Bad Faith Requires Covered Loss – No Coverage For Hurricane Ike Flood Damage Absent Flood Insurance

Bad Faith Requires Covered Loss – No Coverage For Hurricane Ike Flood Damage Absent Flood Insurance

    By Barry Zalma, Attorney and Consultant

Insured Must Prove a Covered Loss

Lexington Insurance Company (“Lexington”) challenged a breach of contract and bad faith judgment in favor of JAW The Pointe, LLC (“The Pointe”). Lexington asked the Texas Court of Appeal to reverse the trial court’s judgment on multiple grounds. In Lexington Insurance Co. v. Jaw Pointe, LLC, 14-11-00881-CV (Tex.App. Dist.14 08/01/2013) [enhanced version available to lexis.com subscribers], the Texas Appellate court was called upon to determine if bad faith damages can be assessed if there is no coverage under the policy.

FACTUAL BACKGROUND

Emery Jakab and several partners formed JAW The Pointe, LLC and then purchased an apartment complex in July 2007 for approximately $5.7 million. The apartment complex consisted of 13 two-story buildings and was located next to the seawall in Galveston.

The Pointe purchased insurance from Lexington and other insurance companies under a group program that provided coverage to hundreds of unrelated apartment complexes in multiple states. The named insured under the Lexington policy is Nations Asset Management LP (CAT), an entity comprising approximately 300 apartment complexes including The Pointe’s Galveston property. The apartment complexes constituting CAT were brought together by an insurance broker.

The Lexington policy was one of several layers that collectively provided insurance coverage up to $100 million for the CAT properties. Lexington’s was the primary policy and provided $25 million in coverage per occurrence under the group program.

Hurricane Ike hit Galveston on September 13, 2008, causing damage to The Pointe’s apartment complex and about 135 other apartment complexes encompassed by CAT insurance program. The Pointe hired a public insurance adjusting firm, Adjusters International, to assist The Pointe during the insurance claims settlement process. Lexington used Cunningham Lindsey as its independent adjuster.

The Pointe initially intended to repair the apartment complex; its plans changed when Jakab attended a meeting with planning officials from the City of Galveston and members of the Galveston County Apartment Association on October 13, 2008. City officials explained that apartment owners would be required to demolish and rebuild to comply with current code requirements if the City determined that an apartment complex’s damages exceeded 50 percent of the complex’s market value.

The Pointe submitted a building permit application on November 12, 2008, to repair the apartment complex. The permit application stated that the repair would cost $6,256,887. The Pointe supported this figure with an estimate it obtained from Camp Construction Services.

The City sent The Pointe a letter on December 19, 2008, informing The Pointe that it had inspected the apartment complex and determined that the complex was “substantially damaged” by Hurricane Ike. The City informed The Pointe that to “ensure that your future flood risk is reduced, your structure must be brought into compliance with local flood damage reduction regulations.

The Pointe concluded it had to demolish and rebuild the apartment complex because it could not elevate the existing buildings to 11 feet as required by City building regulations,

Lexington received an estimate in April 2009 from its building consultant, Unified Buildings Services, regarding damages to The Pointe’s apartment complex. The estimate for damage from wind was $1,278,000; the estimate for damage from flood was $3.5 million. Arnold and Unified Buildings Services agreed that the damage from wind amounted to $1,278,000. The Pointe signed and submitted to Lexington a sworn statement of proof of loss on May 5, 2009, requesting payment for the “whole loss and damage” of $1,278,001.33 minus the applicable deductible of $460,060.39 for a total of $817,940.94. The Pointe received a check from Lexington for the requested amount shortly after submitting the proof of loss.

The Pointe sued Lexington alleging claims for (1) breach of contract, violations of the Texas Insurance Code, violations of the Texas Deceptive Trade Practices Act, and bad faith against Lexington; and (2) violations of the Texas Insurance Code.

The trial court granted Lexington’s motions for partial summary judgment. A jury trial was held from April 18, 2011 to April 28, 2011. The case was submitted to the jury to determine various Insurance Code violations asserted by The Pointe. The jury returned a verdict in The Pointe’s favor.

ANALYSIS

As a general rule, Texas does not recognize a claim for bad faith when an insurer denies a claim that is not covered under the insurance policy. Generally speaking, extra-contractual claims do not survive when the issue of coverage is resolved in the insurer’s favor.

Insurance policies are contracts, and are construed using ordinary rules of contract interpretation.

An insured is not entitled to recover under an insurance policy unless it proves its damages are covered by the policy. When covered and uncovered causes of loss combine to create a loss, the insured is entitled to recover only that portion of the damage caused solely by the covered cause of loss. The insured must present some evidence from which the jury can allocate the damage attributable to the covered cause of loss. The insured must segregate the loss caused by the covered cause of loss from the loss caused by the uncovered cause of loss; the failure to segregate covered and uncovered causes of loss is fatal to recovery.

Lexington promised only that it would pay for demolition and increased rebuilding costs that were caused by ordinance enforcement resulting from any “Covered Cause of Loss.” When ordinance enforcement results from a “Covered Cause of Loss, ” the policy also covers the costs of demolishing and rebuilding portions of the property not damaged by that cause.

Contrary to The Pointe’s contention, there must first be some evidence that (1) a “Covered Cause of Loss” occurred, and (2) the cost to demolish and rebuild The Pointe’s apartment complex was caused by ordinance enforcement that resulted from this “Covered Cause of Loss.”

As evidence of segregation of damage caused by wind versus damage caused by flood, The Pointe relies on the April 2009 estimate of Lexington’s building consultant, Unified Buildings Services. But there is no evidence that the City based its December 2008 substantial damage determination on that estimate. The key issue is the actual basis for the City’s December 2008 substantial damage determination triggering enforcement of the City ordinance.

The Pointe was unable to identify any evidence that the City made its substantial damage determination based on wind damage alone — as opposed to flood damage or a combination of wind and flood damage, both of which are excluded causes of loss.

The parties have not pointed to any evidence that could support a finding that the City’s December 2008 substantial damage determination and resulting enforcement of a City ordinance was based on a Covered Cause of Loss. In turn, there is no evidence that the cost to demolish and the increased cost to rebuild was caused by enforcement of an ordinance or law that was triggered by a Covered Cause of Loss. Thus, there can be no coverage for The Pointe’s loss under the Ordinance or Law endorsement.

The Pointe failed to identify any evidence showing the City made its substantial damage determination based on a Covered Cause of Loss. In turn, there is no evidence that there was cost incurred in rebuilding or additional loss sustained in demolishing as a result of enforcement of an ordinance as a direct result of a Covered Cause of Loss.

The Lexington policy does not provide coverage for The Pointe’s loss under any of its provisions. Because the appellate court resolved coverage in Lexington’s favor, The Pointe’s Insurance Code claims could not survive and the verdict was reversed. because a finding of no coverage establishes that Lexington cannot be liable for bad faith because there is not coverage for The Pointe’s loss under the policy.

ZALMA OPINION

This decision is important because it recognized that a insured has an obligation to do more than report a loss to its insurer. It is obligated to prove that the loss is one due to a covered cause of loss. The Pointe failed to prove that there was a covered cause of loss other than that for which the insurer paid.

The issue may have been more importantly that they insured an apartment building on the water at Galveston, a place hit by hurricanes regularly, without acquiring insurance for flood or wave wash. It tried to cow the insurer into paying for losses it did not owe, convinced a jury, only to lose on the law in the court of appeal.

Neither the insured nor the insurer can change the wording of the policy, the coverages available and the exclusions after a loss.

Reprinted with Permission from Zalma on Insurance, (c) 2013, Barry Zalma.

Barry Zalma, Esq., CFE, is a California attorney who limits his practice to consultation regarding insurance coverage, insurance claims handling, insurance bad faith and fraud and acting as a mediator or arbitrator on insurance disputes. Mr. Zalma serves as a consultant and expert almost equally for insurers and policyholders. He founded Zalma Insurance Consultants in 2001 and serves as its only consultant. He recently published the e-books, "Zalma on Rescission in California - 2013"; "Random Thoughts on Insurance" containing posts from this blog; "Zalma on Insurance;" "Murder and Insurance Don't Mix;" “Heads I Win, Tails You Lose — 2011,” “Zalma on Diminution in Value Damages,” “Arson for Profit” and “Zalma on California Claims Regulations,” and others that are available at Zalma Books.

Mr. Zalma can be contacted at Barry Zalma or zalma@zalma.com, and you can access his free "Zalma on Insurance Fraud" newsletter at Zalma’s Insurance Fraud Letter.

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