Black-letter property insurance law requires that a policyholder have an insurable interest in the property being insured. Normally, a policyholder has an insurable interest in the subject property when he or she either stands to gain a financial benefit from its preservation or will suffer a financial loss from its destruction or impairment. This does not require the policyholder to actually have ownership or title.
Insurable interest is an important facet of insurance because, without it, insurance could be seen as no different from gambling. An important question is how to measure the value of the insurable interest in the event of a loss.
Banta Properties v. Arch Specialty Insurance
In the recently decided case of Banta Props., Inc. v. Arch Specialty Ins. Co., 2014 U.S. App. LEXIS 1419 (11th Cir. Jan. 24, 2014), the Eleventh Circuit Court of Appeals had to decide whether a property manager, whose sole interest in certain apartment buildings was the contractual right to receive 4 percent of the gross rental income, could also recover the cost of repairing physical damage to the property. The court held that Florida's insurable interest statute, Fla. Stat. § 627.405, precluded recovery of the repair cost.
The Facts of the Case
As the court noted, this case was complicated by the ownership structure of the apartment buildings at issue. Banta Properties was one of many companies owned by the Banta family. Banta Properties served as the property management company for three apartment complexes, Parkcrest Apartments, Colonial Park Apartments, and Westwood Apartments (collectively the "Apartments"), which were owned by separate legal entities that were not owned by Banta Properties but by the Banta family. Parkcrest was organized as a conglomerate of limited liability companies, Colonial Park was operated as a land trust, and Westwood was organized as "Westwood Apartments LLC."
In exchange for managing the complexes, the owners paid Banta Properties 4 percent of gross rents. When the property insurance was purchased, the Banta family owned the separate legal entities comprising Parkcrest, Colonial Park, and Westwood. The central issue in this case arose from the fact that, when the insurance was purchased, Banta Properties was listed as the named insured. The Apartments were each individually named as additional named insureds on the primary and excess policies. Just prior to the loss at issue, the Banta family sold Parkcrest to an unrelated entity, while Banta Properties continued to serve as the property management company.
In August 2005, the Apartments were damaged by Hurricane Wilma. In addition to a multimillion dollar claim for physical damage, Banta Properties promptly filed a business interruption claim with its primary insurer for $39,000, representing the total amount of lost rents. Banta Properties and the primary insurer eventually settled for the policy limits of $2.5 million to cover the losses to the Apartments, after which Banta Properties sought coverage from the excess insurer, Arch Specialty Insurance. Unable to resolve the claim, Banta Properties filed suit and won a jury verdict of approximately $1.3 million. This amount accounted for the money paid by the primary insurer, pre-judgment interest, and the deductibles. The court twice denied Arch's motion for judgment as a matter of law, and Arch appealed.
The Appellate Decision
On appeal, Arch argued that Banta Properties' insurable interest was limited to its revenue stream from the Apartments, namely 4 percent of the lost rents due to the hurricane (approximately $1,600). Banta Properties countered by arguing that the Banta family's ownership interest in the Apartments allowed Banta Properties to recover for the entire loss to the Apartments. Alternatively, Banta Properties claimed that it had a contractual obligation to procure insurance, and that obligation created an insurable interest.
The court first noted that, "[u]nder Florida law, property insurance contracts are enforceable only where the insured has an insurable interest in the covered property at the time of the loss." Florida law defines insurable interest as an "actual, lawful, and substantial economic interest" in keeping the property "free from loss, destruction, or pecuniary damage or impairment measured by the extent to which the insured might be damnified by loss, injury, or impairment thereof." After analyzing Florida appellate court decisions, the court held that "the measure of an insurable interest is the loss the insured might suffer from damage to the property." Using this rule, the court found that Banta Properties had no property rights in the Apartments. The only right Banta Properties had at the time of loss was the right to collect its 4 percent of gross rentals income for managing the Apartments.
Banta Properties' other arguments were also rejected by the court. First, Banta Properties tried to argue that its suit was actually a suit representing the interest of the Banta family. The court noted that, even if it allowed the argument that Banta Properties was representing the Banta family's interests, the Banta family still did not have enough insurable interest in the Apartments to trigger the excess coverage. Banta Properties claimed $6.1 million in damages to the Apartments, $3.5 million of which was attributed to Parkcrest. The Banta family, however, did not own Parkcrest at the time of the loss. Thus, the most that could be claimed was $2.6 million, below the $3 million attachment point of the Arch excess policy (the $2.5 million primary policy limits and the deductible of approximately $500,000). Therefore, regardless of the entity making the claim, the Arch excess policy was not triggered.
Banta Properties also claimed that the property management contracts required it to procure insurance on behalf of the owners, thus creating an insurable interest. However, the court held that the language of these agreements established that Banta Properties had neither an obligation to purchase insurance on behalf of the owners nor the authority to do so. Therefore, the judgment was reversed and the jury verdict nullified.
This case teaches important lessons. The facts of this case reasonably led to the decision reached by the appellate court. Despite all of the complicated business entities involved, this case turned on the simple fact that once the Banta family sold Parkcrest, the Bantas (regardless of which entity) had no grounds to claim an interest greater than the management fee. Had the property not been sold, even if Arch argued that Banta Properties only had a 4 percent interest, Parkcrest was a named insured on the policy and therefore would have been able to file its own claim under the policy. The sale of Parkcrest limited the Banta interest to an amount within the primary coverage. Thus, we see the importance of evaluating insurable interest both when purchasing insurance and at the time of any transaction involving ownership interests.
When employing complicated and multilayered business structures, one must ensure that care is taken to name the right entities on the various insurance policies. As the court noted, "[t]he Banta Family created numerous business entities to manage its business ventures. Consequently, they are bound to both the benefit and burden of the limited liability and interests of the entities." Here, the sale of Parkcrest was dispositive as to Banta Properties because its insurable interest was so limited. If some other entity had an insurable interest that was not already protected, it should have been named on the policies.
One should also be careful when transferring insured assets among a family of business entities. For example, if a general partnership owns a piece of insured property and transfers it to a limited partnership comprising the same partners, the insurance does not automatically transfer, and the limited partnership has to seek its own insurance. See Shotmeyer v. New Jersey Realty Title Ins. Co., 948 A.2d 600 (N.J. 2008) (holding that the partners did not hold an insurable interest in the land because the insured—i.e., the general partnership—no longer held title to the land, which was transferred to a new and separate legal entity, the limited partnership).
The opinion in Banta Properties leaves some questions unanswered. Why would the Banta interests seek to repair a building they did not own and had no legal obligation to repair? The case does not discuss who purchased Parkcrest other than to state that the new owners were not affiliated with the Banta family. The new owners undoubtedly procured their own insurance to cover Parkcrest. If so, any recovery by the Bantas would likely have been a windfall.
On the other hand, it is also problematic that Banta Properties was the named insured on these policies. The broker and the underwriter should both ensure that the insureds have valid insurable interests and the extent of these interests. Arch successfully argued that Banta Properties' insurable interest was limited to 4 percent of the rental income collected at the Apartments. If Banta Properties was charged a premium as if it owned a full interest in the apartment complexes, it was vastly overcharged. Banta Properties bought the insurance to protect the Banta interests in the Apartments. One reasonable approach to this loss would have been to reform the insurance policies, naming the Banta family as an insured. This would be in line with the intent of the parties to the insurance contract. This argument does not appear to have been made, although it would not have added to the Banta family's insurable interest after selling Parkcrest.
It is also interesting to note that the primary insurer chose to settle for policy limits. It could be that the primary insurer was aware of the potential underwriting defects. It could also be that the argument that it was really the Banta family's interests at issue was more persuasive when considering only the properties owned by the Banta family. Furthermore, as noted, all of the ownership structures for the Apartments were named as additional insureds. These additional insureds might have filed their own claims or allowed Banta Properties, as the named insured, to adjust and settle the loss on behalf of all insureds.
The ability to create business entities to limit liability and maximize tax benefits is a powerful tool. With power, however, comes responsibility. Owners and risk managers must ensure proper transfer or acquisition of insurance, especially among related entities, to avoid finding a significant gap in coverage after a loss.
Jay M. Levin is a member of Reed Smith's Insurance Recovery Group, resident in the firm's Philadelphia office. He represents policyholders in disputes with insurers and writes and speaks frequently on professional responsibility topics. Anthony B. Crawford is an associate in Reed Smith's Insurance Recovery Group, also resident in the Philadelphia office. They can be reached, respectively, at [email protected] and [email protected].
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.