The “Economy Ignored” cases stick to the more traditional coverage analysis where courts measure the business interruption loss by comparing the actual past business experience against the probable experience during the period of restoration had the peril not occurred. This type of analysis, however, does not consider the impact a catastrophic peril could have had on the economy, market or demand for the insured’s goods or services […]

Conversely, under the “Economy Considered” line of cases, courts use a different approach to place the business in the position it would have occupied had it been operating in the actual, post-catastrophe environment, but only allowing losses that directly flow from the insured damages [...]

In Catlin Syndicate Limited v. Imperial Palace, No. 09-60209, 2010 WL 9008731 (5th Cir. 2010), the Fifth Circuit Court of Appeals recently followed the “economy ignored” line of cases, foreclosing any consideration to an insured’s post-loss earnings to determine lost profits under Texas and Mississippi law. In Catlin, the insured did very well after Hurricane Katrina because it was one of the first casinos to reopen after the hurricane, but the Court only allowed consideration of the historical sales figures, finding that “loss” and “occurrence” are one and the same in the business interruption provision.  It ruled that “had no loss occurred” in the “Experience of the Business” provision means “had no hurricane occurred.”

Six months after Catlin, the Fifth Circuit Court of Appeals revisited the same issue in Consolidated Companies, Inc. v. Lexington Insurance Company, but this time under Louisiana law. In Consolidated, the insured did poorly after Hurricane Katrina. The insurer wanted to consider the poor post-loss market condition, arguing that the insured’s profits would have been reduced from their usual level even if there had been no property damage, but Catlin was too hard to distinguish.

In Consolidated the Court held:

We reject this [Lexington’s] interpretation for the same reasons we rejected it in Catlin (citation omitted). The jury was not to look at the real world opportunities for profit post-Katrina, but instead was to decide the amount of money required to place Conco [insured] in the same position in which it would have been had [Katrina not] occurred […]

The Court further stated that the insured “was not required to draw a bright line in its evidence between loss stemming from property damage and loss stemming from market conditions.” I love this quote. It certainly makes the debate interesting.

I recognize that the “economy ignored” cases are premised, for the most part, on valid concerns of preventing abhorrent windfalls, but this hard-line analysis may have undesired effects. In my recent post, I commented:

[…]the “economy ignored” analysis provides less coverage than the basic requirements otherwise permitted when the insured performs better post-catastrophe, but more coverage that the basic requirements when the insured performs worse after the catastrophic loss. The “economy considered” analysis, however, may serve as a more accurate “measuring stick,” since the formula considers the changes in the post-catastrophe economy without regard to whether the insured would have performed better or worse after the catastrophe, and it only covers loss earnings directly flowing from the physical damage […]

I have also noted that experts on this matter still believe and conclude that the “economy ignored” framework has the effect of treating business interruption coverage as some sort of catastrophe insurance, instead of insurance for the financial consequences of defined property damage, which is the intent and purpose behind business interruption coverage. The debate is very much alive. Stay tuned.

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.

* * * *

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.

The Insured has an obligation to incur any expense with the object of minimizing a loss hereunder, such expenses subject to prior agreement of Insurers being for Insurers account, provided that the loss is reduced as a result of such expenditure, and provided such expenditure is not recoverable from other policies taken out by the Insured. Insurers have the right to require the Insured to incur any expense which would reduce Insurers liability under this policy provided such expense is for Insurers account.

Metalmasters of Minneapolis v. Liberty Mutual, 461 N.W. 2d 496 (Minn. App. 1990) is an example of what can happen if the insured and insurer are not the same page with respect to mitigation costs.

Metalmasters manufactured precision computer disk drives and other small machine parts. A two-inch overhead pipe carrying water for cooling and air conditioning ruptured during the night and flooded Metalmasters' shop. Metalmasters was shut for nine weeks, with partial production resuming after three weeks.

Metalmasters began using its clean rooms within four months after the water damage, but in order to produce a rust-free product (and protect its product from the water intrusion due to the pipe loss), Metalmasters incurred an additional expense of $4.90 for each of 15,500 spindle assemblies, totaling $75,590.

Unfortunately, Metalmasters was not able to recover $193,500 of loss of net sales during the nine week interruption period because Metalmasters was not able to show a loss in gross earnings since it had a buyer purchase all of its non-damaged goods. However, Metalmasters was able to recover the $75,590 as a mitigation cost under the Extra Expense provision of the policy, despite Liberty Mutual’s hard fight.

I am always tickled by case law that restates obvious principles and where the court’s frustration with one of the parties is apparent.

These additional production expenses were expenses of mitigation. Liberty cannot have it both ways. If, as they strenuously urge, the insured has a contractual as well as a common law duty to mitigate damages, then the expenses of that mitigation must be covered. If the mitigation efforts take longer than the interruption period, then the business interruption clause cannot limit coverage to that period, since the activity is in the interest of the insurer. In this case the expense continued beyond the four weeks during which the clean rooms were inoperable.

Mitigation is a duty the insured performs for the insurer's benefit. Mitigation cost is recoverable so long as it is reasonable and less than the damages would have been without it. In this case the cost of mitigation is unquestionably less than damages would have been without the additional production expense.

Mitigation costs are generally recoverable under a range of coverages, but to avoid a Catch-22 situation where the insurer denies payment for mitigation efforts taken because they do not meet a certain definition under the policy, I suggest that after a business loss, the inusured or its representative openly discuss the insurer’s expectations with respect to mitigation efforts and how these costs should be presented for recovery.

Reliance paid nearly $1,000,000 for certain claims but partially denied the claim for ingress/egress coverage asserting that without property damage, the insured could not recover under this provision and that there was no actual impairment to access since Fountain was able to drive its workers over the flooded and eroded roads for three days.

Fountain filed suit seeking appraisal, but Reliance refused and asked the court to interpret the following provision:

Loss of Ingress or Egress: This policy covers loss sustained during the period of time when, as a direct result of a peril not excluded, ingress to or egress from real and personal property not excluded hereunder, is thereby prevented.

The court held as follows:

The plain meaning of this language indicates an agreement between the parties that the contract for insurance cover any business interruption caused by loss by any peril not excluded. A “loss” is not predicated on physical damage but is one category of recovery along with damage and destruction as indicated by the use of the alternative coordinating conjunction “or.” Flooding due to Hurricane Floyd is exactly the type of peril this business interruption loss was drafted to insure against.

Furthermore, Reliance was aware of the location of the Fountain facility and was aware that the facility had a limited access. The court can only conclude that the parties intended that the policy would provide coverage not only when the property itself was inaccessible, but also when the only route to the Facility caused the property to be inaccessible. The court's conclusion that no physical loss is required to trigger business interruption coverage is further bolstered by the parties' inclusion of the following provision:

5. Interruption by Civil or Military Authority: This policy is extended to cover the loss sustained during the period of time when, as a direct result of a peril not excluded, access to real or personal property is prohibited by order of civil or military authority.

This provision immediately precedes the loss of ingress/egress provision. Neither provision requires physical loss, but merely covers loss sustained due to lack of access to the property. Therefore, the court finds that no requirement for physical loss to the property is required under the contract of insurance in order to trigger business interruption coverage under the ingress/egress clause.

Interestingly, the court found that the length of time for which loss of ingress/egress may be claimed is the length of time to restore Fountain's business to the condition that would have existed had no loss of ingress/egress occurred. The court also found that the insured’s efforts to pick up its employees and drive them to work were extraordinary (since they were driving over flooded and closed roads) and that the ingress/egress provision related only to reasonable access to the property.

Not all ingress/egress provisions are as expansive as the one interpreted in Fountain Powerboat, as most forms will limit the period of recovery to a few weeks. It is highly recommended that any business located in an isolated or hard to access area consider reviewing the ingress/egress provision of its policy to ensure that adequate coverage is provided.

In consideration of additional premium, the Time Element [ie business interruption] coverage of this Policy is extended to cover the actual loss sustained caused directly by the interruption of the specified incoming services during a Period of Service Interruption, or if applicable, during the Restoration of Normal Operations […]

Coverage is provided for loss resulting from interruption of the following specified incoming services: Gas, Water, Electricity, Telephone […] by reason of any accidental [occurrence] to the facilities of the following suppliers: Any Public Utility[,] that immediately prevents in whole or in part the delivery of useable services specified[..]

Because reality bites harder than illusion, a case which illustrates the importance of “service interruption” coverage is in order. In Red Bird Egg Farms, Inc. v. Pennsylvania Mfrs. Indem. Co., 15 Fed. Appx. 149 (4th Cir. 2001), the insured ran an egg farm with more than half a million chickens. In this type of facility, constant ventilation is required or the chickens perish within an hour. To prevent this massacre, the insured employed an extensive system of electric ventilation fans that required a “three-phase” alternating current to operate correctly and keep the chickens cool.

For those who don’t know, alternating currents oscillate between positive and negative voltage. In ordinary household current, this oscillation is a straightforward sine wave and it is called a “single-phase” current. A three-phase current is essentially the “stacking” of three single phase voltage oscillations on a single line. This stacking enables greater power transmission over an existing electrical line. Each stacked wave is slightly out of phase with the others. Electric motors, such as the ones housed in the chicken facility, were built to handle only one type of alternating current. Three-phase power is used mainly in industrial applications. Three-phase motors will burn out if they are supplied with single phase current.

In this case, lightning struck outside the chicken facility and the power supply was interrupted. The facility’s generators, which were capable of generating three-phase alternating currents, responded immediately, but then failed because of a ruptured coolant hose. As the facility’s employees worked to fix the generators, the local power plant restored service, but only in a single-phase power, which blew out the motors of 100 ventilation fans. An employee disconnected the incoming power and activated a secondary generator, but that generator failed as well, at least partly because it could not handle the increased load of the burned out fan motors. All 500,000 chickens died.

The chicken facility submitted a claim for the loss of the birds, debris removal, damage to the generators, and business interruption. The carrier paid approximately $1,000,000 for the loss, but denied the business interruption claim under a loss of power exclusion endorsement, which read as follows:

(1) Any loss caused directly or indirectly by the failure of power or other utility service supplied to the described premises, however caused, if the failure occurs outside of a covered building.

But if the failure of power or other utility service results in a Covered Cause of Loss, we will pay for the loss resulting from that Covered Cause of Loss.

After a bench trial, the lower court found that the introduction of single-phase current caused the motors to blow out, which led to the demise of the chickens. The trial court also found that the power failure and restoration incident fell under the exclusionary language above. The facility appealed and argued that that since the motors in the fans burned out, the introduction of single phase power cannot properly be considered an “interruption” in power, and, in fact, can best be characterized as too much power for the three-phase fans.

The appellate court upheld the trial court’s finding stating:

First, the language of the policy excludes business interruption losses caused by a “failure of power or other utility service,” and does not mention “interruptions.” Accordingly, Red Bird's detailed discussion of the accepted meanings of the word “interruption” is irrelevant. It is the language of the policy that controls.

Second, the record evidence supports the determination that, contrary to Red Bird's assertions, single-phase current was not “too much” power for the ventilation fans. Rather, single-phase power was the wrong type of power for the fans. Red Bird's argument that single-phase power should be considered to be “too much” power is unsupported by the record.

Surprisingly, the trial court was not persuaded by the facility’s ensuing loss argument, that since the motors “blew out” there was business interruption coverage as a result of a fire. The appellate court was not so kind either.

Once the electric motors in the ventilation fans were exposed to single-phase current, the motors in many of the fans “burned out.” This appears to have involved overheating, melting of the insulation around wires in the motors, and some smoke. But, there was no evidence of any flames. The district court found as a fact that although the motors “burned out,” there was no actual “fire” involved. The damage caused in this case is enough like fire that perhaps a finding that the damage was fire damage would be supported by the evidence. However, the damage is not so obviously “fire” damage as to render the district court's factual finding clearly erroneous.

If there’s a lesson to be learned from this chicken demise, is that “service interruption” coverage should be strongly considered if a business heavily relies on utilities. As seen above, service interruption coverage would have provided business loss protection because the power supply was interrupted by the lightning, irrespective of the sophisticated power needs of the chicken facility.

When considering a policy that covers "accidental physical risks of loss," I wonder what a "loss" would be if there were no "damage" that occurred with it. I cannot think of such a situation.

An avid reader commented:

A couple of scenarios come to mind where a loss has occurred but NO physical loss to the insured property has been sustained.

Referring to the ISO Homeowners program the coverage for Civil Authority comes to mind where ALE costs would be paid even if there is no physical damage to the insured property.

Another situation may be a municipal water source which is contaminated and a coffee shop/restaurant is shut down because of it. The water is not insured (at least not before it runs through the meter) yet there may be a Business Interruption claim as a result.

To which Chip responded:

Thanks for your comment. I think there is a "physical" damage or loss component to each.

The ISO business income form CP 00 30 04 02 promises to pay "for the actual loss of business income you sustain and necessary extra expense caused by action of civil authority that prohibits access to the described premises due to direct physical loss of or damage to property, other than at the described premises, caused by or resulting from any covered cause of loss." So, the form itself refers to "physical" damage or loss.

Under ISO homeowners forms for loss of use, those state that if "a civil authority prohibits you from use of the `residence premises' as a result of direct damage to neighboring premises by a Peril Insured Against, we cover the loss as provided in 1) additional living expense and 2) fair rental value above for no more than two weeks." Again, the "direct" damage is meant to be "physical" albeit to the neighbors policy.

This “loss or damage” debate is also highly litigated in business interruption claims. The opinion in Philadelphia Parking Authority v. Federal Ins. Co., 385 F.Supp.2d 280 (S.D.N.Y. 2005), is illustrative. In this case, a Pennsylvania state-created agency that operated a parking facilities at Philadelphia airport sued its property insurer for certain business losses sustained when the FAA grounded all civil aircrafts after the 9/11 terrorist attacks.

The parking authority presented a claim under its Business Income, Contingent Business Premises, and Civil Authority Provisions of the policy. The carrier denied business interruption coverage stating that no “direct physical loss or damage” had occurred “to the insured premises.” The carrier further denied coverage under the Civil Authority Provision stating that there was no direct nexus between the physical loss or damage (that occurred in DC, New York and Western Pennsylvania) and the closure of the airport and the parking facility in Philadelphia.

The parking authority argued that the claim was covered under its Business Income and Contingent Business claim, contending that the phrase “direct physical loss or damage” is ambiguous because it is unclear whether “direct physical” modifies “damage” as well as “loss” and that therefore the Court should construe the phrase in Plaintiff's favor and read the word “damage” to include economic damage. The court rejected this argument and held that:

[i]f Plaintiff's proffered interpretation of the language were correct, the Provisions' requirements would be unreasonable as applied to a business interruption claim based on purely economic damage. As discussed above, an insured making such a claim would need to show not only that the economic damage (to either the insured's covered property or a contingent business premises) resulted from a “covered cause of loss,” but also that the economic damage itself caused the interruption in the insured's business operations. It is difficult to imagine such a situation actually taking place. Moreover, it was clearly not the situation here.

However, if, as Defendant argues, “direct physical” modifies both loss and damage, the Provisions' requirements make sense: the interruption in business must be caused by some physical problem with the covered property (or the contingent business premises), which must be caused by a “covered cause of loss.” For example, if an insured business had to temporarily close its store because of structural damage caused by a fire, the Business Income and Extra Expense Provision would clearly cover the resulting losses. In that instance, the “direct physical loss or damage” would be the structural damage, and the “covered cause of loss” would be the fire. Thus, the Court will not adopt Plaintiff's “torturing the phrase” merely to create an ambiguity which does not exist when the contractual text is read in context and its words construed in their commonplace meanings.

With respect to the Civil Authority provision, the parking authority argued that the FAA’s order grounding civil aircrafts “effectively prevented ingress and egress of passengers into terminal areas of the airport and the parking facilities” and, as a result, there was a severe reduction in business. In this case, the court held that:

The plain language of the [FAA order] did not “prohibit[ ] access to” Plaintiff's garages as the policy requires. The NOTAM was issued to the attention of “all aircraft operators,” and deals only with the grounding of airplanes. While this unprecedented order may have temporarily obviated the need for Plaintiff's parking services, it did not prohibit access to Plaintiff's garages and therefore cannot be used to invoke coverage under Plaintiff's policy.

Since the [FAA order] did not prohibit access to Plaintiff's garages, it is unnecessary for the Court to decide whether the FAA issued the NOTAM “because of” the damage caused by the plane crashes in New York, Washington D.C., and Pennsylvania or, as Defendant argues, only to prevent additional terrorist attacks.

The question whether coverage is triggered by the mere existence of a “loss” without a finding of “damage” is one of the most debated causation dilemmas in property insurance coverage litigation. Philosophically, the “loss or damage” debate could be as difficult as the “chicken and egg” conundrum, but the mystery certainly keeps matters interesting.

Gordon was required to continue or to resume manufacture of polystyrene from monomer liquid plastic when and if possible and to sell the product manufactured by it as it would have done if no fire had occurred. However, it was not required to buy from competing manufacturers and resell their product, which it would never have done had no fire occurred. The purpose of the policy is to preserve the continuity of the insured's earnings. The policy does not accomplish that purpose if the insured manufacturer is required to act as a distributor for its competitors in order to reduce its business interruption loss.

Alternatively, most policies provide as part of an insured’s duties to mitigate that existing inventory should serve as a means for reducing a business loss. In Northwestern State Portland Cement Co. v. Hartford Fire Ins. Co., 360 F.2d 531 (8th Cir. 1966), a cement company suffered a loss of production at one of two clinker plants. However, the insured did not suffer a loss in sales because there was a large inventory of finished cement and stock pile clinker. In this case, the court did not allow recovery for the loss of clinker production, but it did, however, allow recovery for extra expenses necessarily incurred in replacing finished stock to reduce to the loss.

Under the terms of [the policy] the insured is not permitted to sit idly by during a business interruption but must take affirmative action to reduce the loss of earnings. It must reduce the loss resulting from the interruption of business, if possible, by partial or complete resumption of the business; by making use of other property at the location; by making use of stock, raw, in process or finished. Such reduction is to be taken into account in arriving at the amount of loss.

It is clear that there would have been a loss of sales (income) except that plaintiff took the steps required of it by Paragraph 3 to reduce, and in fact to prevent, any loss of sales from occurring. Thus, the actual loss sustained by plaintiff was its loss of stock used to prevent loss of sales and thereby protect its earnings which would result in the normal uninterrupted operation of the business. The policies specifically state what is to be paid an insured for taking these required steps to prevent loss. Paragraph 4 provides the insured is to be compensated therefore by receiving such expenses, in excess of normal, as would necessarily be incurred in replacing any finished stock used to reduce the loss.

Further, on the subject of inventory, a court has found that if an insured is able to sell its entire damaged inventory, the insured may not have a viable business interruption loss. In Baxter Inter., Inc. v. American Guarantee and Liability ins. Co., 861 N.E. 2d 263 (1st Dist. 2d 2006), the insured sustained property and inventory damage after a hurricane suspended its pharmaceutical manufacturing operations.

In this case, Baxter submitted claims to recover losses resulting from property damage and business interruption. American indemnified Baxter for the property damage portion of its claim, including losses to Baxter's damaged finished goods inventory. American paid Baxter the amount Baxter would have received had Baxter been able to sell the inventory. Of the $30.7 million American paid in damages to Baxter's inventory, about $15 million accounted for lost profit. Baxter did not claim business interruption losses resulting from the damaged inventory. Baxter, however, claimed it suffered business interruption losses due to damage of other property. American maintained the profit component of the damaged inventory payment must be considered in calculating Baxter's total actual loss during the period of interruption. Baxter maintained American could not consider payments it made under the personal property provision of the policy to reduce its obligation under the business interruption provision. The parties filed cross-declaratory actions.

Baxter sought a declaration that American's liability for losses due to business interruption is independent of its liability for damaged inventory. American asserted the policy covered only “actual loss” due to business interruption, which must be calculated by considering profits Baxter realized from American's “purchase” of the damaged inventory.

On summary judgment the court held that:

[A]n insured cannot recover for lost profit due to business interruption where there has been no actual loss. In other words, business interruption is not itself a loss. An actual loss occurs only where the insured is unable to reduce or eliminate lost profit caused by the interruption. Baxter was able to reduce its lost profits by selling its damaged inventory to American during the business interruption.

Without citation to authority, Baxter contends its business interruption loss is independent from the profit it realized from selling its damaged inventory to American. Baxter explains the profit it realized from the sale of the damaged inventory was not the result of business interruption but the result of property damage. We fail to see how this distinction matters. The business interruption provision provides coverage for actual loss resulting from business interruption but not exceeding “gross earnings.” “Gross earnings” is defined in the policy as “total” sales and other earnings minus costs. It is not defined, as Baxter suggests, as “only the gains or losses resulting from such business interruption.” In other words, there is no suggestion from the language in the policy that a distinction can be made between different types of profit.

This year has already produced 2 tropical systems early in the season. We are receiving a warning loud and clear. Please take time to make hurricane plans. Inventory your belongings. Make necessary changes to your insurance policy. Many folks have their property under-insured, don't let this happen to you. If you need to increase your insurance limits, then do so...don't expect the insurance companies to know your needs. This is your responsibility.

From a Business Interruption perspective, these forecasts should not be taken lightly. For those who do not regularly keep up with this blog, I suggest you read Learning from Other’s Mistakes – Understanding Business Interruption Claims – Part 15 to learn how a catastrophic loss could run a business to the ground without the possibility of recovery despite having adequate insurance coverage. For those keeping score at home, I suggest you read it again.

The best business interruption claim is one that is planned for in advance of a loss. In other words, the success of a business interruption claim after a catastrophic loss will most likely depend on how well prepared the business is to handle an interruption event. Many companies have emergency response plans, which include team coordination and responsibilities. However, many small businesses barely have such response plans in place.

I recently came across an article in CAT Claims: Insurance Coverage for Natural and Man-made Disasters – Chapter 10- Proving Business Interruption Losses, where the authors suggested that many businesses should consider having an “insurance recovery team” as part of their response plans, where the team would work in tandem with risk managers and attorneys in order to address issues such as preservation of evidence to prove insurance coverage and causation, as well as the costs incurred in responding to a loss and the interruption event.

The article suggests a few pointers worth sharing:

• At the first team meeting the risk management personnel or the broker should brief the other team members on the scope of the coverage provided in the policy to insure that everyone has a clear understanding of what is covered and what type of documentation is needed to support a claim. Documentation will include accounting documents for all loss related expenses, budget/forecasts, accident reports made by the company, etc.

• The operations representative should review the loss event and the impact that it will have on the business. As this is early in the process it is unlikely that all the effects will be identified and the discussions should address the worst case and the likely case [scenarios].

• The accounting representative should inform the team on how the normal accounting process would respond to the event and what additional steps will need to be taken to capture the information needed to substantiate the claim to an adjuster.

• The planning representative will need to review the budget and model that is used for forecasting income and expenses. This [step] is critical as BI claims are based on theoretical calculations of what the business would have made as income had the event not occurred. The risk management personnel broker and claim consultant need to have a good grasp of this prior to communicating with the insurance adjuster. The adjuster’s first report to the underwriter sets the stage for the claim and correcting any misunderstanding in this first opinion is very difficult.

• The team, with the input of the claim consultant should develop the initial strategy for the handling of the claim along with setting up the schedule for the next meeting.

• The legal representative should advise the team on confidentiality issues and assist in the analysis of subrogation potential as the facts surrounding the event become known.

The reality is that many small businesses can only dream of having such an organized team in place to assist it before or after a loss. However, carefully following the highlighted pointers should, at minimum, give the business owners or managers an idea of the value of its claim and the period of time it will take to bring the claim to a successful conclusion and, hopefully, to a full resumption of operations.

WMS manufactures electronic slot machines and provides different options for continuing services for those slot machines. Casinos can lease from WMS (1) stand alone slot machines, which operate individually; (2) “local-area progressive” (“LAP”); (3) “wide-area progressive” (“WAP”) slot machines, which are networked across multiple casinos and centrally monitored by WMS. Each class of WMS’s WAP machines participates in a single progressive jackpot, with WMS taking all wagers from a central monitoring location and paying out from that location. In Mississippi, WMS operated its WAP machines from a central facility known as “Premises 24” in Gulfport, which was connected to the actual slot machines at participating casinos by T-1 data lines provided by a third party.

WMS had a $100 million limit under its business income and extra expense coverage, but only $1 million under its dependent premise coverage. WMS was able to resume operations of its Premises 24 on December 2, 2005, but many of its casino customers took much longer to resume operations, if at all.

Concluding that the bulk of WMS’s losses resulted from WMS’s casino customers’ delay in reopening rather than from damage to WMS’s own premises, Federal paid the policy limits under the dependent business premise coverage. WMS’s losses, however, were much larger.

WMS’s relevant policy provisions read as follows: 

Property means: building; personal property; personal property of employees; electronic data processing property; valuable papers; fine arts or research and development property.

Premises Coverages-

The following Premises Coverages apply only at those premises for which a Limit Of Insurance applicable to such coverage is shown in the Declarations.

Except as otherwise provided, direct physical loss or damage must:

• be caused by or result from a covered peril; and

• occur at, or within 1,000 feet of, the premises, other than a dependent business premises, shown in the Declarations.

Business Income And Extra Expense

We will pay for the actual:

• business income loss you incur due to the actual impairment of your operations; and

• extra expense you incur due to the actual or potential impairment of your operations,

during the period of restoration, not to exceed the applicable Limit of Insurance for Business Income With Extra Expense shown in the Declarations [$100,000,000].

This actual or potential impairment of operations must be caused by or result from direct physical loss or damage by a covered peril to property, unless otherwise stated. (emphasis added)

Dependent Business Premises-

We will pay for the actual:

• business income loss you incur due to the actual impairment of your operations; and

• extra expense you incur due to the actual or potential impairment of your operations,

during the period of restoration, not to exceed the applicable Limit Of Insurance for Dependent Business Premises show under the Business Income in the Declarations [$1,000,000].

This actual or potential impairment of operations must be caused by or result from direct physical loss or damage by a covered peril to property or personal property of a dependent business premises at a dependent business premises.

The Fifth Circuit Court of Appeals agreed with Federal in finding that the business income/extra expense provision at issue unambiguously required that the losses in question flow from the damage to one of the listed premises and not just to property damage anywhere.

Although not clear, it appears that the Court decided that the term “property” in the business income/extra expense provision is limited to the premises listed in the declarations page. But after reviewing the appellate briefs from both sides, it is clear that the court refused to address crucial and meritorious arguments raised by WMS’s attorneys.

WMS essentially argued that the “Premises Coverage” section is a “trigger” provision which requires property damage at the defined premises, but that the “scope” of coverage is actually defined within the business income/extra expense provision, which would include property located elsewhere [not just at the described premises]

WMS argued in its appellate briefs that Federal’s failure to explicitly limit the scope of its business income coverage, as limited elsewhere in the policy, was an implicit grant of broad coverage:

Federal attempts to defend its interpretation by arguing that it is “absurd” to provide coverage to WMS for damage to the property of casinos because BI/EE coverage is a “Premises Coverage” because it is triggered by damage to the premises. The fact that BI/EE coverage is a “Premises Coverage" does not mean that only damage to property at the premises is compensable under the Policy. Imposing such a limitation would render [other] Premises Coverages such as Ingress and Egress and New Product Delay equally “absurd”. The Policy’s Ingress and Egress coverage protects against damage to property “at a location contiguous to” a covered premise. The Policy’s New Product Delay coverage protects against damage to any property that “results in a delay in the introduction of any new product” irrespective of where that property is damaged. Both are nonetheless Premises Coverages.

The WMS Industries v. Federal Insurance opinion is scant in length. As a federal law clerk, I always felt that parties deserved a detailed and lengthy explanation as to why the court ruled one way or the other. It is the least a court can do, to consider exhausted parties that have long battled for a court resolution and to also consider the concept of stare decisis, since opinions are likely to become the mantras of many attorneys for generations to come.

Click here to read the full opinion by the Court and Reply brief.by WMS Industries.

We will pay for the actual loss of Business Income you sustain due to the necessary suspension of your “operations” during the “period of restoration”. The suspension must be caused by direct physical loss of or physical damage to property at the “scheduled premises”…caused by or resulting from a Covered Cause of Loss.

Begins with the date of direct physical loss or physical damage caused by or resulting from

a Covered Cause of Loss at the “scheduled” premises, and

b. Ends on the date when: (1) The property at the “scheduled premises” should be repaired, rebuilt or replaced with reasonable speed and similar quality; or

(2) The date when your business is resumed at a new, permanent location. Whichever is earlier.

Often a commercial lessee will not obtain building coverage because the lessee does not own the leased property, but it will obtain coverage for business personal property and the equipment maintained at the leased premises. In these types of cases, commercial tenants who sustain a property loss will argue for a lengthier period of restoration by asserting that “scheduled premises” refers to the actual building in which it leases space, and therefore, the period of restoration should end when the building owner repairs, rebuilds, or replaces the building in which the damage is located. On the other hand, insurers argue that the period of restoration should end when the commercial lessee obtains new leased space and repairs, rebuilds, or replaces the business personal property that was lost.

But what if the commercial lessor takes too long to repair or restore the insured building? Should the lessor’s delay or inability to rebuild be taken into consideration in the lessee’s claim for business interruption coverage? After the terrorists attacks of 9/11, courts were asked to answer the question of whether the actions of the commercial lessor should be considered in determining the period of restoration. In general, courts held that the period of restoration should be only tied to the insured’s lease and business personal property and not to the original location of the building that housed the insured’s leased space.

Specifically, in Duane Reade, Inc. v. St. Paul Fire and Marine Ins. Co., 411 F.3d 384 (2nd Cir. 2005), the court found that there was nothing in the business interruption clause that provided site-specific coverage, i.e., to resume operations at the World Trade Center. The Court specifically stated:

It would be entirely unreasonable to interpret the Restoration Period to include the time it would take for Duane Reade to resume operations in a store located at its former site where that site was neither the subject of the insurance policy nor expressly provided for in the calculus set forth in the Restoration Period.

In Lava Trading v. Hartford Fire Ins. Co., 365 F.Supp.2d 434 (S.D.N.Y. 2005), Hartford argued that the period of restoration ended when the insured “should have” replaced its personal property and relocated with “reasonable speed and similar quality.” In contrast, the insured argued that the phrase “property at the described premises” referred to the entire World Trade Center building, and because that building could not be rebuilt within the twelve months following September 11, 2001, the period of restoration should be the maximum twelve months allowed for under the policy. The Court rejected the insured’s argument, holding that the policy did not provide coverage for the “building” in which it operated, finding that the phrase “property at the described premises” referred to the insured’s business personal property located in its rented office suite.

Notwithstanding the bright line rule established in the World Trade Center cases, courts have found that if the commercial lessee has an insurable interest over the “described premises,” the period of restoration will be tied to the restoration of the original site.

For example, in Zurich American Ins. Co. v. ABM Industries, Inc., 397 F.3d 158 (2nd Cir. 2005), the insured was a contractor who employed more than 800 people to provide maintenance, janitorial and HVAC services in the common areas of the World Trade Center. In finding in favor of the insured, the court noted that although the insured did not “own” or “lease” the common areas and the premises of the other tenants, the insured “controlled,” “used,” or “intended to use” these areas and the common areas were vital to the execution of the insured’s business purpose.

The ABM court also reasoned that “while exclusive access to an area is not necessary to ‘control’ that area, exclusivity strongly supports that ‘control’ exists.” Id. at 166-167. The court found that “ABM’s privileged relationship with, and management of, its offices, storage spaces, freight elevators, closets, and sinks indicates that it exerted power and direct influence over these premises . . .[it] ‘controlled’ its occupied properties.” Id.

In light of these legal nuances, it is important to closely look at the relationship between the lessor and the lesee to determine whether the lessor’s failure to restore the premises where the business is located can be tied to the lessee’s period of restoration.

In smaller losses, where the insured is able to rebuild and resume operations rather quickly, the period of recovery will be measured by the “actual time” it took to rebuild and resume operations. In large-scale or catastrophic losses, however, it may take years for an insured to resume its pre-loss operations. Many times, insureds are so financially devastated by a loss that they are unable to even attempt at resuming the business. In these cases, recovery is measured by a theoretical period of restoration, where differences of opinion are likely to take place.

When dealing with a theoretical period of restoration carriers will come up with rigid formulas to determine how long it “should” take its insured to rebuild and resume operations, but these formulas seem only to work in a vacuum as they rarely take into account “real world circumstances”, which is why many will take their battles to court.

Anchor Toy Corp. v. American Eagle Fire Insurance, 155 NYS 2d 600 (Sup. Ct. 1956) is seminal to understand theoretical periods of restoration. In Anchor Toy, the insured’s factory burned to the ground. The insured did not rebuild the site. Instead, the insured directed its energies to purchasing another factory, but the deal fell through and the insured gave up on resuming operations.

After considering expert testimony with respect to the time it would theoretically take to rebuild and resume operations, the Court then held that:

It is defendants' contention that the building to be rebuilt would be an exact duplicate of this structure. The detailed description would reduce the time to be spent on architectural services to a minimum. This premise is however at fault. The rebuilding contemplated by the policy is the replacement that would actually follow after a disaster. It is beyond the bounds of reasonable contemplation to expect that a replacement structure would ignore all progress in the art and slavishly retain any proven disadvantage. It must be the intent of the policy that the new building to be erected would be modern as well. Doubtless if an extraordinary additional time would be required to include improvements or innovations these would not be included. It would follow that an architect's services and time for their performance would be needed.

In rejecting the rigid formula that the carrier proposed, the court went on to state:

Actual construction would take twenty-two weeks. Installation of machinery was fixed at six weeks, but one week of this would coincide with the completion of the building. This totals thirty-eight weeks. This is the time it would take to replace the structure providing the building was put up by the experts in the court room. But buildings seldom are. In the field it snows, and men fall off girders, and the wrong size window glass is delivered. An estimate of eight weeks for these contingencies is not believed to be excessive.

In a recent article published by the American Bar Association titled Business Interruption Insurance: Calculation of the Period of Restoration Must be Informed by Post Loss Challenges, it was noted that:

Anchor Toy stands for the straightforward proposition that even where a property owner does not rebuild, it still may recover its business interruption loss as if it had rebuilt. This is important protection because after a major loss, businesses may face difficulties securing financing, worker attrition, a diminished market, or other challenges that stand in the way of a return to profitability. When faced with such challenges, insureds may decide that it is economically or otherwise impractical for them to repair or rebuild lost property. In such instances, the theoretical period of restoration makes insurance recovery possible. By taking into account real-world circumstances when calculating the theoretical period of restoration, however, the insured likely can obtain all the benefits due under the policy.

Another opinion that considers the challenges an insured may face after a devastating catastrophe is SR Intl. Bus. Ins Co. v. World Trade Center Properties, LLC, 2007 WL 519245 (S.D.N.Y 2007). In SR International the insured argued that in cases where the insured property was located inside the World Trade Center, the rental value claims should be computed via a “theoretical period” vis a vis the “actual time” it would take to rebuild the WTC site, as it was on the morning of 9/11.

While the Court held that the claim loss of rent claim would be valued by an appraisal panel under a “theoretical period” to rebuild as it was on the morning of 9/11, the court also stated that the panel may:

[…] indisputably may consider “real-world circumstances” such as rental market rates or vacancy statistics for the relevant time periods after 9/11 in arriving at its valuation. Such data will undoubtedly reflect a changed, post-9/11 commercial real estate market in New York. The Appraisal Panel is entitled to give that evidence whatever weight it feels it deserves. “[Although] [t]he restoration period remains theoretical ... it is not computed in a vacuum.

In sum, both opinions allow the insured to factor in “real world” contingencies in the theoretical period, which should yield a more accurate measure of recovery even in the strictest hypothesis.

The Standard ISO Extra Expense provision reads as follows:

[Insurer] will pay necessary Extra Expense you incur during the ‘period of restoration’ that you would not have incurred if there had been no direct physical loss or damage to property at the described premises ... caused by or resulting from a Covered Cause of Loss.

Extra Expense means expense incurred:

(1) To avoid or minimize the suspension of business and to continue ‘operations':

(a) At the described premises ...

(2) To minimize the suspension of business if you cannot continue ‘operations.’

(3) (a) To repair or replace any property ...

to the extent it reduces the amount of loss that otherwise would have been payable under this Additional Coverage or Additional Coverage f., Business Income ...

After reading the extra expense provision, it is ascertainable that the timing of when an expense is incurred is just as important as the fact that it is incurred at all. The provision expressly states that extra expense is limited to those costs actually incurred by the insured itself during a period of restoration. However, most policies do not define the term “incur”. As such, courts are often required to interpret the plain meaning of this provision and a set of facts.

Chatham v. Dann Insurance, 812 N.E. 2d 483 (Ill. App. Ct. 2004) provides a detailed analysis on this issue. Chatham ran a medical equipment sterilization facility. After an explosion, the facility was shut for seven months. During that time, Chatham could not sterilize equipment for one of its main customers. Pursuant to Chatham’s contract with its main customer, Chatham was obligated to arrange for alternate sterilization and pay the cost of shipping the customer’s unsterilized goods to the alternate facilities. The contract, however, did not require Chatham to pay for shipping the sterilized equipment back to its customers and Chatham never did pay for such “outbound freight” costs. Chatham submitted a claim that included those return shipping costs that its main customer incurred and sought coverage under their policy extra expense provisions.

The carrier paid for the reconstruction of the facility and for $1MM of “inbound freight” costs as extra expenses claimed by the insured as a result of the explosion, but it refused to pay an additional $1MM in return shipping costs incurred by Chatham’s biggest customer. Chatham filed suit.

Although the carrier had made a partial payment for extra expenses, the court found that the carrier had not waived its coverage defense and held that the costs of shipping products from an insured's alternate facilities to the insured's customers were not covered, reasoning that Chatham had not itself incurred those expenses:

We are unable to find any ambiguity in the contract language regarding extra expenses.[…] This commonly understood meaning encompasses expenses that the named and additional insureds to the policy, Chatham and SSV, were required to incur during the reconstruction of the sterilization facilities. It does not encompass expenses that the insureds may have wanted to incur on a gratuitous or voluntary basis, which would have been the opposite of “necessary.” It also does not encompass expenses that other, nonparties to the contract were required to incur during the facility reconstruction period. The only party required to pay for the cost of shipping [the customer’s] sterilized products away from the alternate sterilization facilities was [the customer’s] itself, not Chatham or SSV.

The court further defined the meaning of incurred:

“Incur” is another term that was not defined in the contract, but it has a plain, ordinary, and popular meaning of “to become liable or subject to through one's own action; [to] bring or take upon oneself.” Random House Webster's Unabridged Dictionary 969 (1998). Chatham never became liable or subject to the expense of [the customer’s] outbound freight. [Its customer] did.

In conclusion, under the standard extra expense provision, although certain extra expenses may be a direct consequence of a loss, they will not necessarily be covered unless the named insured incurs it on its own -- not through a third party.

A fire at the insured’s headquarters resulted in smoke and water damage that allegedly made use of the facilities impossible. The insured immediately rented space at an alternative site and relocated there the next day, albeit with substantially fewer telephone lines. The insured did not return to its headquarters for approximately six weeks.

The insured submitted a claim for the policy's $500,000 limits for lost income and extra expense premised on the period of restoration.

The extra expense provision stated:

We'll pay your actual loss of earnings as well as extra expenses that result from the necessary or potential suspension of your operation during the period of restoration caused by direct physical loss or damage to property at a covered location. The loss or damage must occur while this coverage is in effect and must be due to a covered cause of loss.

We'll pay your earnings and extra expense loss from the date the property is damaged until the earliest of the following:

• the date you resume normal business operations;
• as long as it should reasonably take to repair, rebuild or replace the damaged property, plus 30 consecutive days; or
• 12 months, regardless of your policy's expiration date.

St. Paul denied the claim, citing the fact that no suspension of business had occurred. Surprisingly, the trial court agreed with Saint Paul on summary judgment. The insured appealed.

Fortunately the court of appeals read the policy in its entirety and remedied the Catch-22 situation that policyholders often face:

If a trier of fact believes AMIC's evidence, we conclude that the alleged loss would be a covered one. According to its version of the facts, AMIC experienced a “necessary suspension” of its business operations briefly on the morning following the fire. Moreover, on that morning, it faced a “potential suspension” of a much longer duration. Fortunately for AMIC and St. Paul, AMIC acted promptly to mitigate its loss and managed to make arrangements to conduct its business on a scaled-down basis at an alternative site. As a result of that “necessary suspension” and that “potential suspension,” St. Paul was required to indemnify AMIC for any lost earnings or extra expenses arising from such suspensions during the period up to the date upon which AMIC was able to resume its normal business operations at the Gibraltar Road site, i.e., the covered location.

Under the district court's construction of the policy, the insured would have no motivation to mitigate its losses. Continuing in business at any level would bar recovery because the insured would be carrying on the same kind of activities that occurred at the covered location. We decline to accept the suggestion that this was the intent of the parties. Indeed, other provisions of the policy bear witness to a contrary intent. For example, the policy imposes on the insured an affirmative duty to mitigate its losses:

If you can reduce your loss by resuming operations at the covered location or elsewhere by using damaged or undamaged property ... you agree to do so.

Under the district court's reading, this provision would have imposed upon AMIC a duty, the performance of which would have forfeited its right to recover under the policy. We are confident that such an anomalous result was not intended and choose to read the policy terms regarding St. Paul's duty to indemnify as consistent with AMIC's duty to mitigate. Moreover, as appears from the earlier quoted portion of the policy, St. Paul's obligation to indemnify continues until the resumption of “normal business operations.” This necessarily implies that the obligation to indemnify can arise while business continues, albeit at a less than normal level.

Keith Turner, a fellow attorney from California, forwarded me a novel and interesting court opinion from his home state that may change the typical business interruption rhetoric.

* * * * * *

Section V-Definitions

1. “Business income” means:

a. Net income (net profit or loss before income taxes) that would have been earned or incurred; and
b. Continuing normal operating expenses incurred, including payroll.

* * * * * *

Under this provision, carriers will often argue that if a policyholder was operating at a net loss greater than the business’ normal operating expenses, the business interruption recovery would be zero. In Florida, some carriers rely on Dictiomatic, Inc. v. Mercury Cas. Co., 958 F.Supp. 594 (S.D. Fla. 1997), where a court held that “business interruption insurance may not be used to put the insured in a better position than it would have occupied without the interruption,” to deny or offset recovery for operating costs if the business was not doing so well prior to the loss.

However, an appellate court in California used a different kaleidoscope to read the same provision and found that that, in the event of a covered loss that forced the complete suspension of its business operations, the policy would provide coverage for any lost profits, and, even if there were no lost profits, for ongoing expenses incurred during the period of suspension. In Amerigraphics v. Mercury Casualty Company, 182 Cal. App. 4th 1538 (March 23, 2010), the Court declined to follow Dictiomatic and held that:

[i]f a catastrophic event damages an insured's business premises and prevents the insured from being able to operate, any business in that situation would face two distinct problems: (1) a loss of money coming into the business (loss of income), and (2) payment of ongoing fixed expenses, even though no money is coming in. A reasonable insured would see that the definition of “Business Income” has two distinct components: (i) net income, and (ii) continuing normal expenses. Because the definition provides that “Business Income” includes both items, a reasonable insured relying on the plain language of the clause would reasonably conclude that the policy covers both items. Indeed, we note that the “Business Income” provision appears in the policy under the preceding heading of “Additional Coverages.” Given its placement in the policy and the plain language of the provision, it would be objectively reasonable for an insured purchasing the policy to construe it as protecting both its lost income stream and as defraying the costs of ongoing expenses until operations were restored.

Under both parties' interpretation, an insured business will be paid if the business were operating at a profit prior to the covered loss. It is only when a business was operating at a net loss greater than its operating costs that it would not be paid at all under Mercury's interpretation. But there is nothing in the policy language to suggest to an insured that if a business is not earning a profit it should not expect coverage for its continuing expenses during the period it cannot operate. It is not unusual for business income to fluctuate from year to year. A business should not have to be concerned that if it does poorly for one or two years and a covered catastrophic loss occurs during that time frame, then the business will not be paid anything under the “Business Income” provision. In essence, Mercury's interpretation relies on the implied assumption that only a profitable business would be protected by the provision. A business that is just starting out may operate at a temporary loss until it becomes established and secures a customer base. If that business knew that there would be no coverage under the “ Business Income” provision of the policy for ongoing expenses if it suffered a catastrophic loss under the policy, there would be no point for that business to purchase the additional coverage.

Feel free to contact me if you have any questions or concerns about how this new decision may impact your business interruption claim.

Most extra expense provisions state that coverage will be extended for necessary expenses that the insured incurs during the “period of restoration.”

While there is normally little debate as to when the period of restoration begins, there is often much debate as to when the period ends, since most policies limit the time period to the time that it would take to repair or replace the damage “with reasonable speed or similar quality” and return the business to its pre-loss operational capability. This means that if an operation is suspended for four months but the premises could have been restored to operating conditions in eight weeks “with reasonable speed and similar quality,” the recovery period will probably be limited to eight weeks.

Insureds should keep in mind that returning the business to “operational capability” does not necessarily mean to return the business to pre-loss income levels, a feat which may take much longer to accomplish. Operational capability is merely the entity’s ability to produce goods and provide service at the same level, efficiency and speed as before the loss.

As a general rule, the end date of the period of restoration cuts off the loss of income and extra expense claim.

For example, in Millville Quarry v. Liberty Mutual, 31 F. App’x. 116 (4th Cir. 2002), a quarry operator maintained a system of four water pumps to remove naturally occurring excess water. The pumps were affixed to a platform and the policy only covered the pumps and the platform, but not the entire quarry. One day the quarry flooded and the pumps were lost. In order to save the quarry, the insured rented four additional pumps that were identical to the previous ones, but could not install them due to unrelated electrical problems. The quarry operator then rented additional pumps stabilized the quarry and resumed operations six months after the flood. The quarry operator filed a $9 million extra expense claim with Liberty Mutual. Liberty Mutual advanced $450,000 to the quarry operator to pay for the cost of pumping activities, but it denied the balance of the claim.

In affirming the lower court's grant of summary judgment in favor of Liberty Mutual, the court reasoned that the period of restoration imposed a “temporal rather than substantive limitation on the” policy's extra expense coverage. The court specifically noted that the period of restoration ended when the quarry operator obtained pumps that were identical in number and pumping capacity to the four that had been destroyed by the flood. Although the pumps were not operational on the date they were delivered due to the electrical problem, the court held that the pumps should have been replaced with reasonable speed and similar quality by the date of delivery and that any delay in making the replacement pumps operational did not arise out of the flood or any damage to the lost pumps. Extra expense costs incurred beyond the period of restoration, including costs for additional pumping activities, the construction of a second barge, hydrology investigations, and limestone grout work to stabilize the quarry, were denied as they were incurred outside of the period of restoration.

On the other hand, in Zurich American Insurance Co. v. ABM Industries, Inc., 2006 WL 1293360 (S.D.N.Y. 2006), a janitorial company that held a contract to clean the World Trade Center (“WTC”) submitted a claim to its carrier as a result of the September 11 attacks. ABM was a facility services contractor that provided janitorial, lighting, and engineering services in the common areas of the WTC; provided janitorial services for virtually all of the tenants in the WTC; and operated a call desk through which it provided engineering and lighting services to the WTC tenants.

Among the claimed extra expenses were (1) increased salary costs that resulted because the janitorial company was required to bump junior employees at other locations with more senior employees displaced from the World Trade Center, (2) increased unemployment insurance assessments levied by the State of New York after dozens of the company's workers filed for benefits, and (3) costs associated with the termination of engineers whose services were no longer necessary following the destruction of the buildings. The policy had a standard period of restoration provision, stating that the length of time will not exceed what “would be required with the exercise of due diligence and dispatch to rebuild, repair, or replace the property that had been destroyed or damaged.”

Following remand from the U.S. Court of Appeals for the Second Circuit, and contrary to some other WTC decisions, the district court held that “restoration of the World Trade Center itself [was] necessary for ABM to resume its operations.” In that case the court did not set a specific date for the end of the period of restoration and held that the “appropriate period of recovery is the hypothetical length of time required to rebuild the WTC”, which left the closure of the period of restoration to be determined by a jury and placed the policy's entire $50 million extra expense limit in the hands of a jury.

Many business owners consider “pulling the plug” after a loss. Whether emotionally based or a strict numbers decision, business owners want to know if they can sell their business and assign their business loss claim as part of the package.

Bronx Entertainment, LLC v. St. Paul’s Mercury’s Ins. Co., 265 F.Supp.2d 359 (S.D.N.Y. 2003), is illustrative of the type of analysis that courts will engage in when determining the recoverability of assigned claims. In Bronx Entertainment, an insured suffered windstorm losses at its golf driving range facility. The insured made an insurance claim for the property damage and business losses and then sold the business to Bronx Entertainment. As part of the business transaction, the insured also assigned the policy to the buyer. Bronx Entertainment subsequently presented a business interruption claim for its own business losses; the carrier denied the claim and Bronx Entertainment filed a lawsuit.

In Bronx Entertainment, the Court essentially held that the claimant could no longer show actual losses sustained as required under the business interruption provision because the sale reduced the amount of continuing business losses to zero. The Court explained, however, that it may be possible to maintain an action for the losses accrued by the original insured [the assignor] at the time of the assignment.

[i]n the instant case, plaintiff is seeking to collect business interruption damages arising out of a business which did not come into existence until 17 days after the wind damage, and after Family Golf [original insured], the named insured, to whom defendant had issued its policy had ceased to operate the business covered and had transferred the title, ownership and control of the premises to plaintiff. Therefore, plaintiff cannot assert a claim for losses it suffered. Of course plaintiff may maintain an action for Family Golf's losses that accrued as of the date of the assignment. However, plaintiff is proceeding on the theory that it is also entitled to those business losses which had yet to occur at the time of the assignment. This plaintiff cannot do because it would, in effect amount to an assignment of the entire policy to which defendant did not consent.

In other words, a business owner may assign the rights and benefits of an insurance claim to a potential buyer as part of the deal. The buyer, as assignee of the insurance claim, cannot pursue a claim in his or her own right, but rather make a derivative claim as if standing in the shoes of the original insured. It is also important to note that, as a matter of assignment law, the buyer [or assignee of the claim] will also be subject to any defenses that the carrier had or could have had against the original insured [assignee], i.e., normal policy exceptions and exclusions.

Complying with code upgrades often extends the period of time it takes to repair or replace the property after a loss. Depending on the type and nature of the code requirements, repairs could be extended for several months and depending on the type of policy this time delay may not be covered. Depending on the size of the business, this could translate into significant unrecoverable losses.

"period of restoration" does not include any increased period due to the enforcement of any ordinance or law that regulates the construction, use or repair, or requires the tearing down of any property.

Most business policies also have a standard ISO CP 00 10 “Building and Property Coverage Form,” which will provide coverage for the increased costs incurred to comply with the enforcement of new building codes up to a cap or limit. However, the delay in repairs or replacement caused by complying with the required forms may still not be covered by this basic form.

Large-scale business owners, should speak with their brokers about company or manuscript forms that provide not only complete coverage for the increased costs, (i.e., not limited to a percentage), but will also provide coverage for the period of time required to adhere to the code upgrades. Typical wording is the following:

Increased Cost of Construction
This policy also covers any increase in the Business Interruption and extra expense loss arising out of the additional time required to comply with state law or ordinance.

All business owners should call their agents to give their policies a little spring check-up on code upgrade coverage.

Many policyholders are not familiar with the documents or income accounting records required to present a business interruption claim. To comply with the requests from an insurance carrier, policyholders are often forced to retain accountants to accumulate the data and provide a report to the company, but such services are rarely free.

While the typical answer to this question is “It depends,” The FC&S Bulletin addresses and clarifies the question as follows:

There is nothing in the wording of the business income portion of the policy [CP 0030] that obligates the insurance company to pay the insured's accounting cost to determine the extent of the business income loss. The policy promises to pay for "the actual loss of Business Income you sustain due to the necessary suspension of your 'operations' during the 'period of restoration.'" Business income is defined in the policy to mean "a. Net Income (Net Profit or Loss before income taxes) that would have been earned or incurred; and b. Continuing normal operating expenses incurred, including payroll." The accountant's fee is neither net income nor continuing normal operating expenses.

Now, CP 00 30 also provides extra expense coverage and some may argue that this coverage would apply to the accounting documentation charges. The argument goes that extra expense is defined to mean necessary expenses that the insured incurs during the period of restoration that would not have been incurred if there had been no direct physical loss; and, the accounting fees in question would not have been incurred had there been no loss. Furthermore, the policy also requires that the extra expense be incurred to avoid or minimize the suspension of business and to continue operations. Since it is fair to assume that the insurance company would not have paid the business income loss if the insured had not submitted the requested accounting information, and since the insured's business would have continued to be suspended or operated at reduced income if the insured had not been paid for the business income loss, the accounting documentation was a necessary expense to continue the insured's operations.

We do not agree with such an interpretation of the extra expense coverage. However, one of the duties of the insured in the event of loss is to cooperate with the insurer in the investigation or settlement of the claim. If the insurer requests that the insured provide accounting documentation to support a claim, this can be seen by the insured as a duty required of him by the insurer. And, it is reasonable for the insured to assume that the insurer would pay for the insured's costs in performing this duty. The policy's terms do not require such a payment, but the costs the insured incurs while cooperating with the insurer should be taken into consideration in the final settlement of the claim.

Yesterday, I wrote about how swiftly the insurance industry has decided to shut down the possibility of recovery on business interruption claims resulting from the recent volcano eruption in Iceland. As reported, it is estimated that having to close Europe’s busiest airports may cost the airline industry in excess of $2 billion. While the insurance companies’ message of non-recovery was heard loud and clear, coverage fights will likely ensue, depending on the language of each individual policy.

With so much lost income at stake, the coverage dispute will certainly be hard fought. As a matter of Property and Aviation Law, some state courts have found that ownership interest of a surface proprietor could extend to the airspace above the property. See, e.g., Berenson Wholesale v. Arizona Public Public Service Co., 803 P.2d 930 (Ariz. App. 1990). As noted in my previous blog,

It has been reported that volcanic ash is extremely fine and, if aspirated, it could damage airplane engines and affect the navigation gear. P&C National Underwriter reported that the last eruption from this volcano lasted more than 12 months.

It is likely that policyholder advocates will argue that the volcanic ash damaged the integrity of the property’s airspace. Of course, a reading of each policy at issue will be necessary to understand the nature of the coverages afforded for a disaster of this nature and to qualify the definitions of what constitutes “property,” “direct physical loss” and “property damage.” At this time, though, the coverage issue is far from resolved.

Depending on the specific policy language involved and the nature and circumstances of the damages, the airline industry and many insureds could find recovery for business losses caused by this massive natural disaster.

For example, with so many businesses dependent on airline services for their supply and demand operations, contingent business coverage, if applicable, could provide business interruption coverage for the suspension or delay in the chain of services or goods. There are four (4) types of dependent business ISO endorsements:

1. Contributing Premises, such as the businesses that deliver materials to the insured,
2. Recipient Premises, such as the businesses that receive the insured’s products,
3. Manufacturing Premises (businesses that make products for delivery to the insured) and
4. Leader Premises, such as businesses that bring the customers to the insured.

If coverage is found, the airline industry and other insureds could also look into extra expense coverage as an additional coverage that goes beyond the typical coverage for direct physical losses contemplated by the general insuring agreement. Extra expense coverage should allow a business to continue in the event of an emergency, by indemnifying the insured for reasonable and necessary increased costs of operations that would not normally have been incurred, but for the covered loss (i.e., employee overtime and temporary computer systems or office equipment). 

On April 14, 2010, a volcano that was silent for almost 200 years spewed a massive plume of ash thousands of feet into the Icelandic sky. The volcanic ash quickly spread throughout Europe’s atmosphere, forcing the cancellation of 81,000 flights and the closure of airports in U.K., France, Germany and Scandinavia. Millions of passengers were stranded and flights did not resume until almost a week after. The International Air Transport Association and the Centre for Asia Pacific Aviation estimated that the disruption may cost the airline industry in excess of $2 billion.

Loretta Worters, spokesperson for the Insurance Information Institute (I.I.I.), noted that “in terms of business interruption for airports, there would be none because there is no physical damage to the airport or planes. So certainly this will be a financial set back for the airlines.” Lloyd’s of London, which received almost $1 billion in premiums from airlines in 2009 alone, must feel relieved.

However, it has been reported that volcanic ash is extremely fine and, if aspirated, it could damage airplane engines and affect the navigation gear. P&C National Underwriter reported that the last eruption from this volcano lasted more than 12 months. It is possible that, with time, some jet planes will be damaged, but it is hard to predict how insurance carriers will deal with this type of loss.