Covid-19: Business Interruption insurance, an FCA class action, and the long-tail risks to insurance brokers
Daniel Shapiro QC, Elizabeth Boon, James Sharpe and Frederick Simpson consider (i) the operation of Business Interruption (BI) insurance, (ii) the FCA’s proposed class action and (iii) the risks to insurance brokers from disappointed claimants. BI cover is ill-understood and complex. It is not typically intended to cover disruption from Covid-19 yet insureds often believe it should provide such cover. In the short term the FCA is attempting to take a grip of resolving the issue of what cover there is under BI policies. In the longer term, these circumstances could give rise to claims (probably with little merit) against insurance brokers.
The impact on the business of small and medium enterprises from the current Covid-19 pandemic and lockdown are obvious. Many have looked for an indemnity under Business Interruption (BI) insurance policies. There has been apparent bemusement that most BI policies do not cover business interruption resulting from Covid-19. In our view that stems from a misunderstanding (perhaps mainly of journalists in reporting the issue) of the essential cover provided by a BI policy. There has, however, also been frustration where the policy language apparently covers business interruption resulting from Covid-19 but BI insurers are refusing to pay. It is this latter issue that the Financial Conduct Authority (“FCA”), in their 1 May 2020 announcement, are intending to tackle. The FCA intends ‘to obtain a court declaration to resolve contractual uncertainty in business interruption (BI) insurance cover’. As we set out below, resolution would be welcome but may be harder to achieve than hoped, again because of the structure and operation of BI cover. Finally, we consider the risk of claims against insurance brokers who, in the present environment, often appear to be on the wrong end of criticism.
Business Interruption insurance
Business Interruption (BI) cover is typically intended to protect a business against the consequential financial losses of damage to property. BI policies almost invariably cover consequential financial loss upon damage to property. Indeed, most BI policies or sections require, as a condition of indemnity, that the damage to the property is itself covered under a property damage policy. Essentially BI cover would be more accurately described as “Property Damage Consequential Loss Insurance”.
BI cover is not, however, described as “Property Damage Consequential Loss Insurance”: it would hardly be a snappy description. It would also be an incomplete description. That is because the basic BI cover is typically augmented by a number of extensions, which provide cover in specific further circumstances. These may be of narrower or wider scope. Where the extensions are of narrower scope they are typically limited to ‘damage-based’ extensions covering the effects of damage to, for example, other property in the vicinity. Where the extensions are of wider scope they may include ‘non-damage-based’ extensions covering some other common situations which can cause an interruption to an insured’s business in the absence of damage. It is these non-damage-based extensions which are of particular concern in the circumstances.
First, however, it is worth noting that little is required by way of damage. The classic example of what little is required to amount to damage is the sub-molecular changes in the pastel of La Danse Grecque, a Degas pastel, affected by a fire (although the pastel did not sustain direct fire or smoke damage) while in a strongroom at an auctioneer’s. There was a chance that the pastel would decay sooner than it otherwise would have, thus reducing the sale value. The Court held that sub-molecular changes were damage. See Quorum v Schramm  1 Lloyd’s Rep 249.
Further, in the context of a tortious claim, contamination which merely requires cleaning has been held to constitute damage to property. See Losinjska Plovidba v Transco Overseas Ltd (The Orjula)  2 Lloyd’s Rep 395 where it was held that a vessel had been damaged when the deck was contaminated with acid which had to be cleaned by specialist contractors, even though there was no physical change to the vessel which had occurred affecting its value in the longer term.
Potentially, contamination of property by Covid-19 requiring cleaning might be sufficient for damage. However, the practical impact of this for BI purposes is likely to be limited. Government advice is to clean the infected area thoroughly using normal cleaning products; once this is done, the area can be brought back into use. Businesses are looking to claim not for the time spent cleaning but for a long term shutdown.
Second, there are damage based extensions, typically with lower limits of indemnity, against BI resulting from material damage in the vicinity of the insured premises causing a denial of access or a loss of attraction. See, for an example clause, Orient-Express Hotels Ltd v Assicurazioni General SpA  EWHC 1186 (Comm). Such extensions may similarly offer limited cover.
In the present circumstances, however, BI losses are not generally caused by damage but are caused by the government’s mandated lockdown. Many have been instructed to close; and many which have not have nonetheless been indirectly affected by the various measures requiring people to stay at home and to socially distance when out in public. Therefore, the more significant extensions, and the ones that the FCA is interested in investigating, are extensions providing cover for BI as a result of the actions of civil authorities and/or in response to notifiable diseases. These are the extensions which, depending on their language, may provide cover.
These extensions are often unsatisfactorily worded. That often results because the insurer has bolted on an extension to the BI cover which responds in the absence of property damage but to a BI section where the principal cover only responds where there is property damage and is written in language which is anchored in the happening of property damage.
These extensions of cover provide indemnity for BI losses as the result of the actions of civil authorities and/or in response to the outbreak of a “Notifiable Disease” within a specified radius of the insured premises (usually 1, 25 or 50 miles) and/or denial of access/loss of attraction. Covid-19 was made notifiable in England on 5 March 2020 by an amendment to the Health Protection (Notification) Regulations 2010 (2010 No. 659).
These extensions were typically intended to cover interruptions to businesses specific to the business or locality i.e. a flood in a local area. The issue now is that these extensions are being called on to cover business interruption due to the general market conditions or interruptions which are nationwide.
The issue, again illustrated in the Orient-Express, is that BI policies typically seek to indemnify only BI losses specific to the particular business. Businesses are subject always to fortune – external forces may cause a business to succeed or fail. BI policies seek to cover the business against BI caused by fortuities which are outside of the businesses control but are specifically happening to it. That makes commercial sense as BI cover is not designed to cover losses from, say, a general recession which affects all businesses. Therefore, BI policies typically do not cover BI losses which a business would have suffered in any event irrespective of any particular event, happening or cause specifically affecting it.
In Orient-Express a hotel in New Orleans was damaged by Hurricane Katrina. Insurers paid out under the extension for loss of attraction/denial of access, but denied indemnity under the main BI clause, on the basis that both the main clause and the extension only applied to interruptions to the Insured’s business which would not have occurred but for the damage to the hotel or damage to the property in the vicinity, but since an undamaged Hotel in a damaged New Orleans would have suffered the same interruption as a damaged Hotel in a damaged New Orleans, this “but for” test of causation could not be satisfied. In effect the argument was that the damage to the Hotel made no difference as no tourists would have been visiting New Orleans anyway for many months after Katrina. The Court found for insurers, and thus the Hotel claimant was only able to recover under the smaller denial of access and loss of attraction covers.
We observe that, although Orient-Express has been criticised by some commentators, it was a decision of Hamblen J (as he then was) refusing to allow an appeal from the award of an arbitral tribunal which included George Leggatt QC (as he then was). On any view it was not a decision made in ignorance of the proper operation of BI insurance policies.
It will also be necessary to consider particular exclusions in BI policies. Policy wordings may include a defined list of diseases covered under the terms of the policy, which range from smallpox, through SARS to Ebola. One anticipates that Covid-19 and coronaviruses more generally will be the subject of specific exclusions in most BI Policies going forward. That perhaps merely illustrates that BI cover was not typically intended to protect against epidemics or pandemics. That intention is likely to be given express effect going forward. In the meantime there are, as we are aware, various disputes as to whether Covid-19 is an excluded cause of loss depending on whether it is SARS like, a pneumonia, or similar to other diseases (Ebola, MERS, HIV).
Policy wordings also typically contain the standard ABI pollution and contamination exclusion (which has never been tested in Court). That may now be tested to establish if Covid-19 is “contamination”.
There are also policy wordings excluding loss caused by a “micro-organism”. Can a virus properly be described as a micro-organism?
The FCA’s move to resolve these matters
The FCA is moving to try to resolve these matters. The FCA’s stated intention is to obtain “a court declaration to resolve contractual uncertainty in business interruption insurance cover”. That is a far from a simple matter. The FCA is itself candid that “The issues around BI policies are complex and there are significant differences in policy wording between policies and across firms.” It is also important to note that the FCA recognises that in many cases it will be clear that businesses do not have cover. Their action is aimed at those situations where there remains some uncertainty.
We consider that the FCA’s move to resolve these matters is broadly welcome. Although there are many policy wordings written in different language, an attempt to resolve some of the principal issues at the earliest opportunity is obviously a good thing. Difficulties may, however, arise with the practicality of the approach. The danger of a lead action is that other actions are stayed until it is resolved but that can take a long time as the lead action is particularly susceptible to appeal because it is potentially resolving issues more widely. As policy construction issues are also particularly susceptible to appeal the risk is that the FCA’s intervention actually slows down the resolution of these issues. That would be particularly unfortunate because what businesses need now is for insurers (where there is cover) to provide an indemnity and to do so without delay.
The risks to insurance brokers
Insurance brokers are particularly exposed, in our view unfairly, to litigation at present. Brokers are sometimes treated as insurers of last resort by insureds. In recent years clients are increasingly turning to their insurance brokers (and the brokers’ professional indemnity insurers) to meet their losses where their insurers have refused to pay.
The current law as to brokers’ duties encourages such claims. In Standard Life Assurance Limited v Oak Dedicated Limited  EWHC 222 (Comm);  Lloyd’s Rep IR 552, having reviewed the case law and heard expert evidence as to market practice, Tomlinson J provided the following summary of the law (at ):
“1) It is the duty of a broker to identify and advise the client about the type and scope of cover which the client needs and, in doing so, to match as precisely as possible the risk exposures which have been identified within the client’s business with the coverage available.
2) Having identified what cover the client needs, it is the broker’s duty to arrange insurance cover which clearly meets those requirements.
3) If the cover which is needed by the client is not available, the broker must take care to ensure that the precise nature of what is and is not covered is made entirely clear to the client.
4) In relation to the preparation of the policy, the broker must be careful to ensure that the policy language clearly encompasses the needs of the client.”
That summary has been repeatedly applied subsequently. The issue with it is not that it is obviously incorrect but that it is in such general language that it requires a broker to have been either perfect or to have taken a number of defensive measures in the course of broking to avoid liability. Otherwise, it is all too easy to suggest that the risk exposures could have been matched “more precisely” (para 1) or that the cover does not clearly meet the client’s requirements (para 2) or the policy language is not sufficiently clear (para 4).
Further, the Courts have found that a broker owes an obligation to guard his clients against unnecessary risk, including the risk of litigation. See FNCB v Barnet Devanney  Lloyd’s Rep IR 459. Given the extent of insurance litigation and that much perfectly common and sensible policy language can, particularly in the right hands, give rise to considerable argument, that is a particular exposure for insurance brokers.
BI cover already gives rise to a disproportionate number of claims against insurance brokers. That is principally for two reasons. First, insureds often do not wish to pay the higher premiums frequently associated with business interruption cover for a 24-month period of indemnity as opposed to a 12 month period of indemnity. However, when an insured then suffers a loss the insured insists it would definitely have wanted the 24-month period of indemnity if only the broker had made clear the importance of it. Second, the calculation of gross profit or gross revenue for the purposes of business interruption cover differs from the normal accounting treatment. Mistakes in calculation may lead to claims against the broker, although the calculation should be done by the insured (albeit appropriately advised as to how to perform it). Third, there is an incentive on insureds to understate gross profit or gross revenue so as to obtain a lower premium. However, when indemnity is required insureds then suggest that this was a calculation mistake caused by the broker.
The present circumstances are likely to give rise to disappointed insureds seeking advice on whether they can claim against brokers. Although we anticipate such claims will come, in our view, such claims are likely to be unfair and unmeritorious.
First, it is likely that when discussing the BI cover with insureds, the discussions will have centred around what would happen if the property was damaged, and how long it would take the business to recover were the property to be damaged. That is the essential discussion because it is necessary for working out the BI indemnity period. Therefore, we consider most insureds will have been well aware that the BI cover was principally in respect of protecting the business following damage to property.
Second, this is an unprecedented event which was anticipated by few outside specialist areas. If anything, the lack of impact in Europe of SARS, MERS and Ebola probably encouraged complacency. We consider it would be most unfair for Courts now to suggest that insurance brokers should have been asking businesses about their preparations for and cover for epidemics or pandemics.
Third, it is unrealistic to suggest that the various extensions which might provide cover were anything other than an automatic add-on to most cover. The suggestion that brokers should have been trying to tweak the policy language of insurers’ standard extensions is, we consider, unrealistic. The cover was available as written only.
What is clear is that litigation is inevitable. Hopefully the FCA’s steps will assist the speedy resolution of such litigation and litigation will cease with that between insured and insurer, without involving insurance brokers.
The contents of this article, current at the date of publication, are for reference purposes only. This article and its contents do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought and no action should be taken based on this article.
 See the Health Protection (Coronavirus, Restrictions) (England) Regulations 2020 (2020 No. 350)