PES Holdings, LLC - Adversary Proceeding

IN THE UNITED STATES BANKRUPTCY COURT

FOR THE DISTRICT OF DELAWARE

In re: ) Chapter 11

)

PES HOLDINGS, LLC, et al., )

) Case No. 19-11626 (LSS)

Debtors. ) Jointly Administered

__________________________________ )

)

PES HOLDINGS, LLC, et al., )

)

Plaintiffs, )

)

-and- )

)

ICBC STANDARD BANK PLC, )

)

Intervenor-Plaintiff, )

)

v. ) Adv. No. 20-50454 (MFW)

)

ALLIANZ GLOBAL RISKS US INSURANCE, )

CO., et al., )

) Rel. Docs. 1; 204; 205;

Defendants. ) 207; 208; 215; 222; 224;

__________________________________ ) 236; 237

OPINION1

Before the Court are cross motions for partial summary

judgment filed by the Debtor, PES Holdings, LLC, and its

affiliates (collectively, “PES”) and a subset of its insurers

named as Defendants (the “Insurers”) on the proper interpretation

of their insurance policy. For the reasons stated below, the

Court will grant PES’ motion and deny the Insurers’ motion.

1 This Opinion constitutes the findings of fact and

conclusions of law of the Court pursuant to Rule 7052 of the

Federal Rules of Bankruptcy Procedure.

I. BACKGROUND

PES operated a complex of interdependent oil refineries

(collectively, the “Refinery”) in Philadelphia, Pennsylvania. On

June 21, 2019, a leak in the hydrofluoric alkylation unit (the

“HF Unit”) resulted in a fire and a series of explosions

(collectively, the “Explosion”). As a result of the Explosion,

the HF Unit was destroyed and PES could no longer operate the

Refinery.

Prior to the Explosion, PES had mortgaged the Refinery to

ICBC Standard Bank PLC (“ICBCS”) under the terms of the Sixth

Amended and Restated Supply and Offtake Agreement (the “SOA”),

which inter alia required that PES insure the Refinery for a

minimum of $750 million. (Adv. D.I. 209, Ex. 3.)2 At the time

of the Explosion, PES had a total of $1.25 billion in property

insurance, divided into five $250 million layers and spread among

30 insurers. (Adv. D.I. 209, Ex. 2.) The Defendants are 26 of

those insurers.3

2 References to the docket in this adversary proceeding are to

“Adv. D. I #” while references to the docket in the main case are

to “D.I.#.” The parties have each attached the Policy and the

SOA to Declarations in support of their motions. For

convenience, the Court refers to the exhibits attached to PES’

Declaration. (Adv. D.I. 209.)

3 Four insurers are non-parties because they had arbitration

clauses in their policies. (Adv. D.I. 215 at *10 n.35.)

2

On July 21, 2019, shortly after the Explosion, PES filed a

chapter 11 bankruptcy petition. (D.I. 1.) The Fourth Amended

Joint Chapter 11 Plan (the “Plan”) was confirmed on February 13,

2020. (D.I. 1004.) In conjunction with the Plan, the Refinery

was sold to Hilco Redevelopment Partners (“Hilco”). As a result,

PES will not be rebuilding the Refinery. Under the terms of the

sale, PES retained the right to pursue actions against the

Insurers for damages suffered as a result of the Explosion.

On February 12, 2020, PES sued the Insurers asserting

property damage and business interruption claims resulting from

the Explosion.4 The Court granted ICBCS’ motion to intervene.

On September 20, 2021, PES and the Insurers filed cross

motions for partial summary judgment on PES’ property damage

claim. The Insurers also seek to dismiss Count VI of the

Complaint, which alleges consequential damages flowing from the

alleged breach of their duty of good faith and fair dealing. On

October 27, 2021, the Parties responded to each other’s motions.

On November 12, 2021, the Parties replied to the responses. Oral

argument was held on December 6, 2021. The matter is fully

briefed and ripe for decision.

4 On November 9, 2021, the Parties filed a Joint Status Report

advising that they had settled the business interruption claim.

A hearing on the motion for approval of that settlement is

scheduled for December 20, 2021. Trial on the remaining claims

is scheduled to commence on January 24, 2022.

3

II. JURISDICTION

The Court has subject matter jurisdiction over this

adversary proceeding, which is a core proceeding. 28 U.S.C. §§

157(2)(A) & (O), 1334. The Court may enter a final order on the

Motions because the parties have consented. Wellness Int’l

Network, Ltd. v. Sharif, 575 U.S. 665 (2015) (holding that even

if the bankruptcy court does not have the constitutional

authority to enter a final order, it may do so if the parties

consent). PES has expressly consented. (Adv. D.I. 207.) The

Insurers have impliedly consented by filing their motion for

summary judgment. (Adv. D.I. 204.) Wellness, 575 U.S. at 683

(“Nothing in the Constitution requires that consent to

adjudication by a bankruptcy court be express. Nor does the

relevant statute.”); True Traditions, LC v. Wu, 552 B.R. 826, 838

(N.D. Cal. 2015) (holding that implied consent is given by party

who files a motion for summary judgment).

III. DISCUSSION

A. Standard of Review

1. Summary Judgment

A court should grant summary judgment “if the movant shows

that there is no genuine dispute as to any material fact and the

movant is entitled to judgment as a matter of law.” Fed. R. Civ.

4

P. 56(a).5 The court must rely upon the record of the case,

including the pleadings, exhibits, and declarations submitted by

the parties. Id. at 56(c).

The movant bears the initial burden of proving its case from

the established record and showing that there is no genuine

dispute of material fact. Celotex Corp. v. Cartrett, 477 U.S.

317, 323 (1986). The court must view the record “in the light

most favorable to the party opposing the motion.” United States

v. Diebold, Inc., 369 U.S. 654, 655 (1962). See also McNamee v.

MinXray, 370 F. Supp. 3d 928, 929 (N.D. Ill. 2019) (“In deciding

cross motions for summary judgment, the Court views the facts in

the light most favorable to the respective non-moving party”).

Where a court finds that there is no genuine dispute of material

fact, it may enter judgment as a matter of law, either for or

against the movant, in full or in part, applying the applicable

substantive law. Fed. R. Civ. P. 56(a) & (f).

2. Interpretation of Contracts Under New York Law6

New York law interprets insurance contracts using general

principles of contract construction. Olin Corp. v. Am. Home

5 Federal Rule of Civil Procedure 56 is made applicable to

adversary proceedings by Federal Rule of Bankruptcy Procedure

7056.

6 The parties agree that New York law is the applicable law

for interpretation of the contracts at issue here. (Adv. D.I.

209, Exs. 1 at ¶ 8 & 3 at § 16.01.)

5

Assur. Co., 704 F.3d 89, 98 (2d Cir. 2012); McGrail v. Equitable

Life Assur. Soc’y of U.S., 55 N.E.2d 483, 486 (N.Y. 1944). Under

New York law, contracts may be construed as a matter of law -

and, hence, through summary judgment - unless “determination of

the intent of the parties depends on the credibility of extrinsic

evidence or on a choice among reasonable inferences to be drawn

from extrinsic evidence.” Uniroyal, Inc. v. Home Ins. Co., 707

F. Supp. 1368, 1374-75 (E.D.N.Y. 1988) (citing Hartford Acc. &

Indem. Co. v. Wesolowski, 305 N.E.2d 907 (N.Y. 1973)). Where a

contract is unambiguous, a court may always construe it as a

matter of law. Wesolowski, 305 N.E.2d at 909. Where a contract

is ambiguous, a court may still construe the contract, including

ambiguous terms, as a matter of law based on extrinsic evidence

if there is no issue of credibility or ambiguity regarding any

such evidence. Uniroyal, 707 F. Supp. at 1375.

B. The Disputed Provisions of the Policy

1. Stipulated Loss Value Clause

The Policy provides, inter alia:

where the Insured is contractually obligated to insure

specific property for a stipulated loss amount, then in

the event of a loss, this Policy will provide for the

stipulated loss value regardless of whether such

property is replaced. However, in no event shall this

amount exceed the Replacement Cost Value of such

property (plus in addition the covered cleanup costs).

In the event of a loss up to USD 250,000,000,

regardless [sic] whether the affected property is

replaced, the loss settlement will be on a replacement

cost basis. In the event of a loss in excess of USD

250,000,000 and the insured does not replace the

affected property, the loss settlement will be on the

basis of Actual Cash Value with a minimum of USD

250,000,000.

(Adv. D.I. 209, Ex. 1 at §I, 5(e) (emphasis added) (hereinafter

“the SLV Clause”).)

The Parties dispute whether the SLV Clause is applicable

and, in particular, whether PES was “contractually obligated to

insure specific property for a stipulated loss amount.” PES

contends that the SOA between it and ICBCS provided a contractual

obligation satisfying that requirement. The Insurers contend

that the SLV Clause is not applicable because the SOA does not

provide for an obligation to insure “specific property” or

require that it be for a “stipulated loss amount.”

a. Specific Property

PES argues that the SOA, taken as a whole, specifies the

Refinery as property required to be insured. It asserts that the

SOA grants a mortgage in its property to ICBCS and specifically

describes the Mortgaged Property by metes and bounds to encompass

the entire Refinery complex. PES further notes that the SOA

provides, in pertinent part, that PES

shall maintain . . . Comprehensive Property Insurance

on a replacement cost basis, subject to a minimum

amount of $750,000,000 (SEVEN HUNDRED FIFTY MILLION

USD) for All Risk of Physical Loss or Damage. Coverage

must apply to all Crude Oil and Refined Product.

Coverage shall be comprehensive and include but not be

limited to Fire, Explosion, Property Damage, Business

Interruption, Flood, Earthquake, Named Windstorm,

7

Tornado, Tsunami, and Volcano. In the event that a

Transaction Party purchases insurance in excess of the

limits specified in this section, such higher limits

shall apply to ICBCS as an additional insured. Not

later than 30 Business Days from the Effective Date,

each Transaction Party shall name ICBCS as a loss payee

and as an Additional Insured as their interests may

appear. Once annually, each Transaction Party shall

provide ICBCS a certificate of insurance evidencing the

required insurance. At the reasonable request of

ICBCS, and not later than 30 Business Days from the

Effective Date, each Transaction Party shall provide

ICBCS with a complete copy of such insurance policy.

(Adv. D.I. 209, Ex. 3, Part 10, Schedule 10.04 (hereinafter

referred to as the “Insurance Requirement Clause.”)

PES contends that the Insurance Requirement Clause obligated

it to maintain property insurance on, inter alia, the Mortgaged

Properties (i.e., the Refinery) which were damaged in the

Explosion and are the subject of its dispute with the Insurers.

The Insurers argue that the Insurance Requirement Clause

does not mention the Mortgaged Properties but, instead, only

specifically refers to insurance on the Crude Oil and Refined

Product. (Adv. D.I. 209, Ex. 3, Part 10.) They contend that

this is understandable because the SOA was in essence a supply

agreement between ICBCS and PES dealing with the refinement of

crude oil. They argue that reference to other parts of the

Agreement is improper and that PES’ attempt to hobble together

diverse provisions of the SOA is not sufficient to evidence an

agreement to obligate PES to insure the specific property at

issue in this case.

8

The Court disagrees with the Insurers’ argument. Under New

York law, the Court must consider the agreement as a whole and

give effect to every term. See, e.g., In re Viking Pump, 52

N.E.3d 1144, 1151 (N.Y. 2016) (holding that unambiguous terms

must be enforced in accordance with their plain meaning and all

terms must be given effect); Riverside S. Planning Corp. v.

CRP/Extell Riverside, L.P., 920 N.E.2d 359, 363-64 (N.Y. 2009)

(noting that New York courts construe contracts holistically,

rather than taking each term in isolation).

The SOA provides in relevant part:

- Section 10.04(b) requires that PES “Keep its

property insured at all times in accordance with

the insurance requirement set forth in Schedule

10.04.” (Adv. D.I. 209, Ex. 3, Part 1.)

- Section 10.12 requires that PES “shall deliver to ICBCS

Mortgages” relating to each of the Mortgaged Properties

and “shall deliver to ICBCS a copy of, or a certificate

as to coverage under, and a declaration page relating

to, the insurance policies required by Section 10.04.”

(Id. at Part 4.)

- Mortgaged Properties is a defined term that includes

all of PES’ Real Property, described by metes and

bounds in Schedule 1.01(h). (Id. at Part 1.)

- Schedule 10.04 includes the requirement to maintain “so

long as the Agreement remains in effect and until all

Obligations have been paid in full” twelve different

forms of insurance, including “Comprehensive Property

Insurance on a replacement cost basis, subject to a

minimum amount of $750,000,000 . . . for All Risk of

Physical Loss or Damage. Coverage must apply to all

Crude Oil and Refined Product.” (Id. at Part 10.)

(Adv. D.I. 209, Ex. 3.)

The Court concludes that the SOA taken as a whole

unambiguously obligates PES to maintain insurance on all its

9

property, including the property at issue here, which is

specifically described in detail in the SOA. The fact that the

SOA also requires that PES maintain insurance on other property

does not detract from this obligation. Therefore, the Court

concludes that the SOA meets the first requirement of the SLV

Clause that PES be “contractually obligated to insure specific

property.” (Adv. D.I. 209, Ex. 1.)

b. Stipulated Loss Amount

The Insurers also argue that the Insurance Requirement

Clause fails to satisfy the SLV Clause because it does not

provide for a Stipulated Loss Amount. They contend,

specifically, that the “minimum insurance” requirement of the

Insurance Requirement Clause is not a stipulated loss amount.

They contrast it with liquidated damages and other like

provisions that actually obligate a party to pay a specific

amount on a breach of contract or incurrence of a loss. Damages,

Black’s Law Dictionary (11th ed. 2019) (defining liquidated

damages as “an amount contractually stipulated as a reasonable

estimation of actual damages”); Edwin E. Huddleson, III, Old Wine

in New Bottles: UCC Article 2a - Leases, 39 Ala. L. Rev. 648-40

(1988) (“Typical liquidated damages clauses in wide-spread

commercial use, [set] the lessor’s damages equal to the so-called

“stipulated loss value” of the goods.”)

10

The Insurers seek to bolster their argument by noting that

extrinsic evidence (presented by PES in its own brief) proves

that the SLV Clause was intended to require payment of a

stipulated loss amount. In 2012 when negotiating the terms of

the Policy, PES insisted on the SLV Clause in order to satisfy

its contractual obligation to Carlyle and Sunoco who had invested

$250 million in the Refinery and wanted to guarantee that PES

repaid that investment in the event the Refinery was destroyed

and not rebuilt. (Adv. D.I. 215 at 5.)

The Court finds it unnecessary to consider extrinsic

evidence, however, because the language of the SLV Clause is

unambiguous.7 Further, the extrinsic evidence offered by the

Insurers does not change that unambiguous language. The SLV

Clause does not require that PES be contractually obligated to

pay anyone a stipulated loss amount, it requires that PES be

obligated to insure specific property for a stipulated loss

value. That is what PES has done in the SOA: it has obligated

itself to maintain insurance on its property for a minimum of

$750 million.

7 Only if a term is ambiguous may a court consider extrinsic

evidence. Viking Pump, 52 N.E.3d at 1151 (under New York law

unambiguous terms must be enforced in accordance with their plain

meaning); Ellington v. EMI Music, Inc., 21 N.E.3d 1000, 1003

(N.Y. 2014) (ambiguity arises “when the contract . . . fails to

disclose its purpose and the parties’ intent, or when specific

language is susceptible of two reasonable interpretations”).

11

The Insurers argue further, however, that the Required

Insurance Provision does not satisfy the SLV Clause because it

provides that ICBCS is to be an additional insured and loss payee

on the comprehensive property insurance. (Adv. D.I. 209, Ex. 3,

Part 10.) As a result, they argue that PES and ICBCS agreed that

the latter would have the right to a direct action against the

Insurers if there were a loss but not that ICBCS would be

entitled to be paid a “stipulated loss amount” by PES.

Again, the Court rejects the Insurers’ argument, because

the SLV Clause does not require that PES be obligated as the

payor of the stipulated loss amount, only that it insure its

property for such an amount. (Adv. D.I. 209, Ex. 1.) The fact

that PES agreed that ICBCS would be named a loss payee on the

Policy does not negate the fact that the SOA specifically

required that PES maintain insurance in the amount of $750

million on its property. As stated above, the express terms of

the SLV Clause in the Policy require an obligation to insure the

property for a specific amount, not an obligation to pay a

specific amount.

The Insurers also argue that the obligation in the SOA is

not sufficient to satisfy the SLV Clause because it just

specifies a “minimum” insurance that is required without stating

a specific loss amount. The Court rejects this argument. While

PES is permitted in the SOA to insure its property for more than

12

$750 million, it is not obligated to do so. But it is obligated

to insure the property for $750 million. This, the Court

concludes, satisfies the SLV Clause in the Policy that PES “is

contractually obligated to insure specific property for a

stipulated loss amount.” (Adv. D.I. 209, Ex. 1 at § I(5)(e).)

2. Effect of the SLV Clause

Under the SLV Clause, the Policy provides for the payment of

the Stipulated Loss Value. (Adv. D.I. 209, Ex. 1 § I(5)(e).) If

the loss is less than $250 million the payment will be the

replacement cost (“RC”); if the loss is more than $250 million

and the property is not replaced, the payment will be the Actual

Cash Value (“ACV”) with a minimum of $250 million. (Id.)

RC is defined in the Policy, in pertinent part, as “[t]he

amount it would take to repair or replace the damaged or

destroyed property with materials of like kind and quality,

without deduction for depreciation or obsolescence . . . all

determined at the time and place of loss.” (Id.) ACV is defined

in the Policy as the “Replacement Cost less deduction for

physical depreciation.” (Id.)

The Parties dispute the meaning of “physical depreciation.”

PES argues that, as a matter of law, physical depreciation does

not include obsolescence or labor depreciation. While the

Insurers agree that obsolescence is not included in the term

“physical depreciation,” they contend that labor depreciation is

included.

The Insurers assert that the public policy underlying

indemnity insurance is simply to return the insured to as good a

position as it was at the time of the loss. McAnarney v. Newark

Fire Insurance Co., 159 N.E. 902, 904-05 (N.Y. 1928). In keeping

with that principle, the Insurers argue that physical

depreciation must include depreciation of labor where PES does

not repair its property because otherwise PES “would receive a

windfall based on labor costs [it] never incurred... .”

Graves v. Am. Fam. Mut. Ins. Co., 686 F. Appx. 536, 539 (10th

Cir. 2017) (concluding that depreciation of labor in calculation

of actual cash value was appropriate under general principles of

indemnity insurance which seek “to prevent an insured from

directly profiting through the receipt of cash funds beyond the

actual cash value of the loss.”).®

8 See also Papurello v. State Farm Fire & Cas. Co., 144 F.

Supp. 3d 746, 765-67 (W.D. Pa. 2015) (where contract just uses

term actual cash value, court applied Pennsylvania law to

determine that labor was part of depreciation); Henn v. Am, Fam,

Mut. Ins., Co., 894 N.W.2d 179, 189-91 (Neb. 2017) (because

actual cash value was not defined in the policy, court applied

well-developed case law that labor was included in depreciation);

Wilcox v. State Farm Fire & Cas. Co., 874 N.W.2d 780, 785 (Minn.

2016) (holding that if policy did not define actual cash value,

trial court was permitted to include labor-cost depreciation when

estimated cost to repair or replace damaged property included

materials and embedded-labor components); Redcorn v. State Farm

Fire & Cas. Co., 55 P.3d 1017, 1020 (Okla. 2002) (in determining

actual cash value of a damaged roof, court held that a roof is

the product of both materials and labor and therefore both should

be depreciated under general purpose of indemnification).

14

PES argues, however, that many of the cases cited by the

Insurers are distinguishable because they had no express

definition of the actual cash value to be paid and therefore

reliance on the broad concepts of indemnity insurance was

appropriate. However, where the term actual cash value is

defined by the parties in their contract those principles cannot

be applied to change the actual language chosen by the parties.

In the latter instance, PES contends that the Court must enforce

the terms of the contract as the parties wrote them. See SR

Int’l Bus. Ins. Co. v. World Trade Ctr. Props., LLC, 445 F. Supp.

2d 320, 346 (S.D.N.Y. 2006) (rejecting the ruling in McAnarney

that broad evidence of the meaning of actual cash value should be

considered in contrast to the express terms defined in the

parties’ contract).

The Court agrees with PES. Because the parties have defined

the term ACV in their Policy, general principles of indemnity law

cannot be applied in contravention of that express language. SR

Int’l, 445 F. Supp. 2d at 346.

The Insurers contend nonetheless that, even where the actual

cash value is defined in the policy, courts conclude that a

deduction for depreciation includes labor depreciation.9

9 E.g., Graves, 686 F. App’x at 537 (affirming decision that

“physical deterioration and depreciation” used in calculation of

actual cash value had to include “all costs necessary to

15

PES responds that none of the cases cited by the Insurers

construe New York law. It argues that the trend in this area is

to exclude labor from the term “depreciation” as evidenced by

more recent cases and recent legislation.'® Even if the term

(re)creating the insured ‘property’ - including the costs

associated with labor - when calculating actual cash value”); In

re State Farm Fire & Cas. Co., 872 F.3d 567, 572 (8th Cir. 2017)

(reversing order certifying class because deducting the cost of

labor as part of depreciation was not unreasonable); Basham v.

U.S. Auto. Ass'n, C.A. No. 16-cv—-03057-RBJ, 2017 WL 3217768, at

*3 (D. Col. July 28, 2017) (concluding that labor is included in

depreciation because, although labor itself does not depreciate,

it can add value to an asset and that value depreciates); Branch

v. Farmers Ins. Co., 55 P.3d 1023, 1027 (Okla. 2002) (concluding

that labor was depreciable under broad evidence rule even where

actual cash value defined in the policy as replacement cost less

depreciation).

10 E.g., Perry v. Allstate Indem. Co., 953 F.3d 417, 423 (6th

Cir. 2020) (concluding that plaintiff’s “interpretation — that in

calculating ACV depreciation does not include labor costs — has

been recognized as reasonable by numerous state and federal

courts, including our own, because depreciation traditionally

refers to value lost from physical wear and tear”); Hicks v.

State Farm Fire & Cas. Co., 751 F. App’x 703, 709 (6th Cir. 2018)

(holding that a “layperson confronted with State Farm's policy

could reasonably interpret the term depreciation to include only

the cost of materials”); Cal. Fair Plan Ass’n v. Garnes, 218 Cal.

Rptr. 3d 246, 259-62 (Cal. Ct. App. 2017) (holding that labor is

not depreciable under California statute which provides “a

deduction for physical depreciation shall apply only to

components of a structure that are normally subject to repair and

replacement during the useful life of that structure”) (citing

Cal. Ins. Code § 2051(b) (West 2021)); Lains v. Am. Family Mut.

Ins. Co., Case No. C14-1982-Jcc, 2016 WL 4533075, at *2-3 (W.D.

Wash. Feb. 9, 2016) (finding policy ambiguous and construing it

in favor of insured to exclude labor costs in depreciation);

Lammert v. Auto-Owners (Mut.) Ins. Co., 572 S.W.3d 170, 179

(Tenn. 2019) (same); Adams v. Cameron Mut. Ins. Co., 430 S.W.3d

675, 678 (Ark. 2013) (stating that the court, like the dissent in

Redcorn, “simoly cannot say that labor falls within that which

16

depreciation includes labor, however, PES argues that the Policy

mandated that RC only be reduced by “physical depreciation” not

by depreciation.

The Court agrees with PES that it need not decide which line

of cases is correct and whether depreciation includes the

depreciation of labor. The Court is called upon to determine the

meaning of the term “physical depreciation” which the parties in

this case used, rather than the term depreciation.

PES argues that the only reasonable interpretation of

“physical depreciation” is that it does not include the

depreciation of intangible, non-material costs, such as labor.

PES argues that, because physical depreciation is not defined in

the Policy, it must be considered based on its meaning in common

speech. It contends that the term “depreciation” in common

can be depreciable”), superseded by statute, Ark. Code Ann. §

23-88-106(a)(2) (2017). See also Wash. Admin. Code § 284-20-010

(2021), printed in 2021 WA REG TEXT 587383 (netscan) (“Except for

the intrinsic labor costs that are included in the cost of

manufactured materials or goods, the expense of labor necessary

to repair, rebuild, or replace covered property is not a

component of physical depreciation and may not be subject to

depreciation or betterment.”); Depreciation of Labor Expenses in

Property Loss Claims, Miss. Ins. Dep’t Bulletin 2017-8 (Aug. 4,

2017), https://www.mid.ms.gov/legal/bulletins/20178bul.pdf

(insurers must “clearly provide for the depreciation of labor in

the insurance policy”); Property Loss Claims: No Labor

Depreciation, VT Dep’t Financial Reg., Div. of Ins., Bullet No.

184 (May 1, 2015), available at https://dfr.vermont.gov/sites/

finreg/files/regbul/dfr-bulletin-insurance-184.pdf (“Labor,

unlike physical materials, does not break down or lose value over

time.”).

17

parlance means “a decline in an asset’s value because of use,

wear, obsolescence, or age.” Depreciation, Black’s Law

Dictionary (11th ed. 2019). PES argues that adding “physical” as

a modifier to depreciation in the definition of ACV means that

the deduction only includes depreciation “of, or relating to, or

involving material things” or “pertaining to real tangible

objects.” Physical, Black’s Law Dictionary (11th ed. 2019).

Consequently, PES contends that labor that is not already

imbedded in the materials’ costs11 cannot be part of the physical

depreciation component of ACV.

The Insurers argue that the term “physical depreciation”

means that economic and functional obsolescence must be excluded

from the depreciation deduction. In their view, all other

depreciation - including labor depreciation - is included in the

term “physical depreciation.”

The Court disagrees with the Insurers on this point.

Obsolescence is already excluded from depreciation under the

terms of the Policy because the definition of RC uses

11 PES concedes that some labor costs – intrinsic labor costs –

reflected in the price of materials and equipment will be

depreciated as those materials and equipment are themselves

depreciated. PES does not argue that the Court must extricate

these costs from the cost of tangible things to avoid their

depreciation. PES argues, however, that extrinsic labor costs,

namely the costs to plan and implement a rebuild or repair on

site, which it would pay as overhead rather than as part of the

materials, cannot be physically depreciated.

18

depreciation and obsolescence as two separate and distinct terms.

See SR Int’l, 445 F. Supp. 2d at 351-53 (holding that

depreciation did not include obsolescence where ACV was defined

as RC less “physical deterioration, depreciation, obsolescence

and depletion”). Therefore, the use of the term “physical

depreciation” in the definition of ACV could not have been

intended to exclude obsolescence.

The Court further agrees with PES that physical depreciation

must mean something less than depreciation. E.g., Westview

Assocs. v. Guar. Nat. Ins. Co., 740 N.E.2d 220, 222 (N.Y. 2000)

(“surplusage [is] a result to be avoided”). Therefore, the cases

cited by the Insurers concluding that depreciation includes labor

depreciation are not on point.”

te While three of the cases the Insurers cite have policy

definitions of ACV that include reference to “physical,” all

three based their conclusion on a finding that “depreciation”

alone includes “labor depreciation.” Graves, 686 F. App’x at 537

(policy defined ACV as RC less “physical deterioration and

depreciation, including obsolescence”); Riggins v. Am. Fam. Mut.

Ins. Co., 281 F. Supp. 3d 785, 789 (W.D. Mo. 2017) (policy

defined ACV as RC “less depreciation for physical deterioration

and obsolescence”); Ware v. Metro. Prop. & Cas. Ins. Co., 220 F.

Supp. 3d 1288, 1290-91 (M.D. Ala. 2016) (policy defined ACV as

the replacement cost “less allowance for physical deterioration

and depreciation including obsolescence”). Notably, the Riggins

Court originally ruled that the term “less depreciation for

physical deterioration and obsolescence” excluded labor

depreciation. Riggins, 281 F. Supp. 3d at 786. After the Eighth

Circuit’s State Farm decision, however, the Riggins Court

concluded that labor depreciation was included in “depreciation”

because the policy did not expressly exclude it. Id. at 789

(citing State Farm, 872 F.3d at 570-77).

19

Moreover, the Court agrees with PES that “physical” should

properly be given its plain meaning and the reference to its

definition in Black’s Law Dictionary is appropriate. See CT Inv.

Mgmt. Co., LLC v. Chartis Specialty Ins. Co., 9 N.Y.S.3d 220, 223

n.2 (N.Y. App. Div. 2015) (“It is common practice for the courts

of [New York] to refer to the dictionary to determine the plain

and ordinary meaning of words to a contract.”). Thus, the Court

concludes that “physical” depreciation is the physical

deterioration or wear and tear of tangible property resulting in

a diminution in value. See also 2 Real Estate Transactions:

Structure and Analysis with Forms section 19:7 (stating that

depreciation is “the deterioration or the physical wearing out of

man-made buildings or improvements due to the passage of time,

the effect of weather, or the manner of using the property”).

The Court concludes that labor costs that are imbedded in

the cost of materials is depreciable as the value of those

materials depreciate through wear and tear. Brown v. Travelers

Cas. Ins. Co., Civ. No. 15-50-ART, 2016 WL 1644342 (E.D. Ky. Apr.

25, 2016) (concluding that “[t]o the extent that labor does not

increase the market value of a finished good — as with a haircut

— the value of the labor does not depreciate along with the good.

For this reason, the ordinary meaning of “depreciation” allows an

insurer to depreciate the value of labor that has merged with a

20

finished good. It does not, however, allow an insurer to

depreciate the value of pure labor that has not merged with a

finished good”). However, the Court agrees that labor which is

procured separately from materials, is unlike physical property

and it is hard to conceive of how it can be physically

depreciated. The labor used in constructing the Refinery was not

subject to deterioration or wear and tear from the elements. The

Illinois Supreme Court recently expressed just this analysis in

concluding that labor is not included in the term depreciation □□

let alone physical depreciation - in calculating the actual cash

value in an insurance policy.

[L]abor 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. Labor isa

fixed cost that is not subject to wear and tear,

deterioration, or obsolescence.

Sproull v. State Farm Fire & Cas. Co., Docket No. 126446, 2021 WL

4314060, *13 (Ill. Sept. 23, 2021).'° While the Court does not

opine on whether depreciation simpliciter includes labor

13 See also Bailey v. State Farm Fire & Cas. Co., Civ. A. No.

14-53-HRW, 2015 WL 1401640, at *8 (D. Minn. Mar. 25, 2015) (“The

very idea of depreciating labor defies good common society.”),

aff’d sub nom Hicks, 751 F. App’x 703; Arnold v. State Farm Fire

& Cas. Co., 268 F. Supp. 3d 1297, 1312 (S.D. Ala. 2017) (noting

the “inherent logical contradiction of depreciating non-

depreciating things” in considering what a reasonable insured

would understand the term actual cash value to include); Adams,

430 S.W.3d at 679 (“The very idea of depreciating the value of

labor is illogical.”) (superseded by statute) Ark. Code Ann. §

23-88-106(a) (2) (2017).

21

depreciation, it finds the reasoning of these courts supportive

of its conclusion that the use of the term “physical

depreciation” was meant to exclude depreciation of extrinsic

labor.14

For the foregoing reasons, the Court concludes that the

definition of ACV in the Policy, which reduces RC only by

“physical depreciation” means that ACV is not reduced by any

extrinsic “labor depreciation.” Accordingly, the Court will

grant PES’ Motion and deny the Insurers’ Motion for summary

judgment on this issue.

C. Consequential Damages

In their motion for summary judgment, the Insurers also ask

the Court to dismiss Count VI of the Complaint which seeks

consequential damages for breach of the implied covenant of good

faith and fair dealing. The Insurers acknowledge that New York

law recognizes such a claim with respect to insurance contracts.

See, e.g., Bi-Econ. Mkt. Inc. v. Harleysville Ins. Co. of N.Y.,

886 N.E.2d 127, 131 (N.Y. 2008) (holding that the implied

covenant requires an insurer to “investigate in good faith and

pay covered claims.”). However, they note that the burden to

establish such a breach is extremely high. Sukup v. New York,

227 N.E.2d 842, 844 (N.Y. 1967) (“It would require more than an

14 See cases cited at n. 10 supra.

22

arguable difference of opinion between carrier and insured over

coverage to impose an extra-contractual liability for legal

expenses in a controversy of this kind. It would require a

showing of such bad faith in denying coverage that no reasonable

carrier would, under the given facts, be expected to assert

it.”).

While not conceding that there has been any breach of the

covenant of good faith and fair dealing, the Insurers argue that

they are entitled to summary judgment on this count because PES

has presented no evidence in discovery (or in response to their

summary judgment motion) to establish it suffered any damages as

a result of any such breach. They contend that all the damages

alleged in the Complaint and articulated in PES’ expert reports

and discovery responses are not consequential damages but,

instead, are merely damages resulting from the Insurers’ alleged

breach of the Policy. E.g., Biotronik A.G. v. Conor Medsystems

Ireland, Ltd., 11 N.E.3d 676, (N.Y. 2014) (“General damages ‘are

the natural and probable consequence of the breach’ of a

contract.”) (citations omitted)).

PES responds that it seeks the attorneys’ fees it incurred

as consequential damages resulting from the Insurers’ breach of

the implied covenant of good faith and fair dealing. PES argues

that its claim for attorneys’ fees is the type of damages

23

foreseeable from such a breach and have been allowed by New York

courts. E.g., Certain Underwriters at Lloyd’s v. BioEnergy Dev.

Grp. LLC, 115 N.Y.S.3d 240, 241 (N.Y. App. Div. 2019) (denying

motion to dismiss claim for attorneys’ fees for the breach of the

implied covenant of good faith and fair dealing because it was

foreseeable that an insurer’s breach would cause the policyholder

to incur attorneys’ fees in order to obtain payment of its

claim).

The Insurers argue in response that any claim for attorneys’

fees is expressly excluded under the terms of the Policy. (Adv.

D.I. 209, Ex. 1 at § 3 7 4 (excluding expenses of public

adjusters or attorneys).) They contend that New York courts do

not allow attorneys’ fees for a breach of the implied covenant of

good faith and fair dealing in the face of such express contract

provisions.’

ts E.g., 30-40 E. Main Street Bayshore, Inc. v. Rep. Franklin

Ins. Co., 981 N.Y.S. 2d 616, 617 (N.Y. App. Div. 2014) (denying

leave to amend complaint where “the inability of the plaintiffs

to recover an attorney’s fee, costs, and interest as

consequential damages in this affirmative action against their

insurer is clear and free from doubt”); N.Y. Univ. v. Cont’l Ins.

Co., 662 N.E.2d 763, 769-72 (N.Y. 1995) (noting that “[t]t is

well established that an insured may not recover the expenses

incurred in bringing an affirmative action against an insurer to

settle its rights under the policy”); Stein, LLC v. Lawyers Title

Ins. Corp., 953 N.Y.S.2d 303 (N.Y. App. Div. 2012) (“nothing in

Bi-Economy or Panasia alters the common-law rule that, absent a

contractual or policy provision permitting the recovery of an

attorney’s fee, an “insured may not recover the expenses incurred

in bringing an affirmative action against an insurer to settle

24

PES contends that any language of the Policy excluding

attorneys’ fees is irrelevant because under New York law, “an

insured may recover foreseeable damages, beyond the limits of its

policy, for breach of the covenant of good faith.” Panasia

Ests., 886 N.E.2d at 136-37 (citation omitted) (affirming denial

of motion for partial summary judgment which asserted that

contract provision precluding attorneys’ fees barred any action

seeking such fees as consequential damages for breach of covenant

of good faith and fair dealing). Accord Bi-Econ., 886 N.E.2d at

196.

The Court agrees with PES. The attorneys’ fees claimed by

PES are not for breach of the insurance policy but rather for

breach of the covenant of good faith and fair dealing.

Consequential damages are recoverable for a breach of the

covenant of good faith and fair dealing under New York law, if

they are proximately caused by the breach and are foreseeable to

the parties at the time of contracting. Bi-Econ., 886 N.E.2d at

192–93; Sukup, 227 N.E.2d at 844 (acknowledging that attorneys’

fees may be awarded if bad faith were found but denying them in

the absence of such a finding). Such attorneys’ fees are

recoverable even in the face of a contract provision that

generally precludes attorneys’ fees, such as the one here.

its rights under the policy”) (citations omitted)).

25

Panasia Ests., 886 N.E.2d at 136-37 (contract provision

precluding attorneys’ fees does not bar recovery of such fees as

consequential damages for breach of covenant of good faith and

fair dealing).

While the Insurers cite New York cases denying attorneys’

fees, the Court finds them unpersuasive. For example, the

Bayshore case cites the Bi-Econ. case as support for its blanket

assertion that attorneys’ fees cannot be recovered as

consequential damages. 981 N.Y.S. 2d at 617. However, the Bi-

Econ. court made no such holding; to the contrary it upheld the

right of the insured to assert consequential damages for breach

of the covenant of good faith and fair dealing even in the face

of a contract provision precluding consequential losses. 886

N.E.2d at 132. Furthermore, while the Court in the NYU case

ruled that generally attorneys’ fees are not recoverable for an

ordinary breach of contract, it did not address whether they are

recoverable for a breach of the implied covenant of good faith

and fair dealing. N.Y.U., 662 N.E.2d at 772. Similarly, the

Stein case dealt with a breach of insurance contract, not a claim

for breach of the covenant of good faith and fair dealing. 953

N.Y.S.2d at 304.

In addition, however, the Insurers argue that they are

entitled to summary judgment on Count VI because PES provided no

26

evidence during discovery (or in response to their motion)

supporting its claim for attorneys’ fees. E.g., In re Indesco

Int’l, Inc., 451 B.R. 274, 316 (Bankr. S.D.N.Y. 2011) (granting

summary judgment for defendant because plaintiff failed to prove

any damages).

While PES acknowledges that no evidence to support the

attorneys’ fees has been presented to date, it contends that the

time to do so is after the Court finds bad faith.16 This, PES

contends, is appropriate because those fees continue to accrue

and it is not possible to finally calculate them until the trial

is concluded. In the event the Court does find bad faith, PES

asserts that it will submit a fee application detailing those

damages.

The Court agrees with PES that the time to consider any

claim it may have for legal fees is after trial. Such

consequential damages are due only if, and when, the Court

determines that the Insurers’ acted in bad faith. If it does,

PES will be in a better position to present evidence of any claim

for consequential damages and the Insurers will be in a better

16 E.g., Maule v. Phila. Media Holdings, LLC, 2010 WL 3859613,

at *5 n.3 (E.D. Pa. Oct. 1, 2010) (rejecting argument that

defendant had no notice of claim for attorneys’ fees, noting that

prayer for relief clearly asserted such a claim); Fed. R. Civ. P.

54(d), incorporated by Fed. R. Bankr. P. 7054 (allowing the

filing of a motion and proof of fees incurred by prevailing party

after a favorable award).

27

position (after reviewing any fee request) to respond if they are

not properly characterized as consequential damages because they

were not foreseeable or not a consequence of their bad faith.

The Court will accordingly, sua sponte, bifurcate the trial

on Count VI between liability and damages. Fed. R. Bankr. P.

7042, incorporating Fed. R. Civ. P. 42(b) (“For convenience, to

avoid prejudice, or to expedite and economize, the court may

order a separate trial of one or more separate issues, claims,

crossclaims, counterclaims, or third-party claims.”) (emphasis

added). See also Franklin Music Co. v. Am. Broadcasting Cos.,

Inc., 616 F.2d 528, 538 (3d Cir. 1979) (upholding district

court’s sua sponte decision to bifurcate). Courts have

discretion to bifurcate issues in a case if it will not be

prejudicial to the parties. Barr Labs., Inc. v. Abbott Labs.,

978 F.2d 98, 115 (3d Cir. 1992); Lis v. Robert Packer Hosp., 579

F.2d 819, 824 (3d Cir. 1978).

The Court finds that there will be no prejudice to PES

because bifurcation will protect any attorney-client privilege

PES may have by not requiring the production of the attorneys

bills while this litigation is pending. Similarly, the Court

concludes that bifurcation will not be prejudicial to the

Insurers. First, this is not a jury trial, where prejudice

arising from bifurcation has usually been contested. E.g., Lis,

28

579 F.2d at 821. Second, the Court will provide ample

opportunity for discovery and preparation for the damages trial,

in the event one is necessary. E.g., In re Vaso Active Pharm.,

Inc., 500 B.R. 384, 400 (Bankr. D. Del. 2014) (amending

scheduling order to avoid prejudice flowing from bifurcation).

Bifurcation will also promote judicial economy by allowing

the Court to consider the threshold and potentially dispositive

issue of liability alone, without the necessity to consider any

proof of damages unless liability is established. This is

especially true, where, as here, the plaintiff has a heavy burden

in establishing liability. Sukup, 227 N.E.2d at 844. This

benefit has no significant counterbalance: the issues of

liability and damages are not, in this case, inseparable. Barr,

978 F.2d at 115 (bifurcation is proper where issues are not

“inextricably interwoven”).

Accordingly, the Court will deny the Insurers’ Motion for

summary judgment on Count VI and will enter an order bifurcating

the issues of liability and damages on that Count.

IV. CONCLUSION

For the foregoing reasons, the Court will grant PES’ Motion

29

for summary judgment and deny the Insurers’ Motion for summary

judgment.

Dated: December 15, 2021 BY THE COURT:

Mary F. Walrath

United States Bankruptcy Judge

30