Calculating Losses for Covid-19 Business Interruption Claims

Much of the analysis concerning COVID-19 business interruption coverage has focused on whether insurers have an obligation to pay — and not on how much they should pay.[1] But attention must be paid.

The loss determination provisions of business interruption policies are susceptible to competing interpretations and sensitive to specific factual predicates. A policyholder therefore should prepare loss submissions that carefully model its lost profits against the policy language and applicable legal notions of causation and proof. Insurers should be prepared to defend based upon the same considerations. A discussion of these considerations follows.

A. Background

Business interruption losses generally are calculated by measuring the profits a business would have earned had certain real life events not occurred. When business is interrupted after catastrophic events such as hurricanes, floods or pandemics, two different counter-factual cases can be posed against which to measure losses.

In the first, loss is measured against a hypothetical case in which the catastrophic event itself never had happened, and business continued as it had prior to the event. Under that hypothetical, losses are measured by the business’ predisaster, historic profits level.

In the alternative, loss can be measured against a hypothetical case in which the disaster did happen, but the business remained open. In this hypothetical case, losses are measured taking account of postloss economic conditions.

Depending upon circumstances, these alternative hypotheticals may inure to the benefit of either the insurer or the policyholder. In some instances, a disaster may create favorable post-loss economic conditions for the affected business.

For example, a hurricane may produce increased sales for a home-repair store that was open for business. In those circumstances, policyholders might advocate that post-loss conditions be considered when calculating business interruption losses.

In other instances, the converse is true; a disaster may create unfavorable post-loss economic conditions, such as where demand for the business would have been diminished by the disaster if the business had remained open. In those circumstances, insurers might advocate that post-loss conditions be considered.

B. The Policy Terms

Any analysis of whether loss measurement should account for post-disaster economic circumstances would begin with the policy language. Policyholders suffering COVID-19 business interruption damages typically look to both direct damage business interruption coverage and civil authority coverage.[2]

Business Interruption coverage typically covers direct physical loss or damage that causes a suspension or curtailment of business. It pays until the property is repaired or business resumes at a new location. Civil authority coverage applies when physical loss or damage to property other than the covered property spurs civil authorities to prohibit access to the insured’s property. Commentators disagree whether COVID-19 damages trigger these coverages.[3]

Policies also frequently include a loss determination provision detailing how business interruption loss is to be determined. A typical loss determination provisions says that the amount of business interruption loss will be determined based on (1) the net Income of the business before the loss; and (2) the likely net income had no physical loss occurred. (As discussed below, the loss determination provisions also may contain a favorable conditions clause, which excludes from the lost profit calculation any increase in profits resulting from favorable post-loss business conditions.[4])

The phrase “had no physical loss occurred” in the loss determination provision is frequently the focus of post-disaster disputes. Parties that seek to recover losses based on post-disaster economic conditions frequently seize on the “physical loss” language of this phrase.

They argue that the only counter-factual circumstance to be measured is that in which the physical loss to the property itself did not occur; and that the phrase does not contemplate measuring a counterfactual circumstance in which the disaster had not occurred. Had the policy so intended, they argued, the policy should have so specified by saying: “had the disaster not occurred.”

In contrast, parties who wish to look to preloss economic conditions (i.e. historical profits) as the intended measure argue that the policy did not intend to distinguish between the intertwined events of the disaster and the loss. They assert that such a distinction, while theoretically valid, is not meaningful in the context of a catastrophic event, and that the appropriate measure of loss is one in which the catastrophic event did not occur at all.

C. Interpreting the Policy

1. Policyholders Should Recover at least Historical Profits.

The majority of courts to have addressed the issue, including the U.S. Court of Appeals for the Fourth Circuit and U.S. Court of Appeals for the Fifth Circuit, have held that, when large-scale disasters strike, the standard policy language is interpreted so that loss is measured at a minimum by a business’ historical profits rates, even if, had the business reopened sooner (or not been damaged), its actual profits during the recovery period would have been lower.

In Finger Furniture Co. Inc. v. Commonwealth InsuraCo.,[5] Tropical Storm Allison forced the plaintiff furniture store to close for a weekend. The following weekend, Finger Furniture slashed its prices, and sales (and net profits) soared. The insurer sought to offset the losses from the closure by the extra profits Finger Furniture earned the following weekend.

The Fifth Circuit rejected this argument, holding that “the contract language does not suggest that the insurer can look prospectively to what occurred after the loss to determine whether its insured incurred a business-interruption loss.”[6]

The Fifth Circuit expounded again on the standard policy language in Catlin Syndicate Ltd. v. Imperial Palace of Mississippi Inc.[7] Imperial Palace involved a casino forced to close due to damage from Hurricane Katrina. The casino reopened before others did, which produced a significant increase in revenues. The casino then argued that its loss calculation should be based on its increased, post-loss revenue.

The Fifth Circuit rejected the argument, relying extensively on its holding in Finger Furniture and expanding on its reasoning in that case. The court “decline[d] to interpret the policy” in a manner that “disentangle[d] the loss from the occurrence and determine[d] loss based on a hypothetical in which … the occurrence occurred but the loss did not,” since the two were “inextricably intertwined under the language of the business-interruption provision.”[8]

The Fourth Circuit in Prudential LMI v. Colleton Enterprises[9] adopted the same interpretation of the relevant policy[10] as had the Fifth. In Colleton Enterprises, an unprofitable motel suffered damage from Hurricane Hugo. At the same time, Hugo had increased demand in the area for hotel rooms and such demand allegedly would have made it profitable. As in Finger Furniture, the majority opinion held that damage would be determined based upon what would have happened if the hurricane itself had not occurred.

Thus, under Finger Furniture, Imperial Palace and Colleton Enterprises, the standard policy language is interpreted so that the reimbursable loss should be measured at a minimum by historical profit rates.

2. There May Be Factual and Legal Bases for Recovering Damages Based on Post-Covid-19 Favorable Business Conditions.

Some policyholders may wish to argue that they are entitled to measure losses based on favorable business conditions that evolved for them after the onset of COVID-19. For policyholders with a standard policy form, such an argument would find support in Judge Hall’s dissenting opinion in Colleton and a few similar opinions.[11]

Writing in dissent in Colleton Enterprises, Judge Kenneth Keller Hall asserted that the phrase “had no loss occurred” in the loss determination provision required the insurer to calculate loss based on a hypothetical that the loss had not occurred, rather than a hypothetical in which the hurricane had not occurred.

In the case of the Colleton Enterprises motel, he held the policy should be interpreted to allow a policyholder to calculate damages as if the hurricane had occurred but damage to the motel had not occurred, allowing the motel to recover additional money (topping up its recoverable profit rate) based on favorable post-loss conditions. Under Judge Hall’s dissent, a policyholder would be allowed to top up its recoverable profit rate based on favorable post-loss economic conditions.

Some policies include, however, a “favorable conditions clause” in the Loss Determination provision which provides that damages should be calculated based upon:

The likely Net Income of the business if no physical loss or damage had occurred, but not including any Net Income that would likely have been earned as a result of an increase in the volume of business due to favorable business conditions caused by the impact of the Covered Cause of Loss on customers or on other businesses;

Policies with such clauses might effectively limit recoverable losses to historical profits. In contrast, the absence of this widely used clause would imply that the policyholder may recover amounts based on post-Covid-19 favorable business conditions.

Policies with such clauses might effectively limit recoverable losses to historical profits. In
absence of this widely used clause would imply that the policyholder may recover amounts based on post-COVID-19 favorable business conditions.

Policyholders whose policies diverge from the standard policy language may find additional support in their policy language for recovering favorable-conditions profits. In Levitz Furniture Corp. v. Houston Cas. Co.,[12] for example, the court interpreted a loss determination provision that provided for calculating the loss as if “no interruption of production or suspension of business operations or services occurred.”

This loss calculation provision differed from the policy language in Finger Furniture, Imperial Palace and Colleton Enterprises, which calculate the loss as if “no physical loss occurred.” The court interpreted the relevant policy language to authorize Levitz to recover based upon the increased furniture sales it would have made due to favorable post-flood business conditions.

3. Recoveries for Covid-19 Losses Should Not be Reduced Due to Unfavorable Post-Loss Market Conditions.

Some insurers may wish to argue that, because of the general downdraft of the economy, policyholders are not entitled to be reimbursed based on their historical profit levels. They may argue that because policies indemnify for actual loss — and are not performance bonds providing for a guaranteed profit level — the actual lost business should be calculated factoring in the broader adverse economic conditions.

They too might seek support from Judge Hall’s dissent in Colleton Enterprise and similar cases by arguing that the standard policy language is best interpreted to measure loss based on a hypothetical in which the disaster occurred but the business was not physically harmed. Such an interpretation would dramatically reduce reimbursement for many COVID-19 business interruption claims.

This argument appears to conflict with a policy provision in the standard policy’s extended business income coverage. Extended business income coverage provides additional coverage for the period after business operations have resumed (and business interruption coverage has terminated), but before income has returned to its previous levels. For that coverage only, the standard policy provides that:

Extended Business Income does not apply to loss of Business Income incurred as a result of unfavorable business conditions caused by the impact of the Covered Cause of Loss in the area where the described premises are located.

The existence of this specific provision for extended business income coverage only should preclude using unfavorable post-disaster economic conditions to reduce covered losses for business interruption claims.

There is another reason that policyholders’ historical profits should not be reduced by unfavorable-conditions losses. Even assuming arguendo that post-disaster conditions were a cause of a policyholder’s business interruption losses, there is a compelling argument that damage to the property is a sufficient cause of a policyholders loss of historical profits, and therefore should be reimbursed.

In Orient Express Hotels Ltd. v. Assicurazionia General SPA[13] from the Queens Bench in London, Orient Express Hotels was owner of a premier hotel in the Central Business District of New Orleans; the hotel and business district both were devastated by Hurricanes Katrina and Rita.

The insurer argued that the post-hurricane unfavorable conditions should form the basis of the damages calculation because the loss for which it indemnifies is only that shown to be the result of the covered damage; it argued the policyholder could not disentangle its loss from covered perils from the more general loss it would have suffered from the complete fall off in tourism following the disasters.

The policy at issue in OEH included a trends clause that required that losses be measured by the results which would have been obtained “but for the damage.” The court interpreted the “but for the damage” provision to mean that OEH was required to establish a causal connection between the damage to the hotel and any loss of business — similar to Judge Hall’s interpretation of the standard policy.

In OEH, the court found, the damage to the hotel could not be proven to be a “but-for” cause of the loss because even absent that damage, the damage to the surrounding area would have produced an identical loss.

The court recognized that the harshness of its failure-of-proof rationale could be overcome by showing that fairness and reasonableness required that the but-for test should not be applied. It invited more specific showings of a more generous underwriting intent or market practice. It nevertheless applied the but-for test both because of the specific “but-for” language of the particular policy, and the policyholder’s failure to adduce any facts in support of the more generous standard before the fact finder.

While OEH is of no precedential value in U.S. jurisdictions, the decision highlights that even when unfavorable post-disaster events contribute to business loss, full historical profits may be available under an appropriate causation analysis.

D. Loss Submissions Should Account Carefully for Policy Language and Legal Duties.

The materials above highlight the need for policyholders to account for their specific factual circumstances, policy language and relevant legal precedent in crafting their loss submissions. In OEH, for example, the policyholder’s recovery was significantly reduced due to its failure at the outset of the case to support adequately the interpretive rationale for its loss calculation.

A similar failure of proof infected the policyholder’s case in Bros. Inc. v. Liberty Mutual Fire Insurance Co.[14] In that case, the District of Columbia Court of Appeals held that a curfew resulting from rioting after Martin Luther King Jr.’s murder was not covered by business interruption insurance because the policyholder had failed to show physical damage to the premises or to adjacent property. Had the policyholder established at the outset the legal and factual basis for relating physical property damage to its property losses, it might well have prevailed in the case.

E. Conclusion

“A wise person,” Ecclesiastes says, “has eyes in his head; a fool walks in darkness.” Policyholders who have focused on coverage triggers need also to focus on showing the resulting covered loss.

When preparing loss submissions, they need carefully to model their lost profits against the policy language and applicable legal notions of causation and proof in order to maximize recovery. Insurers, in turn, should carefully consider the same issues when evaluating and defending against a claim. Absent such consideration, they may be as those who walk in darkness.