Interrupting the pandemic

Another record-breaking hurricane season is upon us. The frequency of named storms making landfall has already surpassed prior years. At the same time, the COVID-19 pandemic continues to have a significant economic impact on businesses and communities across the country, and it seems more apparent that this impact is likely to linger through, and possibly beyond, this hurricane season.

Let’s take a look at some of the issues that may arise when calculating the potential business interruption claims arising from storm damage while the pre-existing economic impacts of the pandemic last. With COVID-19-related influences lasting for six months already, a key issue is what period should be used to calculate business loss from an event occurring in this hurricane season.

Business interruption policies insure against lost earnings that arise from the suspension of business operations because of an insured hazard. Such coverage generally aims to place the business in the position in which it would have been had the interruption not occurred. In a business interruption loss, the insured has the burden of proving actual loss by reliance on objective data. As such, determining loss is relatively straightforward for a well-established business with a clear history and trend of earnings. However, the calculation is more difficult when the business has faced a variation in past performance or a recent change in economic conditions.

We look at three types of cases that may contain some relevant analysis for such situations. First, we discuss cases in which the catastrophe changes the market where the insured business was operating. Second, we consider how courts have addressed economic factors distinct from the event causing the loss, which is closer to the current COVID-19 environment. Third, we look at cases dealing with businesses that experienced net losses before a business interruption. Given how long the current economic downturn has lasted, this last category could have increasing significance.

How economic changes affect BI calculations

A significant catastrophe can bring economic changes affecting the market in which the insured business operates. Such changes can bring into question how one measures the impact of the interruption. For example, if a catastrophe creates a boost in the demand for the insured’s goods or services, how should this affect the business interruption calculation? If an insured who suffers a short business interruption can recoup those losses from the increase in demand created by the catastrophe, should an insurer be able to account for such post interruption gains as an offset of the interruption losses? Conversely, if an insured suffers loss as a result of an interruption, should it be able to seek greater indemnity on the basis that it could have earned more if not for the interruption, because of a boost in demand caused by the catastrophe that was missed during the interruption?

Courts have analyzed the issues raised in connection with, among others, the due consideration clause. A sample of such a clause might state:

 …due consideration shall be given to the experience of the business before the date of the damage or destruction and to the probable experience thereafter had no loss occurred.

Some courts have used such language to limit the parties to reliance on the historic record of performance to calculate an interruption loss, without considering what happens following the interruption or loss. Conversely, other courts have held that a business can recover for increased market demands after a catastrophe.

While attention to the policy wording is paramount, as a general principle, some courts distinguish between allowing an insured to establish an expected economic upturn from a separate event or set of circumstances and an insured attempting to use the economic upturn that is created by the covered event as a basis for calculating its loss. In this context, some courts invoke the indemnity principle which, generally provides that an insured should not recover more than the actual loss sustained.

Economic factors distinct from the cause of loss

These catastrophes may shed light on how more immediate impacts on a business might affect the calculation. However, they are distinguishable from the current situation in a significant way because they do not address the question of what business interruption can arise if the physical damage from the catastrophe occurs at a time when the business is already closed or experiencing a significant downturn.

The Northern District of Iowa was faced with similar facts in Penford Corp. v. Nat’l Union Fire Ins. Co. of Pittsburgh. Penford involved a flood damage claim during the Great Recession. In considering a motion in limine to bar certain evidence, the court held that because market conditions would have affected the insured’s earnings regardless of whether the flood ever occurred, they were relevant to the question of what the insured’s likely revenues would have been in the absence of the flood.

The court agreed with the insurer that the insured could not “recover what it would have earned in the absence of both the flood and the recession… [but] only what it would have earned in the absence of the flood.” Therefore, the court determined that the recent economic downturn could be factored into the loss calculation.

Net operating loss before interruption

Another relevant consideration is how courts have handled cases where a business was operating at a net loss immediately before the damaging event that caused the business interruption. In the current environment, many businesses will have operating losses due to COVID-19 shutdowns.

Some courts have held that the calculation of business interruption loss involves adding the net income (be that a profit or a loss) and the net operating expenses. If the net income was negative and larger than the operating expenses, then the business interruption loss figure would be negative, and there would be no recoverable loss.

Conversely, in Amerigraphics, Inc., a printing and graphic design company sought business interruption coverage after their business was flooded. The company had performed poorly the two years immediately preceding the flood. A California Court of Appeal held that Amerigraphics could recover because the provision allowing for recovery of lost profit was distinct and should be calculated separately from the provision allowing for recovery of operating expenses.

Therefore, even if a business experiences a loss before an interruption, it can still recover for continuing operating expenses. The court reasoned that a business should not have to worry about performing poorly and suffering a catastrophic loss. Moreover, the court noted that without this holding, there is no incentive for new businesses to purchase business interruption insurance if they know they will not be profitable for some time.

The decision in Amerigraphics does not appear to be the majority view. However, if a policy allowed for recovery of operating expenses independent of any operating losses, in this context, one would have to consider whether the company had accepted any PPP funding for its payroll leading up to the loss.  In such an event, the recovery of such expenses might depend on whether or not the company would be compelled to pay back such funds to the government.

These are unique times that will generate new questions for insurers, insureds, and courts to consider. This information is designed to highlight some of the ways these questions might be handled. Each potential loss will ultimately depend on the relevant policy language, which is given great weight by the courts, the nature of the interruption, and the experience of the business both before and during the COVID-19 pandemic.

Peter Rossi is senior counsel at Clyde & Co. and focused on insurance coverage and commercial litigation. Contact him at Peter.Rossi@clydeco.us. Rita Tavares is an associate with Clyde & Co., specializing in the insurance, trade and commodities, and marine sectors. She can be reached at Rita.Tavares@clydeco.com.

Related:

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• To emerge from COVID-19, we must learn from it together
• Pandemic influences future insurance losses