Foran Glennon Palandech Ponzi & Rudloff

February 2016

When Can Insurers Challenge an Improper Appraisal Demand?

Brian Devilling

Appraisal demands raise numerous issues for property insurers, including whether the demand improperly seeks determination of coverage issues, whether the opposing appraiser is competent and impartial, and whether there is truly a disagreement as to the amount of loss.  If an insurer concludes that appraisal is improper, when is the proper time to raise the issue?  Should insurers challenge appraisal demands before the appraisal proceeds, or must an insurer proceed with appraisal and challenge the award after it is issued?  As is the case with most appraisal issues, courts are split.

Typical appraisal provisions permit either party to an insurance policy to demand appraisal of the ‚Äúamount of loss‚ÄĚ if there is disagreement on the issue.¬† Each party must appoint a ‚Äúcompetent and impartial‚ÄĚ appraiser (sometimes described as ‚Äúcompetent and disinterested‚ÄĚ).¬† If the appraisers cannot agree on the amount of loss, they must select an umpire to resolve the dispute.

Appraisal provisions are silent, however, on how to resolve a dispute over whether appraisal is proper in the first place.  If, for example, an insurer contends that an appraisal demand improperly seeks resolution of coverage issues, most policies provide no guidance as to whether the insurer can decline to participate, or must participate and challenge the appraisal after the panel issues an award.

The stakes for both parties are high.  An appraisal can be costly, particularly in cases involving complex damage calculations.  Appraisals can also take significant time, delaying resolution of a claim.  If an appraisal is not permitted under the policy, both parties will have wasted significant time and expense during the appraisal process, and will incur substantial legal fees litigating the propriety of the appraisal after the award is issued.  An appraisal award that improperly resolves causation or coverage issues can also create false expectations of payment, leading insureds to become intractable in subsequent litigation and negotiation.  Finally, by proceeding to appraisal, an insurer could waive its objections if they are not properly preserved in a reservation of rights.

Faced with the prospect of an improper appraisal, insurers can (1) proceed with the appraisal, reserve the right to challenge the appraisal in subsequent litigation, and file a declaratory judgment action after the award is issued; or (2) file a declaratory judgment action before the appraisal begins.  Courts are split as to the proper approach.

In State Farm v. Johnson, 290 S.W.3d 886, 888 (Tex. 2009), an insured claimed that her entire roof needed to be replaced as a result of hail damage.¬† The insurer contended that only the ridge line was damaged and in need of replacement.¬† The insured demanded appraisal.¬† The insurer refused to participate, contending that the appraisal would require resolution of causation issues.¬† The Texas Supreme Court held that the appraisers could consider causation in determining the amount of loss, but that the parties could later challenge the panel‚Äôs determination in court.¬† The court held that it was improper to challenge the propriety of an appraisal before it occurs.¬† The court reasoned that (1) appraisal is usually less expensive than litigation; (2) the parties should be able to structure appraisal in a way ‚Äúthat decides the amount of loss without deciding any liability questions;‚ÄĚ and (3) ¬†‚Äúthe scant precedent involving disputes about the scope of appraisal suggests that appraisals generally resolve such disputes.‚Ä̬† The court added, ‚Äú[E]ven if an appraisal award is flawed, that can be easily remedied by disregarding it later.‚Ä̬† Thus, under Johnson and similar cases, an insurer must participate in appraisal and wait to challenge its propriety until after the panel issues its award.

Other courts, however, have held that it is proper to challenge an appraisal demand before the appraisal proceeds.  In Lee v. California Capital Insurance, 237 Cal.App.4th 1154, 1170 (Cal. App. 2015), an insured demanded appraisal after a sustaining a fire loss.  The parties not only disputed the cost to replace particular items, but also disputed whether some items ever existed or were damaged at all.  The court held that the insurer had the right to challenge the appraisal before it began, holding as follows:

[I]f California Capital believed it was wasteful to engage in an appraisal before coverage or other legal issues were resolved, it could have sought to stay the appraisal pending resolution of those issues in a declaratory relief action. In an appropriate case, this approach could provide valuable guidance to an appraisal panel that might otherwise struggle with disputed legal issues that are outside the scope of an appraisal.

Johnson and Lee demonstrate the diametrically opposite views that courts have taken on the timing of a challenge to appraisal. The Johnson court relied on the argument that appraisal is more efficient than litigation, and that courts can easily remedy issues with the scope of an appraisal by disregarding an award. Conversely, the Lee court reasoned that uncertainty regarding the scope of appraisal makes the process less efficient.  If parties can challenge the scope of appraisal before it starts, the court can provide guidance to the parties that will streamline the appraisal.

Regardless of which position is right, insurers are left with an uncertain landscape in responding to an appraisal demand.  The response requires careful consideration of the law in the jurisdiction not only with respect to scope of appraisal and competence and impartiality of appraisers, but also with respect to the timing of the insurer’s response or rejection.  What might be an acceptable response in California under Lee, for example, would clearly be unacceptable in Texas under Johnson, and might expose an insurer to additional liability for bad faith.

Accordingly, claims personnel must be familiar with the law in their jurisdiction.  Those who operate in multiple jurisdictions or are uncertain of the law in their jurisdiction should consult in-house or outside counsel for guidance in responding to a demand.