Principles Applicable to Claims for Recovery on a Replacement Cost Basis

Many commercial first-party property insurance contracts detail circumstances under which an insured may seek and recover for physical loss or damage to insured property on a replacement cost basis. If the contract does not provide that option, or if the conditions for replacement cost recovery are not met, the insured's recovery typically is limited to the actual cash value of the lost or damaged property. Because the measured difference can be substantial, certain principles have evolved in practice and case law concerning this distinction.

In concept, replacement cost recovery restores the insured's business property to the same capacity it had on the date of the event causing physical loss or damage, while actual cash recovery provides the insured with a payment equal to the value of that property on that date. Each type of recovery must be assessed in light of the wording in the contract, which can vary in a number of respects. Generally, replacement cost exceeds actual cash value, which is calculated by deducting depreciation and any other stated factors from replacement cost. Absent an unusual wording, the replacement cost recovery is not available unless the property is actually replaced within a stated or reasonable period after the loss or damage occurs. This result follows from the concept that the “insured is not entitled to the full replacement value of an item until he proves that he has, in fact, replaced that item.” See Dickerson v. Lexington Ins. Co., 556 F.3d 290, 296 (5th Cir. 2009). As with many other areas of insurance law, courts seek in this area to determine and apply the intent of the parties embodied in the specific contract language, consistent with the equitable considerations that flow from that intent, though the analysis of these concepts is often colored by whether the insurance at issue is for a commercial entity or, e.g., an individual homeowner, and precedent in this area must be reviewed with that lens in mind.

Conditions on Replacement Cost Recovery

Replacement cost is generally described in terms such as “the cost, at the time of loss, to repair or replace the damaged property with new materials of like kind and quality, without deduction for depreciation.” Dombrosky v. Farmers Ins. Co., 928 P.2d 1127, 1135 (Wash. Ct. App. 1996). Cf. Dickler v. CIGNA Prop. & Cas. Co., 957 F.2d 1088, 1091 (3d Cir. 1992) (“The policy defined 'replacement cost' as 'the amount it would take to replace property with property of the same kind and quality, determined at the time of the loss'”). In the absence of explicit policy language permitting replacement at a different site, replacement generally must occur “on the same premises.” Maryland Cas. Co. v. Knight, 96 F.3d 1284, 1293 (9th Cir. 1996).

The period of time needed to plan, select, and replace property varies with the severity of the physical loss or damage that has taken place. Some first-party policies expressly provide that once the loss has been quantified, the insured may recover up to the actual cash value, with the balance held for later consideration when the replacement has been completed. Depending on the type of loss and circumstance, the insured and insurer may also agree to proceed in this fashion as part of the adjustment. In any event, there are limits ' express or implied ' on the time period to elect and complete the replacement. Certain policies affix a set time period, providing, for example, that the replacement must be made “within two years from the date of the loss.” Though such an explicit time frame often is enforced as written, certain commentators argue that the application should “take account of the many, many variations that appear in the circumstances, including the size and complexity of the structure, local building industry conditions, and so on.” Lee R. Russ & Thomas F. Segalla, 12 Couch on Insurance ' 176:64 (3d ed. 2011). The need for limitations is apparent, however, in those decisions where courts have implied and enforced a “reasonable time” limitation where one was not explicitly stated in the policy wording. E.g., Maine Mut. Fire Ins. Co. v. Watson, 532 A.2d 686, 689 (Me. 1987); Bourrie v. U.S. Fid. & Guar. Ins. Co., 707 P.2d 60, 63 (Or. Ct. App. 1985). A similar effect is achieved through policy language requiring actual replacement by the insured with “due diligence and dispatch.” See, e.g., Versai Mgmt. Corp. v. Clarendon Am. Ins. Co., 597 F.3d 729, 738 (5th Cir. 2010); Central Nat'l Ins. Co. v. Devonshire Coverage Corp., 565 F.2d 490, 496 (8th Cir. 1977). What is reasonable will, of course, vary on the facts of a given claim. The court in Devonshire, for example, held that where the insured began replacement within six months after a loss and continued “steadily until” the process was “completed,” it had satisfied the requirement to exercise due diligence and dispatch under the circumstances presented. Id. at 496.

In order to make a valid claim for replacement costs, the insured must not only act with due diligence and dispatch, but must also undertake and complete actual replacement. This concept is embodied, for example, in some policy provisions stating that “until replacement has been effected the amount of liability under this Policy in respect of loss shall be limited to actual cash value at the time of loss.” Versai, 597 F.3d at 738; see also Hess v. North Pac. Ins. Co., 859 P.2d 586, 587 (Wash. 1993) (quoting policy that provides insurer “will pay no more than the actual cash value of the damage unless ' actual repair or replacement is complete”); Lerer Realty Corp. v. MFB Mut. Ins. Co., 474 F.2d 410, 413 (5th Cir. 1973).

Enforceability of Conditions on Replacement Cost Recovery

Generally, replacement cost policy provisions have been found enforceable and free from ambiguity. Knight, 96 F.3d at 1292. The core condition ' that of actual replacement ' has been described as an “inescapable” requirement. See Bourazak v. North River Insurance Co., 379 F.2d 530, 532 (7th Cir. 1967), the sine qua non of replacement cost recovery. See also, e.g., Versai, 597 F.3d at 738. As the U.S. Court of Appeals for the Third Circuit recognized, such an interpretation prevents the insured from recovering a windfall award. See Dickler, 957 F.2d at 1096. In fact, “[i]t is the act of replacing the property that causes the insured to suffer an additional loss for which he purchased additional coverage.” Fitzhugh 25 Partners, L.P. v. KILN Syndicate KLN 501, 261 S.W.3d 861, 864 (Tex. Ct. App. 2008). Absent that act, there is no “event that triggers” replacement cost recovery. Id.

Some courts hold that this requirement “operates as a condition precedent to recovery of replacement costs.” Conrad Bros. v. John Deere Ins. Co., 640 N.W.2d 231, 239 (Iowa 2001). Other courts have looked to “equitable principles” in the individual situation under review that are said to counsel against enforcing the policy as written particularly when the insured is an individual claiming under a homeowners' policy. See Rockford Mut. Ins. Co. v. Pirtle, 911 N.E.2d 60, 66 (Ind. Ct. App. 2009). That situation could arise, for instance, under the doctrine of “practical impossibility” discussed below.

Practical Impossibility

Homeowners have argued, with some success, that where insurers have denied their claim, they have made actual replacement a “practical impossibility” and have thereby excused the requirement to actually replace. A classic formulation of that argument was put forth by the homeowner-insureds in Zaitchick v. American Motorists Ins. Co., 554 F. Supp. 209 (S.D.N.Y. 1982). There, the insured property was a home that was lost in a fire and the insurer disclaimed coverage, contending that the insureds had committed arson by purposefully setting the fire. Id. at 215. The court concluded otherwise, finding that the fire was not set purposefully and that it caused a covered loss under the contract. Id. The insureds, who had not replaced their home, sought full replacement costs. Id. at 216. They contended that the insurer's “refusal to pay any money [on the claim] prevented them from rebuilding their home.” Id. They further reasoned that “a bank would be chary to lend money” needed for a replacement “on the basis of an unlitigated law suit [sic]” concerning coverage. Id. at 217. The court embraced the insureds' argument, concluding that the insurer's disclaimer of coverage “made it impossible for the [insureds] to fulfill the condition precedent, and therefore, excuse[d] [insureds] from performance” of actual replacement. Id. In reaching that conclusion, the court was drawing on its view of the equities of the case and, in particular, the view that an individual homeowner without the financial resources to independently fund rebuilding of his or her home should not be deprived of replacement cost recovery through allegations of arson that ultimately were insufficiently substantiated. Though the holding was confined to these facts, other courts have erroneously cited the holding of Zaitchick outside the homeowners context. See, e.g., Vantage View, Inc. v. QBE Ins. Corp., No. 07-61038, 2009 WL 536546, *3-4 (S.D. Fla. Mar. 3, 2009) (excusing performance of actual replacement and allowing replacement cost value for insured's damaged condominium complex).

The better-reasoned and supported view is that an insurer's initial denial of a claim or a disagreement between the parties concerning the loss amount will not render actual replacement a “practical impossibility.” As the Supreme Court of Michigan has held, the insured's “interest in obtaining payment of replacement cost can be protected without estopping the insurer from requiring” the actual replacement consistent with the policy. Smith v. Michigan Basic Prop. Ins. Ass'n, 490 N.W.2d 864, 868 (Mich. 1992), superseded on other grounds by statute, Mich. Comp. Laws ' 500.2826, as recognized in Salesin v. State Farm Fire & Cas. Co., 581 N.W. 2d 781, 787 (Mich. Ct. App. 1998). The Smith court directed the entry of a judgment requiring payment of actual cash value to be supplemented by “an additional payment ' when and if the” insureds actually replaced the damaged property. Id. at 866. The U.S. Court of Appeals for the Third Circuit adopted the same approach in Dickler, noting that if the insured undertook replacement within one year it would be entitled to “a supplemental payment as required by the insurance policy such that the total recovery would equal the building's replacement cost.” 957 F.2d at 1096; accord Watson, 532 A.2d at 689.

Replacement Cost Recovery in the Commercial Context

The better view articulated by these courts is consistent with the approach most often taken in the commercial first-party insurance context.

First, where the insured has established sufficient facts to demonstrate that insured property was physically lost or damaged by an insured peril during the policy term, the insurer works with the insured to measure and agree upon the actual cash value of that property. As the Court of Appeals of Michigan noted, where the insurer has paid actual cash value and challenges only “the issue of whether additional monies would be due under the relevant replacement cost contract provis[ions],” the insured will have “at least some money with which to begin rebuilding their property.” Pollock v. Fire Ins. Exch., 423 N.W.2d 234, 236 (Mich. Ct. App. 1988); see also Knight, 96 F.3d at 1292 (actual cash value payment “could have been immediately applied toward the repair and replacement.”).

Second, the insurer and insured will give due consideration to the insured's business, proposed actions, and declared interests at the time of replacement. Where the insured is a sophisticated business with multiple options and capacity, the considerations are “far different” and the reasons for imposing timing and replacement limitations are compelling. See Dickler, 957 F.2d at 1096. These circumstances contrast with those of the individual homeowner. For example, in Pirtle, 911 N.E.2d at 66, where the insured property was a private home, during a six-month delay in the payment of actual cash value the property was condemned and foreclosed thereby making replacement actually impossible.

Third, linear measurement of time limitations must also take account of other factors, such as the existence of a dispute between the insured and insurer. In those circumstances, if the disputed coverage issue ultimately is resolved in favor of the insured, time limitations on actual replacement may not begin to run until the time of that resolution. See, e.g. Smith, 490 N.W.2d at 867-68 (once “it has been determined that” the loss is covered and that the insured is “entitled to payment of actual cash value,” the insured may then be afforded a reasonable time to actually replace the damaged property); Watson, 532 A.2d at 689.

Fourth, these matters are less likely to pose problems if the insured and insurer maintain an open dialogue about replacement cost issues. Courts sometimes recognize this in fashioning a judgment. To illustrate, the insured city in City of Hollister v. Monterey Insurance Co., sought to recover for a building destroyed by fire at its municipal airport. See 165 Cal. App. 4th 455, 461 (Cal. Ct. App. 2008). The replacement cost policy provision required that the city contract with a contractor to perform the replacement within 180 days of the loss. Id. at 491. The insurer simultaneously reserved the right to deny reimbursement for replacement costs, but declined to take any position on coverage until after the city had “bound itself by contract to pay for a replacement building.” Id. The insured responded by seeking replacement cost but refusing to retain a contractor for replacement until it had assurances of coverage, creating a standoff. The court declined to enforce the 180-day requirement as written, Id. at 500-13, and instead put the parties to a middle ground they might have found themselves in with better lines of communication, holding that the insured could recover replacement costs, provided it engaged a contractor within 180 days after the entry of judgment. Id. at 514.

Alternative Recoveries on a 'Hypothetical' Replacement Cost Basis

The enforcement of conditions on replacement cost recovery can be more challenging in policies that include alternatives other than: 1) actual cash value recovery, or 2) replacement cost recovery when the property is repaired or rebuilt with new materials of like kind and quality, without deduction for depreciation. For example, certain policies explicitly permit the insured to elect to rebuild at a different location, which can complicate calculation of an accurate replacement cost value. Application may become even more complicated when the valuation provisions state that the insured may elect to recover on a replacement cost basis when, instead of replacing the property, the insured makes other actual “capital expenditures related to the insured's operations.” This option applies where those capital expenditures were unplanned at the date of physical loss or damage and are expended within a stated or reasonable time thereafter. The application, however, requires consideration of a “hypothetical” replacement cost valuation ' i.e., the potential for recovery of replacement cost without actual replacement of the property. There must still be an actual expenditure, but because those expenditures are now measured against a hypothetical replacement cost value, there is greater potential for disagreements as to application and disputes to arise in quantifying the claim.

Conclusion

Where policies contain replacement cost provisions, the parties can expect that policy language, case law, and general policy considerations will require actual replacement within a reasonable time in order for an insured to recover replacement costs. The parties should bear in mind that variations may arise from the type of insured and type of loss, and from the provisions in the valuation wording that may introduce other alternatives and considerations. Due consideration to these points and an open dialogue between the parties during the adjustment offer the best prospect for avoiding misunderstanding and controversy over these matters.

Catherine A. Mondell, a member of this newsletter's Board of Editors, is a partner at Ropes & Gray LLP, in Boston, and has handled a wide range of complex insurance coverage disputes and other commercial litigation matters. She has litigated in multiple jurisdictions cases involving first-party property claims with substantial time element and contingent time element components. M. Patrick Moore, Jr. is a litigation associate in the firm's Boston office. He specializes in representing insurance carriers in coverage matters and in commercial litigation.

Many commercial first-party property insurance contracts detail circumstances under which an insured may seek and recover for physical loss or damage to insured property on a replacement cost basis. If the contract does not provide that option, or if the conditions for replacement cost recovery are not met, the insured's recovery typically is limited to the actual cash value of the lost or damaged property. Because the measured difference can be substantial, certain principles have evolved in practice and case law concerning this distinction.

In concept, replacement cost recovery restores the insured's business property to the same capacity it had on the date of the event causing physical loss or damage, while actual cash recovery provides the insured with a payment equal to the value of that property on that date. Each type of recovery must be assessed in light of the wording in the contract, which can vary in a number of respects. Generally, replacement cost exceeds actual cash value, which is calculated by deducting depreciation and any other stated factors from replacement cost. Absent an unusual wording, the replacement cost recovery is not available unless the property is actually replaced within a stated or reasonable period after the loss or damage occurs. This result follows from the concept that the “insured is not entitled to the full replacement value of an item until he proves that he has, in fact, replaced that item.” See Dickerson v. Lexington Ins. Co. , 556 F.3d 290, 296 (5th Cir. 2009). As with many other areas of insurance law, courts seek in this area to determine and apply the intent of the parties embodied in the specific contract language, consistent with the equitable considerations that flow from that intent, though the analysis of these concepts is often colored by whether the insurance at issue is for a commercial entity or, e.g., an individual homeowner, and precedent in this area must be reviewed with that lens in mind.

Conditions on Replacement Cost Recovery

Replacement cost is generally described in terms such as “the cost, at the time of loss, to repair or replace the damaged property with new materials of like kind and quality, without deduction for depreciation.” Dombrosky v. Farmers Ins. Co. , 928 P.2d 1127, 1135 (Wash. Ct. App. 1996). Cf. Dickler v. CIGNA Prop. & Cas. Co. , 957 F.2d 1088, 1091 (3d Cir. 1992) (“The policy defined 'replacement cost' as 'the amount it would take to replace property with property of the same kind and quality, determined at the time of the loss'”). In the absence of explicit policy language permitting replacement at a different site, replacement generally must occur “on the same premises.” Maryland Cas. Co. v. Knight , 96 F.3d 1284, 1293 (9th Cir. 1996).

The period of time needed to plan, select, and replace property varies with the severity of the physical loss or damage that has taken place. Some first-party policies expressly provide that once the loss has been quantified, the insured may recover up to the actual cash value, with the balance held for later consideration when the replacement has been completed. Depending on the type of loss and circumstance, the insured and insurer may also agree to proceed in this fashion as part of the adjustment. In any event, there are limits ' express or implied ' on the time period to elect and complete the replacement. Certain policies affix a set time period, providing, for example, that the replacement must be made “within two years from the date of the loss.” Though such an explicit time frame often is enforced as written, certain commentators argue that the application should “take account of the many, many variations that appear in the circumstances, including the size and complexity of the structure, local building industry conditions, and so on.” Lee R. Russ & Thomas F. Segalla, 12 Couch on Insurance ' 176:64 (3d ed. 2011). The need for limitations is apparent, however, in those decisions where courts have implied and enforced a “reasonable time” limitation where one was not explicitly stated in the policy wording. E.g. , Maine Mut. Fire Ins. Co. v. Watson , 532 A.2d 686, 689 (Me. 1987); Bourrie v. U.S. Fid. & Guar. Ins. Co. , 707 P.2d 60, 63 (Or. Ct. App. 1985). A similar effect is achieved through policy language requiring actual replacement by the insured with “due diligence and dispatch.” See , e.g. , Versai Mgmt. Corp. v. Clarendon Am. Ins. Co. , 597 F.3d 729, 738 (5th Cir. 2010); Central Nat'l Ins. Co. v. Devonshire Coverage Corp. , 565 F.2d 490, 496 (8th Cir. 1977). What is reasonable will, of course, vary on the facts of a given claim. The court in Devonshire, for example, held that where the insured began replacement within six months after a loss and continued “steadily until” the process was “completed,” it had satisfied the requirement to exercise due diligence and dispatch under the circumstances presented. Id. at 496.

In order to make a valid claim for replacement costs, the insured must not only act with due diligence and dispatch, but must also undertake and complete actual replacement. This concept is embodied, for example, in some policy provisions stating that “until replacement has been effected the amount of liability under this Policy in respect of loss shall be limited to actual cash value at the time of loss.” Versai , 597 F.3d at 738; see also Hess v. North Pac. Ins. Co. , 859 P.2d 586, 587 (Wash. 1993) (quoting policy that provides insurer “will pay no more than the actual cash value of the damage unless ' actual repair or replacement is complete”); Lerer Realty Corp. v. MFB Mut. Ins. Co. , 474 F.2d 410, 413 (5th Cir. 1973).

Enforceability of Conditions on Replacement Cost Recovery

Generally, replacement cost policy provisions have been found enforceable and free from ambiguity. Knight, 96 F.3d at 1292. The core condition ' that of actual replacement ' has been described as an “inescapable” requirement. See Bourazak v. North River Insurance Co. , 379 F.2d 530, 532 (7th Cir. 1967), the sine qua non of replacement cost recovery. See also, e.g., Versai, 597 F.3d at 738. As the U.S. Court of Appeals for the Third Circuit recognized, such an interpretation prevents the insured from recovering a windfall award. See Dickler, 957 F.2d at 1096. In fact, “[i]t is the act of replacing the property that causes the insured to suffer an additional loss for which he purchased additional coverage.” Fitzhugh 25 Partners, L.P. v. KILN Syndicate KLN 501 , 261 S.W.3d 861, 864 (Tex. Ct. App. 2008). Absent that act, there is no “event that triggers” replacement cost recovery. Id.

Some courts hold that this requirement “operates as a condition precedent to recovery of replacement costs.” Conrad Bros. v. John Deere Ins. Co. , 640 N.W.2d 231, 239 (Iowa 2001). Other courts have looked to “equitable principles” in the individual situation under review that are said to counsel against enforcing the policy as written particularly when the insured is an individual claiming under a homeowners' policy. See Rockford Mut. Ins. Co. v. Pirtle , 911 N.E.2d 60, 66 (Ind. Ct. App. 2009). That situation could arise, for instance, under the doctrine of “practical impossibility” discussed below.

Practical Impossibility

Homeowners have argued, with some success, that where insurers have denied their claim, they have made actual replacement a “practical impossibility” and have thereby excused the requirement to actually replace. A classic formulation of that argument was put forth by the homeowner-insureds in Zaitchick v. American Motorists Ins. Co. , 554 F. Supp. 209 (S.D.N.Y. 1982). There, the insured property was a home that was lost in a fire and the insurer disclaimed coverage, contending that the insureds had committed arson by purposefully setting the fire. Id. at 215. The court concluded otherwise, finding that the fire was not set purposefully and that it caused a covered loss under the contract. Id. The insureds, who had not replaced their home, sought full replacement costs. Id. at 216. They contended that the insurer's “refusal to pay any money [on the claim] prevented them from rebuilding their home.” Id. They further reasoned that “a bank would be chary to lend money” needed for a replacement “on the basis of an unlitigated law suit [sic]” concerning coverage. Id. at 217. The court embraced the insureds' argument, concluding that the insurer's disclaimer of coverage “made it impossible for the [insureds] to fulfill the condition precedent, and therefore, excuse[d] [insureds] from performance” of actual replacement. Id. In reaching that conclusion, the court was drawing on its view of the equities of the case and, in particular, the view that an individual homeowner without the financial resources to independently fund rebuilding of his or her home should not be deprived of replacement cost recovery through allegations of arson that ultimately were insufficiently substantiated. Though the holding was confined to these facts, other courts have erroneously cited the holding of Zaitchick outside the homeowners context. See, e.g., Vantage View, Inc. v. QBE Ins. Corp., No. 07-61038, 2009 WL 536546, *3-4 (S.D. Fla. Mar. 3, 2009) (excusing performance of actual replacement and allowing replacement cost value for insured's damaged condominium complex).

The better-reasoned and supported view is that an insurer's initial denial of a claim or a disagreement between the parties concerning the loss amount will not render actual replacement a “practical impossibility.” As the Supreme Court of Michigan has held, the insured's “interest in obtaining payment of replacement cost can be protected without estopping the insurer from requiring” the actual replacement consistent with the policy. Smith v. Michigan Basic Prop. Ins. Ass'n , 490 N.W.2d 864, 868 (Mich. 1992), superseded on other grounds by statute , Mich. Comp. Laws ' 500.2826, as recognized in Salesin v. State Farm Fire & Cas. Co. , 581 N.W. 2d 781, 787 (Mich. Ct. App. 1998). The Smith court directed the entry of a judgment requiring payment of actual cash value to be supplemented by “an additional payment ' when and if the” insureds actually replaced the damaged property. Id. at 866. The U.S. Court of Appeals for the Third Circuit adopted the same approach in Dickler, noting that if the insured undertook replacement within one year it would be entitled to “a supplemental payment as required by the insurance policy such that the total recovery would equal the building's replacement cost.” 957 F.2d at 1096; accord Watson, 532 A.2d at 689.

Replacement Cost Recovery in the Commercial Context

The better view articulated by these courts is consistent with the approach most often taken in the commercial first-party insurance context.

First, where the insured has established sufficient facts to demonstrate that insured property was physically lost or damaged by an insured peril during the policy term, the insurer works with the insured to measure and agree upon the actual cash value of that property. As the Court of Appeals of Michigan noted, where the insurer has paid actual cash value and challenges only “the issue of whether additional monies would be due under the relevant replacement cost contract provis[ions],” the insured will have “at least some money with which to begin rebuilding their property.” Pollock v. Fire Ins. Exch. , 423 N.W.2d 234, 236 (Mich. Ct. App. 1988); see also Knight , 96 F.3d at 1292 (actual cash value payment “could have been immediately applied toward the repair and replacement.”).

Second, the insurer and insured will give due consideration to the insured's business, proposed actions, and declared interests at the time of replacement. Where the insured is a sophisticated business with multiple options and capacity, the considerations are “far different” and the reasons for imposing timing and replacement limitations are compelling. See Dickler, 957 F.2d at 1096. These circumstances contrast with those of the individual homeowner. For example, in Pirtle, 911 N.E.2d at 66, where the insured property was a private home, during a six-month delay in the payment of actual cash value the property was condemned and foreclosed thereby making replacement actually impossible.

Third, linear measurement of time limitations must also take account of other factors, such as the existence of a dispute between the insured and insurer. In those circumstances, if the disputed coverage issue ultimately is resolved in favor of the insured, time limitations on actual replacement may not begin to run until the time of that resolution. See, e.g. Smith, 490 N.W.2d at 867-68 (once “it has been determined that” the loss is covered and that the insured is “entitled to payment of actual cash value,” the insured may then be afforded a reasonable time to actually replace the damaged property); Watson, 532 A.2d at 689.

Fourth, these matters are less likely to pose problems if the insured and insurer maintain an open dialogue about replacement cost issues. Courts sometimes recognize this in fashioning a judgment. To illustrate, the insured city in City of Hollister v. Monterey Insurance Co., sought to recover for a building destroyed by fire at its municipal airport. See 165 Cal. App. 4th 455, 461 (Cal. Ct. App. 2008). The replacement cost policy provision required that the city contract with a contractor to perform the replacement within 180 days of the loss. Id. at 491. The insurer simultaneously reserved the right to deny reimbursement for replacement costs, but declined to take any position on coverage until after the city had “bound itself by contract to pay for a replacement building.” Id. The insured responded by seeking replacement cost but refusing to retain a contractor for replacement until it had assurances of coverage, creating a standoff. The court declined to enforce the 180-day requirement as written, Id. at 500-13, and instead put the parties to a middle ground they might have found themselves in with better lines of communication, holding that the insured could recover replacement costs, provided it engaged a contractor within 180 days after the entry of judgment. Id. at 514.

Alternative Recoveries on a 'Hypothetical' Replacement Cost Basis

The enforcement of conditions on replacement cost recovery can be more challenging in policies that include alternatives other than: 1) actual cash value recovery, or 2) replacement cost recovery when the property is repaired or rebuilt with new materials of like kind and quality, without deduction for depreciation. For example, certain policies explicitly permit the insured to elect to rebuild at a different location, which can complicate calculation of an accurate replacement cost value. Application may become even more complicated when the valuation provisions state that the insured may elect to recover on a replacement cost basis when, instead of replacing the property, the insured makes other actual “capital expenditures related to the insured's operations.” This option applies where those capital expenditures were unplanned at the date of physical loss or damage and are expended within a stated or reasonable time thereafter. The application, however, requires consideration of a “hypothetical” replacement cost valuation ' i.e., the potential for recovery of replacement cost without actual replacement of the property. There must still be an actual expenditure, but because those expenditures are now measured against a hypothetical replacement cost value, there is greater potential for disagreements as to application and disputes to arise in quantifying the claim.

Conclusion

Where policies contain replacement cost provisions, the parties can expect that policy language, case law, and general policy considerations will require actual replacement within a reasonable time in order for an insured to recover replacement costs. The parties should bear in mind that variations may arise from the type of insured and type of loss, and from the provisions in the valuation wording that may introduce other alternatives and considerations. Due consideration to these points and an open dialogue between the parties during the adjustment offer the best prospect for avoiding misunderstanding and controversy over these matters.

Catherine A. Mondell, a member of this newsletter's Board of Editors, is a partner at Ropes & Gray LLP, in Boston, and has handled a wide range of complex insurance coverage disputes and other commercial litigation matters. She has litigated in multiple jurisdictions cases involving first-party property claims with substantial time element and contingent time element components. M. Patrick Moore, Jr. is a litigation associate in the firm's Boston office. He specializes in representing insurance carriers in coverage matters and in commercial litigation.