As previously mentioned in my blog posts on May 3, 2012 and May 17, 2012,  courts are frequently asked to determine whether an appraisal award should be overturned or vacated. Recently, the United States Court of Appeals for the Sixth Circuit held that, under Michigan law, judicial review of an appraisal award is limited to instances of bad faith, fraud, misconduct or manifest mistake. The court upheld a federal district court’s decision to vacate an appraisal award because the umpire committed a manifest mistake when he used two different valuation approaches when valuing the building and loss for coinsurance purposes.

In Evanston Insurance Company v. Cogswell Properties, LLC, Docket No. 10-2075, 2012 U.S. App. LEXIS 12168 (6th Cir. May 29, 2012)¹, the defendant’s building sustained fire damage. The building was insured for $1 million, subject to coinsurance at 80%. Cogswell’s property insurer determined the actual cash value (“ACV”) of the building. When the policy’s coinsurance provision was applied, the insured was required to carry no less than $8,178,707 in insurance on the building, and therefore, the insurer was only required to pay for 12.23% of the loss. With a loss ACV of $342,836, the insurer concluded that it was only required to pay $36,918 to the insured.

The insured did not agree with its insurer’s loss assessment, so the insurer demanded an appraisal of the dispute pursuant to the policy. The parties’ appointed appraisers were unable to agree on an umpire, so the insurer filed a petition in Michigan state court to appoint an appraisal umpire. The insured counterclaimed, arguing that the $1 million policy limit on the building served as the value of the building for coinsurance purposes, resulting in no coinsurance penalty. The case was removed to the United States District Court for the Western District of Michigan, which ruled on the insured’s motion for summary judgment, finding that the $1 million policy limit did not serve as the value of the building for coinsurance purposes. For purposes of the appraisal, the court also ordered that, consistent with Michigan law, the appraisal panel must follow the “broad evidence rule”, requiring the panel to consider any evidence and methodologies, in order to reach a correct estimate of the value of the damaged property.

The insured’s selected appraiser used a “fair market value” approach to value the building (for purposes of the coinsurance analysis) and a “replacement cost less depreciation” approach to value the loss. The insurer’s selected appraiser proposed building and loss valuations under three different valuation approaches, “replacement cost less depreciation”, “market value” and “market value based on actual purchase price”.

The appraisal umpire elected to use two different definitions of ACV – “market value” for the building, resulting in an ACV of $1,540,000, and “replacement cost less depreciation” for the loss, resulting in an ACV of $736,384. The insured’s selected appraiser agreed with the appraisal findings.

On a motion for summary judgment, the federal district court vacated the appraisal award, finding that it demonstrated both a manifest mistake and an error of law because the umpire applied a different valuation methodology to determine the ACV of the building as it did to determine the ACV of the loss. The court held that the policy calls for one consistent definition of value, and by using two different approaches for determining the ACV of the loss and building, the umpire’s valuation was inaccurate.

The insured moved for reconsideration, arguing that the district court failed to use the more stringent standard of review provided for under the Federal Arbitration Act (“FAA”), 9 U.S.C. §§1, et seq., and instead, improperly used the “manifest mistake/error of law” standard of review provided for by Michigan law. The district court denied the motion, holding that the insured failed to raise the issue during the summary judgment stage, and as such, it could not consider this new argument in the context of a motion for reconsideration.

Consistent with the district court’s order, the umpire issued a new appraisal award, using the same approach for determining the ACV of the building and loss. The insurer’s selected appraiser accepted this finding. When the coinsurance policy principles were applied, the insurer was only responsible for 13.42% of the loss, or a total of $128,645. The district court entered judgment consistent with the umpire’s new appraisal calculations.

The insured appealed the entry of judgment, arguing that the district court committed reversible error by failing to find that the FAA provided the basis for the district court’s review of the award, not Michigan law. The insurer argued that the court applied the correct standard of review under Michigan law. The United States Court of Appeals for the Sixth Circuit upheld the district court’s order which gave rise to the new appraisal award, finding as follows:

• The FAA did not apply to the appraisal proceeding at issue in the case, because, unlike arbitrations, (1) the appraisal provision found in insured’s policy does not provide for a final and binding remedy, because Michigan allows an insurer to retain its right to deny a claim even if there is an appraisal, and (2) there is no requirement that the umpire hold an actual hearing.
• Under Michigan law, an appraisal is subject to the same judicial review standard as that used in common law arbitrations, involving instances of bad faith, fraud, misconduct or manifest mistaken.
• In the case of the first award, the umpire’s use of two different valuation methods for the ACV of the building (for purposes of the coinsurance analysis) and ACV of the loss violated the policy’s requirement that one consistent definition of value be used, rendering an illogical result that contravened the purpose of the broad evidence rule, used to formulate a correct estimate of the value of the damaged property.

It is important to note that this decision was reached based on the wording of the appraisal language found in the policy at issue in the case, and interpretation of Michigan law. The language of appraisal provisions, which are often mandated by state statute, vary from state to state. Therefore, as mentioned in my previous blog posts, it is always important to consult with counsel and research the law of the applicable jurisdiction when appraisals are involved.

¹ Reproduced by Robinson & Cole LLP with the permission of LexisNexis. Copyright 2012 LexisNexis, a division of Reed Elsevier Inc.  All rights reserved.  No copyright is claimed as to any portion of the original work prepared by a government officer or employee as part of that person’s official duties.