The Fifth Circuit reversed and remanded a case that had found certain compensation costs incurred by an insured were not covered because they were discretionary. The case is SW. Airlines Co. v. Liberty Ins. Underwriters, Inc., 90 F.4th 847 (5th Cir. 2024). Please note that this case is separate and distinct from Southwest's system failure in 2022.
In 2016, Southwest Airlines experienced a computer failure that knocked out its flight schedule for three days and led to cancellations or delays longer than two hours for nearly 476,000 flights. Southwest issued promo codes, refunds, travel vouchers, and rewards points to customers whose flights had been affected by the system failure; the airline also incurred advertising expenses to extend a sale that had been running at the time of the computer failure. These categories–promotions, refunds, vouchers, rewards points, and advertising, collectively called "compensation costs"–made up more than $35 million of the total claim.
Southwest submitted a claim for more than $77 million to insurers under a cyber risk policy and multiple excess policies. The cyber risk policy covered "all Loss[es] … that an Insured incur[s] … solely as a result of a System Failure.…" Liberty had issued one of the excess policies to Southwest that would be triggered only if the losses directly resulting from a system failure were greater than $50 million. The cyber risk insurer and other excess insurers paid an aggregate $50 million to Southwest on its claim. Liberty, however, denied coverage, alleging the compensation costs Southwest had spent on affected customers and extra advertising were merely business decisions not subject to the policy and without which Southwest's claim could not reach the $50 million threshold that would activate the Liberty policy.
Southwest filed suit against Liberty in Texas for breach, bad faith, and a declaratory judgment that the losses were covered. Liberty sought summary judgment based on an alleged lack of coverage. The District Court for the Southern District of Texas granted Liberty's motion, stating that the compensation costs incurred by Southwest were "purely discretionary," and that coverage was precluded by policy exclusions. Southwest appealed.
Determining 'Sole Cause'
The judges of the Fifth Circuit were faced with defining the terms loss, incur, and sole cause in the context of Southwest's policy to decide whether the system failure was one of or the only cause of loss for the compensation costs incurred by Southwest. Based on the policy definition of loss, the related policy term "material interruption," and guidance from the Texas Supreme Court, the court determined that Southwest's compensation costs were incurred losses within the meaning of the policy.
Though the Texas Supreme Court had posited that "solely" meant "to the exclusion of all else" and "without another," it wasn't quite enough for the Fifth Circuit to determine what was meant by "sole cause" in Southwest's policy. The term had not yet been interpreted in the context of business interruption coverage. In Wright v. Western Southern Life Insurance Company, 443 S.W.2d 790 (Tex. App. 1969), the Texas Court of Civil Appeals had determined that gangrene was not the "sole cause" of a lost foot because the gangrene had been the result of of a gunshot wound and was not "an independent cause [of loss]." In Wells v. Minn. Life Ins. Co., 885 F.3d 885 (5th Cir. 2018), the Fifth Circuit was tasked with determining the "sole cause" of death under a life insurance policy. In that case, similar to Wright, the court held that "an injury is still the sole cause of death even if death resulted more directly from complications like septic shock or multi-system organ failure." With this standard in mind, the judges determined that "sole cause," in context of the policy issued to Southwest, referred to an independent cause of loss that precipitated the loss itself.
Liberty claimed it had been Southwest's decision to incur more than $35 million in compensation costs that had caused the loss, not the system failure. Extending coverage to discretionary costs, Liberty argued, meant Southwest could determine its own amount of loss. This argument, according to the court, undermined the basic tenets of business interruption coverage: to get the insured back to the place where it would have been in the absence of the interruption. The judges said that Southwest's claim was still subject to the established policy conditions that required a causal connection between the system failure and the compensation costs incurred. The system failure was the "but for" cause of the compensation costs. Had the system failure not disrupted Southwest's operations, Southwest would not have spent the money to compensate affected consumers.
Since Southwest's incurred compensation costs had not been the result of an independent cause of loss, the judges ruled that granting summary judgment to Liberty had been inappropriate. The Fifth Circuit reversed the lower court's decision and remanded it for consideration consistent with the Fifth Circuit ruling.
Editor's Note: The question of what, exactly, caused a loss is a common question in insurance litigation. If an independent cause of loss is not covered by a policy, it is much less likely that the insured would receive coverage. In this case, Southwest successfully showed how the compensation costs it had incurred were directly tied to the system failure. The system failure had caused a great number of cancelled or severely delayed flights. In order to mitigate the situation with affected customers, Southwest issued the vouchers, rewards points, refunds, and promotions, as well as extending a sale interrupted by the failure, that it would not have had to issue had the system failure not occurred. The concept of "but for" is an important one in determining cause of loss. It highlights the importance of how the given peril is related to the damages being claimed.
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