I recently got interviewed by Ed Beeson of the Newark Star-Ledger as part of his article about the looming Superstorm Sandy insurance coverage litigation. The insurance industry has definitely circled the wagons, and the first suits are now being filed. There will be a lot of battles over causation (e.g., wind versus flood), as well as E&O litigation against brokers. You can read the full article here.
When Hurricane Sandy struck New Jersey last week, one of my out-of-state lawyer friends, employing the sort of dark humor that perhaps only other lawyers can appreciate, congratulated me on my “happy positioning in the world’s greatest business interruption insurance goldmine.” I told him that, unfortunately, this time I might be a plaintiff instead of coverage counsel. Luckily, through yeoman’s work by my firm’s staff, we were able to get up and running again fairly quickly (although without heat for awhile).
I know that, in the wake of this terrible disaster (described by some as “Katrina without the body count”), virtually every insurance broker and coverage lawyer is rushing to publish articles and blog posts on property coverage. Given my friend’s comment, and not to be outdone, I thought I would take a brief look at a couple of important aspects of the law relating to business interruption insurance, based upon a Third Circuit case from a few years back.
The case is Eastern Associated Coal Corp. v. Aetna, 632 F.2d 1068 (3d Cir. 1980), and while it involved a fire rather than a hurricane, it neatly illustrates some of the typical problems encountered with business interruption claims.
Basically, Eastern owned a coal mine that suffered an underground fire. With respect to the business interruption aspect of the claim, Eastern wanted reimbursement in two areas. First, Eastern wanted compensation for the sales value of a portion of the coal that would have been mined by Eastern during the interruption covered by the policy. Second, Eastern wanted reimbursement for expenses incurred by Eastern in obtaining alternative coal to fulfill its contractual obligation to supply metallurgical coal from the mine to Sharon Steel Corporation.
Let’s begin with the good news for Eastern. There’s no question that there was a covered loss – fire was a peril covered by the policy – and that the potential for business interruption coverage therefore existed. Without physical damage caused by a covered peril, there can be no business interruption coverage. This showcases the need to follow the first rule of coverage work: Read The Policy. You can bet there will be a lot of battles in the Sandy arena over whether a covered peril exists. First party policies, for example, may exclude flood damage but include wind damage.
Now, let’s briefly define the type of coverage provided by business interruption insurance. BI insurance is meant to cover “but for” income – that is to say, income that the policyholder would have realized “but for” the physical damage. Business interruption loss, then, is the difference between (A) what the policyholder would have earned, and (B) what the policyholder actually earned, during the loss period. If net income equals revenue less expenses, then lost income for BI purposes equals (1) “but for” revenue minus “but for” expenses, LESS (2) actual revenue minus actual expenses.
This formula may seem simple, but it’s precisely where many disputes arise between policyholders and insurance companies. Insurance companies are forever contending, for example, that the “but for” side of the equation is too speculative – which is exactly what happened in the Eastern case.
Under the coal supply contract, Eastern agreed to furnish Sharon’s metallurgical coal requirements, estimated at 250,000 tons annually, for a ten-year period. The contract contained base prices for coal, and an escalator clause to cover increases in the cost of production. The contract contained a provision that required all metallurgical coal to have a sulphur content of less than 1.6%.
The insurance companies argued that all of the metallurgical coal would have been sold to Sharon under the contract. If so, the total recovery under the policies for lost production would have been $5.3 million. Eastern, however, argued that 77,000 of 181,000 tons of lost metallurgical coal production would have been rejected by Sharon because they would have had a sulphur content in excess of the 1.6% requirement under the contract. If so, the 77,000 tons would have been sold on the open market and would have been valued at a higher market price, increasing the recovery from the carrier by almost $900,000.
To prove its point, Eastern submitted evidence of the sulphur content of the coal remaining in the metallurgical portion of the mine at the time of the fire. This data had been obtained by analyzing bore samples of coal from the metallurgical section of the mine. Eastern argued that this data showed that approximately 77,000 tons of metallurgical coal in the mine had a sulphur content ranging from 1.6% to 2.0%. The jury bought this argument. Unfortunately for Eastern, though, there was testimony at trial that the coal routinely underwent a “washing” process before sale, which would reduce the sulphur content by an unspecified amount. The appeals court overturned the jury verdict, writing: “Without evidence of the effectiveness of the washing process, the jury could only speculate concerning the sulphur content at the time of delivery. There is no evidence from which the jury could infer the effectiveness of washing.”
It’s easy for me to play Monday morning quarterback 30 years later, but how difficult would it really have been to provide an analysis of the effectiveness of the washing process? Probably not very. That leads me to two possible conclusions. First, the data was not good for the policyholder, in which case the policyholder was simply hoping for a $900K windfall. Second, someone got lazy. Never get lazy on a business interruption claim, especially a sizable one. The carrier is going to look for any way it can find to knock down the policyholder’s number or argue it’s too speculative. It’s important to think through all aspects of the claim and provide conservative, justifiable data. Always be thinking about how things will play out in Court (and try to avoid getting there).
The second element of the claim involved additional expense incurred by Eastern to comply with its supply contract with Sharon. On this element, the Court interpreted the policy quite strictly, writing: “Eastern argues that its substitute and brokerage coal expense was ‘incurred by the Assured to reduce loss’ caused by the interruption and, therefore, is covered by the policy. We do not doubt that Eastern's liability to Sharon was reduced by its resort to substitute and brokerage coal. However, Eastern fails to take account of the exact words of the policy. The provision compensates insureds for expenses incurred ‘to reduce loss hereunder’. We believe the phrase ‘loss hereunder’ plainly refers to loss compensated under the policy.” In other words, the additional expenses were not aimed at reducing loss under the policy, but at reducing contractual liability to a third party.
From the perspective of Sandy, the reason I mention this second ruling is that you can’t simply assume that all additional expense will be covered under a business interruption form. In fact, until you have a commitment in writing from the carrier, it’s safest to proceed from the assumption that none of the additional expense will be covered, unless and until a court decides otherwise. As a wise man once said, bank in the bank, not in your head.
If you’re interested in reading the entire Eastern Associated decision, click here.
Saw this post over at Property-Casualty 360 and got a kick out of it. Enjoy.
Here's a pretty good article from ABC news about how contingent business interruption coverage works. There have been a lot of questions about this coverage folowing the earthquake in Japan.
In the last post, we took a look at the Dictiomatic case, in which the policyholder took a beating for overreaching on a business interruption claim. Turnabout being fair play, let’s now have a look at a recent case in which the insurance company got thumped in the business interruption arena. The case is Amerigraphics v. Mercury Casualty Co., 2010 Cal. App. LEXIS 377 (Cal. Ct. App. Mar. 23, 2010).
(By the way, the Amerigraphics decision has the first-party claim community more than a bit worried, judging from a recent article in Claims magazine.)
The essential issue was as follows. Amerigraphics was a three-person graphics company. A flood seriously damaged its business premises, knocking out its operating equipment. The property carrier (Mercury Casualty) determined that, but for the flood, Amerigraphics’ operating expenses would have exceeded revenues, resulting in a projected operating loss of about $159,000. After stalling on the business interruption claim for an extended period of time (and causing Amerigraphics to go out of business), Mercury came to a “no pay” conclusion. Mercury reasoned that, absent the flood, Amerigraphics would have been in the red. Therefore, Mercury argued, how could Amerigraphics legitimately claim that it had lost any income?
Unfortunately for Mercury, the appeals court saw things differently. The business income coverage - in this case, ISO Form 0030 – provides for two components:
(1) Net income (net profit or loss before expenses) that would have been earned or incurred absent the event that caused damage.
(2) Continued normal operating expenses paid or incurred, including payroll.
Generally and not surprisingly, insurance companies take the position that if (in their view) the policyholder would have operated at a net loss, there is no business income coverage. The Amerigraphics court disagreed with that position, finding that items (1) and (2) were separate and distinct. Specifically, the Court ruled as follows:
“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.”
The case had been tried to a jury, and, in addition to awarding $170,000 in compensatory damages, the jury found Mercury liable for $3 million in punitive damages for dragging its feet on the claim, and for telling Amerigraphics that certain coverages did not exist under the policy, when in fact they did. As in: “Volper [the policyholder’s principal] called Brown [the insurance claims person] and told him he wanted to make a claim for normal operating expenses. Brown responded that there was no such coverage. Volper then sent Brown a letter enclosing a copy of the relevant policy page with the relevant provision circled. Brown then requested that Volper provide him with a list of the normal operating expenses Amerigraphics had incurred.”
The appeals court described Mercury’s conduct as “despicable” (never a good thing for a claims department), and said: “Amerigraphics, which thought it had insured itself against catastrophic loss, and faithfully paid its premium to Mercury, ultimately became a particularly vulnerable victim. Put simply, Mercury's egregious conduct put Amerigraphics out of business.” The trial court had reduced the jury’s $3 million punitive damages award to $1.7 million, a 10-to-1 ratio with compensatory damages. The appeals court, however, further reduced the punitive damages award to $500,000, finding that a 10-to-1 ratio was excessive under United States Supreme Court precedent.
I’m getting ready to speak at an ABA-TIPS conference on the topic of business interruption insurance. Given the number of horrible tragedies we’ve been through in the past decade (prayers for all those affected by the earthquake in Japan), it’s certainly a timely subject.
To cut to the chase: Business interruption insurance is designed to protect the earnings that the policyholder would have made, had the event or occurrence insured against not happened. Many courts have noted that business interruption insurance is not designed to put the policyholder in a better position than it would have been in had no business interruption occurred.
The elements of proof for a business interruption claim are pretty simple. Basically, the policyholder must generally establish the following:
- That damage covered by the policy has taken place.
- That there was an interruption to the business (“suspension of operations”) caused by the property damage.
- That there was an actual loss of business income during the period of time necessary 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 (like, for example, lousy products or services). See, e.g., Dictiomatic v. United States Fidelity & Guaranty Co., 958 F. Supp. 594, 602 (S.D. Fl. 1997).
As with most claims, BI claims can easily go off the rails when the policyholder takes extreme positions, damaging its credibility. The poster child for that situation is the Dictiomatic case. (It’s never good when the court uses the word “speculative” to refer to your claim in seven different places in its opinion.) I recommend that anyone involved with this area of the law read that decision very carefully.
Basically, the case involved a company that made hand-held electronic gizmos that translated certain languages into English (including the immensely popular Hungarian and Icelandic). The latest generation of the gizmos didn’t work very well. In fact, in an “OJ with the gloves” moment, the policyholder apparently demonstrated how “well” they worked during the trial, prompting the court to remark tartly: “The in-court demonstration of the product revealed that the sound quality of the speaker was poor and that the pronunciation was not clearly discernible.”
Dictiomatic was taking on water like the Andrea Doria – over $1 million in debt and no discernible market for its poorly-made products in sight. (The court remarked: “[Due to inconsistencies in Plaintiff's proof and sloppy record keeping, the court is unable to determine the exact amount of debt. The evidence is clear and consistent, however, that at the time of the Hurricane the Plaintiff's debt was substantial and was in an amount in excess of $1,000,000.”) Then Hurricane Andrew came, which damaged the company’s Florida administrative offices, but not its subcontractor’s manufacturing facility in Singapore, where tens of thousands of the gizmos sat collecting dust. Undeterred, Dictiomatic put in an initial BI claim of $1.3 million (later supplemented to include more), claiming that, despite its woeful financial records, the company would have turned huge profits if not for the bad weather.
The Court made numerous snarky remarks about the credibility of Dictiomatic’s position, and ultimately dismissed the case at the close of plaintiff's proofs, stating in part as follows:
“[T]he evidence shows that the summaries of past profits the Plaintiff provided to the Defendant in support of its claims of past sales were not accurate inasmuch as bookkeeping journals and ledgers to support the summaries were not diligently kept current on a regular basis. In sum, during processing of the claim, Dictiomatic never provided USF&G with consistent, reliable information which might have supported its claim for loss of business income.”
“Consistent and reliable” documentation. If you want to win on a BI claim, that’s the key.
By the way, if you want to know anything and everything there is to know about business interruption insurance, check out some of Michelle Claverol’s wonderful posts on the subject. Michelle has gone above and beyond the call of duty in explaining this area of insurance and the law.