Sixth Circuit Holds That Declines in Market Value are Not a Factor in Determining Actual Cash Value

In a case of first impression in Michigan, the federal Court of Appeals determined last month that general market conditions could not be considered when calculating actual cash value.  In Whitehouse Condominium Group, LLC v. Cincinnati Ins. Co., — Fed.Appx. —, 2014 WL 2743480 (6th Cir., June 17, 2014), the contract of insurance defined ACV as replacement cost less a number of factors including “obsolescence .”  The Sixth Circuit held that the word connoted only functional obsolescence as opposed to both functional and economic obsolescence.

The policyholder owned a condominium building in Flint, Michigan that was heavily damaged by fire in November of 2010.  The policy afforded coverage for ACV, which was defined in the contract of insurance to mean “replacement cost less a deduction that reflects depreciation, age, condition and obsolescence.”  The insurance carrier, Cincinnati Insurance Company, determined that the value of the structure was $1,187,660.38, and it paid that amount to the insured.  The policyholder contended that the building was actually worth $1.6 million more, however, and it demanded appraisal.

The sole issue was the meaning of the word “obsolescence.”  The insured contended that it meant only functional obsolescence, which the Court of Appeals defined as “a loss in value due to something inherent in the building itself such as old technology (think an electric panel that is no longer acceptable under current codes) or bad design (think a five bedroom house that only has one bathroom).”  Cincinnati, on the other hand, argued that it meant both functional and economic obsolescence – “a reduction in value due to market factors entirely external to the building, such as neighborhood factors (this might occur if the neighborhood were suddenly under a noisy flight path) or the general market (the real estate market crash appears to be the factor in this case);”  The decline in property values in Flint was the reason for the difference between the two parties’ ACV numbers.

Prior to appraisal, the insured asked the Eastern District of Michigan to determine what obsolescence meant, and that court held that the term did not include economic obsolescence.  On appeal, a unanimous Sixth Circuit panel agreed.  Judge Jane Branstetter Stranch’s opinion was bottomed on:

• the fact that dictionary definitions of the word suggested “that economic obsolescence is a specialized concept not included in the commonly used definition of obsolescence” and “point[ed] to a common understanding that something becomes obsolete when it becomes outdated due to some feature inherent in the thing itself;”
• the fact that “the contract definition [of ACV] only allows for reductions for various purposes, not for additions, possibly suggesting that market values, which can also increase, were not intended to be included;”
• the fact that “[a]ll three of the other terms listed – depreciation, age, and condition – reflect something inherent in the building itself rather than an external market condition, suggesting that obsolescence is similarly restricted;” and finally
• Judge Michael Mukasey’s decision reaching an identical result under New York law in SR Int’l Busi. Ins. Co. Ltd. v. World Trade Ctr. Properties, LLC, 445 F.Supp.2d 320 (S.D.N.Y. 2006).

The Sixth Circuit therefore concluded that the term obsolescence does not account for a decline in market value.  In addition, the Court of Appeals held that to the extent that the word was ambiguous, it would be strictly construed against the insurance carrier.