Webinar - D&O: life after the pandemic
Agenda
This talk will provide a recap on the types of claims that directors can face and how D&O policies can respond to them. It will also examine some of the issues arising with D&O claims, and how Covid-19 could present further challenges ahead for the D&O market.
James Breese is a Senior Associate at Fenchurch Law
Webinar - FCA Test Case: The Supreme Court Judgment
Agenda
Following the Supreme Court’s announcement that it will hand down its judgment in the Test Case on Friday 15 January, our webinar will give an overview of the key findings of the Supreme Court, including the final determination of business interruption coverage provided under Disease, Prevention of Access and Hybrid covers. Our session will also cover next steps for policyholders and consider some of the further issues that may arise in the adjustment and settlement of outstanding Covid-19 BI claims.
Presenters
Aaron Le Marquer, Partner
James Breese, Senior Associate
FCA Test Case – the Supreme Court Judgment: A guide for policyholders
On Friday 15 January 2021 the UK Supreme Court handed down its judgment in the FCA Test Case. The case was brought under the Financial Markets Test Case scheme by the FCA against 8 insurers, and considered the extent to which BI coverage was available under a selection of ‘non-damage’ BI extensions provided in a sample of 21 policy wordings.
The judgment is wide-ranging and extends to 114 pages. This guide does not attempt to capture all of the Supreme Court’s findings nor to describe the legal issues in any detail, but aims to provide Policyholders with what they need to know.
Who won?
The Supreme Court found resoundingly in favour of policyholders, essentially upholding the findings of the High Court and in some cases broadening the coverage available for Covid-19 BI losses.
Did insurers succeed on any aspects of their appeals?
No, insurers’ appeals were dismissed in their entirety.
Which Policyholders does the judgment assist?
Policyholders with coverage under those Prevention of Access and Hybrid clauses that the High Court found would respond to Covid-19 BI losses are now likely to have broader coverage in two important respects:
- Some policyholders whose coverage would not have been triggered at all under the ruling of the High Court will now be able to claim – in particular businesses that were only partially closed (for example a restaurant that was able to continue to offer takeaways services.)
- Policyholders whose coverage would not have been triggered until the coming into force of legal Regulations on 21 or 26 March 2020 may now claim from an earlier date, if their business was affected by instructions issued by the Government.
Importantly, no policyholder with a valid claim will now have the value of their claim reduced by virtue of a downturn in business caused by the effects of Covid-19 prior to coverage being triggered, or by taking into account any Covid-19 related factors whatsoever in considering the benchmark performance of the business against which the losses should be measured.
Are there any policyholders whose position is not affected?
Policyholders with coverage under those Prevention of Access clauses which were unsuccessful in the High Court, because of findings that the clauses were intended to respond to specific localised events such as gas leaks and bomb scares, rather than broader circumstances of the pandemic, do not benefit from the Supreme Court’s decision, as the FCA chose not to appeal the High Court’s findings in relation to those policies.
Are there any policyholders who are now worse off?
No. The Supreme Court dismissed all of the Insurers’ multiple grounds of appeal which, if successful, would have resulted in a less favourable position for policyholders.
What is the effect of the decisions on causation, trends clauses and the Orient Express case?
Complex cases were argued by all the parties before the Supreme Court on the linked issues of causation, trends clauses and the Orient Express v Generali case. Whilst the court’s findings in relation to those issues are of significant importance for the industry and English insurance law going forward, any detailed discussion is beyond the scope of this note.
The takeaway for Policyholders is that, in overruling Orient Express and taking a ‘concurrent causes’ approach generally to the issue of causation, policyholders whose coverage is triggered will now be entitled to an indemnity for the full extent of their Covid-19 related losses. Whilst there will inevitably be room for significant disagreement as to the correct measure of those losses, the Supreme Court has made it clear that the comparison against which the actual performance of the business must be measured must not take into account any impact of Covid-19 on the business, including any downturn in business prior to the business being closed and Policy coverage being triggered.
Are there issues left unresolved that the SC does not address?
The Supreme Court decision is final and now represents the settled position under English law as far as coverage, causation and the application of trends clauses is concerned.
There are other issues that will affect the coverage and quantification of business interruption claims which the Supreme Court did not consider, including:
Aggregation
For the purposes of the application of sub-limits of liability and deductibles, how many ‘losses’, ‘events’ or ‘occurrences’ has the policyholder suffered? This is particularly pertinent to policyholders with multiple premises and to consideration of further local and national lockdowns.
Disease at the premises
The Test Case did not consider, and did not therefore make any ruling in relation to Infectious or Notifiable Disease clauses that respond to losses caused by occurrences of disease ‘at the insured premises’ (as opposed to occurrences within a specified radius of the insured premises). The findings of the Supreme Court may now cause coverage under those clauses to be revisited.
Loss of Rent
The Test Case only considered policies providing ‘traditional’ BI coverage i.e. for loss of gross profit and increased cost of working. Policies providing express coverage for loss of rent by landlords were not considered. Different coverage issues arise in relation to those policies, which are not straightforward.
Deduction of government assistance
Many policyholders bringing claims will have benefited from various forms of government assistance since the emergence of the pandemic, and the correct treatment of such financial assistance for the purpose of calculating a BI claim indemnity is unsettled. The FCA issued a ‘Dear CEO’ letter on 18 September 2020 in which it advised insurers “We therefore do not consider the Government’s treatment of the Small Business, Retail, Hospitality and Leisure or Local Authority Discretionary grants for tax purposes is a proper basis for insurers treating those payments as turnover under the policies. Nor do we see that insurers can apply these amounts as savings against fixed business expenses”. As to other forms of government support, there remains ample scope for further disagreement.
Damages for late payment
The Enterprise Act 2016 introduced into law a new right for policyholders to claim damages for late payment of insurance claims, which did not previously exist. The right to claim damages remains untested by the courts, but the present circumstances may well lead to policyholders seeking to recover the additional costs they have incurred as a result of not being paid their claims promptly since notification in March 2020, including additional costs of financing, and in some cases costly corporate re-organisations and administration processes.
What should I do next?
The FCA and Insurers will now work with the Supreme Court to agree a set of declarations giving effect to the Supreme Court’s findings. The FCA has also indicated that it intends to issue a Q&A document for policyholders, giving guidance on who is now entitled to claim.
Previous guidance from the FCA required all insurers with ‘potentially affected claims’ to communicate with policyholders on the status of claims already submitted, and to review the coverage status of such claims following the High Court judgment in September 2020. Policyholders who have previously received communications from insurers in this respect can expect further communications following the Supreme Court judgment.
Policyholders that submitted claims earlier but that have not heard from insurers since the commencement of the Test Case, but who believe that their claim may be affected, should contact their broker or insurer to seek clarification on the status of their claim.
Policyholders that did not submit a claim earlier but believe that they may now have a valid claim following the Supreme Court judgment should contact their broker or insurer to discuss how to notify a new claim.
For a more detailed discussion and analysis of the Supreme Court judgment, please join our webinar on 21 January. Joining details can be found here.
Reasonable precautions conditions – what do they really mean?
Conditions which require insureds to exercise ‘reasonable precautions’ are a staple of insurance policies. However, there is often a misunderstanding as to their meaning and effect, and what an insurer must show in order to rely on a breach to decline the claim. In this article we take a look at the applicable principles.
Reasonable precautions in a Professional Indemnity policy
Professional indemnity (“PI”) insurance is designed to protect an insured which has incurred a civil liability to a third party arising from negligence.
PI policies almost always require insureds to take reasonable care or reasonable precautions not to cause loss or damage to a third party. If “reasonable care”, in this context, had the same meaning as a tortious duty of care, the policy would be deprived of any real value, since that would effectively exclude the very liability that the policies are intended to cover.
To overcome that issue, the Courts have consistently held that an insurer can only rely on a reasonable precautions clause where it shows recklessness by the insured. In particular, in Fraser v Furman [1967]1 WLR 898, the Court held that it must be “shown affirmatively that the failure to take precautions … was done recklessly, that is to say with actual recognition of the danger and not caring whether or not that danger was averted”. Therefore, acting carelessly will not be sufficient; the requirement is that the insured must be reckless and not care about its conduct.
Reasonable precautions in a property policy
Over time, reasonable precautions clauses have become more commonplace in property and other first-party insurance policies (such as travel or motor insurance); but what does a requirement to take reasonable precautions in a property policy mean? Can an insurer decline a claim if an insured fails to take reasonable care? Does negligence suffice?
The Court of Appeal has confirmed that the recklessness threshold applies equally in property insurance. So, in Devco Holder Ltd v Legal and General Insurance Society [1993] Lloyd’s Rep 567, where a driver deliberately left his keys in the ignition for a few minutes whilst visiting his place of work, the Court of Appeal found that the driver breached the reasonable precautions condition in his policy because he was “deliberately courting a danger”. On that basis, the driver was not entitled to recover under the Policy.
The Court of Appeal in Sofi v Prudential Assurance Company [1993] 2 Lloyd's Rep. 559 reaffirmed the decision in Devco Holder that mere negligence will not suffice. So, in order to prove recklessness, it must be shown that the insured appreciated the risk (and that appreciation will be assessed subjectively). If it can be shown that an insured appreciates the risk but simply didn’t care or ignored it, he will be found to be reckless.
On the basis that a reasonable care clause is intended to exclude liability, the burden is on the insurer to prove recklessness.
In which situations might reasonable precautions conditions be relevant?
The drafting of reasonable precautions conditions is usually broad. For example, the clause may require an insured to “take all reasonable precautions to prevent or diminish damage or any occurrence or cease any activity which may give rise to liability under this Policy and to maintain all Property insured in sound condition.”
The general actions expected from insureds to diminish or reduce danger are likely to vary on a case by case basis and therefore not readily summarised; however, examples in a property context would include locking all doors and windows when the premises are empty (so as to minimise the risk of theft); taking precautions against fire or alerting the fire brigade promptly in the event of a fire; and adhering to guidance from professionals such as surveyors.
It is perhaps more illustrative, by comparison, to consider the sorts of actions which have been found to constitute a breach i.e. where an insured has acted recklessly. In particular:
- Lambert v Keymood Ltd [1990], in which an insured continued to set bonfires at its premises, despite being warned about the dangers of doing so;
- Limit (No.3) Ltd v Ace Insurance Ltd [2009], where an insured took no steps to repair a building, notwithstanding the fact that it was warned that it might collapse;
- Grace Electrical Engineering Pte Ltd v EQ Insurance Co Ltd [2016], where an insured ignored advice regarding cooking operations taking place in the basement of its premises.
There is however an important distinction to be drawn between reasonable precautions and positive obligations under the policy which require insureds to take specific actions, such as hot works conditions, unoccupied buildings conditions, and security conditions. In Aspen Insurance v Sangster & Annand Ltd, the Court commented that the recklessness threshold will not apply where there is “a highly defined and circumscribed set of particular safeguards which have to be put in place” which involved a detailed hot works condition clause with which the insured had failed to comply.
Reminder for brokers and policyholders – a health warning
In order to avoid the risk of insurers seeking to decline the policy for a breach of reasonable precautions conditions, it is important for brokers and policyholders to be fully aware of their continuing obligations throughout the duration of policy.
Failure to warn the insured about such policy conditions may result in a broker being held liable in the event that indemnity is declined due to breach of a reasonable precautions or other specific condition - RR Securities & Ors v Towergate Underwriting Group Ltd [2016]. In this case, following a fire caused by arson, the insurer sought to decline the claim due to failure to comply with the minimum-security standards and failure to take reasonable precautions to avoid the loss. The Court found that the insured had not been reckless and therefore there had been no breach of the reasonable precautions condition. However, the broker was found to be liable to the insured for failing to bring the onerous security conditions to the insured’s attention.
Whilst we see insurers seeking to rely on reasonable precautions conditions in circumstances where the insured has merely been careless or negligent, equally care should be taken to ensure that policyholders are fully aware of their obligations and to distinguish between reasonable precautions conditions and other more onerous requirements defined in the policy. In short:
- Where the policy contains a reasonable precautions clause, the insured must not act recklessly or against advice where it appreciates that a risk exists which might cause a loss; and
- Where the policy contains specific obligations, such as a hot works condition or unoccupied buildings condition, the reckless threshold does not apply – the insured must therefore take extra care to fully comply with those obligations or avoid a declinature of a claim at a later date.
Webinar - FCA Test Case: the Appeal
The Test Case brought by the FCA to determine coverage issues in relation to Covid-19 Business Interruption losses has been unique in a number of respects. It was the first case of its kind to be brought under the Financial Markets Test Case Scheme. It was brought, heard and decided on an unprecedented accelerated timetable. And it affected an enormous number of policyholders – over 370,000 according to the FCA’s estimate. The judgment issued in September produced some important results for policyholders, but many of the key findings are now under appeal at the Supreme Court.
Following the conclusion of the Supreme Court appeal hearings on 19 November, this session examines the main issues under dispute, the positions of the parties, and the implications of the outcome for policyholders and the insurance industry.
Aaron Le Marquer is a Partner at Fenchurch Law
Covid-19 BI Update: TKC London Ltd v Allianz – Covid-19 closure not “accidental loss” of property
Hot on the heels of the FCA Test Case judgment, on 15 October 2020 the Commercial Court granted summary judgment in favour of Allianz Insurance Plc, in a case brought by The Kensington Creperie (‘TKC’) seeking coverage of its BI losses arising from enforced closure in the wake of the Covid-19 pandemic[1].
In contrast to the FCA Test Case which examined coverage under ‘non-damage’ business interruption extensions, but echoing many of the cases currently being pursued in various US jurisdictions, TKC sought to establish coverage on the basis that it had suffered an “accidental loss of property”.
TKC’s Arguments
The Policy provided cover for loss resulting from business interruption “in consequence of an event to property”, “Event” being defined as “Accidental loss or destruction of or damage to property used by the Insured at the Premises for the purpose of the Business.”
Seeking to establish that the mandatory closure of its business from 21 March to 4 July 2020 could amount to an Event within the meaning of the Policy, TKC argued that “accidental” meant nothing more than “unlooked for or unintended”, and that “loss of property” included temporary loss of use. TKC pointed to the use of the words ‘All Risks’ in the titles of the relevant insuring clauses, and various judicial authorities supporting an interpretation of ‘loss’ going beyond pure physical damage.
Additionally and alternatively, TKC argued first that the business interruption cover was triggered by loss of or damage to stock, and secondly that the right to carry on business from the premises could itself amount to intangible property which, by virtue of the Regulations, was lost or damaged.
Allianz’s Position
Allianz, represented by Gavin Kealey QC, submitted that the temporary closure of the premises did not amount to “accidental loss of property”, both because accidental loss referred only to physical loss and because something more than merely transient deprivation was required. The temporary closure of the premises failed on both counts.
Relying on an extensive line of case law considering the meaning of the word “loss” (including, probably uniquely, two different cases concerning lost pearl necklaces), Mr Kealey reminded the Court of Sir Martin Nourse’s memorable comment in Tektrol Ltd v International Ins Co of Hanvover Ltd:
““Loss” is a word whose meaning varies widely with the context in which it is used. If a man said to you: “I have lost my wife”, you would understand him to mean one thing outside the maze at Hampton Court and another outside an undertakers in the high street.”
In the context of the Policy, Allianz submitted that a number of further authorities supported an interpretation of loss limited to physical damage, as well as to circumstances where recovery was at least uncertain (and not therefore temporary). This, Allianz argued, was also the only interpretation of the Policy that made commercial sense of the Policy as a whole, since any other construction would render the proviso and Denial of Access provisions in the policy redundant.
The Judgment
The Court gave TKC’s arguments short shrift. As to what was meant by the word “loss”, the Court found that:
“the immediate context of the word “loss” within the definition of “Event” is that it is followed by the words “or destruction of or damage to”. I again accept Mr Kealey’s submission that those words strongly suggest that “loss” here is similarly intended to have a physical aspect. … Taking these contextual matters into account as a whole, it therefore seems to me that the expression “loss … of … property” in the definition of “Event” cannot sensibly be interpreted as including mere temporary loss of use of property.”
As to TKC’s alternative submission that the Policy was triggered by damage to TKC’s stock, the Court found that:
“the factual assertion that the deterioration in TKC’s stock caused (proximately or otherwise) any relevant interruption or interference with TKC’s business is one which … I can summarily reject as wholly unrealistic even at this preliminary stage.”
As a result the Court found that TKC’s action was bound to fail and granted summary judgment in favour of Allianz.
Comment
The case is of general importance to policyholders seeking recovery of their BI losses flowing from Covid-19 related closures. Whilst the FCA Test Case has established (subject to appeal) that certain ‘non-damage’ business interruption extensions will respond to losses caused by the consequences of the Covid-19 pandemic, a majority of policyholders will not have had the benefit of policies containing such extensions, and those that do are in most cases subject to sublimits of liability that fall far below the main policy limits. A favourable finding in relation to the meaning of “accidental loss of property” could potentially have opened the floodgates to many thousands of additional claims and dramatically increased insurers’ exposure.
The relevance of the present case was recognised by the Court in the Introduction to its judgment:
“The decision in the present case may therefore be of consequence for other potential claimants. To that limited extent, this judgment is therefore something of a footnote to the comprehensive and (subject to any appeal) authoritative statement of the law and exegesis of the various policy provisions in the judgment of Flaux LJ and Butcher J in the FCA test case.”
The Court’s findings are therefore unsurprising, particularly in light of the detailed conclusions reached by the Court in the FCA Test Case. If the Court had found in favour of TKC in this case, the issues determined in the Test Case would largely have become irrelevant, since a majority of policyholders would be covered under the main property damage sections of their policies, and would have no need to turn to the ‘non-damage’ extensions for cover.
Although not on the face of it a positive outcome for policyholders, the Court’s decision is therefore useful in further clarifying the legal position in relation to the cover available to businesses for their Covid-19 business interruption losses.
[1] TKC London Ltd v Allianz Insurance Plc [2020] EWHC 2710 (Comm)
The Good, the Bad & the Ugly: 100 cases every policyholder needs to know. #10 (The Bad). Orient-Express Hotels v Generali
Welcome to the latest in the series of blogs from Fenchurch Law: 100 cases every policyholder needs to know. An opinionated and practical guide to the most important insurance decisions relating to the London / English insurance markets, all looked at from a pro-policyholder perspective.
Some cases are correctly decided and positive for policyholders. We celebrate those cases as The Good.
Some cases are, in our view, bad for policyholders, wrongly decided, and in need of being overturned. We highlight those decisions as The Bad.
Other cases are bad for policyholders but seem (even to our policyholder-tinted eyes) to be correctly decided. Those cases can trip up even the most honest policyholder with the most genuine claim. We put the hazard lights on those cases as The Ugly.
At Fenchurch Law we love the insurance market. But we love policyholders just a little bit more.
#6 (The Bad)
Orient-Express Hotels v Generali – an update
This note is an update to that which we provided on Orient Express on 1 July 2019. The Commercial Court considered Orient Express during the FCA Test Case in July 2020. The Test Case concerned the business interruption losses that arose following the outbreak of Covid-19 in the UK. Orient Express was a hotly contested issue, and we look here at how the Test Case may affect its application.
In Orient Express Hotels Ltd v Assicurazioni Generali SPA t/a Generali Global Risk [2010] EWHC 1186 (Comm), the Commercial Court held that the ‘but for’ causation test applies under standard BI policy wordings where there are two concurrent independent causes of loss, and there could be no indemnity for financial loss concurrently caused by: (1) damage to the insured premises – a luxury hotel in New Orleans, and (2) evacuation of the city as a result of Hurricanes Katrina and Rita.
Orient Express Hotels Ltd (OEH) was owner of the Windsor Court Hotel (the Hotel), which suffered significant hurricane damage in August and September 2005 leading to its closure for a period of two months. The surrounding area was also devastated by the storms, with the entire city shut down for several weeks following the declaration of a state of emergency, and the imposition of a curfew and mandatory evacuation order.
The arbitral Tribunal held that OEH could only recover in respect of loss which would not have arisen had the damage to the Hotel not occurred, and this meant that OEH was to be put in the position of an owner of an undamaged hotel in an otherwise damaged city. Since New Orleans itself was effectively closed for several weeks due to widespread flooding, with no-one able to visit the area or stay at the Hotel even if it had (theoretically) been undamaged, OEH could not recover under the primary insuring provisions for BI loss suffered during this period. A limited award of damages was made under separate Loss of Attraction and Prevention of Access extensions to the policy.
OEH appealed to the Commercial Court, arguing that the Tribunal’s approach was inappropriate given the wide area damage to the Hotel and the vicinity caused by the same hurricanes. OEH sought to rely upon principles established in: Miss Jay Jay [1987] and IF P&C Insurance v Silversea Cruises [2004], that, where there are two proximate causes of a loss, the insured can recover if one of the causes is insured, provided the other cause is not excluded; and Kuwait Airways Corpn. v Iraqi Airways Co. [2002], that, where a loss has been caused by two or more tortfeasors and the claimant is unable to prove which caused the loss, the Courts will occasionally relax the ‘but for’ test and conclude that both tortfeasors caused the damage, to avoid an over-exclusionary approach.
Mr Justice Hamblen dismissed the appeal, concluding that no error of law had been established in relation to the Tribunal’s application of a ‘but for’ causation test under the policy on the facts as found at the arbitration hearing, whilst recognising “as a matter of principle there is considerable force in much of OEH’s argument”. The insurance authorities mentioned above were distinguished as involving interdependent concurrent causes, in which case the ‘but for’ test would be satisfied. The Court did appear to accept that there may be insurance cases where principles of fairness and reasonableness meant that the ‘but for’ causation test is not applicable, but OEH was unable to establish an error of law by the Tribunal where this argument had not been raised at the arbitration hearing. Given these evidential constraints on an appeal limited to questions of law, OEH was unsuccessful in the Commercial Court.
Permission to appeal was granted, indicating that the Court considered OEH’s grounds for further challenge had a real prospect of success. Settlement on commercial terms was agreed between the parties prior to the Court of Appeal hearing, however.
The decision in this case has been criticised by commentators as unfair, giving rise to the surprising result that the more widespread the impact of a natural peril, the less cover afforded by the policy. The High Court appears to have agreed in the Test Case that concluded in July 2020.
In a judgment handed down on 15 September 2020, Flaux LJ and Butcher J said at paragraph 523:
“We consider that there are several problems with the reasoning in Orient Express. First and foremost, as we see it, there was a misidentification of the insured peril… It seems to us that the error in the reasoning may have come about because the judge focused only on the “but for” causation issue and, to our minds surprisingly, did not pose the question of what was the proximate cause of the loss claimed…”
The judgment continues at paragraph 529:
“It follows that, if we had thought that the decision in Orient Express somehow dictated the consequences in terms of cover and the counterfactual analysis for which the insurers contend in the present case, we would have reached the conclusion that it was wrongly decided and declined to follow it…”
This is welcome news for policyholders. It is clear that Flaux LJ and Butcher J disagreed with the principles that underpinned the decision in Orient Express, and this can only be positive for the adjustment of insurance claims moving forward. However, importantly, the Court’s comments regarding the correctness of the decision in Orient Express are strictly obiter, since the case was distinguished from the fact under consideration in the Test Case. On that basis the ‘wide area damage’ principle set down in Orient Express, at least as applied to property-linked BI claims, remains good law and it is likely that Insurers will continue to rely on it unless and until the decision is overturned by a superior Court.
That said, readers will likely be aware that there is a chance that the insurers that participated in the FCA Test Case will appeal. We anticipate that we will learn of any such appeal on 2 October 2020, with the leapfrog appeal to the Supreme Court being heard in December 2020 / January 2021. While it may be frustrating for policyholders that there remains a risk that Orient Express could have some application moving forward, the possibility of the Supreme Court deciding the outcome one way or another must be welcomed. The law as it stands as now unsettled and ultimate clarification from the Supreme Court will provide the finality required by all stakeholders.
You have to be pulling my LEG(3)
An unwelcome consequence of the London Market’s preference for including arbitration clauses in most types of commercial insurance policies, is that disputes regarding the meaning of clauses in those policies are frequently resolved in private, rather than in a public forum where the decision of a Court could assist policyholders and insurers in avoiding similar disputes in the future.
In a Construction All Risks context, insurers’ preference for arbitration clauses has had the remarkable effect that in the nearly 25 years since the London Engineering Group (“LEG”) first introduced its suite of defects exclusions, there has not been a single Court decision, anywhere in the world, on the meaning of the defects exclusion which LEG intended to be the most favourable for policyholders: LEG3.
So, if there are no reported cases on LEG3 then where can one look for guidance? The current (2nd) edition of Paul Reed QC’s excellent book “Construction All Risks” doesn’t consider LEG3 in any detail. Whilst we understand that the omission will be corrected in the forthcoming 3rd edition, at present Mr Reed’s book refers to LEG3 as being an equivalent of the most favourable of the “DE” defects exclusions: DE5. That equivalence, however, is not accepted in all parts of the insurance market.
As noted in an article published by Iftikhar Ali of DWF in 2019, the absence of the word “additional” from LEG3 (as opposed to DE5, which explicitly excludes “additional costs of improvement”) has encouraged some to interpret LEG3 as excluding all costs which relate to works which have the effect of improving the original works. If this interpretation was correct then it would produce particularly harsh results for policyholders where the contract works have suffered damage as a result of defects in design, as in one sense all remedial works carried out according to a different design must necessarily be an improvement if the remedial works are defect-free as a result. For that reason Mr Ali (correctly in our view) reaches the view that such an interpretation, whilst consistent with a literal reading of LEG3, would be “a commercial nonsense”. Unfortunately, in our experience, that does not always prevent insurers from running the argument, to the surprise and disappointment of any policyholder or broker who is familiar with how the market ordinarily approaches the clause.
Whilst other texts and commentaries are consistent with the guidance notes produced by the London Engineering Group itself, that LEG3 was intended by the underwriters who drafted it to provide the “the widest form of cover, for physical damage caused by defects”, none of the texts or commentaries discuss how, precisely, one should determine: (i) what constitutes an improvement for the purposes of LEG3; and (ii) what cost is thereby excluded. This article attempts to address that gap.
What is an improvement for the purposes of LEG3?
For the purposes of this article the relevant part of LEG3 provides that:
“the cost of replacement or rectification which is hereby excluded is that cost incurred to improve the original material workmanship design plan or specification” (our emphasis).
It seems to us that for remedial works to constitute an improvement as compared with the original works:
- The remedial works must be different in some way from the original works; and
- That difference must be more than an equally valid way of performing the works, and must produce a tangible benefit (for instance an improved factor of safety, or a longer design life, or superior functionality - in all cases as compared with the original works as completed, as opposed to the outcome desired by the employer).
The requirement for the difference to produce a tangible benefit in order to constitute an “improvement” is important. The fact that remedial works are different to the original works does not on its own mean that they are an improvement, even if the remedial works are more expensive.
In the context of a Construction All Risks claim, if an insurer cannot identify a tangible benefit produced by the remedial works as compared with the original works, then it will not be able to show that the remedial works are an improvement, and any difference in cost between the remedial works and the original works will be irrelevant, and should not result in a deduction under LEG3. It is only if the insurer is able to identify a tangible benefit produced by a way in which the remedial works are different from the original works that one is required to consider what cost is thereby excluded by LEG3.
What cost is excluded?
Once one has a taken a view not just on how the remedial works are different from the original works, but also in what way that difference relates to a tangible benefit (i.e. what is the “improvement”), one can then try to identify the cost that relates to that improvement. Pausing there, it is of course entirely possible that there may be no “cost” of improvement, because a policyholder may find a different way of approaching the remedial works which, although producing a tangible benefit as compared with the original works, is nevertheless cheaper than the original works. In that situation whilst there is an “improvement”, there would be no “cost incurred to improve”, but rather a saving.
Any other interpretation would be precisely the “commercial nonsense” referred to by Mr Ali, and we doubt that there is a single CAR underwriter who, when writing a risk, would want to encourage their policyholder to carry out remedial works more expensively than a cheaper and better alternative if one was available.
Assuming, then, that remedial works are both an improvement, and are more expensive than the original works, it seems to us that the “cost incurred to improve” can then be identified in one of the two following ways.
Item by item comparisons
Depending on the facts, it may be possible to identify excluded costs on an item by item basis. For instance, there will be occasions when:
- Some elements of the remedial works are different to the original works, but produce no tangible benefit (“Differences”);
- Some elements of the remedial works are exactly the same as the original works; and
- Some elements of the remedial works are different to the original works, and do produce a tangible benefit (“Improvements”).
In that situation, the Differences may occasionally be cheaper than the comparable items of the original works. However, there wouldn’t be any justification, in our view, for offsetting any such savings against the cost of the Improvements if those were more expensive than comparable items of the original works. Rather, the cost excluded by LEG3 in that situation would be the un-discounted difference in cost between the Improvements, and the comparable items of the original works.
Equally, if the Differences are more expensive than the comparable items of the original works we can see no justification for excluding the difference in cost relating to them: what is excluded by LEG3 remains the difference in cost between the Improvements, and the comparable items of the original works.
It should be obvious, we hope, that any differences in cost which relate to elements of the remedial works which are exactly the same as the original works, are unaffected by LEG3.
The approach of separating Differences and Improvements should, in our view, be applied not only to separate items of work, but where required by the facts can also be used to identify the excluded costs where individual items of work may contain both Differences and Improvements.
Items of work containing both Differences and Improvements
How this would work in practice in relation to individual items of work can be illustrated by considering a length of steel pipe which was under-specified, has suffered damage by becoming deformed under expected pressure, and has been replaced by thicker steel pipe. In that situation:
- There is a difference between the original works and the remedial works, in that a thicker steel pipe has been used in the remedial works; and
- The fact that the steel pipe used in the remedial works is thicker than that used in the original works produces a tangible benefit, in that is more robust and less likely to become deformed under expected pressure (i.e. the pipework constitutes an Improvement in that it is thicker).
Suppose the thicker steel pipe used in the remedial works is more expensive for two reasons:
- Because more steel has been used to make it thicker; and
- Because the cost of steel has increased since the original works were carried out.
In that situation LEG3 would only exclude the cost of making the pipe thicker by using more steel, as it is only that cost which is related to the way in which the thicker steel pipe is superior to the original steel pipe. The increased material cost is not related to the way in which the thicker steel pipe is superior to the original steel pipe, and so that difference in cost is not, in our view, excluded by LEG3.
Holistic comparisons
There will be other occasions where individual items of remedial work cannot sensibly be compared with any items of the original works (for instance, where the remedial works follow a substantially re-designed scheme). In that situation it will be necessary to compare the overall (remedial and original) schemes with each other.
Even in that situation, however, care needs to be taken not simply to subtract the cost of the original works from the cost of the remedial works in order to identify the cost excluded by LEG3, because that would risk including Differences (i.e. which don’t relate to the way in which the remedial works improve the original works). Rather, the cost of any Differences (e.g. fluctuations in material costs), need to be identified and disregarded.
Ordinarily the most appropriate way to do so in order to produce a reliable holistic comparison, is to compare the cost of the remedial works against not the cost of the original works, but against the cost that would have been incurred if the original works had been re-performed (in exactly the same way) following the occurrence of damage instead of the remedial works which were actually done.
Authors:
Rob Goodship, Associate Partner
FCA Test Case Update – Judgment
Today’s judgment in the FCA’s Test Case on Covid-19 Business Interruption coverage has provided some welcome good news for many policyholders – as well as disappointing findings for others. The court’s findings were very clearly divided between the policyholders seeking coverage under Disease clauses, and those claiming under Prevention of Access or similar extensions.
Disease
With the exception of two of the QBE wordings under consideration, it is unquestionable that the judgment is favourable for those policyholders that have one of the Disease Wordings that has been assessed as part of the FCA Test Case. Critically, the court found that the occurrence of the disease did not need to occur only within the radius contemplated in the policy. Provided that the occurrence of the disease extended into the specified radius, the coverage would be triggered. This has been one of the first coverage issues that policyholders have had to overcome, and which insurers have strongly resisted.
Furthermore, for those policyholders that do not have the benefit of the specific Disease Wordings looked at the FCA Test Case, but instead some other Disease wording, the consistency of the findings is likely to provide persuasive authority to support the ongoing claims under those other wordings.
Prevention of Access and Public Authority wordings
The position, however, is surprisingly less favourable for the majority of those policyholders with Prevention of Access and Public Authority Wordings that were considered as part of the FCA Test Case.
The starting point for these particular wordings appears to be that they would only in principle respond to localised occurrences of the disease. Interestingly, the Court reached a very different and narrower conclusion on the meaning of the term ‘vicinity’ in the context of the Prevention of Access wordings, compared to that under the Disease clauses. Each particular wording will have to be closely scrutinised, however, as the judgment affects different wordings in different ways, as may the application of the facts pertaining to individual policyholders.
While it is clear that this aspect of the judgment is unhelpful for affected policyholders, it remains to be seen whether the FCA will appeal any aspect of it, and whether the judgment is as unhelpful for those policyholders that have Prevention of Access/Public Authority wordings other than those specifically looked at as part of the FCA Test Case.
Causation
A striking aspect of the judgment is the way the Court neatly dispatches with the complicated causation arguments raised by insurers, by making it a part of their very clear finding on the construction of the coverage clause. Because, the court says, the insured peril is the composite peril of interruption or interference with the Business caused by the national occurrence of COVID-19, the causation arguments ‘answer themselves’. There is only one cause of loss. For the same reasons, trends clauses are largely irrelevant and the principle in Orient Express has no application.
The court’s finding that Orient Express was wrongly decided and that they would not have followed it even had they not found it to be distinguishable, will certainly raise eyebrows, and will surely lead to an appeal from Insurers on this issue at least. In deciding whether also to appeal on the policy trigger issues, Insurers will have to weigh up the potential further reputational damage they may suffer from being seen to resist the Court’s very clear findings.
Our detailed analysis of the judgment and commentary on next steps will follow.
Covid-19 Business Interruption Update: Is another storm brewing?
With the FCA Test Case concluding last week, and judgment not expected until mid-September at the earliest, this blog looks briefly at what further tumultuous times may lie ahead for policyholders. Specifically, whether policyholders’ business interruption (“BI”) losses following COVID-19 will be aggregated.
Policyholders and their brokers will know that aggregation is not in the scope of issues that has been considered by the court in the FCA Test Case. There will therefore be no fresh judicial assistance available to insureds on this issue.
Given the significance of some policyholders’ losses, we anticipate that this will be a hotly contested battle with insurers that will yet need to be resolved post-FCA Test Case.
Aggregation
In summary, aggregation is a principle under which two or more separate losses are treated as a single loss because of a unifying or connecting factor.
For those policyholders that have multiple premises insured under a single composite policy, additional aggregation arguments may arise (subject to the specific policy wording).
Where the sub-limits relevant to these COVID-19 BI claims are often lower, any aggregation of claims may ultimately be the difference between claims of hundreds of thousands of pounds or multi-millions.
On that basis, it is inevitable that insurers will use any and all arguments available to them to limit the losses recoverable, presuming policyholders succeed at least in part on liability and are able to pursue the quantification of claims.
Key issues
Whilst insurers may well seek to aggregate the losses for those policyholders that have suffered large losses, there must be a proper legal and policy basis for doing so. We are not convinced that, market-wide, there is such a basis.
As a starting point, there are numerous BI policies that do not have any aggregation wording present at all. In those cases, policyholders can take some comfort depending on how the applicable limits and sub-limits are expressed.
There are others that may face arguments from insurers that suggest that throwaway comments such as “any one loss” amount to an intention to aggregate losses, even where the wording does not purport to be an aggregation clause. Such assertions are capable of being firmly rebutted.
Any application?
On one view, it might be that aggregating wording is not triggered in any event. If the wording responds in cases where there has been ‘Damage’ i.e. property damage, one might question the relevance of that wording to the non-damage linked extensions with which COVID-19 BI claims are principally concerned. If the definition of ‘Damage’ is not extended to include non-damage perils, then it may be arguable that any aggregating wording is limited to apply only to those damage-based claims.
Commercial intentions
Even if it is conceded that there is a hypothetical basis for aggregation wording applying to a BI policy, policyholders may wish to look for the commercial realities of the effect of aggregation.
Taking the example of multiple premises being insured under one policy, where the sub-limits of the non-damage BI extensions are often a lot lower than the sum insured, policyholders may reasonably arrive at the conclusion that the aggregation of its losses would result in a commercial absurdity. Policyholders might be left with entirely inadequate cover, which cannot have been what was intended by policyholders or their brokers when obtaining cover.
Policy construction and factual issues
Notwithstanding the primary arguments above, policyholders can take some comfort that there are likely to be good policy construction arguments available, which may well be supported by a proper application of the facts.
Each policy and claim will of course have to be assessed on its own merits and facts. That notwithstanding, we would encourage insureds and their brokers to very carefully consider: (a) the construction of the wording that the insurer wishes to rely on (where relevant); and (b) how the insured’s losses have actually arisen.
Close attention needs to be paid to the actual aggregating words used: clauses that purport to aggregate losses by ‘originating cause’, ‘event’, ‘occurrence’, or ‘claim’, will have very different effects, and despite a long line of case law considering the meaning and application of these terms to various facts and circumstances, their proper application in any given case remains perennially contentious.
No two losses will have arisen in the same way. Referring again to the example of a limit applying ‘any one loss’ in a policy covering multiple insured premises, it is likely implausible that the same losses will have arisen across multiple premises, at the same time, in the same way, and with the same consequences. Might the better analysis be that multiple losses and therefore claims have in fact arisen, which therefore do not fall to be aggregated?
Further Lockdowns
As we move into the next phase of the pandemic and a new era of local lockdowns and other containment measures, many recently re-opened businesses may find themselves shutting down once more. Do any losses arising as a result give rise to a new claim under the policy, or do they fall to be aggregated with any claim already submitted from the earlier national lockdown?
The answer will lie partly in the outcome of the FCA Test Case, which will give us clearer guidance on exactly how and when the various non-damage BI clauses respond, and partly on an analysis of the relevant aggregating language in the policy. No doubt further disputes will arise over whether local lockdowns and restrictions imposed in relation to localised COVID-19 outbreaks amount to independent ‘causes’, ‘events’, or ‘occurrences’, and again the outcome may make the difference between no cover and full cover for continuing losses suffered by many businesses affected by the progress of the pandemic.
In the meantime, any policyholder that is subject to new restrictions on their business that are likely to result in losses should make a fresh notification under their policy via their broker.
Comment
We remain hopeful that the judgment following the FCA Test Case will decide at least some of the issues in favour of policyholders so that claims in principle may yet fall to be indemnified. If that is right, policyholders will understandably wish to proceed as quickly as possible to the quantification, and recovery, of losses.
In circumstances where that point is nearing, and losses may begin to be crystallising as those shorter indemnity periods end, we would encourage policyholders to seek assistance from their professional advisers in presenting the losses in an accurate and appropriate way. Failure to take care in doing so only risks backfiring at a later stage.
If policyholders or their brokers would like advice on any of the issues discussed in this article, or COVID-19 BI claims generally, please do not hesitate to contact us. In addition to written material, our thoughts on these issues are also disseminated by webinar as part of Fenchurch Law’s The Associate Series.