P&C

To Cover Or Not To Cover?

U.S. and international courts split over COVID-19 BI coverage.
By Zach West Posted on July 22, 2020

With revenue streams cut off by stay-at-home orders, restaurants, gyms, hotels, and other businesses suddenly found themselves facing possibly fatal budget shortfalls. Naturally, they turned to their insurers for business interruption relief.

But in many cases, insureds would find their claims categorically denied.

Reasons why the claims may have been denied have been covered before in Leader’s Edge, but to review: most common business interruption coverages, such as business income coverage, civil authority coverage, contingent business interruption (CBI) coverage, and ingress/egress coverage all require the insured business or, in the case of CBI, a key customer or supplier, to suffer direct physical loss or damage from a covered cause of loss. The question that immediately follows is whether or not contamination by a virus counts as physical damage.

Ambiguous language has also contributed to the confusion. In the case where a policy has an extension to cover losses from contagious disease, it has been argued that the losses do not stem from the disease specifically, but from the closure orders. Additionally, it is debatable that business interruption policies were never intended to cover losses of such magnitude, as pandemics are inherently uninsurable. Thus, insurers should not be forced to pay claims the policy never intended to cover. A third sticking point is that some business interruption policies provide coverage for losses due to a “notifiable disease,” any disease required by law to be reported to the relevant health authorities. As such, policyholders may find themselves without protection should COVID-19 not qualify as a “notifiable disease”—but this depends on the jurisdiction. For example, the U.K. moved to make it a notifiable disease in March.

As a result, insureds across the world have taken their insurers to court. In France, for example, Stéphane Manigold sued AXA for coverage of two months’ worth of lost revenue due to the pandemic. In the U.S., restaurants in many states have initiated litigation on the federal and state level, and in the UK, insurers Hiscox, Aviva and QBE have found themselves as a target of group action lawsuits from two groups of disgruntled policyholders, the Hospitality Insurance Group Action and the Hiscox Action Group.

Recently, judges have handed down rulings in two cases in France and South Africa, and in at least two of the U.S. cases. Currently, it seems as though precedents set internationally will differ from those set in the U.S.

The French Connection

The French case stems from a dispute over a clause in the business interruption policy for Eclore, the restaurant group owned by Manigold. Manigold claimed the clause, which covers “business interruption losses in the event of administrative closure imposed by the police or health or security services,” would therefore cover losses from the nationwide restaurant closure order promulgated March 14, 2020. AXA, however, argued the clause was meant to cover losses from a closure for only the insured business, rather than losses from an order closing of all of a particular kind of establishment (e.g., restaurants) to prevent the spread of a virus—such losses are too widespread, and thus are uninsurable.

But a Paris commercial court disagreed, rejecting the idea that the pandemic was uninsurable and saying that if AXA intended to exclude this risk the policy should have explicitly said the risk was excluded. In May, the court ordered that AXA pay the restaurant group the equivalent of two months of COVID-19 related revenue losses. Said Manigold’s lawyer, “This means that all companies with the same clause can appeal to their insurers.”

Though AXA first said it will appeal the decision, it has now said it plans to pay the claims in dispute in the lawsuit as well as other similar policies, admitting that the policy wording in question is ambiguous.

This case could set a costly precedent for French insurers, and possibly for insurers around the globe. The decision, as well as AXA’s admission that the policy language was indeed ambiguous, could provide additional support for arguments in U.S. lawsuits and other lawsuits abroad, most of which are premised on the idea that traditional business interruption policies should cover pandemic-related losses.

Cape Town Smackdown

In South Africa, insurer Guardrisk also found itself in the crosshairs of legal action. Like France, the U.S., and the rest of the world, South Africa imposed a national lockdown in hopes of preventing the spread of the virus. Café Chameleon, a restaurant in Cape Town, sought payment from its insurer, Guardrisk, for the business interruption losses it suffered as a result of this lockdown, and when the insurer denied the claim, Café Chameleon took the insurer to court.

The main point of contention in this case differs from the one in France. Café Chameleon’s policy has an extension that is supposed to provide coverage when the café suffers losses as a result of an outbreak of disease. But Guardrisk argued that the losses were due to the closure order, not COVID-19, and therefore it should not have to pay the café’s claim.

Additionally, the insurance company made a similar argument to AXA in the French case, warning that losses from COVID-19, both in South Africa and worldwide, would likely be “very substantial” and would place “significant demand” on insurer resources. A ruling in favor of Café Chameleon, said the group, would “open the floodgates of liability,” not just for Guardrisk but for the insurance industry in general—echoing the argument made by AXA that losses from the pandemic are uninsurable because of their sheer magnitude and global reach.

The judge approached Guardrisk’s argument with skepticism, writing, “It is difficult not to accept that there is indeed a clear nexus between the Covid-19 outbreak and the regulatory regime that caused the interruption of [Cafe Chameleon’s] business. The suggestion therefore that the regulatory regime was only introduced to ’flatten the curve’ and had little to do with the Covid-19 outbreak is misplaced.”

He levelled the same skepticism at the argument that a ruling in favor of the café would result in opening “the floodgates of liability.” “In any event, each case must be decided upon its own facts and the law. Whether the floodgates will open, as suggested by the respondent, will ultimately depend upon the prevalence of the precise wording of the notifiable disease extension in any contract of this nature. The gloomy predictions of industry collapse within the insurance world […] are therefore nothing more than speculation,” he wrote.

The judge went even further, stating that even if the company “is confronted with substantial insurance claims,” that is not sufficient reason for it to deny claims that should rightfully be paid. “It cannot be a defense for an insurer to say that it must be excused from honoring its contractual obligations because its business has unexpectedly incurred greater debt than had been expected.”

The South African case sets less of a precedent than does the French case, as it hinges less on the question of whether viral contamination qualifies as physical damage than on a debate over whether the government regulations triggering the café closure are somehow independent of the COVID-19 outbreak in South Africa. Nevertheless, that the judge so explicitly rejected the argument that BI claims could well bankrupt the industry should it be forced to pay them is concerning, and may have implications for other cases in the region.

The ruling will be appealed, so this case may merit watching, especially because the wordings being considered are very similar to those used in the U.K., where the Financial Conduct Authority has brought a test case over similar issues with business interruption claims.

U.S. Courts Stand Alone

While in the two previous cases, courts have sided with the insureds, in the U.S. they have come down on the side of the insurers. Two cases recently brought against insurers in Michigan and in New York, were ruled on in favor of the insurers.

In Michigan, insurer Michigan Insurance was sued by restaurant group Gavrilides Management Company after the insurer denied civil authority coverage under the restaurant group’s business interruption policy.

The judge dismissed the plaintiff’s central argument that, “the government order that restricted business to dine-in only amounts to a physical loss because the order effectively blocks public entry to the property.” According to the judge, “That argument is simply nonsense. […]There has to be something that physically alters the integrity of the property. There has to be some tangible, i.e., physical, damage to the property.”

The case in New York follows the same lines as the Michigan case. Magazine publisher Social Life Magazine sought a declaratory judgment that its business interruption policy should cover losses from COVID-19, alleging that viral contamination had damaged its office and prevented it from printing the magazine. The motion comes after the claim it submitted for lost income to insurer Sentinel was not paid.

In denying the motion, the New York judge said much the same thing as the Michigan judge. Responding to the assertion of the insured’s lawyer that COVID-19 had damaged their property, she said, “There is no damage to your property. […] It damages lungs. It does not damage printing presses.” She went on to state that the lost income was also not due to the virus but due to government closures, an interesting contrast to the judge’s perspective from the case in South Africa.

Considering many of the cases brought in the U.S. hinge on whether viral contamination counts as property damage, the fact that two jurisdictions have (so far) strongly and explicitly stated that it does not is a big win for insurance companies with U.S. clients.

However, it should be noted that no cases like the AXA case—i.e. where a policy could be said to have ambiguous language, as opposed to the clear requirement for physical damage in addition to viral contamination exclusions found in the two U.S. cases—have been fully litigated in the U.S. as of now. “The reality (I’m told) is that 95% of the cases in Europe are pretty much like the 95% of cases here where the policy language appears clear,” explained Joel Wood, SVP, Government Affairs at The Council of Insurance Agents & Brokers.  “What’s being litigated against AXA (and in the test cases) is language in the 5% of the rest of the cases that is NOT clear (no viral exclusion in addition to direct physical damage), and we have yet to see any of those cases fully litigated here.”

Keep Calm and Carrier On

In the face of widespread closures and the battles over whether or not insurers should compensate claimants for business interruption losses linked to the pandemic, the U.K. Financial Conduct Authority (FCA) has decided to seek legal clarity on the issue in the U.K. courts by filing a test case with the cooperation of several insurers, including Hiscox and QBE. According to the FCA, “The result of the test case will be legally binding on the insurers that are parties to the test case [and] will provide persuasive guidance for the interpretation of similar policy wordings and claims that can be taken into account in other court cases,” but companies will still be free to pursue other means of claims settlement independently.

There are two central questions the FCA is asking the courts to consider in this test case. First, even if the business interruption policies would unambiguously allow coverage for losses incurred not necessarily through physical damage, does that cover pandemic losses? Second, if coverage is indeed applicable here, can policyholders establish a “causal link” between the losses they have suffered and the pandemic?

While the trial began on July 20, 2020 and is set to take place over eight days, the current progress of the test case has provided some worrying signs. The FCA has, in whole or in part, rejected all of the insurer defenses, holding that their arguments rely on “adopting unduly restrictive meanings of particular words and approaches to proof as to the presence of COVID-19, and causal tests prescribing unrealistic, impractical counterfactuals, depriving the cover clause of much of its apparent and intended scope, none of which reflect what the reasonable person in the position of the parties would understand.”

For example, insurers argued that their policies were not intended to provide pandemic coverage, even if the clause in question did not specifically exclude it. According to the insurers, even if pandemic coverage was not excluded in a particular coverage clause, the fact that it was excluded in other clauses show that it was not intended to be covered. The FCA strongly rejected this argument, stating that “had loss resulting from pandemics been intended to be excluded, then the reasonable person would anticipate that it would have been excluded by clear words. It would be obvious to the reasonable person that this could be done. …Further, where a pandemic exclusion is present in the same policy as a relevant [clause] but has not been applied to it […] then that demonstrates a positive decision not to exclude losses from pandemics.”

Another example of an argument from the insurers is the allegation that “the government action in response to COVID-19 would have been the same, and would have had the same effect on an insured’s business, whether the disease had occurred or manifested within any relevant area around the insured location or not.” Therefore, the losses are not causally connected to the pandemic.

This is, according to the FCA, a “wholly unrealistic counterfactual.” The closures were attributed to the widespread outbreak of COVID-19 within the U.K.; had the outbreak been contained to a particular part of the country (which it was not), then any government action would have been restricted to that particular part of the country, rather than the whole country. Additionally, the counterfactual would mean that no insured could ever have their claims paid, as “insurers could refuse indemnity to an insured in locality A by relying on the existence of an outbreak in other localities, even though exactly the same argument was being used against insured in those other localities by reference to locality A.”

The cases here could be a good sign for insurance companies worldwide. In the French and South African cases, as well as in the test case brought by the FCA, we saw that those cases did not grapple with the issue of whether viral contamination qualifies as property damage. The disputes in those cases generally hinged on specific policy language (France) or the intent and scope of provided coverage (South Africa and FCA test case). It seems as though significant conflict arises only when policy language contains specific ambiguities—when it is clear (as it was in the U.S. cases), the courts have sided with the insurers thus far.

Ultimately, whether insurers will be compelled to pay for business interruption coverage is still up in the air, and likely will be dependent on in which country an insurer operates.

These precedent-setting cases will have ramifications for not just particular insurance companies but for the insurance industry as a whole. Keep an eye on them.

Zach West Market Intelligence & Insights Associate Read More

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