Proving Diminution of Value in a Commerical Property Case

The recent Georgia decision of Royal Capital Development LLC v. Maryland Casualty Company, 291 Ga. 262, 728 S.E.2d 234 (Ga. 2012) opened a new world of claims for property insurers, in that the Court concluded that economic loss ensuing from property damage (in this particular case so-called “stigma damage” was at issue) was covered under a commercial property policy.

While this decision changed the first-party claim landscape for insurers of property in Georgia, it also creates both additional challenges and opportunities for subrogation recovery as well. To the extent that diminution of value beyond repair cost is compensable under an insurance policy as “damage,” that diminution of value should be recoverable in a subrogation action, but only upon presentation of adequate proof to take the claim of diminished value beyond speculation to a level that is quantifiable and susceptible to consideration by a jury without guesswork.

To establish diminution of value in a commercial property loss, the first step will be to involve competent and licensed property appraisers, preferably at the outset, to assist in evaluation of the question of diminution of value. Since recent economic history has demonstrated that property values can fluctuate quickly and significantly because of external influences from the general economy, getting this work done as soon as practicable after the loss is important. Subrogation cases may progress for a period of years before getting to trial, with investigation taking considerable time even before any filing of litigation can occur and the ability of an appraiser to obtain useful and reliable data will diminish over time.

In Georgia, as in most jurisdictions and in the Federal courts, a property appraisal intended to establish recoverable diminution of value will have to employ a reliable and acceptable methodology that will withstand scrutiny in litigation under Daubert and its progeny. Appraisal opinion evidence is the type of expert opinion evidence that will be evaluated in Georgia civil matters and in the Georgia Federal District Courts under the standard for admission of any type of expert opinion evidence and, in both state and Federal courts, the Daubert standard of reliability is applicable.

Use of “comparables” (i.e., comparing a subject property with recent sales or appraisals of property of similar size, cost of replacement, siting, etc.) to establish value of property is a typical and generally accepted methodology used by appraisers. For most types of property, it is generally not too difficult for the appraiser to find appropriate “comparables” to establish the value of a subject property. However, use of “comparables” to establish proof of diminution of value after a casualty and subsequent repair is more problematic. There is no established index or track record of sales or appraisals for reference to determine the extent to which a casualty, fully repaired, nonetheless diminishes the value of a building by stigma or otherwise. Use of appraisers with MAI status (Member of the Appraisal Institute) or other recognized advanced professional certifications will be advisable for any large diminution of value claim.

It should also be noted that, even if a particular property policy does not, by its terms, afford coverage for diminution of value, that component of loss may still be present and recoverable against responsible third parties. One of the traditional measures of damage for injury to property has been comparison between fair market value of the property immediately prior to the loss and immediately after the loss. “Stigma” or other economic damage that is not remedied by repair of the structure can factor into this measure of damage.

A subrogation claim against third parties is predicated upon the actual damage sustained by the owner/insured, not the amount indemnified by the insurer under the insurance contract (such as is the case with replacement cost coverage for personal property). The amount of the insurer’s payment may cap what the insurer can recover, but it does not cap the amount of claim that can be asserted in a recovery action. When established and included as an element of actual damage in a claim against third parties, diminution of value can provide additional leverage in negotiations and also provides additional “skin in the game” for an insured, giving the insured more motivation to cooperate and assist with recovery efforts. For these reasons, it can be advantageous for the subrogation professional to investigate and document diminution of value even if the contract giving rise to the subrogation claim does not provide coverage for such loss.

It should not be assumed that every loss will have a component of economic loss for diminution of value. However, if reasonable investigation of this loss component demonstrates a rational basis to support a claim of diminution of value of the covered property proximately caused by the casualty resulting in the loss and that diminution of value cannot be alleviated by repair or restoration of the property, subrogation professionals should be alert to this issue and be prepared to expend the resources necessary to document the diminished value sufficiently to make that portion of a property loss a realistic component any claim against responsible third parties.

The Potential for Stigma Damages in Subrogation Actions

The Supreme Court of Georgia recently held that stigma damages are potentially covered under a property insurance policy, leading to the possibility that the property insurer could pursue such damages in a subrogation action. Royal Capital Development LLC v. Maryland Casualty Company, 291 Ga. 262, 728 S.E.2d 234 (Ga. 2012).

In Royal Capital, the insured owned an eight-story commercial building in Atlanta. In 2003, the insured purchased an insurance policy from Maryland Casualty to insure the building. Construction damage on an adjacent property caused physical damage to the insured’s building. The insured submitted a claim to Maryland Casualty, seeking both (1) the cost to repair the damage and (2) the diminution in the market value of the property resulting from the stigma of the building’s past physical damage, even after all repairs had been made. Maryland Casualty agreed to pay the insured $1,132,072.96 as compensation for the estimated costs to repair the property, but refused to acknowledge responsibility for the alleged diminution in the value of the property.

In reaching its decision that an insurer could be responsible for both diminution in value and cost of repairs, the Court recognized that “cost of repair and diminution in value can be alternative, although often interchangeable, measures of damages with respect to real property.” In some circumstances, it may be appropriate to award a combination of both damages in order to make the insured whole. “In such cases, notwithstanding remedial measures undertaken by the injured party, there remains a diminution in value of the property, and an award of only the costs of remedying the defects will not fully compensate the injured party.” (quoting Thurmond & Associates v. Kennedy, 668 S.E.2d 666 (Ga. 2008)).

The Court did not answer the ultimate question of whether the policy at issue covered stigma damages. Rather, the Court stated: “whether damages for diminution of value are recoverable under [the insured’s] contract depends on the specific language of the contract itself and can be resolved through application of the general rules of contract construction.” The case is currently on remand to the District Court for the Northern District of Georgia.

Despite the Court’s decision in Royal Capital, the ability of a property owner (and an insurer as subrogee of the property owner) to recover stigma damages is far from clearly established. In general, stigma damage refers to some loss in a property’s market value caused by a public perception of a risk associated with the property. Stigma damage occurs when potential buyers of property fear that a disclosed problem may recur even after the problem has been repaired, and consequently demand a lower price for the property. In such circumstances, the property owner seeks to recover the difference between the market value of the property before the damage and the market value of the property after the damage has been repaired.

In seeking to recover for stigma damages, property owners (and their subrogated insurers) may encounter a number of obstacles. First, the plaintiff must establish that there has been an actual decrease in the market value of the property. This will most likely require testimony from an expert in real estate appraisal. The expert should be prepared to testify that the damaged property has a lower market value than comparable properties without the damage.

Second, the courts are generally reluctant to award stigma damages in the absence of permanent physical injury to property. If the property is capable of being repaired or remediated, the courts are likely to conclude that stigma damages are not recoverable.

Finally, the plaintiff must link the decrease in the market value of the property to the defendant’s conduct. A defendant can raise a variety of explanations for the alleged decrease in the market value of the property, independent from the defendant’s own conduct. If a defendant was confronted with a claim for stigma damages in the current marketplace, the defendant could easily argue that any decrease in the market value of the property resulted from a general reluctance to purchase property in the present economy.

The Supreme Court’s decision in Royal Capital presents the possibility that a claim for stigma damages may arise in the context of a subrogation action. It remains to be seen whether this decision will result in increased claims for stigma damages, or even more importantly, additional guidance as to what evidence is required to prove such damages.