On 15 January 2021, the UK Supreme Court handed down its judgment in the test case brought by the Financial Conduct Authority (“FCA”), which is intended to clarify how commonly-used business interruption insurance wordings will respond to losses arising from the Covid-19 outbreak in the United Kingdom. The Supreme Court’s decision followed a ‘leapfrog’ appeal from the High Court judgment dated 15 September 2020, which means that the test case bypassed the Court of Appeal entirely.

The case only considered so-called “non-damage” business interruption policies, rather than policies that typically cover business interruption losses arising from “physical loss or damage” to the insured premises. However, some aspects of the judgment will have broader implications for both damage and non-damage business interruption policies — particularly the decisions relating to loss adjustment or “trends” clauses, which are summarised below.

This alert provides a brief overview of the most important aspects and practical implications of the judgment, which was broadly favourable to policyholders with non-damage business interruption policies but still leaves some questions unanswered.

In summary, the test case addressed a sample of non-damage business interruption wordings that had insuring clauses falling into three broad categories:

• Disease clauses, which provide cover for business interruption losses resulting from the occurrence of a notifiable disease (i.e. Covid-19) at, or within a specified distance of, the insured premises;
• Prevention of access clauses, which provide cover for business interruption losses resulting from public authority intervention that prevented or hindered access to or use of the insured premises; and
• Hybrid clauses, which combine the main elements of the disease and prevention of access clauses.

The judgment is directly binding on the defendant insurers to the test case, but the FCA has estimated that the issues considered in the test case could indirectly affect over 60 insurers and about 370,000 policyholders, with approximately 700 types of policy.[1] Policyholders whose wordings were not considered in the test case will need to consider whether their own policies are similar to the wordings addressed by the Supreme Court, and evaluate the extent to which the judgment may be relevant to the interpretation of their policies. 

At a high level, the Supreme Court substantially dismissed the insurers’ appeals against the High Court decision and allowed the FCA’s appeal. In effect, the Supreme Court upheld the High Court’s judgment, which was broadly favourable to policyholders, albeit based on different reasoning in some important respects. The key decisions made by the Supreme Court are as follows:

1. Broad interpretation of disease, prevention of access, and hybrid clauses:

a. The Supreme Court concluded that insurance cover is available under a disease clause when there was any occurrence (i.e. at least one case) of a notifiable disease within the specified radius of the insured premises. The cover extends to business interruption losses caused by any cases of the notifiable disease within the geographic limit, but not to business interruption losses caused by cases occurring outside that area.

b. In respect of the prevention of access and hybrid clauses, the Supreme Court went further than the High Court in several respects that are helpful for policyholders.

i. First, with regard to any wording covering business interruption losses caused by usage restrictions on premises, imposed by a public authority, the High Court had previously said that the coverage would only be available where the relevant restrictions were expressed in mandatory terms and had the force of law. The Supreme Court rejected that narrow interpretation, and found that coverage could also be available if a public authority were to issue an instruction that does not yet have legal force, provided that, “from the terms and context of the instruction, compliance with it is required, and would reasonably be understood to be required, without the need for recourse to legal powers”. The relevant instruction would also need to be “in clear enough terms to enable the addressee to know with reasonable certainty what compliance requires”. This is helpful to policyholders, given that the UK Government introduced both legally-binding legislation and non-legally-binding guidance in response to the Covid-19 outbreak.

ii. Second, with respect to wordings covering business interruption losses caused by the inability to use insured premises due to restrictions imposed by government, the Supreme Court also went further than the High Court. The High Court had said that coverage would only be available if there was a complete inability to use the relevant premises. The Supreme Court agreed that inability to use must be established, not merely impairment or hindrance in use, but it did not accept that the inability had to be a total inability to use any part of the premises for any business purpose.Instead, the Supreme Court held that coverage could indeed be available if the policyholder was unable to use the premises for a discrete part of its business activities, or if the policyholder was unable to use a discrete part of its premises for its business activities. The Supreme Court used the example of a golf club which remained open but had shut its clubhouse, and was therefore unable to use a discrete part of the insured premises for a discrete but important part of its business, namely hosting events or serving food and drink. Similarly, for wordings that provide coverage for loss arising from prevention of access to insured premises, the Supreme Court found that a complete closure of the premises was not required. Rather, there could be prevention of access where there was prevention of access to a discrete part of the premises, or for the purpose of carrying on a discrete part of the policyholder’s business.

2. Causation: As noted above, the Supreme Court found that disease clauses only cover the losses arising from Covid-19 cases occurring within the specified radius of the insured premises. The insurers argued that, whatever the exact nature of the causal link required by the relevant policy wordings (e.g., “following”, “arising from”, “in consequence of”), it is a minimum requirement of any causation test that the occurrence of the insured peril made a difference to the occurrence of loss: i.e. that the loss would not have been sustained but for the occurrence of the insured peril. They also asserted that the occurrence of one or more cases of Covid-19 within the specified radius cannot be a cause of business interruption loss if the same interruption would have occurred anyway as a result of other cases elsewhere in the country. The Supreme Court rejected this approach. Instead, the Court held on the topic of causation that it is sufficient for a policyholder to prove that their business interruption was a result of government action taken in response to cases of disease which included at least one case of Covid-19 within the geographical area covered by the clause. This is because each individual case of illness resulting from Covid-19 which had occurred by the date of any government action was a separate and equally effective cause of that action, and of the response of the public to that action. Moreover, the Court held that this conclusion “does not depend on the particular terminology used in the clause to describe the required causal connection between the loss and the insured peril”.

3. Adjustment to loss (‘trends’) clauses: Most of the sample wordings addressed in the test case included clauses that require business interruption losses to be adjusted to reflect the “business trends” or other circumstances in a period (typically 12 months) immediately preceding the interruption. The purpose of these clauses is to ensure that the calculation of losses reflects, as best as possible, the financial results that would have arisen had the insured peril not occurred. For instance, if the performance of an insured business had been declining even before the insured peril had occurred, the policyholder should not be able to calculate losses as though the earlier decline in trade had never occurred. The Supreme Court held that these clauses are part of the loss quantification machinery of the policies, and do not seek to delineate the scope of the indemnity. Accordingly, the trends clauses should, if possible, be construed consistently with the insuring clauses in the policy, and should not operate as a de facto exclusion of coverage. Unless a particular policy wording otherwise requires, the relevant counterfactual for the purpose of making adjustments under a trends clause is the financial result that would have been achieved by the business during the indemnity period but for the insured peril and its underlying or originating cause (i.e. the Covid-19 outbreak). By way of example, if a pub suffered a 70% fall in turnover due to Covid-19 fears in the week preceding the introduction of government restrictions requiring mandatory closure, this fall in turnover would not be a trend or circumstance for which an adjustment is permitted or required.

4. Overruled Orient-Express: The Court considered and overruled the High Court’s judgment in Orient-Express Hotels Ltd v Assicurazioni Generali SpA [2010] EWHC 1186 (Comm), on the basis that it had been wrongly decided. That case concerned a hotel in New Orleans that had suffered hurricane damage in 2005. The business was affected by both the physical damage to the hotel itself, and the wider impact of the hurricanes on the city. A dispute arose between the insurers and the hotel regarding the amounts the hotel was entitled to recover. An arbitral tribunal and the High Court had both found in favour of insurers, and held that the hotel could not recover business interruption losses that the hotel would have sustained as a consequence of the wider damage to the city, even if the hotel itself had been undamaged (i.e. if it was an undamaged hotel in a devastated city).

The decision had been widely criticised, including on the basis that it could give rise to surprising results, to the detriment of policyholders. For instance, in reliance on Orient-Express, insurers potentially could assert that the more widespread the impact of an insured peril, the more restricted the coverage provided under the relevant policy. The precedent had also been applied inconsistently by insurers following previous disasters.  The Supreme Court held that the correct approach would have been to construe the relevant wording to exclude from the assessment of what would have happened if the damage had not occurred, any circumstances that had the same underlying or originating cause as the damage, namely the hurricanes. As noted above, this is consistent with the approach taken by the Supreme Court in relation to the interpretation of trends clauses.

The decision of the Supreme Court is broadly welcome for policyholders with non-damage business interruption policies, and is the final word in the test case brought by the FCA. As noted above, the judgment is directly binding on the insurers who were party to the test case in respect of the specific policies considered in the case, but the Supreme Court’s findings will also have implications for other policies with similar or identical wordings.

In guidance to insurance firms published in June 2020, the FCA set out the actions insurers should now take following the resolution of the test case. In particular, insurers must review and revisit all potentially affected claims that were rejected or adjusted before the judgment, and deal with any complaints raised before the judgment (excluding any claims or complaints that were settled). Insurers must also inform their policyholders promptly of the outcome of their reassessment. Prudent policyholders should consider the implications of the judgment with their brokers and other professional advisors, rather than relying on the insurers’ assessments.

Although the judgment should assist many policyholders in advancing their business interruption claims, there are several issues that have been left unresolved by the Supreme Court judgment, which will need to be considered in the future. For instance, although the Supreme Court has explained how disease clauses should be interpreted, policyholders will still need to establish and prove the presence of one or more Covid-19 cases within the specific geographic limits set out in their policies. The FCA has already issued draft guidance on how the presence of Covid-19 may be established, including by reference to official statistics. The final version of the guidance is likely to be released soon. 

Additionally, while the judgment addresses the interpretation and application of trends clauses, it does not address other loss calculation issues, which will need to be considered on a case-by-case basis. Likewise, the Supreme Court does not address whether insurers can deduct amounts that policyholders have claimed under government support schemes, and whether losses suffered over the course of the last year can be aggregated, which may turn on how individual wordings define the relevant indemnity periods.

Finally, as we set out above, the judgment does not generally address the interpretation of business interruption policies requiring physical damage, and there is little English precedent on such clauses. In October 2020, in the case of TKC London Limited v Allianz, the High Court considered the interpretation of a policy that provided coverage for business interruption losses arising “in consequence of an event to property used by the Insured at the Premises for the purpose of the Business”. The term “Event” was in turn defined as “accidental loss or destruction of or damage to property used by the Insured at the Premises for the purpose of the Business”. Following an application by the insurers for summary judgment or strike out, the Court found against the policyholder, concluding that the policyholder had not suffered a loss of property in the sense of a physical loss, but only a temporary loss of use of the insured property. The availability of coverage under other damage-based business interruption policies will turn on the specific wordings of those policies and the facts in a particular case, and in any event some courts in the US have ruled in favour of coverage under similar damage-based policies. Policyholders asserting claims under such policies for business interruption losses from transient or non-physical loss of property may well benefit from expert analysis of both their specific policy language and their distinct pandemic-related facts.

If you have any questions concerning the material discussed in this client alert, please contact the following members of our Dispute Resolution and Insurance Practice Group.

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