Ignoring Economic Realities – The Illinois Supreme Court’s Decision in Sproull

Written by: John Eggum, Foran Glennon Palandech Ponzi & Rudloff, P.C., Chicago

Anyone that has ever traded-in a vehicle is familiar with the concept of depreciation. Imagine your trade-in was purchased ten years ago. The original purchase price a decade ago was a function of many factors—materials, labor for manufacturing, shipping, sales costs, and other charges, plus profit. Now, ten years down the road, it is worth less, due to wear and tear, the passage of time, and other reasons. It has depreciated. The current year’s model costs more, of course. Just like the trade-in, the new car—the replacement of the trade-in vehicle—has a price that is a function of substantially the same factors, including both the materials and the labor involved to assemble the car and create its component parts. This replacement vehicle’s current value is greater than the depreciated value of the trade-in (what we might call the “actual cash value”). We accept that replacement cost value is greater than actual cash value, and we accept the economic reality that the replacement vehicle is likewise going to depreciate over time; day-by-day. All of the “cost components”, including labor, that came together as part of the original price depreciate, and its actual cash value will decrease.

The Illinois Supreme Court recently considered these same concepts—replacement cost, depreciation, and actual cash value—in connection with residential homes and property insurance policies. The Court’s decision in Sproull v. State Farm Fire & Cas. Co. parted ways with the economic reality of depreciating assets. See Sproull v. State Farm Fire & Cas. Co., 2021 IL 126446, ¶ 1. The Court accepted an artificial distinction argued by the policyholder—that replacement cost was divisible into two components, an “intangible labor component” and a “property structure and materials” component. Id. at ¶ 54. The Court found that absent a specific definition of the words “actual cash value” in the insurance policy that mandated depreciation of labor costs, a reasonable interpretation of the phrase “actual cash value” was that the so-called intangible labor component was not depreciable. Id. at ¶ 49. Although the Court found the insurance company’s interpretation of the policy language was “perfectly reasonable”, the policyholder prevailed because the Court found this alternative interpretation was also reasonable, and standard rules of insurance policy interpretation therefore required a finding in favor of the policyholder. Id. at ¶ 44. The Sproull decision was unanimous. Id. at ¶¶ 55-59. (note Justice Theis did not participate).

The practical result of the Sproull decision is that policyholders that agreed that they would only be paid the replacement cost of damaged property if and when they actually replaced the property now have the opportunity to obtain a windfall. Unless and until the commonly-used policy language at issue in Sproull is amended (such as by being updated with additional defined terms), policyholders can demand a higher up-front payment after an insured property damage event, since the Sproull decision precludes insurers from depreciating anything that falls in the “intangible labor component” bucket addressed in Sproull. Policyholders that do not actually replace or repair the damaged property can pocket the Sproull non-depreciated labor payment (that would otherwise not be paid until actual repair/replacement happened, and which would not be paid ever if there were no repairs/replacement completed), thereby obtaining a windfall. Insurance is only supposed to put the policyholder back to their pre-loss position, but under Sproull, policyholders with old, dilapidated property can demand higher payments without having to repair or replace their property.

Sproull hinges on a fiction—an intellectual thought exercise about what labor is and how that relates to the price and value of depreciating assets. In the above vehicle example, no one thinks of their new car as being divisible into a “materials” component and a “labor” component, even though it is certainly true that the cost of the replacement vehicle obviously accounts for the labor of putting the car together, the labor of human resources at the dealership, the labor of finance and sales personnel, and other labor costs. There is no pricing transparency to those components, however, so they are difficult to segregate from the buyer’s perspective. Pricing transparency in certain aspects of property restoration does exist, but that is not a logically sound foundation for the legal distinction crafted in Sproull. The truth of the matter is that labor is depreciable— in all instances where depreciation impacts a physical item (“property structure and materials”, in the words of the Sproull Court), the “intangible labor component” is, in fact, depreciated. Sproull teaches that property insurers must ignore economic realities.

Background

The concept of “actual cash value” in insurance policies is predicated on the equitable concept that a policyholder is only entitled to be put back in the position they were in at the time of the loss; they cannot achieve a betterment of their pre-loss position on account of an insurance claim. 12 COUCH ON INS. § 175:19, What Constitutes ‘Actual Cash Value,’ Generally (3d Ed., Steven Plitt et al. eds.) (“‘Actual cash value policy’ is a pure indemnity contract, and its purpose is to make the insured whole but never to benefit the insured because a property loss, such as a fire, occurred.”). The use of the phrase “actual cash value” in insurance policies is ubiquitous in the insurance industry. Both the meaning—replacement cost minus depreciation—and the underlying policy concerns—returning the insured to pre-loss condition—have been addressed by countless judicial decisions. The Seventh Circuit Court of Appeals has explained that “actual-cash-value insurance will compensate an insured for the value of damage to the covered property in its depreciated state.” Edgewood Manor Apartment Homes, LLC v. RSUI Indem. Co., 733 F.3d 761, 765 (7th Cir. 2013). The Edgewood court provided this example: “[I]f property worth $10,000 deteriorates and is worth only $8,000 at the time of loss, the insured will receive $8,000. . . . Because actual-cash-value proceeds may not be sufficient to permit an insured to repair or rebuild the damaged property to its original specifications, insurers offer optional replacement-cost coverage for the full cost of repair or replacement.” Edgewood Manor, 733 F.3d at 765. There are numerous similar decisions. See In re State Farm Fire & Cas. Co., 872 F.3d 567, 573 (8th Cir. 2017) (“The basic premise of traditional property insurance is the concept of indemnity. . . . The insured who suffers a covered loss is entitled to receive full, but not more than full, value for the loss suffered, to be made whole but not be put in a better position than before the loss. . . . Policies that provide this level of coverage are universally known as actual cash value policies. . . . ‘[T]he insured bears the share of the loss resulting from deterioration, obsolescence, and similar depreciation of the property’s value at the time of the loss.’”); Bradley v. Allstate Ins. Co., 620 F.3d 509, 520 (5th Cir. 2010) (“‘The touchstone for . . . determining actual cash value is the basic principle that an adequately insured person should incur neither economic gain nor loss when his property is destroyed.’ . . . ACV is determined by calculating the cost of duplicating the damaged property with new materials of like kind and quality, less allowance for physical deterioration and depreciation.”); Palmieri v. Allstate Ins. Co., 445 F.3d 179, 188 (2d Cir. 2006) (“‘Actual cash value” is defined in the agreement as ‘the replacement cost of an insured item of property at the time of the loss, less the value of physical depreciation.’ . . . The language of the contract is plain. . . . Allstate reasonably denied Palmieri recovery for the depreciation value of his personal property.”).

Illinois has a long history with insurers providing coverage on an actual cash value or “ACV” basis. There are records dating back to 1857 showing coverage being provided on an actual cash value basis. See Peoria Marine & Fire Ins. Co. v. Lewis, 18 Ill. 553, 554 (1857) (“[S]aid loss or damage to be estimated according to the true and actual cash value of the property.”) (cited by the Brief of Amici Curiae American Property Casualty Insurance Association, National Association of Mutual Insurance Companies and Allstate Insurance Company in Sproull v. State Farm Fire & Cas. Co., 2021 WL 1669548, No. 126440, submitted Jan. 28, 2021) (hereafter “APCIA Amicus Brief”). In fact, even today, the Illinois Department of Insurance explains to consumers that the difference between Replacement Cost and Actual Cash Value is as follows:

Replacement Cost or Actual Cash Value?

You have the option to choose to insure your home and belongings for either replacement cost or actual cash value. Replacement cost is the amount it would take to replace or rebuild your home or repair damages with materials of similar kind and quality, without deducting for depreciation. It is important to insure your home for at least 80 percent of its replacement value. Actual cash value is the amount it would take to repair or replace damage to your home after depreciation.

ILLINOIS DEPARTMENT OF INSURANCE, Shopping Tips and Information, available at https://www2.illinois.gov/sites/Insurance/Consumers/ConsumerInsurance/HomeOwnerRenter/Pages/shopping-tips-and-information.aspx (last visited 12/21/2021). This explanation is consistent with the “Homeowners and Renters Definitions” provided to consumers by the Illinois Department of Insurance:

Actual Cash Value: Replacement cost less depreciation, considering the age and condition of your property.

***

Replacement Cost: A determination of the cost to replace contents, rebuild your home, or repair damages with materials of like kind and quality, without subtracting for depreciation.

ILLINOIS DEPARTMENT OF INSURANCE, Homeowners and Renters Definitions, available at https://www2.illinois.gov/sites/Insurance/Consumers/ConsumerInsurance/HomeOwnerRenter/Pages/homeowners-and-renters-definitions.aspx (last visited 12/21/2021); see also APCIA Amicus Brief, 2021 WL 1669548 (discussing Illinois Department of Insurance statements and regulations).

Nothing in the above authorities suggests that consideration of the actual cash value of property requires a “two-part”, separate assessment of “intangible labor costs” and “materials costs”. Based on a review of judicial decisions available on Westlaw, it does not appear anyone asserted such a distinction was proper prior to the year 2000, when this purported distinction was litigated in Oklahoma. See Branch v. Farmers Ins. Co., No. 00-6385, 2001 WL 1028385, at *2 (10th Cir. Sept. 4, 2001), certified question answered, 2002 OK 16, 55 P.3d 1023 (in case filed in 2000, “Judge Vickie Miles-LaGrange of the Western District Oklahoma held that Defendant-Insurer properly depreciated labor costs in calculating the replacement cost actual cash value.”).

In the Branch case, the Supreme Court of Oklahoma, on a certified question, confirmed that “labor costs” could not be properly excluded from the actual cash value equation. Branch v. Farmers Ins. Co., 2002 OK 16, ¶ 14, 55 P.3d 1023, 1027 (“Our answer to the first certified question was that replacement cost includes the labor involved in replacement, and therefore is subject to depreciation under a ‘replacement cost less depreciation’ endorsement in the insurance policy.”). Notwithstanding the fact that the policyholder position was rejected in Branch, that did not end policyholder attempts to put forward this novel argument about how depreciation works. As both the APCIA amici and a policyholder amicus group would point out in Sproull, courts around the country have recently been inundated with litigation raising the argument that labor cannot be depreciated. See APCIA Amicus Brief, 2021 WL 1669548; see also Brief of Amicus Curiae United Policyholders in Sproull v. State Farm Fire & Cas. Co., 2021 WL 1669557, No. 126446, submitted March 8, 2021). This includes in Illinois—Sproull presented as a class action, and as noted in the APCIA amicus brief, at the time of its decision by the Illinois Supreme Court, Sproull was one of several pending Illinois cases where policyholders raised the issue of depreciation of labor. See APCIA Amicus Brief, 2021 WL 1669548.

Facts of Sproull

The facts of Sproull are straightforward. Plaintiff Jarret Sproull purchased a homeowners property insurance policy (the “Policy”) from State Farm that provided replacement cost coverage for structural damage. Sproull, 2021 IL 126446, ¶ 3. As is typical, the Policy provided that the insured must actually repair or replace damaged property before the insurer would pay the full replacement cost. Id. Prior to repair/replacement, the insurer was only obligated to pay “actual cash value.” Id. The phrase “actual cash value” was not defined. Id. ¶ 4.

Here is the language of the Policy:

COVERAGE A—DWELLING

1. A1—Replacement Cost Loss Settlement—Similar Construction.

a. We will pay the cost to repair or replace with similar construction and for the same use on the premises shown in the Declarations, the damaged parts of the property covered . . . subject to the following:

(1) until actual repair or replacement is completed, we will pay only the actual cash value at the time of the loss of the damaged part of the property, up to the applicable limit of liability shown in the Declarations, not to exceed the cost to repair or replace the damaged part of the property;

(2) when the repair or replacement is actually completed, we will pay the covered additional amount you actually and necessarily spend to repair or replace the damaged part of the property, or an amount up to the applicable limit of liability shown in the Declarations, whichever is less;

(3) to receive any additional payments on a replacement cost basis, you must complete the actual repair or replacement of the damaged part of the property within two years after the date of loss, and notify us within 30 days after the work has been completed.

Id. ¶ 3.

Mr. Sproull made an insurance claim to State Farm for relatively minor wind damage to his home. Id.¶ 4. The insurance adjuster determined that the replacement cost value of the damage was $1,711.54, before application of a $1,000 deductible. See Id. That means the amount/value of the total damage, on a replacement cost basis net of deductible, was $711.54. State Farm then calculated the actual cash value of the damage to be $317.18. Id. The difference represented $394.36 for depreciation. Id. Note that the $1,000 deductible applies irrespective of whether the loss is paid on an RCV or ACV basis, so the entire focus of the case was the propriety of State Farm’s $394.36 depreciation deduction. See Id.

Mr. Sproull filed suit and challenged the depreciation of labor and made several arguments about the impropriety of such deductions. Sproull, 2021 IL 126446, ¶¶ 4-9.

Procedural Background

In response to Sproull’s two-count putative class action complaint for breach of contract and declaratory judgment, State Farm moved to dismiss for failure to state a claim, pursuant to Section 2-615 of the Illinois Code of Civil Procedure. Id. ¶ 10 (citing 735 ILCS 5/2-615). State Farm’s position was that the depreciation of labor was proper under the Policy and under the regulations of the Illinois Department of Insurance, and therefore it did not breach the Policy as a matter of law. Also, State Farm asserted that Plaintiff could not be afforded the declaratory relief sought, which was a declaration that State Farm could not apply depreciation to anything other than materials costs. Id. The trial court denied the motion, but granted a motion to certify a question of law pursuant to Rule 308(a) of the Illinois Supreme Court Rules. Id. ¶¶ 13-14. The Fifth District Appellate Court then issued an opinion affirming the trial court. Id. ¶¶ 15-16. The Illinois Supreme Court granted a petition for leave to appeal under Supreme Court Rule 315. Id. ¶ 17.

The Illinois Supreme Court’s Analysis of the Putative “Intangible Labor Component”

The Illinois Supreme Court began its analysis of the depreciation issue presented in Sproull by discussing the familiar rules of insurance policy interpretation. In evaluating the meaning of insurance policy language, Illinois courts apply the same rules generally applicable to any written contract. Sproull, 2021 IL 126446, ¶ 19. Illinois courts seek to give effect to the intention of the parties, as expressed by the policy language. Id. Ambiguities will be found if policy language is susceptible to more than one reasonable meaning, and are construed against the insurer. Id. Undefined terms are given their “plain, ordinary, and popular meaning; i.e., they will be construed with reference to the average, ordinary, normal, reasonable person.” Id. (citing Outboard Marine Corp. v. Liberty Mutual Insurance Co., 154 Ill. 2d 90, 115 (1992)).

After discussing these baseline rules, the Illinois Supreme Court next focused on the limited history of disputes over labor depreciation. It discussed decisions of other courts that have evaluated whether the determination of actual cash value should include deduction for depreciation for both materials and labor. See Sproull, 2021 IL 126446, ¶¶ 22-26. The Court first addressed the decision of the Oklahoma Supreme Court in Redcorn v. State Farm Fire & Casualty Co., 2002 OK 15 (2002), a companion case to Branch, discussed above. Id. In Redcorn, the Oklahoma Supreme Court, in a split decision, found that both labor and materials could be depreciated. Id. ¶ 24. Using the example of a roof that needs replacement, which has a materials component (shingles) and a labor component (installation of the shingles), the Oklahoma Supreme Court found that the replacement of the roof was essentially a single undertaking – a “product of materials and labor” – and a fact-finder was entitled to consider both when determining the appropriate amount of depreciation. Id. To hold otherwise would unjustly enrich the plaintiff, according to the Redcorn court. Id.

Perhaps to set the stage for the Illinois Supreme Court’s contrary determination, the Sproull decision also highlighted the dissent in the Oklahoma Supreme Court’s Redcorn case. See Sproull, 2021 IL 126446, ¶ 25. The Redcorn dissent had argued that it was illogical for labor to be depreciated. Id. It presented the question as follows:

[S]hingles are logically depreciable because they age and lose value due to wear and tear. . . . “Labor, on the other hand, is not logically depreciable. Does labor lose value due to wear and tear? Does labor lose value over time? What is the typical depreciable life of labor? Is there a statistical table that delineates how labor loses value over time? I think the logical answers are no, no, it is not depreciable, and no.

Id.

Based on the quoted rationale, the Redcorn dissent would have allowed depreciation only for “the value of the shingles”, and required the insurer to pay that amount, plus the undepreciated cost of their installation (the labor). Id.

After discussing the Oklahoma Supreme Court’s decision in Redcorn, the Illinois Supreme Court acknowledged various courts had split on the issue, with some courts following the rationale of the Redcorn majority, and some courts adopting the position articulated by the Redcorn dissent. Sproull, 2021 IL 126446, ¶ 28. It acknowledged that, in addition to Oklahoma, courts in North Carolina, South Carolina, and Nebraska had found labor to be depreciable. Id. ¶¶ 29-30. The Tenth Circuit Court of Appeals (applying Kansas law), the Eighth Circuit Court of Appeals (applying Missouri law), and a federal court in Pennsylvania (applying Pennsylvania law) had also agreed labor could be depreciated. Id. ¶ 31. On the other side of the issue were courts in Tennessee, Arkansas, the Sixth Circuit Court of Appeals (applying Kentucky law), and the Fifth Circuit Court of Appeals (applying Mississippi law). Id. ¶¶ 32-40. While there was variation in these courts’ reasoning, their ultimate position was that labor was separable as part of an actual cash value analysis, and labor was not subject to depreciation. See Id.

Announcing its decision on the issue, the Illinois Supreme Court first found that the State Farm Policy issued to Mr. Sproull was ambiguous. Sproull, 2021 IL 126446, ¶ 42. This was a departure from the Fifth District’s position and from the arguments of both parties – Plaintiff and Defendant had argued the language of the Policy was unambiguous, and when the Fifth District affirmed the trial court, it simply agreed with Mr. Sproull’s view. Id. at ¶¶ 42-44. The Illinois Supreme Court found that State Farm had “offered a perfectly reasonable interpretation of the policy”; it simply did not agree that was the only reasonable interpretation. Id. ¶ 44.

The Court had three primary reasons for asserting that the policy is ambiguous on the question of labor deprecation. First, citing the dissent in the Redcorn case from Oklahoma, the Court said that “labor is not logically depreciable, as it does not lose value over time due to wear and tear. . . . Materials deteriorate with time, but labor does not.” Sproull, 2021 IL 126446, ¶ 50. The Court, citing a Tennessee case, also stated that it would be reasonable for a homeowner to believe that depreciation would only apply to “physical materials, those things that actually deteriorated.” Id.

Second, the Illinois Supreme Court explained its view was that depreciating labor can result in the insured being placed in a worse position that he was in before the loss. Id. at ¶ 51. This is because the labor cost of installing old materials would be the same as the cost to install new materials. Id. Since other courts had accepted that argument, that meant it was reasonable for the Illinois Supreme Court to determine this was “simply proper indemnity.” Id. The Court did not address that the Policy does indemnify the insured for the costs of replacement; it simply requires the insured to incur those costs before they are payable.

Third, according to the Illinois Supreme Court, Mr. Sproull’s understanding was “more in keeping with actual insurance industry practice.” Id. at ¶¶ 52-53. Citing the fact that State Farm uses a computer program called Xactimate to prepare estimates, the Court found that because the Xactimate software allows the estimator to decide to depreciate labor costs or not, that meant that it was proper to interpret the words of the insurance policy (an integrated agreement) as reasonably meaning that labor was not subject to depreciation. See Id. There was no discussion of why “trade usage” and other extrinsic evidence was appropriate to consider as part of interpreting an integrated contract.

The Illinois Supreme Court therefore held that the following is a correct statement of the law:

“Where Illinois’s insurance regulations provide that the ‘actual cash value’ of an insured, damaged structure is determined as ‘replacement cost of property at time of loss less depreciation, if any,’ and the policy does not itself define actual cash value, only the property structure and materials are subject to a reasonable deduction for depreciation, and depreciation may not be applied to the intangible labor component.”

Id. ¶ 54 (quoting the Fifth District opinion, Sproull, 2020 IL App (5th) 180577, ¶ 41) (emphasis added).

As a result, the certified question was answered, the appellate court was affirmed, and the case was remanded for further proceedings. Id. ¶ 55-58.

Discussion of Sproull

The Court’s statement in Sproull that only the property structure and materials are subject to a deduction for deprecation may seem reasonable at first glance. But a closer assessment of what is meant by “property structure and materials” demonstrates an intellectual inconsistency in the ruling. Recall, the premise of the distinction is that labor costs are not logically depreciable, and that is why the Court found that insurers need to divide replacement costs into two buckets, allowing depreciation only for property structure and materials. To evaluate this distinction, it is appropriate to use a roof-related example, given the Court also focused on roof replacement to illustrate its points.

Assuredly, there is pricing transparency in roof replacement. For simplicity in the example, assume there are only two components—the purchase price of the shingles, and the cost of labor to install the shingles. The Sproull analysis highlights that when we segregate the labor component and try to conceptualize “depreciating” the shingle-installer’s labor, that can seem illogical. In our example, we have a worker on a roof that takes the old shingles off and puts the new shingles on, and charges for his labor. When we isolate those actions, the idea of “depreciating” that person’s labor does not seem possible, particularly if we conflate depreciation and physical deterioration. Conversely, applying depreciation to the other component in our example—the shingles—does not cause the same initial intellectual aversion. A shingle is tangible—we can see it, and we can see it age, becoming brittle and worn-looking from exposure to the elements. Stating that the value of the shingle can depreciate does not seem to give rise to the same concerns with depreciating labor, at least on the surface.

The Sproull Court’s distinction between labor and materials is faulty in large part because it relies on the incorrect premise that “depreciation” and “deterioration” are perfectly synonymous. It is true that physical deterioration is a proper reason to apply depreciation, as the brittle shingle illustrates. But the word “depreciation” does not simply describe something’s physical condition. Depreciation is how we express a reduction in value—we assess the cost of the new shingle and we assess the old shingle, and determine the actual cash value of that old shingle considering the totality of the circumstances. See Alicia Tuovila, Depreciation, INVESTOPEDIA, available at https://www.investopedia.com/terms/d/depreciation.asp (“The term depreciation refers to an accounting method used to allocate the cost of a tangible or physical asset over its useful life or life expectancy. . . . Depreciation represents how much of an asset’s value has been used.”). Every single time a physical item like a shingle is subjected to a depreciation assessment, the process requires considering a factor that Sproull suggests is literally impossible to depreciate; namely, labor.

The starting point for evaluating the shingles—again, an item Sproull agrees is depreciable – is an assessment of the cost of a bundle of new shingles. “Asphalt shingles” are not a naturally-occurring product that just appear at the job site, ready to be installed by the non-depreciable labor provider. Instead, they are purchased, and the purchase price is a function of many factors, including labor. The labor and other factors that comprise the replacement cost of the new shingles (or the original cost of the old shingles) is not easily segregated or assessed. Sellers like Menards and Home Depot will not readily answer the question: What part of the sales price for these shingles is for “property structure and materials” and what part of the sales price is for “the intangible labor component.” See Sproull, 2021 IL 126446, ¶ 54. But that question has an answer—there is an embedded labor component and the price could be broken down and disclosed. Shingle sellers, however, do not provide that type of pricing transparency in the ordinary course of business, so the answer to the question is not as readily ascertainable as it is with regard to the roofer.

The existence of pricing transparency in the roofer’s work—the final step where labor is applied to the shingles—is a poor justification for determining that the meaning of “depreciation” and “actual cash value”, as a matter of law, excludes the roofer’s labor, but not the shingle-seller’s labor, or the shingle-shipper’s labor, or the shingle-manufacturer’s labor. And it is indisputable that the cost of the shingles comprises the labor of everyone involved in the process up to the point of delivery to the roofer. Whenever an insurance company depreciates shingles or any other “property structure and materials” in the future in accordance with Sproull, it will be depreciating labor—the labor of everyone involved except the last worker’s labor. Sproull’s flawed premise that labor cannot be depreciated stems from conflating depreciation and deterioration, and the distinction ultimately is shown to be unreasonable and illogical because all “property structure and materials” depreciation involves the depreciation of someone’s labor. See Wilcox v. State Farm Fire & Cas. Co., 874 N.W.2d 780, 784 (Minn. 2016) (“The Wilcoxes do not advance a reasonable interpretation of the phrase ‘actual cash value’ that would categorically exclude embedded-labor-cost depreciation under every circumstance.”).

Since all property structure and materials depreciation requires depreciation of embedded labor costs, it is not a reasonable interpretation of the insurance policy to find that when determining actual cash value, it is acceptable to depreciate everyone’s labor except that last worker in the chain of replacing the damaged property. But that is what paragraph 54 of Sproull ultimately holds, without reasonable justification.

Another way to illustrate the problem with the holding in Sproull is to consider whether the Court’s decision would make sense if there was a market for used or damaged roof shingles. All property loss valuation relating to structures has a subjective component, because there is no market check, like there is with automobiles. Return to the car trade-in example above. “Value” is what a willing buyer will pay to a willing seller. If we want to know the value of the old vehicle, we can figure that out by comparison/analogy to what other buyers and sellers have agreed to pay for similar vehicles. If a similar condition car sold for $7,000 and the original price (and, for simplicity to this example, the replacement cost) was $20,000, then the depreciation was $13,000. The United Auto Workers personnel that assembled that vehicle put their labor into it, the $20,000 purchase price included that labor. The actual cash value of $7,000 shows that those workers’ labor has depreciated; the value of their labor and other initial costs of the vehicle has decreased by $13,000.

There is no readily available process to assess the value of an old roof, and thus there is no similar “market check” that illustrates that attempting to depreciate the cost or value of everyone’s embedded labor except the last worker is nonsensical. As a further example, consider the situation when property is completely destroyed. When a car is totaled and is sold for scrap, its value is the scrap value of the metal, from the perspective of a buyer that has an interest in purchasing that scrap metal. In that case, all of the labor that was put into the car and that was factored into the original purchase price has been depreciated. Labor added value, and all that value is all gone – it has depreciated to zero. A roof at the end of its useful life is the same, except there is no willing buyer for the scrap. Nonetheless, the “intangible labor component” of the roof installer, the shingle-seller’s labor, the shingle-shipper’s labor, and the shingle-manufacturer’s labor is fully depreciated, just like the equivalent labor inputs that were part of the totaled car.

The fact that a proper depreciation analysis considers the “whole cost” of something explains why several courts have rejected the labor-is-not-depreciable argument. See, e.g., Henn v. Am. Fam. Mut. Ins. Co., 295 Neb. 859, 874–75 (2017) (“[T]he insured does ‘not pay for a hybrid policy of actual cash value for roofing materials and replacement costs for labor.’ . . . The property is a product of both materials and labor.”); see also Papurello v. State Farm Fire & Cas. Co., 144 F. Supp. 3d 746, 770 (W.D. Pa. 2015) (“When a roof is in issue, as it is here, the ‘plain and ordinary’ meaning of the ‘property’ to which the Policy refers is the finished product in issue—the result or physical manifestation of combining knowhow, labor, physical materials (including attendant costs, e.g., the incurrence of taxes), and anything else required to produce the final, finished roof itself.”). Distinctions that are illusory, which require pretending that labor is not being depreciated every time “property structure and materials” are depreciated, are unreasonable, which is why many courts have refused to draw such distinctions. Basham v. United Servs. Auto. Ass’n, No. 16-CV-03057-RBJ, 2017 WL 3217768, at *2 (D. Colo. July 28, 2017) (“Accordingly, repair and replacement costs comprise the cost of materials (e.g., shingles and nails), and the cost of labor (e.g., roofing contractors). . . . Both the cost of materials and the cost of labor are therefore subject to a depreciation deduction. . . . Despite this straightforward definition, plaintiff strains to find ambiguity in the policy.”). Of course, the fact that it also provides a windfall to the insured is a separate and independent reason to reject such an interpretation, as an interpretation of a contract that results in a windfall to one party is unreasonable and contrary to the principles of indemnity. Graves v. Am. Fam. Mut. Ins. Co., 686 F. App’x 536, 539 (10th Cir. 2017) (“[I]f American Family could depreciate only the cost of materials in determining the actual cash value of Graves’ loss, she would receive a windfall based on labor costs she never incurred with respect to her kitchen ceiling. . . . Such a result is contrary to the principle of indemnity because she would be in a better position than she was before the damage occurred.”).

With Sproull being a unanimous decision, it is nonetheless the law in Illinois that the labor of the last workers— the contractor and laboring subcontractors with transparency to their pricing— is not depreciable, and the labor of everyone else involved in creating the “property structure and materials” being used for that work is subject to depreciation. The fact that the deprecation “math” cannot be checked against real world market conditions, due to the lack of a market for old roofs and similar property, helps support this groundless distinction, which would be seriously undermined if there were a market check similar to the used car or vehicle scrap market. Ultimately, to draw from a comment once made by United States Supreme Court Justice Robert H. Jackson, the Sproull rule is not final because it is right; it is “right” merely because it is final. Brown v. Allen, 344 U.S. 443, 540 (1953) (Jackson, concurring). Amendment to the policy language considered in Sproull, perhaps by the addition of definitions of depreciation and actual cash value that encompass all labor, is the only clear solution to eliminating the Sproull illusory distinction.

About the Author

John Eggum is a partner at Foran Glennon Palandech Ponzi & Rudloff P.C., where he concentrates his practice on insurance coverage matters and commercial litigation. He represents insurers, TPAs, brokers, and captive managers in professional liability disputes, and also litigates cyber/technology liability claims. Mr. Eggum’s law degree was obtained, with distinction, from The University of Iowa College of Law, and following law school, he served as the law clerk to the Hon. Bruce A. Markell in the United States Bankruptcy Court for the District of Nevada, in Las Vegas. Mr. Eggum serves as the Vice-Chair of the IDC Legislative Committee.