When the Lights Go Out: Coverage for Business Interruption

Transcription

1 When the Lights Go Out: Claims and Coverage for Business Interruption after Superstorm Sandy When the Lights Go Out: Coverage for Business Interruption Sherilyn Pastor 1 McCarter & English, LLP Four Gateway Center 100 Mulberry Street Newark, NJ (973) spastor@mccarter.com Introduction Hurricanes, floods, earthquakes, and ice storms can shut down utility services for weeks. Heavy snow and strong winds downed trees, leaving over 3 million in the dark, some for up to 10 days during the 2011 Halloween nor easter. In August 2003, problems with the electrical grid caused a blackout over much of the northeastern United States and Canada that lasted four days and left over 50 million people without power. People are generally resourceful; they stock up on needed supplies as storms approach. But businesses that rely heavily on utility services need more than flashlights and fresh batteries to survive a storm. Many companies purchase commercial property insurance to cover direct physical loss or damage to their property. They also may purchase business interruption insurance, which reimburses lost business income and unavoidable continuing 1 Sherilyn Pastor is a partner in, and Practice Group Leader of, McCarter & English, LLP s Insurance Recovery Group. Ms. Pastor is Co-Chair of the Insurance Coverage Litigation Committee, and has recovered hundreds of millions of dollars for policyholder clients. She also counsels clients analyzing existing insurance policies, and new insurance products. This publication is not intended to provide legal advice. Issues relating to insurance coverage and litigation are fact specific, and their resolution will depend on the facts involved and the law governing the disputes, which varies from state to state. The views expressed in this publication are not necessarily those of McCarter & English or its clients. Copyright by author (2014).

2 expenses caused by an interruption of business stemming from damage to covered property. What some companies do not realize is that business interruption coverage may not respond to service interruptions, when, for example, severe winds knock down nearby power lines, plunging a business into darkness. Businesses heavily dependent on power suppliers should consider service interruption coverage to protect against losses they may suffer when their power supply is interrupted by a covered peril, such as wind, fire or lightning. This article examines service interruption coverage, and offers tips to maximize such coverage when the lights go out. An Illustration Service interruption-related losses can be catastrophic. In Red Bird Egg Farms, Inc. v. Pennsylvania Manufacturers Indemnity Co., 15 Fed. Appx. 149 (4th Cir. 2001), the policyholder operated an egg farm with over 500,000 chickens. The chickens required constant ventilation, which was provided by industrial fans running on a special current known as three-phase alternating current. When lightning struck the facility and power was interrupted, the facility s generators, which were capable of generating three-phase alternating currents, initially responded but, soon thereafter, failed because of a ruptured coolant hose. As the facility worked to fix the generators, local power service was restored, but it was single-phase, and it began to blow out the fans motors. An employee disconnected those fans not already blown from the incoming power and activated a secondary generator, but that generator also failed because it could not handle the increased load. All of the chickens eventually died. The policyholder submitted a claim for loss of the birds, debris removal, damage to the generators, and business interruption. The insurer paid for the property loss, but denied the substantial business interruption claim on the basis that the policy contained a power exclusion. The policyholder disagreed and filed suit. It urged that the power exclusion was not applicable as its business losses were due to something akin to a fire when the fans melted down, and/or because its fans had too much single phase current (not an interruption of current). The Fourth Circuit Court of Appeals disagreed with the policyholder, and entered judgment for the insurer, finding that the single phasing was tantamount to a

3 power interruption within the exclusion s meaning. The policyholder was left uninsured for its service interruption losses. Policy Language Commercial property policies can expressly provide for service interruption coverage. A typical service interruption grant provides insurance for direct physical loss, damage, or destruction to electrical, steam, gas, water, sewer, telephone, or any other utility or service including transmission lines and related plants, substations, and equipment of suppliers of such services, as follows: A. Coverage UTILITY SERVICES TIME ELEMENT This endorsement modifies insurance provided under the following: BUSINESS INCOME (AND EXTRA EXPENSE) COVERAGE FORM Your coverage for Business Income and/or Extra Expense, as provided and limited in the applicable Coverage Form, is extended to apply to a suspension of operations at the described premises caused by an interruption in utility service to that premises. The interruption in utility service must result from direct physical loss or damage by a Covered Cause of Loss (as provided under the applicable Causes of Loss Form indicated in the Schedule) to the property described in Paragraph C. if such property is indicated by an X in the Schedule. B. Exception Coverage under this endorsement does not apply to Business Income loss or Extra Expense related to interruption in utility service which causes loss or damage to electronic data, including destruction or corruption of electronic data. The term electronic data has the meaning set forth in the Coverage Form to which this endorsement applies. C. Utility Services 1. Water Supply Property, meaning the following types of property supplying water to the described premises: a. Pumping stations; and b. Water mains. 2. Wastewater Removal Property, meaning a utility system for removing wastewater and sewage from the described premises, other than a system designed primarily for draining storm water. The utility property includes sewer mains, pumping stations and similar equipment for moving the effluent to a holding, treatment or disposal facility, and includes such facilities.

4 Coverage under this endorsement does not apply to interruption in service caused by or resulting from a discharge of water or sewage due to heavy rainfall or flooding. 3. Communication Supply Property, meaning property supplying communication services, including telephone, radio, microwave or television services, to the described premises, such as: a. Communication transmission lines, including optic fiber transmission lines; b. Coaxial cables; and c. Microwave radio relays except satellites. It does not include overhead transmission lines unless indicated by an X in the Schedule. 4. Power Supply Property, meaning the following types of property supplying electricity, steam or gas to the described premises: a. Utility generating plants; b. Switching stations; c. Substations; d. Transformers; and e. Transmission lines. It does not include overhead transmission lines unless indicated by an X in the Schedule. D. As used in this endorsement, the term transmission lines includes all lines which serve to transmit communication service or power, including lines which may be identified as distribution lines. E. The Coinsurance Additional Condition does not apply to this endorsement. F. The Utility Services Limit Of Insurance, as shown in the Schedule, is the only Limit which applies to the coverage provided under this endorsement, and is part of, not in addition to, the Limit Of Insurance stated in the Declarations as applicable to the described premises. A policy s service interruption clause may have limitations, such as the maximum distance the damaged and non-functioning utility equipment may be from a policyholder s location. It may exclude certain perils such earthquakes or flood. It also may exclude certain equipment, such overhead distribution lines. Further, the owners, managers, or operators of utilities typically cannot be named insureds under another s property policy.

5 Physical Loss or Damage Broadly speaking, to be covered, the interruption in utility service must result from physical loss or damage. When a transformer explodes or a water main bursts, the damage is obvious to all. Physical damage, however, also has been held to embrace and include loss of use, value, or function. Knowing the contours of the applicable law is critical. In Wakefern Food Corp. v. Liberty Mutual Fire Insurance Co., 968 A.2d 724 (N.J. App. Div. 2009), the policyholders, supermarkets trading under the Shop-Rite banner, sustained significant losses as the result of food spoilage and loss of business when the interconnected North American electrical power generation and transmission system (colloquially known as the electrical grid ) caused a four-day blackout. The policyholder sought coverage under an all risk insurance policy, which contained an additional Services Away From Covered Location Coverage Extension. The extension provided coverage for losses resulting from interruptions in electrical power caused by physical damage to certain electrical equipment and property located off of supermarket property. The insurer denied coverage, claiming that the losses sustained were not the result of physical damage. The appellate court disagreed, explaining that the term physical damage was not defined in the policy, and concluding that it should be given its plain meaning based on the policyholders understanding of the protections they were purchasing, and not some hyper-technical meaning based on the intricacies of electrical power transmission systems. Thus, the court found that the electrical grid was physically damaged because it could not perform its essential function of providing electricity, at least until damaged equipment was replaced. The court pointed out, in a footnote, that it might have reached a different conclusion if the blackout had been the result of something other than the physical inability of the electrical grid to function (such as, for example, if a regulatory authority had ordered that power be shut off to conserve electricity). The court, however, made clear that the policyholders should not be subjected to technical encumbrances or hidden pitfalls and their policies should be construed liberally in their favor to the end that coverage is afforded to the full extent that any fair interpretation will allow. Id. (quoting Kievit v. Loyal

6 Protective Life Ins. Co., 34 N.J. 475, 482 (1961)). The court observed that neither the policyholder nor the insurer were electric utilities, operators or providers with detailed knowledge about the workings of the electrical grid and its components. As such, it made no sense to assign a highly technical definition to physical damage. Rather, the term had to be defined from the point of view of a customer of electrical power who had purchased insurance to protect against the risk of losses from the loss of electrical power used to refrigerate products. According to the court, [t]he average policyholder in plaintiffs position would not be expected to understand the arcane functioning of the power grid or the narrowly-parsed definition of physical damage which the insurer urges us to adopt. The court also rejected the insurer s argument that physical damage must involve permanent ruin or destruction of the electrical grid or its components. The court concluded that a temporary loss of function, after which the electrical grid goes back on line, is sufficient as the inherent nature of power losses is necessarily temporary. Meaning, electricity will always be restored eventually. Thus, adopting the insurer s requirement of permanent ruin or damage would have rendered the policyholders insurance coverage illusory. That the electrical grid could not function was enough to demonstrate physical damage sufficient to trigger service interruption coverage. Covered Perils & Causation To fall within coverage, the loss, damage, or destruction resulting in the loss of service must also be the result of a peril (or perils) similar to those covered under the policy. Indeed, when dealing with business interruption claims, a key consideration is whether the damage-causing event is a peril covered by the policy. Insurers and policyholders often disagree over causation issues. See, e.g., Bayrock/Sapir Org. LLC v. Affiliated FM Ins. Co., No /2013 (N.Y. Sup. Ct. 2013) (policyholder alleging that power interruption was caused by explosion at substation and flying debris; insurer contending it was caused by flooding and therefore excluded from coverage). The law on causation varies from state to state. New York, for example, applies a proximate, efficient and dominant cause of loss test. Meaning, when a loss is caused by covered and excluded causes, the policyholder is entitled to coverage if the covered peril is the

7 dominant and efficient cause of the loss. See, e.g., Leonard v. Nationwide Mut. Ins. Co., 499 F.3d 419, 431 (5th Cir. 2007). New Jersey, however, looks to whether the first or last step in the chain of causation resulting in the loss was a covered event. If it was, there is coverage. See, e.g., Simonetti v. Selective Ins. Co., 859 A.2d 694, 700 (N.J. App. Div. 2004). Some policies may contain anti-concurrent causation ( ACC ) provisions. ACC is the terminology used by insurers to frame discussions over what is covered and what is not covered under their policies. Some insurers contend that these provisions exclude from coverage any loss caused in part by any excluded peril. ACC provisions have been met with mixed responses by courts and insurance regulators. Some states, such as California, North Dakota, Washington, and West Virginia, prohibit their enforceability. Some states, such as New Jersey and New York, have recently introduced legislation to ban them. Still, other courts disfavor these clauses, give them limited effect (applying them to events that happen at the same time (concurrently), and not to sequential events), or decline to enforce them as vague or contrary to policyholders reasonable expectations. See, e.g., Safeco Ins. Co. of Am. v. Hirschmann, 112 Wash. 2d 621, 773 P.2d 412 (1989). Accord Fruit & Vegetable Supreme Inc. v. The Hartford Steam Boiler Insp., 28 Misc.3d 1128 (N.Y. Sup. Ct. 2010) (food spoilage and loss of income not recoverable because service interruption coverage was excluded, but pre-black out damages were unrelated and constituted covered loss). Thus, when an ACC clause is in issue, a policyholder needs to consider the specific facts and policy language, the applicable law, and whether the insurer has drafted an ACC clause in vague and imprecise terms or buried it deeply within a confusing section of its otherwise all risk policy. Conclusion When purchasing property and business interruption insurance before a loss policyholders should consider the extent to which their operations rely on electricity, natural gas, water, sewer, and telecommunications or Internet services, and then tailor their insurance policies to meet their needs. Moreover, they should consider whether the policies key terms and requirements are clear. If a policy is

8 vague, policyholders should seek to clarify the policy s provisions so that the policy can be applied without undue delay or controversy. After a loss, a policyholder should gather and review all of its insurance policies to determine the scope of coverage. If appropriate, it should notify insurers of the loss. If a policyholder needs help identifying coverage, assessing the viability and strength of its potential claim, or communicating with the insurers representatives, it should seek advice from insurance professionals, brokers or attorneys to assure it does not leave needed insurance money on the table.