Can a new or unprofitable business make a Business Income claim? Often, a policyholder makes a claim for Business Income loss from a new business that does not have a long track record. In general, a policyholder can recover lost income from such a business, but may be held to a higher standard of proof in establishing the profits that would have been earned. With regard to unprofitable businesses, note that Business Income covers both profits and unavoidable continuing expenses. If profits were sufficient to cover such expenses, or at least a portion of such expenses, prior to the loss, recovery can still be had for such amount. Further, an unprofitable business is permitted to attempt to demonstrate that it would have become profitable during the Period of Restoration; again, however, the burden of proof in doing so may be high.

Can the insurance company seek credits for pent-up demand or make-up sales after the Period of Restoration? Additionally, insurance companies will frequently demand a “credit” for the policyholder’s performance after the Period of Restoration. For instance, if the policyholder is a seller of eyeglasses, knocked out of operation by fire for two months, the policyholder may enjoy a period of increased demand after reopening as customers who put off replacing their glasses during the two-month Period of Restoration come into the store, along with the normal flow of customers. Policyholders should know, however, that insurance companies will not pay for additional losses that occur after the Period of Restoration (or extended period of restoration). Accordingly, policyholders, too, should refuse to grant insurance companies “credits” for performance after the Period of Restoration ends. Further, language in commercial use can address such “make up” sales, so if the policy is silent, the insurance company should not be permitted to claim such credits.

What is the length of the Period of Restoration? Issues typically arise regarding the length of the Period of Restoration. As generally written, this period during which the loss of Business Income is covered is bounded by the shorter of (i) the hypothetical time in which the destroyed property could be repaired, rebuilt, or replaced, or (ii) the actual time it takes to repair, rebuild or replace the property. A number of issues can arise surrounding the former, “hypothetical” date. For instance, does it start during the period when authorities will not let the policyholder on site because of ongoing investigation, e.g., by environmental authorities? (Generally, no.) Relatedly, is the Period of Restoration extended to account for insurance company conduct, such as refusing to advance sufficient funds to rebuild? (Generally, yes.) Indeed, to the extent the policyholder is not responsible for a delay, it will generally serve to extend the Period of Restoration.

Can the insurance company slash recovery because of the wider effects of catastrophe? After the attacks of 9/11 and the 2005 hurricanes, some property insurance companies argued that Business Income recovery is diminished by the wider economic effects of the catastrophes. Typically, “Business Income” is defined to include “Net Income (net profit or loss before income taxes) that would have been earned or incurred.” Further, the profit component of lost Business Income is figured by computing the net income the policyholder was earning prior to the “physical loss or damage,” and the net income that the policyholder would have earned “if no direct physical loss or damage occurred.” There is typically no provision permitting insurance companies to reduce estimates of their policyholder’s lost Business Income on account of generalized lack of consumer demand throughout an area affected by a catastrophe because the “direct physical loss or damage occurred.” Nonetheless, this is what insurance companies have attempted to do, both after the WTC attacks and the 2005 hurricanes. There is, however, some rough case law consensus that has emerged that the policyholder’s loss is measured on the basis of its expectation immediately prior to the catastrophe.

Contingent Business Income

Contingent Business Income coverage is designed to cover a policyholder for loss of income caused by damage to or destruction of property owned by others (often called “dependent property”), usually identified as “contributing,” “recipient” or “manufacturing” locations (i.e., suppliers, customers and manufacturers). Some policies limit coverage to named dependent properties, others cover (or cover subject to a sublimit) dependent properties on a blanket basis. The property damage to the third-party property typically must be of a type that would have been covered had it happened to the policyholder’s own property. An example would be coverage purchased by a car maker to protect it if its sole supplier of a key component suffers destruction of its factory, and the car maker suffers a Business Income loss from its inability to complete manufacture of cars. Accordingly, a business that had a close commercial relationship with a company affected by the 2017 hurricanes may be able to recover for losses attributable to damage to the facilities or equipment of that company, and the following issues may arise:

What is the Period of Restoration? Note that, properly applied, the Period of Restoration is typically figured in the same manner as for Business Income coverage: the hypothetical period of time needed to reconstruct the damaged or destroyed property. Unlike Business Income coverage, however, the policyholder does not control whether or not the third-party business decides to mitigate its loss by using makeshift operations or relocating. Accordingly, although insurance companies typically try to shorten the Period of Restoration for Contingent Business Income losses on the basis that the third-party could have relocated or engaged in partial operations, the policyholder is entitled to its full loss incurred during the full Period of Restoration, based upon what the third party actually did. This should be resisted.

Will the Period of Restoration terminate if alternative suppliers or customers are located? Policyholders should reject insurance company efforts to terminate the Period of Restoration for a Contingent Business Income loss if the policyholder finds an alternate supplier or customer, if that supplier or customer is not equivalent to the original. In such a situation, the policyholder still continues to suffer a loss, and is entitled to its profits during the entire hypothetical Period of Restoration for the third-party property, minus whatever profits it manages to earn from its dealings with the alternate supplier or customer. Must a loss be fully perfected during the Period of Restoration? Frequently, a policyholder with a supplier may have sufficient inventory to avoid a loss during the period needed by the supplier to rebuild after a loss; i.e., given the “pipeline,” the loss from a disruption is incurred after the supplier rebuilds. In such circumstances, insurance companies universally attempt to confine measurement of the loss to the Period of Restoration. As noted above, however, insurance companies frequently attempt to seek credits (e.g., from pent-up demand) after the end of the Period of Restoration. Recently, courts have shown willingness to countenance losses outside the Period of Restoration if attributable to events within it.

Can a policyholder order its claim to ensure recovery? It is not uncommon for a policyholder to have a Business Income and a Contingent Business Income claim from the same event; e.g., a business may be physically located next to its main supplier, and both may be knocked out by the same catastrophe. Further, the policyholder in such circumstance may have different sublimits; e.g., a maximum year-long Period of Restoration and a $5 million sublimit for Contingent Business Income. Under such circumstances, the policyholder, suffering a simultaneous Business Income and Contingent Business Income loss, may elect to order its claim to ensure full recovery: i.e., it can claim the first year of loss as Business Income, and then seek any further loss under the uneroded $5 million Contingent Business Income limits.

Conclusion

Policyholders adversely impacted by the 2017 hurricanes need to begin focusing on their insurance coverage promptly so that no rights or remedies are potentially compromised. The sooner this effort is undertaken, the more likely policyholders will avoid issues like lack of documentation down the road. In the end, time and effort that is devoted to this task in the early stages often proves to be the difference in the ultimate outcome, and helps secure as full a financial recovery as is possible under these tragic circumstances.

Client Briefing 2017-214