Business Disruption Claims: Lawyers Perspective

Even those of us who witnessed the events of Sept. 11 at closerange still have difficulty believing it really happened. No one,however, could dispute the reality of the human cost of thathorrendous day. It is enormous and ultimately beyond measure.

The economic toll on affected businesses–in downtown Manhattanand more widely–is also real and enormous. By contrast, however,those losses have a clear unit of measurement: the dollar.

This article looks, in brief, at the potential for businesses torecover those losses under business disruption insurance policiesand concludes that many will inevitably be disappointed.

Not every loss can lead to compensation. That is especially truewhen the damage is economic, rather than physical, in nature. Theeconomic consequences of any act can be large and unexpected andthe law normally seeks to confine liability to manageable levels.That concern is reflected in the practice of the insurance industryin writing business disruption policies.

Of course, each policy and individual case has to be separatelyexamined to determine, first, whether payments are due and, second,the level of those payments. This article focuses on a typicalbusiness interruption policy, which has the following features:

It covers the insured for “actual loss of business income.”

There must be a “necessary suspension” of businessoperations.

The suspension must be caused by “direct physical loss ordamage” to the insured's premises. (Indeed, business interruptioninsurance often appears as an endorsement to commercial propertyinsurance.)

It may be a requirement that the loss or damage be caused by aparticular peril or hazard (or losses caused by particular perilsor hazards may be excluded).

Lost income is covered during the “period of restoration”only.

Well look at each of these features, in turn.

Loss of business income

A business disruption policy is intended to protect theinsured's income during the period of disruption. It typicallyindemnifies the insured against the loss of the net income thatwould have been earned during that period, plus continuing normaloperating expenses including payroll. Lost income is estimatedbased on the past performance of the business, projected on thebasis of current business conditions.

Whether in litigation or in simply making a claim, the insuredwill need to provide evidence to demonstrate the amount of the lostincome. Unsubstantiated claims or vague claims about lost businessopportunities are unlikely to be persuasive to insurers or thecourts. The policy may prescribe the evidence to be provided by theinsured. In litigation, expert financial evidence would likely beneeded.

Business disruption policies frequently provide coverage forexpenses incurred in seeking to mitigate losses, such as theexpenses of moving to and setting up at an alternative location. Inthe absence of specific provision in the policy, however, thoseexpenses will not be covered.

What is a “necessary suspension” of business operations?

Most courts across the United States (including those in NewYork) have held that a “necessary suspension” requires a totalcessation of business activity. It therefore follows that once aninsured continues its operations at an alternative site, the“necessary suspension” (and with it the business interruptionpayments) come to an end. It also follows that no claim can be madeif the insured's business simply slows down, becomes lessefficient, or is disrupted without stopping.

In one case, however, the court held that where the insured wasunder an affirmative duty in the policy to mitigate its loss (bymoving to and resuming operations at an alternative location), itdid not lose the business disruption cover by doing so. The insuredwas therefore entitled to payment to reflect the reduction in itsincome during that period. Other courts have declined to followthat ruling.

Direct physical loss or damage to the insured's premises. Whatabout businesses that were just inaccessible?

Businesses inside and outside the World Trade Center area havelost (and are still losing) money. Business premises nearby weredamaged or destroyed. Some, in a larger area, wereinaccessible.

Other businesses based outside the immediate area were neitherphysically damaged nor inaccessible, but have lost money as aresult of the attacks.

Policies do exist that provide for payment of lost businessincome in case of inaccessibility (so called “ingress and egress”clauses) and such clauses have been interpreted not to requirephysical damage to the insured's property. Policies also existwhich provide for payments if business is disrupted by damage tonearby premises.

In the absence of such provisions, however, it should be obviousthat a typical policy requiring direct physical loss or damage tothe insured's premises will not avail a business whose premiseswere simply inaccessible.

However, the cases in which the civil authorities have orderedbusinesses to be closed (without suffering physical damage) are inconflict. Different courts have reached different conclusions onwhether those businesses were entitled to recover under theirbusiness disruption policies.

Those cases turn on the precise wordings of the policy and aredifficult to distinguish; some included express provision forclosure by the civil authorities. It may be, however, that aclosure ordered due to the danger of physical damage stands abetter chance of triggering a business disruption policy than, forinstance, a closure ordered to facilitate a rescue effort.

Whatever the ambiguities in the position of inaccessiblebusinesses, it will be obvious that an organization simplysuffering a reduction in its business as a result of the attackswill be unable, absent provision to the contrary in the policy, torecover its loss under a standard business disruption policy.

What is the “period of restoration”?

The “period of restoration” usually begins with the date of thephysical damage and ends when the premises are actually rebuilt,repaired or replaced or, if earlier, when they should, withreasonable speed, have been rebuilt, repaired or replaced.

Where this term is used it emphasizes that the policy coversonly situations of physical damage or loss.

Lost income may, of course extend beyond the time that thepremises are damaged. For example, a commercial landlord may havedifficulty in re-letting premises once they have been rebuilt.Dependent upon the terms of their leases, tenants will likely beentitled to stop paying rent during the period of inaccessibilityand the lease may come to an end.

It has been held that a building owner is not entitled to becompensated under a business disruption policy for the time ittakes to re-let the property after it is repaired.

If there is no insurance cover, what about compensation fromother sources?

The prospects for businesses seeking to obtain compensation fromother sources are also unpromising for several reasons:

The government-funded compensation scheme to be created byCongress will presumably not extend to business losses (althoughother government aid may be available).

It would be extremely difficult for a private litigant to obtainand enforce a judgment against those alleged to be behind theattack.

There are formidable difficulties in the way of a civil claimagainst any other defendant. (In particular, the need to shownegligence and difficult issues of proximate causation.)

It is anticipated that any claims against the airlines will belimited, by statute, to their insurance coverage.

A ruling earlier this year by New York's highest state courteffectively confines business disruption damages in civil actionsto cases where the plaintiff suffers (and the economic loss resultsfrom) property damage or personal injury.

Michael Diamond is a partner and heads the litigationdepartment in the Los Angeles office of Milbank, Tweed, Hadley& McCloy LLP. Andrew Rhys Davies is admitted in England &Wales and works as an international associate in the New Yorkoffice of Milbank, Tweed, Hadley & McCloy LLP. He is notadmitted in New York.

Reproduced from National Underwriter Property &Casualty/Risk & Benefits Management Edition, November 5, 2001.Copyright 2001 by The National Underwriter Company in the serialpublication. All rights reserved.Copyright in this article as anindependent work may be held by the author.

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