In addition to covering property damage, most first-party commercial insurance policies offer business interruption coverage. Business interruption coverage typically has two different built in coverages: business income and extra expense. Both are intended to assist businesses in the event a covered peril damages business property and impacts business operations.
Business income provisions generally provide the insured with coverage for the loss of net business income, limited either by:
- a time period such as 6 or 12 months or
- a specific policy limit that is sustained due to the business’s suspension of operations during the “period of restoration.”
The period of restoration is generally understood to mean either
- the time it takes the insured to actually repair, rebuild or replace the damaged property, or
- the time it should take a reasonable insured exercising due diligence and dispatch to repair, rebuild or replace the property under the circumstances.
Generally, extra expense coverage provides coverage for necessary expenses incurred during the period of restoration that would not have been incurred without the loss. This coverage pays for the extra expenses incurred to avoid or minimize the suspension of business and to continue operations at the business premises described in the insurance policy or at a replacement premises or temporary location, including relocation expenses and costs to equip and operate the replacement premises.
Welspun Pipes Inc. v. Liberty Mutual Fire Insurance Company,1 provides a good example of how these coverages come up and how they differ in property damage claims.
Welspun Pipes won a $330 million contract with Enterprise Products Partners for six segments of a 670-mile oil pipeline from Cushing, Oklahoma, to Houston. The parties’ agreement called for deliveries of pipe to be completed by August 2013.
Welspun was scheduled to begin production in July 2012, but a fire at its Little Rock production facility forced it to cease production until repairs could be made. In order to meet the deadlines for the Enterprise contract, Welspun moved production for about 40,000 metric tons of the pipe to a facility in India.
Welspun was insured by Liberty Mutual. Its commercial insurance policy provided roughly $68 million in coverage for business income losses and $1 million in coverage for extra expenses.
Welspun claimed a business income loss of approximately $28,000,000 as well as an estimated $14,500,000 in what Welspun characterized as mitigation expenses.
Welspun’s forensic accountant determined that the company had incurred expenses of nearly $14 million associated with the post-fire production shift to India.
The parties reached a partial settlement in which Liberty Mutual paid Welspun’s loss of business income claim in the amount of $22,300,026 and a total of $1,000,000 for what Liberty Mutual characterized as the insured’s Extra Expense claim. The partial settlement agreement acknowledged that Liberty Mutual and Welspun disagreed over the characterization of the expenses and that a dispute remained as to the claim for mitigation expenses.
Welspun filed suit in Arkansas federal court, seeking to force Liberty to pay $13.5 million of unpaid expenses it incurred to move its production of the pipeline to India to meet the Enterprise contract deadline. Welspun asserted that the production shift was necessary to avoid losing the entire Enterprise order.
The Liberty Mutual policy specified:
C. If coverage for loss of business income is provided …, we will pay for:
2. The necessary expenses you incur in excess of your normal operating expenses that reduces your loss of business income. We will not pay more than we would pay if you had been unable to make up lost production or continue operations or services.
D. If coverage for extra expense is provided …, we will pay for:
1. The actual extra expense you incur during a period of restoration directly resulting from damage by a peril insured against to the type of property covered by this policy at a covered location.
Extra expense means the reasonable and necessary extra costs:
1. Incurred to temporarily continue as nearly normal as practicable the conduct of your business; or
2. Of temporarily using property or facilities of yours or others.
3. For purposes of applying the above provision “normal” means the condition that would have existed had no covered loss happened.
The parties filed cross motions for summary judgment.
The trial court analysis focused on section C. 2 of the policy’s business income provision, and determined that in order to prevail on its claim, Welspun would have had to show it incurred necessary expenses beyond its normal operating costs in order to avert a loss of business income within the time frame laid out in the policy.
The court found that while Welspun’s forensic accountant estimated the cost for the hypothetical loss of the whole pipe order at $69 million, the accountant failed to show how, if Welspun hadn’t spent extra money to shift production to India, it would have suffered a specific loss during the restoration period or the extended period. Specifically, the court stated:
The plaintiffs have no evidence that the mitigation expenses at issue averted a net decrease in production value during the period of restoration or the extended period of restoration…. Absent evidence that the mitigation expenses averted a decrease in the net sales value of production during the period of restoration or the extended period of restoration, the plaintiffs cannot present evidence on an essential element of their claim, so their claim must fail.
In my opinion, the costs associated with moving the operation to India to meet the Enterprise contract deadline—based on the express terms of the policy—should have been viewed as a pure extra expense under section D.1 of the policy—not a business income loss under section C. 2—because it was an extra cost incurred directly resulting from the fire. The benefit of the pure extra expense provision (when compared to the business income provision) is that its coverage grant is not limited to the expenses incurred in excess of normal operating expenses that reduce the insured’s loss of business income claim. Instead, it provides coverage for all extra expenses incurred to temporarily continue as nearly normal as practicable the business, or of temporarily using property or facilities of others. Under the circumstances that is exactly what happened—the fire caused the insured to incur extra expenses to temporarily continue its business operations by moving its operations to India to meet the deadline under the Enterprise contract.
However, unlike the business income coverage which provided up to $68 million in coverage, the policy only provided up to $1 million worth of coverage for pure extra expense (an amount that had already been exhausted). Consequently, Welspun likely tried to creatively classify its extra expenses as a “necessary expense” under the business income coverage, which provided a much higher policy limit. However, by failing to sufficiently demonstrate how the costs associated with moving the operation to India averted a net decrease in production value during the period of restoration, Welspun failed to establish coverage under the more stringent business income coverage provision.
This case offers a good lesson to public adjusters and policyholder advocates. It is important to understand the meaning and nuances of the coverage provisions at issue in complex claims. Understanding the coverage enables us to understand what experts and evidence we need to sufficiently trigger coverage. Here, had Welspun understood this, it might have had its forensic accountant specifically address how the costs associated with moving the operation to India averted a net decrease in production value during the period of restoration.