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November 11, 2015 Articles

Insurance Appraisal Proceedings: What May the Appraisers Decide?

By Sheila J. Carpenter

A recent California Court of Appeal case, Lee v. California Capital Insurance Co., 188 Cal. Rptr. 3d 753 (Ct. App. 2015), attempted to clarify the dividing line between the authority of the appraisers and the courts in considering disputed property damage claims. California Insurance Code section 2071(a), like the insurance codes of many states, dictates standard language for fire insurance policies, including a procedure for appraisal if the insurer and insured cannot agree on the amount of a loss. Each party selects a "competent and disinterested" appraiser within 20 days of the request for appraisal. The appraisers are then to select an umpire. If they cannot agree on the umpire within 15 days, a court of record where the property is located makes the appointment. The party-appointed appraisers "shall then appraise the loss, stating separately actual cash value and loss to each item; and, failing to agree, shall submit their differences, only, to the umpire. An award in writing, so itemized, of any two when filed with this company shall determine the amount of actual cash value and loss." Formal discovery is prohibited, and the rules of evidence do not apply. In California, a party seeking to confirm the award follows the same procedure as a party seeking to confirm an arbitration award. California Capital, 188 Cal. Rptr. 3d at 760; see Cal. Civ. Proc. Code § 1286.2.

In California Capital, the insured and the insurance company had wildly different views as to cost of repairs due to a fire in a 12-unit apartment building owned by Li-Lin Sung Lee. The insurer claimed that the damage was largely confined to the one apartment that it asserted suffered flames from the fire. It initially approved payment of about $70,000. Lee's public adjuster asserted that smoke damage required the interior rooms of five other apartments to be completely dismantled and replaced, iron balcony railings and part of the building's stucco exterior to be removed, and the entire building to be repainted. Costs were submitted for asbestos abatement, cleaning, reconstruction of the apartments affected, and loss of rent. The claim exceeded $800,000.

The Appraisal and Lower Court Proceedings
Lee requested an appraisal proceeding pursuant to the policy. California Capital requested a reinspection of the property but Lee refused. Instead she filed a petition to compel the appraisal and for appointment of an umpire. The court suspended the case to allow the requested reinspection, after which California Capital paid approximately another $110,000. Upon resumption of the court proceedings, California Capital argued that the court had no authority to order the appraisers to consider the disputes between the parties as to the extent of damage to the apartment building, the scope and cause of damage to the building's exterior, and work required by code upgrades and other legal requirements, including whether the policy covered the latter.

The initial court order fails. The court granted Lee's petition to compel the appraisal but ordered that the appraisers were to value only the damages caused by the fire. The scope of the loss was limited to items agreed by the parties to have been damaged in the fire, and the appraisers were not to make any coverage or causation determinations.

The appraisal proceeding moved forward with a court-appointed umpire. At the appraisal hearing, Lee's public adjuster continued to argue that the appraisers should consider the entire universe of losses Lee submitted. The umpire suspended the hearing to seek clarification from the court, and two days later Lee filed a bad faith lawsuit against California Capital. California Capital then filed a motion to dismiss the petition to compel the appraisal, arguing that Lee had waived her right to the appraisal proceeding by filing the second lawsuit.

Query: The court-appointed umpire was a retired judge. Appraisal procedures, in contrast with the majority of commercial arbitrations, are used because the appraisers employ their own backgrounds and knowledge to resolve disputes over valuation rather than forming judgments based on evidence presented to them in the form of expert reports and testimony. Query whether the appraisal proceeding might have gone more smoothly had the umpire been someone whose business was the appraisal of fire damage. Given the nature of Lee's claim and her haste to file a bad faith lawsuit, perhaps not; however, the court's first order was clear (although erroneous), and a business person might not have felt the need to go back to the court for clarification of an issue the court had already decided.

The second court order produces odd results. The court denied the motion to dismiss and issued a second order in response to the request for clarification, directing the appraisers to:

value three categories of items: (a) items of loss agreed by the parties to have been damaged by the fire; (b) items of loss asserted by Lee to have been damaged by the fire but where [California Capital] disputes coverage; and (c) items of loss asserted by [California Capital] to have been damaged by the fire but where Lee does not assert a claim.

California Capital, 188 Cal. Rptr. 3d at 758 (alterations in original). The appraisers were again directed not to make any causation or coverage determinations. The trial court added: "Following the appraisal proceedings, the parties can through other proceedings resolve their disputes regarding whether an appraised item was covered by the policy, whether the item was damaged, and whether the item was damaged by the fire." Id.

The appraisal panel declined California Capital's request to inspect the property. It issued a unanimous award that recited separately replacement cost and cash value losses for the insurer's scope of loss and the insured's scope of loss. It valued the former at about $190,000 and the latter at about $800,000. The award stated:

The award with attached exhibits takes no position on the appropriate scope of construction or method of repair; it makes no determination of coverage under the insurance policy at issue; it does not indicate what is due and owing under the terms of the insurance policy; it does not provide [an] interpretation of the insurance policy; it does not address the question of whether items claimed were in fact damaged/destroyed by the fire damage [sic] or other questions of causation. The panel has made no determination whether the items claimed existed.

California Capital, 188 Cal. Rptr. 3d at 758 (alterations in original). The trial court entered a judgment attaching the award and noting the limiting language.

The Court of Appeal Reverses
California Capital appealed, and the California Court of Appeal (First District) reversed and remanded, holding:

[T]he award issued in this case pursuant to the trial court's directive neither complies with the terms of the governing statute nor accomplishes the objectives of an appraisal. It was error to compel the appraisal panel to assign loss values to items simply because they were listed in the insured's scope of loss and regardless of whether inspection revealed they were undamaged or never existed.

California Capital, 188 Cal. Rptr. 3d at 756.

Standard of review. The court of appeal reviewed de novo the trial court's decision to order the appraisal because that decision involved interpretation of the insurance policy and an analysis of the statutory scheme. However, the decision whether to defer the appraisal pending resolution of the scope of loss issues was a matter committed to the sound discretion of the trial court. For purposes of reviewing the appraisal award, the court considered the appraisal proceeding to be an arbitration. Thus, every reasonable inference was made in support of the award. See also TMM Invs., Ltd. v. Ohio Cas. Ins. Co., 730 F.3d 466 (5th Cir. 2013).

Reasoning. The court noted that while appraisal is a form of limited arbitration, there are significant differences between an appraisal and an arbitration. Arbitrators exercise "essentially judicial functions, including deciding issues of law, and often resolve[] the entire dispute between the parties." California Capital, 188 Cal. Rptr. 3d at 761 (internal quotation marks omitted). On the other hand, an appraiser only has authority to decide a question of fact—the amount of damage to property presented for his or her consideration. The court of appeal rejected California Capital's assertion that existing case law dictated that only items the parties agreed were damaged by the fire could be considered by the appraisal panel, holding that the panel may assign values to disputed items; those items can be stricken from the award if later proceedings determine that the items are not covered. Rejecting the argument that this order of events would be wasteful, the court opined that having all items appraised at once was more efficient than potentially requesting a second appraisal for disputed items later found to be covered. It stated that if California Capital had been concerned about the appraisal proceeding being wasteful, it could have requested the lower court to stay the appraisal proceeding pending decisions about disputed items.

Practice note: The appraisal procedure is designed to resolve disputed claims very quickly while court procedures generally are not. Thus, for major and sharply disputed losses, unless the opportunity for appraisal will be lost with the passage of time, early consideration should be given to requesting a stay of an appraisal pending coverage or causation decisions. However, in State Farm Lloyds v. Johnson, 290 S.W.3d 886, 893–95 (Tex. 2009), the Supreme Court of Texas ruled that appraisals should ordinarily proceed prior to litigation except on rare occasions. It reasoned that appraisal proceedings should be faster and much less expensive than litigation and may resolve the dispute.

The court's holding. "[A] panel does not necessarily exceed its authority by appraising items within a disputed scope of loss when the disputes turn on issues of coverage, causation, or other legal issues that an appraisal panel is not authorized to decide." California Capital, 188 Cal. Rptr. 3d at 765. However, the trial court should not have ordered the panel to evaluate all items Lee claimed were damaged, regardless of whether the items were actually damaged or even existed. Appraisers are to value losses; if an item was not damaged or never existed, there has been no loss. The court of appeals attempted to provide clear guidance on the line between the appraisal panel's authority and that of the courts:

The existence of damage to an item as well as the nature of the claimed item are factors that directly bear upon the valuation of the loss, including the cost to repair or replace the item. By contrast, the cause of any damage does not bear upon the amount that may be required to repair or replace the item, although it may be appropriate to include different amounts for the same items of loss when the condition of the property prior to the loss is disputed and relevant to the valuation. Consequently, while an appraisal panel exceeds its authority by awarding nothing for damaged items based on causation or other coverage determinations, a panel does not exceed its authority by awarding nothing for items that are not damaged or never existed, where the nature or existence of the item is readily ascertainable. If there is a dispute about causation, the panel does not exceed its authority if it determines and clearly labels different amounts of loss where the amounts differ due to stated assumptions about the condition of the property prior to the loss.

California Capital, 188 Cal. Rptr. 3d at 767.

Practice note: The court of appeal did not explicitly say so, but its references to an inspection suggest that the California Capital panel erred in refusing to inspect the property. An inspection would have allowed it to resolve such disputes as differing square footage for the same room and whether a room had one window or two, disputes the court specifically said the panel should have resolved.

Other Decisions
California Capital is interesting because it attempts a precise treatment of the limits of an appraisal panel's authority. A number of courts have struggled with this issue. This short article cannot discuss additional cases in any number or depth, but there are a few recent cases warranting mention because they touch on issues decided in California Capital.

In American Family Mutual Insurance Co. v. Dixon, 450 S.W.3d 831 (Mo. Ct. App. 2014), homeowners claimed damage to their driveway, porch, and wood deck from a hailstorm. The insurer initiated an appraisal proceeding; its appraiser concluded that the driveway and porch had not been damaged by hail and that the damage to the deck was minimal. The Missouri Court of Appeals upheld the homeowners' position that the question of whether the damages to the property were caused by hail and thus were covered losses under their policy was not for the appraisers. Such questions "may not be delegated lawfully to an internal resolution procedure provided in the insurance policy, but may be fully litigated by Homeowners in a court of law." Id. at 832.

In TMM Investments, 730 F.3d 466 (5th Cir. 2013), the Fifth Circuit reviewed another hail damage appraisal award involving causation issues. The district court had set aside the award because it believed that the appraisers had improperly decided issues of causation. The appraisal award was a fraction of what the insured sought because the insurer-appointed appraiser and the umpire believed that the roof was in poor condition due to other causes, including improper installation of the membrane, and that the skylights had been damaged by rocks thrown from below rather than by hail. The Fifth Circuit reversed, primarily relying on the Texas Supreme Court's decision in Johnson, 290 S.W.3d 886 (Tex. 2009), for its discussion of Texas law.

At the very least, Johnson arguably establishes that appraisal panels are within their rights when they consider whether damage was caused by a particular event or was instead the result of non-covered pre-existing perils like wear and tear. . . . To the extent the appraisers merely distinguished damage caused by pre-existing conditions from damage caused by the storm, they were acting within their authority.

TMM Investments, 730 F.3d at 474–75. Johnson takes a practical approach to an appraisal panel deciding causation issues:

Causation relates to both liability and damages because it is the connection between them. . . . In the abstract, it is hard to say whether causation is more a question of liability or damages.

But in actual cases, causation usually falls into one category or the other. Thus, when different causes are alleged for a single injury to property, causation is a liability question for the courts. . . .

By contrast, when different types of damage occur to different items of property, appraisers may have to decide the damage caused by each before the courts can decide liability. . . .

The same is true when the causation question involves separating loss due to a covered event from a property's pre-existing condition. Wear and tear is excluded in most property policies (including this one) because it occurs in every case. If State Farm is correct that appraisers can never allocate damages between covered and excluded perils, then appraisals can never assess hail damage unless a roof is brand new. That would render appraisal clauses largely inoperative, a construction we must avoid.

Johnson, 290 S.W.3d at 891–93 (footnotes omitted). The Texas Supreme Court noted that although it first dealt with insurance appraisal clauses in the nineteenth century, Johnson was the first case in which it opined on causation. The court concluded from this that, in practice, appraisals were resolving causation disputes.

Unlike arbitration panels, appraisal panels are not authorized to decide legal issues. Thus, they may not decide what is or is not covered by an insurance policy. Causation presents a more difficult question because it is normally viewed as a legal issue but, as a practical matter, as the Texas Supreme Court said in Johnson, "appraisers must always consider causation, at least as an initial matter. An appraisal is for damages caused by a specific occurrence, not every repair a home might need." 290 S.W.3d at 893. The line must be drawn in each case; doing so requires consideration of precedent in the state involved and the factual issues in dispute.

Keywords: litigation, ADR, insurance, appraisal, arbitration, scope of loss, causation

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