(Article from Insurance Law Alert, September 2018)
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As North and South Carolina and other coastal states grapple with the devastation caused by Hurricane (turned Tropical Storm) Florence, affected companies will likely seek business interruption coverage to alleviate their losses. Business interruption coverage generally applies to losses an insured sustains due to the necessary suspension of operations as a result of a covered peril. The suspension of business operations may be due to physical damage to the business itself, a civil authority order preventing the business from operating, or damage to a third-party supplier of goods or services that the business relies on.
In order for business interruption coverage to apply, the insured typically must establish that it was necessary to suspend its business operations. Some courts interpret a suspension of operations to include either a partial or complete interruption of business. See Prudential LMI Commercial v. Colleton Enterprises, Inc., 976 F.2d 727 (4th Cir. 1992); Fountainbleau 2006, LLC v. United States Fire Ins. Co., 2010 WL 11597704 (N.D. Ga. Dec. 21, 2010). Other courts, however, have interpreted suspension to require a complete cessation of activity, such that losses arising from reduced hours of operation, for example, are not covered. See Quality Oilfield Prods., Inc. v. Michigan Mut. Ins. Co., 971 S.W.2d 635, 638 (Tex. App. 1998). Additionally, policy language often requires that the suspension of business was due to a “direct physical loss or damage to” covered property. Fountainbleau, 2010 WL 11597704; Ne. Georgia Heart Ctr., P.C. v. Phoenix Ins. Co., 2014 WL 12480022 (N.D. Ga. May 23, 2014).
Storm-related business losses may also implicate civil authority provisions, which provide coverage when a civil authority order prohibits access to the insured’s premises due to direct physical loss or damage to property. Assurance Co. of Am. v. BBB Serv. Co., 265 Ga. App. 35 (2002). For coverage under civil authority provisions, courts generally require a complete denial of access to the covered property. See Paradies Shops, Inc. v. Hartford Fire Ins. Co., 2004 WL 5704715 (N.D. Ga. Dec. 15, 2004) (finding an order grounding all flights after September 11th was not an order that specifically prohibited access to stores in airports); Abner, Herrman & Brock, Inc. v. Great N. Ins. Co., 308 F. Supp. 2d 331 (S.D.N.Y. 2004) (concluding that traffic restrictions which merely made it difficult for customers to access the covered property were insufficient to implicate business interruption indemnity); 730 Bienville Partners, Ltd. v. Assurance Co. of Am., 2002 WL 31996014 (E.D. La. Sept. 30, 2002) (finding no coverage where the FAA prohibited flights into the affected city but there was no order prohibiting access to the insured’s hotel).
Furthermore, civil authority coverage is generally available only when the order was made because property was actually damaged; a mere threat of damage is insufficient. See Assurance Co. of Am., 265 Ga. App. 35; Paradies Shops, Inc., 2004 WL 5704715. Moreover, courts typically require a sufficient causal nexus between the civil order and the property damage in order to find coverage under a civil authority provision. Dickie Brennan & Co. v. Lexington Ins. Co., 636 F.3d 683 (5th Cir. 2011); S. Texas Med. Clinics, P.A. v. CNA Fin. Corp., 2008 WL 450012 (S.D. Tex. Feb. 15, 2008).
Policyholders may also seek coverage for storm-related losses under a contingent business interruption (“CBI”) policy provision. CBI coverage applies to losses incurred by policyholders as a result of damage to the property of a third-party that supplies goods or services to the policyholder’s business. Many CBI provisions require the third party to be a direct supplier to the policyholder. In such cases, the existence of an intermediate entity in the supply chain would preclude CBI coverage even where an indirect supplier sustains property damage that prevents the transfer of goods or services. See Millennium Inorganic Chemicals Ltd. v. Nat'l Union Fire Ins. Co. of Pittsburgh, PA, 744 F.3d 279 (4th Cir. 2014).
Finally, issues relating to the proper measure of recovery are often raised in the context of business interruption coverage disputes. More specifically, courts have addressed the appropriate measure of recovery for business interruption losses as well as the standard of proof for establishing lost profits. Although specific policy language and governing law may be outcome determinative in any given case, courts have generally held that business interruption recovery should reflect what the insured business would have earned if no interruption had occurred. Prudential LMI Commercial, 976 F.2d 727. Thus, courts typically look to the earnings of the business prior to the interruption in calculating lost income recovery. In terms of the appropriate standard of proof, courts have emphasized that lost profit damages must be established with “reasonable certainty” and cannot be based on hypothetical or speculative forecasts. Blis Day Spa, LLC v. Hartford Ins. Grp., 427 F. Supp. 2d 621 (W.D.N.C. 2006).
Significantly, the Fourth Circuit has held that an insured may not claim as a source of expected earnings (or operational expenses) a source that would not itself have come into being but for the interrupting peril. Prudential LMI Commercial, 976 F.2d 727 (finding that motel could not claim that if it was not damaged, it would have been able to profit from the influx of temporary residents and relief workers that the hurricane brought to the area).
The Fifth Circuit, addressing business interruption claims in the wake of Hurricane Katrina, reached the same conclusion. Consol. Cos., Inc. v. Lexington Ins. Co., 2010 WL 3223137 (5th Cir. Aug. 17, 2010) (holding that calculation of lost profits must be based on a scenario in which the hurricane did not strike at all, not on a scenario in which the hurricane struck, but did not damage the policyholder’s facilities) (Louisiana law) (discussed in our October 2010 Alert); Catlin Syndicate Ltd. v. Imperial Palace of Miss. Inc., 600 F.3d 511 (5th Cir. 2010) (Mississippi law) (discussed in our May 2010 Alert); Finger Furniture Co. v. Commonwealth Ins. Co., 404 F.3d 312 (5th Cir. 2005) (Texas law). Addressing a related recovery issue, the Fifth Circuit has also held that the amount of “charges and expenses” to which a policyholder is entitled under business interruption coverage must be offset by income earned by the policyholder during the relevant time frame. Consol. Cos., Inc., 2010 WL 3223137.
We will keep you apprised of important developments in coverage actions that arise in this context.