Time Element (Business Interruption) Insurance – New Appleman on Insurance Law Library Edition, Chapter 46

Time Element (Business Interruption) Insurance – New Appleman on Insurance Law Library Edition, Chapter 46

By Bernard P. Bell, Partner, Jones Day

Chapter 46 provides an analysis of time-element insurance generally, and business interruption insurance in particular.  Section 46.01 sets out the general purpose of time element insurance.  While standard first-party "all risks" property insurance policies cover the cost of rebuilding, repairing, or replacing property damaged by a covered peril, they do not cover the indirect losses to business that often result.  Insureds frequently purchase separate coverage for such indirect losses, especially for business interruption losses and expenses that continue during the interruption.  These coverages frequently are referred to as "time element" coverages because the quantum of an insured's loss is directly related to the interval of time during which the insured's business is interrupted.

Section 46.02 sets out the three basic forms for time element coverages:  Insurance Services Office ("ISO") Forms; Highly Protected Risk ("HPR") Forms; and Manuscripted Forms.  The ISO is an organization of property and casualty insurers that drafts, compiles, and issues standard policy forms for use by its members, and most businesses in the United States purchase standard insurance policies using or based upon ISO forms.  HPR coverage generally provides greater protection than the ISO forms, at least with respect to the coverage grants and exclusions most likely to concern HPR purchasers, who are among the largest national and international mercantile, manufacturing, mining, or refining businesses.  The HPR market is selective and offers coverage only to those businesses that meet certain loss-prevention-and-reduction criteria, and the relationship between HPR insurer and insured usually encompasses a significant shared loss-prevention effort.  Finally, some major insurance brokers have developed their own policy forms based, in large part, on a combination of HPR forms, and brokers and underwriters sometimes tailor, or manuscript, these forms to meet the needs of individual policyholders or a class of similar risks.

Section 46.03 introduces business interruption coverages.  The general purpose of business interruption insurance, explained in Section 46.03[1], is to do for the insured during the period of business interruption what the business would have done had no interruption occurred.

Sections 46.03[2] through 46.03[5] discuss the "physical loss or damage" requirement for triggering business interruption insurance.  Under many policy forms, for business interruption coverage to exist, the interruption must be caused by physical loss or damage to the property of the insured.  The generally prevailing meaning of the adjective "physical," as it modifies the nouns "loss" or "damage" in property insurance policies, is to require that the loss or damage be "of or relating to that which is material.[1]  The requirement that the loss or damage be "physical" therefore has been found to preclude coverage for losses that are solely intangible or incorporeal; for example, an economic loss unaccompanied by a distinct physical alteration to property.

Section 46.03[3] takes up the issue of what constitutes "physical loss or damage."  Courts have held that contamination of property by vapors, bacteria, or other foreign substances can constitute "physical" loss when it renders the property essentially unusable.  The leading case is Western Fire Insurance Co. v. First Presbyterian Church.[2]  In Western Fire Insurance, the insured property was ordered closed after gasoline infiltrated the soil under and around the building, causing vapors which contaminated the foundation, halls, and rooms.  The Colorado Supreme Court held that the infiltration of the gasoline and vapors constituted direct physical loss once "the church building was rendered uninhabitable."[3]

Courts have followed the reasoning of Western Fire Insurance in a series of contexts involving contamination, including vapors from methamphetamine labs, asbestos, bacteria, lead particulates, and wood chips.  In these cases, courts have held that where the contamination renders the property unfit for its intended purpose, there has been a physical loss.  In fact, the reasoning of Western Fire Insurance has carried beyond contamination cases, and courts in other factual scenarios have found "physical" loss when insured property remains intact but is rendered unfit for its intended use.  In one case, a court held that an electrical grid was "physically damaged" when its properly functioning safety mechanisms cut off power to prevent a power surge because the generators and lines were incapable of performing their essential function of providing electricity.

As electronic data has become an increasingly important asset for many businesses, the need to protect against business interruptions resulting from the loss of that data has grown.  A threshold question, however, is whether the loss of data is "physical loss or damage," and courts are divided over their resolution of this issue.  Courts that have found that loss of computer data is "physical loss or damage" have generally reasoned that the loss of the data is a loss of access or use of the physical computers.  Other courts, however, have rejected this reasoning, and instead have focused on the non-physical nature of electronic data to hold that the loss of this data cannot be "physical loss or damage" unless there is corresponding damage to the computers or physical media on which the data is stored.

Another question that frequently arises is whether an insured has suffered "physical loss or damage" when it is prohibited from accessing its business premises by an order of government authorities.  Some courts presented with this situation have held that an insured cannot recover under such circumstances because physical damage is a prerequisite to recovery in a business interruption policy.  Other courts have rejected this analysis and held that an insured may recover for lost business income, notwithstanding the lack of any physical damage to its premises, if access is prohibited by an order of civil authorities.

Section 46.03[4] discusses the question of what property must be lost or damaged in order for business interruption coverage to commence.  Courts differ on whether the property of the insured that is damaged must be insured by the property part of the policy.  Some policies explicitly require that the loss be to "covered" property.

Courts have permitted recovery for damage to non-covered property when the damaged property and covered property were "mutually dependent" on one another.  The seminal case involving mutually dependent premises is Studley Box & Lumber Co. v. National Insurance Co.[4]  In Studley Box, the policyholder operated a factory that had several structures, including a small mill and a barn.  The insured's business was partially interrupted after a fire destroyed the barn, killing some of the horses used to operate the business, though the fire did not damage the saw mill.  The policyholder's lumber production decreased after the fire because there were fewer horses to work.  The court granted coverage, explaining that because the different parts of the plant were "mutually dependent" on each other such that "if one fails, the others ordinarily suffer," a "loss on any of the units of the plant affects the business in its entirety and not merely the particular part of it carried on in such unit."[5]

Some courts have limited the application of the principle of mutual dependency to losses affecting the operation of the insured's facility and compromising the insured's ability to produce goods or offer services.  For example, one court refused to find mutual dependency and denied coverage where a fire destroyed a restaurant located at the insured hotel's property because the hotel was able to accommodate the same number of patrons, even if its actual number of customers was decreased due to the loss of the restaurant.  The better view, however, is that "the concept of 'mutual dependence' applies whether or not the structure that is damaged relates to producing the goods or services or providing the ability for customers to purchase the goods or services."[6]  One court adopting this view held that an insured hotel and casino could recover where it suffered a decrease in patronage after an adjacent expansion collapsed while under construction.  Regardless of whether the damaged property must also be the insured property, courts have held that a business interruption claim is not dependent on making a property damage claim.

Section 46.03[7] addresses another major requirement for triggering business interruption coverage:  that the insured have suffered a "suspension" or "interruption" of its business.  Courts differ on whether policies covering losses from business interruption require a total cessation of business operations.  This sometimes turns on the policy language.  For example, certain forms require a "suspension" of business, while others require only an "interruption."

Most newer business interruption policy forms include language specifying that total cessation is not required to trigger coverage, covering "suspension" of operations and defining "suspension" to mean the "slowdown or cessation of business."  Even with "suspension" forms, however, courts have differed in the requirements they have imposed on a policyholder to show that a suspension has occurred.  Some courts have required total cessation, while others have found coverage for partial interruptions.

Many forms explicitly cover loss resulting from "partial" business interruption, and therefore plainly provide coverage for a mere diminution of business without requiring a total cessation.  Many courts have found, however, that "when there is a loss of production capacity without a loss of earnings there is no recoverable business interruption except the extra expense necessary to prevent loss of earnings."[7]

Section 46.04 takes up another form of time element coverage:  extra expense coverage.  Most business interruption policies require that the insured take steps to reduce its business interruption loss following property damage.  When these steps are successful, they can reduce or eliminate the business interruption loss, but often at great cost.  These costs are not business losses per se, but rather are extra expenses that are greater than the sums that the insured would have spent but for the property damage.  Such costs are the subject of "extra expense" coverage.

Extra expenses commonly are covered if, by incurring them, the insured entirely avoids the loss of business income.  Examples include expenses to continue or resume operations at the damaged premises, or to equip and operate at replacement premises or temporary locations.  The same types of extra expenses are also covered if, by incurring them, the insured minimizes the suspension of business.  Courts thus have allowed coverage for extra expenses incurred for increased costs of production and costs for overtime labor, temporary premises or equipment, hotel and apartment accommodations necessary to support workers in temporary offices, replacement of water supply or other utility services, and advertising and marketing.  Costs for replacing inventory used to avoid a loss of income, however, have been held not to be a covered extra expense.  And only those extra expenses incurred during the period of restoration will be recoverable.

Section 46.05 introduces various coverage enhancements and extensions that an insured may purchase to expand business interruption coverage.  Section 46.05[1] deals with contingent business interruption coverage, which covers an insured's losses due to damage to its customers, suppliers, and so-called "leaders" (nearby flagship businesses that attract customers to the insured).  The basic business interruption insurance provisions do not extend to losses suffered because of damage to property owned by these groups because the property insurance policies normally do not cover damage to third-party property.  To protect against such losses, insureds may add coverage for "contingent" business interruption.

Contingent business interruption coverage typically requires that there be physical damage to the contingent property caused by the type of peril that the insurance policy covers.  Some policies cover only the loss of income that arises from damage to a list of scheduled properties, while others cover losses arising from damage to the property of a broader set of defined or undefined "suppliers" and "customers."

As with basic business interruption coverage, contingent business interruption coverage often includes contingent extra expense coverage as well.  A contingent extra expense is the same sort of expense covered under an ordinary "extra expense" clause, but is triggered by damage to contingent property.

One type of contingent coverage focuses on utilities that supply the insured's business.  Business interruption losses often occur as a result of loss of power or other utilities.  Such losses may not be covered under some forms unless the policy contains an endorsement or separate insuring agreement for losses resulting from utility service interruption, however, because basic forms do not afford coverage for interruptions resulting from damage to property not owned by the insured.

Causation issues sometimes arise that are unique to contingent claims.  For example, when an event causes damage to both the insured's property and contingent property, determining which damage caused the interruption of business can be difficult.  Other issues may arise when the chain of causation becomes attenuated.  These issues are discussed in Section 46.05[1][e].

Sections 46.05[2] through 46.05[8] discuss various other coverage enhancements available for business interruption insurance:  rental value (46.05[2]); ingress and egress (46.05[3]); interruption by civil or military authority (46.05[4]); interruption of computer operations (46.05[5]); expenses to reduce loss (46.05[6]); law or ordinance coverage (46.05[7]); and port blockage (46.05[8]).

One form of specialized business interruption coverage is for loss of rental income that an insured landlord would have received but for physical damage to the property.  Proof of such a claim should take into account past and expected occupancy rates.  Another form of specialized coverage provides coverage for business losses where an insured peril impairs or prevents access to the insured premises, even without an order of civil authority or physical damage to the premises themselves.

Still other policies extend coverage to business losses caused by an order of civil authority prohibiting or impairing access to the insured property, even in the absence of any physical damage to the insured property.  However, several courts, particularly those involving the grounding of airplanes and closure of certain airports nationwide following the terrorist attacks of September 11, 2001, have declined to extend coverage under civil authority clauses to losses resulting from orders not based on physical damage.

Recent ISO forms specifically have noted that business interruption and extra expense coverage does not include losses caused by "destruction or corruption of electronic data, or any loss or damage to electronic data," except as provided under an additional coverage grant for "Interruption of Computer Operations."  This additional coverage frequently is subject to a sublimit.

Many policies extend time element coverage to include expenses necessarily incurred for the purpose of reducing loss, including an extra expense incurred in replacing any finished stock used by the insured to reduce loss.  This coverage may be limited to the amount by which loss otherwise payable has in fact been reduced.

Replacement value property insurance policies typically contain an express exclusion from coverage for any increase in costs caused by the enforcement of any ordinance or law regulating the construction, use, repair or demolition of the insured property.  Just as commonly, most highly protected risk policy forms, as well as negotiated language for sophisticated insureds, expressly add back coverage for a category of the excluded losses, sometimes subject to a sublimit.  If the insured has purchased time element coverage under a policy with this law or ordinance coverage, the time element coverage typically will extend to time element losses sustained during the additional time necessary to rebuild as a consequence of the enforcement of a law or ordinance.  Disputes sometimes arise under this language with respect to whether the enforcement of the law or ordinance was caused by an insured peril.

Finally, for insureds whose business depends on access to navigable waters, time element coverage may be available for loss resulting from (1) vessels  being denied access to or egress from the insured facility or another property; or (2) inability to deliver cargo or feedstock from a vessel that does reach the facility.

Having discussed various coverage extensions in Section 46.05, Section 46.06 considers some common exclusions from business interruption coverage.  Section 46.06[1] begins by examining the interplay with exclusions from the property damage or "cause of loss" portions of an insurance policy.  The time element provisions of a property insurance policy frequently contain exclusions that are applicable only to the time element coverage.  The property damage or "cause of loss" portions of the policy typically contain a different set of exclusions.  Still, whether the exclusions in the property damage portions of the policy apply to the time element claims can be a subject of dispute.

Some common exclusions found in the business interruption portions of a policy include:  idle periods (Section 46.06[2]); utility services (Section 46.06[3]); finished goods or stock (Section 46.06[4]); dishonesty or theft (Section 46.06[5]); consequential loss (Section 46.06[6]); and loss of market or contract (Section 46.06[7]).

Time element policies typically exclude coverage for periods following a loss during which business operations would have been interrupted even absent the covered peril, such as delays in repairing damaged property due to labor strikes or scheduled holidays.  This idle periods exclusion may also apply to interruptions due to concurrent, non-covered causes of loss.  In such a situation, where an interruption of business is caused both by a covered cause of loss and a non-covered (or excluded) cause of loss, a policy with an idle periods exclusion may exclude coverage for the period of interruption attributable to the non-covered or excluded cause of loss.  At least one court has applied the idle periods exclusion proportionally in a situation in which a concurrent, non-covered cause of loss applied to the entire period of interruption but contributed only partially to the interruption.

Some time element forms explicitly exclude coverage for losses arising from utility service interruption.  Others exclude coverage for loss resulting from damage to finished products manufactured by the insured and for the time required for their reproduction.

In addition, many business interruption policies exclude coverage for losses due to dishonesty or theft by employees or agents.  This exclusion applies to dishonest acts of all employees, whether or not the property has been entrusted to the employee.  In addition, the exclusion extends to dishonest acts by employees of companies acting as the insured's authorized representative, even if the individual employees were not specifically authorized by the insured.  Although generally an "innocent insured" may recover under an insurance policy if the loss was caused by a fraudulent or criminal act by another insured, the dishonesty exclusion in business interruption policies "expresses a contractual intent to create joint obligations and to prohibit recovery by an innocent co-insured."  Finally, it is important to note that the exclusion does not apply unless the dishonest act causes the loss.

Some time element policies contain an exclusion denying coverage for losses that are "contingent or remote."  This exclusion, however, will not preclude an insured from recovering damages from an insurer for breach of contract, as some insurers have argued.

Time element polices sometimes contain an exclusion for "loss of market," a type of consequential loss that results when demand for the insured's property or product in general diminishes during the period of repair or restoration.  Thus, one court has held that the term "relates to losses resulting from economic changes occasioned by, e.g., competition, shifts in demand, or the like; [but] it does not bar recovery for loss of ordinary business caused by a physical destruction or other covered peril."[8]  "Loss of market" is not the same as "loss of market value," or the diminution in value of a property after a loss, which typically is a covered loss.

Another typical business interruption exclusion is for loss resulting from the cancellation of a contract as a result of the interruption of business.  This exclusion is designed to apply to losses arising outside of the period of indemnity due to the loss of a contract, but will not bar coverage for losses sustained during the period of indemnity.

The distinguishing feature of time element insurance is that the quantum of recovery is directly related to the interval of time during which the insured's business is interrupted.  Defining and measuring this length of time is critically important in resolving claims under time element insurance. Section 46.07 takes up this topic, discussing various issues related to the period of recovery.

Most newer ISO forms define the interval during which they will cover the losses sustained due to a necessary suspension of operations as the "period of restoration."  Other forms may define the coverage period as a "period of liability," a "period of recovery," or a "period of restoration."  Some forms may specify a maximum length of time during which losses will be covered; this length of time is often called the "period of indemnity."

Under ISO forms, the "period of restoration" typically begins either 72 hours after the time of any direct physical loss or damage that triggers business interruption coverage or immediately after the time of any direct physical loss or damage that triggers extra expense coverage.  In other forms, business interruption coverage will attach only upon the expiration of a defined "waiting period," which is typically expressed as a number of days.  In policies providing ingress/egress or civil authority coverage, the period of recovery may commence before the physical loss or damage to the insured property, if for example the insured is ordered to evacuate in advance of a peril, although this depends on the terms of the coverage.

As explained in Section 46.07[3], under ISO forms the "period of restoration" ends on the earlier of:  "(1) The date when the property at the described premises should be repaired, rebuilt or replaced with reasonable speed and similar quality; or (2) The date when business is resumed at a new permanent location."  Under other forms, the period of recovery often ends when, "with due diligence and dispatch," the relevant property could be rebuilt, repaired or replaced and made ready for operations under the same or equivalent physical and operating conditions (sometimes phrased as "the same quality of service") that existed immediately preceding the loss.

As both forms suggest, an insured is not required to rebuild or resume operations to obtain coverage.  However, if an insured does elect to resume operations, it does not have a choice between repairing or replacing its damaged property, absent policy language to the contrary.  Rather, "[w]hether demolition and reconstruction are proper depends entirely on whether such steps are necessary to restore the building to its former condition.  Where the damage is repairable the insured would have no right to compensation for the longer period of time it would take to completely demolish and reconstruct the premises."[9]

When the insured does not rebuild the damaged property, the period of recovery (or "period of restoration") is defined by a hypothetical or theoretical "reasonable" period.  When the damaged property is restored following a loss, the determination of the loss period begins with the actual time taken to restore the damaged property to its pre-loss condition.  The actual time then may be compared to a "due diligence and dispatch" period.

"Due diligence and dispatch" means that the policyholder must act with the measure of prudence, activity, or assiduity properly expected from and ordinarily exercised by a reasonably prudent person under the particular circumstances.  Whether an insured has acted with "due diligence and dispatch" is a question for the jury, though the "loss period" should reflect the fact that the process of rebuilding is likely to take longer in real life than might be projected as necessary by experts sitting in a courtroom.

Where the policyholder elects to rebuild or replace its insured property, disputes frequently arise over policy language restricting coverage to amounts - or in time element coverages, the time - it would take to replace the damaged or lost property with new materials of "like kind and quality," or similar language.  These disputes commonly concern both factual issues regarding whether the new property is superior to the old in construction, technology, function, or capacity, and consequent legal issues regarding whether, under the policy terms at issue (which vary widely on this point), there is coverage for the alleged improvements.

While the period of restoration generally ends when the damaged property has been restored and the business has begun to operate, where the policy provides coverage for the period it takes to restore the insured's business to "normal" operations, courts have held that the period of restoration continues until the insured's business is operating at the same level as before the property damage occurred.  In addition, some policies offer "extended period of loss" coverage, discussed in Section 46.07[5], which provides coverage until, under the ISO forms, the earlier of: (1) the date the insured could restore operations, with reasonable speed, to the level which would generate the business income amount that would have existed if no direct physical loss or damage had occurred; or (2) thirty consecutive days after the end of the original period of recovery.  Other forms may extend the period of recovery, beyond the date on which the liability of the insurers would otherwise terminate, for such additional period of time as is necessary to restore the insured's business "to the condition that would have existed had no loss occurred."  As with the ISO forms, these extended periods of indemnity commonly contain an outside limit expressed as a number of days.

Delays by the insurer in adjusting the insured's claim may extend the period of recovery, as explained in Section 46.07[6].  In addition, when the time to complete construction is delayed by a contractor, the period may also be extended.  The recovery period is not terminated, however, if the insured sells the property, regardless of whether the insured elected to rebuild.  Nor will the expiration date of the policy cut short the period of recovery.

Certain causation issues, discussed in Section 46.07[9] may also arise when determining the period of recovery.  Because the period of recovery is limited to the time in which loss of income is caused by or results from a covered cause of loss, concurrent non-covered causes of loss may either delay the commencement of the period of recovery or cut it short.  In addition, where an insured uses the business interruption to make improvements to its damaged property, some courts have held that losses associated with the additional time it takes to complete the improvements are not recoverable.  Finally, determining the period of recovery for certain businesses located in the World Trade Center prior to the terrorist attacks of September 11, 2001, has caused courts to consider whether the recovery period should be tied to the time necessary to rebuild the entire World Trade Center complex or to the time necessary for the insured to rebuild or relocate its office or store.  To resolve this question, courts have examined the relationship between the business and the World Trade Center complex to determine whether the insured's business was sufficiently "dependent" on the complex to say that the destruction of the complex was the cause of the insured's loss, rather than simply the destruction of the office or store.

Section 46.08 takes up issues related to establishing the measure of recovery.  The amount recoverable under a business interruption policy will vary depending on whether the policy insures a stipulated value agreed upon before the loss (a "valued" policy), or, more commonly, a value to be established after the loss in accordance with the policy terms (an "open" policy).  In general, valued policies have distinct advantages over open policies in terms of the ease of adjusting claims, but the agreed value in these policies may end up being quite different from the insured's actual loss.  More commonly, however, business interruption insurance is written on an "open" basis, leaving the amount of recovery to be calculated after the loss in accordance with the policy terms.

"Open" policies are discussed in Section 46.07[3].  The most prevalent forms cover the insured's "actual loss sustained" during the period of indemnity.  Generally, policies define the "actual loss sustained" as the reduction in earnings less normal charges and expenses that do not continue during the interruption of business, plus continuing expenses. "Continuing expenses" means fixed costs, that is those costs that must be paid during the period of recovery even when a company is not operating at normal capacity, such as mortgage or rent payments; certain, but not necessarily all, salaries; advertising; insurance; and property taxes.

Courts have stated that "losses are to be determined in a practical way, having regard to the experience of the business before the fire and its probable experience thereafter."[10]  The measure of recovery should be the actual income lost, not simply the gross amount that the business would have received during the recovery period.  In fact, an insured may be entitled to recover even if a business was operating at a loss at the time of the interruption. Earnings still are computed by adding the business's earnings (either positive or negative) to the amount of continuing expenses. Accordingly, a business operating at a loss still may recover as long as the business's net loss is less than its operating expenses.

In determining the measure of recovery, courts have given, and many policies specifically require, "due consideration" of the experience of the business before the loss and the "probable experience thereafter" had no loss occurred.  Section 46.07[3][c] explores this topic in detail.  While consideration of the past experience of a business is often straightforward, establishing the insured's "probable experience thereafter," had no loss occurred, is a decidedly less certain exercise, and by its nature counterfactual.

Section 46.07[3][c][iii] discusses evidentiary issues regarding loss computation.  It is the policyholder's burden to prove the loss, though the initial burden on the policyholder is a light one, and the policyholder will not be precluded from recovering simply because he or she cannot calculate the exact amount of loss.  Once the policyholder has met his or her burden of establishing a reasonable amount for the loss, the insurer may rebut this calculation by introducing contrary evidence.

Due consideration of an insured's probable experience "had no loss occurred" frequently begins with the insured's actual pre-loss projections of its performance during the period of recovery.  Courts often accept business plans, sales forecasts, and other forward-looking projections as competent evidence of actual loss sustained, particularly where these forecasts were prepared in the ordinary course of the insured's business.

Frequently it is necessary, when considering an insured's probable experience during the period of recovery, to account for seasonal or cyclical fluctuations in the insured's business.  These fluctuations may affect many elements of the claim calculus, including projected demand, supply costs, sales prices and transportation expense.

Expert testimony is admissible to prove the amount of loss.   Generally, courts will admit expert testimony that relies on objective, verifiable data to support its conclusions.   In contrast, experts who rely solely on unverifiable information communicated to them by the party for whom they are testifying have been excluded by courts.   Likewise, courts have rejected expert testimony where the expert had limited experience in making economic forecasts.

Section 46.07[3][c][iv] discusses how courts have considered post-loss market conditions during the period of recovery.  There are sharp differences among courts regarding whether it is appropriate to consider actual post-loss market conditions during or after the period of recovery in measuring the insured's actual loss sustained.  These disputes may arise when an insured peril creates a significantly different market environment after the loss than the environment immediately preceding the loss.

 Disputes regarding the propriety of considering post-loss market conditions typically focus on the proper interpretation of the phrase "had no loss occurred." One interpretation is that the word "loss" in the phase "had no loss occurred" means the financial result to the policyholder of the peril insured against, and does not mean either the peril itself or the effect of the peril on customers or other business.  Under this reading, therefore, gross earnings provisions direct the parties to give due consideration to the policyholder's probable experience at the insured location had that location not been damaged, but instead had been able to operate in the environment that existed in the immediate aftermath of the peril.  Although neither courts nor litigants are rigidly consistent in their interpretations, this reading tends to permit consideration of actual post-loss market conditions.  A contrary interpretation is that the words "had no loss occurred" mean "had no peril occurred," or, stated otherwise, had no hurricane (or flood, or earthquake, or explosion) occurred.  Generally (though not uniformly), this reading tends to forbid consideration of actual post-loss conditions, at least when those conditions are related to the insured peril, because it posits that the peril did not occur.  Neither of these approaches is inherently coverage-maximizing or coverage-minimizing, and under both approaches, whether consideration of the post-loss environment minimizes or maximizes coverage will depend on the facts.

A leading case concerning this issue is Prudential LMI v. Colleton Enterprises, Inc.,[11] in which the court interpreted the "had no loss occurred" language to preclude a motel owner's claim that, had a hurricane not damaged the motel, the insured would have been able to profit from increased demand for hotel rooms caused by the hurricane.  The majority's decision rested not on its interpretation of the insurance policy language, but on its conclusions regarding the parties' reasonable expectations and the proper purposes of business interruption insurance.

The opposite conclusion was reached in another hurricane case, Stamen v. CIGNA Property & Casualty Insurance Co.[12]  In Stamen, the owner insured 35 convenience stores under the same policy.  Hurricane Andrew damaged some of the stores, which were then closed for repairs.  Most of the insured's stores that remained open, or that could re-open quickly, experienced increased income immediately after the hurricane.  The court held that the policy required the insurer to consider what each insured store would have earned if it had been open after the hurricane.

Returning to calculation of the loss under "open" time element policies, Section 46.07[3][d] discusses continuing expenses, which are covered, and non-continuing expenses, which are not.  Continuing expenses are those that the insured will incur during the period of interruption regardless of the damage or loss.  Continuing expenses typically include, for example, payroll and rent.  Non-continuing expenses commonly are defined as "charges and expenses which do not necessarily continue during the interruption," and include costs avoided as a result of the interruption.[13]

Most policies provide that payroll expenses are covered as a continuing expense, though disputes may arise regarding what payroll expenses are "necessary" under policies which define loss to include payroll expenses "necessary to resume operations with the same quality of service that existed just before the direct physical loss or damage."  Whether rent is a continuing expense often depends on the terms of the insured's lease.  Where rent obligations continue notwithstanding damage to the leased premises, rent will be a continuing expense.  Where, however, an insured's obligation to pay rent terminates upon damage or destruction of the premises, rent may not be a continuing expense.  Finally, while interest is a continuing expense, depreciation, because it does not affect cash flow but is merely an accounting device, is not.

Section 46.07[4] takes up the insured's responsibility to mitigate its loss.  In addition to the policyholder's common law duty to mitigate its insured loss and corresponding right to recover from its insurer the costs of mitigation, most time element policies condition recovery on certain specific mitigation efforts by the insured.  Common policy terms direct that, in determining the amount of insured loss, the insured should account for the possibility of reducing loss by (1) "complete or partial resumption of operation of the property herein described, whether damaged or not"; (2) making use of merchandise or other property, at the insured location or elsewhere; or (3) making use of stock (raw, in process, or finished) at the insured location or elsewhere.

Although many policies require insureds to mitigate their damages by using other buildings, machinery, personal property, or inventory that they own, an insured is not denied recovery when the resumption of operations would be harmful to its business.  Thus, an insured is not required to use inferior goods, components, or materials.  Nor must the insured take measures that would cost it market share, aid its competitors, or compromise its intellectual property rights.

Finally, Section 46.09 concludes by noting that the length of the period of recovery and the quantum of loss sustained are issues of fact normally reserved for decision by the jury.   Courts have been extremely reluctant to take these issues from the jury, either by summary judgment, directed verdict, or on appeal.

[1]  Random House Dictionary of the English Language 1087 (1996).
[2]  CO-
437 P.2d 52 (Colo. 1968) (en banc).
[3]  CO-
437 P.2d at 55.
[4]  NH-
154 A. 337 (N.H. 1931).
[5]  NH-
154 A. at 337.
[6]  AZ-
Aztar Corp. v. U.S. Fire Ins. Co., 224 P.3d 960, 970 (Ariz. Ct. App. 2010) (emphasis in original).
[7]  IL-
Lyon Metal Prods., Inc. v. Protection Mut. Ins. Co., 747 N.E.2d 495, 505 (Ill. App. Ct. 2001).
[8]  US/NY--
Duane Reade, Inc. v. St. Paul Fire & Marine Ins. Co., 279 F. Supp. 2d 235, 240, aff'd as modified, 411 F.3d 384 (2d Cir. 2005).
[9]  WI--
Congress Bar & Rest., Inc. v. Transam. Ins. Co., 165 N.W.2d 409, 413 (Wis. 1969).
[10] US/VA--
Fidelity-Phenix Fire Ins. Co. of N.Y. v. Benedict Coal Corp., 64 F.2d 347, 352 (4th Cir. 1933).
[11] US/SC--
976 F.2d 727 (Table), No. 91-1757, 1992 U.S. App. LEXIS 25719 (4th Cir. Oct. 5, 1992).
[12] US/FL--
No. 93-1005-CIV-DAVIS, 1995 U.S. Dist. LEXIS 22481 (S.D. Fla. June 13, 1994).
[13] US/PA--
Eastern Associated Coal Corp. v Aetna Cas. & Sur. Co., 632 F.2d 1068, 1077-1078 (3d Cir. 1980).

Cross Reference: For an article on practical guidance as to business interruption insurance issues, see Richard P. Lewis, Business Income Insurance Disputes: Twenty Lessons Learned Since the Attacks of September 2001, New Appleman on Insurance: Current Critical Issues in Insurance Law (Spring 2011). See also New Appleman Premium Online Checklists § 31.04: CHECKLIST: Evaluating Business Interruption Insurance Policy to Determine Scope of Coverage.

Bernard P. Bell is a partner in the Washington DC office of Jones Day, and is a member of that firm's Insurance Recovery Practice.  With more than twenty years of experience in insurance coverage disputes and litigation, his practice covers the full range of insurance issues, representing policyholders in major property damage and business interruption losses, pollution legal liability and other environmental disputes, director and officer claims, securities class actions and products and toxic tort liability matters.  Mr. Bell is a graduate of Colgate University and Fordham Law School. The views set forth herein are the personal views of the author and do not necessarily reflect those of the law firm with which he is associated.  Mr. Bell is grateful for the valuable assistance that his colleagues Christopher DiPompeo, Mark Lentz and Benjamin Robinson provided.

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