Math has never been my strong suit. My wife, who has an M.B.A., sometimes shakes her head at my unsuccessful attempts to balance our checkbook. And I still remember sitting in my 10th Grade Algebra class with Ms. Babiak at Watchung Hills Regional High School back in the ‘70s and wishing that I could somehow transport myself to the Black Hole of Calcutta. (Sorry, Ms. Babiak, if you’re out there.)
But at least that kind of math has an objective answer that I can usually understand if I apply myself hard enough. Accounting projections that veer into gray areas, on the other hand, can be frustrating. And I’m sure many jurors and judges feel the same way. (In fact, I know they do, from monitoring mock jury trials.)
Business interruption claims involve projections of lost revenue, and can sometimes get a bit squirrelly. The basic concept seems simple enough. A fire or other disaster damages your business premises, making them temporarily unusable. So, business interruption coverage reimburses you for the lost income. Your policy may also cover operating expenses, like electricity, that continue even though business activities are temporarily shut down. And “extra expense” insurance reimburses your company for the reasonable sum of money that it spends, over and above normal operating expenses, while your property is being restored. Usually, the carrier will pay extra expenses if they help to decrease business interruption costs.
(By the way, in reviewing your coverage. make sure the policy limits are sufficient to cover your company for more than a few days. After a major disaster, it can take more time than many people anticipate to get the business back on track. And note that there’s generally a 48-hour waiting period before business interruption coverage kicks in.)
Easy peasy, right? The problem is that reasonable minds can disagree on the proper calculation of the numbers, which often involves assumptions. I’ve written several times over the years on some of the issues that can arise. (Just type “business interruption” in the search bar of this blog to find the posts.)
Here’s an interesting curveball. What if you have a business in which income can fluctuate fairly wildly from year to year? How do you calculate projected future earnings? What if, for example, you have a law firm that operates largely on a contingency-fee model, like a plaintiffs’ personal injury firm, as opposed to on an hourly billing rate model? Since your firm doesn’t get paid unless it wins or settles, and that can be difficult to predict, how do you calculate future earnings?
In a recent New York case, a law firm, Bernstein Liebhard LLP, suffered a fire that destroyed the floor of its office that housed its mass tort law practice, including files, firm-wide computer servers, and telephone switches, knocking the practice out of business for a lengthy period. Bernstein submitted an insurance claim for $27 million, which the firm said represented lost income from several hundred mass tort clients who failed to retain the firm during the 12-month period after the fire.
The carrier, Sentinel, denied the claim, contending that the policy’s definition of “Business Income” precluded coverage. The policy defined “Business Income” as “Net Income (Net Profit or Loss before income taxes) that would have been earned or incurred if no direct physical loss or physical damage had been incurred.” Sentinel argued that the claim was too speculative, because it was impossible to determine when Bernstein would’ve “earned” fees from clients that hadn’t even retained the firm. (The policy covered income that would’ve been “earned” in the 12 months after the fire.)
A cynic (not me, of course) might say that Sentinel was actually relying on the “too many zeroes” exclusion (in other words, too many zeroes on the end of the claim).
The Court disagreed with Sentinel, writing: “Recovery is not precluded where there is a certain loss within the applicable period, even if the loss cannot be quantified until sometime thereafter. Here, an economist or other expert could identify the relevant existing mass tort cases during the 12-month period [that the policy covered] and opine as to the present value of those cases, even though the amount of loss may not have been determinable until years after the fire.… To deny Bernstein coverage would be to punish it for its business model; that is, a mass tort business that is paid on a contingent-fee basis, as opposed to a traditional hourly basis.”
You can read the full decision here.
(Pro tip, by the way: If you’re in the business of selling insurance policies, you probably shouldn’t argue that figuring out when they apply is impossible. Not a good look.)
The bottom line is that large business interruption claims, like many other large insurance claims, often result in a fight. The reason why isn’t a mystery. Warren Buffett has been pretty straightforward about how the insurance industry uses the concept of “float” to its advantage. (You can read an article about that here.) So, faced with a large business interruption loss, you’re going probably going to need a solid expert to calculate damages…and a lot of patience.