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

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

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

There must be a “necessary suspension” of business operations.

The suspension must be caused by “direct physical loss or damage” to the insured's premises. (Indeed, business interruption insurance often appears as an endorsement to commercial property insurance.)

It may be a requirement that the loss or damage be caused by a particular peril or hazard (or losses caused by particular perils or 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 the insured's income during the period of disruption. It typically indemnifies the insured against the loss of the net income that would have been earned during that period, plus continuing normal operating expenses including payroll. Lost income is estimated based on the past performance of the business, projected on the basis of current business conditions.

Whether in litigation or in simply making a claim, the insured will need to provide evidence to demonstrate the amount of the lost income. Unsubstantiated claims or vague claims about lost business opportunities are unlikely to be persuasive to insurers or the courts. The policy may prescribe the evidence to be provided by the insured. In litigation, expert financial evidence would likely be needed.

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

What is a “necessary suspension” of business operations?

Most courts across the United States (including those in New York) have held that a “necessary suspension” requires a total cessation of business activity. It therefore follows that once an insured continues its operations at an alternative site, the “necessary suspension” (and with it the business interruption payments) come to an end. It also follows that no claim can be made if the insured's business simply slows down, becomes less efficient, or is disrupted without stopping.

In one case, however, the court held that where the insured was under an affirmative duty in the policy to mitigate its loss (by moving to and resuming operations at an alternative location), it did not lose the business disruption cover by doing so. The insured was therefore entitled to payment to reflect the reduction in its income during that period. Other courts have declined to follow that ruling.

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

Businesses inside and outside the World Trade Center area have lost (and are still losing) money. Business premises nearby were damaged or destroyed. Some, in a larger area, were inaccessible.

Other businesses based outside the immediate area were neither physically damaged nor inaccessible, but have lost money as a result of the attacks.

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

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

However, the cases in which the civil authorities have ordered businesses to be closed (without suffering physical damage) are in conflict. Different courts have reached different conclusions on whether those businesses were entitled to recover under their business disruption policies.

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

Whatever the ambiguities in the position of inaccessible businesses, it will be obvious that an organization simply suffering a reduction in its business as a result of the attacks will be unable, absent provision to the contrary in the policy, to recover its loss under a standard business disruption policy.

What is the “period of restoration”?

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

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

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

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

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

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

The government-funded compensation scheme to be created by Congress will presumably not extend to business losses (although other government aid may be available).

It would be extremely difficult for a private litigant to obtain and enforce a judgment against those alleged to be behind the attack.

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

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

A ruling earlier this year by New York's highest state court effectively confines business disruption damages in civil actions to cases where the plaintiff suffers (and the economic loss results from) property damage or personal injury.

Michael Diamond is a partner and heads the litigation department 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 York office of Milbank, Tweed, Hadley & McCloy LLP. He is not admitted 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 serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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