What happens when grapes under contract are damaged (but not totally destroyed) by fire or smoke?10/18/2017 The Napa and Sonoma fires have destroyed thousands of properties. This post addresses the obligations of the buyer and seller when grapes are damaged (but not destroyed) by the fire. Even for those vineyards not destroyed by the fire, the smoke from the wine county fires may cause “smoke taint” which can seriously affect the quality of the grapes. Many of these grapes and wines are under existing contracts of sale.
As in the case of a complete destruction of the grape crop, the seller should notify the buyer when the seller first becomes aware of the problem. Under the California Commercial Code, anything less than “perfect tender” (i.e., grapes meeting the exact specifications of the parties) is a breach of contract. In the event of a breach, the buyer may recover damages, generally the difference between the contract price and either the price at which the buyer bought substitute grapes or the fair market value of the grapes. The buyer is also entitled to consequential damages to the extent they were foreseeable. This might include lost profits suffered on the buyer’s end as a result of the defective grapes. In order to recover damages, the buyer must mitigate its damages. This means attempting to purchase substitute grapes. It may also mean selling the damaged grapes if they are in the buyer’s possession and at risk of perishing or further deteriorating in quality. Section 2613 of the California Commercial Code may also apply and has slightly different rules. Where goods are identified (e.g., grapes from a certain vineyard), the buyer has a right to demand an inspection. Thereafter, the buyer can cancel the contract or accept delivery. This can be done either in whole or in part. If the buyer cancels the contract, neither party has any additional liability. If the buyer accepts the grapes in their non-conforming/damaged state, the buyer is entitled to an adjustment in purchase price, basically the difference between the price of the grapes as promised and the price of the grapes as delivered (in their damaged state). The buyer in this case would not be entitled to consequential damages (as the buyer might be in a case where Section 2613 does not apply). In addition to grape purchase contracts, the above rules also apply to a custom wine making agreement whereby the seller agrees to sell finished wine to the buyer under the buyer’s label. These agreements can sometimes be more detailed than a grape purchase agreement (especially with respect to the quality and specifications of the finished product). In all cases, reference must first be made to the terms of the written agreement itself which may expressly or implicitly allocate the risk of loss in a different manner. Many of these agreements have detailed dispute resolution procedures and (sometimes) limitations of liability (e.g., disclaiming consequential damages and the like). Most grape purchase and custom winemaking agreements have force majeure clauses. It is important to review this language. For example, clauses only apply if the seller’s operations are suspended for things like fire and would not cover things like smoke damage to the grapes or the wine.
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The Napa and Sonoma fires have destroyed thousands of properties. This post addresses the obligations of the buyer and seller when grapes or vineyards are destroyed by fire.
The wine country fires destroyed many vineyards. In many cases, the grapes had not yet been harvested, resulting in a total loss of the 2017 crop. Many of these grapes were under contracts of sale. The seller/vineyard owner (obviously) cannot perform. The first thing which should be done is for the seller to notify the buyer as soon as possible of the destruction of the grapes. Upon receipt of such notice, the buyer has a duty to mitigate damages. Generally, this will mean attempting to purchase grapes from another source. Unless the grape purchase contract allocates losses in a different manner, in most cases, the seller’s performance should be excused. There are a number of ways to reach this result. First, under Section 2613 of the California Commercial Code, where goods are identified (e.g., grapes from a certain vineyard), the total loss of such grapes results in the termination of the contract without any further liability. If, however, the loss is partial (e.g., half of the vineyard is destroyed), the buyer may demand an inspection, and thereafter, either cancel the agreement, or accept the undamaged grapes with an allowance in the purchase price for the decreased quantity. Second, under Section 2615 of the California Commercial Code, if the seller is unable to perform due to the occurrence of a contingency (i.e. a fire) the non-occurrence of which was a basic assumption on which the contract was made, the contract may be avoided. This is the defense of “impracticability.” Third, many grape purchase agreements have a force majeure clause which can likewise excuse performance. A typical force majeure clause can read something like the following: “If either Seller or Purchaser is unable to carry on its normal operations or is compelled to reduce or suspend its operations because of forces beyond its immediate control, including but not by way of limitation, laws, regulations, court orders, labor disputes, breakdown of machinery, lack of transportation, interruption of power, fire, catastrophe, earthquake, war, civil commotion, quarantine, weather, drought, frost, and other action of the elements, crop failure or shortage, Act of God, or other matters beyond its immediate control, then the party so affected shall, while so affected, be relieved to the extent it is prevented from performing its obligations hereunder, but in such event, said party shall take reasonable measure to remove the disability and resume full performance at the earliest possible date.” In the event a part of a vineyard was destroyed, and more than one buyer had contract to purchase grapes from that vineyard, the seller is required to allocate between the multiple buyers in a reasonable manner. The seller is also required to notify the buyers of their respective expected quotas. The Napa and Sonoma fires have destroyed thousands of properties. This post addresses the obligations of the insured following a loss.
Immediately a loss occurs, the insured has a duty to mitigate further damage. Stated differently, the insured has an obligation to take steps to prevent further damage to the property. The failure to mitigate further loss is a ground for denying coverage. As soon as possible after a loss, the insured must notify the insurer or the insurance agent of the loss. This is called a “notice of claim.” Typically, the policy does not prescribe a specific time-period for providing the notice of claim (e.g., 15 days after the loss). Rather the policies usually require notice “without delay”, “immediately” or “promptly” after the loss. The failure to promptly provide notice of claim is not a ground for denying coverage unless the insurer was actually and substantively prejudiced by the late notice. Note, however, that Insurance Code Section 550 provides that in cases of fire insurance, an “unnecessary delay” in providing notice will exonerate the insurer (although courts have found ways around this). After the notice of claim is made, the insurer must commence an investigation of the claim. The insurer is also required to provide receipt of the notice of claim within fifteen days. After the notice of claim is made, the insured is required to submit a “proof of loss.” This must generally be submitted “without unnecessary delay” or within a set time period (e.g. 60 days). The proof of loss must include a complete inventory showing in detail the quantities, costs, actual cash value and amount of loss claimed. In addition, the insured must submit a sworn statement providing the time and origin of the loss, the interest of the insured in the lost property, and the actual cash value of each item and amount of loss. The proof of loss must be made on the best evidence available to the claimant at the time it is submitted. This does not mean you need proof like what you would provide at a trial. Nevertheless, substantial compliance with the proof of loss provisions is required. A proof of loss which fails to provide the basic information and required documentation has been held to be a material breach of the insurance policy and negates the insurers obligation to indemnify for the loss. The insurer is not obligated to indemnify if no proof of loss is filed. The insurer may object to a proof of loss on the basis of incomplete descriptions or omissions. The claimant has a reasonable time to provide a supplemental response. Any defects not objected to by the insurer are waived. The insurer may not object to a proof of loss based on issues of credibility. The insurer will sometime prepare its own proof of loss based on the information provided to it by the claimant. They will then send this to the claimant asking them to sign it. Unless you believe the insurer is so generous that it is trying to maximize your recovery, instead of minimizing their own exposure, do not sign the insurer-provided proof of loss. You have the right to submit your own estimates. In the event your estimates are higher than the insurers, the insurer must either: (i) pay the higher amount, (ii) provide the claimant with the name of a person or entity who agrees to perform such repairs at the insurer’s cost estimate, or (iii) make written adjustments to the claimant’s estimates and provide a copy of such adjustments to the claimant. Throughout the process, the insured has a duty to cooperate with the insurer. The insurer is entitled to review your books, records and other documents. It is entitled to talk to you and your employees and others with knowledge of the loss. Upon demand, you are also required to submit to an examination under oath (similar to a deposition). There are reasonable limits to what the insurer can and cannot demand (e.g., they must have some relevance), but typically, the insured is advised to cooperate to the extent possible. The failure to cooperate with the insurer will void coverage if the insurer can establish it was substantially prejudiced by the failure to cooperate. In any event, the insurer’s duty to pay is suspended until such time as the claimant adequately cooperates. The claimant has the right to see all claim related documents. Upon demand, the insurer must provide, within 15 days, all bids and estimates, appraisals, third party findings, all reports and drawings and all valuation and loss adjustment calculations. Almost all policies have statutes of limitation saying when a lawsuit must be filed against the insurer. Homeowners’ policies generally have a two-year statue of limitations; other property insurance policies often have a one year statue of limitation. The limitations period typically runs from the date of loss. The limitations period is tolled (i.e. suspended) during the time period from when the notice of claim is made and when the insurer unequivocally denies coverage. In the event there is a dispute as to the valuation of the property (as opposed to the existence of coverage or another policy related dispute), both the insurer and insured have the right to commence an appraisal process to determine the amount of loss. The Napa and Sonoma fires have destroyed thousands of properties. This post addresses the obligations of insurers under California’s Fair Claims Settlement Practices regulations (the “Regulations”).
The Regulations prohibit an insurer from doing a number of things, including: (i) discriminating on the basis of sex, race, religion, property location and additional factors, (ii) failing to notify a claimant of the benefits under a policy, the coverage under a policy and applicable time limits for acting, (iii) requiring the claimant to submit a notice of claim or proof of loss within a specific time (unless the policy itself contains such a time limit), (iv) making a partial payment accompanied by language releasing the insurer unless the policy limits have been paid or the parties have entered into a mutual settlement of the claim, and (v) requiring the claimant to submit to a lie detector test. The Regulations also provide specific notice requirements and time periods for acting. For example: · The insurer must acknowledge receipt of a notice of claim within 15 days of receipt; · The insurer must respond to any correspondence from the claimant within 15 days (if the correspondence seeks a response); · The insurer must commence investigation of the claim within 15 days after receiving the notice of claim; · The insurer must accept or reject a claim no later than 40 days after the claimant submits a proof of loss (although the insurer may extend this time period by giving written notice every 30 days in the event the insured has not submitted sufficient information); · The insurer must tender payment of the undisputed portion of a settlement payment within 30 days. The Regulations impose additional substantive requirements on insurers. An insurer is prohibited from making an “unreasonably low” settlement offer. The insurer is prohibited from requiring the claimant to use a particular person or entity to perform the repairs (although they may make recommendations). If the insured submits a higher repair estimate than the estimate prepared by the insurer, the insurer must either: (i) pay the higher amount, (ii) provide the claimant with the name of a person or entity who agrees to perform such repairs at the insurer’s cost estimate, or (iii) make written adjustments to the claimant’s estimates and provide a copy of such adjustments to the claimant. The insurer is also required to notify the claimant of the benefits under the policy, the coverage under the policy and any applicable time limits for action. The failure to do so is a prohibited act under the Regulations. With respect to actual cash value policies (as opposed to replacement cost policies), the carrier has the burden of justifying any depreciation in an itemized and explicit manner. This must be explained to the claimant. The cost of labor is not included in any depreciation deduction. If a claim is denied or rejected, either in full or in part, the insurer is required to, amongst other things, provide a factual and legal basis for the denial, including citations to applicable statutes and/or the policy language itself. The Napa and Sonoma fires have destroyed thousands of properties. Most homeowners’ insurance policies include coverage for living expenses, such as rent and food. This post addresses the tax ramifications of such payments.
Unless the loss occurred in a federally declared disaster area, if the living expense insurance payments are more than the temporary increase in your living expenses, the excess is taxable as ordinary income. This rule can best be explained by means of an example. Assume your normal living expenses (rent and food) are $1,000 per month. As a result of a fire, you are forced to move into a hotel and your living expenses (hotel and food out) are $2,500. The difference between your normal living expenses and your actual living expenses is $1,500. This is called your temporary increase in living expenses. If you receive $2,000 from your insurer for living expense, you would have $500 in income. This is the difference between the insurance proceeds received ($2,000) and the temporary increase in living expenses ($1,500). The Napa and Sonoma fires have destroyed thousands of properties, including many businesses and commercial properties. This post addresses standard “business interruption” coverage in commercial property insurance policies.
The standard policy language indemnifies the insured for business interruption “during the suspension of operations during the period of restoration.” The suspension of operations must be caused by covered physical loss to property of the insured at the insured premises. Stated differently, the business interruption must be caused by damage to your property. In addition, the coverage is only triggered if there is a complete suspension of operations. There is no coverage for a business slowdown or for the interruption of a specific project or contract. For example, in one case, a law firm’s building was flooded, but since the lawyers were able to generate billable hours during that period (albeit at much lower hours than normal), no coverage was allowed. Business interruption generally indemnifies the insured for net income lost and ordinary operating expenses until such time as the property is restored. Some policies limit the time period, for example, only covering the first twelve months, even if the premises are not restored and business has not commenced again. Occasionally, the policy itself will set the amount recoverable (e.g., $1,000 per day), although usually amount of the insured loss is determined after the loss. In this case, the insured has the burden of proving its lost net income and operating expenses. Because the insured has the burden of proof, it is imperative to have an accurate accounting to prove the net profits of the business when submitting a proof of loss. It is also imperative to understand the different coverages, endorsements, limitations and exclusions so the proof of loss can be drafted to account for these issues. Additional coverages include extra expense coverage (such as the cost of relocating or hiring additional labor). Rental coverage may also indemnify landlord form lost rental income (even, in some cases, if the property was not leased at the time of the loss). The Napa and Sonoma fires have destroyed thousands of properties. This post addresses the loss settlement provisions in property insurance policies. Loss settlement refers to the valuation method used to compensate the insured for a covered loss.
The statutory default rule provides that the insured will be indemnified for the “actual cash value” of the lost property. In the case of a total loss, this means the fair market value of the lost property. In the case of a partial loss, this means the cost to repair, replace or rebuild the lost property, less depreciation. The insured has the burden of proving the fair market value or cost of repair. The insurer has the burden of proving the amount attributable to depreciation. Some policies alter this rule by providing for replacement cost coverage, which does not include any deduction for depreciation. There are three types of replacement cost coverage. Standard coverage covers the replacement cost, up to the policy limits. Extended replacement cost covers the replacement cost, plus either a fixed dollar amount or percentage amount above the policy limits (e.g., 150% of the policy limits). Guaranteed replacement cost covers the full cost of the repair or replacement irrespective of the policy limits. Although the insured is not required to rebuild the lost property, many policies allow the carrier to withhold the difference between the lower actual cash value of the property and the higher replacement cost until such time as the repairs or replacement is complete. In effect, if the insured does not repair or replace the damage property, they may be limited to the lower actual cash value. In addition, many policies impose time limits. For example, some policies require that the insured enter into a contract to perform the repairs within a fixed amount of time. Other policies require the insured to complete the repairs within a fixed time (at least 12 months, or 24 months in the case of a state declared emergency). The failure to meet these conditions could result in a waiver of the increased replacement cost. Another issue with replacement cost involves the cost to comply with new building codes and laws. Most policies (through different provisions) do not cover the increased cost of complying with new building codes. Stated differently, they will pay to replace to repair the property as it was built (not at today’s cost which would reflect additional building code requirements). Some policies have an “ordinance or law” endorsement which does indemnify the insured for the increased cost of rebuilding to current code. Before preparing a proof of loss, it is imperative to understand the coverages and possible limitations or exclusions so these issues can be addressed from the outset with the carrier. The Napa and Sonoma fires have destroyed thousands of properties. This post addresses the tax ramifications which result when the property owner receives their insurance payments.
Under the Internal Revenue Code, the destruction of property is called an “involuntary conversion” and the receipt of insurance proceeds is treated as if the owner had sold the property for the amount of the insurance payments received. For example, assume you own a property with a basis of $100,000 which is destroyed by a fire. Assume further that you receive $400,000 from the insurance company. Under these facts you would have $300,000 in taxable gain. Talk about adding insult to injury. Section 1033 of the Internal Revenue Code provides some relief. It says that if you use the insurance money to buy replacement property (or rebuild the destroyed property), you can defer the gain, if you rebuild or purchase new property within two years after you receive the insurance proceeds. (This two year period is extended to four years in the case of the loss of your principal residence in the event of a federally declared disaster area.) If the property is rebuilt, it must be finished within two years (or four years in the case of a principal residence in a federally declared disaster area). It is possible to apply for an extension with the IRS to extend these deadlines. Thus, under the example above, if the $400,000 is used to purchase a new property, or to rebuild the replaced property, the gain can be deferred and you would take a $100,000 basis in the new/replaced property if you rebuilt or replace the property within two years after receipt of the insurance proceeds. The rule is a bit more complex for single family homes used as a primary residence. Assume that your principal residence has a basis of $100,000 and it is destroyed by fire. If you receive $400,000, you would be able to exclude $250,000 (if you file a single return) or $500,000 (if you file a joint return). If you are filing jointly, the full $400,000 payment would be exempt from taxation. If you are filing jointly, $50,000 of the payment would be taxable ($400,000, less $100,000 basis, less $250,000 exemption). You would need to use the $50,000 to rebuild or find a replacement property to exclude this amount. In order to defer all of the insurance proceeds, all of the proceeds need to be used to rebuild or buy replacement property. Thus, if you took the $400,000 in insurance proceeds, but used just $300,000 to rebuild (or find replacement property), you would have $100,000 of taxable gain. The Napa and Sonoma fires have caused widespread destruction. This post addresses what happens when property in contract is destroyed prior to close of escrow.
The default rule is found in Civil Code Section 1662. It provides that if title or possession have not passed, the seller cannot enforce the purchase agreement if a “material” portion of the purchase property has been destroyed. The buyer may, however, elect to enforce the contract and take the property in its damaged condition. Disputes may arise as to whether the property has been “materially” damaged. Under the same rule, if title or possession have passed, the risk of loss is transferred to the buyer who cannot escape or terminate the contract. Most residential purchase agreements do not address what occurs in the event of damage or destruction, and therefore, the default rules will apply. In commercial purchase agreements it is common (especially given the longer closing periods) for the agreements to expressly allocate what happens in the event of damage. Often the contract will distinguish between minor and major damage. For example damage under $100,000 may be considered minor and damage over $100,000 would be major. Often, in the case of minor damage, the buyer must close escrow without a purchase price adjustment, but frequently, the seller will be required to assign any insurance proceeds to the buyer. In the case of major damage, it is common for the buyer to have two options – to cancel the contract, or proceed with the contract without a purchase price adjustment. When the buyer proceeds with the contract, the seller typically assigns the insurance proceeds to the buyer. Some contracts give the seller the right to replace or repair the damaged property (typically within a given amount of time). If the seller makes the election, the buyer typically must purchase the property at the purchase price and close of escrow is generally extended for a reasonable time to make the repairs without any reduction in the purchase price. If you are a seller or buyer and the property has been destroyed prior to closing, it is imperative to review the purchase agreement. When the contract addresses damage and destruction, the buyer and seller typically have specific time periods in which to make their elections. Often, the failure to make an election will result in the choice being made for you. For example, sometimes, if the buyer does not elect to terminate within a certain number of days, the buyer is deemed to elect to proceed with the sale. The Napa and Sonoma fires have caused widespread destruction. This post addresses what happens when leased premises are destroyed by fire.
The default rule is that the tenant may elect to terminate the lease if the premises is totally destroyed (or substantially destroyed). It the tenant exercises this option, the duty to pay rent ends. Note, however, that this rule only applies to the leased premises. For example, under a ground lease, the ground tenant has a duty to pay rent even if the building on which the land is located is destroyed. The default rule is commonly adjusted in most commercial leases. In these cases, the rights and obligations of the parties depend on the lease-specific language. It is not uncommon for leases to distinguish between “partial” damage to the premises and “total” damage to the premises. Typically, in the event of total damage, the lease will terminate. Sometimes, however, the landlord will have the right to continue the lease if they make the needed repairs/replacement within a specific time period. In the case of partial damage, leases sometimes distinguish between damage which is fully covered by insurance, and damage which is not covered by insurance (or inadequately covered by insurance). Generally, if there is sufficient insurance, the landlord is required to repair the premises and rent is abated (in full or in part) until the premises are usable. When insurance is not available (or is insufficient), the lease may give the landlord or the tenant the right to make the repairs, but will terminate if neither party elects to make the repairs. Special rules sometimes apply when damage occurs near the end of the lease term. In these cases, sometimes the landlord may elect to terminate the lease. This right can sometimes be trumped (depending on the language of the lease) if the tenant has an option to renew the lease for an additional term. Rent is generally abated in the case of damage. If the damage is total (and the election is made to replace the premises), all rent is abated. If the damage is partial (and some portion of the premises is usable), generally the rent is only abated proportionately. Some leases require the tenant to insure its personal property, alterations and trade fixtures. The landlord often has a lien on these insurance proceeds until the tenant makes the required repairs. As can be seen, what happens after a fire or other casualty to leased premises can vary significantly and often depends on very detailed provisions of the lease. It is imperative to act quickly to make the required elections before any time periods pass. |
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