In today’s world, business models are limited only by our imagination. Transforming an idea into a business reality is probably one of the most rewarding achievements in our society. However, not all businesses are alike and, as such, not all business interruption claims should be put through the same rigors. While most business income policies contain standardized language, insurers should take into account the atypical nature of a business when necessary so as to never deprive a policyholder of its right to receive the capital needed during the period of restoration to sustain the business while its operations are suspended as a result of damage caused by a covered peril.
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.