Southern Response Liable For Contingencies And Professional Fees

Background

Avonside Holdings Limited (“Avonside”) owned a residential property in Christchurch.  It was insured under a policy issued by AMI Insurance Limited (now Southern Response).  The property was damaged in the Christchurch earthquakes and is in the residential red zone.

Southern Response deemed the house to be uneconomic to repair and Avonside sold the property to the Crown under the red zone offer.  As the house was deemed uneconomic to repair, Avonside exercised its right of election under the policy to buy another house.

Policy Wording

Under the AMI policy, where the insured elects to buy another house, it states:

“We will pay the cost of buying another house, including necessary legal and associated fees.  This cost must not be greater than rebuilding your rental house on its present site” (clause 1(c)(ii)).

Clause 4 of the policy covers a number of additional costs that are payable to the insured, if those costs are approved by Southern Response prior to them being incurred.  Those costs include the reasonable cost of architects’ and surveyors’ fees.

Decision

The issues on appeal were in calculating the notional cost of rebuilding the house on its current site:

1. Whether there should be a sum for contingencies;

2. The extent of the allowance to be made for professional fees; and

3. The relationship between clause 1 (the general insuring clause) and clause 4 (cover for additional costs) of the policy. 

Relationship between clause 1 and clause 4

The Court held that the cover for professional fees under clause 4 of the policy was for fees that the insured wished to incur that are additional to the necessary costs of rebuilding or repairing.  The professional fees allowed for by Avonside related to rebuilding the existing house only and, therefore, came within the general insuring clause under clause 1(c)(ii).

This distinction is important, as Southern Response sought to argue that clause 4 only applies if the house is rebuilt.

Contingencies

The Court stated that the amount payable under the policy “can be no more than the cost of rebuilding the house on its present site”.  As Avonside had elected to purchase another house, the exercise that needed to be undertaken was to estimate the actual costs of rebuilding the house on the existing site. 

It found that there were “unknowns” in any building project and that the 10% allowance for contingencies made by Avonside’s quantity surveyor was accepted to be standard quantity surveying practice.  Therefore, it held that 10% of the total price calculated was a reasonable allowance. 

Professional fees

Again, the Court reinforced that the exercise required was to estimate the actual cost of rebuilding the house on the existing site.  It accepted that Avonside’s allowance for professional fees of 10% of the total cost was based on orthodox quantity surveying practice. 

One side-issue that was raised was the allowance for professional fees for redrafting the house plans.  Although there were historical plans available, the evidence provided by Avonside’s quantity surveyor was that the plans would need to be redrafted to comply with current building code requirements.  Avonside allowed for the cost of an architectural draughtsperson to undertake this and, although the amount of Avonside’s allowance was disputed, Southern Response accepted that an allowance for this was “orthodox surveying practice”.

The Court also made note that Avonside’s 10% allowance for professional fees was very similar to the percentage used by Arrow in its estimate of what it would actually cost to rebuild.  Arrow had allowed 9%. 

The Court ultimately held an allowance for professional fees should be made and 10% was considered a reasonable allowance.

Conclusion

The Supreme Court’s decision not only makes it clear that the calculation of a notional rebuild amount needs to include an allowance for contingencies and professional fees, but it also establishes that 10% of the base rebuild price is a reasonable allowance for each of these items.

The decision also touches on another issue – that is whether an insurer needs to make an allowance for the drafting of plans where historical plans exist.  Some insurers have sought to argue that where historical plans exist, there is no need to provide an allowance for design, or only a nominal allowance needs to be provided.  Not only was it accepted by the Court that an allowance would still be needed to redraft historical plans to take account of current building code requirements, but it was also accepted that 5.5% of the total cost (included within the 10% allowance for professional fees) was a reasonable allowance for this.

Some policyholders may be curious as to what the position will be if they cash settle the rebuild cost of their existing home on the basis that they intend to rebuild the home.  Although this decision was made in the context of a policyholder electing to buy another existing house, the budget was based on the cost of rebuilding the existing house.  Given this, there would appear to be scope for a policyholder to request an allowance in the cash settlement for contingencies and professional fees based on 10% of the build cost.  However, insurers may seek to deal with this issue by inserting a clause into cash settlement documentation that allows for further payments by the insurer if variations are required during the course of a rebuild or if higher professional fees are incurred.  It may be that such a clause would satisfy an insurer’s obligations.

The above decision was decided on the specific wording of the AMI policy held by Avonside.  If you have any concerns as to whether or not this decision has any impact on your insurance claim, please contact Saunders Robinson Brown to discuss your specific circumstances.

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