In his seminal book published more than 75 years ago entitled Business Interruption Insurance (Philadelphia 1930), C.M. Kahler wrote that "[u]nfortunately the development of an adequate system of business interruption insurance has been hampered by the fact that it has always been considered as a part of the direct damage insurance of the particular hazard." Had United Airlines heeded Kahler’s insights into the nature of business-interruption coverage it could have structured its policy coverage to position itself better for recovery from its 9/11 losses; instead, United Airlines litigated a case that it lost at the trial court level and lost again on appeal to the Second Circuit. United Air Lines, Inc. v. Insurance Co. of the State of PA (2d Cir. Feb. 22, 2006).
It is crucial that policyholders understand that business-interruption insurance is fundamentally tethered to an antecedent physical property loss. Consequently, one sees litigation, as with the Chicago flood more than a decade ago, where tenants on the upper floors of a building were denied coverage because only the building’s lobby was flooded, impeding access to their property, and no physical loss occurred to their own property as to qualify them for business-interruption coverage.
Because of this relationship between physical loss and the business-interruption or business-income insurance recovery, policyholders seek to expand the triggers of the coverage to include circumstances that do not cause physical damage to their own property interests. As a result, policyholders will purchase coverage-trigger enhancements such that their policies apply if there is interference with "ingress-egress" to their property or if the suspension of operations results from the action of public authorities.
The key is to understand that because the paradigm of business-interruption cover is tied to a physical loss, so if the policyholder wishes to obtain coverage more broadly – something that may be quite advisable – it must take care to ensure that the contract is clear on this point.
United Air Lines may have thought that it had done that, but at least in the language quoted by the courts it failed (one might now expect a suit against its broker). Two years after the 9/11 attacks, United Airlines brought suit under its $25 million "Property Terrorism & Sabotage" insurance policy, seeking coverage for its losses associated with its former facility in the World Trade Center as well as for losses associated with its facilities at Ronald Reagan Washington National Airport. To the extent United needed to tether its Washington-area claim to a physical-damage loss it sought to do so based on the proximity of the Pentagon to the airport.
United argued that the policy broadly covered losses due to the government’s shutdown of the air-traffic system following 9/11. United focused on trigger – what must happen during the policy period for the policy to potentially apply – while effacing and hence eliding the valuation provision that calculates what, if anything, is owed in the event of a loss triggering the coverage. (As will be seen, the valuation provision took away what (arguably) the trigger provision gave.)
The policy covered business interruption that resulted from Terrorism and "any ensuing fire damage, damage from looting, or other damage caused by an act of a lawfully constituted authority for the purpose of suppressing or minimizing the consequences of [a terrorism] incident[]." United argued this language provided coverage for "Suppression Damages" up to the policy limit for loss of gross earnings. While the face of this language would seem to focus on "damage" – a category different from "loss of gross earnings" -- and thus negate United’s argument (but the court sort of accepted arguendo the assumption of coverage), the Second Circuit held against United on the ground that the policy set forth how one calculates covered "loss of gross earnings" and that within that provision there was a codicil limiting recoverable amounts to those stemming from damage to an "adjacent property."
In other words, the policy did not cover loss of gross earnings in general but rather only a limited subset of that type of loss tethered to some physical damage to an adjacent property. Or put somewhat different, the court looks less to what is covered in the abstract but rather focuses more pragmatically on the concrete conduct required by each party and what can be compelled against an unwilling other failing to live up the language of the bargain it signed. (United might well have had argument that the valuation language was too buried in the fine print to overcome the thrust of the insuring agreement, Haynes v. Farmers Ins. Exch., 32 Cal. 4th 1198 (2004), but such arguments often face uphill sledding when run by companies the size of United.) The "Valuation" section and its specification of indemnifiable "gross earnings" instantiated and made manifest the scope of the coverage promised in the insuring agreement. In other words, what gummed up United was not that the loss it suffered did not result from suppression damages from terrorism so much as that the indemnifiable loss it suffered was controlled by the valuation provision and assayed thereunder to be zero.
Given the wording of the valuation provision, "in order for [the insurer] to have a duty to indemnify United for lost earnings, the government action in question must either have physically damaged United’s property or been caused by physical damage to adjacent property." (Slip op. at 12) This construction is based on the policy language stating that gross-earnings coverage "is specially extended to cover a situation when access to the Insured Locations [the airport] is prohibited by order of civil authority as a direct result of damage to adjacent premises." In other words, even though "suppression damages" are covered, they are measured only by gross-earnings loss stemming from either direct-damage or damage to adjacent facilities.
The Second Circuit held that the Pentagon was not "adjacent" to United’s facility with the Washington, D.C. airport, which certainly comports with the facts on the ground. As the court earlier concludes, "[t]here is, in sum, no validity to United’s argument that there arises under [the insuring agreement] a duty for [the insurer] to indemnify United for any and all damages of any kind whatsoever that result from the government’s efforts to suppress terrorism." (Slip op. at 13)
The United case is consistent with the deep presumptions governing business-interruption coverage for the past 75 years since Kahler’s study. First, the insured needs to possess some "insurable interest" in the subject property whose interruption in operations is insured. See Zurich American Ins. Co. v. ABM Industries, Inc., 397 F.3d 158 (2d Cir. 2005); Kahler, Business Interruption Insurance, Ch. II; cf., Wal-Mart v. AIG Life (Del. Ch. March 2, 2004). Second, the paradigm supposes some property is physically damaged, whether that property is the insured’s or is that of a supplier or customer whose risk of loss is insured against under "contingent business interruption" coverage. The policy can be expanded beyond physical-damage claims, but care must be taken to ensure that this is true as a matter of both trigger and valuation (measurement of what component of loss is indemnifiable).
Just as the integration of the economy generally makes traditional and contingent business-interruption coverages all the more important, the newly felt risks of loss in the modern era from terrorism and other economically oriented assaults like cybercrimes make broad, non-physically tied losses crucial to insure against too. But given the background principles and biases imbuing the field of business-interruption coverage, policyholders wishing to purchase this form of protection must make it absolutely clear in the policy that the transfer of these types of risks is what it is paying for.
No one doubts that United’s loss here was genuine; there is no moral hazard or risk that the presence of insurance somehow contributed to the amount of loss it suffered. (Cf., Kahler, Ch. II at 2.) The question the Second Circuit confronted was whether United had transferred the risk of loss to its insurer: under the policy language at issue it is fairly clear that United did not do so.
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