Knowing the Code

After a lengthy adjustment involving numerous inspections, intense negotiations, and supplemental payments, a claims professional is about to close a particularly grueling file. Then a fax arrives: The insured submits a supplemental claim in excess of $1 million for “code upgrades” involving new electrical wiring, thicker concrete foundations, and new HVAC systems. None of these areas were damaged in the incident or previously raised in the claim. Aghast, the claims professional turns to the “ordinance or law” coverage to find out what exactly is covered by the policy.   

The term “ordinance or law” in code-upgrade provisions generally encompasses government-mandated requirements only. This includes statutes or building codes adopted at the state, federal, city, or local level. However, the mere existence of a building code, such as the BOCA standards and the National Fire Protection Association (NFPA) guidelines, are not ordinances or laws within the scope of coverage if they are not adopted by a governing body. The same is true for communications and recommendations by a government body regarding the construction. [See Consol. Rail Corp. v. Aspen Specialty Ins. Co., 2019 WL 2425118, at *8 (D.N.J. June 10, 2019)].

Defining “Enforcement”

In most circumstances, the local code official will not visit the property and submit a detailed list of the required code upgrades. An insured or the insurer may each retain its own engineer to evaluate the scope of repairs, and there may be great disparities in how each expert views the scope of repairs.
Some states focus not on what the code technically says, but rather on what building officials actually require. According to the court in St. Luke’s Episcopal Health System Corp. v. Factory Mut. Ins. Co., 2007 WL 1217763 (S.D.Tex. Apr. 24, 2007), an “enforcement” occurs when the local government body withholds permits for construction in violation of those standards. Since the city officials didn’t undertake any actions and the insured was not sanctioned as a result of the alleged non-compliance, the code-upgrade coverage did not apply.

On the other hand, the courts in two other cases—Consol. Rail Corp, and Regents of Mercersburg Coll. v. Republic Franklin Ins. Co., 458 F.3d 159, 170 (3d Cir. 2006)—held an “affirmative enforcement action” is not required before a party may seek to recover under a “law or ordinance” contract clause, and instead, “an enforceable legal requirement suffices to trigger that coverage.”

According to these courts, the law and ordinance provision requires that “the renovation or modification was necessary under the law” and that it mandates changes. The portion of the Americans with Disabilities Act (ADA) at issue in Regents of Mercersburg, for example, specifically required that any alterations to the facility be “readily accessible to and usable by individuals with disabilities,” and detailed the requirements. The ADA is also accompanied by very specific regulations that explain, among other things, what constitutes a covered “alteration.” The court held that the existence of the requirements was an enforcement sufficient to trigger coverage.

Ultimately, there is no bright line rule as to what constitutes an enforcement, as the answer varies by jurisdiction.  

Undamaged Areas

If an area of the building is damaged by a covered loss, and the building code requires that the repair or replacement of the damaged areas conform to current code, then the typical ordinance or law grant of coverage pays for the cost. But when a loss occurs and a local code enforcement officer inspects the proposed area of area of repair, the officer may notice other non-compliant areas in undamaged sections that must be brought up to code. Courts in different jurisdictions have applied a variety of tests in such cases.

Where the insured voluntary repairs undamaged areas to code following a loss, the question becomes whether these costs are a “loss” as defined by the insurance policy. The court in Regents of Mercersburg held that voluntary repairs undertaken to undamaged portions of the building are not a loss unless required by a law or ordinance. Rather, for coverage to apply, there must be some actual covered cause of loss that damages the building—the repair of which must legally be accompanied by changes to the undamaged portion of the building. Under this interpretation, the ordinance and law coverage does not provide coverage for renovations made to undamaged portions if not required by code.

Some courts have decided that if the code violation exists independent of the loss, then there is no enforcement of a code. In Chattanooga Bank Associates v. Fidelity & Deposit Co. of Maryland, 301 F. Supp. 2d 774, 776 (E.D. Tenn. 2004), although the violations might have remained undiscovered if not for the fire loss, the violations in question existed independent of the fire and the fire did not cause the enforcement of a building code, because the code violation existed independent of the loss.   

A different result was reached in Davidson Hotel Co. v. St. Paul Fire & Marine Ins. Co., 136 F. Supp. 2d 901, 910 (W.D. Tenn. 2001). There, a water leak in a hotel led to a thorough inspection by city building inspectors, who “required compliance with numerous building code provisions” discovered during the inspection, even in areas not damaged in the loss. The court found coverage for the code upgrades since the inspection occurred only because of the incident giving rise to liability, and, secondly, the thoroughness of the inspection was also a result of the incident.

Courts in New York have recently applied a more proximate-cause approach that there must be some direct connection between the covered damage and the enforcement of the ordinance. In two cases—St. George Tower v. Ins. Co. of Greater New York, 139 A.D.3d 200, 30 N.Y.S.3d 60 (N.Y. App. Div. 2016) and Sanderson v. First Liberty Ins. Corp., 2019 WL 2009332, at *6 (N.D.N.Y. May 7, 2019)—a covered loss resulted in certain damage to buildings. The insured discovered code violations during the course of repairs in other parts of the building. The covered work could not be completed until the code-compliant repairs were performed. The loss did not cause the code violations.

The courts found no coverage for areas that were not damaged in the loss and where the code did not require upgrades to complete repairs to the covered damage. The court in St. George Tower ultimately reasoned that, if the rule was otherwise, “even an inspector’s discovery of code violations resulting from shoddy original construction, such as beams or pipes made of sub-par materials, would leave the insurance company liable for the necessary replacement of those materials any time the problem happened to be uncovered in the course of damage remediation.”

Payment

The typical code-upgrade provision states that the insurer has no obligation to pay for code upgrades “until the property is actually repaired or replaced.” The Eastern District of Pennsylvania decision in Monarch, Inc. v. St. Paul Prop. & Liab. Ins. Co., 2004 WL 1717618, at *2 (E.D. Pa. July 30, 2004) is directly on point to the question of whether plaintiff can pursue a claim for ordinance or law coverage without actually having performed the work. The court held that the insurer’s obligation under the contract becomes due only when the repair or replacement is made.

The ordinance or law coverage may provide that the insurer will not pay for such code upgrades unless the repairs or replacement are made within two years. Courts have held that the requirement that repairs or replacement occur within two years is a condition of performance by the insurer regarding payment of proceeds under this provision. Where the insured does not make the repairs within two years, courts have held that the insured waited too long and its window for receiving code-upgrade proceeds expired.

Presentation of a code claim involves complex issues and requires the adjuster to review the policy language, the scope of repairs, and review the governing law in the jurisdiction. It is advisable to bring in a consultant to review the damage, the scope of repair, and the actual requirements of the local code.