Posted on Friday, February 3, 2023The California federal district court case of KB Home v. Illinois Union Insurance Co., No. 8:20-cv-00278-JLS-JDE, (C.D. Cal. August 23, 2022), provides much needed guidance for cases involving builder's risk insurance claims for soft cost coverage.
The case stems from damage to several of KB Home’s residential building sites caused by a severe rainstorm in January 2017. Each home site was a smaller part of a large housing development project. The damage caused significant delay in the completion of some individual home sites, although there was limited evidence of delay to the overall housing development project.
As a result, KB Home sought coverage under a builder’s risk policy purchased from Illinois Union for both hard costs and soft costs. “Hard costs” are the costs directly associated with repairing property damage to the sites. Conversely, “soft costs” are indirect expenses associated with project delays caused by such property damage and repair efforts. For example, hard costs would include labor and materials, whereas the soft costs claimed by KB Home included additional real estate taxes, construction loan interest, and advertising and promotional expenses incurred because of the delays. Illinois Union paid the claim for the hard costs, but denied the soft costs claim. KB Home filed suit and Illinois Union eventually filed a motion for summary judgment.
“Insured Project” Included Individual Home Sites Within Overall Project
Illinois Union’s first argument in support of its coverage denial was that the policy’s soft costs provisions only covered delays in the completion of the entire housing development project, not individual home sites. Because KB Home could not produce evidence that the entire project was delayed, as opposed to only submitting evidence that each individual home sites were affected by the rain, then summary judgment should be granted to Illinois Union.
The court first detailed the standard under California law regarding interpreting contracts. Under ordinary rules of contract interpretation, the mutual intention of the parties at the time the contract is formed governs interpretation. The parties' mutual intent should be inferred, if possible, solely from the written provisions of the contract. Language in an insurance policy is interpreted as a whole, and in the circumstances of the case, cannot be found to be ambiguous in the abstract. Ambiguous terms in an insurance policy are resolved in the insured’s favor, consistent with the insured’s reasonable expectations.
The court rejected Illinois Union’s first argument that the soft costs policy applies only to the whole project and not the construction of individual homes. The court noted that the term “Insured Project(s)” was not defined, nor was there any language in the policy that suggested that the term was restricted only to the overall housing development project.
Further, the court noted that KB Home submitted evidence that the rainstorms delayed site development work, which caused changes to in-house projections of sales, starts, and closings. The court determined that a jury could reasonably find that the evidence submitted by KB Home proves the rainstorms caused a delay in the completion of a “building or structure” under the policy.
Soft Cost Claim for Construction Loan Interest
Next, the court analyzed whether KB Home’s soft cost claim for construction loan interest was valid. The evidence demonstrates that KB Home did not use traditional lending sources when borrowing money for projects. It would “borrow” money through “senior notes” it offers to investors and, when due, would pay the notes back with interest. These notes, however, are dispersed through KB Home’s subsidiaries, not KB Home the corporate parent. Illinois Union argued that these were not traditional loans as contemplated by the policy and that, ultimately, KB Home, as the parent corporate entity, never paid extra interest due to the rain event.
The court first noted that the policy did not define what a “construction loan” should look like to be afforded coverage under the policy. Therefore, any financial instrument used by KB Home that required it to repay with interest could be construed as a construction loan. Second, KB Home submitted an expert opinion that KB Home’s subsidiaries paid more interest than necessary due to the rain event. The expert opined that if the individual home building sites could have been completed on time and sold, the sale proceeds could have paid down the notes, allowing the subsidiaries to pay less interest. Thus, the court concluded that based on the evidence submitted by KB Home, a reasonable jury could find it paid more interest than it would have if the rainstorms did not occur.
Soft Cost Claim for Additional Real Estate Taxes and Marketing Expenses
Illinois Union’s final argument failed to provide evidence that its real estate taxes and marketing expenses increased as required to trigger soft cost coverage. The court disagreed. There was testimony from KB Home management personnel indicating that both taxes and marketing expenses increased due to the delay caused by the rain event. The court concluded that the evidence was substantial enough that a reasonable jury could rule in favor of KB Home. Therefore, Illinois Union’s motion for summary judgment was denied.
KB Home confirms that soft cost coverage can extend to: (a) delays for individual building units, even where completion of the project as a whole is not set back; (b) delay-related increases in loan interest and fees, even from non-traditional construction funding sources; and (c) increased taxes and marketing expenses supported by reasoned projections from management personnel. Of note, many of Illinois Union’s arguments hinged on the alleged lack of documented support for KB Home’s soft cost claims. Although these arguments proved unsuccessful, it serves as a reminder for project teams to maintain detailed and comprehensive records of expenses both directly and indirectly related to construction delays, as this can be instrumental in resolving builder’s risk soft cost claims expeditiously.
