Property Insurance Coverage Law Blog : Florida Insurance Lawyer & Attorney : Merlin Law Group Law Firm : Tampa, Houston, Coral Gables, Gulfport

The catastrophe area experienced a series of earthquake aftershocks (one as recent as December of 2011) which inevitably delayed rebuilding projects. Mindful of the one-year coverage deadline, many businesses are feeling pressured to pay increased costs to speed up construction and resume normal operations.

The New Zealand Herald noted an example:

Louisa Cullen, of Beale and Cullen Dentists, said there had been pressure on her business to get up and running again before her insurance policy payments ran out. After the September [2010] earthquake, the business claimed a week of interruption insurance but realised that if it had been forced out of action for longer, it would not have been able to survive. The business' cover was increased three-fold before the February earthquake, which Cullen said enabled it to retain all its staff while its doors were shut for 10 months. Cullen had to find new premises for her business and said she was conscious of the February deadline.

"The builder's timeline initially had it finished in February but we said it had to be done before Christmas, come hell or high water," Cullen said.

The dentists are now operating again and the government is providing marketing assistance to rebuild its customer base, but not all Canterbury businesses have been as successful.

Canterbury’s Governor, Alan Bollard, addressed the Canterbury Board of Employers on the issue of delays recently and stated, “[w]ith the risk of ongoing damage from aftershocks and still high levels of uncertainty, insurers are not currently increasing their overall exposure to Canterbury and some insurance holders are having difficulties getting cover for new risks or increased limits”

A spokesperson for Vero Insurance stated that the company had paid out over NZ $800 million across their group towards claims in Christchurch, Canterbury, but the reality is that, unlike the dentists, many businesses did not have adequate insurance. The earthquake killed 181 people, and it has been estimated to be the world’s third costliest earthquake ($20 billion dollars).

Brett Solvander, of the Insurance Council of New Zealand, said the quake highlighted the fact that a lot of businesses did not have adequate insurance.

We know, anecdotally, that some small- to medium-sized businesses did not have sufficient business cover when the first earthquake happened in September 2010 ... The big February 2011 earthquake compounded the issue.

Notwithstanding the panoply of pressures, Christchurch policyholders should not cave to the insurance and reinsurance market. In fact, the U.S. has had numerous experiences with catastrophic claims handling and, under similar contruactual agreements, policyholders have been successful in extending the period of restoration beyond the theoretical period of coverage, which is calculated by insurers and rarely considers real world circumstances like aftershock delays. Christchurch policyholders can also benefit from the newest business interruption claims handling trends, where some courts have agreed that post-loss market conditions (i.e., recessions and downturns) should benefit policyholders. For a brief outlook on these issues, readers can follow this blog at Can "Real World Circumstances" Be Considered To Establish a Theoretical Period of Restoration? - Understanding Business Interruption Claims, Part 26 and To Consider the Economy, or Not To? 'That is the Question' -- Understanding Business Interruption Claims, Part 9.

H&H Hospitality L.L.C., the owner/operator of a motel located in Spring, Texas, was the named insured on a commercial property insurance policy issued by Discover Specialty Insurance Co. In September 2008, Hurricane Ike damaged the hotel, rendering approximately 40 rooms unrentable, but other rooms remained rentable and were rented following the storm. The policyholder submitted a claim to the insurer for business interruption losses of $293,191. After the insurer paid $51,971 on the claim, H&H sued Discover for wrongful denial of its claim for the remaining amount, and both parties subsequently moved for summary judgment.

In its decision, the District Court noted that the phrase “necessary suspension of your operations,” contained in the policy’s business interruption provision had been interpreted to cover the risk of a complete cessation of business activities at the covered premises. By contrast, policies that describe “necessary or potential suspension” of business activities have been interpreted to allow coverage for a partial cessation of business. As a result, the Court found that the policyholder’s argument that its policy provided coverage for reduced business operations lacked support in the plain language of the policy.

Interestingly, the Court pointed out that even if it assumed the existence of coverage, H&H failed to present evidence to raise a fact issue that it was unable to meet customer demand for rooms because H&H’s own “listing of occupancy stats,” which was uncontroverted, supported an inference that H&H did in fact have a supply of rooms sufficient to meet demand. For these reasons, the District Court granted summary judgment in favor of the insurer.

For more analysis of the suspension or interruption requirement in hotel/hospitality policies, see Michelle Claverol’s post, Hotels May Find Courts' Interpretation of Business Interruption Coverage Inhospitable.

For tips on avoiding business interruption coverage gaps check out Michelle’s post,
Hotels May Find Courts' Interpretation of Business Interruption Coverage Inhospitable, Part 2.

For instance, in O.T. Food & Liquor v. Hartford Insurance Co., 1996 WL 131805 (N.D. Ill. Mar. 21, 1996), the policyholder operated a retail grocery and liquor store that suffered substantial damage to its real property and inventory when a fire occurred in an adjacent building. The policyholder remained closed the morning of the fire and then reopened. The insurance company hired an adjuster to work with the policyholder's adjuster to segregate destroyed inventory from the "damaged" inventory. The policyholder believed much more inventory was damaged than the amount the insurance company found and subsequently sold the damaged inventory during a "2 for 1" sale. The policyholder kept no records of that sale. The policyholder then submitted a Business Income claim for destroyed and damaged inventory. In the coverage action, the insurance company argued that the policyholder’s failure to keep records of the damaged inventory meant that the policyholder could not demonstrate the amount of its loss. The court noted that this failure was not a breach of the insurance contract and that, at a minimum, the jury should determine the amount of the loss based on the evidence introduced at trial:

It is true that under Illinois law, which the parties assume controls this diversity action, the plaintiff bears the burden of providing its damages by a preponderance of the evidence. However, "[i]n virtually every type of case involving proof of damages, whether based upon negligence or upon the provisions of a policy, the assessment of damages claimed by the plaintiff is primarily a question of fact within the discretion of the jury." In the instant case, the [policyholder's] witnesses claim that all of the inventory in the store was damaged by the fire, but that only some of it was so destroyed as to be unfit for sale. The remainder was either partially damaged or cosmetically altered such that it could not be sold at full price…[T]here is at least some non-speculative, non-conjecture based testimony supporting the [policyholder's] claim of damage. Thus, viewing this eyewitness testimony of [the policyholder] and [the public adjuster] in a light most favorable to [the policyholder], we cannot conclude as a matter of law that the remainder of [the policyholder's] inventory was completely undamaged. Although [the policyholder's] failure to keep detailed records of its "2 for 1" sales, and its decision to move undamaged goods into the store from another location, certainly hampers its ability to prove its damages, we do not believe that it so undermines the [policyholder's] case as to warrant a grant of summary judgment.

A recent Business Insurance article stated that:

Moody's Investors Services Inc. weighed the reputational damage in its review of Penn State's bond rating.

In 2011, Penn State's major sources of revenue supporting its $4.5 billion in operations were derived from student tuition, housing and auxiliary fees, and health care operations. Private donations totaled $235 million—among the highest of all U.S. public universities, Moody's said in a statement.

Sources of Penn State's credit risk include the cost of litigation and potential settlements, loss of federal and state funding for research and other programs, weakened student demand, and diminished philanthropic support, among others, Moody's said.

Higher education risk managers can mitigate potential reputational risks using insurance and risk management techniques, which often start with making sure that allegations of misconduct are avoided, experts say.

The standard ISO Business Income Coverage Form CP 00 10 does not provide coverage for reputational or consequential damages. Educational risk managers, and those involved in protecting well-established brands or institution should be concerned. Reputational damage is difficult to quantify and the risk of loss is as predictable as a two-year old.

Further, most reputational risk insurance products provide only crisis management services (a.k.a public relation firms) and do not indemnify loss of revenue tied to potential reputational damage.

Many higher education institutions rely on Enterprise Risk Management (ERM) programs (offered by large risk managing firms), where teams perform routine due diligence reviews to maintain university community awareness of their responsibilities and obligations and the rules and procedures in place to deal with potential misconduct. Another best practice is to have a business continuity plan that provides faculty and administrators with updates on the various reporting laws and institutional procedures.

ERM programs and business continuity awareness plans are transferrable tools that could help any business that derives income from its public image. However, it is important to note that these tools do not provide coverage for the millions of dollars lost as a result of a scandal that tarnishes a business’ reputation.

The article also reports that efforts to develop business income loss coverage for reputational damage are already under way.

Lockton Cos. L.L.C. is working with insurers to develop business interruption insurance coverage resulting from the reputational damage suffered by universities or colleges, said Teena Hostovich, executive vp at Lockton Insurance Brokers L.L.C. in Los Angeles.

“Reputational damage has several different forms,” Ms. Hostovich said, noting that a decrease in student recruitment stemming from reputational damage is a business interruption loss that is very difficult to quantify.

“Most business interruption coverage currently is tied to specific types of losses that are much (easier) to quantify,” she said. “We're working on some language now that might address this type of thing."

Reputable brand name enterprises should consider these products and best management practices. The days of sweeping mishaps under the rug are over and the court of media and public opinion can trash a hundred years of hard work, judging the conduct of a single moment.

The yoga studio experienced two floods in the same year and sustained costly business income losses and loss in market share after they were forced to relocate half a mile away for over four months. After the second flood, the owners contemplated whether the location was worth the risk of another flood and restoration process (the second flood did not force them to relocate, but their customers had to wear headphones to block out construction noises during their sessions) or if they were better off somewhere else.

The New York Times asked business and risk experts to weigh in:

Ken Barnett, chief executive of MARS Advertising, a marketing agency based in Southfield, Mich., that lost everything in its 50,000-square-foot headquarters to a 2004 fire: “The karma may be great along the river, the space may be perfect, but the fact is there are enough things in business that you cannot plan for. Why burden yourself with the uncertainty, lying in bed on a stormy night, that your business may not survive?”

Donna Childs, author of a book about disaster preparedness: “The answer to the question of should they move to a new location is to be found in the mission of the business, providing stress-reducing yoga to aid fertility. Disruptions are stressful.”

John Glenn, Enterprise Risk Management (Miami) says: “Even the best business continuity plan won't save an organization teetering on failure before an event."

The verdict: the yogis decided to stay down the hall from the clinic. Here’s an excerpt of their interview.

Q: Did you survey your customers and employees to learn their feelings on being dislocated and inconvenienced by your floods?

Ms. Quinn: We did an informal survey at checkout when we were in our temporary location. We asked: How did you find the experience and location? What we should have done is like a SurveyMonkey, something a little more anonymous, because I’d say 80 percent of our patients put a very nice smile on their face and said, “Oh, you guys are so nice here.” A sort of attaboy pat on the back. I’m not certain we got many straight answers. I do remember a couple of clients saying the temporary location didn’t work, that it was noisy and felt incomplete. So I do think we lost some clients, but I also think those who stayed were committed to us on a lot of different levels.

Q: It sounds like there continues to be some uncertainty.

Ms. Quinn: There is some uncertainty. When Beth and I tried to renew our insurance, we were denied. Our insurance was dropped. Our insurance broker said this had nothing to do with our two losses but because we were becoming more like a bona fide medical facility because we were going into areas like nutritional supplementation, which is a field that scares some insurers, I guess.

Q: Do you have liability insurance and flood insurance at the moment?

Ms. Quinn: We do, but we had to put our entire account up for review and go to the open market. And we’re paying more than twice as much now, up from around $10,000 a year to about $24,000 a year.

Q: You’re insured, but there’s no guarantee, of course, that you won’t have another flood next July.

Ms. Heller: Believe me, Tami and I are going to have our toes, fingers and eyes crossed for the entire rainy season in Chicago. Honestly, Tami, every time it rains don’t you think, Oh, dear God, what’s happening at the river?

Q: Even with the advantages of being down the hall from the fertility doctors, is the karma really right at this site for an enterprise built upon such healing arts as yoga and massage?

Ms. Quinn: Because our mission is to integrate holistic medicine with traditional Western medicine, we don’t want to be separated. So we’re willing to take the risk of another flood to accomplish that mission, of having a Western medical doctor on one end of the hall and a holistic practitioner on the other end of the hall who talk to each other, and patients who treat all aspects of their person — mind, body and spirit.

Q: So if you suffer another flood, you would suck it up and stay where you are?

Ms. Quinn: If we ever had to temporarily relocate again, we would break our lease and say sayonara. I think if it happened a third time, and the doctors didn’t want to move, we’d have to go on our own because at that point we’d just be stupid.

The yogis made a business decision to stay. It appears that they are already experiencing insurability issues and a hike in premiums, but their business model is dependent on the location and they have decided to hedge the odds of another loss.

Chip Merlin noted in his blog post, Anticipating Manmade and Natural Disaster Trends That Impact Businesses, that:

Disasters are occurring with greater frequency with widespread financial impact; this is inevitable as the world’s population has increased and global trade is more frequent. Even when disasters occur far away or last for a relatively short period of time, we live in a globally interdependent society and are likely affected.

Buying adequate insurance coverage is a fundamental step in ensuring the success of a business enterprise, but insurance is never a substitute for a risk management plan that will help businesses maintain daily operations after a catastrophic event. As attorneys and consultants, we urge our clients to invest in understanding the ebb and flow of their operations and develop a resilient catastrophe plan that will jump start right away.

At a glance, it appears that the yogis did not have a resilient Business Continuity Plan as they relied on the landlord’s emergency response plan, which was frustratingly sluggish. We all wish the yogis the best of luck, but we all also hope they learned some valuable lessons on risk management and business interruption claims. The yogis should also consider purchasing adequate Contingent Business Income coverage, since they are dependent on the fertility clinic and another catastrophic loss could likely damage and interrupt the clinic as well.

The New York Times posted an interesting case study in their Small Business Section, A Business Ponders Whether Its Location Is Perfect, or a Disaster.

Pulling Down the Moon provides holistic services to women undergoing fertility treatments like yoga, acupuncture and nutritional counseling. I have to disagree with John Keynes, women from Venus have been hard wired to get what we want, when we want it, no matter what. Women drive the US economy and if you give us more money, we will save the world’s financial crisis one card swipe at a time. Pulling Down the Moon understands this paradigm and runs three successful locations with 35 employees and earns $1.3 million in annual revenue catering to women that want babies now, not when the economy recovers.

In 2010, heavy rains brought about an inch of water into Pulling Down the Moon’s main location in Chicago, which is conveniently nestled next to one of the country’s biggest fertility clinics. The yogis were at the ready with their mops and aromatherapy, but the building’s drains and sewers failed, bringing in a deluge of Chicago River water into the studio. The yogis’ landlord (the major fertility clinic) did not have a good disaster response plan and the restoration work took months as the yogis struggled to service their determined customers at a different locale. The yogis rebuilt and resumed operations at their original location 4 months after the flood. A business-interruption rider paid for the move to temporary quarters and reimbursed the ailing company month by month for lost revenue as patient visits dropped by as much as 30 percent.

Happy ending? No. Seven months later, another downpour flooded the yogis studio, but didn’t cause as much damage so they were able to resume operations quickly. Should the yogis stay? Should they go? The results of the NY Times’ case study will be posted this week as we all ponder the issue.

Some experts have weighed in:

Ken Barnett, chief executive of MARS Advertising, a marketing agency based in Southfield, Mich., that lost everything in its 50,000-square-foot headquarters to a 2004 fire: “The karma may be great along the river, the space may be perfect, but the fact is there are enough things in business that you cannot plan for. Why burden yourself with the uncertainty, lying in bed on a stormy night, that your business may not survive?”

Donna Childs, author of a book about disaster preparedness: “The answer to the question of should they move to a new location is to be found in the mission of the business, providing stress-reducing yoga to aid fertility. Disruptions are stressful.”

John Glenn, Enterprise Risk Management (Miami) says : “Even the best business continuity plan won't save an organization teetering on failure before an event.

Should the yogis move? Should they keep relying on poor landlord response and spend hard earned cash while they wait for insurance to pay every time it rains hard and they lose market advantage? We’ll see what the yogis decide next week.

Property Casualty 360° highlighted a few of the survey’s findings:

• The earthquakes and tsunami experienced in Japan and New Zealand this year, affected 20 percent of responding organizations, which were headquartered in 18 different countries.
• Cyber attacks became a top three source of disruption in the financial services sector.
• Supply chain incidents led to a loss of productivity for almost half of businesses along with increased cost of working—38 percent of respondents—and loss of revenue—32 percent of respondents.
• Longer term consequences of disruption in the supply chain included shareholder concern, 19 percent of respondents, damage to reputation—17 percent—and expected increases in regulatory scrutiny—11 percent.
• For 17 percent of respondents the financial costs of the largest single incident totaled a million or more Euros. This figure almost doubles to 32 percent where less resilient supply chains are evident in the research.
• Loss of talent or skills rose from 14th place in 2010 survey to 6th place in 2011. This represents a warning that lay-offs among supply chain partners is leading to increased disruption, the report says.
• Seventy-four percent of respondents either strongly agreed or somewhat agreed with the proposition that outsourcing and just-in-time/lean strategies were making their organizations more vulnerable to supply chain disruption.

In essence, globalization trends of outsourcing and “just-in-time efficiencies” are making supply chain relationships more vulnerable to disruption. Many global enterprises are profiting from outsourcing services and lean manufacturing costs in countries with lax regulatory requirements, which have been catastrophe prone this year. As global economies of scale become more and more attractive, it is important for businesses to understand their critical supply chain risks and exposures. Businesses should also obtain adequate insurance and establish reliable business continuity plans that rely less on insurance protection and more on resilient response planning.

In my blog post, Understanding Supply Chain Exposures – Understanding Business Interruption Claims, Part 76, I noted that risk managers should not stop at acquiring the best coverage available for a dependent businesses or service. They should also have a good back up plan to keep the supply chain running through a first party coverage claim. Risk managers must also understand the bottlenecks and supply chain problems that will likely occur in the midst of a catastrophe and have a plan that will keep the chain moving. While many feel that risk management is an unnecessary expense, it is actually an investment on market competitive advantage that guarantees higher profits, even in a futuristic dystopian world.

Forensic accountants can learn a few tricks from Johnny Cochran. It is very easy for scientists to give an opinion by applying the same set of rules to produce an “either, or” outcome. But without departing from the generally accepted principles in their field, forensic experts should strive to employ more holistic approaches that can put the facts in perspective, numerically speaking.

In Bemo USA Corp. v. Jake's Crane, Rigging & Transp. Int'l, Inc., 10-16663, 2011 WL 5438584 (9th Cir. Nov. 10, 2011), the trial court relied on the opinions of the plaintiff’s three experts, including one forensic accountant, in granting summary judgment in favor of Bemo USA for property damage, business income losses and extra expenses in the amount of $2,996,611.00.

Bemo is an Arizona corporation in the business of manufacturing taper mills, which are portable machines used to install metal roofs. Taper mills are approximately 40 feet long and weigh approximately 48,000 pounds. Jake’s Crane is in the business of rigging and heavy transportation. Bemo hired Jake’s Crane to mount a taper mill on a structure, but on September 7, 2005, the crane operator dropped the taper mill and destroyed the sophisticated machine.

Bemo ordered a replacement taper mill on an expedited basis to mitigate its losses, but it takes 12-15 months to manufacture and deliver. As a result, Bemo sustained more losses than Jake’s Crane was willing to pay and litigation ensued.

During the lawsuit, Jake’s Crane admitted liability. In support of its Motion for Summary Judgment, Bemo presented the Affidavit of Martha Zehnder, CPA. The trial court entertained written and oral arguments from both sides and ruled in favor of Bemo. Jake’s Crane appealed, alleging that the trial court abused its discretion when it accepted Marthan Zehnder’s Affidavit to support the summary judgment ruling.

Without entertaining oral arguments, the Ninth Circuit Court of Appeals affirmed the lower court’s ruling and stated in an unpublished opinion:

The contention that the district court erred because the report failed to affirm explicitly that it was based on generally accepted accounting principles (“GAAP”) fails for at least two reasons. First, the district court could reasonably conclude from the phrasing of Zehnder’s disclaimer that she did use GAAP except to the extent that she capped damages according to the requirements of the insurance policy. See Fed.R.Evid. 104(a). Second, there was no evidence that GAAP even addresses the question how damages for business interruption should be computed, much less that Ms. Zehnder failed to adhere to GAAP.

While the opinion does not have any precedential value, it certainly should give forensic accountants courage to test the parameters calculating business interruption losses.

Some policies require direct physical damage to the property before business interruption coverage is covered. Generally, under these types of policies, where the order of civil authority (and not physical damage) causes the business interruption loss, coverage is not triggered.

Other polices require a “direct nexus” between the civil authority order and the suspension of the insured’s business. See Southern Hospitality, Inc. v. Zurich American Ins. Co., 393 F.3d 1137, 1141 (10th Cir. 2004),

The FAA's order stopped airplanes from flying; it did not close hotels. Considering the policy as a whole, we agree with the district court's conclusion that the policy was intended to cover losses from an order directly affecting the hotels, not one tangentially affecting them as here. As we see it, the policy requires a direct nexus between the civil authority order and the suspension of the insured's business. That nexus is missing here. We hold that the civil authority provision does not apply because the FAA's order grounding flights did not itself prevent, bar, or hinder access to Southern Hospitality's hotels in a manner contemplated by the policies.

Other business interruption coverage depends on the specific language in the business interruption endorsement. The treatise, 11 Couch on Ins. § 167:15 provides the following guidance regarding actions of civil authorities absent physical damage to property:

. . . where civil disturbances led to a curfew resulting in a loss of income from food and beverage sales, the insured could not recover under the business interruption provisions of a policy because the access to its premises was not denied based upon damage to or destruction of the insured's property.” Caesars Corp. v. Jefferson Ins. Co., 280 A.2d 305, 307-308 (D.C. 1971).

However, no physical damage to the insured's property was required to trigger coverage where losses resulted from a curfew imposed after widespread riots, where the policy contained a provision stating that the policy “is extended to include the actual loss as covered hereunder, during the period of time, not exceeding 2 consecutive weeks, when as a direct result of the peril(s) insured against, access to the premises described is prohibited by order of civil authority,” and riots were a covered peril. Sloan v. Phoenix of Hartford Ins. Co., 207 N.W.2d 434, 436 (Mich. App. 1973).

Where a policy covered business interruption losses for up to two weeks if civil authorities denied access to the insured's theaters because of damage to adjacent property, an insured could not recover losses it suffered as a result of its decision to close its theaters during a curfew imposed after the Rodney King riots. Access to the insured's property was never specifically denied by civil authorities, the insured's theaters and properties next door to and across the street from the theaters had not been damaged, and no property within two blocks of the insured's theaters had been damaged or destroyed. Enterprises v. Home Ins. Co. of Indiana, No. 94-0756 FMS, 1995 WL 129229, at *1 (N.D. Cal. March 21, 1995).

If a policy provides for business interruption coverage where access to an insured's property is denied by order of civil authority, access to the property must actually be specifically prohibited by civil order, not just made more difficult or less desirable. Development, Inc. v. United Fire & Cas. Co, No. Civ. 04-5116, 2006 WL 694991, at *6 (D.S.D. March 14, 2006) (finding that road closures near property made access to the insured's property more difficult but did not equal a denial of access as per the terms of the policy).

Another consideration is whether the insured has an insurable interest in other property and the policy includes other property within the definition of covered property. See Abbey Co., LLC v. Lexington Ins. Co., 289 F. Appx 161, 163 (9th Cir. 2008) (damage from debris collecting in canal after storms triggered coverage; the definition of insurable property contained in the underwriting agreement included “the interest of the Insured in all real and personal property including but not limited to property owned, used, leased or intended for use by the Insured.”)

Policyholders, public adjusters and lawyers dealing with the recent wildfires and business interruption claims must closely examine the policy language regarding the property covered and the business interruption language regarding civil authority. The insured may have coverage for losses due to civil authority order-- even where property was not physically damaged by the fires.

Chip Merlin noted in his blog post, Anticipating Manmade and Natural Disaster Trends That Impact Businesses, that

Disasters are occurring with greater frequency with widespread financial impact; this is inevitable as the world’s population has increased and global trade is more frequent. Even when disasters occur far away or last for a relatively short period of time, we live in a globally interdependent society and are likely affected.

Wikipedia defines business continuity planning (BCP) as "the creation and validation of a practiced logistical plan for how an organization will recover and restore partially or completely interrupted critical (urgent) functions within a predetermined time after a disaster or extended disruption."

Note the following scenario posted on the Business Insurance website:

Many Japanese companies moved production to Thailand or found alternative component suppliers in Thailand after March's devastating earthquake and tsunami, RPC said Wednesday in a statement.

The move helped many companies mitigate their losses in the Japan disaster, but many face further losses as a result of flooding in Thailand this fall, RPC noted.

“The problem for insurers who provide business interruption cover to Japanese manufacturers is that they have to cover the losses stemming from the Thai flooding because so many businesses moved some or all of their supply chain there,” said Daniel Saville, legal director in the reinsurance and corporate insurance department of RPC.

“Moving production from Japan to Thailand was ‘Plan B.' The question now is whether those businesses have a ‘Plan C,'” he said in a statement.

“An additional factor in business interruption claims, especially those arising from electronics manufacturers, is that production may have been scaled up to deliver goods to the Christmas market,” said Victoria Sherratt, a partner at RPC. “Losses in those cases could be even higher,” she noted.

Are businesses required to also have a Plan C? Maybe. Certainly insurance companies will modify their products to draw the line somewhere and those who have too much to lose will likely keep going down the alphabet.

The New York Times reported this weekend that:

Russell Hunter, who owns Pfau’s Hardware in West Hartford, said that after a bizarre fall snowstorm knocked out power to nearly one million people in his state and millions more throughout the Northeast last weekend, his store was cleaned out of all storm-related supplies. They went at about five times the normal rate of sale, with everything from batteries to oil lamps to gas grills flying out the door as fast as he could order them.

While Mr. Hunter may have increased sales as a result of the snowstorm, not many other businesses are enjoying the same luck. Retail and service related enterprises are probably bleeding to death as they wait for the slow recovery.

Power outages are common following major weather events. Loss of income and other damage may be caused by off-site damage, similar to the power outage experienced by the businesses in Connecticut. For such situations, it is important to have off-site power outage coverage endorsed to the policy. When there is no direct damage to covered property, but damage to property of others results in a loss of power, most commercial property insurance policies will not provide for loss of income and other losses by definition. Off-premises damage resulting in loss of power is generally added as an endorsement.

For example, Utility Service Interruption Coverage generally provides:

We will pay for loss of or damage to Covered Property described in the Schedule, caused by an interruption in utility service to the described premises. The interruption in utility service must result from direct physical loss or damage by a Covered Cause of Loss (as indicated in the Schedule) to the property described in Paragraph C. if such property is indicated by an ‘‘X’’ in the Schedule and is located off the described premises.

The loss still needs to be caused by a covered peril, but this endorsement adds coverage otherwise excluded. Some business interruption forms are more restrictive and eliminate coverage for income losses if the failure occurs ‘‘outside of a covered building,’’ rather than loss of power on premises.

Restaurants, food stores and food brokers should also purchase Spoilage Coverage. This provides for losses caused by power outages on or off premises with the following language:

Power Outage, meaning change in temperature or humidity resulting from complete or partial interruption of electrical power, either on or off the described premises, due to conditions beyond your control.

Power outage is a common and significant threat to businesses. Prudent risk management requires power back-up systems as well as proper insurance coverage for these disasters. Otherwise, a second financial disaster will likely occur.

J&K Body Shop, Inc. v. Zurich American Insurance, et al., Civ-11-0077-HE (W.D. Oklahoma, 2011), illustrates the importance of submitting a well-documented business income claim.

The loss in question was a burglary where the perpetrators vandalized the insured’s office and stole several items. The insured reopened for business shortly after the burglary. The insured, however, spent three or four days seeking bids to have the office repainted. Repainting took most of a week, and it took several days to install carpet in the office, several hours to compile the list of damaged and stolen items, 16 and 24 hours contacting, or trying to contact, the insurance adjuster, and at least three days shopping to replace the computer and other electronic equipment.

The carrier adjusted the loss and paid $2,871.94 for damage to the building, $2,733.20 to repair and replace the business property that was damaged or stolen inside the office. Six months after the loss and after a series of carrier delays, the carrier offered $2,231 for the business income claim. The insured did not dispute the adjustment of the property claim, but it disagreed with the adjustment of the business income loss. After the insured objected, the carrier doubled its offer to $4,462, but the insured refused and filed a suit. The carrier filed a motion for summary judgment, arguing that $4,462 was more than enough to meet its contractual obligation under the policy.

The insurance policy contained a business recovery expense endorsement which obligated the carrier to pay “the extra expenses and reduction of business income” as a result of a covered loss. The policy stated that the carrier would pay those expenses “for as long as it reasonably takes to restore the damaged or destroyed building or contents, and to resume operations with the same quality of service which existed immediately before [the burglary], regardless of the expiration date of this policy.”

The only evidence relating to the adequacy of the lost business income was a letter from the business’ accountant describing a year-to-year reduction in gross income figures for the indicated six month period. That letter stated that the insured’s gross was $121,360.79 less than its gross income during the same six month period the year prior to the loss. The letter, however, made no effort to address the insured’s net income during the period of restoration, and failed to rebut or contradict the carrier’s contention that it had adequately adjusted the business income claim.

Given the lack of evidence presented by the insured, the court ruled in favor of the carrier and stated:

The letter offers no support for plaintiffs’ assertion that the reduction during this six month period was attributable to the burglary. Plaintiffs’ submissions are insufficient to show a justiciable question as to the contract claim. The $2,231 originally offered by Universal was based on J&K’s total sales for May, 2009—the month of the burglary. See Def. Fact 16. It calculated J&K’s average daily sales by assuming that all its May sales were generated before the burglary and then used that average to calculate estimated lost income for the remaining eleven days of the month.

Because J&K was open for business and in fact had sales in May after the burglary, that calculation plainly overstated the daily loss to J&K. Further, the calculation was based on gross profit (i.e. gross sales less cost of goods sold) rather than net profit, the standard under the policy provision, and therefore overstated the loss on that basis. For those reasons, defendant reduced the calculation by half to reach the $2,231 figure. Plaintiff offers no evidence or argument which undercuts defendant calculation of the daily loss or the loss figure based on that. Moreover, defendant’s doubling of the amount to $4,432 eliminates any conceivable question as to accuracy of the loss calculation unless some basis is shown for concluding J&K was entitled to be paid for more than the liberally calculated losses estimated for roughly two weeks of operation.

Without more details about the claim or the policyholder attorney’s decision to submit a three (3) page response that relied solely on a letter from an accountant, I cannot disagree with the outcome in this case.

In a previous blog entry – The Speculative Card - Understanding Business Interruption Claims, Part 68, I discussed the fine line that practitioners must walk to avoid this type of situation.

As a matter of Florida law, business interruption losses should be determined in a practical way, having regard for nature of business and methods employed in its operation, in order to give practical effect to intentions of parties and purpose of insurance as evidenced by terms, conditions, and provisions of policy. See, Travelers Indem. Co. v. Kassner, 322 So.2d 80 (Fla. 3rd DCA 1975).

The holding in Travelers does not mean that “anything goes” in business interruption claims. A speculative claim will never be covered by a policy and it is always the insured’s burden to provide competent proof of an actual monetary loss as a result of the suspensions of its operations.

It is always prudent to consider retaining forensic accountants to help a business review its financial statements and prepare reports in support of its claim, especially if the claim is on the way to litigation.

Cases holding that business interruption coverage is triggered even when the insured suffers only a partial suspension or impairment to its business operations are hard to find and often rely on specific and alternative wording in the business interruption section in the property insurance policy. For example, the court in Aztar Corp. v. U.S. Fire Ins. Co., 224 P.3d 960, 965 (Ariz. App. 2010), determined the insured’s business interruption coverage may have been triggered, even when the hotel’s operational capacity was not diminished, because the specific words in the policy modified “interruption:”

This policy insures against loss resulting directly from necessary interruption of business, whether total or partial, caused by damage to or destruction of all real or personal property, manuscripts and watercraft, by the peril(s) insured against, during the term of this policy, on premises situate per the Territorial Limits in this policy.

Because the hotel’s business interruption coverage included the word “partial,” the casino owner was able to recover for loss of revenue due to decreased patronage. Inclusion of the word “partial” meant the business impairment did not need to impact the entire business, but only a portion.

TIPS FOR HOTEL OWNERS AND RISK MANAGERS

To avoid business interruption coverage gaps consider the following:

1. Review the hotel’s property policy to determine if the business interruption provisions contain words such as suspension, cessation, or interruption of operations.
2. Consult with an insurance broker, agent or lawyer educated in business interruption and hospitality property coverage and determine whether the hotel’s policy would likely require a complete suspension of operations before coverage is triggered.
3. If hotel mitigation efforts may defeat business interruption coverage, shop for business interruption coverage that contains words that modify the term “suspension.” Look for terms in the business interruption provisions such as partial suspension, impairment, harm, slowdown, decrease, or reduced income.
4. Shop for endorsements which contain a definition of the word “suspension” that will protect the hotel even if it only suffers a slowdown due to property loss. Market segments endorsements, like ISO form MS HM 01 07 07, Hotels, Motels and Inns, defines the term “suspension” as, “the slowdown or cessation of your business activities.”

Although courts’ interpretations of these terms can be unpredictable, understanding the interpretations in Part I and Part II of this series and using these tips when shopping for business interruption insurance, can help a business avoid financial devastation after a loss. Careful review of a hotel’s property policy will help ensure that the hotel is not wasting its premium payments on business interruption coverage which will likely never be triggered. Similarly, an educated review will help hotel owners and risk managers purchase business interruption coverage that provides actual security for hotel income and makes sense for the hospitality industry.

The Standard ISO Extra Expense provision reads as follows:

2. Extra Expense

a. Extra Expense Coverage is provided at the premises described in the Declarations only if the Declarations show that Business Income Coverage applies at that premises.

b. Extra Expense means necessary expenses 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 caused by or resulting from a Covered Cause of Loss.

We will pay Extra Expense (other than the expense to repair or replace property) to:

(1) Avoid or minimize the "suspension" of business and to continue operations at the described premises or at replacement premises or temporary locations, including relocation expenses and costs to equip and operate the replacement location or temporary location.

(2) Minimize the "suspension" of business if you cannot continue "operations."

We will also pay Extra Expense to repair or replace property, but only to the extent it reduces the amount of loss that otherwise would have been payable under this Coverage Form.

Clearly, when an expense is incurred is just as important as the fact that it is incurred at all. The provision expressly states that extra expenses are limited to those actually incurred during a period of restoration. Most policies do not define the term “incur,” and parties often find themselves in court asking for favorable interpretations.

“Incur” is ordinarily defined as “to become liable or subject to through one's own action; [to] bring or take upon oneself.” Random House Webster's Unabridged Dictionary (1998).

This definition will typically exclude gratuitous or voluntary obligations (i.e., not otherwise helpful in reducing or minimizing the loss), which would not have been “necessary” and therefore not recoverable even though “incurred”

In Business Interruption-Coverage, Claims and Recovery, Daniel Torpey elaborates on the issue of paid vs. incurred expenses:

When a policyholder buys goods or services in connection with restoring its assets, it will likely do so under some type of financing arrangement. That expense is incurred at the time the goods or services are purchased, but it may be paid over a period of time. The expense is accrued for payment-as accounts payable-under accrual accounting at the time the obligation is incurred. When the actual payment is made, the payable balance is reduced, as is the company’s cash. Most disputes do not typically revolve around these concepts. Insurance companies generally recognize accounts payable and other accrued expenses as legitimate expenses in their loss calculations, although they often require proof of payment of those items before settling the loss.

The issue becomes significantly more complex and contentious when the dollar obligations are large and extend for a significant period beyond the time required for restoration or replacement of the damaged property.

Consider the situation of many major financial institutions after September 11, 2001. While most institutions had backup facilities for vital operations, thousands of employees were displaced by the damage or destruction of the buildings. Assuming that there would be a high demand for office space, some companies took unusual measures-from occupying entire hotels to entering in five or ten-year leases-to assure that they had sufficient temporary space to accommodate employees as quickly as possible and to minimize their business interruption losses during the reconstruction or relocation periods. As it turned out, more space was available than expected in the New York real estate market, and most institutions were able to relocate their work forces to permanent spaces fairly expeditiously. Unfortunately, these institutions then had unneeded space under long-term leases they were obligated to pay. And the soft, post 9/11 real estate market made subleasing virtually impossible.

The obligation for these leases was generally incurred during the period of indemnity for these companies, with the payment of these obligations set to occur over time. These specific issues still have no clear resolution, although most companies asserted claims for the present value of the tail on the residual lease obligations. Disagreements regarding the responsibility for paying these types of incurred, but not paid, obligations continue to be included in the ultimate negotiation of insurance and reinsurance claims. A very strong case can be made, based on insurance policies and simple logic, to support the validity of these claims. As a practical matter, the leases could be terminated – and the expense of doing so rightfully claimed-within the indemnity period.

I could not find a published court opinion that dealt specifically with long-term temporary losses incurred during the period of restoration, but the payment of which fell outside of the period. I believe that a policyholder’s efforts and money spent to resume operations swiftly and which reduce or eliminate a business income loss should be fully compensated, even if the time of actual payment for those efforts falls outside the period of restoration. Public policy should prevent an insurance company from denying coverage for legitimate and documented expenses incurred in accordance with a policyholder’s contractual obligation to mitigate its business income loss.

Most hotel owners and risk managers know that property policies require the insured to make all reasonable efforts to mitigate the loss through cleanup, emergency repairs, remediation, or containment. What many insureds don’t understand, however, is that their mitigation efforts (required by the policy) may actually defeat business interruption coverage. Ironic? Yes. But this inconsistency within property policies has been addressed and often enforced in favor of insurers by numerous courts, and still exists in many property insurance policies today. Part One of this post explains this coverage hazard. Part Two of this post will provide tips that may help hotel owners and risk managers avoid this hazard.

The business interruption section of many hotel property policies contains language similar to the following:

We will pay you 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 damage to property, including personal property in the open (or in a vehicle) within 1000 feet, at premises which are described in the Declarations and for which a Business Income Limit of Insurance is shown in the Declarations. The Loss or damage must be caused by or result from a Covered Cause of Loss.
. . .

“Loss Provisions:”

4. Loss Determination

c. Resumption of Operations

We will reduce the amount of your:

(1) Business income loss, other than extra expense, to the extent you can resume your “operations,” in whole or in part, by using damaged or undamaged property (including merchandise or stock) at the described premises or elsewhere.

(2) Extra Expense loss to the extent you can return “operations” to normal and discontinue such Extra Expense.

d. If you do not resume “operations,” or do not resume “operations” as quickly as possible, we will pay based on the length of time it would have taken to resume “operations” as quickly as possible.

The inconsistency with business interruption coverage lies in the following mitigation requirement:

C. Duties in the Event of Loss

You must see that the following are done in the event of loss or damage to Covered Property:

* * *

4. Take all reasonable steps to protect the Covered Property from further damage by any of the Covered Causes of Loss. If feasible, set the damaged property aside and in the best possible order for examination. Also keep a record of your expenses for emergency and temporary repairs, for consideration in the settlement of the claim. This will not increase the Limit of Insurance.

The conflict created by these inconsistent provisions often results in a coverage gap when the hotel mitigates the loss, takes all steps possible to relocate guests to other areas of the hotel, seals off damaged portions of the property, and thereby continues hotel operations at a reduced level. By mitigating damage from the loss, the hotel prevents a total suspension of its operations, and thereby defeats coverage for business interruption.

Although illogical, courts around the country follow this inconsistent interpretation of what constitutes a “suspension” or “interruption” of operations for the purposes of business interruption insurance. See Keetch v. Mutual of Enumclaw Ins. Co., 831 P.2d 784 (Wash. App. 1992) (damage from volcanic eruption causing a reduction in business at motel not a suspension of business activity); Hotel Properties, Inc. v. Heritage Ins. Co. of America, 456 So.2d 1249 (Fla. App. 1984) (diminution in business of hotel caused by closing of restaurant due to fire did not constitute interruption of business within policies in question); Howard Stores Corp. v. Foremost Ins. Co., 441 N.Y.S.2d 674 (N.Y.A.D. 1981) aff'd 439 N.E.2d 397 (1982) (recovery denied for water damage to business where there was no actual suspension of business but rather an alleged adverse effect on continuing sales); Pacific Coast Engineering Co. v. St. Paul Fire & Marine Ins. Co., 88 Cal. Rptr. 122 (Cal. App. 1970) (purpose of Business Interruption Insurance is to indemnify for loss due to inability to continue to use specified premises); Rothenberg v. Liberty Mutual Ins. Co., 153 S.E.2d 447 (Ga. App. 1967) (recovery under business interruption policy denied where theft of merchandise resulted in loss of business, court held that insured had not suffered an interruption in business but rather a diminution in volume).

These holdings are particularly devastating to the hospitality industry given the multi-purpose and interconnected nature of hotel business operations. Larger hotels often include within the “property” coverage: guest rooms, restaurants, meeting space, ballrooms, catering facilities, recreation amenities, shopping, casinos, and more. Even a massive property loss at this type of location is not likely to cause a complete and total cessation of all business operations. For hotels and resorts of this type, business interruption coverage may be rendered useless given courts’ interpretations of the policy language which require a complete suspension of operations to trigger coverage—regardless of severe income losses. See 37 A.L.R.5th 41:

"Necessary suspension" of operations, required as condition of business interruption coverage of apartment building owner's commercial property insurance policy, meant total cessation of insured's business operations, not mere suspension of normal business activities; thus, policy did not cover building's loss of income resulting from terrorist attacks nearby, once tenants, who had been excluded from building for one week, were permitted to return, regardless of fact that upon their return insured's business activities, and income, did not return to normal.

William H. Danne, 37 A.L.R.5th 41, summary of Broad Street, LLC v. Gulf Ins. Co., 37 A.D.3d 126, 832 N.Y.S.2d 1 (1st Dep't 2006).

It is important to note that many insurance agents sell business interruption coverage without knowledge of the above case law, and without ever informing owners or managers that the entire hotel or resort will likely need to shut down and cease all operations in order for the business interruption coverage to ever apply. Agents may not understand—and therefore not inform insureds how the coverage applies in light of the insured’s duty to mitigate. Insureds may purchase the coverage with the false sense of security that their hotel is protected from a huge decrease in income after a loss to their property.

A Ray of Light for Hospitality:

Fortunately, a few courts acknowledge the conflict between the insured’s duty to mitigate the loss, and the business interruption language requiring a suspension of business activity. Certain courts interpret the policy to provide coverage under circumstances that many insureds believe would entitle them to coverage, given the additional premiums paid for business interruption coverage.

In American Medical Imaging Corp. v. St. Paul Fire and Marine Ins. Co., 949 F.2d 690 (3rd Cir. 1991), the court reasoned that given the mitigation clause in the policy, an interpretation requiring a complete suspension of operations would create an inconsistency within the policy because an insured would have no motivation to continue its business at a reduced level and thus would have no motivation to mitigate its losses. The policy contained a condition creating an affirmative duty on the insured to mitigate its losses and that “under the district court's reading, this provision would have imposed upon [plaintiff] a duty, the performance of which would have forfeited its right to recover under the policy.” Id. at 693.

The 8th Circuit Court of Appeals, applying Minnesota law, issued a similar holding interpreting the words “interruption of business.” An “interruption of business” triggering contingent business interruption and extra expense coverage of commercial property insurance policy did not require cessation of business at insured's plants, but only impairment to insured's business arising from damage to supplier's property. Because the policy at issue defined “extra expense” to include expenses necessary to carry on business operations, the extra expense provisions would have been rendered nonsensical if contingent business interruption and extra expense coverage was triggered only upon cessation of business. Archer Daniels Midland Co. v. Aon Risk Services, Inc. of Minnesota, 356 F.3d 850 (8th Cir. 2004).

Cases holding that business interruption coverage is triggered even where the insured suffers only a partial suspension or impairment to its business operations are hard to find and often rely on specific and different wording in the business interruption section in the policy. Therefore, it is essential that hotel owners and risk managers carefully review the policy wording to determine if coverage is only triggered upon a suspension of business operations. The following tips may help insureds determine whether they are covered for partial suspension of hotel operations, or need to shop for a new policy.

1. Review the policy: Being able to recite ISO forms from memory, while impressive, is not enough. The best practice is to read the entire policy, including all endorsements, with every claim and take notes of the different categories of losses and expenses that could be covered. Sometimes the best words are found on the last page.

2. Understand your client: Not all businesses are alike. Understanding your clients’ business models, their projections, and how they maintain their books is critical. A successful and expedited business interruption claim will depend on how well the accounting data tells the story.

3. Give notice: Almost every policy requires that an insured give notice of the loss “promptly,” “as soon as practicable,” “immediately,” “within a reasonable time,” or within some other time period specified under the policy. Failure to comply with this policy condition may result in a denied claim.

4. Telling the story: In general, a policyholder bears the burden of measuring, documenting, and establishing his/her claim. Most businesses have internal accounting programs that capture and categorize the ingress/egress budget flows. Setting up a claim expense category in the accounting program (“claim schedule”) and keeping track of the expenses and invoices in real time is the best practice to document and measure the extent of the business income loss and incurred extra expenses. Producing massive reports alone is not compelling or persuasive. Modern computer programs have interesting features that will create custom accounting reports and summaries that present the hard data in a manner that tells a holistic story of loss from summary to detail (pyramid style). Organized reports presented with summaries and links to underlying hard data are extremely attractive and greatly appreciated by the carrier’s loss recovery team. These reports should be generated and submitted without delay.

5. The Meeting: Inform the carrier’s adjuster of your perception of the loss adjustment process in a small meeting. Be specific and mention areas that you find challenging. Suggest ways to overcome these obstacles, and ask the adjuster for advice on how to resolve the hurdles. If the harder issues are addressed at the beginning of the claim, the likelihood of success is almost guaranteed.

6. Cooperation: If you have followed suggested techniques 1 - 5, there should not be much left to get the claim resolved. If you have not been able to present an organized and supported claim, the policyholder will likely receive a lengthy letter requesting all sorts of information to assist the insurer in its investigation. This will inevitably cause significant delay in the adjustment process, and many business owners will not appreciate the intrusiveness of the request. Rightfully so, the information requested may infringe on trade secrets or information that fuels the business’ competitive advantages. If this is a concern, an insured should consider retaining an attorney, not only to openly discuss these concerns without fear of publicity, but also to consider the possibility of drafting and entering into a confidentiality agreement with the insurer. Most of the time, the insurer merely seeks to quantify a claim and will not oppose such an agreement.

7. Mitigation: Many policies cover only those losses that could not be avoided through reasonable post-loss mitigation efforts. With respect to business interruption coverage, an insured is often required to exercise due diligence to repair covered property damage and resume operations. Therefore, after a loss, an insured should quickly evaluate whether there are reasonable steps it can take to avoid additional business or property losses. To the extent possible, an insured may want to consider informing its insurer of its mitigation efforts to provide an opportunity for input and to avoid dilemmas after the fact. These mitigation expenses could also be covered as “extra expenses” under the policy, so following suggested technique 4 is also important for this type of coverage.

8. Document everything: Many business owners and managers already engage in the practice of documenting every relevant meeting and development in a claim, but in times of distress and anxiety after a loss, many forget to maintain this important practice. I always say, there is nothing more powerful than those green certified mail receipt cards at the post office; this practice simply makes life easier.

Manpower Inc. v. Ins. Co. of Pennsylvania, 08-C-0085, 2011 WL 3904643 (E.D. Wis. Sept. 6, 2011) is a horror story and a lesson to all coverage practitioners.

Manpower, Inc., leased office space in a building located in Paris, France. The building sustained a collapse loss and the collapse caused an interruption in Manpower’s business. Manpower filed a claim for business interruption coverage with its insurer, but the insurer denied the claim and Manpower filed a lawsuit. During the lawsuit, the court decided that Manpower was entitled to business interruption coverage and the only issue before the jury was the amount of the business interruption claim.

Before the trial, the insurer moved to strike Manpower’s accountant under Federal Rule of Evidence 702 (aka Daubert Challenge), claiming that his opinions and formulations were unreliable and therefore inadmissible for trial purposes. The court agreed with the insurer and did not allow Manpower’s expert to testify. The insurer then claimed that without an expert, Manpower could not prevail and that the case should therefore be summarily adjudged.

Manpower’s attorneys advised the court that they would use the insurer’s experts to prove the amount of the loss, a move not recommended for those with heart conditions. To complicate matters, Manpower was not able to compel one of the insurer’s experts to trial so the court had to decide the issue by looking at the deposition transcripts and expert reports.

In reviewing the reports the court found that the insurer “recommends” that the carrier pay no more than €399,821 to Manpower in connection with the claim. Manpower intended to offer this recommendation at trial as to the amount of the business-interruption loss.

The court, however, did not accept the recommendation as a reliable and admissible expert opinion that could have been presented to the jury to support Manpower’s claim.

A fundamental problem for Manpower is that Lewis's “recommendation” is not an opinion that would allow a jury to reasonably determine the amount of Manpower's loss. In the report, Lewis makes clear that he does not have enough information to express an opinion as to the amount of the loss and that therefore he can do no more than critique the calculations performed by Herr Experts and Sullivan. His “recommendation” is merely that—a recommendation to ISOP about how much to pay in connection with the claim in light of the limited information then available. Although this recommendation is an opinion, it is not an opinion that meets the requirements of Federal Rule of Evidence 702, and ISOP never intended that it serve as one. Indeed, Lewis explicitly states at various points in the report that he does not have sufficient facts or data to render an opinion as to the amount of the loss. Moreover, during his deposition, Lewis repeatedly states that he does not have an opinion as to the amount of the loss.

Manpower points to an excerpt from the deposition in which Lewis is asked about his “determination” of the amount of the business-interruption loss based on certain assumptions. Manpower argues that in this excerpt, Lewis is offering an opinion as to the amount of the loss. However, even if he were, that opinion would be inadmissible under Rule 702 because it is merely the “recommendation” discussed in the previous paragraph, which was not based on sufficient facts or data. Moreover, the cited excerpt appears after Lewis testified that he had no opinion as to the amount of the loss, and thus the full context of the deposition makes clear that Lewis was simply discussing the conclusions he drew from the limited data, not changing his earlier testimony and offering an opinion as to the amount of the loss.

Experts involved in the determination or calculation of a business income claim should be precise in their calculations and be able to support their conclusions with reliable and readily acceptable facts. An opinion without a factual basis is unreliable and inadmissible for trial purposes and worthless in the time of need. 

"Rental value" is a term specifically defined in coverage ISO form CP 00 30 10 91. To receive payment under the “Rental Value” the policyholder much show with competent proof:

a.) The total anticipated rental income from tenant occupancy of the premises described in the Declarations as furnished and equipped by you, and

b.) Amount of all charges which are the legal obligation of the tenant(s) and which would otherwise be your obligations, and

c) Fair rental value of any portion of the described premises which is occupied by you.

If the adjustment of a rental income claim is part of a business income calculation and the insured had no real prospects for its rental, it is not reasonable to anticipate rental income. If, however, the building had been rented consistently prior to the loss, and had only recently been vacated, or if the insured has verifiable prospects for a speedy re-rental, then it is appropriate to anticipate rental income.

If this is not the case, the Loss of Use provision in some commercial property forms may provide alternate coverage.

DePhelps v. Safeco Ins. Co. of America, 65 P.3d 1234, 1239-40 (Wash. Ct. App. 2003) is instructive. Thomas and Karen DePhelps owned a residence zoned general commercial and had five bedrooms, three full baths, four half baths, one great hall, and two kitchens - one of which was industrial. The DePhelpses rented rooms on a bed and breakfast basis. They also rented the great hall occasionally for weddings and similar events. Safeco Insurance Company sold them a homeowners' policy.

Heavy accumulations of snow and ice shifted and loosened part of the metal roof. Safeco covered the property damage loss, but the building and zoning department deemed the property to be a hotel and required commercial upgrades before approving repairs. Safeco refused coverage for the upgrades, arguing that it only expected to cover upgrades for homeowner purposes and not for commercial uses. Safeco also declined payment for the loss of rental income of the bed and breakfast operations.

The court disagreed with Safeco on both issues and granted coverage for both the code upgrades and loss of use for the bed and breakfast operations. With respect to the loss of use claim, the court stated:

[T]he policy contains separate loss of use provisions: one for the loss of the insureds' own housing and another for lost rental income. Again, as we read these provisions, the DePhelpses may recover the rental value of the home as a single family rental. Or they can recover the reasonable cost of equivalent housing for themselves (as reduced by the rental activity) plus an estimate of the amount they would have earned from the rented portions.

In other words, when a commercial lessor is found without proof of an “actual loss” of rental income, the lessor may find some measure of recovery for the theoretical loss of a rental period that it would have enjoyed, but for the loss to the property (limited to an actual period of restoration or when the repairs are completed).

Catastrophe losses are hard to estimate, especially after only a few days. In some areas of the Eastern seaboard, Irene broke flood records. I like to say that the insurance industry is in the business of making certainty out of uncertainties. Actuaries and risk managers are already heralding and attenuating Irene’s impact on the claims industry, but Irene’s final chapter is yet to be written.

The National Underwriter reported: “Irene: No Large Commercial Losses, but Justification for Recent NE Rate Increases,” stating:

Irene will not be enough to create a hard market turn because capacity remains available, but the pricing impact will most likely come to property and business interruption insurance coverage.

“This is a market that we already see in transition,” says Ellis. “There is ample capacity, but what will we pay for it?”

For the Northeast region, he says it also proves some modelers’ assertions that the area is susceptible to hurricane and tropical storm activity, justifying underwriting increases for those types events for commercial accounts.

“This is not a big enough loss to change the market, but the definition of catastrophe just got a little broader,” notes Ellis.

For wind exposures, risk managers can now expect to see higher rates on the risks they pay for, he says.

In fairness, National Underwriter recognizes that loss estimates will continue to rise in the flood claims arena, but they are not predicting business interruption to play a big role in CAT adjustment because this was not an event of “widespread devastation” with destroyed buildings or points of entry. The article also downplays the role of business interruption coverage, stating that:

Ports aren’t destroyed, trains and airlines are up—so there will probably be less of a business continuity aspect to losses,” he explains. “The average loss will be for short-term clean-up and spoilage.

I am still feeling the human impact and captivated by the devastation. Millions of businesses will suffer beyond actuary imagination. I anticipate a fierce battle in the adjustment and accounting methods in business interruption claims. The state of our economy will certainly have an impact in business income claims; the question will be “how do we account for it” -- in favor of or against the insured? For those keeping score of this trend in business income claims, I urge you to study this issue. A good place to start are my previous posts,

• To Consider the Economy or Not to? - That is the Question;

• Post Loss Market Earnings Ignored in Mississippi, and

• What’s Good for the Goose is Good for the Gander – Post Loss Market Conduct Ignored in Louisiana

If you have questions or comments on this issue, feel free to contact me or post a comment to engage in an open discussion.

The picture below shows Hwy 12 on the north edge of Rodanthe, North Carolina.

A typical ingress/egress provision will provide coverage for economic losses sustained when access to the insured property is impaired. The language found in most commercial policies reads as follows:

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.

Under most policies, the insured property does not need to sustain direct physical loss or damage for the insured to recover income losses which were the proximate result of inaccessibility to the insured premises.

Fountain Powerboat v. Reliance Ins. Co., 119 F. Supp. 2d 552 (E.D. N.C. 2000), illustrates of the value of this type of coverage. Fountain manufactured, distributed and sold boats and boating equipment out of a facility in Washington, N.C. In 1999, Hurricane Floyd dumped record-setting rain fall over the eastern part of North Carolina. After the storm passed, the only roads leading to the Fountain facility were closed for seven days. For three days, Fountain used large trucks to pick up workers from various “pick-up points” and transport them to the facility. As a result of displacement caused by the floods, production at the Fountain facility fell to 33 percent of full capacity.

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 despite their extraordinary efforts to resume operations, because there was no “actual impairment” to access as they were able to drive over the flooded and eroded roads for three days.

The Reliance policy had a standard ingress/egress provision, and the court rejected the insured’s “actual impairment” requirement.

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 could be claimed was the length of time it took to restore Fountain's business to the condition that would have existed had no loss of ingress/egress occurred.

Not all ingress/egress provisions are as expansive as the one interpreted in Fountain Powerboat. Most forms will limit the period of recovery to a few weeks. I strongly urge all claims professionals to carefully read the applicable provisions to determine if ingress/egress coverage dovetails into a commercial property insurance claim.

As recovery efforts take place, claims professionals should not only look for structural or physical loss at a property but should also consider important commercial coverages, such as service interruption and ingress/egress that are often triggered without requiring “direct physical loss or damage” at the insured property.

For example, in A Power Outage Saga Comes To An End – Understanding Business Interruption Claims – Part 61, I wrote about a case that interpreted a Service Interruption provision in favor of the insured after a power grid failure caused multimillion dollar loses in food spoilage at a supermarket chain.

The Extension provided that:

A. We will pay for consequential loss or damage resulting from interruption of:
(1) Power;
. . . .
B. We will pay only if the interruption results:
(1) From physical damage by a peril insured against;
(2) Away from a covered location; and,
(3) To the following types of property, if marked with an "X":
(X) Any powerhouse, generating plant, substation, power switching station, gas compressor station, transformer, telephone exchange;
. . . .
(X) Transmission lines, connections or supply pipes which furnish electricity . . . to a covered location.
The term "physical damage", however, was not defined in the Extension or in the underlying policy. The carrier insisted that the power grid did not sustain physical damage from a covered peril, but rather that the outage was caused because the grid internally failed. The court ruled in favor of the policyholder as follows:
We conclude that the undefined term "physical damage" was ambiguous and that the trial court construed the term too narrowly, in a manner favoring the insurer and inconsistent with the reasonable expectations of the insured. In the context of this case, the electrical grid was "physically damaged" because, due to a physical incident or series of incidents, the grid and its component generators and transmission lines were physically incapable of performing their essential function of providing electricity. There is also undisputed evidence that the grid is an interconnected system and that, at least in some areas, the power could not be turned back on until assorted individual pieces of damaged equipment were replaced. However, we do not rest our decision on that evidence. Rather, we look at the larger picture concerning the loss of function of the system as a whole.

It is important to note that Service Interruption provisions may have a time element requirement (i.e., only triggered after a certain number of days or hours have passed). I urge all agents, adjusters and risk managers to carefully read all applicable provisions before making a claim or a coverage determination. As the damages are assessed, I will highlight important coverage considerations that may assist claims professionals in recovery efforts.

Notwithstanding this exclusion, the standard business income loss provision should provide coverage for any interruption of business operations caused by direct physical loss or damage to the business owned vehicles.

The FC&S publication confirms this enigmatic issue.

Q&A

If there is a business interruption due to windstorm damage to vehicles parked on the insured's premises, does the phrase "to property at premises described" encompass any kind of property, like vehicles? Would such a loss be covered under business income coverage?

Puerto Rico Subscriber

While the commercial property form lists vehicles as property not covered, there is no such limitation on the business income form CP 00 30 04 02. In addition, CP 00 30 is not tied to the commercial property form; it can be written as a stand-alone coverage. Based on this, vehicles may be considered property in context of the business income insuring agreement, which requires that business income losses arise from a "suspension" of business that is caused by direct physical loss of or damage to property at described premises.

However, two other requirements must be considered when determining whether business income coverage is triggered.

1. The damage to or loss of vehicles parked at the premises must cause a "suspension" of business—that is, either a slowdown or cessation of business—that leads to a loss of income.
2. The second factor is that business income payments are available only during the "period of restoration," which is defined as beginning seventy-two hours after the direct physical damage and ending on the date when the property at the described premises "should be repaired, rebuilt or replaced with reasonable speed and similar quality."

The insured would have to prove that the damage to the vehicles led directly to a suspension of business and loss of income.

If requirement number one were met, recovery would be limited to the loss of business income beginning three days (seventy-two hours) after the direct damage and ending when the vehicles can be replaced "with reasonable speed and similar quality." Unless these are customized autos, it seems that it would be possible to replace them fairly quickly. The insured may have to rent autos if permanent replacements cannot be found within three days, which should be recoverable under extra expense if the insured carries that coverage.

There is nothing in the business income form that specifically excludes coverage for the situation you mention. However, the insured would have to prove that requirements one and two were met before coverage is triggered.

Policyholders should always consult with coverage counsel if they are ever in this enigmatic position and need help convincing their insurance company not to exclude an otherwise covered claim.

Typically, ownership or control between the dependent companies destroys contingent business income coverage in the event of a loss. However, an FC&S Bulletin article discusses the possibility of presenting a claim for “interdependent” businesses that share the same owners and avoid the coverage foreclosure.

Question:

Our client has complete or majority ownership of many companies, which are all insured on the same property and business interruption policy. Some of the companies make goods that are bought by the other companies within the group.

For example, one company is a paint producer and buys cans from another company in the group in which the actual paint is merchandised. Therefore, if one of these producing companies suffers a loss that is insured under the property coverage, there is a possibility that not only will this company suffer a direct business interruption loss but also that the recipient company of these goods will suffer an indirect business interruption loss because they could not produce their own products.

Would the business interruption loss suffered by the recipient company be covered under the policy given that they are insured under one policy and that they are companies of similar ownership? In order for the loss suffered by the recipient company to be covered, does there have to be an explicit clause or sublimit covering contingent business interruption?

Answer:

Our interpretation is that contingent business interruption is meant for companies that are important suppliers to a client but that do not share ownership or are controlled by the same administration. In turn, we believe that contingent coverage will not respond in this example.

However, we believe that interdependent business interruption coverage for companies that have similar ownership or that are controlled by the same administration is what would apply in this example. We consider this coverage to be required in explicit terms within the policy when these companies have different policies for each business or when the insurance company wants to sublimit this coverage to an amount smaller than the total business interruption limit of the policy.

If, as is our case, these companies are within one policy, unless excluded specifically in the policy, our understanding is that there is interdependent business interruption coverage up to the limit of the policy without the policy being required to specifically list it.

FC&S feels that it may depend on how the business income limit(s) was calculated. If it is based on total sales for all companies, then the "interdependent coverage" could be automatic. That is, because the can production is interrupted at Company A, Company B cannot sell its product, the loss of paint sales would be covered. However, if Company A and Company B have separate limits, the coverage may not work that way.

In the scenario discussed above a contingent business income endorsement alone would have failed to protect the policyholder’s loss. To avoid this costly coverage foreclosure, insurance agents, risk management professionals and company underwriters should carefully consider the interrelationships of the policyholder’s business operations to adequately endorse and structure the insurance product before it is issued.

In Averting Disaster: Techniques for Analyzing Business Interruption Claims, N.Y. St. B.J., October 2008, Russell Kranzler provides excellent practice pointers to beat these odds.

Immediately after a loss, it is critical to assemble a multidisciplinary team of competent, independent professionals to launch the recovery plan. With an attorney coordinating the effort, the team may include public adjusters, independent appraisers and forensic accountants with insurance experience.

Too often, businesses fall into the trap of relying too heavily on the insurance carrier's forensic accountants or its own internal accounting staff to calculate the business interruption loss. The insurance company's accountants, however, work for the carrier. Even if they endeavor to provide an accurate estimate of the loss, they have no incentive to pursue creative, but legitimate, interpretations of policy language that would enhance the insured's recovery.

It is important to move quickly. Soon after a business notifies the carrier of its claim, the carrier, with the advice of its adjuster, will establish a reserve. Once that figure is set, it can be very difficult to convince the carrier to settle for a larger amount. The business will benefit greatly if its financial experts have an opportunity to meet with the adjuster and provide their input into the development of a preliminary loss estimate. By providing the carrier's representatives with the relevant facts and educating them about the nature of the policyholder's business and its financial condition, a forensic accounting analysis can help ensure that the insurance company does not underestimate the loss.

Insurance carriers typically focus on an insured's historical operating experience to determine the measure of business income loss. However, in some cases, it is possible to demonstrate that the insured would have generated more income during the recovery period than it did in the past.

Consider the case of General Insurance Co. of America v. Pathfinder Petroleum Co.,145 F.2d 368 (9th Cir. 1944). The insured, which had been in business only eight months, had little or no profit before a fire destroyed its gasoline manufacturing plant. It sought to recover lost profits under a 90-day “use and occupancy” policy. One issue in the case was whether the insured's recovery should include net profits that would have been earned by a polymerization plant the insured had contracted to build on the destroyed premises during the recovery period.

The insurance carrier argued that the insured should not recover these profits because the plant didn't exist at the time of the loss. The court disagreed, noting that the insurance policy covered net profits from the business of manufacturing gasoline and the contracted polymerization plant was part of that business. The loss of use of its facility prevented the insured from building the plant and earning the profits it would have generated.

This demonstrates that a thorough analysis of a company's pre-loss business plans and projections, as well as post-loss market conditions, can help it develop a picture of the expected financial performance. 

Couple Products designed and manufactured component parts for the auto industry. At the time of the loss, the company had invested heavily in designing and developing unique and patented prototypes that were expected to meet its customers' requirements far more efficiently than its competitors. The insured had a contract with General Motors and was preparing to launch a new business proposal with its new line of products. The insured’s direct competitor leased a space in the same building, and the two companies were competing for an exclusive contract with General Motors. In the heat of the race, the competitor’s engineer stole various component parts from the insured’s prototype and testing laboratory. Despite the theft, the insured was able to continue its normal operations.

Upon arrest, the thief confessed to police that he stole parts from the insured because he “didn't have time” to obtain the parts lawfully before the competitor’s product was supposed to launch; the thief needed to figure out how the new components worked. A week after the theft, GM informed the insured that it lost the bid to the competitor and cancelled their existing contract.

The insured filed a claim with its insurer for the theft and claimed the loss of its competitive advantage constituted a loss under the policy’s business income provision. The parties stipulated that the theft was a covered loss and that it caused direct physical loss at the insured location. The insurer, however, argued that the loss of GM’s contract or the loss of future business was not covered under the policy’s business income provision.

The court was not persuaded by the insured’s unfortunate tale. In granting summary judgment in favor of the insurer, the court stated that:

Interpreting business interruption coverage to cover the loss of a competitive advantage suffered as a result of a theft of intellectual property would actually require insurers to subsidize insured victims of industrial espionage almost indefinitely—a result plainly contrary to both precedent and the reasonable expectations of the contracting parties.

Winters v. State Farm Fire and Casualty. Co., 73 F.3d 224 (9th Cir.1995), supports the proposition that the loss of a competitive advantage does not constitute a business interruption when operations continue unabated. In that case, a trial attorney filed a claim with his insurer after hand saws to be used as examples in an upcoming trial were stolen from his office. The attorney claimed that as a result of this theft, he lost the suit, which would have earned him over a million dollars in contingency fees. The court found that the policy did not provide coverage, since the attorney was able to continue his law practice after the theft, albeit without the competitive advantage of exemplar hand saws at trial. It is true, as CP points out, that the terms of the Winters policy differ from the Harleysville policy at issue here; the Winters policy required a suspension of operations, while the Harleysville policy covers a whole or partial business interruption. But the Winters court nevertheless focused on the plaintiff's “operations”, not the strength of his case relative to that of his opponent, and denied coverage because “[i]t is undisputed that there was no suspension of operations attributable to the theft.” Id. at 229.

Numerous other cases have held that it is the inability to meet customer demand—not reduced customer demand—that triggers business interruption coverage. See, e.g., Ramada Inn Ramogreen, Inc. v. Travelers Indem. Co. of Am., 835 F.2d 812, 814–15 (11th Cir.1988) (denying recovery to hotel owner under business interruption policy when fire damaged nearby restaurant and hotel business slowed but hotel remained operational); Rothenberg v. Liberty Mut. Ins. Co., 115 Ga.App. 26, 153 S.E.2d 447, 448 (1967) (denying recovery under business interruption policy where theft of merchandise resulted in loss of business; court held insured had not suffered an interruption of business, but rather a diminution in volume); Howard Stores Corp. v. Foremost Ins. Co., 82 A.D.2d 398, 441 N.Y.S.2d 674 (N.Y.App.Div.1981) (denying recovery for water damage to business where there was no actual suspension of business, but rather an alleged adverse effect on continuing sales).

Since the insured continued to perform its normal operations at a “similar level of service” as it did before the theft, the court found that the insured could not recover for the lost GM contract.

In considering Extra Expense provisions, however, courts will not require a total cessation of the operations to trigger coverage for necessary expenses incurred in reducing the amount of the loss.

A good explanation of the general requirements to trigger extra expense coverage can be found in Archer Daniels Midland Co. v. Aon Risk Services, Inc. of Minnesota, 356 F.3d 850 (8th Cir. 2004).

ADM processes and markets a variety of agricultural commodities such as corn, wheat, and soybeans. ADM uses corn to make such products as high-fructose corn syrup (“HFCS”) and ethanol. It relies heavily on corn producing operations and government transportation ways along the Mississippi and Illinois Rivers to conduct its operations. ADM insured its operations for $100 million under a difference-in-conditions program with several layers of insurance.

In 1993, severe floods devastated the Midwestern corn crops. The flood also obstructed the waterways and hampered the ability to navigate and move products by barge on the river. ADM claimed the flood caused it to incur extra expenses to procure sufficient quantities of corn for its processing and that the prolonged closures of parts of the Mississippi and Illinois Rivers caused it to incur additional expenses in alternative transportation. ADM ultimately submitted claims to its insurers for losses from the flood totaling more than $166 million, in extra expenses and contingent business income losses.

ADM filed suit against all its insurers and settled with all, except for the hardiest $50 million layer with Hartford. The district court found that Hartford's policy insured only against direct physical damage to ADM's insured property, and that Hartford was not responsible for any contingent business or extra expense losses. ADM filed suit against its broker, Aon Risk Services, seeking $50 million in damages for Aon's failure to secure contingent business interruption and extra expense coverages in the Hartford policy. The broker alleged that ADM could not seek to recover Hartford’s excess layer because it had not exhausted the underlying layers. The court denied Aon’s motion and allowed ADM to proceed against its broker, holding that ADM had exhausted the lower layers by agreeing to settle with the underlying insurers for a partial sum and absorbing the balance.

Aon then argued that even if it had procured contingent business and extra expense coverage under Hartford’s policy, ADM could not have recovered because its operations were not interrupted. Aon also argued that ADM’s expert was not offsetting the amounts that the manufacturing giant was hedging in the commodities futures market or the increased costs that it passed down to its buyers.

The jury returned a verdict of $16.5 million against Aon and the court awarded $3.6 million in pre-judgment interest. Aon appealed.

In affirming the verdict and interest award, the court of appeals stated:

The phrase “interruption of business,” as used in section 13Q of the DIC policy, does not require ADM to show that its corn processing plants stopped or slowed production. An interruption of business means some harm to the insured's business, including the payment of extra expense, that would not have been incurred but for damage that an insured peril has caused to the property of any supplier.

Section 10B specifically excludes from the definition any “extra expense in excess of that necessary to continue as nearly as practicable the normal conduct of the insured's business.” Because the definition of extra expense contained in Section 10B applies wherever the term is used in the DIC policy, it applies to the extra expense coverage provided by Section 13Q.

As defined in Section 10B, extra expense clearly includes those expenses necessary to carry on business operations. Section 10B would not make any sense if the DIC policy were interpreted as covering only the extra expense incurred as a result of a complete cessation of business. Accordingly, Aon's argument that the policy only covers extra expense if business operations were stopped is inconsistent with the terms of the policy.

The cases cited by both parties demonstrate that parties to an insurance contract can require a slowdown or cessation of business before extra expense coverage applies. The DIC policy, however, does not include such a requirement with respect to the extra expense coverage and we are not at liberty to rewrite the policy to include one.

Notwithstanding this general principle, every policy must be read carefully to determine if this general rule applies to a particular claim. Feel free to call if you have questions.

For example, in Tucci v. Hartford Fin. Services Group, Inc., No. 08-4925, 2011 WL 2555379 (D.N.J. June 27, 2011), the insured leased his land to a Howard Johnson Motor Lodge hotel franchise. Howard Johnson built and operated buildings and entered into a management agreement with an entity called Vraj Brig PA, LLC (“Vraj Brig”), under which Vraj Brig assumed management and operational control over the premises. In addition to operating the two hotels, Vraj Brig also leased space in one of the buildings to a restaurant operator. Vraj Brig owned the furniture and appliances in the hotel properties, including hotel room beds and laundry machines. The owner of the restaurant owned the furnishings and equipment of the restaurant.

After many decades of maintaining this business relationship, the owner evicted the long-term tenants for material breach of their lease. Upon taking possession of the property, the owner discovered that the hotel buildings had been vandalized and that furnishings and fixtures he expected to be there had been removed.

The owner filed a claim for vandalism, but the “ownership” issue ended in court.

During litigation, the owner argued that the movable furnishings and trade fixtures owned by Vraj Brig and the restaurant owner should be covered under his policy as business personal property. The owner alleged that while he may not have had actual ownership of or legal title to the personal property of Vraj Brig and the restaurant owner, he had an “insurable interest” in them. A federal court in New Jersey, however, was not inclined to stretch the definition of “insurable interest”

The New Jersey Supreme Court has held that in certain circumstances, an individual may have an insurable interest in property that he or she does not technically own. Miller v. New Jersey Ins. Underwriting Ass'n, 82 N.J. 594 (1980). There, the Court held that for an individual holding an insurance policy governing property he or she does not own, “[t]he extent of coverage would be measured by the reasonable expectations of the insured, taking account of events subsequent to the time of the loss .” Id. at 602

Plaintiff argues that the circumstances prior to September 1, 2006 created in him a reasonable expectation of retaining this property despite the fact that he did not own it. He argues that this interest began when Hartford issued its expanded coverage of the hotel premises because Plaintiff requested and paid premiums on a policy that covers up to $3,500 per room of the hotel to cover the contents of each room.

The Court finds that, to the extent that Plaintiff had such an expectation at all, no reasonable factfinder could conclude it was a reasonable one as required under Miller. First, the Court notes that there is undisputed testimony that Plaintiff was aware that Vraj Brig claimed ownership of the furnishings and fixtures of the hotel. Indeed, there is undisputed testimony that Plaintiff was even offered the opportunity to buy or rent the property from Vraj Brig in the weeks immediately prior to September 1, 2006, which he rejected.

The Court finds that it would not be reasonable for anyone in Plaintiff's position to expect to be able to make use of goods he did not own, that he knew were being removed by the true owner, and that he had declined the offer to purchase or rent. Consequently, the Court concludes that Plaintiff's business personal property coverage is limited to those items of property that fit within the ordinary meaning of the definition of “covered property” in his policy, which excluded property owned by residents or tenants of the Plaintiff.

This issue is never simple. Chip’s blog Title to Property Does Not Determine Insurable Interest should also be considered when determining whether an insured has an insurable interest in non-owned property.

An excellent post by Brandon McWherter, of the Tennessee Insurance Litigation Blog, correctly noted an important point regarding insurable interest and title. The general rule is that title is not necessary to establish an insurable interest in property.

In Recent Developments - Adams v. Tennessee Farmers Mutual Insurance Company, McWherter noted:

[L]egal title is not required in order to have an insurable interest in real property. Tennessee Farmers argued that an insured’s transfer of legal title to a family member mandated a finding that there was no insurable interest. The Court of Appeals disagreed, finding that any interest in property, even the mere right to use property, is enough for a finding that there is an insurable interest. All that is required is that the insured benefit from the property’s continued existence or suffer a loss as a result of its destruction.

The firm of Edwards Angell Palmer & Dodge will be presenting a free webinar July 28, 2011, Fallout from the Japan Disaster: Causation & Aggregation Issues Under CBI & Reinsurance Policies.  They describe the focus of the webinar on their site:

The financial fallout from the March 2011 Japan earthquake and tsunami will continue to impact companies worldwide which rely on Japanese suppliers. Contingent business interruption (CBI) insurance, which indemnifies an insured for financial loss caused by damage to its suppliers' property, will be the focus of UK and US companies seeking to recoup losses arising out of Japanese supply chain interruptions.

This webinar will focus on the complex causation issues likely to impact coverage of CBI claims, including the interplay between covered, non-covered and excluded perils, as well as how anti-concurrent causation clauses may limit coverage of CBI cliams.

To register for the webinar, click here.

In CII Carbon, L.L.C. v. Nat'l Union Fire Ins. Co. of Louisiana, Inc., 918 So. 2d 1060 (La. Ct. App. 2005), a catastrophic explosion caused significant property damage to several chemical manufacturing plants that were interdependent of each other.

The facts of the case were presented as follows:

CII Carbon owned and operated an industrial facility in Gramercy, Louisiana that processed coke by heat-treating petroleum coke in kilns to make it suitable for use in the aluminum smelting industry. The heat-treated coke was sold to CII Carbon's customers. The heat that escaped from the coke kilns was captured and used to operate a boiler that generated steam. CII Carbon either sold the steam to neighboring plant owners or used the steam to generate electricity that it also sold.

Pursuant to a series of contracts, the steam produced by CII Carbon was sold to Kaiser for use in its operations at the Bayer plant, which processed bauxite ore into alumina, the raw material for manufacturing aluminum. Also pursuant to the contracts, CII Carbon subleased certain equipment located in Kaiser's powerhouse that was necessary for CII Carbon to operate the boiler that produced the steam that CII Carbon sold. The CII Carbon boiler was located on the grounds of the CII Carbon coke facility, but the boiler could not be operated unless the subleased equipment in the powerhouse supplied water to the boiler and accepted the steam generated by the boiler.

In July 1999, a massive explosion occurred at the Kaiser plant. The Kaiser plant suffered extensive damage, and there was some damage to the powerhouse equipment that was subleased to CII Carbon. The CII Carbon coke facility suffered minimal property damage and was able to resume heat-treating coke shortly after the explosion. CII Carbon did not make a claim under its business interruption losses in connection with its coke production operations. CII Carbon did present a claim for business interruption relating to the loss of steam sales.

The damaged boiler was repaired on November 15, 2009, but the Kaiser plant did not become fully operational to accept the steam from the boiler until the end of December of 2000. The insurer paid for CII Carbon’s lost steam sales from the date of the loss until the date the boiler was repaired under the policy’s business income provision.

CII Carbon alleged that the subleased equipment was not repaired until it was restored to a condition in which it could perform the functions of supplying water to, and receiving steam from, the CII Carbon boiler, so that the steam could be received by the Kaiser plant. In other words, CII Carbon alleged that the period of restoration under its business income provision did not end until December 2000, when the Kaiser plant was fully operational and capable of receiving the steam.

The insurer disagreed and argued the business income provision provided coverage until the damaged subleased equipment was repaired (July 1999) and that the contingent business insurance provision (with a lesser amount of insurance) provided coverage for the loss of steam sales from July 1999 until December 2000, when the receiving facility became fully operational.

The insurer won a bench trial on all its defenses, and CII Carbon appealed. The appellate court found that:

The trial court determined that the Kaiser Bayer plant was a “recipient property” within the meaning of the contingent business interruption endorsement to the National insurance policy. That endorsement provides that there is coverage for the length of time required to rebuild, repair, or replace the recipient property “which is not operated by the Insured.” The loss suffered by CII Carbon after the subleased powerhouse equipment was repaired is exactly the type of loss that contingent business interruption insurance is designed to cover. Damage to the subleased powerhouse equipment was not responsible for CII Carbon's losses after the equipment was repaired as of November 15, 1999. Instead, the damage to the Kaiser Bayer plant, which was neither owned nor operated by CII Carbon, was responsible for the losses suffered by CII Carbon thereafter.

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

Businesses should always be prepared for a loss. Maintaining and organizing financial information is as important as developing an emergency plan that is implemented in moments of panic. To that extent, insureds should consider pulling all the necessary and relevant financial data in a “mock” emergency to determine whether their information systems could be improved.

The authors emphasize that

The insured must commit the necessary resources to gathering, interpreting and explaining the documentation that is relevant to the claim. Modern accounting and information systems have the ability to store and produce an avalanche of data, and providing this volume without proper context can lead to a prolonged period before settlement can be reached.

Custom accounting reports and their corresponding supporting data for review by the insurers are typically ineffective without a summary of the entire claim that tells the story of the loss to the organization. The organization should use spreadsheet tools to assimilate the large quantity of supporting data into a set of claim schedules that build up, almost pyramid-like, into summary schedules by primary claim categories that insurers can review easily.

Today’s claim adjuster can work multiple loss files in a remote location while accessing vast volumes of information forwarded from claimants to adjusters via email and online secure working environments such as eRooms. These techniques allow the insured tp efficiently update insurance claim data and share relevant information with insurer representatives.

Insureds should use all technological resources available to collect and organize financial data and have information systems that generate strong reports which tell a story and go beyond the numbers. For example, maintaining data in advance that correlates to the various coverages purchased (i.e., net income, normal operating expenses and payroll, electronic inventories for business personal property, etc.) should save precious time when it is needed the most.

In Abner, Herrman & Brock, Inc. v. Great Northern Insurance Company, 308 F. Supp. 2d 331, 333 (S.D.N.Y. 2004), the court held that a civil authority provision of an insurance policy did not provide coverage for an insured’s alleged loss of income after access to its building was restored, even though vehicular traffic in area continued to be diverted, and the firm’s employees were confused about whether access was restored.

In Abner, the plaintiff was an investment advisory firm that offered portfolio management service to high-net-worth individuals and their families, endowments, foundations and corporate retirement plans. While the plaintiff suffered no physical damage to its property as a result of the events, access to the business premises in lower Manhattan was prohibited by civil authority through Friday, September 14, 2001, as a result of the terrorist attacks on September 11, 2001.

The plaintiff’s office was located in an area of lower Manhattan where vehicular traffic was restricted through September 17, 2001, but pedestrian access was permitted, and public transit was available as of September 14, 2001. The plaintiff alleged that the traffic restrictions made it difficult for the plaintiff’s employees to get to the premises, as well as attend meetings around the downtown area, which was plaintiff’s usual business practice. The plaintiff further alleged that the emergency traffic restrictions put a crimp in the Chairman’s ability to use his car and driver, and walking and public transportation were not palatable alternatives.

The Civil Authority provision of the policy provided:

[Great Northern] 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, when a civil authority prohibits access to your premises or a dependent business premises.

The policy also provided that:

[C]overage will begin immediately after the time the civil authority prohibits access and will end 30 consecutive days after this coverage begins; or when your business income coverage ends, whichever occurs first.

The plaintiff claimed that it was entitled to full coverage for five business days starting September 11, 2001, due to the civil prohibition from entering the premises, and to half coverage for the following twenty-five days due to the restraints the vehicular traffic. The plaintiff also claimed that the full coverage should extend for five days, instead of the four days when the civil authority actually prevented access, due to confusion by its employees over whether access to the premises was permitted.

The court did not really appreciate the Chairman’s plight and held that:

The relevant part of the Civil Authority insurance provision states that Great Northern will pay for loss “when a civil authority prohibits access to your premises.” Because access was prohibited by civil authority from September 11, 2001, through September 14, 2001, the coverage applies only to these four days. The coverage does not extend through September 17, 2001, despite any confusion that AHB employees may have had about access to the premises and despite any difficulties AHB’s Chairman or his driver may have had in getting around the city.

Notwithstanding the time restriction on the civil authority claim and despite the fact that the plaintiff’s property did not sustain any physical loss or damage, the court allowed the jury to consider whether there was a business income loss due to the inability of plaintiff’s staff to work at its premises while it was closed by the civil authority order.

Contingent business coverage is a type of business interruption coverage will protect the “dependent business” from an external business income exposure. 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.

In lay terms, 1) suppliers, 2) buyers, 3) providers, and 4) drivers.

Supply chain enterprises should not stop at just purchasing this important coverage, but also carefully understand the intricacies of their interrelationships and have contingency plans in anticipation of a calamity.

William Austin, of Austin & Stanovich Risk Managers, LLC, recently wrote an article for IRMI, Supply Chain Exposures – What it Means to A Risk Manager, and explained that contingent insurance may not always provide coverage for loss of income or increased operating expenses. He advised that risk managers should not stop at acquiring the best coverage available for a dependent business, they should also have a good back up plan to keep the supply chain running while coverage is discerned.

Proper attention to each step of the risk management process is critical to identify all appropriate issues related to supply chain exposures. Wikipedia defines business continuity planning (BCP) as "the creation and validation of a practiced logistical plan for how an organization will recover and restore partially or completely interrupted critical (urgent) functions within a predetermined time after a disaster or extended disruption." BCP must be conducted with input from all levels of the organization. BCP is used whether the issue is how the organization will recover from a localized disaster and interruption at one of its locations or the issue is a supply chain disaster at a key supplier or customer. BCP, when used correctly, can be a dynamic process to identify supply chain exposures and can serve as a template for loss control strategies (i.e., alternate suppliers, customers, etc.).

The creation, modification, and implementation of a business continuity plan may be the most efficient risk management technique for SCM in any organization for both its short- and long-term success. While risk financing, such as contingent business interruption insurance, may provide needed funds during a time of interruption, it will last for a finite time—a period likely much less than the actual period of interruption. BCP is the template for recovery and will likely continue in place long after its insurance is exhausted, assuming the organization had insurance prior to the loss. BCP may also outline timely and efficient ways to maintain the supply chain at the time of a disaster and diminish the need for business interruption insurance.

The risk management process and BCP rely on common processes in order to be successful to the organization from risk identification to loss control to continually testing the process.

As Austin finally notes, today’s risk management professional cannot merely rely on his or her knowledge and understanding of the organization's varied and unique suppliers and customers. They must understand the bottlenecks and supply chain problems that will likely occur in the midst of catastrophe and have a plan that will keep the chain moving.

Lavoi Corp., Inc. v. Nat'l Fire Ins. of Hartford, 666 S.E.2d 387 (Ga. Ct. App. 2008), is one of those cases that needs to be shared. Lavoi is a baking company with locations in Atlanta, Georgia, Tempe, Arizona, and Dallas, Texas. A fire destroyed the insured’s newly-built bakery in Dallas. The location was not open at the time of the fire, but it had already taken orders from Dallas customers. At the time of the loss, the insured carried business income/extra expense (BI/EE) insurance coverage on its two other bakeries but not on the newly built bakery. Following the fire, the insured incurred extra costs in the Georgia and Arizona facilities, including costs for excess freight charges to ship products to the Texas clients and excess overtime to employ workers in the undamaged facilities. The insured made a claim for extra expenses, but both the trial and appellate courts disagreed that coverage could be extended to the uninsured facility.

Holding that the policy language unambiguously required physical loss or damage at the insured facility, the Georgia Court of Appeals wrote:

According to the policy, business income coverage applies to the actual loss of business income sustained due to the necessary suspension of your “operations” during the “period of restoration” [where t]he suspension [is] caused by “direct physical loss of or damage to property” ... at premises that are described in the Declarations and for which a Business Income Limit of insurance is shown in the Declarations. (Emphasis supplied.) It also defines “extra expense” as “necessary expenses 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 caused by or resulting from a Covered Cause of Loss.” The declaration page of the policy shows clearly and unambiguously that Lavoi purchased BI/EE coverage for the Atlanta and Tempe properties, not the Dallas facility. The policy is clear that the coverage applies in the event of loss or damage to the property at the premises described in the Declarations. Therefore, the trial court's conclusion that Lavoi could not recover damages for expenses incurred at the Atlanta and Tempe premises to supply the product that could not be provided by the Dallas plant due to the fire was correct.

In hindsight, the situation could have been avoided if the insured had not delayed the purchase of BI/EE coverage until operations began. That is the lesson I want us all to learn today.

When the Red River flooded and inundated the city of Grand Forks, North Dakota, the entire business district suffered extensive damage. To make matters worse, the power company had not shut down power to the entire area; electrical short circuits in the system because of the rising floodwaters caused a fire that further damages substantial amounts of property in the area. As a result, city leaders redlined an area including the business district, putting off any reconstruction work until final plans could be made to construct retaining walls and take other measurements to prevent future floods.

The vast extent of the damages coupled with the relatively remote location of Grand Forks, created a situation in which there simply were not enough contractors or materials to undertake cleanup, repair, restoration, and replacement. Those factors created controversy as to what period of time was appropriate for businesses in the area to complete their recovery efforts- and by extension the period of indemnity. In one significant situation, a policyholder’s entire operations were located within three buildings inside the redlined zone. All were flood-damaged, and some had experienced fire damage as well. While the company’s representatives were able to visit the sites to assess the damages, they were unable to remove major equipment for repair or to begin other recovery efforts at the properties. When the policyholder began discussing these issues with the loss adjuster, it was distressed to learn that the insurance company’s view was that the redlining issues (which they felt were not technically “code” changes as covered under the policy) were irrelevant to the loss adjustment. Furthermore, the adjuster’s construction expert had ignored the geographic lack of resources and materials in preparing his estimates of cost and timing for reconstruction activities. Thus allowing 6-8 weeks of time element coverage from the date the flood waters receded.

The policyholder had already begun plans to move most of its operations outside the flood plain of the Red River. In the process of trying to line up architects, engineers and contractors for that purpose, the policyholder determined that it was impossible to even procure the necessary resources to begin this work within the time period allotted. At a meeting to discuss an amicable resolution, the policyholder pointed out that the redlining issues should be considered code changes because they created new rules for access to loading docks and other areas due to the soon-to-be-constructed levees and retaining walls. In addition, the policyholder made a compelling argument regarding the availability of contractors and materials. Finally, the policyholder pointed out that construction in the new location was being done using methods that were likely to reduce the actual cost of replacement of the property. The policyholder in the end was successful in negotiating a longer period of indemnity.

In Polymer Plastics Corp. v. Hartford Cas. Ins. Co., 389 F. Appx. 703 (9th Cir. 2010), the plaintiff-corporation moved for a novel reading of the standard business income provision that would prevent carriers from considering gross profits from in the business income methodology in Nevada.

In the unreported opinion, the Court rejected Polymer’s argument stating:

The district court's formulation of the Policy achieves the purpose of the insurance provision in the first place, and most closely conforms to the actual text of the Policy itself. The essential purpose of business interruption insurance is to place the insured in the position it would have occupied if the interruption had not occurred. Business Protection or Interruption Insurance, 46 C.J.S. § 1531. Polymer's formulation ignores the term “actual loss of business income” by refusing to take into consideration the gross profits earned during the period of restoration. The Policy as a whole demonstrates an agreement to pay for actual losses, and not for any recovery above that amount. Adopting Polymer's interpretation would ignore the term “actual loss” as well as the other provisions of the Policy that limit coverage to losses actually suffered. Therefore, we see no error in the district court's interpretation of the Policy as a whole.

Polymer also argues that, at the very least, its interpretation of the Policy is reasonable, and the district court should have adopted its interpretation because Nevada law requires courts to resolve any ambiguities in an insurance contract in favor of the insured. See Insurance Corp. of Am. v. Rubin, 107 Nev. 610, 818 P.2d 389, 392 (1991). As evidence that the Policy could reasonably be interpreted as requiring Hartford to compensate Polymer for continuing normal operating expenses plus net income that would have been earned, without subtracting gross profits actually earned, Polymer relies on Continental Ins. Co. v. DNE Corp., 834 S.W.2d 930 (Tenn.1992). But the insured in that case was projected to operate at a loss, simplifying the calculation.

In addition, the Continental court specifically reiterated that a policy should not be interpreted to put the insured “in a better economic position from having had its business interrupted than it would have occupied had there been no interruption of its business operations.” 834 S.W.2d at 934. In fact, such “an interpretation would obviously be inconsistent with the purposes of providing insurance, as well as with the decisions in other cases involving similar issues.” Id.; see also B.F. Carvin Constr. Co., Inc. v. CNA Ins. Co., 2008 WL 5784516, at (E.D.La. July 14, 2008) (“[T]his type of policy is designed to prevent the insured from being placed in a better position than if no loss or interruption of business occurred.”). Therefore, we conclude that the district court did not err in its business income loss methodology.

From a legal perspective, it will be interesting to see how the Polymer court will treat Amerigraphics v. Mercury Casualty Company, 182 Cal. App. 4th 1538 (March 23, 2010), when analyzing California law, where a State Court of Appeals declined to follow Dictiomatic, Inc. v. U.S. Fid. & Guar. Co., 958 F.Supp. 594 (S.D. Fla. 1997) (which is seminal in the analysis of accounting methodologies) and held:

If 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.

I will keep you updated on this important question that could change the future of business income claims.

Dan Torpey, CPA, CFF, CITP, a leading authority in business income theories, also agrees that some coverage forms allow recovery of consulting fees in connection with the presentation of a business income claim.

In the new 2nd edition of Business Interruption, Coverage, Claims and Recovery, Torpey explains,

There is nothing in the wording of the ISO business income form that obligates the insurance company to pay the insured’s accounting costs to determine the extent of the business income loss. However, the form (CP 00 30) also provides extra expense coverage. Extra expense is defined as “necessary expenses you incur during the period of restoration that you would not have incurred if there had been no direct physical loss”

The policy also requires that the extra expense be incurred to “avoid or minimize the suspension of business and to continue operations.” A case may be made for extra expense payments for the accounting costs. A policyholder could argue that the assistance of outside experts decreased the length of suspension and allowed the company to restore operations more quickly by freeing key management to focus of loss recover rather than data gathering and loss development activities.

Every policy and factual scenario is different and careful consideration should be given to the policy language in question to determine if accounting/consulting fees should be reimbursed.

Claim Preparation Best Practices

1. Communicate Often and Positively - The people in the preceding section have certain common interests with your company. You both want to reduce your loss, return your business to normal as quickly as possible, and resolve the insurance claim with as little delay and controversy as possible. Try to maintain a positive relationship with the carrier's representatives. This may allow you to get early feedback as to the expectations of the insurance company's representative, which in turn may save you time by preparing the claim properly the first time. You will also want to keep the insurance company well informed of your actions. In some cases, the carrier may want to make their own inspections, and sell damaged property before you proceed.

2. Get Outside Help - Some policies will pay for the cost to hire your own claims accountant/consultant. The long list of professionals mentioned in the preceding section will look after the insurance company's interests. When losses are high, you should match the carrier's efforts with your own expertise. An experienced claim consultant will be able to:

   • Provide a skeptical and independent view of what is reasonable.
   • Advise you as to what is allowable, and ensure that your claim is as large as permissible;
   • Avoid wasted time and effort from a claim that does not comply with policy restrictions, and
   • Negotiate with the carrier's adjustors and accountants.

3. Identify a Leader - Claim preparation and management should be supported with someone who has the authority to marshal resources within your company. The leader will need to have broad knowledge of the business. Usually, someone from the risk management or accounting functions, supported by executive management, will take this responsibility.

4. Get an Advance - Negotiate a funding arrangement that advances cash to allow your business to start its recovery. Insurers will generally agree to such advances. However, make sure that these advances are not a final settlement of claims.

5. Create a Timetable - The claim preparation will likely involve multiple functions within your company, each of which requires coordination. Your employees will be busy getting your operations back to normal, so it is easy to delay claim preparation tasks. If not controlled, these delays will keep your company from getting a timely settlement, and may even cause you to miss deadlines required by your policy. Having an outside advisor will provide additional short-term resources that will assist keeping on schedule.

6. Gather Documentation - To obtain a smooth and rapid settlement, you will need to support your claim with detailed business records. Your policy will not specify the records that you will need to produce to document your claim; nevertheless, the insurance company's adjustor and outside accountant will demand substantial documentation before any claim is allowed. Your claim calculation and documentation will need to be much more than a computer-generated spreadsheet. Each key variable will need to be supported with contemporaneous business records and related analysis.

7. Use Multiple Approaches - Claims can be prepared based on (i) specific identification, and (ii) trend, statistical and other analyses. By looking at your claim from multiple perspectives, your business is more likely to address all claim amounts, and have a more comprehensive and convincing analysis.

8. Use your Accounting System to Capture Extra Costs - Policies often contain coverage for extra expenses that would not otherwise have been incurred. These costs vary considerable, and are naturally recorded in a wide range of your regular accounting codes. Simplify the claim preparation process by creating accounts that are used only for extra costs relating to the tragedy. Since you will need to show that these costs are incremental to the disaster, contemporaneously record the reason that the cost was incurred, and why this was caused by the disaster.

9. Identify a Single Point of Contact - All requests of your company by the insurance company's team should be channeled through a single person. Do not let the insurance company's accountants or other representative meet with anyone at your company unless this single company representative is also present.

10. Prepare a Formal Claim - The claim will ultimately be reviewed by several parties, some of whom do not understand your business and the background of your loss. The claim should be a stand-alone document in an easy-to-understand format. To avoid the need for controversy and ongoing dispute, prepare the claim as if there will be a dispute and the document will need to be presented in a court of law.

11. Communicate in Writing - To avoid misunderstandings, have the insurance company's accountants provide their information and document requests in writing. Maintain a written log of everything that has been provided, as it is common for the insurance company representatives to otherwise request the same information on multiple occasions. Once the insurance company's accountants have prepared their analysis, get a copy of this calculation so that your team has time to understand the differences in approach and/or analysis. This will make meetings to discuss the claim more productive.

     

After the hurricane, many of the Louisiana lawyers and employees continued courting their legal practice in alternate locations. The business income carrier denied the law firm’s claim, stating that the law firm suffered only a slowdown of operations, which is insufficient under the terms of the policy to warrant coverage for the business interruption claim.

The policy in question read as follows:

A. COVERAGE

We will pay for direct physical loss of or damage to Covered Property at the premises described in the Declarations caused by or resulting from any Covered Cause of Loss.

4. Additional Coverages

* * * * *

e. Business Income

We will pay for 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 damage to property at premises ... caused by or result from any Covered Cause of Loss....

H. DEFINITIONS

* * * * *

3. “Operations” means your business activities occurring at the described premises.

4. “Period of Restoration” means the period of time that:

a. Begins with the date of direct physical loss or damage caused by or resulting from any Covered Cause of Loss at the described premises; and

b. Ends on the date when the property at the described premises should be repaired, rebuilt or replaced with reasonable speed and similar quality.

Recognizing that a lawyer’s work never ends, the Court ruled against the carrier.

The policy covers “a necessary suspension of the operations,” and the term “operations” is defined as “your business activities occurring at the described premises.” (emphasis supplied). Although the declarations pages of the policy list the “described premises” as Louisiana, Texas, and Colorado, the policy forms applicable to each office differ. In addition to the declarations pages, form PC 7003 (07-96), which applies to the New Orleans office, also refers to “described premises.”

This court finds that a total cessation of business was required under the policy language, and a total cessation of business occurred at the New Orleans office because there is no dispute that work did not occur in that office for a certain period of time following the hurricane. The fact that New Orleans office employees worked from remote locations does not prevent a complete cessation of business from occurring in Louisiana. Evans had an obligation to mitigate his damages. He did so by having the employees work at other locations while the New Orleans office could not be occupied.

Here are a few of the issues about which we can anticipate reading:

Q. I noted this is the second edition to Business Interruption: Coverage, Claims, and Recovery. What prompted you to write another edition? What’s new?

A. This second edition of Business Interruption: Coverage, Claims, and Recovery contains expanded chapters, as well as new chapters to address the emerging issues. For instance, Chapter 10 discusses Federal Emergency Management Agency (FEMA) claims and the Public Assistance Act claims process, as well as the increasingly prominent and important role that FEMA plays in U.S.-based disasters and recovery. This past decade has also shown a continued increase in the globalization of today’s Fortune 1000 companies, the changing workforce, and the ever-increasing need for companies to do more with less. An earthquake in Chile, a volcanic eruption in Iceland, or a civil uprising in Egypt are no longer considered non-issues for U.S. companies; they now impact their supply chains or customer bases. Those concerns, combined with an economic need to recover all losses have provided us with a wealth of material for an updated edition of the book. Even at the present moment we see that the earthquake and tsunami in Japan will impact the U.S. and worldwide markets.

Q. What about the best use of technology in a business interruption claim?

A. The book provides policyholders with guidance to enable them to use technology to present data in a manner that tells a holistic story of loss from summary to detail. Custom accounting reports and their corresponding supporting data for review by the insurers are typically ineffective without a summary of the entire claim that tells the story of the loss to the organization. The organization should use spreadsheet tools to assimilate the large quantity of supporting data into a set of claim schedules that build up, almost pyramid-like, into summary schedules by primary claim categories that insurers and their representatives can review easily. These spreadsheets can be prepared by the policyholder or by a qualified claims accounting professional, but they should provide a step-by-step explanation of the claim being made, from the executive summary to the lowest level of detail. Effective use of technology and claim schedules can expedite review of the claim by insurer and help to keep the claims process for the modern corporation on track.

Albert Einstein once said “The only source of knowledge is experience.” Daniel Torpey humbly follows this adage and encourages young claims professionals to:

Get as much experience as you can about a diverse type of claims and industries. Always read the policy and background on the company before you walk into your first meeting. I have always enjoyed the breadth of experiences of learning about different industries and working with different people. Every time you think you have seen it all, a totally new situation comes into your lap. I was involved with the appraisal recently on a $3 billion claim, and one of the final open claims from the World Trade Center. I was exposed to issues relating to the rebuilding of a train station, valuing art work, calculating the re-work of detailed engineering drawings, and getting into the engineering of how the World Trade Center was actually designed and constructed in the 1960s and completed in the early 1970s.

As a matter of Florida law, business interruption losses should be determined in a practical way, having regard for nature of business and methods employed in its operation, in order to give practical effect to intentions of parties and purpose of insurance as evidenced by terms, conditions, and provisions of policy. See, Travelers Indem. Co. v. Kassner, 322 So.2d 80 (Fla. 3rd DCA 1975).

The holding in Travelers does not mean that “anything goes” in business interruption claims. A speculative claim will never be covered by a policy and it is always the insured’s burden to provide competent proof of an actual monetary loss as a result of the suspensions of its operations.

In some instances, losses under a business interruption provision may be based on profit expectancies, in the absence of profit prior to the loss, when such expected profits are not based on speculation but on real circumstances. Thus, while profit expectancies must be supported by evidence before a recovery may be had, the fact that an insured cannot prove some profit prior to the loss does not preclude it from collecting business interruption damages pursuant to an insurance policy; such losses may be based on profit expectancies properly established by real circumstances.

For example, in National Union Fire Ins. Co. v. Scandia of Hialeah, Inc., 414 So. 2d 533 (Fla. 3rd DCA 1982), the Third District Court of Appeal affirmed a jury award for business income losses even though the insured did not resume operations and did not have the most sophisticated accounting records.

Loss for payroll expense for key personnel which insured would have had to incur during the time it would have taken to go back into business with the same quality of service which existed immediately preceding loss of business by fire is properly a question for the trial court to consider. The fact that an insured decides not to resume business and did not actually pay key personnel during the business interruption does not mean that that item cannot be considered for the purpose of determining the amount of recovery. Where the insured does not go back into business, the deduction from gross earnings for the purpose of determining actual loss would be all of the payroll expense less the amount the insured would have necessarily had to expend to retain key personnel in order to resume business.

The Court further stated:

There is evidence as to the amount of time it would have taken to restore normal operations, the number of personnel that the restoration effort would have required, competent evidence that the future experience of the business would have been much better than the past experience if the loss had not occurred, and accounting evidence, though conflicting, of estimated gross earnings less charges and expenses which would not have continued during the period of business interruption. Having examined the evidence introduced on behalf of the appellee we conclude that it was sufficient to justify submission to the jury. If there is evidence tending to prove an issue though that evidence be conflicting or will admit of different reasonable inferences, it should not be taken from the jury and passed upon by the court as a question of law.

Note that Nat'l Union Fire Ins. Co. interpreted a business interruption provision within the building policy and not a separate business income endorsement that may have had profit experience requirements.

In order to avoid the “speculative” pitfall, small businesses should consider retaining forensic accountants to help them review their financial statements and general business objectives and prepare reports in support of their claim.

In the first trial, a jury found in favor of Aunt Sally’s on all claims and awarded civil penalties. United Fire moved for a new trial, and the court granted its request but only to determine the period of restoration and the quantum of the business income loss at one of the stores.

During the second trial, Aunt Sally’s CEO testified about Aunt Sally’s business, the damages incurred, its efforts to recover from the storm and the potential net income of the store had Katrina not occurred. The CEO’s testimony was the only evidence introduced by Aunt Sally’s to support its loss of income claim during the second trial. United Fire objected alleging that the CEO’s testimony was improper speculation, but the trial court overruled its objection, holding that the CEO’s testimony was permissible lay opinion testimony. After a long procedural battle, a jury again returned a verdict for Aunt Sally’s and awarded additional damages and penalties. United Fire appealed the second jury award challenging the sufficiency of the evidence to support the jury’s verdict, among other issues.

In its published opinion, the Fifth Circuit stated that:

It is well-settled that a business owner or officer who has personal knowledge of the facts may testify as to the business prospects of that business. See Versai Mgmt. Corp. v. Clarendon Am. Ins. Co., 597 F.3d 729, 737 (5th Cir. 2010) (permitting a business’s president to testify as to the losses in income as a result of a hurricane); see also Texas A&M Research Found. v. Magna Transp., Inc., 338 F.3d 394, 403 (5th Cir. 2003) (citing with approval Miss. Chem. Corp. v. Dresser-Rand Co., 287 F.3d 359, 373-374 (5th Cir. 2002) (holding that a corporation’s director of risk management could testify to lost profits)).

Here, it is evident from the record that, as CEO, Simoncioni had personal knowledge of Aunt Sally’s business prospects and could properly testify as to Aunt Sally’s potential net income. That Simoncioni’s testimony was based on new investments in equipment rather than purely historical figures does nothing to change that conclusion. In fact, the only case on which United Fire relies supports the propriety of Simoncioni’s testimony. In DIJO Inc. v. Hilton Hotels Corp., 351 F.3d 679 (5th Cir. 2003), this court found that a financial consultant who was not an employee or officer of the company at issue could not offer lay testimony as to the company’s value. In so holding, the court observed that Federal Rule of Evidence 701 does not “place any restrictions on the . . . practice of allowing business owners or officers to testify based on particularized knowledge derived from their position.” DIJO, 351 F.3d at 685. Therefore, there was no error in permitting Simoncioni to testify.

I believe this opinion is consistent with the recent holdings of the Fifth Circuit in Catlin Syndicate Limited v. Imperial Palace, No. 09-60209, 2010 WL 9008731 (5th Cir. March 15, 2010) and Consolidated Companies, Inc. v. Lexington Insurance Company, No. 09-30178 (5th Cir. August 17, 2010) where although the Court declined to consider post loss market conduct in business income losses, the court has also held that an insured is “not required to draw a bright line in its evidence between loss stemming from property damage and loss stemming from market conditions.”

Japan produces cars, and very good cars, to say the least. Japan also produces 90 percent of the resin used on computer circuit boards and 70 percent of the polymer used to make iPod batteries. The list goes on and on.

Jeff Harrington of the St. Petersburg Times recently wrote, “Ripples in Japanese Supply Chain Will Be Felt Here,” where he noted:

Japan is a major provider of power train systems and electronic components that are increasingly incorporated into U.S.-built autos and trucks. One report predicted a third of worldwide auto production could be idled by the end of April because of Japan. "We're looking at the likelihood of a slow-motion, cascading shutdown," Lynn said.

In one sign of things to come, Toyota this week warned dealers to expect a shortage of at least 233 replacement auto parts, possibly more. Parts in short supply include steering wheel covers and shock absorbers.

Parts managers at some dealerships may have ordered additional parts made in Japan in anticipation of shortages, and those orders could alone cause Toyota to run short, said Earl Stewart, who owns a Toyota dealership in North Palm Beach.

"It's not necessarily being a bad guy. It's just doing your job," Stewart said. "If everybody decides to stock up in advance, it's kind of like hoarding and suddenly there's a shortage."

Potential problems go well beyond cars and car parts.

Japan dominates certain sectors of the electronics market, like computer software tapes, compact discs and capacitors. It holds a strong market share for industrial machinery and components that are vital to U.S. manufacturers, said a U.S. Business and Industry Council report released Wednesday.

Every day, businesses develop and thrive on symbiotic relationships, where the entities rely on the continued operational viability of each other (or even exclusively beneficial relationships). Few businesses, however, consider the risk and exposure of losing that relationship due to an unexpected calamity.

Contingent business coverage is a type of business interruption coverage will protect the “dependent business” from the external business income exposure. 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.

In lay terms, 1) suppliers, 2) buyers, 3) providers, and 4) drivers.

Distributors worldwide rely on Japan’s steady production line. I hope that their insurance agents and risk managers were savvy enough to recognize the need to purchase contingent business income coverage to deal with the uncertain shortage of supply that is yet to dawn at a global scale. If such coverage was acquired, businesses should carefully review the terms and conditions of the policy and consult with a business interruption attorney, as there may be some time restrictions and limitations for recovery.

In Dickie Brennan & Company, Inc., v. Lexington Insurance Company, No. 10-30381, 2011 WL 996193 (5th Cir March 22, 2011), the Fifth Circuit Court of Appeals determined that Civil Authority coverage requires a direct causal relationship between the governmental action and prior property damage.

As Hurricane Gustav approached Louisiana on August 30, 2008, New Orleans Mayor Ray Nagin issued a mandatory evacuation order. Although the Order did not refer to any property damage, it stated that both the Governor and Mayor Nagin were declaring a state of emergency “because of anticipated high like and marsh tides due to the tidal surge, combined with the possibility of intense thunderstorms, hurricane force winds, and widespread severe flooding.”

The civil authority provision in the Brennan policy stated:

“Additional Coverages.”

We will 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. This coverage will apply for a period of up to two consecutive weeks from the date of that action.

In Louisiana, an insured must establish:

1. that the loss of income was caused by an action of civil authority;
2. the action of civil authority must prohibit access to the described premises of the insured;
3. the action of civil authority prohibiting access to the described premises must be caused by direct physical loss of or damage to property other than at the described premises; and
4. the loss or damage to property other than the described premises must be caused by or result from a covered cause of loss as set forth in the policy.

In this case, the parties disputed whether the mandatory evacuation order fulfilled the third element. The Brennans argued that the third element is fulfilled when the civil authority action is a response to property damage (with no geographic limitation) that has been sustained earlier from the same cause threatening to damage the locale where the insured premises are located. The Brennans alleged that Hurricane Gustav had already damaged property in the Caribbean nations of Cuba, Jamaica, the Dominican Republic, and Haiti when Nagin issued the evacuation order.

In other words, the Brennans argued that the prior damage in the Caribbean, coupled with Gustav's projected path toward New Orleans, satisfied this element. Lexington, on the other hand, argued that the policy required a causal link between the prior damage and the civil authority action and that the damage must be near (although not at) the insured premises to satisfy that link.

Mayor Nagin’s Order did not mention the earlier property damage in the Caribbean. It listed possible future storm surge, high winds, and flooding based on Gustav’s predicted path as reasons for evacuation and not “due to” physical damage to property, either distant property in the Caribbean or property in Louisiana.

The Court rejected Brennan’s argument that actual damage that had occurred in the Caribbean was sufficient to establish coverage.

The general rule is that “[c]ivil authority coverage is intended to apply to situations where access to an insured’s property is prevented or prohibited by an order of civil authority issued as a direct result of physical damage to other premises in the proximity of the insured’s property.” Although it does not expressly address the proximity issue, the Lexington policy requires proof of causal link between prior damage and civil authority action.

The opinion read, in pertinent part as follows:

Following discovery of a pathogenic bacterium in several production runs of its ham and turkey products, HoneyBaked Foods, Inc. claimed a loss of about $ 8 million under its “all-risk” policy with Affiliated FM Insurance Co. The claimed amount covered the losses from the inability to distribute tainted and potentially tainted food products and loss of income.

Affiliated FM denied the claim, asserting that exclusions under the policy leave HoneyBaked without coverage for any part of the loss.

Before presenting HoneyBaked with a proposal for coverage, Affiliated FM conducted a site visit and prepared a risk report identifying and discussing the hazards, exposures and risks at HoneyBaked's facility. This risk report noted that “[t]he most significant and common hazards exposing the food industry are centered on the susceptibility of food products to spoilage and contamination.” HoneyBaked purchased the subject all-risk policy mindful of this assessment.

In early November, 2006, HoneyBaked discovered that a sample of its products had tested positive for listeria monocytogenes, a pathogenic bacterium that causes listerosis, an uncommon but potentially fatal disease. Further investigation revealed that a risk of contamination affected over one million pounds of product produced from September 5 through November 5, 2006.

HoneyBaked identified the source of contamination to be in one of the hollow rollers on its conveyor system. It removed this system and conducted extensive cleaning and sampling procedures. As a result of the contamination, HoneyBaked suspended operations twice, issued a recall of 46,941 pounds of its ham and turkey products, and eventually disposed of nearly one million pounds of product.

HoneyBaked submitted a claim of loss to Affiliated FM seeking reimbursement for the value of the discarded food product and additional losses resulting from business interruption.

Affiliated FM denied the claim, explaining that the policy excluded the product loss, and because “there is no covered physical loss or damage, any business interruption associated with the listeria contamination is also not covered.”

Following denial of its claims under the policy, HoneyBaked sued Affiliated FM, seeking declaratory judgment of its rights under the policy and alleging that Affiliated FM had breached the contract and acted in bad faith in denying the claim. The parties filed cross-motions for summary judgment.

I found that the policy excludes the product loss caused by listeria monocyogenes. [ECF 54]. The policy contains a contamination exclusion, stating:

This policy does not insure against loss or damages caused by [contamination, including but not limited to pollution]; however, if direct physical loss or damage insured by this policy results, then that resulting direct physical loss or damage is covered.

[ECF 34-15, at 25-27].

The Ohio Court of Appeals for the Eleventh District has explained that the “usual and ordinary meaning” of “contaminate” is “to render unfit for use by the introduction of unwholesome or undesirable elements.” Hartory v. State Auto. Mut. Ins. Co., 50 Ohio App.3d 1, 3 (1988) (citation omitted); see also Richland Valley Prods., Inc. v. St. Paul Fire & Cas. Co., 548 N.W.2d 127, 131 (Wis.App.Ct.1996) (collecting cases uniformly defining the term “contamination”); Landshire Fast Foods of Milwaukee, Inc. v. Emp'rs Mut. Cas. Co., 676 N.W.2d 528, 532 (Wis.App.Ct.2003) (interpreting “contamination” to include the presence of listeria monocytogenes in food products).

HoneyBaked argues, however, that it reasonably believed that the all-risk policy would cover spoilation of its product during processing. As Affiliated FM itself observed in its risk assessment, the susceptibility of food products to spoilage and contamination is the most significant risk faced by the food industry.

A jury could find that HoneyBaked had a reasonable expectation of coverage for losses due to contamination. But the policy, when closely interpreted, excludes losses caused by contamination. The availability of coverage, notwithstanding the exclusion, turns on the question of whether Ohio law incorporates the reasonable-expectations doctrine and applies such doctrine to this case.

I will continue following the case and will report the outcome of the plight that so many of my clients endure.

Park developed and manufactures printed circuit boards and other advanced materials for the telecommunications, computing, and aerospace industries. Neltec and Nelco Products, Pte., Ltd. (“Nelco”) were wholly-owned subsidiaries of Park. Neltec, based in Tempe, Arizona, manufactured and sells a product called N6000. Neltec purchased its entire supply of “prepreg,” a vital component of N6000, from Nelco, located in Singapore. An explosion at Nelco's Singapore facility destroyed the special “treater” used to produce prepreg, temporarily halting Nelco's ability to supply prepreg to Neltec and, per force, Neltec's ability to produce N6000. As a result thereof Neltec's N6000 customers could not readily substitute any alternative Neltec product, causing Neltec to lose a significant amount of income.

Under “Contingent Business Income,” (CBI) the policy states in pertinent part:

[Continental] will pay for the loss resulting from necessary interruption of business conducted at Locations occupied by the Insured and covered in this policy, caused by direct physical damage or destruction to:

a. any real or personal property of direct suppliers which wholly or partially prevents the delivery of materials to the Insured or to others for the account of the Insured ...

The term “direct suppliers” was not defined anywhere in the policy.

After the November 27, 2002 explosion at Nelco's facility in Singapore, Park submitted a claim under the CBI provision, seeking coverage for Neltec's lost sales income. Continental declined coverage stating that subsidiaries of the insured, such as Nelco, are not considered “direct suppliers” under the policy. Park filed suit contending that nowhere in the policy such was a restriction found.

While courts are typically the ultimate arbiters of policy interpretations, in this case, the court left the issue for a jury to decide.

The term “direct suppliers” is not defined anywhere in the policy. Both parties provide reasonable interpretations of the term: it could be read to include any supplier, regardless of whether the supplier is a subsidiary of the insured, or it could be read to exclude subsidiaries or sister companies of the insured. Moreover, on the one hand, if the term is read to include subsidiaries, then it would arguably make the CBI provision redundant, given that the “Time Element-Gross Earnings” provision already covers business interruption losses caused by physical damage to Park-owned facilities-that is, to avoid redundancy, the CBI provision must have been specifically intended to cover business interruption losses caused by damage to “direct suppliers” outside of Park's control. On the other hand, insurance policies may have multiple or redundant provisions covering certain kinds of losses. The fact remains that the words are ambiguous, and ambiguity requires the Court to consider extrinsic evidence to arrive at a proper interpretation.

Continental presented evidence of industry standards and principles of contingent business income where coverage should not be available if the other property is a branch, department or subsidiary or sister business of the insured. Park, in turn, presented deposition testimony of its broker showing that in the process of shopping for insurance products Continental’s policy was broad enough to suit Park’s needs. Ultimately the $2.5 million dollar question was left for a jury to draw adequate inferences from the common practice and customs of the insurance industry and, ultimately, the knowledge and intent of the parties at the time the policy was purchased.

For the period covering 2003, Wakefern collectively purchased a first party, all-risk insurance policy from Liberty. In addition to the basic policy, Wakefern purchased from Liberty a "Services Away From Covered Location Coverage Extension" (Extension), which extended coverage for consequential loss or damage resulting from an interruption of electrical power to Wakefern's supermarkets when the interruption is caused by "physical damage" to specified electrical equipment and property located away from the supermarkets.

The Extension provided that:

A. We will pay for consequential loss or damage resulting from interruption of:
(1) Power;
. . . .
B. We will pay only if the interruption results:
(1) From physical damage by a peril insured against;
(2) Away from a covered location; and,
(3) To the following types of property, if marked with an "X":

(X) Any powerhouse, generating plant, substation, power switching station, gas compressor station, transformer, telephone exchange;
. . . .
(X) Transmission lines, connections or supply pipes which furnish electricity . . . to a covered location.

The term "physical damage", however, was not defined in the Extension or in the underlying policy.

Following the blackout, Liberty denied Wakefern’s claims for spoiled food and business interruption under both the "direct physical loss or damage" portions of the policy and the "physical damage" part of the Extension. In doing so, Liberty characterized the food-spoilage damages as consequential and not direct losses and asserted that Wakefern had failed to present "evidence of any physical damage to transmission lines, connections or supply pipes which furnish electricity to any covered location." Wakefern filed a lawsuit in 2004 and a six (6) year litigation saga ensued.

The 32-page opinion of the New Jersey Court of Appeals explained the technical intricacies that caused the catastrophic power failure:

The power blackout that occurred on August 14, 2003, began a little after 4:00 p.m. (Eastern Daylight Time), when three large transmission lines in northern Ohio sagged and came into contact with trees that had not been properly maintained at a safe height. Those transmission lines were disengaged from the interconnection by their protective devices, and the electric current that they carried was automatically rerouted to other lines. One of those other lines, the 345-kilovolt Sammis-Star transmission line, became overloaded, and its protection system operated at 4:06 p.m. to disconnect it from the interconnection. According to the Final Report, the "loss of [the] Sammis- Star line triggered" the "uncontrollable 345 kV cascade portion of the blackout sequence." This was so because "the loss of the heavily overloaded Sammis-Star line instantly created major and unsustainable burdens on lines in adjacent areas, and the cascade spread rapidly as lines and generating units automatically tripped by protective relay action to avoid physical damage. It took four days to restore power to millions of Americans.

The appellate court evaluated the relevant expert testimony and resolved the fascinating technical and coverage controversy under the following long standing principles:

It is well settled that those purchasing insurance "should not be subjected to technical encumbrances or to hidden pitfalls and their policies should be construed liberally in their favor to the end that coverage is afforded 'to the full extent that any fair interpretation will allow.'" Kievit v. Loyal Protective Life Ins. Co., 34 N.J. 475, These principles apply to commercial entities as well as individual insureds, so long as the insured did not participate in drafting the insurance provision at issue. Benjamin Moore & Co. v. Aetna Cas. & Sur. Co., 179 N.J. 87 (2004).

We conclude that the undefined term "physical damage" was ambiguous and that the trial court construed the term too narrowly, in a manner favoring the insurer and inconsistent with the reasonable expectations of the insured. In the context of this case, the electrical grid was "physically damaged" because, due to a physical incident or series of incidents, the grid and its component generators and transmission lines were physically incapable of performing their essential function of providing electricity. There is also undisputed evidence that the grid is an interconnected system and that, at least in some areas, the power could not be turned back on until assorted individual pieces of damaged equipment were replaced. However, we do not rest our decision on that evidence. Rather, we look at the larger picture concerning the loss of function of the system as a whole.

We recognize that, to some extent, the blackout was caused by a combination of fortuitous events, together with the operation of safety features built into the system to insure that the essential elements of the grid would not be severely damaged. However, in concluding that the "physical damage" is ambiguous, we consider the context, including the identity of the parties. See Voorhees v. Preferred Mut. Ins. Co., 128 N.J. 165, 176 (1992). These were not two electric utilities contracting about the technical aspects of the grid. Rather, the parties are an insurance company, in the business of covering risks, and a group of supermarkets that paid for what they believed was protection against a very serious risk – the loss of electric power to refrigerate their food. The average policy holder in plaintiffs' position would not be expected to understand the arcane functioning of the power grid, or the narrowly-parsed definition of "physical damage" which the insurer urges us to adopt. See Weedo v. Stone-E-Brick, Inc., 81 N.J. 233, 247 (1979). In this context, we conclude that if Liberty intended that its policy would provide no coverage for an electrical blackout, it was obligated to define its policy exclusion more clearly.

We find no basis in the language of the Liberty policy, or in any of the foregoing cases, to require that the physical damage to the power source be permanent. […] The Services Away Extension would be virtually worthless if it only applied to the permanent destruction of the grid's electrical generating capacity. We find no basis in the language of the Liberty policy, or in any of the foregoing cases, to require that the physical damage to the power source be permanent. […]

The off-premises power failures covered by the Liberty policy will always be temporary, because power will always be restored eventually. Here, the power outage lasted four days, but it was catastrophic. The Services Away Extension would be virtually worthless if it only applied to the permanent destruction of the grid's electrical generating capacity.

Hurray for the policyholder!

The law firm filed a Declaratory Action, seeking an order that compelled State Farm to pay the firm for its continuing normal operating expenses, including salaries, from the time that the fire occurred until the building was repaired, rebuilt or replaced. In other words, the law firm argued that, under a standard CP 00 30, form they were entitled to full business income loss coverage, including payroll expenses and continuing normal operating expenses for the entire period of restoration even though they worked at a temporary place of business. In support of its Motion for Summary Judgment, the law firm filed an Affidavit of its principal partner setting forth that the law office “lost everything required for it to successfully conduct business, including its files, computer server and equipment, emailing capabilities, calendars, books and miscellaneous supplies.”

State Farm argued that, pursuant to the policy, it was only required to pay “the difference between what Plaintiffs would have earned if the loss had not occurred and what Plaintiffs actually earned following the loss and any extra expense that exceeds the normal operating expenses.” Phrased differently, State Farm argued that the law firm’s entitlement to actual loss includes actual loss of business income and actual loss of operating expenses -- meaning any amounts earned during the period of restoration have to be offset from losses.

The court considered the arguments, the language of the policy and some cases that I have previously discussed in my blog series and not surprisingly held that:

To accept this [Plaintiff’s] interpretation would nullify both the clear intent of the policy, which requires them to mitigate their losses and to demonstrate business loss with relevant evidence, and the broader purpose of business interruption insurance, which is to ensure that insured claimants receive the benefits their business would have imparted absent the interruption; not to put them in a better position than they would have been absent the interruption. See American Medical, 949 F.2d at 692-93; Dictiomatic, 958 F.Supp. at 603-04.

The Court, however, noted an incredibly important practice pointer:

If plaintiffs can indeed show that, despite having resumed business at another location, they have been rendered unable to conduct any meaningful business whatsoever, and they have not been able to receive the benefits of their employees' services, this will qualify as an actual business loss. See Koken v. Lexington Ins. Co., No. 04-2539, 2006 WL 5377234 at 7 (E.D.Pa. Feb.1, 2006) (noting that claimant had suffered an actual business loss from failure to receive the benefit of its employees' services at the time those employees were completely unable to access the claimant's business facilities). However, under the terms of the policy, they must present evidence, in the form of financial records, bills, invoices, and other material, showing that they have indeed sustained such loss.

Forensic accounting is fundamental to the success of a business income claim, but accountants are not superheroes and they will be limited by the manner in which a business maintains and allocates its expenses and revenues. I previously noted a similar practice pointer in Not All Businesses Are Alike – Understanding Business Interruption Claims, Part 49:

A creative solution to this dilemma is found in Practising Law Institute Litigation and Administrative Practice Course Handbook Series:

Policyholders can attempt to address this problem at the point of sale by purchasing a form which meters the loss in a manner more consistent with the nature of the business (i.e., billable hours lost for a law firm). Most forms, for instance, measure loss for manufacturing concerns in terms of the ultimate value of the product which cannot be manufactured, and not ultimate sales lost during the Period of Restoration. At a minimum, policyholders must resist insurance company efforts to have it both ways. For instance, many insurance companies seek to take advantage of “credits” for pent-up demand after the Period of Restoration; e.g., sales of eyeglasses to persons who had simply delayed purchase until after the neighborhood eyeglass shop reopens. An insurance company should not be permitted to confine “loss” to the Period of Restoration, but then seek “credits” for amounts earned afterward.

I think the result in Eidelman is unfair, but under the factual circumstances it was easy for State Farm to get away with having it both ways. I would have an instant aneurism if this happened to me and I had to practice law at a temporary location without my computer servers and files. My heart goes out to these colleagues.

For example, in American Medical Imaging Corp., v. St. Paul Fire and Marine Ins. Co., 949 F.2d 690 (3rd Cir. 1991), the court allowed recovery even though business continued at less than normal level rather than requiring a total cessation of the business operations.

In American Medical Imaging, the insured’s business was damaged by fire. The insured immediately rented space at an alternative site and relocated the next day to a place with substantially fewer telephone lines, which were essential for the business’ operations. The insured did not return to its headquarters for approximately six weeks.

St. Paul denied the claim, citing the fact that no suspension of business occurred, and a lawsuit followed. American Medical lost at the trial level, but prevailed on appeal. Under a provision similar to the one cited above, the court ruled in favor of American Medical:

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.

As pointed out in Total Cessation v. Partial Cessation – Understanding Business Interruption Claims – Part 37, Vincent Morgan’s article in CAT Claims: Insurance Coverage for Natural and Man-Made Disasters, explains that while the “total cessation” approach may have some logic, it also has significant shortcomings:

1. Failing to accurately address the realities of large businesses that operate worldwide on a “round the clock” basis that would never cease operations
2. Creating perverse incentives for insureds to enhance their insurance recovery by not taking all possible steps to maintain partial operations, increasing the loss and decreasing economic output; and
3. Creating inconsistent obligations for insureds because of the corresponding duty to mitigate, leaving an insured that can mitigate a loss by maintaining partial operational capabilities without coverage due to the lack of total cessation.

An interesting article published by IRMI titled, When Does Business Interruption Insurance Coverage Stop?, by Jay M. Levin, also elaborates on the issue.

"Necessary Suspension" Includes Awaiting Equipment Repair

This same issue was raised very recently in federal court in Pennsylvania. In iCue Corp. v. USF&G, Civil Action No. 07-1871 (E.D. Pa.), iCue was in the business of broadcasting mass e-mail and facsimile business communications using highly specialized, proprietary computer equipment. iCue would send communications only to recipients who consented in advance to receiving them, as opposed to broadcasting spam. A covered power surge and ensuing power outage struck iCue's offices, causing more than $200,000 in covered damage to the computer equipment.

USF&G determined that the power outage lasted approximately 7 1/2 days. When power was restored, iCue was able to limp along at a significantly reduced capacity while waiting for USF&G to adjust and pay for the loss to the equipment. USF&G ultimately paid for the physical loss or damage, but took the position that BI coverage was available only for the 7 1/2 days power was out and that BI coverage terminated as soon as iCue resumed any operations.

The parties filed cross-motions for summary judgment on the meaning of "suspension" of operations. The court granted iCue's motion and denied USF&G's motion in a 3-page order. In the footnotes to the order, the court held that "necessary suspension" should not be construed to require a total cessation of business operations. Instead, the court held that the policyholder need show only a necessary reduction of its operations. The court, therefore, granted summary judgment that "necessary suspension" included the time when iCue was limping along while awaiting repair and replacement of its equipment.

The lesson for risk managers is that some policies specifically provide coverage for partial suspension of operations and, given positions being advocated by at least some insurers, a risk manager would be well advised to try to obtain coverage, including an express definition of "suspension" that covers both total and partial cessation of operations. If the policy does not contain specific coverage for partial suspensions, the risk manager should ask what position the insurer will take in the event of a covered loss. If the insurer will take the position that BI coverage terminates as soon as the insured resumes partial operations, either an endorsement should be obtained or a new insurer sought.

One way insurers try to reduce an insured’s business income claim is by incorporating any increased sales following a catastrophic event into the loss calculation. In Rimkus Consulting Group, Inc. v. Hartford Casualty Ins. Co., 552 F.Supp.2d 637 (S.D. Tex. 2007), Hurricane Katrina forced Rimkus to shutdown its New Orleans office. However, Rimkus continued to provide its engineering and consulting services out of temporary offices. Because Rimkus worked exclusively for insurance companies, its business following Hurricane Katrina increased dramatically. Hartford introduced evidence that Rimkus’ actual revenues after Katrina were nearly quadruple the projected revenue for that period. However, Rimkus sought business interruption coverage from Hartford, claiming it lost revenue from its regular, pre-storm clientele. Hartford, on the other hand, argued that the difference between pre-storm and post-storm income is meaningless because Rimkus continued to provide its services to the same industry after Katrina.

The Court found that Rimkus received income for its services that should be counted against its business interruption claim. Because its income increased, the court concluded that Rimkus did not suffer a recoverable business income loss. The Court relied on specific policy language that allowed Hartford to reduce amounts payable “to the extent that the reduction in volume of business income from the affected income channel is offset by an increase in the volume of business from other income channels.” Id. at 640.

The Court’s analysis in Rimkus shows that the measurement and extent of business income coverage is heavily dependant on the policy’s language as well as the specific facts of a case. Rimkus serves as a reminder that it is a good idea to read your policy from time to time to ensure that you know what is covered. Although not all insurers attempt to limit or deny coverage, it’s a good idea to read your policy with an eye for denying or limiting coverage. Reviewing your policy this way will prepare you for any pitfalls you might encounter should you ever suffer an insurance-related loss.

A recent FC&S Bulletin exemplifies a common loss-of-rent scenario after a loss:

Loss of Rents and Business Income Loss for Multiple Insureds

Q.
We have multiple named insureds on a property policy with business income and extra expense coverage, including loss of rents. One named insured (ABC) rents all of the locations to another insured. If a business income loss occurs, can both ABC collect for its loss of rents and the other named insureds collect for their actual income loss and extra expenses?

Iowa Subscriber

A.
Yes, the policy would allow ABC to recover for the loss of rents and the other named insureds to collect for their business income losses and extra expenses. Of course, if the other named insureds claim rent payments as part as their continuing expenses, then ABC cannot also collect for loss of rents. But if there is no overlap in what they each claim, they should all be able to recover their losses.

Consider, however, a similar situation where the outcome is entirely different. In Mirlan v. Affiliated FM Ins. Co., No. 09-55662, 2010 WL 4462728 (9th Cir. November 8, 2010), a fire rendered three tenant spaces untenantable. Under the impression that it had purchased coverage for “Loss of Rents,” the commercial property owner-corporation represented to its tenants that they would not have to continue paying rent. The tenant leases, however, provided that the tenants were required to continue paying rent even if fire made the spaces untenantable or there were repairs made to the property. The leases also required the tenants to purchase business interruption insurance. Based on the tenant agreements, the insurance carrier denied coverage for the loss of rental income sustained after the landlord agreed to abate the rent payments.

The “loss of rent” provision at issue stated in pertinent part:

[T]he actual loss of income sustained by the insured resulting directly from the necessary untenantability, caused by loss, damage or destruction by any of the perils covered herein ... to real or personal property.

Although it was undisputed that the fire caused the untenatability of the rented spaces, the court found that loss of income was caused by the owner’s own conduct of abating the rent payments.

Notwithstanding the standard practice of calculating property manager’s fees as a continuing expense of the business operation, I came across an interesting article in the FC&S Bulletin regarding the recoverability of these fees that is worth sharing so that everyone can avoid similar coverage disputes:

Business Income—Status of
Management Fees?

Q
Many of our clients have property management firms who manage their apartment buildings and commercial properties for a percentage fee based on rental income. Frequently, the management agreements call for the firms to be paid an additional fee for any construction management services performed following a property loss.

In our opinion, both these fees should be covered as part of the property owner's business income loss following a covered property loss. However, following a recent covered loss to a large commercial complex containing many leased offices, the adjuster refused to allow either the continuing management fee or the additional fee, stating that both of these were "agreements outside the policy" and therefore not covered.

Specifically, the adjuster pointed to exclusion 4.c.(2) of the CP 10 30 06 95, which eliminates coverage for certain contractual liability assumed by the insured. Not only did he disallow coverage for the additional fee, but for the on-going management fee as well.

Our insured has the [sic.] with business income and extra expense CP 00 30 06 95 attached.

What do you think?

Texas Subscriber

A

The covered direct physical loss to the insured property is the trigger for business income coverage. In the CP 00 30 business income and extra expense form, the insurer promises to pay the net income that would have been earned and continuing normal operating expenses, including payroll.

There is no descriptive or restrictive language in the form detailing what "normal operating expenses" are comprised of. And, although the adjuster may think that this "operating expense" does not continue because there is nothing to manage, this is not necessarily the case. For example, when property is completely destroyed, then maintenance expense—money paid to an outside firm—for building and machinery might discontinue. However, these expenses might well continue if the property is only partially destroyed and if the insured is obligated by contract to continue payment.

The ongoing management fees may be viewed in the same light. If the management fee does not discontinue in event of a covered loss, it therefore is a part of the normal operating expense covered by business income.

The second part of the business income coverage is for extra expense. The CP 00 30 defines extra expense as "necessary expenses [the insured] incur[s] during the 'period of restoration' that [the insured] would not have incurred if there had been no direct physical loss or damage." Further, the extra expense must be for the purpose of avoiding or minimizing the suspension of business and allowing the insured to continue "operations" at the described premises.

The management company's function in this instance is to supervise the leased space construction; since the management company is presumably in a better position to expedite the restoration of the damaged building, the adjuster cannot arbitrarily disallow the fee. If the management company's intervention minimizes the suspension of business by making sure the premises are restored quickly to the preloss condition, then the fee is covered.

The adjuster's citing of exclusion 4.c.(2) is inappropriate, since this exclusion is prefaced by the language (under 4. special exclusions) that "the following provisions apply only to the specified coverage forms." Exclusion 4.c.(2) relates to the legal liability coverage form; specifically the insured's assumption of liability in a contract or agreement. The exclusion precludes coverage, for example, for a hold harmless agreement in which the insured assumes liability rightfully belonging to another. It is not applicable in this situation.

As stated in the FC&S Bulletin, property manager’s fees incurred after a loss to assist in the mitigation of damages above may also be recovered as an extra expense under the policy. A standard extra expense coverage form states "extra expense" means" necessary expenses 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." These extra expenses include those "to avoid or minimize the suspension of business and to continue 'operations' at the described premises, or at replacement premises or at temporary locations."

It is also likely that courts will allow recovery of the property manager’s fees. For example, in  Cotton Bros. Banking v. Industrial Risk Insurers, 951 F.2d 54 (5th Cir. 1992), the court granted coverage for security expenses to avoid theft of a damaged business property. Also, in Northwestern States Portland Cement Co. v. Hartford Fire Ins. Co., 360 F.2d 531 (8th Cir. 1996), under a business interruption endorsement containing an "extra expense" clause, the insured was able to avoid a loss of earnings by using available raw materials to continue production; the extra cost involved in producing replacement raw materials was recoverable, although the total cost of such materials was not.

In 730 Bienville Partners, Ltd. v. Assurance Co. of Am., 2002 WL 31996014 (E.D. La. Sept. 30, 2002), the insured operated two hotels in New Orleans and sought coverage for business interruption losses under the “Civil Authority” provisions of its policy due to the Federal Aviation Administration’s closure of the nation’s airports after September 11, 2001. The “Civil Authority” clause stated:

We will pay for the actual loss of “business income” you sustain and necessary “extra expense” caused by action of civil authority that prohibits access to your premises due to direct physical loss of or damage to property, other than at the “covered premises,” caused by or resulting from any Covered Cause of Loss. This coverage will apply for a period of up to 4 consecutive weeks from the date of that action.

The insured argued that because the FAA prevented anyone from flying during the days immediately following the World Trade Center attacks, guests were unable to travel to to New Orleans and stay in its hotels. In rejecting the Plaintiff’s argument, the Court concluded:

While the FAA’s closure of the airports and cancellation of flights may have prevented many guests from getting to New Orleans and ultimately to plaintiff’s hotels, the FAA hardly “prohibited” access to the hotels.

The Court focused on the “prohibits access to your premises” language of the policy to conclude that the policy did not provide coverage for the FAA shutting down all flights because customers could still access the Plaintiff’s property – albeit, not by plane. However, the policy would have provided coverage in the aftermath of Hurricane Katrina, when the city ordered everyone to evacuate. See, MaGee v. National Fire Ins. Co. of Hartford, 2008 WL 426285 (La. App. 1st Cir. February 8, 2008).

In the past, BI policies included broad forms of coverage that allowed policyholders to consider value of the business location by setting the Period of Restoration - the period during which BI is owed - as the hypothetical time needed to repair or replace damage property at the original location. If the policyholder relocated during that period, the insurance company got the benefit of any income earned by the substitute operations, but relocation did not end the Period of Restoration. Modern forms, however, now define the Period of Restoration as the “lesser” of the time to repair or replace the physical damage at the original location or the time at which operations are resumed at a “new permanent location.” Unfortunately, insurance companies will often use this restrictive language to devalue the policyholder's pre-loss location and cap the loss at the point of relocation, despite the fact that the loss continues at an inferior replacement location.

With respect to whether relocation is temporary or permanent, at least one court has held that if a policy does not define the term “permanent location”, the policyholder’s subjective intent may control when the period of restoration ends. Shore Pointe Enterprises, LLC v. Michigan Millers Mut. Ins. Co., 2004 WL 2914131 (Mich. App. December 16, 2004). In Shore Pointe, the insured property sustained a fire loss. The policyholder signed a lease and relocated the business at a different location for ten months, the policyholder then moved to yet another location. During litigation, the insurance carried was able to persuade the trial court that period of restoration ended when the policyholder relocated the first time. The appellate court, however, reversed the lower court’s finding and held that since the term “permanent” was not defined, the policyholder’s subjective intent created an issue of fact that precluded summary judgment in favor of the insurance company.

Defendant argues that interpreting the phrase “permanent location” from an insured's subjective viewpoint would inappropriately allow an insured to dictate the length of time it could obtain insurance coverage for business income losses “purely my moving from one location to the next, asserting each move is only temporary in nature.” However, this is a result oriented argument that lacks a reasonable connection with the ordinary meaning of the term “permanent” as used in the insurance policy. Even if the insurance policy as drafted provides an undesirable incentive for an insured to use temporary locations following a covered loss, that does not provide a legal basis for slanting construction of the term “permanent” in favor of defendant.

In sum, the issue of whether relocation is permanent or temporary is, of course, debatable. A careful reading of the policy is warranted when considering rebuilding or replacing the property at its original location or relocating the business, given the fact that the value of the business loss claim may be capped at the point of relocation.

Last week I discussed the case of Quality Oilfield Prods., Inc. v. Michigan Mut. Ins. Co., 971 S.W.2d 635 (Tex.App.—Houston [14th Dist.] 1998, no pet.). The provision in Quality Oilfield is a good example of the “casual connection” requirement because it explicitly limited coverage for business income loss “caused by damage to or destruction of property.” The “caused by” language creates the requirement that links the loss of the insured’s income to the damage suffered by the property.

The “causal connection” requirement is imperative in situations where an event affecting a community has a subsequent effect on the insured’s business. For example, in the Lousisana case of Southern Hotels Limited Partnership v. Lloyd’s Underwriters at London, Civ. A. No. 95-2739, 1996 WL 592732 (E.D. La. Oct. 11, 1996), after Hurricane Andrew caused havoc to an insured’s community, there was a lack of customers and the insured hotel owner made a claim for loss of income and for damage to air conditioning units, a pool pump, and the telephone system. The policyholder claimed that the damage made his hotel rooms unavailable for occupancy. However, evidence showed that the insured did not turn away any customers due to the damage allegedly resulting from the hurricane.

The Court in Southern Hotels noted that there was no evidence shown that “causally connects the damage in the rooms to the loss of revenue,” given that client demand never exceeded the availability of undamaged rooms. The Court explained: “[to] state a triable issue for business interruption damages, the plaintiff must show that it lost revenue as a result of damages caused by Hurricane Andrew.” The policyholder must show “a causal nexus” between the damage caused by the hurricane and the business interruption loss. Because the policyholder failed to show any such causation, was lacking, no business interruption coverage was found.

So in order to get business interruption coverage for lost business income, the policyholder has to do more than just claim that a covered peril affected his/her business; s/he has to show a real causal connection between the actual damage to his/her business and the loss of business income.

Under both dependent property forms listed above, a “leader property” (a.k.a. attraction property) is property not owned, controlled, or operated by an insured. Rather, a “leader property” attracts customers to the insured's business. An example is an anchor store in a mall that attracts patrons who pass by the insured's specialty shop nearby. For instance, smaller stores at a mall may have Leader Property coverage to cover them for the drop off in customer traffic and business that might befall them if the flagship store at the mall - e.g., a Wal-Mart or Nordstrom's - is damaged or destroyed.

While it is clear that ownership or an insurable interest over the leader property (ie. leaseholds) do not trigger contingent business income coverage, it must also be understood that control, use and intent of the “leader property” destroys contingent business income coverage.

In Zurich American Ins. Co., v. ABM Industries Inc., 265 F.Supp.2d 302 (S.D.N.Y. 2003), 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 11th 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.

The trial court rejected ABM’s contention that the WTC itself was a “leader property” under the incorrect assumption that the leader property cannot be located in the same site.

But the Court need not reach this latter issue because it is plain that neither the World Trade Center nor its constituent parts is “leader property” in the “vicinity” of ABM which “attracts business” to ABM, but rather is itself the site and source of the ABM business here at issue. This is not a case, for example, where a related business located near a ballpark might suffer a loss if the ballpark were destroyed. Here, rather, the destruction of the World Trade Center caused loss to ABM's business by destroying the tenanted premises and common areas where ABM supplied its services.

ABM appealed the ruling. While the appellate court affirmed the outcome, it rejected the trial court’s reasoning finding that:

We reject the notion that a property cannot “attract” business to another entity at the same site, or adjacent to it. The district court's refutation of this possibility rests on an overly literal interpretation of the word “attracts.” Economic forces need not act in the same physical fashion as does a magnet attracting metal. Indeed, it was the interconnectedness of the WTC complex that “attracted” its tenants to ABM's services by providing an opportunity for ABM to exploit economies of scale. Zurich American Ins. Co., v. ABM Industries Inc., 397 F.3d 158 (2nd Cir. 2005)

Nonetheless, the court concluded that “leader property” coverage was inappropriate because the insured “operated” the infrastructure of the WTC complex, including the common areas and tenanted premises. Agents and risk managers should carefully analyze the particular nature of the businesses that the insured wishes to schedule as a dependent properties to avoid coverage foreclosure, especially in those cases where the limited form is used as an endorsement.

“Business Interruption” coverage provides protection to the policyholder from disruptions of business due to covered perils that damage the policyholder’s property. The coverage supplements the insured’s lost income while his/her property is being repaired or replaced. However, a mere slowdown in productivity is usually not enough to trigger business interruption losses.

For example, in Quality Oilfield Prods., Inc. v. Michigan Mut. Ins. Co., 971 S.W.2d 635 (Tex.App.—Houston [14th Dist.] 1998, no pet.), the policyholder suffered a theft loss of important data and engineering drawings that reduced its ability to perform its operations. Because the policy did not define “interruption of business,” the Court was faced with the question of whether a mere “work slowdown” was enough or if an actual “suspension of operations” was required. After stating that it was an issue of first impression for the Texas courts, the court looked to other jurisdictions for guidance. The Court ultimately concluded that:

“[I]nterruption of business” is an unambiguous term meaning “cessation or suspension of business.” Therefore, Quality was not entitled to business interruption coverage for the work slowdown it experienced and we find the trial court did not err in granting Michigan’s motion for summary judgment.

So if you have a “Business Interruption” policy that does not properly define “business interruption” or “interruption of business,” the case law indicates that you will only be afforded coverage if you suspend or cease all business. Do not expect your insurance company to provide coverage for a mere slowdown. However, because many policies now define “business interruption” and/or “interruption of business” in their policies, it is important to know how those terms are defined should you ever have to make a claim for a loss of business income.

Most commercial property policies define the “period of restoration” as the period of time that:

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.

The business interruption value or the coverage provided during the Period of Restoration can be calculated using either of the following methods, and both will yield the same result:

Business Interruption Value = Net Income Plus Continuing Expenses, or
Business Interruption Value = Gross Earnings Less Non-continuing Expenses

This standard methodology, however, sometimes hurts businesses with a substantial lag between the time they provide a service or sell a good and the time they get paid. Insurers are quick to argue that only losses fully realized during the Period of Restoration may be recovered, but, under such an interpretation, the insurer fails to honor its bargained for promise of fueling the business while it recovers from a loss.

Take for example a law firm that is out of business for a couple of weeks as a result of a covered peril. Those familiar with the business of practicing law will probably find it hard to calculate a business loss under the traditional formula, as it is unlikely that the law firm could perform services, bill for them and receive payment during that period.

In Pennbarr Corp. v. Insurance Co. of North America, 976 F.2d 145 (3rd Cir. 1992), the insured filed a claim under its business interruption insurance policy for the recovery of lost profits and royalties suffered as a consequence of the two earthquakes. In calculating its damages, the policyholder claimed a loss of sales equal to the production lost as a consequence of the earthquakes, approximately 14,900 typewriters. However, the claim did not allege that the loss was incurred during the actual period that its subsidiary (manufacturer) was inoperative as a result of earthquake damage. Instead, much like a law firm would if in this position, the policyholder asserted that its loss occurred during any three-month period of a date certain and argued that it could have sold the 14,900 typewriters that were not produced because inventory was depleted and it could not meet its ordinary sales obligations. The carrier denied coverage of these losses under the business interruption policy on the grounds that only losses incurred simultaneously with an interruption of business came within the clear language of the policy's indemnity period. The court unfortunately agreed with the carrier and held that an insured could only recover for any loss of sales that occurred simultaneously with interruption of production.

Conversely, in Vinyl-Tech Corp. v. Continental Cas. Co., No. 99-1053, 2000 WL 1744939 (D. Kan. Nov. 15, 2000), a manufacturing plant experienced an electrical failure which interrupted operations at the plaintiff's manufacturing plant for nine days. The carrier paid the claim for direct damage to the equipment but denied that the plant experienced any covered loss resulting from the business interruption, claiming that was able to meet all of its ordinary sales obligations by using existing inventory and that the plant had not identified any lost sales or unfilled orders occurring during the interruption period.

The defendant further argued that, under the terms of the insurance policy, lost profits are not recoverable unless they are incurred during the interruption period.  The plaintiff argued that the policy did not preclude recovery of lost profits caused by the business interruption when those losses occur shortly after production resumes and claimed that the sales from inventory, combined with the lost production, resulted reduced profits in the months after the period of restoration.

The court ruled as follows:

The court has found a question of fact concerning the amount of net profits allegedly lost. The plaintiff was able to satisfy all of its ordinary sales obligations during the interruption period from available inventory and has shown no sales that were lost nor any orders unfilled during the interruption period. Those facts do not prevent the plaintiff from showing at trial that it could have sold all of the inventory on hand when the accident occurred and all of the output it could have produced during the interruption period or that, due to business requirements, the plaintiff had to replenish its inventory after the interruption and lost profits on the production that was diverted to replenish inventory. That the amount of lost profits may not be shown precisely will not prevent recovery if the plaintiff makes the amount of its loss reasonably certain by competent evidence.

[…] A reasonable person in the insured's position would have understood the disputed terms to provide coverage for actual loss incurred within a reasonable or foreseeable time after the interruption and for extra expense incurred during the period of restoration, the court finds that such is the interpretation contemplated when the parties entered the contract.

A creative solution to this dilemma is found in Practising Law Institute Litigation and Administrative Practice Course Handbook Series:

Policyholders can attempt to address this problem at the point of sale by purchasing a form which meters the loss in a manner more consistent with the nature of the business (i.e., billable hours lost for a law firm). Most forms, for instance, measure loss for manufacturing concerns in terms of the ultimate value of the product which cannot be manufactured, and not ultimate sales lost during the Period of Restoration. At a minimum, policyholders must resist insurance company efforts to have it both ways. For instance, many insurance companies seek to take advantage of “credits” for pent-up demand after the Period of Restoration; e.g., sales of eyeglasses to persons who had simply delayed purchase until after the neighborhood eyeglass shop reopens. An insurance company should not be permitted to confine “loss” to the Period of Restoration, but then seek “credits” for amounts earned afterward.

The Ft. Myers News-Press reported on the disaster:

The TECO People’s Gas line has been repaired, after being damaged by a
construction vehicle...Approximately 6,500 customers lost their gas connection, and company representatives say it could take up to a week to get all service restored.

As in any emergency, restoration of the utility will occur in order of
priority with the largest and most critical customers, such as hospitals,
nursing homes, assisted living facilities and emergency service facilities,
first.

Commercial customers, such as hotels and restaurants will be next, and
residential customers will be third. If a less critical customers is on the
same line as a critical facility, then their service may be restored more
quickly (similar to what happens in restoring power following a hurricane).

Power outages are common following major hurricane events. The loss of income and other damage may be caused by off-site damage, similar to the power outage experienced by the businesses in Ft. Myers. For such situations, it is important to have off-site power outage coverage endorsed to the policy. Since there was no direct damage to covered property, but damage to property of others resulting in a loss of power, most commercial property insurance policies will not provide for loss of income and other losses by definition. Off-premises damage resulting in loss of power is generally added as an endorsement.

For example, Utility Service Interruption Coverage generally provides:

We will pay for loss of or damage to Covered Property described in the Schedule, caused by an interruption in utility service to the described premises. The interruption in utility service must result from direct physical loss or damage by a Covered Cause of Loss (as indicated in the Schedule) to the property described in Paragraph C. if such property is indicated by an ‘‘X’’ in the Schedule and is located off the described premises.

The loss still needs to be caused by a covered peril, but this endorsement adds coverage otherwise generally excluded. Indeed, some business interruption forms are more restrictive and eliminate coverage for income losses if the failure occurs ‘‘outside of a covered building,’’ rather than loss of power on premises.

Restaurants, food stores and food brokers should also purchase Spoilage Coverage. This provides for losses caused by power outages on or off premises with the following language:

Power Outage, meaning change in temperature or humidity resulting from complete or partial interruption of electrical power, either on or off the described premises, due to conditions beyond your control.

Power outage is a very common and significant threat to businesses. Prudent risk management requires power back-up systems as well as proper insurance coverage for these disasters. Otherwise, a second financial disaster will likely occur.

Most business interruption provisions read as follows:

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 damage to property […] The loss or damage must be caused by or result from a “Covered Cause of Loss."

The “Period of Restoration” (a.k.a. “Period of Indemnity”) in a business interruption claim is a concept of time. The period, as defined in most ISO forms, begins at the time of “direct physical loss or damage” and ends on the earlier of “the date when the property should be repaired, rebuilt, or replaced with reasonable speed and similar quality” or “the date when the business is resumed at a new permanent location.”

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. For example, 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 would be limited to eight weeks if there is no due cause for the delay.

Often, the debate on when a period of indemnity ends can drag out for years in protracted litigation to determine whether actual replacement ends the period of indemnity or whether the carrier’s delay in payment extends the period of indemnity. While I always appreciate intellectual debates of this nature, at least one court has held that the period of restoration can be computed immediately by an appraisal panel or the court. In SR Intern. Business Ins. Co., Ltd v. World Trade Center Properties, LLC, 2005 WL 827074 (S.D.N.Y. February 15, 2005), the court found that a declaratory action to determine whether to use a theoretical or an actual measure of the restoration period was ripe for adjudication since it was clear that the parties were in disagreement.

As discussed below, one of the purposes behind using a theoretical measure of the restoration period is that it allows a court to establish the time for which the insured can be compensated before the rebuilding is completed. See Alevy v. Alliance Gen. Ins. Co., No. 95-56034, 1996 WL 623065, at *2 (9th Cir. Oct.24, 1996) (unpublished opinion); Bard's Apparel Mfg., Inc. v. Bituminous Fire & Marine Ins. Co., 849 F.2d 245, 251 (6th Cir.1988). It is precisely the hypothetical or abstract nature of the restoration period in a case such as this that ensures the recovery granted the insured party will not be subject to contingent future events. See Rogers v. Am. Ins. Co., 338 F.2d 240, 243 (8th Cir.1964) (“A ‘cut off’ date is a necessity. Otherwise, claims would be opened to a degree of speculation which would be absurd. There would be no available method to determine with any degree of accuracy the amount of such losses.”).

Logic persuades us that if the Period of Restoration is subject to immediate calculation, so the amount which will be lost during that period should also be subject to immediate calculation and paid immediately. The practice of paying business income losses at the end of a long claims process is not what business income coverage intends. Insurance companies have a duty to adjust the loss with their insureds, and, similar to any other type of insurance claim, payment should be calculated in a swift manner after a full and fair disclosure of information. Business income should not be treated any differently, as the AON report suggests.

Contingent business coverage is a type of business interruption coverage will protect the “dependent business” from the external business income exposure. 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. In lay terms, 1) suppliers, 2) buyers, 3) providers, and 4) drivers.

It is important to note and understand that contingent business interruption is triggered by the proverbial “actual physical loss” requirement (to the dependent structure) or at a minimum have an “insurable interest” over the dependent structure.

For instance, in Arthur Andersen LLP v. Federal Ins. Co., 3 A.3d 1279 (N.J. Super 2010), an accounting firm filed a $204 million claim under its contingent business interruption provision for business losses sustained after the 9/11 terrorist attacks. Andersen, however, did not own or lease any property at the World Trade Center nor could it identify any supplier or client whose property was damaged to support its contingent business interruption (CBI) claim. Andersen argued that, although there was no actual interruption of goods or services from suppliers, it was entitled to coverage under the contingent business interruption provision because the World Trade Center, the Pentagon, and United Airlines Boeing 757 Aircraft (Flight 93) sustained physical damage and there was a direct nexus to its loss of revenue in the aftermath of the terrorist attacks.

Andersen relied on definition of Real and Personal Property contained in Clause 9.A(1) and argued that the ambiguity should be resolved in favor of coverage.

The interest of the Insured in all real and personal property ... which is not otherwise excluded and which is owned, used, leased or intended for use by the Insured, or in which the Insured may have an insurable interest, or for which the Insured may be responsible for the insurance [..]

The court disagreed with Andersen and found that the accounting firm failed to establish a cognizable relationship between itself and the damaged properties (WTC, Pentagon and the Boeing 757 Aircraft). Andersen did not prove it derived a direct pecuniary benefit from the properties or that it suffered a direct pecuniary loss caused by the damage.

Andersen did not derive any direct pecuniary benefit, such as rental income, from the existence of the WTC and Pentagon and suffered no direct loss from the damage inflicted to those buildings on September 11. Andersen argues that such proof is unnecessary; that an insurable interest means “ any economic interest in the continued existence of the property” and exists “if the loss of the property may cause the insured an economic loss.” (Emphasis added). When the trial court explored the breadth of this contention with counsel at oral argument, Andersen's counsel agreed that, based upon its interpretation, Andersen could assert a claim for lost revenue if a terrorist attack targeted and destroyed property that was completely unrelated to Andersen's ability to conduct its business, i.e., low income housing in New York. This expansive interpretation fails because it conflicts with established caselaw and subverts the policy underlying the insurable interest requirement.

Andersen's theory would permit an insured to allege an insurable interest in a class of property so broad as to be impossible to define and certainly not susceptible to a predictable level of risk. Just as an insurable interest cannot be viewed so narrowly as to create “a windfall for the insurer, allowing it to retain the premiums it reaped on [a] policy without providing anything in return,” Balentine, supra, 406 N.J.Super. at 144, 966 A.2d 1098, the interest cannot be read as broadly as Andersen argues, allowing the insured to reap a windfall recovery for a loss so clearly unanticipated in the calculation of the premium. Such an application would undermine the very purpose of an “insurable interest” requirement, reducing an insurance contract to a “pure gamble,” Lincoln Nat'l Life, supra, 596 F.Supp.2d at 889, and we reject it as a matter of law.

Q

I insure a bill-collection agency on a business owners policy, form BP 00 02. The agency's automatic dialing system was struck by lightning and damaged. The direct damage loss was covered.

However, the system could not be replaced immediately, so temporary employees were hired to place manual calls. The insurer paid these employees under the BOP's extra expense coverage. The agency owner now is making a business income claim, but I don't think business actually was suspended. It just was slowed down.

Should business income coverage apply?

Missouri Subscriber

A

Business income coverage is not triggered. The BOP policy provides business income for losses that are caused by the necessary suspension of operations, but it does not define suspension. In such cases we must refer to the plain meaning of the term. Webster's Revised Unabridged Dictionary defines "suspend" as "to cease from operation or activity." Suspension is defined as the "act of suspending."

The situation is a change in the method of business but not a suspension. Only extra expense is payable.

While many carriers require a “total cessation” in order to trigger coverage under a business income provision (not extra expense), some courts have disagreed with this “all or nothing” approach.

In American Medical Imaging v. St. Paul Fire & Marine Ins. Co., the insured’s business was damaged by fire. The insured immediately rented space at an alternative site and relocated the next day to a place with substantially fewer telephone lines, which were essential for the business’ operations. The insured did not return to its headquarters for approximately six weeks.

St. Paul denied the claim, citing the fact that no suspension of business occurred, and a lawsuit followed. American Medical lost at the trial level, but prevailed on appeal. Under a provision similar to the one cited above, the court ruled in favor of American Medical:

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.

American Medical points out the problem at the heart of the “total cessation” approach: the insured can be punished for attempting to mitigate its own loss, as well as the insurer’s potential loss. Vincent Morgan’s article in CAT Claims: Insurance Coverage for Natural and Man-Made Disasters, explains that while the “total cessation” approach may have some logic, it also has significant shortcomings:

1. Failing to accurately address the realities of large businesses that operate worldwide on a “round the clock” basis that would never cease operations;
2. Creating perverse incentives for insureds to enhance their insurance recovery by not taking all possible steps to maintain partial operations, increasing the loss and decreasing economic output; and
3. Creating inconsistent obligations for insureds because of the corresponding duty to mitigate, leaving an insured that can mitigate a loss by maintaining partial operational capabilities without coverage due to the lack of total cessation.

If you suffer a business interruption loss, I recommend contacting a professional right away to work with your insurer to determine how you can most effectively use your insurance and protect your business.

Recovery under this provision is typically established by calculating the business’ net profit before income taxes that would have been generated had no loss occurred, plus the normal operating expenses that continued during the period of restoration after a loss. For example, if a business would have earned $100,000 in net profit before the loss and it incurred $100,000 in continuing normal operating expense after the loss, the business income figure would be $200,000. The FC&S Bulletin opines that this standard calculation “should put the policyholder in the same position as it was before the loss. The profits that would have been earned are safely in pocket, and the operating expenses that were actually paid out after the loss are reimbursed. Both the profit and the operating expenses would have been covered by earnings before the fire. After the fire, they are covered by insurance. It does not matter what the operating expenses might have been before the fire (other than to help calculate the before-loss profit), because the existence of a profit assumes that all operating expenses, whatever they were, were covered by earnings with funds left over.”

This formula, however, is somewhat problematic for those businesses that were operating at a net loss at the time of loss. For example, if it is found that the business was operating at a net loss of $100,000 (-$100,000) and it incurred $200,000 in continuing normal operating expense after the loss, the business income figure would be $100,000. In other words, under the language of this provision, the net loss would be offset by the operating expenses and, depending on the calculations, the formula could yield to a zero ($0.00) recovery.

Courts have agreed with this answer. In Liberty Mut. Ins. Co. v. Sexton Foods Co., 854 S.W.2d 365 (Ark. App. 1993), the court said:

In order to assess the amount of the loss, the amount of business income should be determined by adding the amount of net income and the amount of continuing normal expenses; if net income is a positive number (which will occur whenever there are net profits), the amount of business income will be the sum of two positive numbers, and the insured will be entitled to recover that amount; if, however, net income is a negative number (which will occur whenever there is a net loss), the amount of business income will be the amount of continuing normal operating expenses reduced by the amount of the net loss; if the amount of the net loss that would have been incurred had there been no business interruption exceeds the amount of the normal operating expenses actually incurred, the resulting number is a negative number, and there can be no recovery for an actual loss of business income.

In deciding a similar case, a Tennessee Supreme Court judge in Continental Ins. v. DNE Corp., 834 S.W.2d 930 (Tenn. 1992) wrote that:

[I]gnoring 'net income' whenever there is a net loss would put the insured, in all cases when there is a net loss, in a better economic position from having its business interrupted than it would have occupied had there been no interruption of its business operations. Such an interpretation would obviously be inconsistent with the purpose of providing insurance, as well as with the decisions of other cases involving similar issues.

Carriers will also 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.

A decision in California has recently leveled the playing field on this issue. 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' interpretations, 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, there would be no point for that business to purchase the additional coverage.

In essence, Amerigraphics at least allows recovery for the continuing expenses despite the net loss, which is a breath of fresh air for many businesses.

In order to protect start-up companies or businesses who operate at a net loss for at least five (5) years, brokers and risk managers often recommend the use of a Valued Business Income Form. The valued form was first drafted by Henry R. Dalton, a Boston insurance agent, in the late 1800s.
Valued forms pay a set amount for each period of business suspension. The time period could be twenty-four hours, one week, or one month.

Because the limit is established prior to the loss, there is no need to perform a lengthy calculation to establish the amount of loss. This means that the issue of a net loss or net profit is addressed prior to the insurance being purchased. There also is no coinsurance clause. Valued forms remove some the uncertainties that can affect recovery under the standard forms (ie. operating at a net loss). Valued forms, however, come with high premiums and not every business may benefit from their use.

The FC&S Bulletin warns on the use of valued forms:

There are several reasons that professionals are cautious of using the valued form of coverage. One reason is that some underwriters believed it created a moral hazard. Companies might profit from the coverage, actually ending up better off during the time of interruption than they would have been if it was business as usual.

This is a valid concern. Careful underwriting of a company's business plan is necessary to counter this possibility. The form should be used as a tool to craft coverage that is suited to companies in their developmental stages, and careful review of the company's business plan is necessary. It should not be used just because a company is operating at a net loss.

Another potential problem with the valued form is that insureds assume the burden of setting the limit of coverage. Even though this method does not rely on the insured's internal financial data when adjusting the loss, it does require careful preparation of a business income worksheet by the insured when the coverage is underwritten. Special attention must be given to the amount of anticipated continuing expenses, as well as any extra expense that might be incurred. The insured must realize that the limit established for each unit of recovery (day, week, or month) is the maximum amount recoverable during each recovery unit.

[…]Another reason to possibly avoid using the valued form is, in the event of a partial suspension of business, the form pays a percentage of the per unit limit. It is important that companies understand that the amount paid each day will be decreased proportionately when a partial shutdown occurs. This percentage is equal to the value of lost production or income divided by its normal value prior to the loss. The formula for a partial suspension is as follows:

Lost Production        x     Working Day Limit = Partial Loss Payment
Normal Production

As an example, a company may lose $50,000 in production during a month that normally would generate production valued at $200,000. If the recovery limit in this situation is $5,000 per day, the partial suspension would be adjusted as follows:

$50,000   =   1   x    $5,000  =  $1,250 recovery per day
200,000        4

The partial loss formula would be triggered when only a portion of the business is suspended because of a loss. It also comes into play as a company begins to resume operations after a total suspension.

A major expense for any organization is employee payroll and benefits (if directly related to payroll and paid by the organization: FICA payments, union dues, and workers compensation premiums) and one that must be reviewed and understood prior to loss as to the extent, if any, that should be continued during the period of restoration. An organization can decide to treat all payroll and benefits as a continuing expense and not remove it from the worksheet and thereby include all within the limit insured. Some organizations may decide that it can lay off certain employees that are not critical for the organization's recovery during the period of restoration. Each organization is different in terms of employee skills, local job markets (low or high unemployment), and cost to retain new employees when prior ones are not available for rehire.

The typical approach for most organizations is to decide what class(es) of employees should be paid during the period of restoration and which ones should not. Most insurers use the term "ordinary payroll" to define that which may be excluded totally or paid for a specific period of time (90 days, 180 days, etc.) by the named insured. Ordinary payroll is a term defined by ISO in form CP 15 10 06 07 as "payroll expenses for all your employees except: officers; executives; department managers; employees under contract; and additional Exemptions, shown in the Schedule as: Job Classifications; or employees." It is possible that certain employees by name or class may fall within the definition of "ordinary payroll" but the organization deems their contribution to be needed during the period of restoration. An exemption to the broad definition of "ordinary payroll" can be used in order to continue payroll and benefits for these key employees. ISO Form CP 15 04 06 07 Discretionary Payroll Expense is used for this purpose.

I find that an example from the National Underwriter FC&S Bulletins is always helpful in understanding the practical application of certain policy endorsements:

Business Income and Ordinary Payroll

Q

A client I handle purchased business income coverage through ISO form CP 00 30. Endorsement CP 15 10 was attached to limit coverage for ordinary payroll to six months. This insured suffered a covered loss and was partially shut down for nine months. I believe he should be allowed to recover ordinary payroll expenses during the entire nine months because the company was only partially shut down.

The insurance company has disallowed ordinary payroll expenses past the six-month time frame. Is that correct?

Ohio Subscriber

A

The standard business income form CP 00 30 provides coverage for the actual loss of business income during the "period of restoration" which, in this case, would be nine months. The form defines business income as net income that would have been earned or incurred had the loss not happened and continuing normal operating expenses incurred, including payroll. Endorsement CP 15 10 limits coverage for ordinary payroll to the period stated on the endorsement.

Since this insured limited ordinary payroll coverage with the endorsement to six months, only the amount accrued during the six-month period of the shutdown can be included in the loss settlement.

Also illustrative is the trial court’s ruling in Consolidated Companies, Inc. v. Lexington Ins. Co., 2009 WL 211751 (E.D. La. 2009). Although this opinion was vacated and remanded by an appellate court on other grounds, the trial court was affirmed on the accounting principles involving the calculation of net profits to the exclusion of ordinary payroll in a case where the business partially resumed operations to minimize its business losses:

Lexington contends that the jury award of $7,071,120 in lost profits as part of the business-interruption claim improperly compensates Conco for its ordinary payroll, which is not covered under the policy. Lexington argues that Conco's computation of its claim for lost profits, by subtracting its actual profit in the aftermath of Hurricane Katrina of $279,006 from the profit it would have otherwise earned is an “end-run” around the exclusion for ordinary payroll. Specifically, Lexington argues that, by deducting $12,900,000 of ordinary payroll in calculating actual net profit, which Conco then subtracted from “but for” profit to compute damages, Conco increased its lost-profit recovery by $12,900,000. Lexington argues that the amount of Conco's net profit after resuming operations must be calculated independently of the amount Conco spent on ordinary payroll. When net profit is calculated this way, argues Lexington, Conco suffered no covered “actual loss” under the policy.

There is no provision in the policy under the “Resumption of Operations” provision that, in calculating the actual profit or loss sustained by the insured during the period of restoration, the net profit prevented from being earned be reduced by ordinary payroll paid during the resumption period. Conco generated over $205,000,000 in revenue when it resumed operations and spent $12,900,000 of that revenue on ordinary payroll. In determining the net profit earned of $279,006, ordinary payroll was properly deducted from the revenue generated during the resumption of operations.

On the issue of tanning beds and extra expense coverage, the FC&S Bulletin published the following:

Extra Expense for a Tanning Salon

Q

The insured owns a tanning salon. He is insured on a standard commercial property form, with the CP 00 50 04 02, Extra Expense, endorsement. There is no business income endorsement. Many of his customers pre-pay for a number of sessions, or have monthly fees directly taken from their credit cards.

He suffered a covered loss in which four out of the seven beds were rendered unfit for use. In order to keep his business alive (particularly in the light of many customers having pre-paid), he contracted with another tanning salon for his customers to use the other salon's tanning beds. He paid the other salon $8 per person/per session, which is what his customers paid.

When he submitted this expense to the insurance carrier, however, the claim was denied. The adjuster stated this was a business income loss and not covered. May we have your opinion?

Pennsylvania Subscriber

A

The extra expense coverage form states "extra expense" means "necessary expenses 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." These extra expenses include those "to avoid or minimize the suspension of business and to continue 'operations' at the described premises, or at replacement premises or at temporary locations."

Since the insured has, through contracting with another tanning salon to serve his customers, incurred expenses he would not otherwise have had, there is coverage. He has minimized the suspension of business through this arrangement. Further, the endorsement does not state the insured must own, rent, or lease the "replacement premises," so the use of the other tanning salon becomes the insured's business's "temporary location."

Other popular “extra expenses” could be temporary office space, temporary computer systems or furniture for the temporary space, overtime for workers who need to spend additional time outside of their normal workday due to the covered event. If employees were not able to bring their lunch to work because the employee’s lounge/kitchenette was burned in a fire, an extra expense claim could be made for feeding them during this time period.

For example, in Cotton Bros. Banking v. Industrial Risk Insurers, 951 F.2d 54 (5th Cir. 1992), the court granted coverage for security expenses to avoid theft of a damaged business property. Also, in Northwestern States Portland Cement Co. v. Hartford Fire Ins. Co., 360 F.2d 531 (8th Cir. 1996), under a business interruption endorsement containing an "extra expense" clause, the insured was able to avoid a loss of earnings by using available raw materials to continue production; the extra cost involved in producing replacement raw materials was recoverable, although the total cost of such materials was not.

It is also important to note that, as with most insurance policies, the insured has a duty to mitigate its damages after the loss and that Extra Expense Coverage allows the insured to recover a measure of the incidental costs expended in trying to mitigate damages pursuant to the terms and provisions of most insurance policies.

At our firm, we subscribe to the FC&S Bulletins, published by the National Underwriter Company, among many other reliable coverage resources, to help our clients make sense of it all. The following bulletin made me think of the many times we have turned a “No” into a “Yes,” especially in the “loss or damage” debate in business interruption claims, as discussed in Does an Insurance Policy Cover only “Loss” or “Damage” to Property? and The "Loss" or "Damage" Coverage Requirements - A Business Interruption Afterword - Understanding Business Interruption Claims, Part 31.

Theft and Loss of Business Income

Q

Our insured, a jeweler, has a business owners policy (BOP), ISO form BP 00 02, which excludes merchandise for sale. A jeweler’s block policy covers the merchandise. The BOP provides for business income coverage when the building or personal property is damaged as a result of an insured peril.

During an armed robbery the gunman fired a shot into the floor damaging the carpet and floor. Of course, that did not cause the interruption; the thief took all the merchandise, which did cause the interruption.

The company says the damage must cause the interruption, and since merchandise is excluded, there is no coverage. They said "as the property damage to carpeting and floor does not cause an interruption of business or the untenantability of your premises, there is no coverage for loss of income."

This might be the intent of the people who wrote this form, but it does not say that. It says only that coverage is triggered when there is damage.

Who is right?

South Carolina Subscriber

A

The BOP business income coverage applies to the actual loss of business income that is due to the necessary suspension of the insured's operations during the period of restoration. The suspension "must be caused by direct physical loss of or damage to property at the described premises."

Note that the damaged property does not have to be "insured" by the BOP; it only has to be located at the premises described in the policy and damaged by any BOP peril.

There need only be damage to any property at the insured location. The most common occurrence of this kind involves a tenant whose business is closed when the landlord's building is damaged by fire. Even though there is no damage to the tenant's own property that is insured by the BOP, there has been damage to property by a covered business-owners peril (fire); the business-owners policy covers the tenant's loss of income during the closing.

In the case cited, the theft of the jewelry is a loss to personal property at the premises as a direct result of an insured peril (theft). The fact that the jewelry is not insured by the BOP does not matter. In addition, the damage to the carpet and floor by the gun shot also is sufficient to trigger coverage under the present wording.

Never give up…

The issue, however, is not a lost cause. The FC&S published a similar question/answer scenario where, given the right circumstances and adequate documentation, recovery may be allowed.

Business Interruption and Unoccupied Premises

My insured’s business is leasing commercial real estate. He was finalizing renovations to a newly-purchased building, and was showing it to potential tenants, when a covered water loss occurred. There is no problem with the insurance policy’s responding to the property loss, but when we submitted a claim for business interruption for the restoration period, the insurer denied coverage. The insurer’s position is that because the building was not yet leased, the insured could not have sustained a loss.

I have looked at the policy (an ISO BP 00 02 12 99), which promises to pay “the actual loss of Business Income you sustain due to the necessary suspension of your ‘operations’ during the ‘period of restoration’.” Further, business income is the “net income (net profit or loss before income taxes) that would have been earned or incurred if no physical loss or damage had occurred.”

The insurer says that there would be coverage only if the insured had a signed lease in hand. Further, the insurer adds, “New York law states that property must be rented before loss of rents can be paid.”

What is your take on this?

New York Subscriber

A review of the policy yields no exclusions. We could not find any New York statute, case law, or policy amendment that holds that a premises must be rented, or with rental imminent as documented by a signed lease. We turned to other jurisdictions. In one North Carolina case, the condominium unit owners’ policy in question (from Lloyd’s) specifically covered loss of rents, which were “new rental proceeds that would be payable to [the named insured] had the premises been occupied in accordance with ‘rental contract’.” (Certain Underwriters at Lloyd’s London v. Hogan, 556 S.E.2d 662 [N.C. App. 2001]) So, no loss of rents was payable since the unit was not rented at the time of loss.

A court in Washington addressed the issue of rental income for a bed-and-breakfast with a different outcome. Here, the policy promised to pay the “fair rental value of that part of the premises that is either rented to others or held out for rental.” The insurer tried to limit payment to the amount for rental of the entire premises as a single-family home, but the court disagreed, saying that the insured could elect payment for rental of the portion “held for rental.” The court added that the insured had to provide supporting documents and records for the claim. (DePhelps v. SAFECO Insurance Co. of America, et al., 65 P.3d 1234 [ Wash. App. 2003]).

The case that seems most applicable, however, is BA Properties, Inc. v. Aetna Casualty & Surety Company, 273 F.Supp. 2d 673 (D.C. V.I. 2003). Here, a hurricane damaged a hotel and the insured claimed a business interruption loss. There was no discussion as to whether the rooms were occupied or there were reservations in hand; the assumption was that the insured was in the business of renting rooms and the covered hurricane damage interrupted that business.

In the situation you describe, the insured is in the business of purchasing and renting commercial property. The insured can prove he has engaged in this business for some time. A covered property loss occurred. We think, therefore, that the loss is covered, but the insured must be able to prove the loss based on his past business experience (since he has none with the subject building), that is, he has a history of successfully purchasing, restoring (if necessary), and renting property.

For additional information on this topic, see The Business Interruption Book (The National Underwriter Co., Cincinnati, Ohio , 2004).

I found the following tips to be insightful for any claim, large or small:

Define the Problem

Problems with property and business interruption claims usually fall into five categories, as follows.

1. Technical disagreement on coverage

2. Valuation and accounting disagreements

3. Questions about the scope of damage

4. Lack of information

5. Personality problems

You will need to define where the problem falls with your own claims team before you move forward with a plan.

Research

Find out more about the issues at hand. Have other companies dealt with the same issues? Have you contacted their risk managers? What experience have you or other clients had with this adjuster? What other claims have they adjusted? Are they well-respected in the field? Are there other corporate clients that you can talk to about their successes or failures in working with the adjuster? What is the adjuster’s experience level? The loss may be too complex for the adjuster to handle. Is your claim consistent with the terms and conditions of the policy? Check with your broker or attorney on coverage issues.

Schedule

Suggest implementing an agreed-upon loss adjustment schedule. Determine what information either party will exchange and when the exchange will occur. “Obtain agreement from the adjuster’s team and your own management team as to the overall goals, priorities and sequence of events and meetings.”

Disclose

Inform your adjuster of your perception of the loss adjustment process in a small meeting. Be specific and mention areas that you find challenging, and suggest some ways to overcome these obstacles. Let the adjuster know that you are responsible for reporting to your management on the claim’s progress. Ask the adjuster for advice on how to resolve items in the claim. Inform the adjuster that you can only allocate a certain amount of time to this project before corporate will ask you to hand over the claim to another group (legal) in your company.

Match Talent

Do you, as the policyholder, have your own qualified claims professional or claims consultant on your team? Nothing can replace time in the field and years of experience in adjusting losses. Your adjuster may relate better to a qualified claims professional with adjustment experience.

Also, check your accounting and engineering expertise. Have you hired your own claim accountant that is independent from the insurance company and its representatives? “Understanding everyone’s role in a business interruption claim is a good starting point to begin to manage expectations.”

Put it in Writing

Request that the adjuster put the issues at hand in writing. A letter may heighten the level of seriousness and ensure that the other side is convinced enough by their position that they will put it in writing. You can also detail out your position in writing to ensure the adjuster and the insurance company know exactly what it is.

Attorneys at the Gate

Insert attorneys into the process. They can assist with negotiations or invoke some method of alternative dispute resolution such as appraisal or mediation. Be sure to select attorneys that specialize in insurance coverage.

Of course, there are many other ways of tackling problems during the claims process. Policyholders should always consider hiring insurance counsel during the early stages of the claim in order to exert more control over the claims process. As with any other problem in life, the key to success is to put yourself in the shoes of your opponent and come up with creative ways resolve your disputes. 

Chris Boggs in his book Business Income Insurance Demystified: The Simplified Guide to Time Element Coverages, explains the dire scenario as follows:

During the period of restoration, the insured’s customers and clients may find alternate sources for the goods, services or products the insured provides. In so doing, those customers may have developed new buying habits or entered into a replacement contractual relationship with another entity. Regaining those customers and the revenue they represent takes time. Replacing the customers and clients with new buyers requires even more time.

Business Income Coverage Form (and Extra Expense) CP 00 30 06 07 and Business Income Coverage Form (without Extra Expense) CP 00 32 06 07 provide indemnification beyond the period of restoration for the difference in income for up to 30 consecutive days or when the business generates the same amount of income that would have been earned had no loss occurred, whichever occurs first.

An article in the FC&S Bulletin is illustrative:

Business Income Coverage—Restaurant Closed due to Robbery

Q. Our insured owns a small restaurant that was robbed at 9:30 on a Saturday night. Everyone was locked in a cooler by the robbers while they emptied the cash drawer and smashed the computer that operates the cash register and customer order system. Because the computer was down, the restaurant remained closed Saturday night and did not open again until its normal opening time of 11:00 Monday morning. The computer was fixed by this time. The insured carried an open perils business income coverage form (without extra expense) and the extended business income option. The insurance company paid the business income loss for the balance of Saturday night and Sunday, but refused to honor the extended business income option for the decrease in business the insured suffered during the week following the robbery. Business was down one third that week.

The insurance company argues that the decrease in business during the week following the robbery was due to fear of bodily injury in the minds of potential patrons and was not caused by the time required to repair the physical damage to the computer. They maintain that the short-term closing was not long enough to cause the loss of customer base intended to be covered by the extended business income option. We feel that the extended business income coverage should apply.

-Ohio Subscriber

A. All of the elements required for a covered extended business income loss are present in your insured's loss. Business was suspended because of direct physical loss or damage to the computer ordering system. The loss was covered by a covered cause of loss. The insurance company admitted this by paying the business income loss suffered from Saturday night until Monday morning. An additional loss of business income began on the date the property was repaired and operations were resumed and ended at the end of the week when the insured's operations were restored to the condition that would have existed if no direct physical loss or damage occurred.

The insured does not have to establish the motives of the customers who stayed away from the restaurant because the policy does not require it. The insurance company's presumption that customers stayed away out of fear of bodily harm is irrelevant, as is the presumption that the restaurant was not closed long enough to lose its customer base. All that is required is a covered loss and a decrease in business during the time period allowed by the policy. These conditions were met by your insured's extended business income loss.

In non-catastrophic losses, Extended Business Coverage can mean the difference between shutting down or staying alive after a loss. However, this time element coverage warrants a caveat.  Chris Boggs warns:

Extended Business Income protection will not allow and is not designed to help the insured recover income lost due to externally poor economic conditions present following the insured’s return to operations. If the insured’s ability to return to pre-loss income levels is stunted buy the surrounding community’s economic condition, the coverage extension does not apply

The issue of whether a total cessation or a mere slowdown in productivity is required to trigger business interruption coverage is one of those questions that will most likely be defined in the policy. If not, courts will be given an opportunity to answer the question, which could lead to undesired results for either party.

In Keetech v. Mut. Of Enumclaw Ins. Co., 831 P.2d 784 (Div. 3 1992), a hotel was covered in ash after Mount St. Helen erupted. Although the hotel sustained “physical damage” as a result of the ash, the hotel remained open. Some of this damage, such as the destroyed plants and shrubs, were not replanted until six months later. Because of the ash fall, and the succeeding ash blowing onto the premises, the physical appearance and physical attractiveness of the motel was damaged. Although the hotel remained open and operated at all times, it suffered a decrease in hotel occupancy and made a claim for business income loss. The carrier denied the claim and suit followed.

The policy in question stated, in part:

[T]he actual loss sustained by the insured resulting directly from necessary interruption of business ... for only such length of time as would be required with the exercise of due diligence and dispatch to rebuild, repair or replace such part of the property herein described as has been damaged or destroyed ... Due consideration shall be given to the continuation of normal charges and expenses, ... to the extent necessary to resume operations of the insured with the same quality of service which existed immediately preceding the loss; and

....

4. 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 complete or partial resumption of operation of the property herein described, whether damaged or not, ...

such reduction shall be taken into account in arriving at the amount of loss hereunder.

The Keetech court denied recovery under the cited provision, holding that “the purpose of business interruption insurance is to indemnify for loss due to inability to continue to use specified premises. Here, [the insured] did not suspend its business activity; its business was not interrupted as provided for in the loss of earnings endorsement.”

Although many courts follow the “total cessation” approach in Keetech, many others will allow recovery under a “slow down” theory, depending on the language of the policy at issue. For example, in American Medical Imaging Corp., v. St. Paul Fire and Marine Ins. Co., 949 F.2d 690 (3rd Cir. 1991), the court allowed recovery even though business continued at less than normal level.

In American Medical Imaging, the insured’s business was damaged by fire. The insured immediately rented space at an alternative site and relocated the next day to a place with substantially fewer telephone lines, which were essential for the business’ operations. The insured did not return to its headquarters for approximately six weeks.

St. Paul denied the claim, citing the fact that no suspension of business occurred, and a lawsuit followed. American Medical lost at the trial level, but prevailed on appeal. Under a provision similar to the one cited above, the court ruled in favor of American Medical:

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.

American Medical points out the problem at the heart of the “total cessation” approach: the insured can be punished for attempting to mitigate its own loss, as well as the insurer’s potential loss. Vincent Morgan’s article in CAT Claims: Insurance Coverage for Natural and Man-Made Disasters, explains that while the “total cessation” approach may have some logic, it also has significant shortcomings:

1. Failing to accurately address the realities of large businesses that operate worldwide on a “round the clock” basis that would never cease operations
2. Creating perverse incentives for insureds to enhance their insurance recovery by not taking all possible steps to maintain partial operations, increasing the loss and decreasing economic output; and
3. Creating inconsistent obligations for insureds because of the corresponding duty to mitigate, leaving an insured that can mitigate a loss by maintaining partial operational capabilities without coverage due to the lack of total cessation.

If you suffer a business interruption loss, I recommend contacting a professional right away to work with your insurer to determine how you can most effectively use your insurance and protect your business.

As noted before, there are two diverging views on whether post-loss market conduct should be considered to determine the value of a business interruption loss. Experts have coined the debate between “economy ignored” and “economy considered” cases as follows:

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.

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.

* * * *

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.

A typical policy defines the duty to mitigate as follows:

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.

Fountain Powerboat v. Reliance Ins. Co., 119 F. Supp. 2d 552 (E.D. N.C. 2000), is illustrative of the value of this type of coverage. Fountain manufactured, distributed and sold boats and boating equipment out of a facility in Washington, N.C. In 1999 Hurricane Floyd dumped record-setting rain fall over the eastern part of North Carolina. After the storm passed, the only roads leading to the Fountain facility were closed for seven days. For three days Fountain used large trucks to pick up workers from various “pick-up points” and transport them to the facility. As a result of displacement caused by the floods, production at the Fountain facility fell to 33 percent of full capacity.

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 yesterday's post, I quoted Barry Zalma’s opinion, "without Insurance the economy of the world would collapse. No entrepreneur would dare invest money in a business if he could not spread the risk of loss." Scott Johnson and his fellow insurance agents would make a much greater impact upon their business clients if they could convince more to purchase complete coverage in the various forms of business loss insurance. Money is the lifeblood of any business organization.

In an upgrade to our website and to make all of Michelle's work more easily available, we have placed them together into an e-book for study. Just click below.

Service Interruption coverage usually reads as follows:

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.

In the post, Chip commented:

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.

In Gordon Chemical Co. v. Aetna Cas. & Sur. Co., 266 N.E. 2d 653 (1971), there was an explosion at the insured’s manufacturing plant which forced the insured to shut down operations for 15 months after the loss. In this case, the insured manufactured high impact polystyrene and sold its entire output to another manufacturing plant next door, which converted the polystyrene into different byproducts. The insured was unable to continue servicing its sole customer for 15 months and thus sustained a net profit loss of $215,350.00. Aetna contended that in order to mitigate its losses, the insured was obligated to purchase manufacturing materials from its competitors in the open market and resell the materials to its sole customer. The court did not find that such a feat was required under the terms and conditions of the policy.

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.

How can you, the CFO or risk manager avoid that day of reckoning when your company cannot afford the economic consequences of an underinsured loss?

When you meet with your broker to review your insurance policy for renewal, focus on your reported or insured values for your business interruption coverage and on the numerous extensions of coverage that are available based on your organization’s specific operations and needs. Calculating the appropriate business interruption values will help you select the proper coverage and respective limits and will enable you to better manage and, more importantly, minimize your financial risk.

Fundamental to obtaining the proper limits/sub-limits and type of business interruption coverage is an updating and reevaluation (or assessment for the first time) of your business interruption values. From my prior experience as a CFO (and being responsible for insurance), I recall the temptation to take business interruption worksheets provided by the broker and subsequently give them back to him or her, along with a copy of the company’s most recent financial statements, and saying, “I don’t understand this form. It does not relate to my business operations. So take my financials and tell me how much BI coverage I should have!” If you recognize yourself in that scenario, you are not alone. CFOs and risk managers should work with brokers and insurance consultants to create a comprehensive analysis of the needed coverage by identifying and quantifying potential operational and financial risks to the organization and by shifting that risk to the company’s insurance carrier(s).

When preparing your updated (or initial) business interruption values calculation, I recommend the following five-step action plan:

1. Communication – Meet with your senior management to review existing business risk assessments, previous loss history, business plans and financial projections and to identify potential mitigation strategies.
2. Diagnosis – Identify contingent and extended exposures, internal and external interdependencies as well as other exposures that may not be triggered from first-party property damage.
3. Technology – Integrate technological solutions to create an efficient and timely valuation process.
4. Analysis – Review and analyze risk exposures to facilitate the quantification of business interruption values.
5. Documentation – Create detailed schedules supporting calculated values by operation and location, including the underlying assumptions.

Preparing a Maximum Loss Scenario (“MLS”) analysis is also beneficial and is generally well received by both senior management executives and underwriters. An MLS analysis is the process of simulating an occurrence in which an organization experiences a catastrophic loss event. The financial impact of this simulated loss event is quantified and addressed in a report to underwriters that provides a more comprehensive analysis and understanding of the risk that they are evaluating and underwriting. Senior management benefits from the MLS analysis because it may identify critical path weaknesses and interdependencies in an organization which may then be used to update their strategic and disaster recovery plans. The MLS analysis should also include an assessment of potential extra expenses that could be incurred as a result of the simulated risk, in addition to the business interruption losses.

As part of the process of determining your business interruption values, you also need to understand the numerous extensions of coverage that are available to mitigate your risk. Many of these additional time-element coverages may be critical to safeguarding potential lost profits from a catastrophic event, and therefore need to be individually analyzed and addressed with your broker. The following are some of the additional coverages to consider:

• Contingent business interruption
  • Provides additional coverage as a result of a covered loss to suppliers and receivers of goods and services. Without this coverage extension, companies that have critical suppliers, customers or feeder-type properties may find themselves at the mercy of a supplier’s or customer’s rebuilding schedule. In the worst-case scenario, you may have to shut down due to a supplier’s or customer’s physical loss.
• Ordinary payroll coverage
  • Your managerial and salaried employees are normally covered as a continued expense. However, your hourly non-managerial employees may not be covered. If you have hourly skilled labor or if you are located in a tight labor market and cannot afford to lose trained workers from not continuing to pay them during a business interruption, you can purchase an extension of coverage that will allow you to pay these workers for a specified period of time while the company is shut down, generally, the coverage is purchased for a specific number of days, e.g., 30, 60, 90, and up to 365. To determine how many days of coverage you may need to purchase, you must determine the skill level of your workforce and evaluate the risk that they will not return to work after a closure.
• Extended period of indemnity
  • Your business interruption coverage indemnifies you through the period of interruption, which is also referred to as the period of indemnity or restoration. This period is often defined as the time it takes to rebuild or restore the damaged property to its pre-loss condition using due diligence and dispatch. An extension of coverage allows for continued indemnification from your insurance coverage for the time necessary to ramp up your business to its pre-loss levels following the physical restoration. This is an important coverage for businesses in a highly competitive environment, such as the hospitality industry.

The following are some additional types of extensions of coverage to consider with your broker:

• Claim preparation fee
• Service interruption/power outage, including off-premises service and overhead transmission lines
• Extra expense
• Expediting expense
• Finished goods inventory selling price
• Loss of attraction (primarily for the hospitality industry)
• Ingress/Egress
• Sue and labor
• Civil authority

CFOs and risk managers should meet with their brokers to closely examine their business interruption values, limits and available extensions of coverage in their current policies. The critical takeaway is that properly calibrated business interruption coverage can be one of your most valuable assets for providing the critical working capital needed to survive a catastrophic event.

- Bob Glasser

While no one can predict the future, we all can at least prepare for it. In his blog post, Mr. Calaci correctly warned:

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.

The Court made the following factual findings:

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.

Most commercial property policies define the “period of restoration” as the period of time that:

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.

The truth is that these claims, like most lost income claims, can be extraordinarily complicated. My conclusion is important and optimistic:

So long as courts continue to interpret the OPA as providing broad theories of recovery, we have a tremendous opportunity to help victims get fully compensated for their economic loss. Attorneys should leave no stone unturned in assessing and valuing claims and pursuing every theory that could restore the livelihoods, property and way of life that have been indefinitely disrupted.

Since these claims will involve so much money, it seems that the following is appropriate for a mid-week break:

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.

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.

[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.

The case American Medical Imaging Corp. v. St. Paul Fire & Marine Insurance Co., 949 F.2d 690 (3rd Cir. 1991), is the epitome of an extra expense Catch-22. In American Medical Imaging, the insured was in the business of providing ultrasound testing services. The imaging services were rendered at physicians' offices, joint venture sites, and other health care institutions, while the scheduling, marketing, billing, and clerical functions were performed at the insured’s headquarters location.

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.

Many can learn what to do by attending the Oil in the Gulf: Litigation & Insurance Coverage Conference on June 24 in Atlanta. Just before Robert Kennedy, Jr., gives the highlight keynote presentation with plenty of media fanfare, I will give a much more practical presentation-- dear to the hearts of all claimants-- regarding how the valuation of oil spill claims should be made. My co-presenter is an experienced Exxon Valdez valuation expert, John Kilpatrick, PhD, the Chief Executive Officer of Greenfield Advisors. His paper, The Aftermath of Katrina: Recommendations for Real Estate Research, should be considered by those representing BP oil spill claimants to provide some ideas as to the long term lost profit implications following this catastrophe.

The BP oil spill claim process for private claimants is currently a publicity stunt. Even President Obama noted this concern in a Bloomberg Businessweek article, Obama Doesn’t Want BP ‘Nickel and Diming’ Victims.

"President Barack Obama said he doesn’t want BP Plc “nickel and diming” fishermen and small businesses and that the company has a “moral and legal obligation” to compensate those affected by the oil spill in the Gulf of Mexico."

The truth is that unless BP is forced to hire a legion of accountants, economists, and scientific researchers right now, nickels and dimes are all oil spill claimants will be paid because the casualty adjusters BP has hired simply do not have the experience, knowledge and creativity to properly forecast and calculate lost profits and lost earning capacity. The insurance industry has substantially outsourced its obligation to adjust lost income and business interruption losses to specialized accounting firms. Claims adjusters no longer have the ability to handle lost profit claims. Unless a sufficient number of those specialized firms and other accountants are retained, along with transparent economic forecasts, claimants will probably not collect or realize the full extent of the damage caused by the oil spill.

BP currently pays a part of the damage, says it "will" pay for all legitimate claims,” and then intentionally fails to retain a sufficient number of motivated experts who can determine the full extent of the damage. BP is not spending the money required to compensate those whose lives and livelihoods have been devastated by this disaster. Yet, BP maintains the appearance of trying to fairly compensate those harmed. It seems as if BP has read the playbook of many insurance companies when it comes to prompt and full payment of business loss claims.

Most business interruption forms read as follows:

* * * * * *

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.

Here is the interview:

I suspect that many insurance companies and their attorneys will be studying the nuances of the Oil Pollution Act claims process regarding first party claims. Many claims can be brought under various first party policies, depending on policy language. Subrogation claims by those insurers will also be made against BP -- after first party losses are resolved with policyholders.

BP has created this monstrous mess. It will have a very big and long tail before it is over.

The period of restoration in a business interruption claim is a concept of time. The period, as defined in most ISO forms, begins at the time of “direct physical loss or damage” and ends on the earlier of “the date when the property should be repaired, rebuilt, or replaced with reasonable speed and similar quality.” […] or “the date when the business is resumed at a new permanent location”

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.

The post, Public Adjusters Arrested in Broken Tile Insurance Fraud Scheme, set records for “hits” on this site. I also received all kinds of emails and discussion from others. At lunch with six attorneys in our firm, I mentioned that I have been doing this line of work since 1983 and have never handled a broken tile claim. Four others had the same experience, one attorney had a couple, and only Michelle Claverol, in our Coral Gables office, had more than a few.

I learned that some experts conducted tests regarding the breaking of tile. They found that breaking tile is not as easy at it may seem. A pot, shoe, or falling object has got to hit a tile just right or the tile has to be loose or set improperly for breakage to occur. They are not fragile. The back side of a hammer is sharp enough to cause the breakage quite easily with a strong strike.

I was reminded that an attorney friend of mine advertised for broken tile claims at the Windstorm Conference several years ago. Apparently, he had a fake million dollar check with his firm and that of a public adjuster as payees. The space in the bottom left had “one cracked tile’ written on the explanation line. The Florida Bar certainly would not have approved of such an advertisement. Indeed, it is quite unprofessional. To imply to public adjusters and the public that attorneys can help obtain large recoveries for a small cracked tile loss begs for the type of conduct that happened as indicated in the post. This past legislative session, some in the Florida Legislature mentioned this type of conduct as a reason to change longstanding consumer protections regarding insurance. If public adjusters and policyholder attorneys want a bad reputation can be developed, all we need is for some to continue this type of conduct. Insurance adjusters and insurance company management are rightfully upset, and so are the rest of us. A few bad apples are harming legitimate and law abiding public adjusters and consumers.

Finally, the oil spill issues are dynamic. Following my post, Accountants and Business Interruption Experts Will Play an Important Role Recovering BP Oil Spill Income Loss Claims, a dozen or so accountants have offered their services for lost income and earning capacity oil spill claims. Two weeks ago, I was in Steve Riggs’ office at Carr, Riggs & Ingram when I appeared on Fox News in the following interview regarding the oil spill:
 

I suggest that businesses consult with their accountants regarding these lost income claims. On anything more than a simple loss, I encourage businesses impacted by the oil spill to at least discuss the matter with qualified counsel. Proof and presentation of these claims and proving the full impact of the loss of earning capacity are what business interruption attorneys do all the time. Whether counsel should be retained should be determined on an individual basis. Often, no attorneys will be needed.

As a general rule, an assignment of an insurance claim after a loss will give the assignee the right to collect insurance benefits under the insurance policy even though the assignee is not a party to the insurance contract. Couch on Insurance §35:7 (3d ed. 2009). There are, however, limits to the kinds of post-loss claims that can be assigned, particularly when they involve business interruption coverage.

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.

As noted by Bruce Smith:

...In my experience, I have found that the earlier the forensic accountant is involved in the claim process, the more value he/she typically provides. The value derived from the forensic accountant is his/her technical knowledge of accounting and familiarity with the claims process, which may result in a more expeditious resolution to the Business Income claim.

...

To quantify a Business Income loss, an analysis of pre- and post-loss revenue, costs and operating expenses is required. A competent forensic accountant will provide...with...knowledge and experience in matters, including, but not limited to: technical aspects of accounting rules and procedures and other related data, familiarity with policy terms and conditions, and establishment of accounting and document control procedures to ensure inclusion of all relevant data into the claim calculation.

The above-mentioned services will result in an expeditious compilation of a Business Income claim that properly indemnifies the policyholder for its Business Income loss in accordance with its coverage(s). Some specific examples of how the forensic accountant can assist:

• Requesting the relevant books and records needed to support a Business Income claim.
• Using his/her general knowledge of coverage to properly analyze, indentify and segregate revenues, costs and expenses to coincide with coverage and facilitate the expeditious preparation of the claim. Please note, a forensic accountant does not provide coverage interpretation, as this is the responsibility of an adjuster and or legal counsel.
• Providing an avenue for communication between the “two sides” on technical accounting and related matters that may be beyond the understanding of the adjuster and or legal counsel.
• Preparing a Business Income analysis...in an expeditious manner. (emphasis added)

Regarding the documentation and financial information needed to support a loss income or earning capacity claim allowed for in the BP Oil Spill claim process, Bob Glasser was completely on point noting:

The ability to submit and ultimately settle a claim for lost revenue with either an insurance carrier, BP, or another entity will be predicated on the culmination of many hours of dedicated recordkeeping and consistent application of data accumulation protocol. The critical lesson learned is that when an organization is able to execute the above steps, the likelihood of proving a loss and recovery is substantially increased. (emphasis added)

Bob Glasser has a specialized understanding of the hospitality industry and has long taught how to calculate lost revenue and account for the expense of mitigation efforts that are unique in that industry, which is being devastated by the significant drop in tourism, even before the oil strikes land. This intimate knowledge was partially demonstrated when he advised:

Quantifying and documenting lost revenue has been a complicated undertaking for the hospitality industry. On one hand, documenting cancellations in connection with booked rooms is relatively straightforward. On the other hand, identifying lost demand prior to a booking can be quite subjective.

Capturing cancellations with appropriate and supportable documentation to withstand future audit can happen only if specific protocols and procedures are put in place now. The process needs to be properly documented and communicated to the relevant employees. Documentation objectives include memorializing discussions and correspondence among hotel sales personnel or reservation agents with guests, potential guests, corporate booking agents and wholesalers, for the purpose of identifying the reason for a cancellation. Loss documentation prepared today should be reviewed by a seasoned financial professional to increase the likelihood it will withstand challenge by an adverse party. Date, time, conversation or action reported contemporaneously, and person making the entry should be made as it is done and collected at least daily.

The protocol for associating lost income from cancelled bookings to the oil spill may include refinements to existing sales software or the use of a database/spreadsheet to include the group name, group contact, intended date of stay, number of rooms, F&B revenue, room revenue, ancillary revenue, date of cancellation and reason for cancellation as well re-booking date if any and where the group moved, if known. Additional recommended procedures to be implemented include but are not limited to the following:

1. Reservation call centers should be provided specific instructions on how to document lost demand when guests ask about oil spill conditions.
2. Properties should identify any group discounts they offer to either appease a group with complaints due to the oil spill or to maintain a group reservation that was considering cancelling due to the oil spill. These discounts would be considered a mitigation strategy to curtail future lost revenues.
3. Any extra expenses incurred for marketing promotion or additional advertising over the normal operations to negate a loss of occupancy due to the oil spill should be documented.
4. Subsequent drops in occupancy rates from historical levels attributable to the oil spill should be recorded. Therefore, pre-oil spill occupancy, ADR and RevPar reports must be archived and maintained for future documentary support of decline in revenue.

The Oil Pollution Act of 1990 specifically indicates that those claiming loss income or loss earning capacity do not have to own the property damaged to have a claim for lost income or earning capacity. This is significant because some state laws which apply to the oil spill might be not so broad. "Loss of profits and earning capacity" under the Oil Pollution Act of 1990 means damages equal to the loss of profits or impairment of earning capacity due to the injury, destruction, or loss of real property, personal property, or natural resources.

The Coast Guard publishes some information describing the business documentation which should be accumulated for an oil spill claim:

You must provide evidence that supports your claim, and you can use whatever documentation you believe best supports that claim. Listed below are examples of documentation often submitted with property damage claims:

• Photographs
• Tax returns for loss year and previous three years,
• Income Statements for loss year and previous three years,
• Balance Sheets for loss year and previous three years,
• Cash Flow Statements for loss year and previous three years,
• Receipts or other proof of revenue combined with proof of expenses
• Reports from the Federal On-Scene Coordinator (FOSC), fire department, police, or other responder
• Information on Coast Guard or EPA notification
• Newspaper reports describing the spill
• Any other documentation you feel supports your claim

A Compliance Guide for submitting claims under the Oil Pollution Act of 1990 has some specific information that BP claims representatives and its lawyers may need before approving business income or earning capacity claims. It provides:

General Information for Claims by Businesses:

• Description and documentation of business losses due to spill
• Copies of letters of business cancellations caused by the spill damage
• Maps or descriptions of the area showing the business location and the spill impact area
• Financial statements for at least two years prior to spill and from the year of the spill
• Signed copies of income tax returns and schedules for at least three years prior to spill
• Details on efforts to mitigate losses or why no efforts were taken
• Statement from you or witnesses on how the spill led to loss of income or earning capacity; explain any earnings anomalies
• For hotels, daily and monthly occupancy information for two years prior to spill and the year of the spill

General Information on Claims by Fishing or Marine Charters:

• Description of business losses caused by the spill
• Evidence that vessel(s) were in the area impacted by the spill and were unable to carry on their business due to the spill
• Maps or descriptions of the area showing business location within spill area
• Statement from you or witnesses on how the spill caused the loss of income; explain any earnings anomalies
• Signed copies of income tax returns and schedules for at least three years prior to spill
• Details on expenses not paid out during period being claimed (e.g., wages)
• Booking records for three years prior to spill and year of spill
• List of charter rates, including any services the business specializes in (e.g., sport fish-ing)
• Copies of any logs relating to boating activities for the year prior to and the year of the spill
• Registration documents for the vessel(s), copies of business license, vessel license, fishing license, captain's license

My advice to all claimants with significant business loss from the BP Oil Spill is to consult with an attorney and retain an expert to prepare a sound and proper explanation of business income loss or loss of earning capacity. Mitigation attempts required under the law can be explored with your counsel and those with experience in disaster recovery. In many instances, the claims may often need no attorney involvement because they are not very complex. The larger and more complex the claim, the greater the need to have a professionally prepared lost income claim with calculations by an experienced expert like Bob Glasser and Bruce Smith.

My friends and attorneys at Levin, Papantonio, Thomas, Mitchell, Echsner, Rafferty & Proctor, P.A. are doing it right. I had the pleasure of working with them as co-counsel on a great number of Hurricane Ivan matters, and they were kind enough to attempt to refer some major business income claims to me following Hurricane Katrina. My understanding is that they have decided to not charge clients for work to recover money that BP will voluntarily pay as a partial damage claim, and they will charge attorney fees only on claims that are denied or have disputed amounts. That is fair. There are some businesses that will need help right away to prepare and present these claims, and the fees for those services should be far lower than the one third of any recovery that some attorneys have been quoting.

Bob Glasser sent me the following article, that I minimally edited, which will help some insurance and BP claimants in their future first and third party claims.

How to Capture Hotel Lost Profits Today Due to the Gulf Oil Spill
in Order to be Reimbursed by the Responsible Party

With uncertainty and concern surrounding the impact of the Gulf oil spill to the coastline from Florida to Texas, many companies are asking what needs to be done to quantify and document lost income for future claims. Many businesses are considering filing insurance claims. Others may be looking at the potentially responsible parties for direct reimbursement. Regardless of the source of indemnification, proper documentation of claimed losses is critical.

Quantifying and documenting lost revenue has been a complicated undertaking for the hospitality industry. On one hand, documenting cancellations in connection with booked rooms is relatively straightforward. On the other hand, identifying lost demand prior to a booking can be quite subjective.

Capturing cancellations with appropriate and supportable documentation to withstand future audit can happen only if specific protocols and procedures are put in place now. The process needs to be properly documented and communicated to the relevant employees. Documentation objectives include memorializing discussions and correspondence among hotel sales personnel or reservation agents with guests, potential guests, corporate booking agents and wholesalers, for the purpose of identifying the reason for a cancellation. Loss documentation prepared today should be reviewed by a seasoned financial professional to increase the likelihood it will withstand challenge by an adverse party. Date, time, conversation or action reported contemporaneously, and person making the entry should be made as it is done and collected at least daily.

The protocol for associating lost income from cancelled bookings to the oil spill may include refinements to existing sales software or the use of a database/spreadsheet to include the group name, group contact, intended date of stay, number of rooms, F&B revenue, room revenue, ancillary revenue, date of cancellation and reason for cancellation as well re-booking date if any and where the group moved, if known. Additional recommended procedures to be implemented include but are not limited to the following:

1. Reservation call centers should be provided specific instructions on how to document lost demand when guests ask about oil spill conditions.
2. Properties should identify any group discounts they offer to either appease a group with complaints due to the oil spill or to maintain a group reservation that was considering cancelling due to the oil spill. These discounts would be considered a mitigation strategy to curtail future lost revenues.
3. Any extra expenses incurred for marketing promotion or additional advertising over the normal operations to negate a loss of occupancy due to the oil spill should be documented.
4. Subsequent drops in occupancy rates from historical levels attributable to the oil spill should be recorded. Therefore, pre-oil spill occupancy, ADR and RevPar reports must be archived and maintained for future documentary support of decline in revenue.

The ability to submit and ultimately settle a claim for lost revenue with either an insurance carrier, BP, or another entity will be predicated on the culmination of many hours of dedicated recordkeeping and consistent application of data accumulation protocol. The critical lesson learned is that when an organization is able to execute the above steps, the likelihood of proving a loss and recovery is substantially increased.

Those making a third party claim or insurance claim should consider obligations of mitigation and consult with competent legal counsel and trusted business professionals.

About the Author
Bob Glasser is a managing director at BDO Consulting, a division of BDO Seidman, LLP, in the New York office. Mr. Glasser is a certified public accountant, a certified fraud examiner and a certified insolvency and reorganization accountant, with more than thirty years of diverse financial management and accounting experience at public and private companies.

Mr. Glasser, who is also known as “B.I. Bob,” leads the firm’s New York Insurance Claim Services practice, assisting insured businesses—including hotels, manufacturers, distributors and service organizations throughout the world—to prepare and substantiate business interruption and property damage claims resulting from physical damage due to hurricanes, floods and other perils. Mr. Glasser has also been involved in forensic investigations of employee theft in the hospitality and retail industries.

EDO hold a variety of certifications, including CPA, CFE, MAI, ASA and MRICS and can be accessed at www.bdo.com
.
Robert Glasser, Managing Director
(212) 885-8173
rglasser@bdo.com

At its very basic form, the standard ISO CP 00 30 "Business Income (and Extra Expense) Coverage Form" states that:

"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.

Clients involved in these types of claims often ask if the cost of accounting is recoverable after the claim is resolved.

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.

So, how about a review of that exciting "Volcanic Activity" provision in the basic, broad, and special CP forms? If the recent Hard Rock Casino advertisement series about "you know who you are" has any truth, those still reading this post know they are the true insurance coverage nerds everybody in the office consults when a hard coverage issue arises.

The basic and broad "causes of loss" form covers "volcanic activity" with the following language:

11.Volcanic Action, meaning direct loss or damage resulting from the eruption of a volcano when the loss or damage is caused by:

a. Airborne volcanic blast or airborne shock waves;
b. Ash, dust or particulate matter; or
c. Lava flow.

All volcanic eruptions that occur within any 168-hour period will constitute a single occurrence.

This cause of loss does not include the cost to remove ash, dust or particulate matter that does not cause direct physical loss or damage to the described property.

The FC&S notes that: 

Volcanic action coverage also was previously available only on an optional basis by endorsement. As a basic cause of loss under the ISO commercial property program, it covers damage from the above-ground effects of a volcanic eruption—airborne blast and shock waves, ash, dust, particulate matter, and lava flow. It does not include, as detailed in the earth movement exclusion, the removal cost of volcanic ash or dust that has not physically damaged insured property, nor the seismic effects of a volcanic eruption.

Coverage under this cause of loss applies to any volcanic eruptions occurring within a seven day period (168 hours). Under the original versions of the form (prior to the 1988 revisions), this period was three days.

The special form policy covers all the "risks" of direct physical loss unless excluded. While it then excludes volcanic eruption, the form then excepts the exclusion for "volcanic activity" to provide this coverage:

(5) Volcanic eruption, explosion or effusion. But if volcanic eruption, explosion or effusion results in fire or Volcanic Action, we will pay for the loss or damage caused by that fire or Volcanic Action.

The bottom line is that many ash claims will likely be denied because insurers claim that the volcanic activity or ash did not result in any "physical damage." If you happen to have that problem, "you know who you are" and who you need to call.

Have a great day!!

Business interruption insurance is intended to return to the insured's business the amount of profit (gross earnings minus normal expenses) it would have earned, had there been no interruption of the business or suspension of its operations as a result of a covered loss. Policyholders’ recovery for business interruption claims as a result of the recent volcanic eruption is unlikely because most policies require direct physical damage to the insured in order to trigger this type of coverage.

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). 

Will the airlines be able to recover the lost revenue during the suspension of operations? Not this time. On April 21, 2001, Bloomberg reported that analysts do not believe that the European airlines will be able to recover business interruption benefits unless the volcanic ash caused direct or physical damage to any airport buildings or airplanes, which none have been reported thus far.

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.

Among many other issues, Duane Reade asserted that it had the right to recover losses for the entire period actually required to rebuild the World Trade Center complex. St. Paul, in contrast, contended that Duane Reade's recoverable losses were limited to those suffered within twenty-one months following the September 11, 2001 destruction of the store-the amount of time it calculated as reasonably necessary for Duane Reade to relocate its store and resume operations. The coverage dispute was worth millions and Duane Reade was ready to fight, but in the end, St. Paul prevailed.

The policy at issue contained the following Period of Restoration provision:

The measure of recovery or period of indemnity shall not exceed such length of time as would be required with the exercise of due diligence and dispatch to rebuild, repair, or replace such property that has been destroyed or damaged, and shall commence with the date of such destruction or damage and shall not be limited by the date of expiration of this policy.

In Duane Reade, Inc. v. St. Paul Fire & Marine Ins. Co., 279 F.Supp.2d 235 (S.D.N.Y.2003), the trial court ruled in favor of Duane Reade by finding that the hypothetical Period of Restoration was extended until Duane Reade resumed its operations in a “functionally equivalent” manner to its pre 9-11 operations. The trial court also declared that the length of the Period of Restoration was tied to the time it would take to rebuild the drugstore at the World Trade Center site. After this ruling the trial court ordered the parties to enter into appraisal to determine the value of the claim. In accordance with the district court’s ruling, the panel appraised the value of the Business Interruption claim to be in excess of $40 million.

St. Paul appealed the declaratory ruling. The Court of Appeals disagreed with the trial court’s interpretation and held that the policy did not provide business interruption coverage until Duane Reade could resume operations in a store located at its former WTC site. Instead, it held that coverage extends only for the hypothetical time it would reasonably take Duane Reade to “repair, rebuild, or replace” its WTC store at a suitable location. In its reasoning the Court of Appeals stated that Duane Reade’s lost profits for rebuilding at a different site would probably fall under the Leasehold Interest clause of the policy rather than the Business Interruption clause and that any losses continued beyond the Period of Restoration would be covered by the Extended Recovery Period provision. Duane Reade, Inc. v. St. Paul Fire & Marine Ins. Co., 411 F.3d 384 (2nd Cir. 2005),

To be sure, there are few if any locations in New York City comparable to the WTC, and Duane Reade will most likely not be able to recreate the profit stream it once enjoyed there. But any discrepancies between the new building and WTC in terms of benefits and advantages are exclusively accounted for under the Leasehold Interest clause.

Id. at 386.

After this opinion, the appraisal panel revised the value of the BI loss at roughly $14 million. The appraisal panel had also awarded in excess of $4 million under the policy’s Extended Recovery provision.

I am not sure why, but Duane Reade dismissed the lawsuit and filed a new lawsuit to recovery under the Leasehold and Extended Recovery provisions in accordance with the appellate opinion. St. Paul pulled an old trick out of the hat and moved to dismiss the second lawsuit under the doctrine of res judicata and to confirm the appraisal award. The trial court agreed with St. Paul, but before kicking the case out of court forever, the Court gutted out the $4 million award under the Extended Recovery provision.

The Extended Recovery Provision read as follows:

This policy is extended to cover the Actual Loss Sustained by [Duane Reade] resulting from interruption of business for such additional length of time as would be required with the exercise of due diligence and dispatch to restore [Duane Reade]'s business to the condition that would have existed had no loss occurred, commencing with the [later] of the following dates:

a) the date on which liability of [St. Paul] of loss resulting from interruption of business would terminate if the [Extended Recovery Period] clause had not been attached to this policy or

b) the date on which repair, replacement, or rebuilding of such part of the property as has been damaged is actually replaced, but in no event for more than twelve months from said later commencement date.

Duane Reade argued that that the requirement of actual replacement should be interpreted to be satisfied when the store could have been replaced, but the court disagreed and interpreted the clause to require “actual replacement” and since Duane Reade had not replaced it was not entitled to this coverage:

Under Duane Reade's reading, prong (b) would automatically be satisfied whenever prong (a) were satisfied. In contrast, by enforcing the requirement for actual replacement, the Court has given meaning to both requirements. For example, if Duane Reade were to delay and actually take more than the time that reasonably would be necessary to replace a protected property, prong (a) would be satisfied (and coverage under the Restoration Period would terminate) when the property could have actually been replaced, and prong (b) would be satisfied (and coverage would recommence under the Extended Recovery Period) when Duane Reade did actually replace the property.

Duane Reade, Inc. v. St. Paul, 503 F.Supp. 699, 701 (S.D.N.Y. 2007).

Duane Reade did not give up and appealed, but the Second Circuit Court of Appeals was less than sympathetic to its plight, ending the saga on March 31, 2010.

Reading this article was like watching a train wreck, but in slow motion and surround sound. Everything that could go wrong did. The multi-million dollar research data was lost, the quality or existence of duplicate data was unknown, the research grants were suspended until 100% resumption of operations, patent paperwork was delayed, key faculty members went to teach elsewhere, and the world was deprived of new bioscience research. Of course, despite the broker’s best efforts to get the BI worksheet right, the institution was significantly underinsured.

However, the institution had only itself to blame for its demise.

According to the risk managers, the lesson to be learned from these costly mistakes is that the purchase of insurance is never a substitute for a risk management plan and that risk financing should only be considered after careful analysis of the value of the business and any related interdependencies of revenue.

A BI worksheet normally uses annual financial statements to determine the insurable value, but in a catastrophic scenario like an unprecedented storm or a consuming fire, the lag in revenue may continue even after the business returns to its pre-loss operational capacity and the exposure oversight can be costly. The following suggestions were offered to minimize risk exposure in a catastrophic scenario:

• Prioritize all revenue sources by contribution toward the aggregate value of the organization, not just by the dollar amount
• Streamline revenue sources within an organization so to identify highest risk exposure
• Identify key buildings and facilities critical to overall revenue generation
• Consider revenue from other sources which may pose contingent exposures
• Establish a Business Continuity Planning Process (or risk management plan) as a pre-loss triage process that concentrates efforts on critical activities (ie. mitigation efforts)

Once the exposures have been identified, a business should then consider financing the risk through the purchase of insurance. In general, after a covered loss occurs, the basic business income coverage should protect the insured from the loss of net income to the extent income would have been earned, including normal operating pre-loss expenses. In the case above, however, the basic coverage can only go so far. If the insured depends on specialized facilities and does not have redundant space or backup facilities to continue or resume operations, the insured can finance the risk of most losses by purchasing additional coverage forms such as, extra expense coverage, ordinary payroll, an extended period of indemnity, contingent/dependent coverage, service interruption and a special research and development form that is available for organizations engaged in this business. A catastrophe may very well deprive the world of a breakthrough scientific discovery, but with adequate coverage and sufficient business resilience, we can continue expecting great things from mankind.

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 [...]

On March 15, 2010, a few weeks after my post, the “Economy Ignored” line of cases scored big in Mississippi. See, Catlin Syndicate Limited v. Imperial Palace, No. 09-60209, 2010 WL 9008731 (5th Cir. 2010). Recognizing the aforementioned debate among courts, the United States Fifth Circuit of Appeals held that as a matter of Texas and Mississippi law:

[A] business interruption loss will be based on historical sales figures and we [courts] should not look prospectively to what occurred after the loss.

Imperial Palace, a Mississippi casino, was shut down for several months after Hurricane Katrina. The casino claimed to have had a business loss claim of $165 million, but Catlin Syndicate calculated the loss at $6.5 million. Basically, the parties disagreed on whether the policy allowed consideration of post-loss earnings in the calculation of business interruption loss.

The provision at issue in Imperial Palace is typical, and read as follows:

Experience of the business- In determining the amount of the Time Element loss as insured against by this policy, due consideration shall be given to experience of the business before the loss and the probable experience had no loss occurred.

Catlin Syndicate argued that under the policy, Imperial Palace’s recovery should be based on the net profits that the casino would have earned had Hurricane Katrina not struck the Gulf Coast by looking solely at pre-hurricane sales, arguing that “had no loss occurred” means “had no hurricane occurred”. The casino, on the other hand, argued that the policy allows consideration of its post-loss earnings and asked the court to interpret “had no loss occurred” to mean that Hurricane Katrina occurred, but the loss to the property did not.

In simpler terms, the casino argued that it should be entitled to recover what it would hypothetically have earned had it been able to remain open immediately after Katrina, while all of its competitors were closed due to damage to the storm.

Although the Fifth Circuit Court of Appeals agreed that, in theory, a “loss” is distinct from an “occurrence,” the Court followed several “economy ignored” cases and found that “loss” and “occurrence” are one and the same in the business interruption provision and ruled that “had no loss occurred” means “had no hurricane occurred,” thereby foreclosing any consideration to post-loss earnings.

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

[…]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 […]

It appears that Texas and Mississippi will adhere to the “economy ignored” framework, where “had no loss occurred” means “had no occurrence occurred.” This is concerning. Notwithstanding Imperial Palace, 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 therefore very much alive.

Truth be told, certain business interruption claims are hard to quantify. Policyholders should be aware of the accounting methodologies employed in the calculation of a business loss to avoid presenting the ubiquitous “speculative” claim that could be easily denied under the consequential (or remote) loss exclusion.

In Florida, courts have held that in order to recover under the business interruption policy, an insured must prove that it sustained damage to property, that the damage was caused by a covered loss, that there was an interruption to the business (“suspension of operations”) which was caused by the property damage, and that there was an actual loss of business income during the period of time it took to restore the business and that the loss of income was caused by the interruption of the business and not by some other factor or factors. See, Dictiomatic, Inc., v. U.S. Fidelity & Guar. Co., 958 F. Supp. 594 (S.D. Fla. 1997), citing Ramada Inn Ramogreen, Inc., v. Travelers Indemnity Co., 835 F.2d 812 (11th Cir. 1988).

In Dictiomatic, the court denied the insured’s business interruption claim as a matter of law after it found, as a matter of fact, that the insured failed to prove it would have realized business income (selling hand-held electronic translators) which was lost solely as a result of Hurricane Andrew. The insured also failed to establish that it would have enjoyed income during the time of restoration, sufficient to pay normal operating expenses or to generate profits.

In my opinion, the policyholder’s demise in Dictiomatic was most likely the result of improper calculation of the actual business loss, since the numbers presented to the court were perceived as inflated and contradictory. Surely, a more thorough review of the evidence before it was presented to the trial court could have avoided a judgment after the insured’s case in chief and potentially resulted in an opportunity to challenge the carrier’s case. If there is one thing to be learned from the “hand-held electronic translator” business, it is to be careful and accurate in presenting a claim for business interruption.

In reviewing my own practice and various treatises on this area of insurance law, there is a consensus that the following strategies will most likely result in a fair resolution of a business interruption claim:

1. Review the policy - it does not matter if you can quote coverage forms by memory, the best practice is to review the policy, along with any applicable endorsements, to note all the various categories of losses and expenses that are covered, or not, as well as to recognize and execute all duties and obligations under the policy.

2. Give notice - almost every policy requires that an insured give notice of the loss, “promptly,” “as soon as practicable,” “immediately,” “within a reasonable time,” or within some other time period specified under the policy. Failure to comply with this policy condition may result in a claim denied. If this happens, the claim will inevitably have to be litigated. In Florida, a denial for failure to give timely notice will unfortunately create a rebuttable presumption that the carrier has been prejudiced as a result thereof. Tiedke v. Fidelity & Cas. Co. of New York, 222 So.2d 206 (Fla. 1969). Therefore, if the insured decides to litigate the claim denial, the insured has the burden of presenting enough factual evidence to overcome this presumption and the court must determine if the time between the loss and the notice was reasonable under all of the facts and circumstances of the case. See, Employers Cas. Co. v. Vargas, 159 So. 2d 875, 877 (Fla. 2d DCA 1964). Also, when giving notice of a claim, avoid making any verbal or written statements regarding coverage, the requirement to give notice, is just that; a duty report the loss in a timely fashion.

3. Cooperation - After a claim is reported, a carrier will begin its adjustment or investigatory phase. During this period of time, the insured is required by the contract to provide as much information as reasonably possible to assist the insurer in its investigation of the claim. Many business owners and managers raise their brows at the type of information that sometimes is requested in support of a BI claim. Rightfully so. At times, the information requested may infringe on trade secrets or information that fuels the business’ competitive advantage. If this is a concern, an insured should consider retaining an attorney, not only to openly discuss these concerns without fear of publicity, but also to consider the possibility of drafting and entering into a Confidentiality Agreement with the insurer, which, most of the time, is merely seeking to quantify a claim and will not oppose such an agreement.

4. Mitigation - Many policies cover only those losses that could not be avoided through reasonable post-loss mitigation efforts. With respect to business interruption coverage, an insured is often required to exercise due diligence to repair covered property damage and resume operations. Therefore, after a loss, an insured should quickly evaluate whether there are reasonable steps it can take to avoid additional business or property losses. To the extent possible, an insured may want to consider informing its insurer of its mitigation efforts to provide an opportunity for input and to avoid dilemmas after the fact.

5. Cost Tracking - In general, a policyholder bears the burden of measuring, documenting, and establishing its claim. Most businesses have internal accounting programs and systems that organize its ingress/egress functions. Hopefully, these systems operate remotely and will survive a catastrophic loss. Otherwise, the insured will face the daunting task of reconstructing its pre-loss costs and post-loss projections from scratch.

6. Document everything - if there is one thing that people can learn from lawyers is the practice of documenting every relevant communication with all relevant parties. Many business owners and managers already engage in this type of practice, but in times of distress and anxiety about survival, many forget to maintain this important practice. I always say, there is nothing more powerful than those green cards at the post office; this practice simply makes life easier.

Business interruption insurance policies frequently provide indemnity not only for lost profits and fixed charges and necessarily continuing expenses, but for expenses, or "extra expenses," which the insured incurred to reduce the loss and resume business operations. Extra expense coverage is an additional coverage afforded to a business, and it goes beyond the typical coverage for direct physical losses contemplated by the general insuring agreement of a building and personal property coverage form in an insurance policy. Extra expense should allow a business to continue in the event of an emergency, by indemnifying the insured for additional expenses that would not normally have been incurred, but which are not covered under their traditional business interruption provision.

However, if the business policy does not contain Extra Expense protection, these costs may never be recovered, despite the due diligence of a business enterprise to resume operations. Under an Extra Expense Coverage provision, expenses incurred for the purpose of resuming business operations are recoverable only to the extent that they, in fact, reduce the loss, and recovery is limited to variable costs directly attributable to the loss mitigation efforts, rather than fixed costs which would have been incurred even in the absence of the loss.

Examples of covered expenses could be temporary office space, temporary computer systems or furniture for the temporary space, overtime for workers who need to spend additional time outside of their normal work day due to the covered event. If employees were not able to bring their lunch to work because the employee’s lounge/kitchenette was burned in a fire, an extra expense claim could be made for feeding them during this time period.

For example, in Cotton Bros. Banking v. Industrial Risk Insurers, 951 F.2d 54 (5th Cir. 1992), the court granted expenses, such as incremental utility costs and other overhead, to the damaged business property to enable the insured to repair the property and resume operations earlier than anticipated, as well as extra expenses for security to avoid theft of business property. Also, in Northwestern States Portland Cement Co. v. Hartford Fire Ins. Co., 360 F.2d 531 (8th Cir. 1996), under a business interruption endorsement containing an "extra expense" clause, the insured was able to avoid a loss of earnings by using available raw materials to continue production; the extra cost involved in producing replacement raw materials was recoverable, although the total cost of such materials is not.

It is important to note that, as with most insurance policies, the insured has a duty to mitigate its damages after the loss. Extra Expense Coverage allows the insured to recover a measure of the incidental costs expended in trying to mitigate damages pursuant to the terms and provisions of most insurance policies. Therefore, even in tough times, it still makes business sense to keep additional insurance protections (ie. Extra Expense Coverage) to avoid wasting the same or more money the business is trying to save by downgrading coverage.

Ideally, commercial interruption claims should be handled by both, the insured and the insurer, in swift and skilled manner. The expediency in which a commercial interruption claim is handled could make or break a business right after a loss. In last week’s blog, Chip noted that:

My experience is that many insurance company adjusters lack the thorough understanding of finance, business management, and accounting required to properly adjust commercial business income and extra expense claims. Most commercial adjusters never do, and lack the skill to do, the income and extra expense calculations themselves. Instead, usually after a delay, the business income claim is referred to insurance accounting firms that provide the analysis only of the numbers, without also having the business operational skills needed to properly determine the amounts owed.

While there may be many talented commercial insurance adjusters out there with the necessary skills and experience who can avoid this situation and, like I, can accomplish anything they want in life, the reality is that some commercial interruption claims are delayed because of carrier mishandling. This can, in turn, lead to a long and protracted legal battle.

For example, in Omaha Paper Stock Co., Inc. v. Harbor Ins. Co., 445 F.Supp. 179 (D.C. Neb. 1978), the court held that:

Where attorney for insured under business interruption policy wrote to adjusters requesting that they advise insured by letter as to any matter which would expedite resumption of operations, but adjusters never responded to the letter nor verbally accepted responsibility to inform insured of any failure by insured to perform as required under the contract, insured could not rely on silence as an acceptance of its attempt to shift the burden of responsibility under the due diligence clause of the contract, and insurer was not estopped from contending that any delay in resuming operations was attributable to lack of due diligence by the insured.

Further, in Hampton Foods, Inc. v. Aetna Casualty, 787 F.2d 349 (8th Cir. 1986), the insured was forced to vacate its building due to an imminent danger of collapse. Coverage was denied, but the trial court ruled in favor of the insured. However, the parties still quarreled over the business interruption calculation. The carrier argued that the period of restoration should be the amount of time it would have taken Hampton to reenter business, had it received payment from Aetna initially. The appellate court disagreed with the carrier and, relying on Omaha, held that the theoretical period of restoration should be reasonably extended because the delay in recovery was due to actions of the insurance company.

One of my mantras in commercial interruption claims is that policyholders should always consider retaining experts to present their claim to avoid the common dilatory pitfalls in this area of the law. Glad to be back. Stay tuned for more.

What generally "happens," is the insurance company limits the period of restoration to the time that the business decision is made not to re-open or the business is sold. I then get a phone call asking if the insurer can do this. As usual, the best place to start such an analysis is to read the relevant policy language and then check an authoritative source. In this case, I will use IRMI.com, which everybody who claims to be a "professional" in insurance coverage and claims should subscribed to, along with the FC&S Bulletins.

The form CP 00 30 reads:

c. Resumption Of Operations

We will reduce the amount of your:

(1) Business Income loss, other than Extra Expense, to the extent you can resume your "operations," in whole or in part, by using damaged or undamaged property (including merchandise or stock) at the described premises or elsewhere.

(2) Extra Expense loss to the extent you can return "operations" to normal and discontinue such Extra Expense.

d. If you do not resume "operations," or do not resume "operations" as quickly as possible, we will pay based on the length of time it would have taken to resume "operations" as quickly as possible.

Demonstrating its value and proving why it should be subscribed to, the IRMI.com has a specific discussion of both issues:

Election Not To Resume Operations. Note that the resumption of operations provision does not require the insured to resume normal operations as soon as possible. Instead, it establishes that the insured's business income or extra expense loss will be calculated based on the amount of loss that would have been suffered if the insured had resumed normal operations as soon as possible. Thus, an insured who elects not to resume operations at all is entitled to a recovery for the business income that would have been earned or the necessary extra expenses incurred during the time it should reasonably have taken to resume normal operations. The same is true of an insured who does not resume operations as quickly as possible.

Sale of Property during Period of Restoration. In BA Props., Inc. v. Aetna Cas. & Sur. Co., 273 F. Supp. 2d 673 (D.V.I. 2003), Hurricane Marilyn damaged the insured's hotel in the U.S. Virgin Islands. While the hotel was undergoing repairs, the insured sold the facility. The insurer argued that the sale of the hotel during the period of restoration terminated the insured's right to receive further business income coverage. The court disagreed. The court held that the amount of the insured's business income loss was fixed as of the time of the hurricane to the amount of lost profits that would have been earned during the period of restoration. The court noted that the business income policy did not expressly require that the insured actually recommence business activities at the hotel as a prerequisite for coverage. If the insured decided to shut the hotel for good after the hurricane, the insurer would still have been obligated to pay the entire business income loss through the entire time it would have hypothetically taken to rebuild and reopen the hotel. Selling the hotel midway through the period of restoration was no different than belatedly deciding to shut it down. In either situation, the insurer was still obligated to pay out the rest of the business income loss. (emphasis added)

Sometimes, a catastrophe is the perfect time to close or sell a business. Commercial policyholders that make such difficult business decisions can still obtain significant business income benefits which many insurance adjusters may otherwise deny.

My experience is that many insurance company adjusters lack the thorough understanding of finance, business management, and accounting required to properly adjust commercial business income and extra expense claims. Most commercial adjusters never do, and lack the skill to do, the income and extra expense calculations themselves. Instead, usually after a delay, the business income claim is referred to insurance accounting firms that provide the analysis only of the numbers, without also having the business operational skills needed to properly determine the amounts owed.

I suggest that unless the commercial claims representative immediately explains the broad benefits potentially available and shows a willingness to fully pay for them, most commercial policyholders need to promptly retain professional help. Often, an insurance agent or broker has a much more thorough understanding of how the insurance product, through business income and extra expense benefits, can potentially save a business from closure. Still, at this most crucial time following a loss, many commercial policyholders have to wait months to get agreement or payment of these benefits. Closures as a result of these delays can be prevented by insurance companies understanding their products and getting money, the lifeblood of any business, back into the business as soon as possible.

In an article published in the July/August 2009 issue of Coverage titled “Measuring Business Interruption Loss in Wide-Impact Catastrophes: Insurance Against Catastrophes or Only Against Insured Damage from Catastrophes?” the authors, Richard Chattman and Gregory Miller, compare diverging views on how courts calculate the measure of business interruption recovery and explore a refreshing, yet sound, perspective on business interruption claims.

Unlike an ordinary loss causing damage to only a single location, a wide-impact catastrophe, whether natural (hurricane, earthquake, flood) or man made (e.g., 9/11 terrorist attack), typically causes widespread damage which often results insignificant economic changes to the impacted area or beyond. A catastrophe can cause major shifts in population and changes in markets or supply and demand, as experienced by certain areas of the Gulf after Hurricane Katrina, or depress an entire industry, as exemplified by the significant decrease in demand for travel and related services following the September 11th terrorist attack.

According to the authors, there are two lines of cases that address the measure of business interruption loss from a wide-impact catastrophe, which they grouped as “Economy Ignored” and “Economy Considered” cases.

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 had on the economy, market or demand for the insured’s goods or services.

American Automobile Insurance Co. v. Fisherman’s Paradise Boats, 1994 WL 1720238, 1994 U.S. Dist. Lexis 21068 (S.D. Fla. October 1, 1994) is usually cited when courts want to use the economy ignored approach. In Paradise Boats, the insured was unable to engage demand for boats in its boat sales operations after Hurricane Andrew severely damaged one of its stores. Apparently, there was a great demand for boats and marine accessories after Andrew, and the insured presented evidence to show that its sales would have increased by 192 percent if the store had not been damaged and if it was positioned to reap the economic benefits of a post-hurricane demand for the goods it supplied.

In denying the insured’s argument the Court held that the policy only allows recovery for net income projection that are not itself created by the peril and that the insured was not entitled to windfall profits for earning sources that would not have come into being had the storm not occurred.

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 Consolidated Companies, Inc. (Conco) v. Lexington Ins. Co., No. 06-4700, 2009 WL 211751 (E.D. La. January 23, 2009), a Louisiana jury awarded a verdict in favor of a food distribution facility of $19.5 million for business interruption loss. Lexington challenged the verdict, arguing that the jury should have taken into account the depressed economy in Louisiana in the aftermath of Katrina to reduce the amount of the loss since the likely future performance was bleak, at best. The court accepted the carrier’s legal position that the post-Katrina economic environment should be considered in the measure of damages, but in this case, it concluded that the award was supported by sufficient proof that established how the business performed in the altered post-hurricane economy had the business not suffered physical damage. It is important to note that the Conco court focused its analysis on what the business would have earned had it not suffered physical loss or damage, rather than what the business would have earned had the storm not occurred, which circumvents the “windfall” concerns that the “economy ignored” advocates fear most.

After carefully considering the pros and cons of both approaches, it appears that while easier, 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.

After a calamity or insured event, category one (1) and two (2) above are typically not the subject of much quandary, insofar as overhead is considered a necessary cost during the Period of Restoration.

Category three (3), however, could give some insurance claims professionals an ulcer, especially in non-manufacturing-business claims, where the overhead cannot be easily tied to a specific production activity. One should expect and prepare for hours and hours of meetings and telephone conversations and debates over the accounting method used to allocate overhead expenses of to the individual business units of a larger corporation, if the calamity is sustained at an individual business unit or operating entity.

As a practice pointer, the insured should always be “at the ready” to argue and prove how the sales (or production) of an operating unit contributes to the general corporate overhead of the organization. Once this is established, the issue is not whether the insured is entitled to recover its fixed overhead expenses, but rather how much should be attributed to the unit or operations affected by the loss. If the company’s accounting and allocation methods directly tie overhead costs to the operating units, the calculator should take care of the amount to be written on the check. However, if the overhead calculation included in a business interruption claim deviates from the normal overhead allocations of the corporation for the affected units, the ulcers will start bleeding until the accounting methods are explained and supported. For this I say, thank God for accountants!

Every day, businesses develop and thrive on symbiotic relationships, where the entities rely on the continued operational viability of each other (or even exclusively beneficial relationships). Few businesses, however, consider the risk and exposure of losing that relationship due to an unexpected calamity. Businesses that are dependent on a non-related entity’s operations should talk to their agents about attaching “dependent business interruption” endorsements to avoid suffering the dairy famers’ fate.

Contingent business coverage is a type of business interruption coverage will protect the “dependent business” from the external business income exposure. 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. In lay terms, 1) suppliers, 2) buyers, 3) providers, and 4) drivers.

Depending on the relationship the dairy famers had with Saputo Cheese, the dairy farmers could have purchased coverage to pay for the loss of income resulting from Saputo Cheese’s suspension of operation until its closure, since most endorsements provide coverage until the dependent business resumes operations or alternate sources are found.

I agree. Some mom and pop stores and small businesses may not be able to generate fancy projected earning and expense reports with pretty graphs, etc. However, as a matter of law, a carrier cannot deny a claim for a small business’ inability produce or generate these documents.

As a matter of Florida law, business interruption losses should be determined in a practical way, having regard for nature of business and methods employed in its operation, in order to give practical effect to intentions of parties and purpose of insurance as evidenced by terms, conditions, and provisions of policy. See, Travelers Indem. Co. v. Kassner, 322 So.2d 80 (Fla. 3rd DCA 1975).

The holding in Travelers does not mean that “anything goes” in business interruption claims. A speculative claim will never be covered by a policy and it is always the insured’s burden to provide competent proof of an actual monetary loss as a result of the suspensions of its operations.

In order to avoid this evidentiary pitfall, small businesses should consider retaining forensic accountants to help them review their financial statements and general business objectives and prepare reports in support of their claim.
 

Specifically, the extent of the loss recoverable can be, and usually is, established by earnings projections prepared by the insured, especially where they were formulated in the regular course of business prior to the loss.

In American Medical Imaging, Corp. v. St. Paul Fire and Marine Ins. Co., 949 F.2d 690 (3rd Cir. 1991), the lower court, sua sponte (on its own) granted summary judgment in favor or the carrier holding that rent for the Plaintiff’s alternative space, extra compensation for overtime work, and excess telephone charges were “too speculative” to prove damages or to support a recovery for lost earnings and extra expenses. The appellate court, however, reversed the lower court’s ruling in favor of the carrier and held that:

“Inherent in the concept of business interruption insurance is the necessity of insureds making claims for lost earnings based in large part on estimates of things that have not happened, i.e., on estimates of what would have happened had there been no fire or other covered cause of loss. Moreover, throughout the world of business, such estimates are invariably based on the results of past performance projected and adjusted on the basis of present business conditions.”

It is important to note that the appellate court did not weigh the sufficiency of the evidence for purposes of recovery, but rather stated that the insured’s evidence should have precluded summary judgment and the issue should have gone before a jury.

In Florida, it has been held that the mere diminution in hotel occupancy as a result of a fire in a restaurant that it leased, as opposed to the actual closing and suspension of business, does not constitute an interruption of the insured's business within the meaning of a policy. Hotel Properties, Ltd. v. Heritage Ins. of America, 456 So.2d 1249 (Fla. 3rd DCA 1984).

In Ramada Inn Ramogreen, Inc. v. Travelers Indemnity of America, 835 F.2d 812 (11th Cir., 1988), the Plaintiff-hotel sustained an identical loss as in Hotel Properties, except that the Ramada owned the restaurant, rather than leasing it like the hotel in Hotel Properties. Ramada argued that the restaurant was vital part of the hotel operation, that each operation was “mutually dependent” on the other and that the diminution in occupancy was a direct result of the fire in the restaurant. In Ramada, the insurer won in trial court and the hotel appealed.

In Ramada, the Eleventh Circuit Court of Appeals affirmed the lower court and rejected Ramada’s “mutual dependency” argument, relying on Studley Box and Lumber Co. v. National Fire Insurance Co., 85 N.H. 96, 154 A. 337 (1931). In Studley, a fire in a stable burned some of the horses which were used in the operation of the lumber plant. Without the horses, the plant was unable to continue its operations and the insured was entitled to partial business income benefits.

Ramada's argument misconstrues the nature of the business interruption policy and the concept of mutual dependency. In Studley, the court said the purpose of the policy is to “insure against consequential loss to the insured's business carried on in the property destroyed or damaged by fire.” This definition is restated in an insurance treatise which says that the purpose of a business interruption policy is to indemnify the insured “for loss caused by the interruption of a going business consequent upon the destruction of the building, plant, or parts thereof.... This type of insurance is usually called use and occupancy insurance.” 1 G. Couch, Couch on Insurance, § 1:28 (2d ed. 1984). Use and occupancy insurance is defined as indemnification for “any loss sustained by the insured because of his inability to continue to use specified premises or his inability to keep the premises occupied by a tenant.” Id. at 1:113.

These definitions indicate that recovery is intended when the loss is due to inability to use the premises where the damage occurs. They are consistent with the court's determination of mutual dependency in Studley as well. Without the horses, the lumber plant was forced to suspend a portion of its operation. This is not the situation in the instant case where the hotel operation was able to accommodate the same number of patrons, albeit their actual number of customers may have been reduced.

The concept of mutual dependency is more appropriately applied to four hotel buildings, which together comprise a single unit. If any one of them were sufficiently damaged, a portion of the hotel operation would be suspended. The insurance policy clearly provides for this situation by allotting an aggregate sum which encompasses damage to any one of the four buildings.

Ramada, at 814. 

In Ramada, however, the restaurant was listed separately in the insurance policy and the court found that evidenced the parties’ intent to treat the restaurant as a separate entity. Ramada also made no attempt to rebuild the restaurant, which also weighed against its argument of mutual dependency--that the fire in one building caused an actual cessation of operations in another building. Instead, the fire in the restaurant caused a loss of business in the hotel, but in Florida, pursuant to Hotel Properties, this type of loss is not covered by a business interruption policy.

The concept of mutual dependency as a measure of business interruption recovery will depend greatly on the facts. It is clear that in the scenario presented, recovery will depend on the evidence pertaining to the relationship between the swanky entities and on the projections for future income that would support the business interruption claim.

In National Union Fire Insurance Company v. Texpak Group, N.V., 906 So.2d 300 (Fla. 3rd DCA 2005), the policyholder, a paper mill company, sued its property insurance carrier to recover more than eight million dollars in business interruption coverage. The loss occurred when a felt belt snapped in one of the machines, which destroyed the entire paper operation. The carrier alleged that the felt belt snapped as a result of the manufacturer’s faulty design. The policyholder prevailed in lower court, arguing that the “all-risk” policy had an “ensuing loss” exception that allowed recovery despite the faulty design exclusion. The carrier appealed.

The policy at issue in National Union read as follows:

Business Interruption

(1) Loss resulting from necessary interruption of business ... caused by loss ... covered herein ... to real and personal property ....

PERILS EXCLUDED

This policy does not insure:

* * *
D. against the cost of making good defective design or specifications.... however, this exclusion shall not apply to loss or damage resulting from such defective design or specifications....

The Third District Court of Appeals, following the Florida Supreme Court’s ruling in Swire Pac. Holdings, Inc., v. Zurich Ins. Co., 845 So.2d 161 (Fla. 2003), held that ensuing loss exception is not applicable if the ensuing loss is directly related to the original excluded risk. The Court further stated that holding otherwise would be to allow the ensuing loss provision to completely eviscerate and consume the design defect exclusion. It is important to note that it was proven at trial that the broken machine was poorly designed and that the felt-belt did not break accidentally.

If we are to learn something from this paper mill’s coverage nightmare, it is that in business interruption claims causation is crucial and that recovery will not possible if the business interruption damages do not directly flow from an underlying covered peril.

Normally, after a policyholder notifies a claim, the carrier will request a proof of loss. Most policies allow 60 days from the day the insurance company provides the form to complete and return the proof of loss to the carrier (except for policies written under the NFIP). Once the property insurer receives proof of the loss, most policy provisions allow the insurer up to 30 days to review the information and decide whether all the necessary proof is present to accept or reject the proof of loss, or continue investigating a claim. Further, depending on the language of certain loss payment provisions, it could take up to an additional 60 days for payments to be issued.

We have all been there. The loss adjustment process is a painful and arduous period of time, especially when you are working on behalf of the policyholder and catastrophe has impacted their lives to the point of insomnia.

While simple property losses are adjusted in a relatively quick fashion, the more complex losses, particularly business interruption claims, will probably devour at least 90 days following the loss to complete the loss adjustment process, determine coverage and receive undisputed payments.

As discussed last week, the Period of Restoration in a business interruption claim is a period of time that is calculated by estimating the maximum coinsurance percentage, the estimated loss of income and subject to the limits of purchased. The Period of Restoration is then fixed on each individual policy based on a worst case scenario and this target will fluctuate depending on the amount of property damage, the time of the year and many other factors at the time of the loss. The Period of Restoration usually begins right after a loss and will end according to the carrier’s calculation of when the repairs should be reasonably completed and to achieve operational capability.

The question is then, is the gruesome loss adjustment process factored in the Period of Restoration? Typically, no. The time necessary to adjust the physical damage on a building and to make coverage determinations is not considered in the business income loss time-formula. Should we all start taking sleeping pills to endure this process? No. Knowing the timing and intricacies of the loss adjustment process and keeping good lines of communications will most likely expedite the process and ease the insured’s anxiety during this period of time.
The question of whether repairs should have “reasonably” been completed in a business interruption claim is a question for a jury to decide. However, on questions of when the Period of Restoration begins and ends, courts found that delays attributed to the insured do not extend the Period of Restoration, but delays attributed to the insurer will impact when the Period of Restoration ends.

In United Land Investors, Inc. v. Northern Ins. Co., 476 So.2d 432 (La App 2d Cir, 1985), the plaintiff’s restaurant was damaged by fire in November 1981. Similar to more modern policies, the business interruption endorsement limited the insurer's liability to "such length of time as would be required with the exercise of due diligence and dispatch to rebuild, repair or replace … ., commencing with the date of such damage or destruction." It was shown that the defendant insurer paid $10,000 for lost earnings in December 1981, but that repairs did not commence until March 5, 1982, when the insurer tendered the full sum necessary to make the repairs, which were completed 12 weeks thereafter. The Court affirmed the award to the insured of the full $60,000 policy limit, subject to a $10,000 credit for the insurer's December 1981 payment, based on the trial court's determination that the 12-week period in which the insured was required to make repairs did not begin to run until March 5, 1982. The court rejected the insurer's contention that the loss period should have been found to commence in November 1981, the date of the loss. It was said that until the insurer and the insured arrived at an amount to be paid, the insured was in no position to contract for or begin repairs to the building, and thus the insured should recover its business interruption losses from the date of the loss until the repairs were completed 12 weeks after March 5, 1982.

Business owners should further rejoice on Hampton Foods, Inc. v Aetna Casualty & Surety Co., 843 F.2d 1140 (8th Cir, 1988), where the Court held under a similar business interruption endorsement, a restoration delay occasioned by the insured's need to negotiate property damage claims under policies with separate insurers, represented by the same adjustment company which represented the business interruption insurer, was within the reasonable anticipation of the business interruption insurer and thus extended the loss period.

Business interruption claims are somewhat more sophisticated than the day to day claim. However, as with everything else in life, a clear understanding of all the factors and elements of this type of claim should make the process a breeze. Stay tuned for more weekly blogs on business interruption issues.

Most business interruption provisions read as follows:

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 damage to property […] The loss or damage must be caused by or result from a “Covered Cause of Loss.

The “Period of Restoration” (a.k.a. “Period of Indemnity”) in a business interruption claim is a concept of time. The period, as defined in most ISO forms, begins at the time of “direct physical loss or damage” and ends on the earlier of “the date when the property should be repaired, rebuilt, or replaced with reasonable speed and similar quality.” […] or “the date when the business is resumed at a new permanent location”

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 would be limited to eight weeks, if there is no due cause for the delay.

To be clear, returning the business to “operational capability” does not necessarily mean to return the business to pre-loss income levels, 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.

The business interruption value or the coverage provided during the Period of Restoration can be calculated using either of the following methods and both will yield the same result:

Business Interruption Value = Net Income Plus Continuing Expenses, or
Business Interruption Value = Gross Earnings Less Non-continuing Expenses

To say the least, time is of the essence in a business interruption claim. Many factors should be taken into account to avoid delays that could compromise a claim. In his recent book, Business Income Insurance Demystified, Christopher Boggs considers 10 time factors that directly affect the Period of Restoration in a business interruption claim.

Specifically, the time it would take to:

1. Adjust the direct property damage
2. Draw building plans and approve them
3. Find and retain a contractor
4. Apply and wait for building permits
5. Prepare and clear a site
6. Rebuild
7. Restock
8. Rehiring and hiring new employees
9. Replace machinery and equipment
10. Potential state or local intervention following a loss.

While the list is not exhaustive, it is certainly important to try to work on these factors simultaneously to swiftly restore operational capacity and obtain the most business interruption value out of the Period of Restoration.

Christopher Boggs has written a down to earth book regarding business income insurance, "Business Income Insurance Demystified: The Simplified Guide to Time Element Coverages." Buy it if you adjust property insurance claims and want to do a better job adjusting business income claims. If you are an insurance company defense attorney, don't buy it--I will use what he has written against your client and I do not need you more educated than you are. Risk managers need to buy it to explain to your CFO's and CEO's why this coverage is so important. Agents should buy the work to sell more business income coverage.

Do any insurance companies have their own adjusters determine the amount of business income or extra expense coverage is owed? Virtually all hire outside consultants and accountants to make the determination. Most adjusters wait weeks or months following a disaster to have these consultants and accountants do the work of evaluating the income and expenses of a business following a disaster. As a result, most business income and extra expense benefits are delayed at the most crucial time following a disaster. Months, rather than days, are the normal sequence for evaluation and payment of time element losses.

Most insurance agents do not understand how to address the importance of business income coverage. "Fear" is a great motivator in life and maybe agents and risk managers should consider the statistics of failure for commercial enterprises following disaster.

Boggs notes:

The insurance industry has long stated that 25 percent of the businesses that suffer a catastrophic loss (one causing a complete shutdown of more than 30 days) never reopen. The percentage could actually be much higher.

Not included in that often-quoted statistic is the number or percentage of the businesses that do reopen but ultimately close within three to five years after the catastrophic loss, with such failure being directly traceable to the loss. Considering those two classifications of catastrophe- induced business closures, the failure rate of a business due directly to major direct property losses could approach 45 or 50 percent...

The point of this post is two-fold. First, businesses need more and better time element coverage. Second, adjustments of these losses need to be much more prompt.

My suggestion to those commercial policyholders suffering a significant loss with downtime is to immediately ask for payment of income coverages and how extra expense dollars can be used to mitigate the loss and prepare for the ongoing operations after the restoration is complete.

Boggs argues in his book that the business income coverages are the most important coverages available to commercial policyholders, more so than other property coverages. I am not so certain about that. Yet, I agree that they are just as important because commercial enterprises rely upon revenue to exist. Money is blood to a business.

I also suggest all property insurance practitioners add Boggs' work to their library.

The sources for my information are former Nationwide Executive General Adjuster Scott Eich and Commercial Large Loss Adjuster Dennis James, as well as interviews with various Nationwide policyholders, adjusters and public adjusters. Eich told me of a story concerning the underpayment and ignorance by Nationwide adjusters and claims management concerning this form of coverage to a fast food franchise.

Apparently, nobody in the claims department at Nationwide taught its adjusters how to inform Nationwide policyholders about this very valuable coverage. Nationwide claims executives intentionally fail to teach their catastrophe and claims adjusters about how this obscure policy provision works.

Scott Eich should know. He was a Subject Matter Expert for Nationwide and helped develop commercial training at Nationwide Insurance Company until he left Nationwide in 2006.
In reflection, he said virtually every business owner that has lost income following a catastrophe should have a dependent property claim investigated because it probably is covered---regardless if the Nationwide customer suffered any physical damage at all.

The point I want to make is that as an obligation of good faith, an insurer must train its claims adjusters about the benefits of the policy so adjusters can intelligently investigate for those damages and inform the policyholder of the benefits. How fair would it be for an insurer to intentionally not train its adjusters so benefits are never paid, and allow otherwise recoverable benefits to go uncollected? This is the effective result of feigned ignorance at Nationwide because no claims personnel understood how the policy worked regarding this coverage. I am certain the underwriters knew and agents should know as well.

Thinking about Nationwide's general claim philosophies, I wonder how many millions (if not billions) of dependent business income coverage benefits have gone unclaimed from Hurricanes and other natural catastrophes over the past decade. I would not be surprised if some major class action law firms do not read this post and try to rectify this situation soon. Maybe Nationwide will contact their customers to correct this underpayment situation and make restitution to business policyholders in catastrophe areas.

Most commercial insurance companies write "dependent" or "contingent" business income coverage as additional coverage under an endorsement. Nationwide has it in the primary business policy, and it is not subject to any policy limits other than the loss of income be incurred within twelve months of the other person's damage.

The key to this type of coverage is to remember the Insurance Company pays its policyholder for its loss of income because of damage to other people's, businesses' and governments' real and personal property. Fulcrum consultants indicate this on its website:

Contingent Business Interruption

If your business has key suppliers or customers affected by a disaster, your business could have insurance for this business interruption. This is true even though your own business property may not have sustained physical damage. This frequently occurs because of (i) strategic supplier and customer relationships, (ii) outsourcing agreements, and (iii) just-in-time inventory systems. If included in your policy, contingent business interruption covers losses caused when key suppliers or customers experience a disaster that also affects your business. Contingent insurance occurs when the physically-damaged property is NOT owned, operated or controlled by the insured. The contingent property may be specifically named, or the coverage may blanket all suppliers and customers. The type and cause of physical damage must be the same as insured under the controlling policy. The actual coverage will depend upon your policy language...

The Nationwide policy provides the coverage on a blanket basis. Essentially, hurricane damage to property owned by others who are customers of Nationwide's policyholder which result in loss of income to the policyholder results in a covered claim. The definition of dependent property is very broad under Nationwide's policy. I am certain there are many business owners with Nationwide that have lost money in many catastrophe areas that are ignorant that their policy will help soften that financial blow
 

The case involved an insurance agent who sold insurance to a private school for 16 years before Hurricane Katrina struck in 2005. At issue, was the relatively limited amount of business interruption coverage. The form sold had a limit of $350,000, inclusive of both business income and extra expenses. Apparently, the coverage limit was raised once during the sixteen years from $250,000 to $350,000, based on an explanation by the agent of what the coverage provided. The agent allegedly told the school's business managers at that time that the coverage protected the school against the risk that it would incur extra expenses while it was fixing physical damage.

Following Hurricane Katrina, the school was closed for several months. The school lost significant income as a result of lost tuition. The school sued the agent for error and omissions of failing to advise school personnel that business income/extra expense coverage included tuition loss. Allegedly, the requested limits would have been much higher had the full explanation of coverage benefits been provided.

The matter went to a trial court which found that the insurance agent breached the standard of reasonable care by failing to fully inform the school of the full nature of the coverage and the need to select higher limits in consideration of the school's one source of revenue--tuition. The damages were found to be $3,166,606.

That is not the end of the story or lesson of this case, however. As is often the situation in agent negligence cases, there is usually the issue of comparative negligence. I once tried a case before a jury where both the agent and my client said the agent failed to purchase theft coverage under a commercial policy. While some may wonder why a trial was necessary when the agent admits such a failure, most states place a duty on the policyholder to read the policy. In that case, my client had the policy for two years. Had he read the policy, he would have learned of the mistake. Thus, the jury had to consider the issue of my client’s failure to read the policy in comparison to the agent's blunder.

Similarly, in the Louisiana case, the school's business managers could have done a number of things to obtain the full understanding of coverage--including simply reading the policy. The court found the school 70% comparatively negligent, and reduced the total award by that percentage.

The lessons from the case are clear for agents and policyholders:

1. Policyholder Must Communicate Needs;
2. Agents Should Communicate Coverages Available--Usually Followed up With Written Information so Policyholders Do Not Get the Wrong Impression;
3. Agents Should Investigate Needs of Clients--Use Checklists Which are Copied for Verification to Policyholders.

Insurance agents perform a vital function in the insurance marketplace and especially with businesses. I am not a fan of internet marketing and placement of insurance because agents can provide much better and detailed explanations of various coverages needed by different businesses.

For instance, our law firm carries an extraordinary amount of coverage for valuable papers and data restoration, which might not be important to a butcher shop. Yet, a butcher shop may need a utility services endorsement, spoilage coverage, and equipment breakdown coverage to properly protect its large investment in refrigerated meat. Insurance agents are trained to investigate those needs and make policyholders aware of those coverages which prevent economic calamity.

My advice is for policyholders to listen to insurance agents about the products that are available. Agents need to spend more time with clients and establish a relationship where insurance is looked upon as a necessary hedge against unthinkable consequences.

I first came across Winans when he sent me an article he wrote, Florida Flirting with Hurricane Insurance Disaster, published by the International Risk Management Institute in 2008. At the time, I was on the Citizens Property Insurance Corporation's Mission Review Task Force. Winan's views are worthy of reflection. Florida will be flirting with that potential financial disaster for some time, although the recent laws allowing rate changes to Citizens will help place them on a much sounder actuarial method of premium rates.

Here were the points from Winan's presentation this morning:

Prepare your insurance policy

1. Do you have proper coverage--

• Flood?

• Excess flood?

• Ordinance and law?

• Offsite power outage?

• Business Interruption/Extra Expense?

• Contingent Business Insurance coverage?

2. Do you have enough coverage—

• Building?

• Contents?

• Inventory?

• Business Interruption/Extra Expense?

3. Your insurance policy—

• Get a complete copy

• Put it in a safe/accessible place

Prepare for the storm

4. Put a catastrophe plan in place

5. Prepare for cash needs

6. Take photos and videos now

7. Back up and protect critical data

After the storm

8. Document the damage

• Photos and videos

• Don’t throw damaged items away

• Save receipts

9. Protect your property from further damage

10. Beware of contractors wanting…

• Cash

• To start without documentation

• To contract non-emergency work

• Payment in full

Policyholders should start on the first four points immediately. Summer is here and the water is warming everyday. Sometime and somewhere, there will be a tropical cyclone threatening the Coastal region before the cooling days of November.

On the Central Gulf Coast we know all too well that after a catastrophic event, it is deeply comforting and reassuring to have the support of our family, friends, neighbors and extended neighbors. In addition to knowing that the replacement or repair of our homes and personal or business property will be taken care of, we should also be able to rely on our wise decisions to cover those additional and necessary expenses for the time period it takes to put our lives back together without the need to stretch our budgets and burden our families, friends and communities.

Some of the most overlooked and underused benefits are Additional Living Expense Coverage, Loss of Rents Coverage, Business Expense Coverage and Business Interruption Coverage. Though these coverages are often reimbursed after the actual costs have been incurred, many insurance carriers will make partial payments to policyholders to assist them on their way to recovery.

The only way to know if you have these coverages is to review the policy. We strongly encourage all of those affected by these recent storms to thoroughly review their complete insurance policy, including riders and endorsements. If you no longer have, or never had a policy, seek one from your insurer immediately.

A typical benefit under the Coverage for Additional Living Expense is coverage for rental or temporary housing when a covered event renders the covered primary home uninhabitable. Other additional expenses can also be covered, such as the additional expense in travel to and from work due to the new living location.

Often owners of residential rental property will have coverage under their rental dwelling policy that covers loss of rents when the covered property is made uninhabitable by a covered event, as a renter has no obligation to continue to make rental payments due to force majeure. A lease or a rental agreement will be helpful in documenting the amounts to be paid under this provision.

A benefit of Business Expense Coverage under a commercial policy may allow a covered business to take the necessary steps to continue the business at another location during the period of restoration to the covered property. This coverage is much like the Additional Living Expense Coverage in that it is intended to offset the “extra expense” associated with returning to the normal operation of the business.

Another valuable coverage to businesses is the Business Interruption Coverage, a.k.a, Time Element Coverage. This coverage often helps prevent a business affected by a covered event from going out of business or into bankruptcy by its receiving the benefit of lost income payments for the period of restoration or replacement of the damaged property.

Though many of these coverages are limited to a 12 month or 24 month period, unless there is an endorsement for an extension, these coverages should be explored and understood at the outset of any insurance claim. Policyholders should read their policies carefully to determine which coverages are available to them and to determine the duties and obligations of policyholders in order for them to make a proper claim for those coverages. Policyholders should also have their insurance carrier verify and commit to coverage early to ensure prompt reimbursement.

At this year’s annual Windstorm Conference held in Orlando, FL [link], there were many vendors in attendance that offer insurance policy related services. Temporary housing services can prove to be very beneficial to policyholders who have been displaced when their home is rendered uninhabitable by a covered event.

While visiting with some of the temporary housing vendors at the Windstorm Conference, we discussed the dilemma for many policyholders with regard to obtaining the temporary housing benefit under their Additional Living Expense Coverage. In the aftermath of a catastrophic event most policyholders are thrown in to a time of uncertainty and do not have the savings or resources immediately available to them to secure temporary housing.

The temporary housing services work directly with the insurance company. The hotel or rental bills are paid by the insurer on behalf of the policyholders directly to the temporary housing service. Informing policyholders that this kind of service can be available could lead to the benefit of temporary housing for policyholders at the time most critical in the recovery—the initial, emergency stages.

Insurance policies can be very difficult to understand. Policyholders should consider making an extra copy of their policy so that they can mark the areas that need further clarification. Policyholders should then consider discussing the meaning of these provisions with a claim representative as soon as possible. If policyholders are not fully satisfied with the answer(s) given, they should consider asking to speak to a Claims Manager or asking to be referred to someone who can assist them. If policyholders are still dissatisfied, have been wrongly denied, or have been told there is limited or no coverage due to exclusionary language, policyholders should consider seeking legal counsel to protect their interests.

Our hearts and prayers go out for all of those affected by these tragic storms and tornadoes and we send our wishes for a speedy recovery.

Best to All,

Deborah

Many carriers limit their payments on a BI claim to (1) the amount of profits lost to a business while it was closed as the result of a covered peril, and (2) operating costs (i.e. salaries and utilities). This limitation in unfairly restrictive, and does not take into account the basic rule behind this and many other types of insurance.

The role of insurance is to place insureds back into their pre-loss condition. Insureds pay their premiums so that after they suffer a covered loss they may then bring their business back to the condition that it would have been in had the loss never occurred. This opens the door to payment for other items that an insured might never have known that it could recover, such as (1) the cost of advertising for reopening a business that has been shuttered; (2) increased costs that have been incurred in order to keep the business afloat during the indemnity period; (3) costs pertaining to the preparation of the claim. These are but a few of the additional costs.

A case which I recently handled also illustrates some of the legal issues that may arise in BI claims. Our firm was retained to assist in the resolution of a BI claim in South Florida. The insured operated a large, membership-driven operation which had closed down for 16 days as a result of Hurricane Wilma. The underlying claim for the physical property, which we did not handle, resulted in a final payment of $200,000 (which was an outstanding result). The insured did not receive full payment until one and a half years after the loss, which was to prove a pivotal point.

The carrier limited its initial payment on the BI claim to $16,000. It attempted to support this number by stating that this was the amount due to the insured for lost profits and operating costs for the sixteen days in which the business was shuttered.

However, there were several factors which the carrier had not taken into account. Although the insured had reopened its business 16 days after the loss, it was a shadow of its former self. There were holes in the ceiling. The glass storefront had been shattered. The place smelled of mildew. For a place that had prided itself as being a first-rate operation, these damages were incalculable.

During the year and a half in which the business struggled along, facing increasingly difficult conditions, the insured lost numerous members and was unable to attract new ones. A once thriving business saw its future hopes imperiled. It was, at the time our firm began its involvement, on its last legs.

Initially the carrier was insistent that the insured had been properly compensated for the loss of its income. Any other payments due would be a minimal amount. The carrier also claimed that the insured had not been been doing all that well prior to the hurricane, and that the current numbers were inflated.

Our firm painted what we felt was a more realistic picture of what had transpired. A business had, for all intents and purposes, been closed for a year and a half. The indemnification period was not sixteen days, but a year and a half. The business had made some money over the year and a half, but not as much as it would have made had (a) the storm never hit, and (b) the insured been paid within an appropriate time-frame.

During settlement negotiations, the carrier changed its tune, and agreed to an additional $235,000 in BI coverage.

Our insured was stunned—not only had it seen more money than it expected, the possibility now existed that it could keep its business afloat. In these times, that is no small feat. It was an honor to represent them, and we look forward to hearing about their continued success.

-Ed Acle

The Value of Forensic Accountants in a Business Interruption Claim

In today’s economic environment, everyone is looking for value. In my experience. I have found that the earlier the forensic accountant is involved in the claim process, the more value he/she typically provides. The value derived from the forensic accountant is his/her technical knowledge of accounting and familiarity with the claims process, which may result in a more expeditious resolution to the Business Income claim.

In simple terms, the purpose of Business Income coverage is to indemnify the insured for its net income or loss plus continuing operating expenses during a period of interruption (period of restoration), resulting from a covered loss. In addition, the insured may be covered for additional expenses (Extra Expense), which it incurred due to the loss incident.

To quantify a Business Income loss, an analysis of pre- and post-loss revenue, costs and operating expenses is required. A competent forensic accountant will provide an adjuster, policyholder, or legal counsel with his/her knowledge and experience in matters, including, but not limited to: technical aspects of accounting rules and procedures and other related data, familiarity with policy terms and conditions, and establishment of accounting and document control procedures to ensure inclusion of all relevant data into the claim calculation.

The above-mentioned services will result in an expeditious compilation of a Business Income claim that properly indemnifies the policyholder for its Business Income loss in accordance with its coverage(s). Some specific examples of how the forensic accountant can assist:

• Requesting the relevant books and records needed to support a Business Income claim.
• Using his/her general knowledge of coverage to properly analyze, indentify and segregate revenues, costs and expenses to coincide with coverage and facilitate the expeditious preparation of the claim. Please note, a forensic accountant does not provide coverage interpretation, as this is the responsibility of an adjuster and or legal counsel.
• Providing an avenue for communication between the “two sides” on technical accounting and related matters that may be beyond the understanding of the adjuster and or legal counsel.
• Preparing a Business Income analysis, which coincides with the language of the policy coverage and that indemnifies the policyholder for its covered loss in an expeditious manner.

Conclusion

A forensic accountant serves as a resource of technical knowledge in accounting related matters that an adjuster or legal counsel may not feel comfortable with. The early inclusion of a forensic accountant into the team of claim professionals will go a long way in assuring that the policyholder is being properly indemnified for its covered loss under the terms of the policy coverage.

--Bruce Smith