Most insurance policies contain conditions precedent, which premise coverage upon an insured’s actions. “As a general rule, if a contract expressly conditions the duty to perform upon the occurrence of a specified event, the duty to perform does not arise until that condition occurs.” Mendoza v. COMSAT Corp., 201 F.3d 626, 631 (5th Cir. 2000). Conditions precedent range from providing prompt notice of a loss, cooperating in an adjustment, and sitting for an examination under oath.
Some policies provide replacement cost value coverage (“RCV”). But most only pay the actual cash value (“ACV”) of property damage until the insured actually repairs or replaces that damage and provides evidence of those repairs. This is yet another condition precedent – the insured’s recovery of any depreciation is conditioned on its actual repair or replacement of property. The same holds true for code upgrades. Most insurance policies premise recovery of code upgrade costs upon the insured’s actually incurring those costs.
These seemingly basic premises invariably are never basic or simple. When parties disagree on the amount of an insurance claim and the matter ends up in appraisal or litigation, replacement cost and code upgrade recovery are often key issues. This is especially the case when there is an appraisal award with both RCV and ACV and there is no evidence the insured completed repairs. When the insurer pays the appraisal award ACV, is the insured entitled to recover the remaining depreciation for RCV? And what happens when the insurance policy limits recovery of replacement value to a certain period of time—such as two years from the date of loss? If that period of time has expired, can the insured ever recover the RCV and code upgrade costs?
Most courts in Texas recognize that when both the insured and insurer are sophisticated parties, and the insurer has paid some portion of the ACV within the policy’s timeframe to complete repairs, the insured’s failure to make those repairs bars recovery. But recently, insureds have argued that the equitable Doctrine of Prevention allows them to recover RCV depreciation, even absent actual repairs or without incurring code upgrade costs. The Doctrine of Prevention is an equitable principle that should only apply to vary the terms of the parties’ contract under three specific circumstances: (1) the insurer engaged in wrongful conduct; (2) the insured was actually prevented from meeting its condition; and (3) the insured can meet equitable principles.
1. What is the Doctrine of Prevention?
Most commercial property insurance policies require an insured to actually make repairs or incur code costs before recovering any depreciation holdback or code costs for the claimed damage. Courts generally recognize that without those repairs, an insured is entitled to the actual cash value of the damaged property.
In recent years, however, insureds and their counsel have raised extra-contractual arguments to support claims for replacement and code costs when the insureds have not completed those repairs. One of the primary arguments proffered by plaintiffs is that they were “prevented” from making repairs by the insurer’s late payment, thereby relieving the insured from its duty to actually make repairs and incur code costs. See e.g. Devonshire Real Est. & Asset Mgmt., LP v. Am. Ins. Co., No. 3:12-CV-2199-B, 2014 WL 4796967, at *7 (N.D. Tex. Sept. 26, 2014) (the insured “argues that the equitable ‘doctrine of prevention’ relieves it of the obligation to make repairs before receiving replacement costs, because [the insurer’s] refusal to pay [the insured] the actual cash value of its second supplemental claim for damage…prevented [the insured] from completing the necessary repairs.”). This argument is called the “Doctrine of Prevention.”
The court in Devonshire was one of the first in Texas to discuss the Doctrine of Prevention in the context of commercial property insurance claims. And since Devonshire, numerous courts have used its analysis in addressing demands for replacement costs and code costs when repairs have not been completed (or even started). Lakeside FBBC, LP v. Everest Indem. Ins. Co., No. SA-17-CV-491-XR, 2020 WL 1814405, at *8 (W.D. Tex. Apr. 8, 2020); Double Diamond Delaware, Inc. v. Homeland Ins. Co. of New York, Case No. 3:17-cv-1403-X, Memorandum Opinion & Order, Dkt. # 105 at 9–13 (N.D. Tex. July 20, 2020); Kahlig Auto Group v. Affiliated FM Ins. Co., No. 5:19-CV-1315-DAE, 2021 WL 5227093, at *7 (W.D. Tex. May 20, 2021). Most courts have found that the Doctrine of Prevention does not apply in the context of commercial claims, especially when the insurer pays the insured the actual cash value of the claim. Id. With these cases, courts have granted summary judgment for insurers because, as a matter of law, the insured did not comply with the policy terms. See e.g. Kahlig Enterprises, Inc. v. Affiliated FM Ins. Co., No. 23-50144, 2024 WL 1554067, at *2 (5th Cir. Apr. 10, 2024).
Recently, though, some plaintiffs’ counsel have used the Doctrine to side-step summary judgment by attempting to create a “fact issue.” And some courts have misapplied the Doctrine in finding a fact issue that purportedly should be considered by a jury. Before giving the issue to a jury, however, a court should first require that the insured meet the high standard set out by the Fifth Circuit Court of Appeals before applying this equitable doctrine to excuse the insured from meeting the terms of the parties’ mutual agreement.
2. Who has the burden of proof to show repairs have or have not been completed?
As an initial matter, when a policy contains a valuation provision requiring repairs or replacement within a certain time frame—such as two years—the insured typically bears the burden to show those repairs were completed. Recently, in Kahlig Enterprises, Inc. v. Affiliated FM Ins. Co., No. 23-50144, 2024 WL 1554067, at *2 (5th Cir. Apr. 10, 2024), the Fifth Circuit rejected the argument that the valuation provision, which describes how an insurer will value (i.e. measure) a loss, is a limitation of liability on which the insurer has the burden of proof at trial. The court recognized that the policy’s structure applied an actual cash value measure if the insured did not repair, replace or rebuild within two years from the date of loss. It found that the insured bore the burden to prove those repairs and held the insured to its burden in its decision.
3. There are three elements to the Doctrine of Prevention an insured must meet to apply the Doctrine.
The Doctrine of Prevention is not widely discussed in Texas case law because, frankly, “no Texas court has employed the doctrine of prevention to vitiate an insured’s contractual obligation to repair or replace damaged property before claiming payment for replacement costs.” Devonshire 2014 WL 4796967. Courts in Texas typically look to the Fifth Circuit’s discussion in Mendoza v. COMSAT Corp., 201 F.3d 626, 631 (5th Cir. 2000) for the parameters of the doctrine.
The Fifth Circuit first noted the general rule: “if a contract expressly conditions the duty to perform upon the occurrence of a specified event, the duty to perform does not arise until that condition occurs.” Id. The court recognized that the Doctrine of Prevention is an exception to this rule. The court noted that the doctrine applies when a promisor wrongfully prevents a condition from occurring, thereby excusing that condition. Therefore, in Mendoza, the Fifth Circuit identified two essential elements the insured must meet in order to avoid a contract provision: (1) that the promisor’s conduct was wrongful; and (2) that conduct prevented performance.
a. Wrongful Conduct
In the recent cases discussing the Doctrine of Prevention, the key element that is often overlooked by courts is whether the insurer’s conduct was wrongful. This was one of the primary issues addressed by the Fifth Circuit in Mendoza, however.
The Mendoza court looked to the Restatement of Contracts and recognized that “the prevention doctrine is subsumed under the duty of good faith and fair dealing.” Mendoza, 201 F.3d at 631. That provision states:
The obligor’s duty [of performance] is not discharged if occurrence of the event (a) is the result of a breach by the obligor of his duty of good faith and fair dealing, or (b) could not have been prevented because of impracticability and continuance of the duty does not subject the obligor to a materially increased burden.
Id. citing Restatement (Second) of Contracts § 230 (1979) (emphasis in original).
The Mendoza court found that the plaintiff must show that there is some wrongful conduct, as opposed to some less culpable form of fault, as a prerequisite to application of the prevention doctrine. The court rejected the plaintiff’s argument that “a showing of bad faith is not required.” Id. Instead, the court noted that a plaintiff must first demonstrate that the defendant’s actions were wrongful.
While insured plaintiffs often allege bad faith in insurance disputes with their insurers, courts can determine as a matter of law, whether the insurer’s conduct rises to the level of bad faith. Aranda v. Ins. Co. of N. Am., 748 S.W.2d 210, 213 (Tex.1988) (recognizing that courts should use an objective standard to determine whether a reasonable insurer under similar circumstances would have delayed or denied payment of the claim). “An insurer violates its duty of good faith and fair dealing only when it has no reasonable basis for the denial or delay in payment of the insured’s claim and the insurer knows or should have known of that fact.” Tex. Windstorm Ins. Ass'n v. James, No. 13-17-00401-CV, 2020 WL 5051577, at *17 (Tex. App.—Corpus Christi–Edinburg Aug. 20, 2020, pet. denied). Essentially, “[a]n insurer does not breach its duty of good faith merely by erroneously denying a claim[, and] evidence showing only a bona fide coverage dispute, by itself, does not demonstrate bad faith.” Id. at *17 (citing Universe Life Ins. Co. v. Giles, 950 S.W.2d 48, 67 (Tex. 1997)).
Accordingly, the insured bears the burden to show that the insurer’s conduct was wrongful—a standard it cannot meet if there is a bona fide dispute between the parties. Unless the insured can demonstrate this higher standard, therefore, its prevention doctrine argument should be rejected.
b. Actual Prevention
In addition to showing wrongful conduct, the insured must also demonstrate that it was actually prevented from complying with the policy’s conditions. This actual prevention is where courts such as Devonshire, Kahlig, and Double Diamond have rejected the insured’s argument.
Specifically, policies typically condition payment for replacement cost and code upgrades on the insured’s actual completion of those repairs and upgrades. Fitzhugh 25 Partners, L.P., 261 S.W.3d at 863. See also Mainali Corp. v. Covington Specialty Ins. Co., 872 F.3d 255, 257 (5th Cir. 2017) (finding the “appraisal panel issued an appraisal award of $387,925.49 as actual cash value and a replacement cost value of $449,349.61. The former was the relevant figure as [the insured] did not repair or replace the property”). As one court astutely reasoned, a time limit to make repairs does not depend on whether or when the insurer makes payment because the Policy requires the insured to make the repairs before being paid: “[the insurer] was not obligated to pay [the insured] upfront and so [the insurer’s] desisting cannot have made it beyond [the insured’s] control to replace the property within three years.” Kahlig Auto Group v. Affiliated FM Ins. Co., No. 5:19-CV-1315-DAE, 2021 WL 5227093, at *6 (W.D. Tex. May 20, 2021) (quoting Double Diamond Delaware, Inc. v. Homeland Ins. Co. of New York, Civ. A. No. 3:17-cv-1403-X, Mem. Op. & Order, Dkt. # 105 at 10 (N.D. Tex. July 20, 2020)). Essentially, an insurer’s non-payment cannot affect the policy’s time limit to make repairs because the replacement cost provision always requires the insured to make repairs before being paid. Id.
This is especially true in a commercial context—when both parties are considered sophisticated. Devonshire Real Estate & Asset Mgmt., LP, 2014 WL 4796967. at *7; Lakeside FBBC, LP v. Everest Indem. Ins. Co., No. SA-17-CV-491-XR, 2020 WL 1814405 (W.D. Tex. Apr. 8, 2020).
Moreover, courts have recognized that when the insurer paid the ACV during the course of the adjustment, the insured cannot be found to have been “prevented.” Id. At most, an insured’s prevention argument could hinge on the insurer’s failure to pay any owed ACV amount during the adjustment. But, as discussed below, the insured’s own conduct cannot contribute to any delays, including failure to support the claim.
Accordingly, in addition to the wrongful conduct, the insured must show that it was prevented from making repairs. But since most policies require repairs to be made before payment for replacement cost or code upgrades are due, many courts have rightfully rejected these arguments when the parties are sophisticated and ACV payments have been made.
c. The Third Element: Clean Hands
“It is old hat that a court called upon to do equity should always consider whether the petitioning party has acted ... with unclean hands.” Alcatel USA, Inc. v. DGI Techs., Inc., 166 F.3d 772, 794 (5th Cir. 1999). While courts recognize that the Doctrine of Prevention requires a showing of wrongful conduct and prevention, inherent in all the courts’ decisions addressing this doctrine is the fact that it is an equitable one, which requires the party asserting same to come with clean hands. Therefore, if the insured argues it was prevented from timely completing repairs, its own actions cannot have caused or contributed to those delays.
The Fifth Circuit recently had an opportunity to address the Doctrine of Prevention in Kahlig Enterprises, Inc. v. Affiliated FM Ins. Co., No. 23-50144, 2024 WL 1554067, at *2 (5th Cir. Apr. 10, 2024). The court summarily rejected the insured’s “contention that any failure to timely repair is excused because [the insurer] was the source of delay.” Id. The court relied upon the evidence in the record that showed those delays in affirming the lower court’s grant of summary judgment.
Other courts have similarly declined to apply the Doctrine of Prevention when the insured’s own conduct contributed to any delays. For example, in another Kahlig matter, the court rejected the insured’s argument that AFM waived its right to enforce the Policy’s two year limitation through its conduct. Kahlig Auto Group v. Affiliated FM Ins. Co., No. 5:19-CV-1315-DAE, 2021 WL 5227093, at *8 (W.D. Tex. May 20, 2021). The court noted that under “the doctrine of equitable prevention, ‘when a promisor wrongfully prevents a condition from occurring, that condition is excused.’ The doctrines of waiver and prevention are both equitable, and thus require a party seeking recovery to come with ‘clean hands.’” Id. (emphasis added). The Kahlig court found it particularly important that the insured had completed only minor repairs at the two-year anniversary deadline in rejecting the insured’s argument. Id.
Accordingly, when there are some delays attributable to the insured, most courts should not apply the Doctrine of Prevention to alter the terms of the contract because the insured’s own unclean hands preclude application of an equitable doctrine.
4. Conclusion
Insurers should stand fast by conditions in their policies, especially those provisions that call on the insured to perform some act, such as completing repairs or incurring code upgrade costs. Courts typically hold the insured to actually repair/replace or incur code costs before awarding those costs to the insured.
So how should this play out in the typical claims context? Insurers should promptly identify those policy provisions that require the insured to make repairs within certain time frames before recovery of withheld depreciation or code costs. In the context of appraisal, the appraisers and umpire should be instructed to separately identify their awards for actual cash value, replacement cost, and code upgrades. And to the extent that the insured maintains that it made partial repairs, the insured should provide concrete proof of the cost of those repairs to recover that portion of the depreciation holdback.
And if the parties still have a dispute (or the dispute is already in litigation) courts should not allow insureds to side-step these conditions when the insured fails to undertake the repairs or upgrades. Courts can look to the facts of a case and determine, as a matter of law, whether the insured can meet the three elements necessary assert the Doctrine of Prevention. If the insured cannot meet these elements, the contract should be enforced as written.
