Business Interruption Insurance

For Damage to Other Property†

Alan R. Miller

Introduction

This article addresses business interruption issues in circumstances where interruption is caused by physical damage to property other than insured property. Specifically, my focus is on coverage for contingent business interruption, ingress/egress, and denial of access by civil authority.

Following September 11th, many businesses found that their customers or suppliers were unable to continue to do business because of the physical damage sustained by those customers or suppliers. If these insureds had contingent business interruption coverage, they were able to look to that coverage as a potential source of recovery.

Some insureds have also presented claims for denial of access. They have predicated these claims on the closure of airports or the closure of certain means of access such as bridges and tunnels. Each case must be looked at individually. Consideration should be given to whether access was in fact impossible to the specific insured property, and the cause of any actual prevention of access. Initial information indicates that many of these claims do not meet the predicates of the coverage.

Both contingent business interruption and ingress/egress claims have benefited very little by way of case law analysis. This article addresses all of the recent reported coverage decisions on point.

II. Contingent Business Interruption

Contingent business interruption insurance protects the earnings of the insured following physical loss or damage to the property of the insured’s suppliers or customers, as opposed to its own property. A distinguishing characteristic is that the risk of insured physical damage rests with the insured’s suppliers or customers who have no contractual relationship with the insurer, at least with respect to the policy issued to the insured.

Contingent business interruption insurance is becoming more important in today’s commercial world as companies increasingly out-source component part manufacturing and rely upon so-called “just in time” inventory systems. It also protects insureds with a limited customer base by protecting the insured’s earnings against the contingency of a covered loss that prevents a key customer from accepting the insured’s products.

Contingent business interruption coverage exists in different forms in many policies and is most often found in policies drafted by brokers. It is still a relatively novel coverage. The absence of such coverage can be significant as demonstrated in Air Liquide America Corp. v. Protective Mutual Insurance Co.[1] There, the insured manufactured product using raw materials from a fertilizer manufacturer on adjoining premises. Both the insured’s property and the fertilizer plant were severely damaged by an explosion at the fertilizer plant. Because of the damage to the fertilizer plant, the insured would not have had any raw materials for its products, even if the insured’s property had not been damaged. The policy contained an idle periods clause providing that no coverage existed during any time when the business would not have continued for any reason other than insured physical damage. The court applied this clause and held that the insured could not recover on its business interruption policy. The court noted, however, that if the insured had purchased contingent business interruption coverage for this business, the result would have been different. It is easy to transport the theory of this case to other situations involving a large area of destruction, including September 11th.

A. Business Interruption v. Contingent Business Interruption Coverage

The primary distinction between business interruption coverage and contingent business interruption coverage is the insured’s relationship to the damaged property that causes an interruption to the business of the insured. As described below,[2] the perils insured against in both cases are those covered by the insured’s own policy, not those covered by any policies purchased by the insured’s customers or suppliers.

As in any insurance case, it is essential to consult the actual policy language involved when evaluating coverage issues. With that caveat, I will describe the general language used in the ISO forms.

B. The ISO Form

The ISO “Business Income from Dependent Properties-Broad Form” provides:

We will pay for the actual loss of Business Income you sustain due to the necessary suspension of your “operations” during the “period of restoration.” The suspension must be caused by direct physical loss of or damage to “dependent property” at a premises described in the Schedule caused by or resulting from any Covered Cause of Loss . . . .[3]

Note that “direct physical loss or damage” must occur to “dependent property” that is scheduled within the policy itself. If the “dependent property” is not scheduled, the coverage grant is significantly limited as follows:

C. The following is added to ADDITIONAL COVERAGES:

Miscellaneous locations. We will pay for the actual loss of Business Income you sustain due to direct physical loss or damage at the premises of a “dependent property” not described in the Schedule caused by or resulting from any Covered Cause of Loss. But we will not pay more than .03% of the Limit of Insurance for each day’s suspension of “operations” due to loss arising from any one location.[4]

C. Dependent Property

The ISO form identifies four types of dependent property. These are contributing locations, recipient locations, manufacturing locations, and leader locations. Each will be discussed in turn.

1. Contributing Locations

Contributing locations deliver materials or services to the insured, or to others for the insured’s account. Utility services (i.e., water, communication, or powers supply services) are excluded from this definition, although contingent coverage is available for utility interruption via a separate “Utility Services-Time Element” endorsement.

A contributing location lies “upstream” of the insured’s production process and usually is a key supplier of component parts, raw materials, or services to the insured. The insured’s operations generally are dependent upon receiving the product or service of the contributing location. For example, a computer company that sells complete desktop computer systems might consider the manufacturers of the keyboards or monitors to be contributing locations.

A contributing location can also provide a service. Using the foregoing example, the computer company could engage an assembly company to assemble various computer components on its behalf so that the computer company can ship complete systems to its end users. If the assembly company’s facility is destroyed, it may no longer be capable of assembling the computer systems, thus impairing the ability of the computer company to ship completed systems to its own customers.

2. Recipient Locations

Recipient locations are those that accept the insured’s products or services. A recipient location lies “downstream” of the insured’s operations and is usually one of the insured’s prime customers. If the recipient location sustains a loss, the insured may lose a principal outlet for its products or services.

The keyboard or monitor manufacturers or assembly companies in the foregoing examples might consider the purchasing computer company to be a recipient location worth insuring, particularly if they have few or no other customers for their products or services.

3. Manufacturing Locations

A manufacturing location produces products for delivery to the insured’s customers under contract of sale. For example, assume that the computer company does no manufacturing of its own, but simply acts as a sales clearinghouse for a variety of different computer systems. Orders are taken from customers and then placed with the various computer manufacturers who, in turn, manufacture computers to specification for the computer sales company to ship to its customers.

A fire at a particular manufacturer’s facility could prevent that manufacturer from supplying the ordered computers to the computer sales company’s customers. Contingent business interruption coverage for damage to property at a manufacturing location thus provides some measure of recovery for sales lost due to the insured’s inability to supply a particular type of computer system to its customers.

4. Leader Locations

Leader locations are other businesses that attract customers to the insured’s business. The businesses need not be related; indeed, they usually are not. The leader location is typically located in the vicinity of the insured and attracts customers to the insured’s business as well as its own.

The typical leader location is the so-called retail “anchor tenant.” For example, a large department store might attract a variety of customers to a strip mall that is also occupied by several other, smaller tenants. Without the department store, general customer traffic in the area would diminish, leading to reduced sales. One of the smaller retail stores may designate the department store as a leader location to protect itself against the contingency that a loss to the department store will result in reduced customer traffic and sales to the smaller retailer.

D. Other Policy Forms

Some policies refer generally to the “suppliers” and “customers” of the insured. An example of such language is:

This policy covers against loss of earnings and necessary extra expense resulting from necessary interruption of business of the insured caused by damage to or destruction of real or personal property, by the perils insured against under this policy, of any supplier of goods or services which results in the inability of such supplier to supply an insured location.[5]

This policy language was the subject of a coverage dispute in Archer-Daniels-Midland Co. v. Phoenix Assurance Co.[6] (“ADM”). The case dealt with the operation of a contingent business interruption endorsement in the aftermath of extensive flooding in the American Midwest during the summer of 1993. Archer Daniels Midland is a large industrial entity that processes farm products for both international and domestic consumption. In an extremely broad construction of contingent business interruption coverage, the ADM court held the U. S. Army Corps of Engineers, the U. S. Coast Guard, and the generic group of “Midwest farmers” to be “suppliers of goods and services” to the insured company.

This decision may reflect an approach to coverage far beyond that contemplated by the parties. It certainly minimizes the requirements to become a “supplier.” However, because it is not an appellate level decision, its effect should be limited. The decision also left open several issues of fact. One of these is the question of whether the physical damage to the suppliers’ property in fact caused the interruption of the insured’s business. For example, the river might have been moving at such a velocity that shipping would have been prohibited even without any physical damage. If so, there would be no business interruption directly caused by the physical damage, and therefore no coverage.

Moreover, in an unpublished memorandum dated September 9, 1997, the court partially reversed its prior decision, reformed the policy’s extra expense coverage part, and limited the insured’s recovery to extra expense stemming from damage solely to property owned by the insured. The ruling did not affect the business interruption claim itself.

E. Insured Perils

A very important consideration in contingent coverage is that nearly all such policies require that the cause of damage and the type of damage to the dependent property be the same as would be covered for the insured’s own property. For example, if a latent defect is not covered under the insured’s policy, there would similarly be no coverage under the contingent business interruption endorsement for a latent defect in the supplier’s or customer’s property. The ISO forms provide specifically that the business interruption must result from a “Covered Cause of Loss.”[7]

F. The Period of Restoration

Coverage exists only for the period of restoration. This period is described in the ISO contingent business interruption form as follows:

“Period of Restoration,” with respect to “dependent property,” means the period of time that:

a. Begins 72 hours after the time of direct physical loss or damage caused by or resulting from any Covered Cause of Loss at the premises of the “dependent property;” and

b. Ends on the date when the property at the premises of the “dependent property” should be repaired, rebuilt or replaced with reasonable speed and similar quality.[8]

Like the usual business interruption coverage, the period of restoration is initially a theoretical period. The theoretical period is the length of time needed to replace or repair the damaged property in the exercise of due diligence and dispatch, starting seventy-two hours after the loss.[9] Thus, the insured will not recover for any additional contingent business interruption loss beyond the theoretical period in the absence of expanded business income (extended period of indemnity) coverage.

The theoretical period can terminate while the insured is still losing sales. By way of example, assume that a fire at the contributing location of a keyboard supplier results in the inability of that supplier to provide keyboard components to an insured computer manufacturer. Also assume that a duly diligent keyboard supplier could repair its facility in sixty days. The theoretical period is limited to sixty days after the fire. Even if the keyboard manufacturer completes the repairs and restarts production in the sixty days, the insured may still face a “pipeline” problem. That is, even though the manufacturer is up and running, the insured may still not receive keyboards for days or weeks after the supplier restarts its business. The theoretical period in the contingent business interruption coverage does not account for any delays between the manufacture of the contributing products and their actual arrival at the insured’s facility. [10]

The length of the “pipeline” delay can depend upon any number of factors, such as delays in distribution, allocation problems, transportation issues, and the like. It may be wise for the insured, therefore, to purchase extended period of indemnity coverage to fully protect itself against a contingent business interruption loss and a resulting pipeline delay.

G. Contingent Extra Expense Coverage

Coverage for contingent extra expense is available with similar provisions to the contingent business interruption coverage. Extra expense is defined in the ISO form as follows:

Extra Expense means necessary expenses you incur during the “period of restoration” that you would not have incurred if there had been no direct physical loss of or damage to the premises of any “dependent property” described in the Schedule caused by or resulting from a Covered Cause of Loss:

a. To avoid or minimize the suspension of business and to continue “operations;” or

b. To minimize the suspension of business if you cannot continue “operations.”[11]

Coverage for the same four types of dependent properties is available, with a coverage grant that provides:

We will pay the necessary Extra Expense you incur due to direct physical loss of or damage to property at the premises of a “dependent property” described in the schedule caused by or resulting from any Covered Cause of Loss.[12]

Note, however, that the seventy-two hour waiting period described in the definition of “period of restoration” in the ISO contingent business interruption endorsement form is not present in the ISO contingent extra expense coverage.

III. Ingress/Egress and Civil Authority Coverage

In addition to contingent business interruption, there are other policy coverages that may be obtained for circumstances where there is direct physical damage, but the damage is not to property owned by the insured. This coverage originated in the civil authority clause that has been in the policy for decades. Some recent forms, however, have also inserted coverage for prevention of ingress/egress and do not require that the prevention be due to civil authority.

Five courts have recently addressed civil authority or access claims. The first dealt with a bridge closure; the second dealt with closure of roads following a hurricane; the third involved the closure of airports following terrorist attack of September 11th; the fourth dealt with the closure of the theatre staging Cabaret; and the fifth dealt with the evacuation of Brevard County, Florida following Hurricane Floyd in 1999.

A. Magnolia Lady - No Prevention of Access

The first decision, St. Paul Mercury Insurance Co. v. Magnolia Lady, Inc.,[13] involved a casino and hotel in Lula, Mississippi. On July 16, 1997, a barge struck and damaged the Mississippi River bridge at Helena, Arkansas. As a result of the barge collision with the bridge, Arkansas state authorities closed the bridge for nineteen days to make repairs. The casino was able to continue operating, but claimed to have sustained an eighty percent decrease in business. Access was available to the casino/hotel, and no physical damage was sustained by the insured because of the bridge closure.

The case involved the interpretation of the civil authority clause rather than an ingress/egress clause, but it is instructive because the decision focused on the denial of access language. It established the need for an actual prevention of access and held that if access is only diminished, there will be no coverage. The court first rejected a claim under the business interruption coverage because of the absence of the physical damage to the insured property, and then addressed a claim for interruption by civil authority. The policy provided:

We will pay your actual loss of earning and expense (business income and necessary extra expense) when a Civil Authority like a fire department denies access to the described location because of direct physical loss or damage to property by a covered cause of loss other than at the described location. We’ll pay for loss up to two consecutive weeks while access is denied.[14]

The court focused on the phrase “denies access,” and in denying coverage, stated:

The plain and common definition of “deny” is to “refuse to grant” or “withhold.” Upon applying these definitions to the insurance policy, it is clear to see that there was no denial of access to the defendant’s casino-hotel. The defendant’s casino-hotel was accessible during the period of time the bridge was under repair, and the defendant continued operating business and accepting customers. Contrary to the defendant’s assertion that customers from Arkansas were denied access, access was never totally denied because customers from Arkansas could have gained access from the Mississippi side of the bridge.[15]

The case is a clear statement of the fact that ingress/egress coverage does not apply when access is still possible, even though it may be affected by physical damage.

B. Fountain Powerboat - Applied to Extended Period of Indemnity

The coverage was also discussed in Fountain Powerboat Industries, Inc. v. Reliance Insurance Co.[16] There, the damage from hurricane Floyd led to closure of roads. The policy provided:

Loss of Ingress or Egress: This policy covers loss sustained during the period of time when, as a direct result of a peril not excluded, ingress to or egress from real and personal property not excluded hereunder, is thereby prevented.[17]

The opinion states that the only road to the plant was closed for approximately ten days because of the flood. The insurer apparently did not contest coverage for the period during which the only road to the plant was closed. The insurer did challenge the claim for extended period of indemnity after access was regained. Under the specific language involved, the court found coverage for the loss during the extended period of indemnity. Note that in most instances the ingress/egress coverage is limited to a specific time such as two weeks or thirty days, and that there is no intent to expand this with the extended period of indemnity coverage. The decision in Fountain Powerboat to the contrary may be attributable to specific circumstances surrounding the policy form ation negotiations or language.

C. 730 Bienville - No Prohibition of Access

The next decision, 730 Bienville Partners Ltd. v. Assurance Co. of America,[18] arises out of September 11th. As is well known, following the attack of September 11th, the United States closed airports and airlines were grounded. The insured claimed that the closure of the airports and cancellation of flights prevented guests from getting to its hotels and constituted prohibition of access to the hotels. The court reviewed the policy language and rejected this claim. The policy stated:

We will pay for the actual loss of “business income” you sustain and necessary “extra expense” caused by action of civil authority that prohibits access to your premises due to direct physical loss of or damage to property, other than at the “covered premises,” caused by or resulting from any Covered Cause of Loss. This coverage will apply for a period of up to 4 consecutive weeks from the date of that action.[19]

The court interpreted this clause as requiring prohibition of access directly at the insured property and stated: “While the FAA’s closure of the airports and cancellation of flights may have prevented many guests from getting to New Orleans and ultimately to plaintiff’s hotels, the FAA hardly ‘prohibited’ access to the hotels.”[20]

This case is consistent with Magnolia Lady, discussed above, in emphasizing the importance of the requirement that access be prevented at or to the insured premises. Taken together, these cases lead to the clear conclusion that ingress/egress coverage is inapplicable when it is still possible to gain access, even if access is substantially limited. The coverage applies only when it is prevented under most forms, and that word has been given its ordinary meaning.

D. Roundabout - No Civil Authority Claim, No Coverage

One case, Roundabout Theatre Co. v. Continental Casualty Co.,[21] did not involve either civil authority or ingress/egress coverage. Rather, a claim was made because of damage in a nearby building that caused the closing of a street. This led to prevention of access to the theatre at which Cabaret was being staged. Because of the prevention of access, thirty-five performances were cancelled. Recovery was sought for the business interruption during this time. The claim was predicated upon the argument that the prevention of access constituted a loss of use and this in turn constituted physical loss or damage. The issuing agreement covered:

[I]nterruption, postponement or cancellation of an insured Production as a direct and sole result of loss of, damage to or destruction of property or facilities (including the theatre building occupied . . . by the Insured . . .), contracted by the insured for use in connection with such Production, caused by the perils insured against . . . .[22]

Perils insured against were described as “all risks of direct physical loss or damage . . . .”[23] The court rejected the contention that the policy covered loss of use.

The Appellate Division, First Department, held that the policy required physical loss or damage, not merely loss of use. It rejected the theatre’s argument that the word “loss” had no meaning in the absence of loss of use. In doing this, the court noted that loss could involve taking by thefts. It also examined other policy provisions, such as the Period of Restoration Clause, because it referenced repair to the theatre. This confirms the requirement of physical damage to insured property.

E. BBB - Evacuation Order not Covered

Assurance Co. of America v. BBB Service Co.,[24] the most recent decision dealing directly with the civil authority clause, arose out of Hurricane Floyd and the evacuation of Brevard County. Wendy’s shut its restaurants in Brevard County due to the evacuation order. At the time, no physical damage had been sustained in the area. The court held that the mere threat of physical damage was not sufficient to warrant applicability of the civil authority clause. Rather, physical damage was required. The case was remanded for determination as to the extent to which any physical loss or damage may have been causally involved in the denial of access.

IV.

Causation

As demonstrated in the foregoing cases, major points to consider in access claims following September 11th pertain to the specific policy language and to causation. Access may have been prevented directly to some property, but the physical damage requirement may not be satisfied. For example, access may have been prohibited because of concerns over a possible further attack. In such a case, it cannot be considered due to physical damage of the type insured. Therefore, it does not satisfy the usual requirement for ingress/egress coverage.

Conclusion

Coverages exist for certain business interruption losses sustained when the physical damage takes place at some location other than the insured property. Two of the more common coverages involve contingent business interruption and ingress/egress. The coverages are usually not part of standard forms and need to be separately purchased, if in fact they are desired. Because the coverages are relatively new, little precedent exists in interpreting their language. What authority exists, however, suggests that it is important to review the nature of the physical damage with respect to contingent business interruption and how that physical damage causes the interruption. With respect to ingress/egress coverage, it is important to determine whether ingress/egress is “prevented.” It is also important to examine the causal relationship between the physical damage and the prevention of ingress/egress. As in all insurance cases, the language of the policy must be analyzed.

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