The recent deadly and destructive Woosley Fire and Camp Fire in California have resulted in billions of dollars in claims. Among them are business interruption claims, a less obvious, yet significant, exposure related to natural disasters. This article highlights the fundamental coverage issues surrounding business interruption claims in this context, including the key elements of business interruption claims and valuation of such claims.
Elements of a business interruption claim
Business interruption insurance offers coverage to make up the difference between the normal income earned by the insured business and its income during and immediately after a forced shutdown. To successfully establish such a claim, an insured has the burden to prove: (1) physical damage; (2) to covered property; (3) caused by a covered peril during the policy period; (4) resulting in an actual loss of income; (5) due to “necessary suspension of operations”; (6) during the “period of restoration.” The last two factors are of particular interest in the context of wildfire-related business interruption claims.
Under California law, a “necessary suspension” means a cessation of operations, not a slowdown or reduction in operations. Moreover, what constitutes a necessary suspension is often a matter of dispute between insureds and insurers. This is particularly true where there is damage that does not force the business to close, but the business chooses to shutter as a matter of discretion or business judgment.
The “period of restoration,” i.e, the length of time for which the policy will pay benefits immediately after the loss, may begin on the first day a business must shut down. Some policies, however, may require a “waiting period,” which acts like a deductible provision, resulting in an insurer having no obligation for loss of business income suffered during a specified period immediately following a disaster. The “waiting period” is often between 24 hours and 72 hours.
On the other end of the spectrum, business interruption policies treat the termination of the “period of restoration” in several different ways. Often, a policy limits the recovery to the time required to repair or rebuild the damaged property with reasonable speed. Under California law, what constitutes a reasonable period to carry out the necessary repairs and resume business for purposes of the “period of restoration” is a question for the jury. Recently, a California federal court questioned whether three months to repair a business ransacked by thieves was reasonable, but ultimately held that, as a matter of law, it could not say how quickly the repairs should have been completed. See Brulee v. GEICO Ins. Agency Inc., 2018 WL 3491680, at *11 (E.D. Cal. July 19, 2018).
In many cases, an insured’s business income will not return to pre-loss levels immediately upon repair. Thus, many business interruption forms provide extended business interruption coverage for a period, usually limited, after a property has been repaired. The ISO business income forms, for example, provide coverage for loss of income for a period that begins on the date the property is actually repaired, rebuilt, or replaced and ends upon the earlier of: (1) the date that the insured could with reasonable diligence restore its operations to generate its pre-loss level of business income, or (2) thirty days.
Some policies may also provide Contingent Business Interruption (“CBI”) Coverage, which covers loss of income due to physical loss or damage to property of a third party, such as a supplier, customer, transporter or other business that the insured relies on to operate its business. Unlike traditional business interruption insurance, which covers loss of the insured’s business income resulting from a physical loss or damage to insured property, such “first-party” physical loss or damage is not needed to trigger CBI coverage.
Valuation and loss calculation methodologies
Calculating how much a policyholder can recover in insurance benefits after a loss can be particularly difficult when economic conditions change following a catastrophe. For instance, an insured hotelier may have enjoyed a tremendous demand for the hotel’s services following a disaster had the hotel been operational. On the flip side, an insured may have experienced no demand for its services following a natural disaster, even if its doors were open. Therefore, it is critically important to examine applicable policy language when valuing a business interruption claim.
The current ISO form provides that the amount of business income loss will be determined based on:
- The Net Income of the business before the direct physical loss or damage occurred;
- The likely Net Income of the business if no physical loss or damage had occurred, but not including any Net Income that would likely have been earned as a result of an increase in the volume of the business due to favorable business conditions caused by the impact of the Covered Cause of Loss on customers or on other businesses.
- The operating expenses, including payroll expenses, necessary to resume “operation” with the same quality of service that existed just before the direct physical loss or damage; and
- Other relevant sources of information, including:
- Your financial records and accounting procedures;
- Bills, invoices and other vouchers; and
- Deeds, liens or contracts.
While only a handful of courts have addressed the effect of changed economic conditions on business interruption recovery, the majority also consider the policyholder’s historical financial data. These courts ignore any potential financial benefit or burden that would have resulted to the insured following the disaster. See, e.g., Finger Furniture Co. Inc. v. Commonwealth Ins. Co., 404 F.3d 312, 314 (5th Cir. 2005) (“[T]he business-loss provision says nothing about taking into account actual post-damage sales to determine what the insured would have experienced had the storm not occurred.”); Prudential LMI Commercial Ins. Co. v. Colleton Enters., Inc., 1992 WL 252507, at *4 (4th Cir. Oct. 5, 1992) (“[A]n insured under a business interruption provision such as that here in issue may not claim as a probable source of expected earnings ... a source that would not itself have come into being but for the interrupting peril's occurrence.”); Am. Auto. Ins. Co. v. Fisherman's Paradise Boats, Inc., 1994 WL 1720238, at *4 (S.D.Fla. Oct. 3, 1994) (“[H]ad no hurricane occurred (the policy's built in premise for assessing profit expectancies during business interruption), [then] neither would the claimed earnings source.”). These rulings are consistent with the indemnity principle that an insured should not profit from its insurance.
Business interruption claims in the context of natural disasters present unique issues with respect to, initially, satisfaction of the applicable insuring agreement and, ultimately, valuing claims. Of particular importance is whether a business that shutters because of a natural disaster will re-open to the same economic realities. In handling business interruption claims related to the recent wildfires, insurers should carefully consider policy language and applicable law to determine to what extent (if any) coverage is impacted.