Business Interrupted: Matters to Consider in Business Interruption Disputes
Business interruption (“BI”) insurance is a popular line of commercial insurance and is common feature of many commercial combined policies.
One of the primary reasons behind obtaining BI cover is for a business to protect its income from the negative effect of certain unexpected perils (usually fires, floods, storms and the like). A business will often expect to rely on BI cover to plug any gap in production (and income), and to ensure the continued life of the business. For this reason, BI disputes often make their way to litigation at a faster pace than other types of loss, as companies use litigation as a tactic to encourage payments.
Given that this year’s tropical cyclone season holds records for both being the first year on record where three hurricanes in the Atlantic Basin each had an accumulated cyclone energy (ACE) of over 40, and for being the most costly season on record (with losses estimated at some US$316.5bn), it is likely that insurers will be dealing with an increased number of business interruption disputes in the very near future.
It is in this context that this article raises some practical tips and considerations for those who may become involved in BI loss disputes governed by English law.
Policy Wordings
At its core, BI cover is intended to maintain company income or profits in the face of an insured event. Policyholders often assume that the level of profit to be paid is that which the business would have received, had the insured event not occurred. This is often, but not always, the formulation of a BI insuring clause; some insuring clauses specify particular amounts (or formulas for calculating particular amounts) which will be paid in the event of a BI claim, whilst others might identify a precise mechanism by which the amount of insured BI loss is to be calculated.
In nearly all policies, a limited period for which BI loss can be recovered is identified, often 12 months, and it is also common for policies to contain trends or variation clauses, which expressly allow an insurer to make adjustments to any proposed profit figures to take account of any business or industry trends. Finally, a policy may also specify certain types of costs which are also recoverable (such as accountancy fees).
In light of this, the first thing to consider, is the wording of the particular insuring clause(s) in issue, and whether the parties have already agreed the amount, factors to be taken into account, or mechanism by which the quantum of the insured loss is to be calculated.
An Art, not a Science
In the event that the policy is silent as to the precise mechanism or approach to be taken to calculating the insured loss, the method as to how the insured figure is calculated can be the subject of dispute, and it is this which is most likely to be at the heart of a litigated BI loss.
The process of calculating the amount of lost profit caused by an insured event is very much an art, not a science, and is therefore open to challenge. Accordingly, it is important that a party’s approach to a calculated BI loss is one which can be justified and explained before a court or arbitral tribunal, if required (for an example of how a Court might approach this process, see the decision in Sugar Hut Group v A J Insurance[1])
Simply taking an average of pre-incident profits and comparing them to post-incident profits may be tempting, but this approach will often not reveal the true picture (or persuade a Judge or Arbitrator that the correct figure has been achieved). A thorough BI calculation should take into account a number of factors in addition to simply financials, including:
- The nature and operation of the business;
- The state of the industry in which the business operates; and
- The nature of the incident.
(i) The Nature of the Business
It is important to understand and investigate the nature of the underlying business, as factors such as the age of the business, the particular business model used, or method of manufacture may all be relevant to the loss of profit calculation.
A new or “start-up” business may have an unusual profit trend, as it may be loss-making for a period of time, followed by a period of rapid growth. A manufacturing business may be affected by the price of raw materials or the availability of certain machinery at other businesses. Likewise, if a business survives on large orders from a small number of customers, the status and position of those customers (and their contracts/orders) may also need to be taken into account in order to accurately predict a future trend.
(ii) The Industry
Similarly, the industry in which the business operates is important as it may, for instance, be seasonal. In the case of an ice-cream manufacturer if a BI event occurs in autumn, it may have less of an impact than if it had occurred in spring.
(iii) The Nature of the Incident
The nature of the incident is also important to understand, as only then can its impact on the business (and its profits) be properly assessed. It may be such as to leave the business with other profit-generating capability which might be increased in order to ameliorate any loss of profits. The nature of the incident may also be such that it accounts for a loss of profit for only a part of the insured period, after which other factors may come into play.
Conclusion
Dealing with a BI claim thoroughly can avoid a dispute altogether but, if a dispute does occur, a party will be in a far stronger position if it is able to show that it has approached the calculation of loss comprehensively.
It will often be beneficial to a party if legal or accounting professionals are involved at an early stage to advise on matters such as policy wording and calculation methods. In addition, industry specialists might need to be consulted to gain an understanding of the insured business.
Information gathering is paramount, and the more that is supplied by an insured, the more accurate a calculation is likely to be. As demonstrated above, this information stretches beyond simply financial records, and may include contract details, internal emails, or industry data. Once all this information is obtained, a thorough and defensible calculation can be carried out. This should avoid a protracted dispute along with the interruption such a dispute might bring.
Timothy Killen, Barrister, 2 Temple Gardens
[1] [2014] EWHC 3352 (Comm)
This article was originally published in Insurance Day, and can be accessed here behind a paywall.
