The actions a company takes to fulfill its contract after a fire may be more than "necessary" to mitigate covered losses. (Photo: Thinkstock)
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When an insured suffers a loss, the insured typically has a duty under its insurance policy to do all it reasonably can to limit or "mitigate" the covered losses. Generally, this can mean securing property after a hurricane or installing a tarp to cover a hole on a house caused by a fallen tree. But when a loss involves business income, to what extent is an insured expected to take action to limit its loss — and when can it recover from its insurer for incurring those expenses?
As made clear by a recent case in the U.S. Court of Appeals for the Eighth Circuit, the ability of an insured to recover for those expenses generally is limited by the policy terms. The circuit court held that an insured could not recover under its insurance policy's business income provisions for expenses it incurred following a fire at an Arkansas plant where those expenses did not reduce covered business income losses. Why not?
The case
On July 14, 2012, a fire damaged equipment at the Little Rock steel pipe manufacturing plant of Welspun Tubular, LLC, a wholly owned subsidiary of Welspun Pipes, Inc., causing the plant to temporarily cease operations.
Fearing it would lose a contract, Welspun had its affiliate in India produce pipe originally scheduled to be produced in Little Rock. Welspun incurred $14 million in incremental costs by shifting production from Little Rock to India.
In August 2012, Welspun submitted claims for real and personal property damage, loss of business income, and extra expenses to Liberty Mutual Fire Insurance Company, from which it had acquired a commercial insurance policy that provided real property, personal property, equipment breakdown, loss of business income and extra expense coverages.
In March 2013, Liberty Mutual settled all claims except Welspun's claim for the $14 million of mitigation costs.
Thereafter, Welspun sued Liberty Mutual, alleging that its unpaid mitigation costs were "necessary expenses" included in the policy's loss of business income coverage.
Liberty Mutual responded that these costs only could be covered as "extra expenses," the policy limits of which had been paid in the settlement.
The U.S. District Court for the Eastern District of Arkansas ruled in favor of Liberty Mutual, deciding that "necessary expenses" under the policy had to be expenses that reduced a covered business income loss. "It would be absurd to construe the insurance contract to include coverage for expenses incurred to avoid a loss that would not have been covered," the district court reasoned.
The district court concluded that Welspun had not demonstrated that its alleged mitigation costs had reduced a covered loss of business income during the appropriate policy period, and Welspun appealed to the U.S. Court of Appeals for the Eighth Circuit.
The Eighth Circuit's decision
The Eighth Circuit affirmed. In its decision, the circuit court found that "necessary expenses" were limited to expenses that reduced a covered business income loss, rejecting Welspun's argument that mitigation costs incurred to reduce even uncovered business income losses qualified as necessary expenses under the policy.
Among other things, the circuit court reasoned that the common law duty to mitigate reflected in the policy was a duty owed to the insurer to reduce the insurer's obligation to indemnify, which "of course" was limited to the insured's covered losses.
The circuit court gave the following example:
Suppose a fire at a bakery threatened the loss of $75 in business income during the indemnified period. Consistent with its duty to mitigate, the bakery spends $20 in mitigation and reduces its covered business income loss to $35. Under [the policy,] the $20 is a necessary expense because it reduced a covered business income loss [and] Liberty Mutual would pay the bakery $55 (if within the policy limit) — $20 in necessary expense and $35 in actual business income loss, which is below the $75 ceiling established by the [policy]. On the other hand, if the bakery spent $50 to reduce its covered business income loss to $35, the [policy] would limit recovery to $75.
The Eighth Circuit added that under Welspun's interpretation of the policy, if the bakery incurred $75 of actual business income loss during the period of indemnity, and spent $20 to reduce an uncovered loss of business income in a later period, it was entitled to $95. In this variation of the hypothetical, rather than reduce the insurer's obligation to indemnify actual business income loss, the $20 of "mitigation" expenses increased the insurer's coverage obligations, the circuit court said.
Accordingly, the circuit court agreed with the district court that coverage was limited to additional expenses necessary because they reduced a covered business income loss.
The case is Welspun Pipes, Inc. v. Liberty Mutual Fire Ins. Co., No. 17-1470 (8th Cir. May 25, 2018).
Steven A. Meyerowitz, Esq., (smeyerowitz@meyerowitzcommunications.com) is director of FC&S Legal, editor-in-chief of Insurance Coverage Law Report, and founder and president of Meyerowitz Communications Inc.
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