pursuant to the Policy, Southern Response will be required to pay the reasonable cost of ground improvement and a TC2 waffle slab.
[8] Shirley Investments bought the Property in December 2014 and took an assignment of the rights under the Policy. It advised Southern Response in February
2015 that it wished to change the election under the Policy and instead chose the option to buy another house in a different location (the buy another house option).
[9] The dispute between the parties is as to the amount Southern Response must pay Shirley Investments under the buy another house option, specifically whether the amount payable should include both the cost of the enhanced foundations and an amount which would have been required to demolish the House in order for a notional rebuild to take place.
[10] There was also an issue between the parties as to whether Southern Response was obliged to pay more than the cost of the house at the other location or whether any money could go towards the cost of buying the land on which that other house was situated. That issue is no longer live as between the parties.
The proceedings
[11] Because Southern Response has a number of similar claims pending, it considers this a significant issue and seeks two declarations.1 First, that the amount payable under the Policy to Shirley Investments under the buy another house option does not include either the notional cost of enhanced foundations for a new house on the same site and/or the cost of demolishing the House. Secondly, that the amount payable by it can be no greater than the cost of Shirley Investments buying another house which does not include the cost of buying the land on which that house is situated.
[12] The application is made on the basis Southern Response interprets the Policy as it applies to the buy another house option to mean:
(i)the cost of enhanced foundations for the purpose of complying with the building code (Enhanced Foundations) is additional;
(ii)the cost incurred for the purpose of complying with the building code is payable only if it will be incurred;
1 Declaratory Judgments Act 1908, s 3.
(iii)where the insured elects to buy another house, the insured will never incur the cost of building Enhanced Foundations;
(iv)the cost of Enhanced Foundations would consequently be a windfall to the insured; and
(v) Southern Response is not required to pay the cost of Enhanced
Foundations where the insured elects the buy another house option.
[13] In relation to the costs of demolition, Southern Response’s position is:
(i) it has rights of salvage in relation to the House and is entitled to remove
it from the Property to realise those rights; and
(ii)where it exercises its rights of salvage, the costs of demolition will not be incurred by the insured and so are not payable to them.
[14] Shirley Investments’ position is that the sum payable by Southern Response under the buy another house option includes the costs of Enhanced Foundations for rebuilding a new house on the existing site and demolishing the house. It says, having elected to buy another house:
(i)quantification of the cost of rebuilding the House on its present site must be estimated;
(ii)in that estimate, costs cannot be excluded merely because the rebuild is not going to happen and costs will not be incurred;
(iii)the costs which would be incurred in rebuilding the House on its present site include the cost of Enhanced Foundations and demolition of the House; and
(iv)the quantification of Southern Response’s liability under the buy another house option must include the estimated costs of Enhanced Foundations and demolition of the House.
[15] In respect of the second declaration sought, Southern Response’s position is the amount payable under the buy another house option can be no greater than the actual cost of buying another house and does not include the cost of buying the land on which the house is located. Shirley Investments considers the cost of buying another house includes the cost of buying the land on which the house is located.
The Policy
[16] The relevant sections of the Policy and the way it is set out are:
What thi s policy cove rs page 2 – 6
page 2–3
cover for your rental house if it is damaged or destroyed
page 3 …
cover for additional costs
• architects’ and surveyors’ fees
• demolition and debris removal
• compliance with building regulations
• removal of rental house contents
earthquake top-up cover
…
our defin ition of ‘rent al house’
property covered by this
policy
…
a. This policy covers residential dwellings
that you own for the purpose of lease under a tenancy agreement. It does not cover
commercial buildings, caravans or temporary structures.
property not covered by this policy
a.
The following do not form part of your rental house and are not covered by this policy:
…
– any land, earth or fill.
…
w hat is covered by this policy
cover for your rental house
Your rental house is covered for any unforeseen and sudden physical loss or damage that is not excluded by this policy.
…
1 What we will pay a. We will pay to repair or rebuild your rental house to an ‘as new’ condition, up to the floor area stated in the Policy Schedule. b. We will use building materials and construction methods in common use at the time of repair or rebuilding.
c. If your rental house is damaged beyond economic repair you can choose any one of the following options:
i to rebuild on the same site. We will pay the full replacement cost of rebuilding your rental house. ii to buy another house. We will pay the cost of buying another house, including necessary legal and associated fees. This cost must not be
greater than rebuilding your rental house on its present site.
iii a cash payment. We will pay the market value of your rental house at the time of the loss.
d. If your rental house is damaged and can be repaired, we can choose to either:
i repair your rental house to an ‘as new’
condition, or
…
cover for additional costs
iipay you the cash equivalent of the cost of repairs.
We will pay for the following additional costs.
1 Professional fees a. We will pay the reasonable cost of any architects’ and surveyors’ fees to repair or rebuild your rental house. These expenses
must be approved by us before they are incurred.
2Demolition and debris removal
a.We will pay the reasonable cost of demolition and debris removal. These expenses must be approved by us before they are incurred.
3Removal of rental house contents
a.We will pay the reasonable cost of removing your rental house contents from your rental house when this is necessary to carry out repair or reinstatement of your rental house.
4Compliance with building legislation and regulations
a.If additional work is required to ensure that the repair or rebuilding of your rental house complies with the building code, we will pay the reasonable costs of the additional work.
b. We will not cover any additional work required:
iif a notice has been served requiring compliance with the Building Act
1991 or the Resource Management
Act 1991 before the loss or damage occurred, or
iiif your rental house did not comply with the relevant governing building controls when it was built or at the time of any alteration, or
iii to any undamaged part of your rental house, whether or not it complies with the building code.
cover for earthquake damage
If the Earthquake Commission agrees to pay a claim for loss or damage to your rental house, we will provide Earthquake top-up cover for loss or damage not covered by the Earthquake Commission.
1Earthquake top-up cover
a.If your rental house is damaged by earthquake, natural landslip, tsunami, volcanic eruption or hydrothermal activity (as defined by the Earthquake Commission Act 1993 and any amendments) we will pay the difference between the maximum amount payable by the Earthquake Commission and:
i the cost of repairing or rebuilding
your rental house, or
ii the sum insured stated on the Policy
Schedule,
whichever is the lesser.
b.
Cover is provided on the same basis as
‘Cover for your rental house’ on page 2.
c.
This cover does not include any excess you may have to pay to the Earthquake Commission.
d.
You will not have to pay any excess to us.
[17] Particularly at issue in this case is the relationship between “cover for your rental house” and “cover for additional costs”.
Prior decisions
[18] Southern Response and Shirley Investments each maintain I am bound by prior Court of Appeal and Supreme Court decisions but each has a different interpretation of those decisions. The first step in my decision is therefore to analyse those decisions to ascertain whether, and the extent to which, they are binding.
[19] The cases involve a High Court decision, Turvey Trustee v Southern Response,2
High Court, Court of Appeal and Supreme Court decisions in Avonside Holdings Ltd v Southern Response Earthquake Services Ltd,3 and Court of Appeal and Supreme
Court decisions in Tower Insurance v Skyward Aviation.4
2 Turvey Trustee Ltd v Southern Response Earthquake Services Ltd [2012] NZHC 3344, (2013) 17
ANZ Insurance Cases 61-965.
3 Avonside Holdings Ltd v Southern Response Earthquake Services Ltd [2013] NZHC 1433 [Avonside HC]; Avonside Holdings Ltd v Southern Response Earthquake Services Ltd [2014]
NZCA 483, (2014) 18 ANZ Insurance Cases 62-040 [Avonside CA]; and Southern Response
Earthquake Services Ltd v Avonside Holdings Ltd [2015] NZSC 110, [2017] 1 NZLR 141 [Avonside SC].
4 Skyward Aviation 2008 Ltd v Tower Insurance Ltd [2014] NZCA 76, [2014] 2 NZLR 713 [Skyward
CA]; and Tower Insurance Ltd v Skyward Aviation 2008 Ltd [2014] NZSC 185, [2015] 1 NZLR
341 [Skyward SC].
[20] I will begin with the Turvey and Avonside decisions as they concern AMI
policies.
Turvey Trustee v Southern Response
[21] Turvey addressed AMI’s policy for owner-occupiers (whereas the Policy covers rental property) but was likewise the premier cover policy. The claim concerned earthquake damage and at issue was the relationship of “cover for your house” and “cover for additional costs”, the latter setting out the same four categories of cover for additional costs with identical wording as in the Policy.
[22] The clauses under “cover for your house” were also identical to those in the Policy relating to “cover for your rental house” although contained a fourth option to apply if the house were damaged beyond economic repair, allowing the insured to rebuild on another site, saying:5
We will pay the full replacement cost of rebuilding your house on another site you choose. This cost must not be greater than rebuilding your house on its present site.
[23] The plaintiff in Turvey elected to rebuild on another site.
[24] The High Court was asked to determine two questions. The first concerned the meaning of the insurer’s obligation to rebuild to an as new condition using building materials and construction methods in common use at the time of rebuilding. That was a live issue because the damaged house included distinctive early 20th Century features. The second concerned the calculation of the cost cap on rebuilding. It is therefore relevant to the present case given the wording of the cost cap was identical to the wording of the cost cap under the Policy except the Policy refers to a “rental” house.
[25] On the second question, the High Court recognised the reality that home owners who had suffered irreparable damage in the areas of Christchurch worst hit by the earthquakes were likely to seek to rebuild in other areas. The worst hit areas were
likely to be rated more highly in terms of geotechnical requirements for foundations
5 Turvey, above n 2, at [4].
of new structures, leading to the prospect that rebuilding in the worst hit areas would involve higher costs for building code compliance than new building away from the worst hit areas. The High Court concluded the insurer’s liability was to compensate for additional costs of rebuilding to the extent occasioned by the need to comply with the current building code as those costs were actually incurred at the new site.
[26] It is evident from the judgment that the arguments put forward in respect of the second question, which is primarily at issue in this case, were the same as those presented before me. That is, the insured argued the calculation of a notional rebuilding of the house on its original site could not be completed realistically without including an allowance for the additional costs involved in upgrading or altering the original construction to make it code compliant.6 For the insurer, it was argued that quantification of this aspect was recognised as a category of costs additional to the cost of constructing the equivalent structure using methods and materials in common use.7
[27] Dobson J reasoned as follows:
[44] The structure and wording of the policy supports the insurer’s approach to quantification of this additional cost. The quantification exercise begins with an election by the insured as to which of the four options available in clause 1c the insured will rely on in pursuing its claim. If that election is to claim under 1cii (as here), then the insurer is not liable for a cost greater than that of rebuilding the house on its original site. That does introduce a notional exercise of assessing the extent of that cost. Separately from that, additional cost liabilities acknowledged by the insurer are in respect of costs that may or may not in fact be incurred. The most logical approach to quantifying any additional costs is to assess what additional costs are in fact incurred in the particular circumstances following the insured’s election. In the present case, the insurer will ascertain the extent of additional work required in the process of rebuilding on a new site, in order to comply with provisions in the Building Act and codes that the existing structure did not comply with before becoming irreparably damaged.
[28] Dobson J considered the approach contended for by the insured would have introduced an additional artificiality which was unnecessary. He also identified the prospect of that approach enabling the insured to claim a windfall through receipt of money in respect of an additional cost which the insured would not in fact incur if
rebuilding on a new site where the requirements for foundations cost less than at the existing site. He noted the corollary that an insured could elect to rebuild on a site with greater geotechnical difficulties than the existing site and oblige the insurer to pay more than the cost of rebuilding on the existing site.
[29] Dobson J concluded a two-stage process would be required, with the insurer’s liability under the “additional costs” component of the policy having to wait until a new site for the rebuilding was identified to enable the actual extent of additional costs to be measured.
[30] Dobson J addressed the issue identified by the insured that the insurer would not be complying with its primary obligation to pay the full replacement cost of “rebuilding your house” if the costing failed to take account of additional or different work required for code compliance because it would be costing a house which could not lawfully be built. He said:
[48] … However, so long as the quantification of the insurer’s primary liability recognises that a discrete exercise needs to be done under the “cover for additional costs” portion of the policy, then there is neither a practical nor legal impediment to calculating the full extent of liability in the two stages that follows from the interpretation I have proposed.
[31] Mr Friar, appearing for Southern Response in the present proceedings, observed that a large number of claims have been settled over the past five years on the basis of this two-stage process.
[32] Mr Campbell, for Shirley Investments, noted the obvious, that is Turvey did not concern the buy another house option. However, the buy another house option in the present case is subject to a cost cap expressed in identical wording to that pertaining in Turvey and therefore the same reasoning must apply. If additional costs are included in the cost of rebuilding under the buy another house option, as Shirley Investments would have it, then they must also be included in the cost of rebuilding under the rebuild on another site option. That would be directly contrary to Turvey which considered the insured’s entitlement to additional costs was a discrete calculation.
Avonside v Southern Response
[33] Avonside concerned the same premier rental property cover as the Policy.
[34] Following the Canterbury earthquakes, the plaintiff’s property was damaged beyond economic repair and it elected to buy another house. At issue was the calculation of the cost cap (rebuilding the house on its present site) and whether, and to what extent, certain items were to be included in that calculation being: builders’ margin; contingencies; professional fees; demolition costs; and external works.8 In the High Court, MacKenzie J allowed a 10 per cent builders’ margin, both sides agreeing this was appropriate to include in a notional rebuild.9 He declined to include any allowance for a contingency sum on the basis that, in a notional rebuild, there could be no unexpected items.10
[35] The professional fees considered in the High Court included fees for structural engineering, geotechnical engineering, design, land surveying, and project management. The insured’s expert made an allowance for professional fees of 10 per cent of the total cost, being a composite figure based on his experience as to the fees of the categories of consultants involved typically in an individually designed house building project. The High Court rejected that approach on the basis the expected professional fees for an individually designed new house was not the appropriate measure, rather those fees that would necessarily be incurred for a notional rebuild of the existing house were to be included. MacKenzie J noted that not every home is architect designed and in a notional rebuild that was not required. He allowed a fee for redrawing of plans to meet the existing building code. Furthermore, he noted the policy itself dealt differently with architects’ fees, which were covered as additional costs and not part of the basic cover.11
[36] As far as demolition costs were concerned, MacKenzie J noted that, in terms of the policy, the cost of demolition and site preparation did not form part of the cost
of a notional rebuild. Read together with the words of the policy specifying the cost
8 Avonside HC, above n 3, at [10].
9 At [14]. The experts varied as to what that percentage would be.
“must not be greater than rebuilding your rental house on its present site”, that meant the cost of demolition and debris removal was dealt with as a separate item and not part of the costs of rebuilding on the present site. He concluded explicitly that demolition and debris removal costs did not fall under the cover for the buy another house option.12
[37] MacKenzie J followed a similar approach to Dobson J in Turvey in identifying that the “additional costs” required separate consideration. Although the decision on contingencies and professional fees was appealed, the High Court decision regarding demolition costs was not. Mr Campbell submitted I should not place too much weight on that and the High Court was wrong as the reasoning in the Court of Appeal demonstrates. Furthermore, the land was sold to the Crown and therefore demolition costs were not a live issue on appeal.
[38] The insured went to the Court of Appeal on the question of whether, and to what extent, an allowance for contingencies, the costs of professional fees and the costs of replacing external works should be included in the calculation of the cost of rebuilding.13
[39] The arguments on appeal were slightly different from the arguments put forward in this case and are worth recording. The insured’s argument was that, in assessing the notional rebuild cost, it was not relevant that the rebuilding would not take place or that rebuilding costs would not actually be incurred. The hypothesis on which cost was to be assessed was that the house was rebuilt on its present site. For Southern Response, the argument focused on the fact the policy was for a rental property and that the policy protected the rental income stream by either providing for an as new rebuild or for the investment of the cost of that as new rebuild in the purchase of another house. The argument was that the cost cap for the buy another house option was determined by the full replacement cost under the rebuild option. And then:
[29] … Putting aside cover for additional costs (which might be payable if the Property was actually rebuilt), the notional rebuild calculation was to be prepared on the basis of the cost of rebuilding, in terms of the plans and the site, what had been built when the Property was first erected.
[30] In general, therefore, architectural plans were not required, new engineering advice was not required, and there were no unforeseen risks. … All that was required was the cost of repeating – albeit using current building techniques and materials – the original exercise of constructing the existing house.
[40] The Court of Appeal considered the evidence focused on estimates for professional fees and contingencies. Importantly, the expert for Southern Response approached his task by identifying that the calculation of the cost to rebuild did not include the costs identified under cover for additional cost but, in terms of professional fees and compliance costs, said:14
Unless the policy holder was in fact rebuilding on the same site, then the cost to design the replacement rental house, including any engineering or geotechnical input into the foundations, would not be paid to the policy holder.
…
[41] The expert approached the question of contingencies in a similar way.
[42] That the Court of Appeal took issue with this approach was not surprising given the professional fees captured under additional costs are in respect of architects’ and surveyors’ fees only.
[43] Therefore, the way in which the case was argued before the Court of Appeal was very important. The focus of Southern Response was that on a notional rebuild, certain costs would not be incurred and this included all professional fees and the need for a contingency. However, neither category of cost fell to be considered separately as an additional cost under the policy.
[44] Southern Response’s approach formed the foundation for the Court of Appeal’s analysis.15 That is, Southern Response distinguished between the cost derived for an actual rebuild and a notional rebuild because in a notional rebuild, various costs would not actually be incurred and hence were not included in the sum to be calculated as the
cost cap for the buy another house option.16
14 At [42].
[45] The Court of Appeal then disagreed with the approach, reasoning that the buy another house option made no reference to “the full replacement cost”. The Court of Appeal said:
[51] The cost of rebuilding the rental house on its present site involves both the full replacement cost and additional costs, encompassing contingencies and professional fees. That is the amount the insurer would be liable for where the insured chose the “to rebuild on the same site” option. We are satisfied, therefore that it is an amount equivalent to the sum of both of replacement and additional costs, and not the lesser amount of solely “the full replacement cost”, that is to be paid by the insurer to the insured when the insured elects the “to buy another house” option. In our view, if the Policy had intended any limit to “the full replacement cost” to apply in cl (c)(ii), it would have said so.
[46] The Court of Appeal agreed with the submission that costs could not be excluded merely because the rebuild was not going to happen and costs would not be incurred.17
[47] Despite the question of Enhanced Foundations not being at issue in the case, the Court of Appeal then said:
[53] Accordingly, for example, we do not think “safe ground” can be assumed. Similarly, we consider that a reasonable estimate for professional fees and contingencies prepared on the basis that the Property is actually being rebuilt on the site should be included. This is so even though the exercise is necessarily a notional one. Where, for example, the Building Code has changed, or there is – as would be the case here – a different assessment of ground risks that would need to be addressed if the Property were to be rebuilt on the site, those costs are, in our view, properly within the cost of rebuilding.
[48] Understandably, it is this paragraph on which Mr Campbell placed considerable weight in the present case.
[49] The Court of Appeal went on to say it had taken a “not dissimilar” approach to that taken in Turvey and:
[58] We take the same approach here. That is, the cost that is payable as part of the required notional exercise – here under cl 1(c)(ii) – is the cost that would actually be incurred (whether as a component of full replacement cost or in terms of matters covered by additional costs) to rebuild the house on the existing site. Thus items such as contingencies and professional fees cannot be excluded on the basis that they will not, in fact, be incurred because it is a notional cost that is being calculated.
[50] The Court of Appeal then confirmed the High Court’s decision in respect of external costs but overturned it on the remaining matters on appeal and ordered the insurer to pay the contingency and professional fees.
[51] Mr Campbell submitted the Court of Appeal decision in Avonside is binding. In his submission, the ratio of the Court of Appeal decision is that, under the buy another house option, the cost of rebuilding (which operates as the cost cap) includes both the full replacement cost and additional costs. On that ratio, he said, the cost cap includes the cost of Enhanced Foundations.
[52] Before exploring that submission in detail, it is necessary to look at what the
Supreme Court had to say.18
[53] The Supreme Court identified the issues as whether there should be a sum for contingencies; the extent of allowance to be made for professional fees; and the relationship between cl 1 (cover for your rental house) and cl 4 (cover for additional costs).19 While observing that the relationship of the clauses of the policy was stressed by Southern Response in its submissions, the Court dealt with it first by observing that the relationship between the two clauses of the policy did not arise in the appeal. Mr Campbell, who appeared for Avonside in the Supreme Court, told the Court it was not part of Avonside’s argument before the Court of Appeal that additional costs were encompassed within the cost of rebuilding and:
[20] … Neither party included, within their estimates of the cost of rebuilding Avonside’s house, any allowance for improved foundations or for additional work required to comply with the building code. Whether an allowance should be made for the costs of such additional work under the “buy another house” option is not an issue on this appeal.
[21] Further, the cover under cl 4(1)(a) for additional costs of professional fees is for fees that the insured wishes to incur that are additional to the necessary costs of rebuilding or repairing. The insured will be covered for that additional cost only if the insurer approves it before it is incurred. Neither Mr Harrison nor Mr Farrell allowed for “additional” fees in that sense. The professional fees allowed for by both Mr Harrison and Mr Farrell related to rebuilding the existing house and thus came within cl 1(c)(ii). MacKenzie J was therefore wrong to characterise them as additional costs.
18 Avonside SC, above n 3.
[54] The Supreme Court accepted the submission that the relationship between the cover for your rental house and cover for additional costs clauses did not arise on the appeal and that Avonside’s claim related only to cl 1 (cover for your rental house). They also accepted Avonside’s submission that the High Court had mischaracterised architects’ fees.20
[55] The Supreme Court concluded that, in determining the cost cap, an allowance for contingencies should be included, saying:21
[38] The amount payable under the policy can be no more than the cost of rebuilding the house on its present site. The exercise that is required is to estimate the actual cost of rebuilding the house on the site.
[39] Mr Harrison, in accordance with what is agreed to be standard quantity surveying practice, included a sum of 10 per cent for contingencies. Southern’s witnesses both agreed that there were “unknowns” in any building project, including in a rebuild of this type (existing house in an existing location).
[40] We accept Avonside’s submission that the fact that this is a notional, rather than actual, rebuild does not affect the inclusion of an allowance for risks generally encountered. Such risks are relevant to estimating the cost of an actual rebuild and, as noted above, it is the actual cost of rebuilding that must be estimated. The Court of Appeal was thus correct to accept the inclusion of an allowance for contingencies.
[56] The Supreme Court then dealt with whether there should be an allowance for professional fees by observing that Southern Response’s expert’s approach was based on his erroneous assumption that a different approach was required for a notional rebuild.22 In contrast, Avonside’s expert’s approach allowed professional fees on orthodox quantity surveying practice. Furthermore, the High Court had misunderstood that the estimate was based on the use of an architectural draughtsperson and not an architect and did take full account of the fact that the notional build was a rebuild on an existing site with existing plans. The Supreme Court said the Court of Appeal’s approach to this issue was correct.
[57] In summary, the Supreme Court concluded the Court of Appeal’s approach to the question of professional fees was correct and the Court of Appeal was correct to
20 At [22].
21 Citations omitted.
accept the inclusion of an allowance for contingencies. The Supreme Court did not, however, address the Court of Appeal’s comments on the relationship between “cover for your rental house” and “cover for additional costs”, saying it was not at issue.
[58] I now turn to consider how and the extent to which those decisions are binding in this case.
[59] Given the issues before the Court of Appeal were contingencies, professional fees and external works,23 I do not accept that the relationship between the two clauses was at issue in the Court of Appeal and thus that the Court of Appeal’s comments should be followed.
[60] The Supreme Court dealt with the question of contingencies and professional fees under cl 1, cover for your rental house. This is because contingencies and professional fees are standard costs. The professional fees at issue did not involve those of an architect or surveyor and therefore did not fall under additional costs. It was made clear to the Supreme Court that the question of Enhanced Foundations and additional work was not relevant to the case, not having been included in either party’s estimates. The Supreme Court specifically did not consider the relationship between the two clauses and accepted Avonside’s submission that the relationship between the two clauses did not arise in the appeal.
[61] Furthermore, in relation to what the Court of Appeal said about Turvey, the
Supreme Court observed as follows:24
The Court said, at [55]–[58], that its approach was similar to that taken by Dobson J in Turvey Trustee Ltd v Southern Response Earthquake Services Ltd. It is not necessary for the purposes of this appeal for us to make any comment on whether that is the case or on Dobson J’s approach.
[62] The distinction drawn by the Court of Appeal between replacement and rebuilding, suggesting full replacement cost does not include additional costs but the costs of rebuilding does, is at odds with the actual words of the rebuild option in the
Policy which are “the full replacement cost of rebuilding”. The words in the buy
23 Avonside CA, above n 3, at [16].
24 Avonside SC, above n 3, at n 19 (citations omitted).
another house option, that the costs must not be greater than rebuilding, must relate back to Southern Response’s obligation to pay the full replacement cost of rebuilding. Similar wording was considered by the Supreme Court in Skyward, where the Court interpreted the clause differently from the Court of Appeal in Avonside as discussed in more detail below.
[63] In Mr Friar’s submission, the Supreme Court accepted the distinction in the Policy between cover for your rental house and additional costs. I am not convinced the Supreme Court went that far. It was simply not required to consider the relationship between the two parts of the policy because the two costs at issue did not fall under additional costs.
[64] I do agree with Mr Friar, however, that the Court of Appeal’s observations about costs occasioned through a change in the building code were obiter. No such costs were before the Court of Appeal and there was no argument on this issue. The ratio of the Court of Appeal decision is limited to external work costs, professional fees and contingencies, none of which are additional costs.
[65] An analysis of these cases demonstrates the rationale for our common law approach to precedent. The value of precedent lies in the ratio decidendi of a case because an analysis of the facts and full argument on the law results in a ratio. The Court of Appeal’s observations in respect of foundation costs did not have the benefit of facts or legal argument. That is why its observations did not form part of the ratio and thus why those observations do not have precedential effect.
Tower Insurance Ltd v Skyward Aviation 2008 Ltd
[66] The Court of Appeal and Supreme Court decisions in Tower Insurance Ltd v Skyward Aviation 2008 Ltd were relied on by Shirley Investments on the basis that the rebuild and buy another house options have the same financial consequences for Southern Response.25 The Skyward case concerned an insurance policy offered by Tower Insurance providing that Tower would pay either: the full replacement value of
a house; the full replacement value of the house on another site; the cost of buying
25 Skyward CA and Skyward SC, above n 4.
another house; or the present day value. The issue was whether it was Tower or the insured who had the right of election.
[67] The Court of Appeal and Supreme Court both considered the election was that of the insured and the maximum amount payable by Tower under each alternative of repair, rebuild or purchase was materially the same.
[68] The evidence, however, was that the parties considered there was some difference between the costs of the various options. Importantly, in the Court of Appeal decision, it was said:26
[7] … The difference would be compounded if another $150,000.00 were factored in for the cost of constructing special foundations for a house in the red zone. But Mr Campbell QC accepts, following the judgment of Asher J in O’Loughlin v Tower, that Skyward is not entitled to claim that cost in circumstances where it will not in fact rebuild in the red zone.
[69] In O’Loughlin v Tower, the O’Loughlins elected to rebuild on another site outside of the red zone.27 Asher J held that, under the relevant policy, Tower could elect to make a payment rather than fund the rebuild.28 More relevant to the present case, and on the basis that the policy specifically excluded liability for reinstating the house “exactly to its previous condition” as well as costs beyond what was “reasonable, practical or comparable with the original”, Asher J also found that Tower’s liability extended only to the cost of rebuilding on a notional site, with sound ground conditions, rather than on the red zone site with its attendant increased structural requirements.29
[70] Returning to Skyward, the option to buy another house was expressed in identical wording to the buy another house option in the Policy, saying:30
The cost of buying another house, including necessary legal and associated fees. This cost must not be greater than rebuilding your house on its present site.
26 Skyward CA, above n 4 (citations omitted).
27 O’Loughlin v Tower Insurance Ltd [2013] NZHC 670, [2013] 3 NZLR 275.
28 That approach was however overturned in Skyward CA, above n 4, at [24].
29 O’Loughlin, above n 27, at [4(e), (f) and (h)] and [173]–[182].
30 Skyward CA, above n 4, at [13].
[71] Other terms of the Tower policy were slightly different from the Policy. Within the same clause as the one containing the options, the terms provided that if, as a result of changes in government or local body bylaws, the rebuild or repair could not be carried out to the same specification as before, the additional costs incurred to rebuild would be paid by Tower. In any event, as indicated, this particular issue was not relevant to the case.
[72] What is relevant, particularly in relation to the Court of Appeal’s decision in Avonside, is how the Supreme Court described the buy another house option and the cost cap, which, as I say, was expressed in identical terms to that in the Policy. The Supreme Court said:31
[14] It is common ground that, for the purposes of cls 1, 2 and 3, Tower has elected to “make payment” (see cl 3). This means that the case falls to be determined under cl 2. It will be noted that options (a), (b) and (c) all provide for recovery which is referable, in one way or another, to the “full replacement value” of the house. In later discussion we will refer to them as providing for replacement value recovery. In contradistinction, option (d) is based on what is normally referred to as indemnity value.
[73] Therefore, even if the Court of Appeal reasoning about rebuilding versus replacement cost in Avonside did form part of the ratio, the later Supreme Court decision of Skyward effectively overrules that.
[74] The Supreme Court judgment is also important because it makes some observations on the general context of insurance claims:32
[24] The insurance policy is for full replacement value and proceeds on the basis of replacement on a new for old basis. The availability of such policies reflects a recognition that a traditional indemnity value policy may not provide sufficient funds to enable a damaged building to be repaired or rebuilt given that such exercises will require new materials and compliance with current building standards which may be more stringent than those in place when the building was constructed. A replacement value policy thus covers the impact of depreciation and increased building costs. ...
[75] The Supreme Court then discussed how replacement value insurance creates heightened moral hazard because an insured may obtain more than their indemnity for
31 Skyward SC, above n 4 (citations omitted).
32 Citations omitted.
the damaged property and thus profit from the loss.33 It explained that the risks can be mitigated, including by policies providing insurers with the option of reinstating the property and limiting replacement value recovery to reimbursement of expenditure incurred by the insured.
[76] Mr Friar submitted this was particularly relevant context in interpreting the Policy. In his submission, the Policy dealt with the moral hazard by separating out rebuilding and additional costs and allowing recovery of the latter only when incurred. In contrast to the Tower policy, Southern Response had not given itself the right to elect which option was to be taken.
[77] Mr Campbell relied on the Court of Appeal’s observation in Skyward that Tower’s obligation was to pay the cost of rebuilding on site, being the full measure of replacement cost,34 and that the maximum amount payable by Tower under all three alternatives was materially the same.35 In his submission, the Tower policy wording was almost identical to that of the Policy and the Court found that Tower’s liability was the same under each option. The Court’s approach, he said, therefore defeated Southern Response’s argument that the cost of Enhanced Foundations will not be payable by it under the buy another house option, even though they might be payable under the rebuild option.
[78] The Tower policy is not on all fours with the Policy. The reference to matters described as additional costs in the Policy are dealt with in the Tower policy under the same clause beginning “we will pay”. Furthermore, what under the Policy are additional costs, are bullet pointed in the Tower policy under the opening words “in all cases”.
[79] The Skyward decisions need to be considered in their context. First, the issue for determination was whether it was the insured or Tower who had the choice as to which option should be elected. Secondly, the question of the correct calculation of
the rebuild cost in the context of the buy another house option was neither argued nor
33 At [26].
34 Skyward CA, above n 4, at [27].
35 At [42].
decided. Thirdly, the policy was different. There was also an acceptance at the Court of Appeal (which must have flowed through into the Supreme Court) that an insured was not entitled to the cost of Enhanced Foundations unless he or she rebuilt in the red zone. So, the issue in the present case was specifically excluded from argument and consideration.
[80] Having manoeuvred my way through the cases, I will now turn to address the interpretation of the Policy. In doing so I am conscious that insurance contracts are interpreted according to the ordinary principles of contractual interpretation. An objective approach is taken, with the aim of ascertaining the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.36 The parties’ intention is taken to be that objective meaning and the context provided by the contract as a whole and any relevant background informs meaning. Furthermore, in Firm PI 1 Ltd v Zurich Australian Insurance Ltd, the Supreme Court held:37
[63] While context is a necessary element of the interpretive process and the focus is on interpreting the document rather than particular words, the text remains centrally important. If the language at issue, construed in the context of the contract as a whole, has an ordinary and natural meaning, that will be a powerful, albeit not conclusive, indicator of what the parties meant. But the wider context may point to some interpretation other than the most obvious one and may also assist in determining the meaning intended in cases of ambiguity or uncertainty.
Submissions
[81] In Mr Friar’s submission, the Policy is clear. It distinguishes between notional build costs and additional costs and the two-stage approach explained in the Turvey decision applies.
[82] In Mr Campbell’s submission, the Policy was drafted by the insurer as a standard form contract sold to consumer insureds and must be interpreted accordingly. In his submission, the natural and ordinary meaning of the Policy is that the buy
another house option is for the benefit of the insured. Southern Response is indifferent
36 Firm PI 1 Ltd v Zurich Australian Insurance Ltd [2014] NZSC 147, [2015] 1 NZLR 432.
37 Citations omitted.
as to which option is elected given the ultimate financial consequences for Southern Response can be expected to be the same; it follows that the cost cap under the buy another house option must take into account the costs which would be incurred in an actual rebuild and this includes demolition costs and the costs of complying with the building code. Furthermore, if Southern Response meant that the buy another house option was almost always going to lead to a different and lower payout than the rebuild option, that should have been made clear.
[83] Even if the distinction identified by the Court of Appeal in Avonside between rebuild and replacement is not valid, in Mr Campbell’s submission the ordinary meaning of rebuild means it must include a code compliant rebuild.
[84] Mr Campbell suggested it was not clear that the additional costs were intended to be additional to, in the sense of separate from, the cost of rebuilding and the more natural reading is that the additional costs are identified for the avoidance of doubt.
First declaration – are the costs of Enhanced Foundations and demolition included in the calculation of an insured’s entitlement under the buy another house option?
[85] The Policy covers damage to the House due to any unforeseen and sudden physical loss and damage except as excluded by the Policy. It is not limited to damage caused by an earthquake but it specifically provides for earthquake damage (and other damage covered by the Earthquake Commission Act 1993). The Policy covers circumstances where the damage can be repaired and where it is uneconomic to repair. Land is not covered by the Policy.
[86] If the House is damaged beyond economic repair there are three options for the insured:
(i) rebuild on the same site;38
(ii) buy another house; or
38 The Policy covers repair but in the circumstances of this case I will confine the discussion to rebuilding.
(iii) a cash payment.
[87] For the first two options (rebuilding or buy another house), how much Southern Response must pay is related to the cost of rebuilding the House on its present site in an as new condition up to the floor area stated in the Policy. The cash payment option is limited to the market value of the House at the time of the loss. Market value is defined as “the value of an item immediately before the loss or damage occurred, taking into account wear and tear and depreciation”. This is traditionally referred to as “indemnity” cover. The difference between the cash payment and other options is that the insured is not required to procure another house either by rebuilding on the same site or buying another house elsewhere. The insured can take the money and go. It is accepted the cash payment option will result in an insured receiving less recompense overall compared to the other two options and there are clearly benefits to that option in terms of allowing an insured the freedom to choose how to use the insurance money.
[88] Similarly, there are clearly advantages in the buy another house option in that it allows the insured to move on, both literally and figuratively. The insured can buy an existing house, will not have to incur the delay in rebuilding and, importantly given this is a rental property policy, resume earning rental income sooner rather than later. Cover for lost rental is an optional extra under the Policy. Other advantages include avoiding further potential damage by moving to a less vulnerable site, as was the case in O’Loughlin.39
Is there any difference between the cost to be paid by Southern Response for the rebuild option as against the buy another house option?
[89] Under the rebuild option, an insured can rebuild on the same site. Southern Response will pay “the full replacement cost of rebuilding your rental house”. The Policy defines “full replacement” as meaning “replacement with a new item, or repairing to an ‘as new’ condition”. Therefore, Southern Response will pay to rebuild to an as new condition using building materials and construction methods in common
use at the time of rebuilding.
39 O’Loughlin, above n 29.
[90] The buy another house option requires Southern Response to pay the cost of buying another house, including legal and associated fees, but with a cap on the cost which must not be greater than “rebuilding your rental house on its present site”.
[91] The first question is whether there is any difference between the two options on this basis alone. There is no reference to “full replacement cost” in the buy another house option. The option does, however, stipulate that the cost to buy another house cannot be greater than “rebuilding your rental house on its present site”. These words are effectively a repetition of the opening words of the rebuild option – “to rebuild on the same site”. The rebuild option is explained in the following sentence, which is that the full replacement cost of rebuilding will be paid by Southern Response.
[92] Given the use of the same language in respect of both options, it is clear to me that they both refer to the same. That is, under both options, Southern Response’s financial obligation is to pay for the cost of rebuilding the house on its current site to an as new condition. This requires the use of building and construction methods in common use at the time of rebuilding. There is no difference between the financial liability of Southern Response under the rebuild and buy another house options so far.
[93] That is the first step in calculating an insured’s potential entitlement under the
Policy.
[94] Southern Response is then obliged to pay specified additional costs. Those additional costs are payable only where they are approved and incurred in the case of architects’ or surveyors’ fees and demolition, reasonable and necessary in the case of the removal of rental house contents, and reasonable and required in the case of additional work to ensure the rebuilding complies with the building code.
[95] There is no doubt, therefore, that in the case of the rebuild option, an insured is entitled to those additional costs only if the qualification for them is met in each case. The issue is whether those additional costs should be taken into account when calculating Southern Response’s liability where the buy another house option is elected. Should the calculation of the buy another house option cost include a reasonable allowance for architects’ and surveyors’ professional fees, demolition,
removal of house contents and compliance with the building code when those costs would have been incurred if the insured had elected to rebuild on the same site? To answer this question it is necessary to go back to the structure of the Policy and consider Southern Response’s liability in relation to its obligation to pay “the full replacement cost of rebuilding your rental house”.
[96] To my mind, the Policy clearly distinguishes between what is included in “the full replacement cost of rebuilding” and what is stated to be additional to that cost. I am not attracted to the submission that the “additional” costs are effectively “included” costs “for the avoidance of doubt”. The Policy makes it clear that Southern Response will pay the cost of rebuilding to an as new condition with building materials and construction methods in common usage at the time of rebuilding. It will also pay the cost of architects’ and surveyors’ professional fees, demolition, contents removal and increased building code compliance but those costs are over and above what is the base or notional rebuilding cost. The word “additional” means what it says. It is additional to, over and above, the notional rebuilding cost where the notional rebuilding cost is the cost of rebuilding the existing house using new materials and methods but not including any additional work required to comply with building code requirements with which the existing house did not comply before the damage.
[97] It does not matter whether there is any logic to architects’ and surveyors’ fees being distinguished from other professional fees. It may well be, as Mr Friar suggested, because architects’ and surveyors’ fees are not ordinarily required in a rebuild of an existing house – only an architectural draughtsperson is needed to draw up the plans and, as the footprint of the previous house is used, there should be no surveyors’ fees. Mr Campbell asked why engineers’ fees, for example, were not included. The point is, the Policy says what it says, and the Policy is the contract between the parties.
[98] In the case of demolition, I do not agree that, because demolition would be inherent in a rebuild, the cost should be assumed to fall within the cost of rebuilding in any event. There is a difference between what might in fact be required and what the Policy says. I can see that, if there were no separate reference to demolition, there would be a good argument that demolition costs would be included within rebuilding
costs. However, in this case demolition costs are specifically carved out and are expressly in addition to the notional rebuilding cost.
[99] The wording in respect of building code compliance is even more explicit, such work being referred to as “additional work” with the obligation on Southern Response to pay the reasonable costs of the “additional work”. The Policy therefore clearly distinguishes between the cost of rebuilding in an as new condition with materials and using construction methods in use at the time, with the cost of undertaking any work to ensure compliance with the current building code. Obviously, a house could not be rebuilt unless it was code compliant. Had there been no separate reference to building code compliance, the cost of it would likely fall within the cost of rebuild. But again, the Policy makes the distinction.
[100] The importance of the additional costs is that they are costs which will not necessarily be incurred. In respect of professional fees, architects and surveyors will not necessarily be involved in a rebuild. Demolition will not necessarily be involved, for example, in the case of a fire causing total destruction.40 The same applies to removal of rental house contents and additional work required for code compliance – such work will not necessarily be required. The additional work is additional to rebuilding or replacing the existing house.
[101] The Court of Appeal and Supreme Court decisions in Avonside can be distinguished because they concerned contingency costs and professional fees (not including an architect or surveyor) which apply to a rebuild regardless.41
[102] The Policy acknowledges the additional costs are costs Southern Response might have to pay but they are specifically in addition to the notional rebuilding cost. It is the notional rebuilding cost which is the cost cap for the buy another house option. Under both the rebuild and buy another house options, Southern Response will pay the cost of “rebuilding your rental house”. Shirley Investments’ interpretation would require those words to be interpreted differently depending on which option were
elected. In the case of the rebuild option, by not including additional costs unless they
40 And it is certainly not inevitable in the case of repair.
41 Avonside SC and Avonside CA, above n 3.
were incurred but in the case of the buy another house option, including them. That cannot be right.
[103] Mr Campbell suggested there were impractical consequences of this approach, requiring two different estimates of cost, being first an estimate of a compliant rebuild in order to determine the economics of repair and then an estimate of a hypothetical notional rebuild not allowing for any changes to the house required by the building code. I am not persuaded any such minor practical difficulties should override the plain words of the Policy. This approach accords with Turvey and is implicitly approved in other decisions.
[104] Mr Campbell then suggested Southern Response’s interpretation of the Policy did not sit well with the earthquake top-up cover part of the Policy. This part provides that Southern Response will provide earthquake top-up cover for loss or damage not covered by the Earthquake Commission (EQC). Mr Campbell pointed out that the Earthquake Commission Act 1993 does not differentiate between rebuild costs and what Southern Response characterises as additional costs. I am not persuaded this point is determinative. EQC’s calculation is a separate analysis.
[105] The structure of the Policy and the context adds weight to the position. The structure of the Policy is explained in the summary on the cover page. It separates “cover for your rental house if it is damaged or destroyed” from “cover for additional costs”. Cover for additional costs is then in a new section of the Policy under the overall umbrella of “what is covered by this policy” but separate from “cover for your rental house”. The opening words under “cover for additional costs” say Southern Response “will pay for the following additional costs”.
[106] Such an interpretation is not bringing hindsight to bear or using a technical interpretation with undue emphasis on the niceties of language.42 It is simply construing the structure of the Policy and the plain meaning of the language used. It
is an objective interpretation.
42 Multi-Link Leisure Developments Ltd v North Lanarkshire Council [2010] UKSC 47, [2011] 1 All
ER 175 at [20]–[21].
Does this interpretation accord with the purpose of the Policy?
[107] The Policy provides insurance in respect of a rental house. It is a reinstatement policy, that is, the intention is to put the insured back in the same position he or she was in before the damage on a new-for-old basis. The insured will obtain the benefit of the house in an as new condition using current building materials and construction methods.
[108] Work required to comply with any changes to the building code is still paid for by Southern Response as an additional cost. The Policy is quite deliberate in doing this.
[109] I am satisfied the interpretation accords with the purpose of the Policy. Three other matters require some discussion in this regard.
(a) Windfall argument
[110] In Mr Friar’s submission, the purpose of providing cover for additional costs is to meet additional out of pocket expenses in fact incurred in order for the existing house to be rebuilt. However, on Shirley Investments’ interpretation, the additional costs would be payable in any event. This effectively would result in a windfall for an insured which goes beyond the purpose of the insurance.
[111] Mr Campbell responded by noting that Southern Response will receive a windfall if an insured chooses the buy another house option because Southern Response would be paying out less than it would have done under the rebuild option.
[112] Where the rebuild on the same site involves the need for Enhanced Foundations, the existing house will be rebuilt to an as new condition under the “what we will pay” part of the Policy and any Enhanced Foundations will be built and paid for by Southern Response under the “cover for additional costs”. The interpretation advanced by Shirley Investments would mean that, if the buy another house option is elected, the insured can buy a house on stable ground with standard foundations and use the notional cost of the Enhanced Foundations to buy a more expensive house. The result is the insured obtains a house worth more than the house he or she would
have obtained had they rebuilt on the same site.43 That would result in a windfall which would not accord with the intention of a replacement policy.
[113] The same applies to demolition costs. The Policy provides that if the existing house is in fact demolished, then Southern Response will cover the cost as an additional cost. On Shirley Investments’ interpretation, an insured would be paid the cost of demolishing the house even if the insured decides not to demolish it. Again, the insured would receive a windfall for a cost which is not incurred.44
[114] This analysis is not limited to the extreme situation which has resulted from the Canterbury earthquakes. Mr Campbell urged me to consider the issue in relation to any additional work required to ensure building code compliance, for example if the code requires every new house to be insulated. The same analysis applies. Had the existing house not been insulated, Southern Response would pay for the cost of insulating the rebuilt house as an additional cost. It does not follow, however, that the cost should be included in the cost cap for the buy another house option, because again that would be putting the insured in a better position than the Policy intended.
[115] The issue is what the contract between the parties provides. The purpose of the Policy, if the house is damaged beyond economic repair and a cash payment is not elected, is to put the insured in the position he or she would have been had the damage not occurred, with the house being put in an as new condition. That will involve some improvement to the insured’s position. It is not, however, intended that the insured is put in a better position by obtaining a house worth more than that of the existing house once rebuilt. Furthermore, as alluded to above, the buy another house option offers other benefits to an insured, including obtaining a new house with little delay in comparison to a rebuild, an early resumption of the rental income stream, and moving
to more stable ground.
43 This is based on what seems a reasonable assumption, which was not contested, that the cost of foundations (literally a sunk cost) is not reflected in a house’s market value.
44 Under the Policy, Southern Response has salvage rights (they are entitled to “take and keep possession of your damaged property” and “deal with any salvage in a reasonable manner”). The evidence was that frequently an insured simply retains the existing house and elects not to repair it because some houses which are uneconomic to repair are still liveable.
(b) The Policy does not cover land
[116] Another relevant aspect in this case, as far as Enhanced Foundations are concerned, is that the Policy does not cover land. In this case, the cost of the Enhanced Foundations includes work described as “deep ground improvement”. That is work required to be carried out to the land to enable the House to be rebuilt. The evidence from Southern Response was that it typically obtains a deed of assignment of the insured’s claim against EQC for earthquake damage to the land and Southern Response can then claim back the value of the work done to the land. If the cost of the Enhanced Foundations including work to the land were to be paid to the insured under the buy another house option, Southern Response would not be able to recover this part of the insurance payout.
[117] I accept Mr Campbell’s contention that any contribution from EQC is a matter between insurers and does not affect an insured’s entitlement under the Policy. However, putting the EQC situation to one side, the fact that Enhanced Foundations may well include work to the land is a relevant consideration. The separation of the Policy into “what we will pay” and “cover for additional costs” confirms that paying for such works is an additional cost which the insurer will meet if the cost is incurred, albeit that it relates to the land which is excluded from the Policy. It emphasises why any such payment is additional to the insurer’s primary obligation.
(c) Impact on other policies
[118] Southern Response says that Shirley Investments’ argument will adversely impact insureds covered by Southern Response’s market value policies, which provide a more limited form of cover than the premier policies for a lower premium. Such policies provide indemnity cover but also contain “cover for additional costs” in the same way as the Policy. This enables an insured under a market value policy to recover indemnity value with additional payments in respect of the additional costs. However, if those costs are effectively considered as part and parcel of the “what we will pay” part of the policy, then holders of a market value policy will be disadvantaged.
[119] In Mr Campbell’s submission, the market value policy is not relevant to interpretation of the Policy. It was not background context that was reasonably
available to both contracting parties at the time they entered into the contract. I agree with that submission, noting the Court of Appeal has previously said the “difference in wording between this and other policies is immaterial”.45
Demolition costs
[120] To the extent not already addressed, the same arguments apply to the question of demolition. Mr Campbell suggested the Policy does not in fact require that demolition costs are incurred, only that the insured obtain approval before the costs are incurred. That is a strained interpretation to say the least.
[121] The declaration sought by Southern Response does not include recognition that, even under the buy another house option, an insured is still entitled (conditionally) to recover demolition costs as an additional cost. Following consultation with the parties, the declaration sought has been amended to reflect that.
Second declaration – does the buy another house option include the cost of buying the land on which the house is situated?
[122] This question was at issue at the time of the pleadings. It is now moot as between the parties given the value of the other house purchased by Shirley Investments exceeded the cost cap. However, the parties both consider it a question of principle which it is appropriate to address as it is of some importance and should not have to wait for another case to be brought.
[123] The question here is, under the buy another house option, is the maximum entitlement of an insured the value of the other house (as opposed to the land on which it sits), even if less than the cost cap? Southern Response emphasises that the Policy does not cover land. Mr Friar noted that in Skyward, the insured accepted the buy another house option under a Tower policy allowed the cost of rebuilding to be applied toward the cost of a new house but not for the cost of buying the land. The Supreme Court was not required to address the issue but did observe in a footnote that the basis
of the position was “since Tower did not insure the land but only the house, it is logical
45 Medical Assurance Society of New Zealand Ltd v East [2015] NZCA 250, (2015) 18 ANZ Insurance Cases 62-074 at [21].
to treat its replacement value payment obligation as triggered only to the extent that the insured’s payment is referable to the house”.46
[124] Furthermore, Mr Friar submitted it would not be appropriate to require Southern Response to pay money towards the purchase of land in circumstances where the insured retains the land on which the existing house is sited. As he said, if the insured required additional funds to purchase another house, they could sell that land.
[125] Mr Friar noted that to date Southern Response has generally accommodated customers who wished to apply the cost of rebuilding towards both the house and land. In many ways, it is unfortunate that a ruling is sought on this aspect as it may adversely impact that flexibility.
[126] Mr Campbell’s submissions focused on what he said was the natural and ordinary meaning of the phrase “to buy another house”. He said, as a matter of ordinary language, when someone talks of buying a house, they refer both to the dwelling and the land. In his submission, reading reference to buying another house in a non-technical context to mean as Southern Response contends is unreasonable and absurd.
[127] Mr Campbell submitted that the interpretation allowing the cost to be applied to the land on which the house sits is reinforced by the clause also covering “legal and associated fees”. In his submission, legal fees generally involve the complexities of a land purchase. He also suggested there would be real practical difficulties given separate valuations would have to be carried out.
[128] Any ambiguity, in his submission, should be resolved against Southern
Response as drafter of the Policy.
[129] I am satisfied that Southern Response’s interpretation is correct. The Policy makes it clear that land is not covered. It is entirely logical, therefore, that buying another house means exactly what it says, namely, it does not include the land. I do
not accept the practical difficulties associated with that. Valuations typically separate
46 Skyward SC, above n 4, at n 8.
land value from improvement value. Legal costs are just as likely to be incurred in dealing with aspects relating to the house itself, code compliance issues being an obvious example. I would be surprised if Southern Response were to take an unduly rigid approach to distinguishing which legal fees related to the house purchase and which to the land and indeed, as I have already observed, it would be a shame if the declaration would stifle flexibility on the part of Southern Response.
[130] I am satisfied that the declaration is properly made.
Result
[131] For the reasons given, I make the following declarations:
(a) The cost of rebuilding Shirley Investments’ rental house on its present site under the buy another house option includes the cost of rebuilding the existing foundations but does not include:
(i)the cost of additional foundation work that is required to ensure that rebuilding the rental house complies with the building code; and
(ii) the cost of demolishing the existing house.
(b)The reasonable costs of demolishing Shirley Investments’ rental house are payable by Southern Response under the “cover for additional costs” section of the Policy if Shirley Investments incurs that cost by demolishing the rental house, and if Southern Response approves that cost before it is incurred.
(c) The amount payable by Southern Response to Shirley Investments under the buy another house option can be no greater than the cost of Shirley Investments buying another house and does not include the cost of buying the land on which the house is situated.
[132] I accept there is an issue as to costs given the nature of these proceedings. If the parties cannot agree, Southern Response is to file a memorandum by 26 January
2018, with any reply 14 days thereafter. A decision will be made on the papers.
Thomas J
Solicitors:
Bell Gully, Auckland for Plaintiff
Shine Lawyers NZ Ltd, Auckland for Defendant
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