Court Reduces Continuing Charges and Expenses From Net Profits When a Business Resumed Partial Operations After a Loss - Understanding Business Interruption Claims, Part 35
The Fifth Circuit Court of Appeals recently issued a 21-page opinion in the case of Consolidated Companies, Inc. v. Lexington Insurance Company, No. 09-30178, ___ F. 3d ___ (5th Cir. August 17, 2010). The opinion is dense, to say the least, but it resolves an issue that sometimes can make or break a settlement in business interruption claims.
Consolidated Companies, Inc. (“Conco”), a food and food-related products distributor, sustained damages to one of its warehouses and equipment as a result of Hurricane Katrina. Conco was able to resume partial operations within ten (10) days of the hurricane, however, it took the company 15 months to resume its pre-loss operations. During those 15 months, Conco earned $205,840,489 in revenues and incurred $205,561,483 in expenses, netting a mere $279,006.
Lexington advanced $3 million under the policy and offered an additional $247,070 in final payment of the claim. Conco rejected the additional $247,070 and filed suit sounding in breach of contract and bad-faith alleging it had a business interruption loss in excess of $19 million (of which $12,308,522 were charges and expenses).
After a trial, the jury awarded $19,586,239 in business interruption, $2.5 million in bad faith damages, and an additional $5,365,797.50 in statutory penalties. Lexington appealed on several grounds, including whether the trial court erred in not instructing the jury to offset the charges and expenses ($12,308,522 ) from the calculated net income. Lexington prevailed, and the award on the business loss was therefore adjusted.
At issue before the Court was the following policy language:
If such loss occurs during the term of this policy, it shall be adjusted on the basis of the actual loss sustained by the Insured, during the period of restoration, consisting of the net profit (or loss) which is thereby prevented from being earned and of all charges and expenses (excluding ordinary payroll), but only to the extent that they must necessarily continue during the interruption of business, and only to the extent to which they would have been incurred had no loss occurred.
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1) RESUMPTION OF OPERATIONS: It is a condition of this insurance that if the insured could reduce the loss resulting from the interruption of business,
(a) by a complete or partial resumption of operations, or
(b) by making use of other available stock, merchandise or location
such reduction will be taken into account in arriving at the amount of loss hereunder, but only to the extent that the business interruption loss covered under this policy is thereby reduced.
As defined in the policy, the “actual loss” consists of the net profit or loss which the business interruption prevents from being earned. The term “charges and expenses” is further defined as expenses that would have been incurred without the loss and have to continue during the business interruption.
Conco argued that the charges and expenses incurred during the period of restoration are recoverable in addition to the lost profits, as calculated under the “actual loss” provision. The trial court agreed with Conco by finding that the “actual loss” provision was ambiguous and resolved the issue in favor of the insured. However, the appellate court disagreed, finding that the “Resumption of Operations” subparagraph resolved the question in favor of Lexington.
In an acrobatic effort to make a difficult issue simple, the Court wrote:
As a condition of coverage, operations had to be resumed “if the insured could reduce the loss resulting from the interruption of business” by such a resumption. The policy states that “such reduction will be taken into account in arriving at the amount of loss hereunder, but only to the extent that the business interruption loss covered under this policy is thereby reduced.”
This clause does not elaborate on what the “loss resulting from the interruption of business” means. Meaning is found in the general section immediately before the “Resumption of Operations” subparagraph. There, “actual loss” from an interruption of business is said to consist of the net profit that the interruption prevented the insured from earning plus “all charges and expenses (excluding ordinary payroll), but only to the extent that they must necessarily continue during the interruption of business, and only to the extent to which they would have been incurred had no loss occurred.” Three paragraphs later, the policy addresses the effect of the insured's resuming operations: “if the insured could reduce the loss resulting from this interruption of business ... by a complete or partial resumption of operations ... such reduction will be taken into account in arriving at the amount of loss.” (emphasis added). This is the same “loss” that is defined as being expected net profit plus charges and expenses. There is no ambiguity.
Therefore, when a partial resumption in operations reduces the “actual loss,” i.e., anticipatable profits and unavoidable costs, so substantially as to create some profit, all charges and expenses have, by definition, been covered by income. The only recovery in such an event is for the diminished profit.
Taking the actual dollar amounts presented in this case, we repeat that Conco earned $205,840,489 in revenues and incurred $205,561,483 in expenses for a net profit of $279,006. The charges and expenses for which the policy would pay had there been no resumption of operations was shown to be $12,308,522. As the policy requires, those expenses are ones that “necessarily continue during the interruption of business, and only to the extent to which they would have been incurred had no loss occurred.” Thus, they are not independent of the costs that are incurred during usual operations, but are a subset of them. Consequently, the roughly $12 million in expenses must be part of the $205 million in expenses that were incurred during resumed operations. All expenses were recouped from the income of the business and are not a “loss” to be compensated under the policy.
It is hard to understand how $12 million can just disappear in a few sentences, but insurance law abhors windfalls on any side. Unfortunately, since the “actual loss” was reduced by $12 million, the court of appeals also reduced the bad-faith damages, because the jury based its bad-faith findings mostly on the failure to pay the $12 million.
For a copy of the complete opinion, click here.
Without looking at the actual numbers/how the lost profit was calculated, it appears the Appeals court's decision was correct. The insured should only be paid for its lost profit. My reasoning can best be explained by the simple example below:
Let's assume: if not for the damage, during the 15 month period of restoration, (1) the insured would have earned $1,000 of revenue, incurred $700 of expenses, resulting in a $300 net profit; and (2) during the 15 month period of restoration, the insured earned $800 of revenue, incurred $600 of expenses, resulting in a $200 of net profit.
BI Calulation:
Projected Actual Difference
Revenue $1,000 $700 $300
Expense $ 800 $600 $200
Profit $ 200 $100 $100
Thus, the insured BI loss would be $100. Under the District court's decision, the insured would have been paid $100 lost profit plus $600 actual expenses, or $700 during the period of restoration....This obviously would be incorrect, as the insured would have only earned $200 during the 15 month period of restoration, had the damage not occurred.
To be safe the insured should wait until repairs and replacements are completed,And then begin the businees operation,Is better to be safe,as we all know Ins are umpredictable.