Adequate Insurance?

May a condominium board of managers be held liable for failure to maintain sufficient insurance to rebuild the property after a fire? The answer was probably "no" in Rahman v. Board of Managers of Yardarm Condominium. Here, the board sought to maintain "full replacement value" to permit replacement of "like kind and quality" even though this did not satisfy current legal requirements for rebuilding.

Plaintiff Yardarm Beach Condominium II is a condominium complex located in Westhampton Beach, New York. There are three Yardarm complexes designated I, II, and III. They each have their own board of managers and operate under their own bylaws. In 1990, the Yardarm condominiums retained Gary D. Salt and Insurance Consulting Associates to review their existing insurance policies and to make recommendations concerning each of the Yardarm's needs. A proposal was obtained from defendant Clair Odell Group for coverage through the Reliance Insurance Group. Yardarm II opted for the proposed coverage for the policy year 1991-92 and renewed that coverage for the 1992-93 year.

On March 13, 1993, a fire at Yardarm II destroyed a substantial portion of the condominium complex. Forty-four of the 52 units at Yardarm II were completely destroyed. Although insurance paid roughly $5.7 million toward the cost of the reconstruction of the complex, it was not nearly sufficient to cover the entire expense. Because of changes in the building codes since the units were originally constructed, the units had to be reconstructed with different materials and to different specifications. An additional sum of $4.3 million was assessed against the owners of the individual units. A number of actions were begun by many of the individual unit-owners as well as by the board of managers of Yardarm II. In many of these actions, the present motions for summary judgment were before the court.

In the first motion, plaintiffs sought summary judgment against the board of managers of Yardarm II on the ground that the board had a clear and unequivocal obligation, as stated in the bylaws of the condominium, to obtain an appropriate appraisal before the renewal or placement of a new insurance policy, which it failed to do.

Plaintiffs also alleged that the bylaws provided that the board was to obtain insurance "in an amount equal to the full replacement value of the buildings" and that the defendant board failed to do this. Plaintiffs relied on the provisions of the bylaws as well as the deposition testimony of the members of the board to argue that they were entitled to the relief they sought. Several of the individual members of the board of managers testified at their depositions that an appraisal of the condominiums for the purpose of obtaining appropriate insurance had not been obtained since 1989.

In opposition to this motion, the defendant board of managers argued that the board did comply with its obligations under the bylaws of the condominium by obtaining fire insurance in an amount equal to the full replacement value of the buildings. Defendant contended that the term "full replacement value" had a very specific meaning in the insurance and construction industries and is defined as "like kind and quality."

According to the defendant, the insurance in place was sufficient to cover the cost of rebuilding the condominiums with materials that were the same or similar to those originally used. This insurance coverage was adequate to rebuild the condominiums and that this coverage discharged the responsibility of the board.

To support its position, the board noted that the deposition testimony of several witnesses. Lou Azus, the public adjuster retained by the condominium after the fire loss, testified that the meaning of the term "full replacement value" is "replace what was there with like kind and quality."

In addition, Maury Alsher, the vice president of Clair Odell, testified that "full replacement value" was the "cost to reproduce...[with the]...same quality at this site or another site." Virtually identical responses were given by both Gary Salt and David Rosenthal, the condominium's current insurance consultant.

In response to the opposition interposed by the board of managers, plaintiffs argued that the "plain, unambiguous, logical and common sense meaning of the bylaws provision is to require the board to obtain sufficient coverage to rebuild Yardarm II, in the event of a loss, without cost to the unit owners."

Plaintiffs contended that the bylaws should not be interpreted by insurance experts since the bylaws are not part of an insurance contract. Rather, plaintiffs asserted, the provision in question should be interpreted in accordance with its plain and unambiguous meaning since it was intended to be understood and implemented by law people.

In an earlier reported case, the court there was faced with an issue regarding the interpretation of a provision of a condominium association's bylaws. In that case, a condominium owner had begun an action against the association seeking to recover for damages allegedly incurred as a result of the association's failure to maintain flood insurance. In fact, the bylaws required that the association maintain water damage legal liability insurance. In reversing the trial court's judgment in favor of plaintiffs, the appellate court concluded that water damage legal liability insurance was not flood insurance and reached this conclusion not by giving that term its ordinary and common-sense meaning but by reference to the Merrit Glossary of Insurance Terms, an insurance industry guideline.

Here, the term "full replacement value" has a definition within the insurance industry as testified to by defendants' witnesses. The court said that nothing offered by plaintiffs contradicted that testimony. In the court's view, plaintiff's arguments that the term should be given a plain and common sense meaning were unavailing. It could just as readily be argued that the term "full replacement value" means just as defendants had contended; that insurance will govern the cost of rebuilding a damaged building just as it was prior to the loss. There is nothing in that term from which it can be inferred that it was meant to include the cost of any additional improvements needed to comply with updated building codes. On the contrary, the court said that to ascribe such a meaning to a term that is otherwise clear would be giving it a meaning well beyond its common sense definition.

The meaning of the term "full replacement value" was not found in any reported case in New York. However, one treatise stated that, where a change in the building code occurs between the time the insured building is constructed and the time of the loss, "(g)enerally, insurers have been held not liable for those costs of repair or replacement associated with such compliance."

Thus, some courts in states other than New York have held that where the repair of a building would be more expensive because of changes in regulations, the insurer's liability is limited to the cost of putting the building into substantially the same condition as it was before the loss. However, there were also courts that held that "full replacement value" insurance does, in fact, include the additional costs associated with building code changes. It appeared to the court not to be an issue that had been decided in New York, nor was it an issue for the court to pass upon.

However, the court noted that had the Yardarm condominium been located in a state where courts have held that full replacement value does include costs related to intervening code changes, the issue of whether defendants violated the bylaws would not be before the court. In that instance, the purchase of full replacement value insurance would have fully insured the Yardarm II condominium for the cost of rebuilding the complex under the then-existing building code.

But, in any case, the court said that the defendants had performed as they were directed to by the bylaws. They purchased a policy of insurance for the full replacement value of the building. What that term means was apparently the subject of much debate in various jurisdictions in this country. And, if the learned courts cited could not agree on the meaning of that term, in the court's view, it could not be said that defendants should be charged with a higher level of insight or knowledge. They purchased a policy commonly offered aby insurance companies - as they were obligated to under the bylaws. In so doing, they fulfilled their obligation under the bylaws.

In this regard, it has long been held that the decisions of a board of managers of a condominium concerning its operation will not be disturbed if the board's actions was authorized under the bylaws, made in good faith, and in furtherance of the legitimate needs and interests of the corporation. In the seminal 1990 Levandusky case, New York's highest court had extended the "business judgment rule" to cooperatives and condominiums. Unless there was a showing of fraud, self-dealing, or unconscionability, a court's inquiry has been limited and it will not inquire as to the wisdom or soundness of the business decision.

Here, the court found that the board's actions with regard to the type of policy if purchased were in keeping with its responsibilities as outlined in the bylaws. Thus, the court's inquiry ended. There was no allegation and certainly no proof that the board of managers acted fraudulently, that there was self-dealing, or that the board's actions were unconscionable; therefore, the court would not inquire as to the soundness of the decisions of the board. While the court said that it certainly might be argued that the board would have been in a better position had there been additional insurance coverage in place, the actions of the board, in compliance with the provisions of the bylaws, cannot now be challenged by the plaintiffs.

The second basis for plaintiffs' motion for summary judgment was their assertion that the Board failed to obtain an "appropriate appraisal" of the property prior to the placement or renewal of the insurance policy. To support this point, plaintiffs pointed to the deposition testimony of several members of the board of directors in which they stated that a formal appraisal of the property had not occurred since 1989.

In response to this aspect of the motion, the board argued that its diligent use of experts when obtaining and renewing policies constituted the type of appraisal required by the bylaws. In his deposition, Charles Miller, the board president, stated that "the brokers did quite a bit of work in determining how much insurance Yardarm needed. I believe that Reliance came out to look at the building to see whether or not it was appropriate to insure it for that amount. That's why they were there, to appraise the building, and the insurance schedules came back to us saying, 'Gentlemen, this is the coverage you should have for you building, and that's done every year.'"

The board also relied on the testimony of Clair Odell's vice president, Maury Alsher, wherein he stated that before issuing the subject policy, the carrier performed a survey in order to determine that the amount of the policy was adequate.

The actual language of the bylaws provided that "(p)rior to obtaining any policy of fire insurance or any renewal thereof, the Board of Managers shall obtain an appraisal form a fire insurance company or otherwise of the full replacement value of the Buildings..."

Although there was testimony that an appraisal was completed by the insurance company prior to issuing the policy in question, that testimony was vague and not specific concerning who performed the appraisal, on what date it was performed, and the amount for which the property was appraised. While it does appear true that a more formal and independent appraisal of the property had not been completed since 1989, the bylaws did not specify that a formal and independent appraisal was required before each policy renewal. On the contrary, the bylaws specifically allowed for the appraisal to be conducted by an insurance company.

However, from the evidence before the court, it was unclear that even this less formal appraisal was performed. A question of fact existed on the issue of whether an appropriate appraisal was obtained by defendants. For that reason, the court declined to award partial summary judgment.

Finally, insofar as plaintiffs argued that in another action, the defendants here had admitted that they failed to comply with the bylaws, the court found no merit to this contention. The court said that allegations made by defendants in another action in which they are plaintiffs could be considered judicial admissions only within the action in which they were made.

The evidence before the court on these applications established that defendants were not in violation of the terms of the bylaws with regard to the type of insurance coverage that was obtained. The court also found that defendants purchased coverage for the full replacement value of the building and thereby discharged their duty with respect thereto as set forth in the bylaws. However, insofar as defendants were obligated to obtain an annual appraisal of the property for the purpose of obtaining appropriate insurance, an issue of fact existed regarding whether they properly discharged their duties.

Comment: This case is somewhat surprising because the insurance was inadequate. It seems that the board got poor advice about the appropriate amount of coverage that was available even if it required payment of an additional premium. It is a good lesson about the need for a co-op or condo board to obtain and follow first-rate advice from competent professional advisers when obtaining property and liability insurance coverage, even in this time of significant increases in insurance premiums.