The Business Interruption Insurance test case

Published on
8 min read

A Supreme outcome for policyholders - on 15 January 2021, the Supreme Court handed down a landmark judgment which will have an immediate impact on many SME businesses affected by the Covid-19 pandemic along with longer term effects for the analysis of insurance claims for years to come. We consider the key take away points.

Background

The Financial Conduct Authority (FCA) brought the test case to consider 21 policy wordings considered to be representative of the “non-damage” business interruption (BI) extensions which are believed to affect 60insurers, 700 policies and around 370,000 policyholders. 

A trial was held in July 2020 and on 15 September 2020, the High Court handed down its judgment, our analysis of which can be found here. The insurers and the FCA appealed.  

All of the insurers’ appeals have been unanimously rejected and the Supreme Court’s decision is a comprehensive outcome for the FCA and affected policyholders.  Many policyholders whose claims have been rejected will now benefit from cover. The majority will find that the extent of cover will have been increased as a result of the judgment. 

Disease clauses

A disease clause is one which can be triggered by the occurrence of a notifiable disease at or within a specified radius of the insured’s premises (generally between 1 and 25 miles). The Supreme Court judges were split in their views and the majority adopted a narrower interpretation than the High Court. These clauses respond provided there has been at least one case of illness caused by Covid-19 within the specified radius. Anything occurring outside the specified area is not within the scope of cover. Although this was a narrower interpretation than that applied by the High Court (and Lords Bridge and Hodge in the Supreme Court), policyholders will benefit from cover because of the Supreme Court’s findings on causation which we address below.

Prevention of access and hybrid clauses

These clauses are triggered by public authority intervention preventing access to, or use of, premises as a result of Covid-19.  The Supreme Court has gone further than the High Court, determining that 

  • Restrictions imposed – the High Court found that any restrictions imposed need to have force of law. The Supreme Court considered this interpretation be too narrow. Instead, for example, the statement “stay at home” delivered by the Prime Minister was a trigger for cover as it was a mandatory instruction, compliance with which was required even if it did not have full legislative effect at that time.
  • Inability to use and prevention of access – the interpretation of these phrases were a crucial aspect of the judgment for policyholders having been narrowly construed by the High Court. They concluded that only a complete prevention of all operations would trigger the policy. This view was however rejected by the Supreme Court who went further. They concluded that businesses who may have been able to continue with discrete parts of their operation, despite being unable to use another part, would now benefit from cover. So, for example, a restaurant whose dining facilities were subject to mandatory closure, but who was able to offer take-away services, will now benefit from at least some cover because access had been prevented or there was an inability to use the dining facility. 

Causation

In what is the most fundamental element of the decision, the Supreme Court conducted a detailed analysis of the “proximate cause” and “but for” tests and concluded that they do not always work.

Insurers had argued that the loss would not have been sustained but for the occurrence of the insured peril because the widespread impact of the pandemic meant that the same or similar loss would have been suffered in any event.  In particular, in respect of disease and hybrid wordings, insurers argued that the occurrence within the radius (defined by each policy) of the premises was not the “proximate cause” of loss, as the occurrence outside of the radius was significantly larger.  Insurers argued further that “but for” the occurrence within the radius, the occurrence outside of the radius would have caused the same losses.

The Supreme Court rejected this analysis on the basis that it does not work when there are a series of events, each of which can cause the insured event, but none of them can be sufficient on their own to cause the loss and where none are specifically excluded. In the case of Covid-19, each of the cases was an effective and proximate cause of the government’s measures and the public’s response to them. The Supreme Court therefore considered that there was a sufficient degree of inevitability that each individual case of Covid-19 was a cause of the loss, even if on their own they may not have resulted in the relevant interruption to a policyholder’s business.

The Supreme Court drew a parallel with a (hypothetical) scenario where 20 people pushed a bus over the edge of a cliff, but as few as 13 people could have achieved the same feat.  Each individual might argue that “but for” their involvement, the bus still would have been destroyed.  Here the “but for” test would result in an absurd result as clearly each person equally contributed to the destruction of the bus.   The Supreme Court applied similar logic and concluded that each occurrence of Covid-19 was a ‘separate, but equally effective cause” of business interruption losses.

Trends clauses

These are clauses in policies that are used to calculate the losses suffered. Insurers had applied them to argue that since policyholders would have suffered losses in any event because of the wider effects of the pandemic, the value of their claims should be reduced. 

Consider the example of a suit shop in the City of London, damaged by fire on the eve of the 2008 financial crisis. A trends clause would operate to ensure that business interruption losses would take into account the reduction in trading as a result of the financial crisis.  Insurers argued that the same logic applies as the wider occurrence of Covid-19 meant that even if insureds were able to trade, such trading would be significantly reduced.

This was an inherently causation based “but for” argument so it is perhaps unsurprising that the Supreme Court roundly rejected these arguments. It determined that trends clauses exist to quantify loss and not to restrict the scope of cover or exclude it altogether.  When applying a trends clause, the calculation of loss must ignore the existence of Covid-19 altogether since that is not a “trend” which would have occurred but for the loss. This is likely to have a dramatic effect on the calculation of most policyholders’ losses. It may also have an effect on the consideration of other BI related losses, for example, arising from floods.

Pre-trigger losses

In a further move away from the High Court’s decision (and consistent with the analysis on causation and trends clauses), the Supreme Court decided that a downturn in business prior to the mandatory closure messages (ie when the policy is triggered) is not a relevant factor in the calculation of loss. Many businesses faced reductions in turnover in the time leading up to their mandatory closure because there was already public concern about contracting Covid-19. Thus such  a reduction in turnover is not something insurers can take account of when calculating loss.

Orient-Express Hotels Ltd v Assicurazioni Generali S.p.A.

This case concerned a hotel which was damaged by hurricanes Katrina and Rita in 2005 triggering a property damage clause in the insured’s policy and a business interruption extension.  Insurers argued that “but for” the property damage, the insured’s business would have been significantly impacted by lack of visitors to New Orleans (as a result of the hurricanes), and that the business interruption claim should be reduced accordingly.  The court agreed with insurers in a decision that bewildered many commentators.  

Interestingly, two of the Supreme Court judges in the FCA test case (Lords Hamblen and Leggatt) were involved in the Orient Express case (one in the arbitration and one in the subsequent appeal).   Would they be prepared to reverse a decision they had made just over 10 years ago? In short… yes.  In their own words they were prepared to (in their own words) “gracefully and good naturedly” decide that Orient Express was wrongly decided by surrendering their “former views to a better considered decision”. Thus that authority has been overruled.

Comment

The FCA had already “won” before the High Court but the Supreme Court has gone further and policyholders are in an even better position than they already were. Only a week after the decision, and the FCA has already released a “Dear CEO” letter to insurers requiring them to pay valid claims “as soon as possible” (and make interim payments if appropriate). Previously rejected claims may now be payable or their value will have increased.

The FCA has stated that insurers now have “the clarity they need to now conclude their claims processes…”. However, will this really be the end of litigation relating to Covid-19, BI and insurance? There are certainly areas yet to be considered. For example,

  1. Will insurers require policyholders to prove the existence of cases of Covid-19 in the vicinity? The FCA opened a consultation before Christmas (which closed in mid-January) about how to prove the presence but in light of the Supreme Court’s decision, this is now almost a given bearing in mind the extent of the pandemic.
  2. Will policyholders pursue claims of damages for late payment under the Enterprise Act 2016 if insurers delay paying claims?
  3. What about aggregation for the purposes of calculating policy limits and excesses? How will insurers treat policyholders with different premises in different areas of the country? What view will be taken about the second and third lockdowns? Since issues of aggregation were expressly excluded from consideration in the test case, this has the makings of a fresh battleground.
  4. How will this new approach to “proximate cause” and the “but for” test affect policy coverage in general?

The willingness of the FCA to fight for policyholders alongside a consumer focussed Supreme Court decision are both indicative of the mood music. It is likely to be a brave insurer who continues to fight these issues. It is also important to recognise that while some 370,000 policyholders are thought to be affected by the Supreme Court’s decision, there are approximately six million SME businesses in the UK and so the vast majority of SME BI policies do not provide cover for the pandemic and its effects.

If you would like to talk about your Business Interuption insurance, or our commercial and corporate insurance services, please do get in touch with Ben or one of the insurance sector team

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