ABSTRACT
How should business interruption valuation clauses be interpreted when a catastrophic event has impacted the business’ surrounding economy? Should it be based on historical data only? Cases in the United States have applied the valuation clauses inconsistently, which causes uncertainty and ultimately is to the detriment of both the insurers and the policyholders.
This article will discuss business interruption insurance generally, the inconsistent interpretations of recent cases in response to Hurricane Katrina in the United States and how Canadian Courts are likely to respond. In considering the Canadian application, this article reviews and then applies the principles of insurance policy interpretation to business interruption valuation clauses with particular reference to the 2016 fires of Fort McMurray.
INTRODUCTION
The Scope and Purpose of Business Interruption Insurance
Business interruption coverage is often part of broader commercial insurance policies, or it can be added as an endorsement. It has a similar purpose to critical illness or short term disability insurance for people, in that it is intended to permit the person or business to cover costs during a period of no income. Business interruption coverage is intended to ensure that the insured’s revenue stream continues during an interruption in its operation.
The first coverage issue when faced with a business interruption claim is to assess whether the business interruption coverage is triggered. Typically it is triggered in two circumstances:
1) Physical damage to the premises caused by an insured peril such that the insured business must suspend its operations (for example a fire like in Fort McMurray or a flood like Hurricane Katrina); or
2) Physical damage to other property that is covered by the policy that totally or partially prevents customers or employees from gaining access to the business (for example a truck breaking down that prevents goods arriving at the business).
Some policies may also include extensions of coverage and associated triggers such as:
4) Civil authority coverage which provides insurance if the government shuts down the area due to property damage caused by an insured peril that prevents the insured business from operating;
5) Service interruption coverage which provides coverage for a policyholder for direct physical loss caused by an insured peril to electrical, steam, gas, water, sewer, telephone or any other utility or service;
6) Contingent business interruption coverage which provides coverage for the insured’s business income loss resulting from physical damage to property owned by identified others (typically defined as those in the supply chain upon whom the policyholder is dependent); and
7) Leader property coverage which provides coverage for the insured’s business income loss resulting from physical damage to property not owned or operated by the insured that impacts the insured business’ customer base.
For any of these coverages to be triggered there must be physical damage caused by an insured peril. The policy must be carefully considered, and in particular the exclusions for certain perils must be analyzed to assess whether coverage is triggered.
If the coverage is triggered, there is a waiting period before the coverage comes into play. The coverage is not retroactive to the day of the event. It is expected that the business will be able to survive the waiting period.
The business interruption coverage is limited, both in length of time, and extent of coverage during the indemnity period. It is not a “blank cheque.” In most claims, the loss provisions can be applied by the adjusters and accountants to arrive at a “fair value.”
In determining what is “fair”, the purpose of purchasing the insurance should be kept in mind. The policyholder purchased the coverage to ensure that if the business was interrupted by an insured peril, the business would survive. The coverage is to cover a shortfall in gross profits, and to pay ongoing costs until the business is back on its feet. The desire of the policyholder will be to be in the same position they would have been in had the disaster not occurred.
At the time of purchasing the policy, however, it unlikely that anyone turned their mind to what would happen if a catastrophe occurred that impacted both the insured business, and the surrounding business environment.
It is recognized that policyholders pay a healthy premium for business interruption insurance. Many small businesses chose not to pay for business interruption insurance, and to either effectively self-insure or simply to take the risk. The policyholder may choose to pay more premium for a shorter waiting period, a longer indemnity period, or for more extensive coverage (such as, for example, covering in addition to expenses all profits during the indemnity period).
But, what is fair? And what happens if the same coverage interpretation would be fair to one policyholder, but not another policyholder?
This question of fairness is highlighted by the issue of whether the policy language requires consideration of historical revenues, or whether the policy language requires that the post-catastrophe economy be considered. Under either scenario, the result may be a windfall for one policyholder, and a gross unfair loss for another policyholder.
This is precisely what has occurred in the United States where the dilemma of post-catastrophe business loss coverage application has now been litigated. Before suggesting an appropriate response under Canadian law, the conflicting cases are discussed.
THE POLICY LANGUAGE
The policy language may read something like:
We will pay for the actual loss of business income you sustain due to the necessary suspension of your “operations” during the period of “restoration.” The suspension must be caused by the direct physical loss, damage, or destruction to property. The loss or damage must be caused by or result from a covered cause of loss.
Or perhaps
In determining the amount of gross earnings covered hereunder for the purposes of ascertaining the amount of loss sustained, 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.
The typical policy wording provides some room for interpretation as to whether the historic business revenues will be the determining factor for the amount of coverage, or whether the analysis will depend on what likely would have happened, but for the insured physical damage.
US CASE LAW POST KATRINA
Highlighting The Unfairness
The 2005 catastrophe Hurricane Katrina is estimated to have resulted in approximately 1 million claims and $41 billion in insured losses.[1] In the last five years or so the cases following Katrina have been litigated, and the unfairness of policy language as applied to different policyholders has been apparent.
(a) Consider only the historical revenues (interpreting wording as though no loss means no catastrophe)
One line of cases interpreted the policy language to find that only historical results should be considered. As cases interpreted the phrase “the probable experience thereafter had no loss occurred” to mean that the catastrophe had not occurred (not just that the insured had not suffered the damage, but that the surrounding businesses and economy had suffered).
To highlight the different results between different policyholders, below we consider two cases:
1) Where Casino did not hit the jackpot (but the Insurer got a full house)[2];
2) Where a furniture store got a windfall by receiving the business loss claim and the post-catastrophe higher sales.[3]
In the first, the insured Casino was shut down for several months following Katrina. However, it was the first Casino to open in the area, and when it opened, it had dramatically increased revenues.
The Casino argued that it was entitled to $80 million in business interruption since, had it been open during those several months (while its competitors were still shut down), it would have made $80 million.
The Insurer based its analysis on the pre-loss revenues, and assessed the loss at $6.5 million.
The Court found that the policy wording should be interpreted to mean the business loss had Katrina not occurred, and accordingly, sided with the Insurer. The Casino certainly did not hit the jackpot. The decision could be considered fair since this Casino did hit the jackpot by being able to open before their competitors.
This case followed an earlier case that interpreted the same policy language as requiring consideration of only historical results; but that case had the opposite result for the insured, who had a windfall.
In the earlier case, the insured was in the business of selling furniture. After the floods, they were unable to operate for several months. Once they reopened, however, because of the floods, there was very high demand for their furniture.
The Insurer argued that the post-catastrophe high sales should reduce the business loss claim. We suggest that this is a very reasonable argument – if the insured would have usually sold 5 benches during the indemnity period, but then sold 10 benches the day they reopened, surely they did not suffer a business loss?
The same US court circuit, however, found for the furniture store, commenting that the “strongest and most reliable evidence of what a business would have done had the catastrophe not occurred is what it had been doing in the period just before the interruption.” The furniture store hit the jackpot and had the benefit of both the business loss coverage during the period (based on historical results) and the increased demand when they reopened.
Between these two cases, the same interpretation (historical results only, and analysis as though the catastrophe had not occurred) had opposite results.
(b) Consider the post catastrophe economy (interpreting as though no loss to mean still catastrophe)
The line of cases from the Louisiana eastern district following Katrina came to the opposite interpretation. They interpreted the policy provisions to require that the impact of the catastrophe on the business economy be considered. In other words that the probable experience of the business had the loss not occurred (but the catastrophe had occurred) was required to be considered under the wording of the policy.
Even under this interpretation, however, the cases gave a windfall to certain types of insureds, and arguably deprived other insureds of a fair result.
The apartment building owners following Katrina benefited from this interpretation in the caselaw in Louisiana. Following Katrina there was a much higher demand for apartments, and any building that could be occupied made considerably more money than they had before Katrina.
Some policyholders with buildings that could not be occupied argued that they should have the benefit of the post-catastrophe higher rates. They argued that the insurance should put them in the same position they would have been had Katrina occurred, but they had not themselves sustained damage. They argued that the intent of the business loss wording was to cover the “actual business loss.”
In the courts of Louisiana, Eastern District, unlike in the 5thcircuit courts, the policyholders were successful.[4] The court accepted the argument that the business owners should be in the position they would have been in had Katrina occurred, but they themselves had not sustained damage.
This was a windfall for the policyholders.
It is notable that there are no cases in Louisiana that considered the same issue for a policyholder of a business that would have lower demand after the catastrophe. We know, however, that many businesses suffer for long periods of time after a catastrophe. Consider for example higher end food or clothing stores, such as those perhaps now located in a residential neighbourhood that is being rebuilt. Or a restaurant in a neighbourhood where most people have lost their jobs and/or homes.
We suggest that the reason that there are no such cases is quite simple: the insurers did not seek to take advantage of the policyholders while they were already down; the insurers did not interpret the policy wording to rely on post-catastrophe business income when that income was less than the historical results. Rather, when approached by the restaurant that would clearly have had lower post-catastrophe business in the post-catastrophe economy, the insurers only considered the historic business results.
How, then, can the Louisiana line of cases be considered “fair”?
CANADIAN APPROACH
Application of Canadian Coverage Principles
To date, there have not been any decisions by a Canadian Court considering the extent to which business interruption policy clauses should consider historic or post-disaster economic conditions. In this section of the article the principles of policy interpretation are discussed, and then applied to the business loss policy language and the question of whether and how to consider the post-catastrophe economic conditions.
In Ledcor Construction Ltd. v. Northbridge Indemnity Insurance Co., [5] the Supreme Court of Canada has recently restated the framework for the principles of insurance policy interpretation as follows:
- Whether the Language is Ambiguous
- Reasonable Expectations of the Parties
- No Unrealistic Results
- Ensuring Consistent Interpretation
- Contra proferentem
(a) The Language of the Exclusion Clause Is Ambiguous
In the seminal case Progressive Homes Ltd. v. Lombard General Insurance Co. of Canada,[6] the Supreme Court of Canada explained that the
“primary interpretive principle is that where the language of the insurance policy is unambiguous, effect should be given to that clear language, reading the contract as a whole.”[7]
The test for determining whether policy language is ambiguous is whether the provisions at issue are reasonable or fairly susceptible to two different interpretations or meanings. If the policyholder and insurer both offer reasonable interpretations of the policy language, then the policy language is ambiguous and should be construed in favour of coverage. Ambiguous insurance policy provisions are those that have more than one reasonable meaning.
The threshold issue, accordingly, is whether the business interruption clauses invite alternative possible interpretations: do they require that only historic results be considered, or do they suggest that “actual” results but for the insured peril causing damage should be considered?
Many, if not all, such clauses invite an argument that there is ambiguity in this regard. Both interpretations are reasonable on the face of the language. The caselaw in the US further underscores the ambiguity in the clause. Accordingly, the rules of contract construction should be employed to resolve that ambiguity.
(b) Reasonable Expectations of the Parties
A staple of insurance law is that a policy should be interpreted in such a way as to fulfil the “reasonable expectations” of the policyholder. In Ledcor the Supreme Court of Canada recognized that these are standard form contracts, and that there is generally no evidence that the parties gave any thought to the specific clauses in the policy. The Court has nonetheless promoted considering the purpose behind the insurance policy to determine the reasonable expectations as to any particular clause in the policy.
At the risk of being simplistic: the purpose of business interruption insurance is to place the policyholder in the same position it would have been if its business had not been interrupted.
The policyholder who buys business interpretation insurance reasonably expects to receive from its insurer for the period of interruption the business earnings it had been receiving prior to the catastrophe. It thus has been suggested that courts should not permit insurers to accept premiums for business interruption but then when a claim is presented, pay the policyholder a fraction of its business interruption loss. To do so would render the coverage provided to the business owner under the policy illusory which is not permitted.
Following this theory, after Hurricane Katrina it was noted that there was little demand for restaurants and if one were to consider the post-catastrophe economic additions, for restaurants in New Orleans, when valuing the business interruption losses, then such restaurants likely would have had little, if any, business interruption losses because there would not have been many customers patronizing the restaurants even if the restaurants had been operational. When applying the reasonable expectations doctrine to the restaurant business, one would conclude that the insurers are precluded from relying upon post-catastrophe experience to determine the business interruption loss.
In the authors’ view, the reasonable expectations doctrine dictates that the post-catastrophe economic conditions should not be considered if the demand for the policyholder’s products or services was negatively impacted by the catastrophe. Indeed, no policyholder would reasonably expect that if a disaster destroys its business and the area near its business, then its insurance would become worthless. In fact, one of the primary reasons that a policyholder purchases business interruption insurance is to cover losses caused by disaster.
If one takes into account post-catastrophe economic conditions, if favourable to the policyholder, it will result in a windfall gain because it would place the insured in a better position than it would have been if no disaster had occurred and its business had not been interrupted.
Consider the Louisiana cases discussed above where the greater demand for housing in the New Orleans area after Hurricane Katrina and the rental value of apartments increased post-catastrophe, does it make sense to allow the policyholder to use the higher rental rates when valuing its business interruption loss? Accordingly, allowing the post-economic conditions to be considered when valuing business interruption losses, would create windfall gains or unfair losses for the policyholder and factual disputes because the parties may not agree on the state of the economy or its impact on the policyholder’s business.
In the same way that a policyholder would not expect its insurance would become worthless, nor would a policyholder expect a windfall gain from its insurance. Accordingly, the reasonable expectations principle favours an interpretation that focuses on the historic results, and not the post-catastrophe economy.
(c) No Unrealistic Results
The third principle of interpretation for insurance policies is to “avoid interpretations that would bring about unrealistic results or results that the parties would not have contemplated in the commercial atmosphere in which they sold or purchased the policy. The interpretation should respect the intentions of the parties and “their objective in entering into the commercial transaction in the first place”, as well as ‘promote a sensible commercial result’ ”[8]
The application of this principle is similar if not identical to the application of the previous principle in this application.
As discussed the catastrophe that causes the business interruption changes the economy in the area of the catastrophe. Consequently, when the post-catastrophe economic conditions are considered when calculating the policyholder’s business interruption loss, the policyholder may receive a windfall gain or an unfairly low loss valuation. If post-catastrophe economic conditions are to be considered, it makes no sense unless one takes into account post-catastrophe economic conditions which are both unfavourable and favourable to the policyholder. One cannot adopt one interpretation where the economic conditions are unfavourable and another where they are favourable.
It would be unrealistic to expect either that the insurance policy would become worthless (if the post-catastrophe economy negatively impacted the type of business) or that the insurance policy would pay out a windfall (if the impact was positive on the type of business insured). The application of this principle also supports an interpretation that does not consider the post-catastrophe economy.
(d) Ensuring Consistent Interpretation
The fourth principle is to consider other cases interpreting similar or identical clauses. Since there are no such cases in Canada, a Canadian Court would likely look to the US. As discussed in the previous sections of this paper, those cases have come to diametrically opposed interpretations. It is difficult to reconcile the US cases, save to point out that each of them consider slightly different policy language
In Ledcor, the Court of Appeal had held that “numerous cases . . . hold that the exclusion is not limited to the cost of re-doing the faulty work, but also extends to the cost of repairing the thing actually being worked on”. The Supreme Court of Canada, however, disagreed, noting that the cases are highly fact-specific. The Supreme Court instead found that “many of these faulty workmanship and faulty design decisions can be read as limiting the faulty workmanship exclusion to only the cost of redoing the faulty work.”
In considering the cases from the US, a Canadian Court is likely to similarly distinguish one of the two lines of cases on the facts and the policy language. It is suggested that this principle is unlikely be significant to the result.
(e) Contra Proferentem
The fifth and final principle is the doctrine of contra proferentem. The Latin phrase is roughly translated as “against the offeror”, and in law is a doctrine that provides that where a contractual term is ambiguous, the preferred meaning should be the one that works against the interest of the party who provided or drafted the wording. The rationale is that the party who provided the wording had an opportunity to choose the words, and so they should suffer for any lack of clarity. With respect to insurance policies, because the policyholder rarely (if ever) has an opportunity to negotiate the terms, this is only ever applied against Insurers.
Thankfully, the cases have made it clear that this harsh doctrine should only be applied if there remains any ambiguity after applying the principles set out above.
The majority in Ledcor found that principles provided a sufficiently clear result such that there was no need to resort to this final principle. In his dissenting decision, Cromwell J. found that the previous principles did not lead to a clear result, particularly because he was to prepare to infer the purpose of the builder’s risk policy, and because previous case law on point came to different conclusions. However, he concurred with the majority decision by applying this final principle as against the insurer.
Insurers may be feeling the bite of recent seminal cases such as Progressive Homes and Ledcor, since most insurers are of the view that the decisions do not reflect the underwriting intent (although the court still found that they do reflect the reasonable expectations of the party).
It has been argued that because insurers seek to invoke the valuation provisions as a way of limiting the amount of coverage to be provided for losses, the language should be narrowly construed against the insurer who drafted the provisions and ambiguity should be construed against the insurer.
Applying this principle in this case would seem to depend on which policyholder was before the court.
Given that an interpretation that requires consideration of the post-catastrophe economy would result in unfairness to some policyholders, the Canadian courts should not have to resort to the application contra proferentem.
CONCLUDING REMARKS
There is a basis in the US cases to support an argument that post-catastrophe sales and expenses should be considered. The policy language typically leaves this open to interpretation, and of course it should be recognized that the policy language has to accommodate and apply to many different scenarios. The scenario of a catastrophe is the anomalous event.
The application of the principles of insurance policy interpretation in Canada should result in a fair interpretation of the policy language. The authors accordingly suggest that the approach best supported by the Canadian principles is that the post-catastrophe business environment should be ignored, and the loss valued on the basis of the historical results as the best indicator of what would have otherwise occurred.
[1] “Hurricane Katrina: The Numbers Tell Their Own Story,” www.Insurance Journal.com, August 26, 2015
[2] Catlin v. Imperial Palace 600 F.3d 511 (5thCir. 2010); 2010 U.S. App. LEXIS 5389; consider also: Consolidated v. LexingtonNo. 09-30178, 2010 U.S. App. LEXIS 17146 (5th Cir. Aug. 17, 2010)
[3] Finger Furniture v. Commonwealth 404 f.3d 312 (5thCir. 2005)
[4] Sher v. Lafayette Ins. Co.,973 So. 2d 39, 62 (La. Ct. App. 2007), aff’d in part, rev’d in part, 988 So. 2d 186, 205 (La. 2008); Berk-Cohen v. Landmark No. 07-CV-9205, 2009 US Dist. LEXIS 77300 (ED La. Aug. 27, 2009): No. 07-9205, 2009 WL 2777163; consider also non-apartment cases: Levitz Furniture Corp. v. Hous. Cas. Co., No. 96-1790, 1997 WL 218256, *3 (E.D. La. Apr. 28, 1997) (in direct contrast to Finger Furniture ibid);
[5] 2016 SCC 37 (“Ledcor”)
[6] 2010 SCC 33(“Progressive Homes”)
[7] Progressive Homesat 22; Non‑Marine Underwriters, Lloyd’s of London v. Scalera, 2000 SCC 24, [2000] 1 S.C.R. 551, at para. 7
[8] Ledcorat pp. 78
