COVID-19 Business Interruption Update: FCA Test Case First Hearing and Guidance for Insurers
First Hearing – Case Management Conference (CMC)
On 16 June the first hearing (Case Management Conference) of the FCA Test Case took place remotely at the Commercial Court. At the hearing, the court granted an order that the case will be expedited in accordance with the proposed timetable (i.e. with a final hearing from 20 July to 30 July) and that the Financial Markets Test Case Scheme will apply. The court confirmed that the case will be heard by a 2-judge panel consisting of Mr Justice Butcher and Lord Justice Flaux.
There was some early disagreement between the FCA and Insurers as to the scope of the declarations sought from the court by the FCA, in particular whether the court should make any ruling as to the actual prevalence of COVID-19 in the UK during the relevant period, and the extent to which any such finding would depend on fact and/or expert evidence. These matters will be considered further at the second CMC on 26 June.
The insurers’ Defences are due to be filed on 23 June and at that stage we will see the full extent and basis on which the insurers will resist the declarations sought by the FCA.
The second CMC will be live-streamed on 26 June via https://fl-2020-000018.sparq.me.uk/
Guidance to Insurers
The FCA’s guidance for insurers and intermediaries has now been finalised and came into effect on 17 June. It is equally useful for policyholders seeking to understand the process and how their claim may be affected. Important points to note include the following.
Summary of Test Case
In summary, the core questions that the test case seeks to resolve are:
i. issues of coverage in relation to ‘disease’ and ‘denial of access’ clauses (including any relevant exclusions); and
ii. causation (including any relevant ‘trends clause’ or equivalent wording).
The test case is not seeking to resolve, in particular:
- coverage issues relating to clauses that have an exhaustive list of diseases which does not include Covid-19
- coverage issues relating to clauses which require the disease to be present on the insured premises
- issues concerning misselling of policies
- other issues flowing from the determination of the questions in the test case such as aggregation, additional causation issues specific to loss of rent and similar claims under a property owner’s policy, and the specific quantum of any particular claims
Policy Review
Insurers are required to examine each of their relevant policy wordings to determine whether the outcome of claims under the policy will be affected by the resolution of the Test Case.
Insurers are to notify the results of their review to the FCA by 8 July. The FCA then intends to publish a comprehensive list of insurers and policy wordings that will be affected by the outcome of the Test Case.
Claims Review
The guidance also sets out quite detailed requirements for communicating with policyholders during the Test Case.
In particular, by 15 July 2020 insurers should individually notify policyholders whose claims or complaints for business interruption losses related to the coronavirus pandemic under relevant non-damage business interruption policies are outstanding or have already been declined (or had an adjustment or deduction for general causation) of:
- whether their claim or complaint is a potentially affected claim or a potentially affected complaint and the implications of that (including the FCA’s expectations of the insurer in respect of such claims or complaints under this guidance), or
- the reasons why their claim or complaint is not a potentially affected claim or potentially affected complaint, and the implications of that.
Insurers are required to continue to communicate with policyholders as and when any developments occur in the case that may affect the outcome of their claim.
Any policyholder whose claim has been declined or remains outstanding should therefore follow up with their insurer or broker if they have received no communication by 15 July at the latest.
Clock Stopped on Time Limits
Time limits for making claims or taking any other step under policies, or for making complaints to the FOS are suspended from 17 June until final resolution of the Test Case.
Whilst most claims should already have been notified before 17 June, this means that any other time limits expressed in the policy, for example in relation to proving calculations of loss, or taking action against the insurer will not apply while the test case is ongoing. That does not stop policyholders from taking such steps or pursuing their claims.
Settlement
The guidance expressly recognises that claims may be settled between insurers and policyholders while the test case is ongoing. However, when making any offer to settle, insurers should inform the policyholder about the test case and its implications. In particular, they should tell the policyholder whether the final resolution of the test case may affect the insurer’s decision about their claim, and the implications of accepting or rejecting an offer made on a full and final settlement basis.
Reassessment of Claims following Final Resolution
Upon final resolution of the Test Case, insurers should reassess all potentially affected claims, apply the judgment, and promptly inform the policyholder of the outcome of the reassessment.
Business Interruption Claims - Improving Outcomes for Policyholders
Insurers are set to pay out a record $135 billion to cover losses from natural catastrophes in 2017, driven by the costliest hurricane season ever in the United States and widespread flooding in South Asia. Extreme weather events such as recent mudslides and wildfires, as well as industrial disasters and acts of terrorism, often cause damage affecting many businesses, bringing into focus the issue of policy response for BI claims involving wide area damage.
Policy Wordings
Standard UK policy wordings provide BI cover for interference to revenues caused by loss or damage to the insured’s property (the “Incident”). The link to physical damage is maintained for purposes of the “Other Circumstances” clause, which provides that adjustments shall be made as appropriate to reflect trends in turnover affecting the business at the relevant time, so the level of indemnity represents so far as reasonably practicable the loss of profits that would have been achieved but for the Incident. This does not encompass interruption consequent upon damage within the surrounding area and is not synonymous with operation of the insured peril itself, which can give rise to anomalous results and severely limit policyholders’ recoveries.
Windfall Profits
In the aftermath of a catastrophic event causing wide area damage not all businesses will be affected in the same way. Despite a general downturn in the local economy, some businesses will experience increased demand (provided they are able to continue trading), for example builder’s merchants supplying materials for reconstruction or those catering for an influx of claims handlers, while similar operations shut down by the damage sustained may be deprived of the opportunity to enjoy such “windfall profits”. There is some reluctance by certain parts of the insurance market to agree to cover lost windfall profits, but in principle the Other Circumstances clause works both ways and policyholders should be able to invoke an upward trend in appropriate cases, subject to adequacy of the overall sum insured.
UK Legal Position
The issue of whether the Other Circumstances clause can or should be used to adjust the standard turnover to reflect trends resulting from an event causing damage not only to the insured’s property, but also to the wider geographical area, was considered by the English courts in Orient-Express Hotels v Generali [2010]. Prior to this some disputes over holiday resorts in the Far East, subject to UK policy wordings, had gone to arbitration and been variously decided both in favour of and against the respective insureds.
The Orient-Express case considered the impact of Hurricane Katrina on a luxury hotel in New Orleans, and the owner’s appeal on points of law following arbitration. In summary, the hotel suffered significant physical damage from wind and water resulting in its closure throughout September and October 2005, and partially reopened in November, albeit with limited amenities and ongoing repairs. A state of emergency had been declared and mandatory evacuation of the city ordered on 28 August, and lifted at the end of September. Insurers rejected the owner’s claim for BI losses during closure of the hotel by applying the trends clause, arguing that New Orleans was effectively closed throughout this period and the adjusted standard turnover should be zero.
The owner argued that: it was entitled to indemnity for losses caused by insured damage even if concurrently caused by damage in the vicinity (The Miss Jay Jay [1987]); a reasonable interpretation should not permit adjustment of the consequences of the same insured peril which caused the insured damage; the trends clause was effectively being treated as an exclusion, which it was not; the precise reasons for cancellations and reduced revenue were likely to be a combination of factors, which could not sensibly be separated from each other evidentially; and insurers’ position had the remarkable result that the more widespread the impact of a natural peril, the less cover is afforded by the BI policy for the consequences of damage to insured property.
The Commercial Court disagreed with these submissions, upholding the tribunal’s conclusion that a “but for” causation test was appropriate in accordance with the policy wording, so that the BI loss was to be assessed on the hypothesis that the hotel was undamaged but the city was devastated, as in fact it was. Permission to appeal was granted, however, and it was subsequently rumoured in academic circles the Court of Appeal might have taken a different view, had the case not settled by then.
US Approach
BI forms in the US generally refer to “Direct physical loss of or damage to property, including personal property in the open or within 100 feet, at premises described in the Declarations and for which a Business Income Limit of Insurance is shown in the Declarations. The loss or damage must be caused by or result from a Covered Cause of Loss”. The link to physical damage for claims involving wide area loss is not as strong as the standard UK wording.
Many US policies include a loss determination provision specifically excluding windfall profits caused by the impact of the insured peril. Nevertheless it is interesting to note the decision in Berkshire-Cohen LLC v Landmark Aon Insurance (2009), in which the claimant realty agents were successful in recovering windfall profits due to increased demand for rental properties following Hurricane Katrina, despite the exclusion clause. The reasoning was that both storm and flood damage had occurred with only the former being a covered cause of loss, and in the US (as in most of mainland Europe) flood is a contingency addressed by the government rather than by insurance. The US District Court therefore held that, whilst the exclusion applied to storm damage under which the property damage claim was presented, it did not apply to an upward trend based on flood damage.
Practical Difficulties
The UK legal position reflected in Orient-Express has been criticised as unsatisfactory for both insurers and policyholders in applying a downward trend or “windfall loss” under the Other Circumstances clause in response to wide area damage during the period when the insureds themselves were affected by their own property damage. Most policyholders expect their loss to be measured in relation to the impact of the event that caused both damage at their premises and more widely, and consider arguments otherwise to be unjust and artificial.
Furthermore, this is in contrast to the approach adopted by the UK market following previous incidents including the City of London bombing in 1992, and severe Cumbrian flooding in 2009. In Cockermouth all businesses on Main Street were submerged to a depth of six feet or more and reconstruction works continued for around six months. A strict application of Orient-Express would have resulted in limited if any BI cover for individual insureds, who would have suffered a severe downturn irrespective of their own damage. Although the reduction might be offset in some cases by windfall profits and “non-damage” denial of access/loss of attraction extensions, subject to inner policy limits, such an outcome seems paradoxical at best and would have been reputationally damaging for insurers.
Potential Solutions
As firms become more exposed to major disasters and subsequent business interruptions as a result of increasingly complex global networks, improvements are required to ensure optimal coverage and effective risk management. It seems that insurers always intended to pay for losses that insureds would have suffered based on their own damage and challenges remain for the market to develop suitable wordings fully consistent with this approach, avoiding punitive application of the “but for” test in wide area damage scenarios that does not reflect well on the industry.
Amy Lacey is a Partner at Fenchurch Law
Bluebon Ltd (in liquidation) – v – (1) Ageas (UK) Ltd (2) Aviva Insurance Ltd (3) Towergate Underwriting Group Ltd (2017)
What was the proper construction of an electrical installation inspection warranty?
Bluebon Limited (‘Bluebon’) brought proceedings against their insurers, Ageas and Aviva (‘the Insurers’), and their broker, Towergate, following a fire at their premises at the Star Garter Hotel, West Lothian (‘the Hotel’) on 15 October 2010.
Bluebon had purchased the Hotel in December 2007, and the relevant insurance policy (‘the Policy’) incepted on 3 December 2009, for a period of 12 months.
The Policy contained the following Electrical Installation Inspection Warranty (‘the Warranty’):
“It is warranted that the electrical installation be inspected and tested every five years by a contractor approved by the National Inspection Council for Electrical Installation (NICEIC) and that any defects be remedied forthwith in accordance with the Regulations of the Institute of Electrical Engineers.”
The last electrical inspection at the Hotel had taken place in September 2003.
The insurers asserted that there had been a breach of the Warranty since no inspection had been carried out in the 5-year period immediately prior to inception, with the result that the Policy was either voided or suspended from inception.
At a hearing of preliminary issues, the Judge, Mr Justice Bryan, was required to determine the following:
- The proper construction of the Warranty – was the five-year period to be calculated from the date of the last electrical inspection, or from Policy inception?
- Was the Warranty a True Warranty, a Suspensive Warranty, or a Risk Specific Condition Precedent, and what was the consequence of a breach?
The First Issue
The Insurers argued that the natural meaning of the Warranty was that the 5-year period had to be calculated from the date of the last inspection, and, if no inspection had been carried out in the last 5 years, the inspection would have to be undertaken prior to or immediately upon inception (with there being no cover until such inspection had taken place). In support of that analysis, they said that the Warranty did not require the inspection to occur within 5 years of inception, and that a reasonable person, having all the background knowledge available to the parties, would know that inspections needed to be undertaken regularly.
Bluebon argued, perhaps optimistically, that the proper construction of the words “be inspected and tested every five years” meant “every five years starting with the date of imposition of the stipulation” i.e. from Policy inception. In support, Bluebon said that the language of the Warranty was “forward-looking”, and that if the Insurers had intended otherwise, the Policy could have stated “has been inspected and tested” or “is inspected and tested.”
The Judge found that Bluebon’s construction made no commercial sense in the context of a 12-month policy, and rendered the Warranty meaningless, since there would be no requirement for an electrical inspection until (at least) after the fourth annual renewal. This provided no protection from the risk of fire and, unsurprisingly, Bluebon’s construction was rejected. It followed that Bluebon had not complied with the Warranty.
The Second Issue
The Insurers’ primary case was that the Warranty was a True Warranty i.e. a term which took effect as a condition precedent to the existence of any cover, such that the breach rendered the Policy void from inception. Alternatively, they said the warranty was a Suspensive Warranty, which had the effect of suspending cover during the period of the breach. Neither construction required a causal link between the breach and the fire, and, accordingly, the Insurers asserted that they had no liability to Bluebon.
Bluebon, by contrast, argued that the Warranty was a ‘Risk-Specific Condition Precedent’ i.e. a term which required compliance as a condition precedent to the Insurers’ liability to provide cover in respect of risks relating to the electrical installation. Put another way, Bluebon said that unless the fire was caused by the electrical installation, their breach was irrelevant.
The Judge again rejected Bluebon’s argument, finding that it would be entirely unbusinesslike for the Warranty to suspend cover in respect of losses arising from defects in the electrical installation (pending inspection of the installation), but not for losses arising out of the fire generally. The Judge’s interpretation was that, while the Warranty was breached, there could be no cover for any losses arising out of fire.
Having regard to his findings on the proper meaning of the Warranty, the Judge found that the Warranty was a Suspensive Condition.
Insurance Act 2015 implications
Although the outcome in Bluebon may not be particularly surprising, it is interesting to consider whether it would have been decided differently under the Insurance Act (‘the Act’).
The Act does not change what an insurance warranty is, but does change the effect if breached. Under Section 11 of the Act, an insured will be protected in the event of a breach of warranty. Providing that it can show that the term was ‘totally irrelevant to the loss’ i.e. the breach “could not have increased the risk of the loss which actually occurred in the circumstances in which it occurred.”
There are two interpretations of how Section 11 might have applied in Bluebon (or for that matter generally), both of which have been postulated by the Law Commission.
Under the ‘non-causation’ interpretation, the Insurers would have been entitled to rely upon the breach of the Warranty, because the absence of an electrical inspection might have made a difference, given the type of loss that occurred i.e. a fire. It would not have been open to Bluebon to argue that the fire would have started even if the electrical inspection had taken place.
Under the ‘causation’ interpretation, it would have been open to Bluebon to establish that the fire was due to some other cause, so that the Insurers would be liable under the Policy. That is because, in that scenario, the ‘circumstances’ of the loss were such that compliance with the Warranty would not have made any difference.
Of course, unless and until the true meaning of Section 11 is determined by the Courts (and, given its importance, the point is likely eventually to end up at the Supreme Court), the interpretation will doubtless remain a matter for debate.
Alexander Rosenfield is an associate at Fenchurch Law
Insurance Act 2015: Some Insurers Crying Foul
When the Insurance Act 2015 came into force in August 2016, it was hailed as the biggest reform of this area of law in over a century. The old law had been criticised by the Law Commission as “out of date” and “no longer reflecting the realities of today’s commercial practices”.
The Act addressed those criticisms head-on. It repealed the archaic “duty of utmost good faith” and created a new, fairer, “duty of fair presentation” designed to clarify precisely what is required from policyholders during the disclosure process, and to increase the burden on Insurers to ask the right questions about the risk they wish to write.
Likewise, the Act softened many of the harsh remedies available to Insurers under the pre-Act regime. Where policyholders innocently omitted to disclose a material piece of information (for a wide variety of unfortunate, but quite understandable, reasons), the old law afforded Insurers the draconian remedy of avoiding the policy in its entirety, even if they would have still written the risk in one way or another.
The Act, on the other hand, asks the very sensible question brokers and coverage lawyers have been asking for decades, which is: “What would you have done had you known?”. If the Insurer would have written the risk in any event, the Act’s new system of proportionate remedies provides a more measured redress mechanism to alter policy terms or the premium retrospectively to reflect what ought to have happened in the absence of the Insured’s oversight.
Uncertainty for Brokers and Policyholders
On the face of it, therefore, the Act generally works in favour of policyholders. However, as with all change (even one for the better), the move from a complex, but established, body of law to a more rational, but nonetheless new and untested, set of rules has created much uncertainty for brokers and their clients over the past six months.
In particular, many brokers now ask themselves and their advisors: “Does the Act really put my clients into a better position than they were in under the old law, and, if not, can I use the prevailing market conditions to improve their position in some way?”
The answer, of course, is that it in many cases the Act puts Insureds in a worse position than under the old law, leaving brokers with the challenge of finding an appropriate solution to protect their clients’ interests.
The best (and most controversial) example of this is the use of “Innocent Non-Disclosure” clauses on certain lines of business. Pre-Act, clauses such as the following were largely uncontroversial and commonplace protections against the risk of avoidance:
“Insurers shall not avoid this Policy as a result of any non-disclosure or misrepresentation by the Insured save in respect of a fraudulent non-disclosure or misrepresentation”.
In other words, under the old law Insurers were prepared (for a variety of reasons, not least their eagerness to write business) to agree that nothing short of a fraudulent non-disclosure or fraudulent misrepresentation would give them opportunity to remove that client’s cover in its entirety.
Under the Act’s new proportionate remedies regime, even an innocent breach of the duty of fair presentation might, for example, entitle Insurers to retrospectively increase an Insured’s premium significantly, or to exclude the type of loss that has unearthed the innocent non-disclosure. In the absence of an Innocent Non-Disclosure clause (tweaked to reflect the new order of things), an Insured therefore has far less protection on certain lines than they might have secured in previous years.
Tension between Brokers and Insurers
It is unsurprising, therefore, that many brokers have continued to insist on the inclusion of Innocent Non-Disclosure clauses (as well as a variety of other protections) to ensure that their clients remain protected against non-disclosure remedies under the Insurance Act, much as they were protected under the old law. The reality is that Insurers today continue to compete fiercely, and many are therefore prepared to maintain these same protections afforded to Insureds that were available when the old law applied.
Many Insurers, however, have cried foul-play, arguing that these clauses should no longer be necessary in the post-Act world. Some go further and argue that taking advantage of soft market conditions to include them is in some way “unfair” to Insurers, given the Insurance Act was designed to “level the playing field”.
Such arguments are unlikely to hold water with brokers. One of the principal reasons the Law Commission recommended changing the law was to ensure that the rights generally afforded to Insurers on all lines of business reflected the realities of today’s market practice. Changing the inherent dynamics of the market was never on the agenda. If soft market conditions mean that Insurers, in competing for business, remain prepared to offer greater certainty and protection to Insureds, then brokers are duty bound to try and secure those things for their clients.
Conclusion
Under the pre-Act regime, the balance of power lay firmly with Insurers. At worst, policyholders might have found themselves without cover for either perfectly innocent non-disclosures or for breaches of terms wholly irrelevant to a particular loss. Market conditions pre-Act gave brokers the ability to protect their clients from those harsh remedies.
While those remedies no longer exist, brokers will continue to use those same market conditions to find ways to eliminate some of the uncertainty the Act has created. Some Insurers will see that as the insurance market working as it should. Others will say that gaining such protections flies in the face of the spirit of the Act.
To those latter Insurers, I can only assure them their own brokers are very probably striving to achieve precisely the same protections for those Insurers’ own exposures. Every cloud?
James Morris is a senior associate at Fenchurch Law.
Third Parties (Rights Against Insurers) Act 2010
The Third Parties (Rights Against Insurers) Act 2010 which received Royal Assent on 25.03.2010 has amended previous legislation governing the relationship between insurers and claimants. Its intention is to make it easier, quicker and cheaper to make a claim against the insurers of insolvent defendants.
The previous Act required a claimant to establish an insolvent defendant’s liability before being able to pursue a claim against insurers. This meant issuing proceedings against the defendant before being able to issue (separate) proceedings against the insurer. The 2010 Act now allows claimants to issue proceedings directly against the insurer in which all issues, including the defendant’s liability, can be established.
Insurers are now no longer entitled to rely on conditions in the policy made impossible by the insured’s insolvency or terms which render the policy ineffective due to the insured’s insolvency. The insurer is still though entitled to rely on defences against the claimant which it could have used against its own insured.