United States: Business Interruption INsurance: A Safety Net for Companies Impacted by the World Trade Center Attacks

Co-written by Jeffrey M Pollock & David Jay

Although the tragic losses suffered from the World Trade Center attacks will remain with us for a long time, New York’s businesses are digging in their heels to rebuild for the future. One asset that may help affected companies is their business interruption insurance. Business interruption insurance pays for lost profits and relocation or other expenses incurred in restoring operations to normal after a shutdown of operations due to physical loss. This insurance is designed to put a company back in the same financial position it would have been in if the loss had not occurred. Business interruption insurance may be accessed, not only by companies whose offices were destroyed in the World Trade Center attacks, but by companies in lower Manhattan that were shut down due to their proximity to the destruction or that suffered losses because of damage to key suppliers or other business partners.

Typically part of a company’s commercial property insurance package, business interruption insurance covers "loss resulting directly from necessary interruption of business caused by damage to or destruction of the policyholder’s real or personal property by a covered peril." A company’s loss is measured in terms of the net profit the company failed to earn as a result of the interruption. While the precise formula used to determine the loss varies from policy to policy, it always accounts for the gross revenues a company would have earned less the operating expenses that were or would have been incurred for that period. Of course, business interruption coverage is additional to a company’s first-party property insurance covering direct physical loss to the company’s office and equipment.

Business interruption insurance terminates on the date that the involved premises would have been repaired or rebuilt had reasonable diligence been exercised regardless of whether the necessary repairs are actually completed. Loss mitigation is expressly required; therefore, a company must make reasonable efforts to resume operations to the extent possible and cannot sit idly by as the insurance company’s losses mount. Business interruption policies do, however, cover extra expenses incurred in attempting to resume operations, such as the expense of salvaging inventory or relocating an office. If a company becomes involved in a dispute with its insurer regarding the scope or amount of coverage, the company should move forward with efforts to resume operations (if economically feasible without the benefit of coverage) because additional delay caused by a coverage dispute may not be covered.

Like property insurance generally, business interruption coverage may be written on a "named peril" or "all risk" basis. A "named peril" policy specifically identifies covered risks such as fire, windstorm, earthquake and others. "All risk" policies cover all risks of physical loss to property except those specifically excluded. Because of the variations in coverage, companies must review their policies carefully to determine whether the events at the World Trade Center were caused by a covered peril.

Business interruption insurance historically covered policyholders only for interruption to their business caused by physical damage or destruction to the insured’s own property. This core business interruption coverage is critical for companies located in the World Trade Center and the immediately surrounding areas. In recent years, however, business interruption insurance has been significantly expanded to account for the economic consequences faced when neighboring companies or business partners suffer physical loss that impedes the policyholder’s ability to operate.

For example, companies located in lower Manhattan that were prohibited from entering their premises even though they suffered no direct physical damage may make business interruption claims under policy provisions covering "Interruption By Civil Authority." This coverage addresses situations where destruction to nearby property causes authorities to prohibit access to, or cordon off, a larger area. Coverage for "Interruption By Civil Authority" will have far-reaching application to the World Trade Center situation where all of lower Manhattan was closed due to the fires, unsound structures, and rescue efforts. This type of coverage is typically limited in duration to no more than one or two months.

Many policies today also contain "Contingent Business Interruption" coverage, which covers policyholders for a suspension of operations caused by damage from a named peril to a "dependent property" such as a key supplier, distributor, or manufacturer. The so-called "dependent property" can belong to a company that the policyholder relies upon either to supply products or components or to complete its product or deliver it to market. The "dependent property" need not be located in the same geographic area as the policyholder. Business interruption insurance may also provide limited coverage for "Service Interruption" resulting from physical damage by a covered peril to a provider of services such as electricity, telephone, or Internet.

First-party property insurance, including business interruption insurance, contains an exclusion for "war or military action," which will likely become the most contested aspect of World Trade Center-related insurance claims. Several different formulations of this exclusion exist, and the nuances in the language may have a tremendous impact on whether an insurer will attempt to invoke the exclusion. One formulation excludes damages caused by "war, including undeclared or civil war." Another formulation excludes damages for "hostile or warlike action in times of peace or war." Although it is very questionable whether this exclusion would bar coverage for a terrorist attack, insurance companies have attempted to invoke far less credible exclusions in the past when faced with staggering potential liabilities, and liabilities associated with this event are expected to reach into the tens of billions of dollars. Consider, for example, the insurance industry’s reaction to the environmental and asbestos claims of the 1980s and 1990s, which were uniformly denied based on a variety of only marginally relevant exclusions. Although case law interpreting the war exclusions is obviously limited, at least one federal court interpreting New York law has found that damages resulting from the hijacking of a plane do not fall within the war exclusions contained in property policies. Pan American World Airways, Inc. v. Aetna Cas. & Sur. Co., 505 F.2d 989 (2d Cir. 1974).

Insurance companies will also need to consider the public outrage and political pressure that could ensue if they are overly aggressive in their treatment of these emotionally charged claims. At least one large insurer has formally announced that it does not intend to invoke the war exclusions in connection with World Trade Center-related claims. Other insurers are still studying the language of the exclusions.

A company is required to provide notice of a business interruption loss as soon as practicable after sustaining the loss. Failure to provide timely notice can result in reduced coverage or absolute denial of a claim. In New York, timely notice is especially critical because New York courts stringently enforce notice requirements in insurance policies, and delays of only a few weeks may bar coverage altogether, regardless of whether the insurer suffers any prejudice from the delayed notice. If a company cannot access its policies or the policies have been destroyed, the company should contact its broker immediately to determine who its insurers are. Finally, because even short delays in providing notice can be fatal to a business interruption claim, companies should not wait for definitive and complete information regarding the scope and extent of a loss before providing notice. Immediate notice containing partial or incomplete information should preserve the company’s rights at the outset; there will be sufficient opportunity to follow up later with more complete information and a detailed proof of loss. It is not uncommon for disputes between companies and their insurers over the valuation of a business interruption claim to take months to sort out. A company’s foremost concern should be the preservation of coverage rather than determining the exact amount that is recoverable.

A company that has been impacted by the World Trade Center disaster and believes it may have business interruption coverage should promptly take the following steps:

Provide immediate notice to its business interruption insurer. If its policies are lost or destroyed, the company should contact its broker immediately to identify its carrier and the correct method of providing notice under its policies.

Review its insurance policies carefully and consult with its broker or legal counsel to determine the extent of coverage available.

Make prompt and reasonable efforts to mitigate its damages, including relocating its office, if necessary. The company is likely taking these steps regardless of its coverage situation, but failure to mitigate could restrict its recovery.

If litigation becomes necessary, consider the possible forums and initiate suit in the most favorable forum before its insurer selects a less favorable forum. Also, consider whether its policies provide for arbitration or an appraisal to resolve valuation disputes.

Consider whether other types of insurance, such as commercial liability policies, D&O insurance, or life and health insurance may provide additional sources of recovery in connection with the recent terrorist attacks.