I was saddened to learn that Judge Ruggero Aldisert, formerly of the Third Circuit, recently passed away.  I never had the privilege of appearing before Judge Aldisert, and I never met the man, but I feel indebted to him for writing two excellent books that were published through NITA:  “Logic for Lawyers” and “Winning on Appeal.”  I think they’re must-reads for litigators, as they focus upon the logical requirements of good argument.  Judge Aldisert once wrote:  “A fallacy can be defined as…a form of argument that has intuitive appeal but does not withstand rational scrutiny.”

I thought of that definition when I read the recent decision in in CV Ice Company v. Golden Eagle Insurance Co., 2015 U.S. Dist. LEXIS 1070 (C.D. Cal. Jan. 6, 2015).  The CV case involved (in part) a type of coverage that’s come up frequently here on the East Coast post-Sandy:  Ordinance or Law coverage.  Basically, this is coverage for loss caused by the enforcement of ordinances or laws regulating the construction and repair of damaged buildings. Older structures that are damaged by a covered cause of loss, for example, may need upgrades due to municipal codes.  The upgrades may include electrical work; heating, ventilating, and air-conditioning (HVAC) work; and plumbing units. Many communities have ordinances requiring that a building that has been damaged to a specified extent (typically 50%) must be demolished and rebuilt in accordance with current building codes, rather than simply repaired.  Ordinance or Law coverage can help with all of this expense.

In CV, an ice company used an antiquated system of machinery to make ice.  Apparently, in addition to being quite old, the piping in the machinery was corroded.  A heavy piece of metal accidentally fell into the piping, puncturing the machinery and rendering it inoperable.  The insurance company contended that the puncture could be repaired with some localized welding.   But according to the ice company, in order to comply with existing codes (which required seamless piping for ammonia-circulating systems, while the older, damaged piping had seams), all 12,000 feet of piping in the system would have to be replaced, at a cost of over $500,000. The ice company also argued that localized welding wasn’t logistically feasible, due to the corroded state of the damaged pipe.

Now, I’m a policyholder-side guy, but my first thought was, this claim had some problems.  “Ordinance or Law” coverage is generally meant to apply to the building, and not to damage to processing equipment.  But that point didn’t come up in the decision.  Instead, in denying Ordinance or Law coverage, the Court turned to a convoluted analogy: Assume that there’s a store.  Two laws apply to the store for purposes of the discussion: (1) a law requiring a wheelchair-accessible restroom, and (2) a law requiring fire sprinklers. A car crashes into the storefront.  The damage requires extensive repair.   According to the Court, the carrier would have to pay not only for the damage, but also for the cost of expanding the existing restroom, “because the covered cause of loss triggered obligations under a law requiring restroom construction.”  But, according to the Court, the carrier would not have to pay for the installation of fire sprinklers, “because that deficiency and obligation pre-dated the occurrence of the covered cause of loss.”  The difference, according to the Court, is that “the restroom law does not require immediate action,” but only requires an upgrade “if the storeowner decides to remodel other aspects of the store.”  The sprinkler law, on the other hand, “is immediately applicable; if the store does not have working fire sprinklers at any time, it is violating the law.”  The Court wrote that “a causation element” had to be “read into” the coverage provision, or the results would be “absurd.” 

In honor of Judge Aldisert, let’s give this a little “rational scrutiny.”  What does the coverage actually say?  It says:  “If a Covered Cause of Loss occurs to covered building property, we will pay…for the loss in value of the undamaged portion of the building as a consequence of any ordinance or law that…[r]egulates the construction or repair of buildings, or establishes zoning or land use requirements at the described premises; and [i]s in force at the time of loss.”  In other words, if the building has to be rebuilt or repaired, the carrier will pay for compliance with all code requirements.

Presumably, before setting premium rates, the carrier felt that it had gathered adequate information about the building. If the carrier intended that the Ordinance and Law coverage should not apply to code requirements that existed prior to the occurrence of a Covered Cause of Loss, the carrier could have specified that in the policy easily enough.  The last clause of the coverage could have stated that the policy applied to code requirements “in force at the time of loss, unless the insured failed to comply with immediately applicable requirements of the ordinance or law prior to the time of loss.”  Using the Court’s analogy, the requirements to make the bathroom ADA-compliant were not “applicable” until remodeling, so coverage for bringing the bathroom into compliance would exist.  The sprinkler requirements were “applicable” before the building was damaged, conversely, so coverage would not exist. 

But I repeat:  That’s not what the policy said.  Any “absurdity” in the policy was created by the carrier, not the policyholder.  Why should the policyholder lose the coverage actually provided by the policy language based upon a requirement that the Court “reads in”? The carrier’s rates are premised upon what the policy says, not what a judge thinks it should say.

That’s one of the frustrating things about risk management. Often, if you ask ten judges what a policy means, you’ll get ten different opinions.  I think this is because most judges aren’t experts in how insurance works, so they try to import concepts from other areas of law.  In CV, the Court seemed to import concepts of “proximate cause” from tort law.  That may have “intuitive appeal,” but it does not withstand rational scrutiny.

One additional interesting tidbit about this case:  The Court refused to dismiss the policyholder’s bad faith claim against the carrier. Why? Because apart from the “Ordinance or Law” coverage, there was a dispute over whether the carrier had reasonably assessed other damages.  The Court wrote:  “Peerless has not yet demonstrated that it acted reasonably in setting a five-week restoration period [on the business interruption portion of the claim] and in not paying for…additional items highlighted by CV Ice [such as the cost of replacing baskets and cans that had been damaged in the accident].”