NZSC 185
Skyward Aviation 2008 Limited owned a property in Burwood, Christchurch (the property) with a 207m2 early 1900s villa home (the house) and a 64m2 free-standing sleep-out built in 2009 (the sleep-out). Both the house and the sleep-out were damaged in the earthquakes, and the property is within the residential red zone.
Skyward and Tower were unable to reach agreement on how to calculate the amount to be paid to Skyward for the house.
The policy provided for four alternative options for settlement. There are:
- the full replacement value of the house at the situation; or
- the full replacement value of the house on another site chosen by Skyward. This cost must not be greater than rebuilding the house at the situation; or
- the cost of buying another house, including necessary legal and associated fees. This cost must not be greater than rebuilding the house on its present site; or
- the present day value.
High Court decision
In the High Court, David Gendall J decided that it was Tower's choice whether to make payment, rebuild, replace or repair the house. He also decided that where the choice is to buy another house, the maximum amount payable is calculated on the cost of purchasing a house which is comparable in size, construction, style, and condition.
Skyward appealed this decision.
Court of Appeal decision
The Court of Appeal reversed the High Court's judgment, making three observations:
"First, only to the extent that the policy restricts its options should the policyholder be deprived of its control over repair, rebuilding or sale of its property. Second, once it is established that the insurer must pay the full measure of loss, it should be indifferent to the policyholder's decision about how to reinstate the property. Third, until that point the insurer has a direct interest in how the claim is settled, since that decision will determine how much it will pay."
The Court of Appeal therefore decided that the homeowner has the ultimate right to decide what to do with the property, and that if the house is not economically repairable it is not up to Tower to choose the basis of settlement. The insured is the one who can chose whether to rebuild on that site, rebuild on another site, or buy another house.
The Court of Appeal then considered the correct way to calculate the amount payable for the purchase of another house. The High Court had said that if the insured was going to purchase a new house, then it should be comparable to the one being replaced. The Court of Appeal disagreed, and said that:
"The amount payable by Tower if Skyward buys another house is not subject to any other limitation. In essence, the policyholder is not obliged to choose a house of comparable size, construction, condition and style as its existing house once it is agreed that its existing house is damaged beyond economic repair."
The only limitation in the policy was that the cost of buying another house must not be greater than the cost of rebuilding the house on its present site.
Tower then appealed this decision.
Supreme Court decision
The Supreme Court noted that Tower had, pursuant to the policy, the option to make payment, rebuild, replace or repair the house, and in this case it was common ground that Tower has elected to make payment. They also recorded that:
"We note in passing that the assumption of the parties is that under option (c), 'the cost of buying another house' refers not to the price paid by the insured for the land and house but rather only that portion of the price which is referable to the house. We have not been asked to determine whether this assumption is correct."
The Supreme Court then went on to consider the main issue before it, how the amount payable by Tower is to be calculated. They noted that the insurance policy is for full replacement, on a new for old basis. They remarked that:
"The availability of such policies reflects a recognition that a traditional indemnity value policy may not provide sufficient funds to enable a damaged building to be repaired or rebuilt given that such exercises will require new materials and compliance with current building standards which may be more stringent than those in place when the building was constructed."
The Supreme Court then stated that these full replacement policies create a "heightened moral hazard", because an insured may obtain more than indemnity value for the damaged property and may therefore profit from the loss, and that as a result the "incentive for carelessness and fraudulent claims is thus greater than in the case of an indemnity value policy". They went on to say that the insurance policy generally mitigates the risk of the moral hazard, through mechanisms such as allowing the insurer the option of reinstating the house.
In this case, the Supreme Court decided that Tower had used its policy to manage the moral hazard using the mechanisms available, and:
"These come down to its entitlement to reinstate the house or, where it is not prepared to do so, to pay no more than indemnity value except by way of reimbursement for expenditure actually incurred. Once Tower has opted to make payment, its obligations are solely monetary in character and, providing the insured actually incurs the expenditure for which it is entitled to reimbursement, Tower should be indifferent to the mechanism by which Skyward triggers its right to replacement value recovery."
The Supreme Court therefore confirmed the decision of the Court of Appeal, saying that:
"we are satisfied that in a case where a house is damaged beyond economic repair and where Tower has decided not to rebuild or replace the house, Tower's payment obligations... are determined by the choice which the insured makes as to whether to rebuild the house or replace it on another site or buy another house."
The Supreme Court also rejected any suggestion that any house purchased as a replacement must be comparable to the existing house. They noted that if that was a requirement, Skyward would need to find a comparable villa build in 1900, and:
"The practical implications for Skyward (and indeed any insured) of such an approach are obvious. It may be that a house which is comparable to the insured house may not exist. If this is so, Skyward can be denied replacement value recovery during a vain search for such a comparable house. As well, given the impressionistic nature of the envisaged exercise, there would be scope for much debate as to whether a house identified by Skyward did in fact satisfy the test. Such debate could no doubt ultimately be resolved by the courts but this would be a time consuming process which might not be able to be concluded before the house in question was sold to someone else."
They therefore said that:
"we are of the view that if the insured chooses to buy another house, the only cap on the cost that Tower must meet is that it will not exceed the cost of rebuilding the insured house at its present site and there is no requirement that the house which is bought be "comparable" to the insured house."
In the Court of Appeal it was noted, in discussions regarding the cost of constructing special foundations for a house in the red zone, that:
"Mr Campbell QC accepts, following the judgment of Asher J in O'Loughlin v Tower, that Skyward is not entitled to claim that cost in circumstances where it will not in fact rebuild in the red zone."
The Court of Appeal therefore decided that Skyward is entitled to purchase a new house, up to the value of the cost of rebuilding the existing house, but excluding the cost of the special foundations that would have been required for a red zoned property.
There was no similar proviso included in the Supreme Court's decision. Instead, they have specified that "if Skyward buys another house, Tower must pay the lesser of the cost of the house or the cost of rebuilding the insured house on its present site", with no reference to foundations.
Counsel in the Supreme Court raised the fact that the O'Loughlin decision referred to above does not sit well with the Court of Appeal's more recent judgment in Avonside Holdings Ltd v Southern Response Earthquake Services Ltd  NZCA 483, which decided that it is irrelevant whether the rebuilding will take place, and that what is required is an assessment of the costs that would be incurred if the rebuild were to occur.
The issue was raised in passing before the Supreme Court, but was not a specific issue that was open for them to determine, or on which they heard detailed argument. Whether the cost of special foundations is claimable, even where repairs will not actually take place, therefore appears to be a live issue.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.