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Nebraska Federal Court Rules in Favor of Property Insurer on Unique Issue of Expenses to Mitigate a Loss

August 22, 2012

Mark Feinberg and Matt Gollinger of Zelle Hofmann Voelbel & Mason obtained a victory for Affiliated FM Insurance Company in the U.S. District Court for the District of Nebraska on a unique issue involving expenses incurred by an insured to mitigate a loss.  Specifically, the question for the Court was: when an insured purchases equipment to mitigate a loss, makes claim for the full cost of the equipment, but the equipment has substantial remaining value once mitigation is complete, is the insured entitled to keep the equipment free and clear or is the insurer entitled to a credit for that remaining value?

KAAPA Ethanol, LLC sustained property damage to four stainless steel ethanol fermentation tanks due to insufficient foundational support. These tanks were essential components of the ethanol production process. KAAPA needed to take each of the four tanks out of service in order to perform the necessary repairs, a process that would take four to eight weeks for each of the four tanks.

In order to avoid a loss of production during repairs, KAAPA elected to build a brand new fermentation tank. By building this additional tank, KAAPA was able to maintain its full production during the time it was making repairs to the damaged fermentation tanks, thus mitigating any business interruption loss.

KAAPA made claim for coverage under its all-risk property insurance policy issued by Affiliated FM, which included coverage for business interruption losses. As part of its claim, KAAPA sought the full cost of constructing the additional tank. KAAPA contended that the cost of constructing the new tank was appropriately covered as a “mitigation expense” that KAAPA incurred to avoid any lost profits during the time the original tanks were being repaired. While Affiliated FM agreed that the cost of constructing the new tank was substantially less than the potential lost profits that KAAPA would have incurred without the use of the new tank, the parties disagreed over the proper measure of recoverable mitigation expenses.

Affiliated FM contended that permitting KAAPA to recover the entire cost of constructing the new tank while retaining possession of the tank following repairs to the tanks would amount to an improper windfall. Affiliated FM argued that the new tank had substantial value far beyond the limited time it was used to mitigate the loss because the new tank allowed KAAPA to take any of its other fermentation tanks off line for maintenance or cleaning without losing a drop of ethanol, as the new tank provided KAAPA the readily available capacity to make up that production. In addition, evidence suggested that the use of the new tank would lengthen the useful life of the existing tanks, as well as potentially increase the plant’s overall efficiency and ethanol production yield.

KAAPA argued that the tank had no value beyond its use in a mitigation capacity.  KAAPA claimed that it had no present plans to expand beyond its existing ethanol production level and that the new tank was completely unnecessary for its present volume of production.  KAAPA additionally contended that, in fact, the tank had a negative value to it because of the expenses it incurred for taxes, maintenance, and insurance on the tank.

With no policy provision specifically addressing the issue and little existing case law directly supporting its position, Affiliated FM based its argument on the longstanding principle that an insured may not benefit from a covered loss such that its insurance recovery puts it in a better position than the one it occupied prior to the loss. To prevent KAAPA from obtaining such an impermissible windfall gain, Affiliated FM argued that since the tank had a useful life of at least 20 years and since it was only used to mitigate the loss for 2 years, KAAPA’s recovery for the cost to construct the tank should be reduced by 90% to reflect the remaining useful life of the tank after its use to mitigate the loss had ended.

In his opinion, Judge Lyle Strom of the U.S. District Court for the District of Nebraska agreed with Affiliated FM and ruled that because the new tank retained substantial value following the conclusion of the repairs, KAAPA’s recovery for mitigation expenses must be limited so that KAAPA could not recover insurance proceeds duplicative of the value remaining in the tank. Observing that the new tank had only been used in a mitigation capacity for roughly 10% of its useful life, the Court limited KAAPA’s recovery for its “mitigation expenses” to 10% of the cost of constructing the new tank.

KAAPA then appealed the trial court’s decision to the Eighth Circuit Court of Appeals.  The Eighth Circuit’s opinion on the other issues raised on appeal made it unnecessary for the Court to reach the mitigation expense issue. Notwithstanding that, the Court concluded its opinion by stating that had the Court reached the issue “we would have affirmed based on the trial record before us.”

The trial court’s opinion can be found at  KAAPA Ethanol, L.L.C. v. Affiliated FM Ins. Co., 2010 U.S. Dist. LEXIS 28735 (D. Neb. 2010).

The Eighth Circuit opinion can be found at KAAPA Ethanol, L.L.C. v. Affiliated FM Ins. Co., 660 F.3d 299 (8th Cir. 2011).