Understanding the Business Interruption Insurance Decision in FCA v Arch Insurance & Others

The Financial Conduct Authority v Arch Insurance & others [2020] EWHC 2448 (Comm)

Last week on 15 September 2020 the High Court consisting of two specialist judges (Flaux LJ and Butcher J) gave its judgment in the business interruption test case. This is a moment that the insurance industry and hundreds of businesses have been waiting for since the lockdown measures in March. We now have some legal clarity as to when the insurers will have to pay out for Coronavirus related business losses.

The judgment was broadly favourable to the small businesses, the Court rejecting several of the insurers’ key arguments for avoiding indemnity. That said, there were several significant decisions in favour of the insurers, and the judgment seems not to have been as bad for insurers as the market might have feared.

There is to be a consequential hearing on 2October 2020, where the Court will hear submissions on the declarations to be made and on applications for appeal. In the meantime, the FCA has issued a letter explaining its expectations of insurers in light of the decision, requiring efficient payment of claims that can now be settled and provision of clear information about next steps where there are outstanding points to be appealed. The FCA also expects a pragmatic, transparent and consistent approach to be taken in handling the evidence related to remaining claims. Guidance is to be published in the coming weeks as to evidence relating to proximity and prevalence for disease coverage clauses. The letter can be found here:

www.fca.org.uk/publication/correspondence/dear-ceo-letter-business-interruption-insurance.pdf

The Judgment

The judgment determined the correct interpretation of 21 sample business interruption clauses. The FCA advanced the interpretation most favourable to the insured while the insurers in each case contended for a more restrictive interpretation. Thus, depending on whose interpretation was preferred, it should now be clear when the insurers have to pay out where similar policy wording has been used, and in the light of generic issues that have been determined.

Each policy had to be considered individually as the interpretation of the clauses needed to be undertaken in the context of the surrounding policy wording. That said, similar wording is used in various different policies, so most of the key arguments were repeated throughout the case. Below is a summary of the central arguments. For the Court’s reasoning and the nuances in relation to each different policy wording, readers are referred to the judgment, which can be found here:

www.fca.org.uk/publication/corporate/bi-insurance-test-case-judgment.pdf

The FCA has also produced a helpful press summary here:

www.fca.org.uk/news/press-releases/result-fca-business-interruption-test-case

Background

By way of background, readers might remember the following events:

• 16 March 2020: UK Government issues non-legally binding guidance for people to stay at home, stop non-essential contact and unnecessary travel, work from home where possible, and avoid social venues.
• 21 March 2020: Health Protection (Coronavirus, Business Closure) (England) Regulations 2020– requiring various categories of business to close, such as pubs, restaurants, gyms etc.
• 26 March 2020: Lockdown measures given effect by theHealth Protection (Coronavirus, Restrictions) (England) Regulations 2020– requiring closure of non-essential shops and restrictions on individual movement.

In the judgment, businesses were placed into six categories according to how they were affected by the lockdown regulations e.g. Category 1 covered restaurants, cafés and bars, which were required to close by the 21 March and 26 March 2020 regulations. Category 3 covered essential shops and businesses that were allowed to stay open subject to social distancing recommendations.

The Court considered three groups of policy wordings: disease clauses, hybrid clauses and prevention of access clauses.

Disease Clauses

Theseprovisions provide coverage in respect of business interruption from the occurrence of a notifiable disease within a specified radius of the insured premises.

e.g. – RSA 3 provides:

“We shall indemnify You in respect of interruption or interference with the Business during the Indemnity Period following:

… iii. occurrence of a Notifiable Disease within a radius of 25 miles of the Premises;

The Causation Argument

The core argument advanced by the insurers was that the policy wordings required business interruption to be caused by the occurrence of a disease within the specified radius, rather than by the wider effects of the pandemic. The argument was as follows:

• The insured is indemnified in respect of business interruption following the occurrence of a notifiable disease within a 25 mile radius (see RSA 3, para. 85);
• This wording implies that the occurrence of the disease within the 25 mile radius must be the proximate cause of the business interruption;
• The insured cannot satisfy this requirement since the loss would have occurred but for any local occurrence of Covid-19 due to the effects of the disease outside of the 25 mile radius, e.g. due to national lockdown restrictions and general reduction in demand.

The Court rejected this interpretation, holding that the policies applied a looser test of causation. Causation is established where there is a national lockdown, not just where business interruption has occurred due to the effects of a local occurrence of a notifiable disease (see para. 107). Of course, the insured will need to provide evidence that there was an occurrence of the disease within a 25 mile radius, but once this is proved then the losses include those caused by the lockdown measures and downturn in demand.

A notable exception was in respect of QBE 2 (a policy designed for night clubs and late night venues) and QBE 3 (a combined commercial policy). In those cases, the policy wording was more specific that the business interruption had to be caused by a particular “event”, specifically a local occurrence of the disease. It was noted that this will be difficult to satisfy in most cases.

The “Trends Clause” Argument

Most of the insurance policies contained “trends clauses” that apply to the calculation of profit, turnover and revenue, similar to the following (from RSA 3):

“…adjustments shall be made as may be necessary to provide for the trend of the Business and for variations in or other circumstances affecting the Business either before or after the Incident or which would have affected the Business had the Incident not occurred …”

The insurers advanced an argument along the same lines as the causation argument, as follows:

• Losses are adjusted according to circumstances before or after the incident;
• Losses therefore have to be adjusted according to the effects of the Covid-19 pandemic;
• Such adjustments would be co-extensive with the losses caused by the insured incident.

The Court held that the effect of that term could not be that the loss would be limited by any part of the insured peril, which included the pandemic. When calculating the loss, one takes out of the counterfactual the business interruption referable to COVID-19 including via the authorities’ and/or the public’s response thereto.

An important qualifier was added for certain policies, however, that the Indemnity Period only begins when a case of Covid occurs within a 25 mile radius of the insured premises. Any business interruption due to the pandemic before such an event is accounted for in quantifying the claim.

Exclusion Clauses

RSA 3 contained an exclusion clause, which excluded loss due to causes including “epidemic or disease”. It was held that this clause did not override the express grants of cover in respect of business interruption caused by a notifiable disease.

Hybrid clauses

These clauses refer both to restrictions imposed on the premises and to the manifestation of a notifiable disease.

e.g. Hiscox 1:

We will insure you for your financial losses and other items specified in the schedule, resulting solely and directly from an interruption to your activities caused by… your inability to use the insured premises due to restrictions imposed by a public authority during the period of insurance following… an occurrence of any human infectious or human contagious disease, an outbreak of which must be notified to the local authority;

“Restrictions”

The Court held that “restrictions” had to be mandatory restrictions, i.e. actual regulations requiring businesses to close. Thus, businesses required to close under the regulations of 21 or 26 March 2020 were potentially covered. The advice and recommendations preceding these recommendations, including the 16 March 2020 government directions would not trigger these clauses.

For businesses that were allowed to stay open until the 26 March 2020 regulations (such as holiday cottages, insured under RSA 1), this means that the policies do not respond until that date.

RSA 4 had a stricter requirement of “enforced closure”, which entailed that all or part of the premises are close under legal compulsion. Again, this could not be before March 21 or 26.

“Inability to Use”

Again, the interpretation of the phrase “inability to use” was somewhat restrictive. “Inability to use” entailed something more than “hindrance”. Complete closure would obviously qualify. Partial use might be rendered sufficiently nugatory or vestigial to amount to an inability to use on the facts of a particular case (para. 268)

Importantly, however, Regulation 6 of the 26 March 2020 Regulations, which was a general prohibition on people leaving the place where they were living without reasonable excuse, did not amount to a restriction that could have led to an inability to use premises.

“Following an occurrence”

As with the disease clauses, it was argued that the “occurrence” in question had to be one local to the insured business. This was again rejected. Restrictions announced after the national outbreak triggered the policy wording.

“Interruption”

In the Hiscox wording, “interruption” included disruption or interference, not just complete cessation.

Prevention of Access Clauses

These policy wordings provide cover where there has been a prevention or hindrance of access to or use of the premises as a consequence of government or local authority action or restriction.

 “Prevention of Access”/ ”Hindrance”

The Arch policy wording covered,

“prevention of access to the Premises due to the actions or advice of a government or local authority”

The phrase “prevention of access” was held to denote impossibility rather than hindrance. This could mean closure as a result of government advice. It could also cover bars and restaurants that had closed but started a takeaway service, or theatres that began a remote streaming service, because this entailed a fundamental change in the nature of the business using the premises. It did not, however, cover businesses that already had a takeaway service as well as a restaurant or bar. Nor would the policy wordings respond to the advice and recommendations of 16 March 2020, which were not sufficient to “prevent access” to the relevant businesses.

Complete, not just partial, closure was required. Closure means closure of the business, so a policyholder could still physically access the premises, e.g. for essential maintenance.

In contrast, the RSA 4 wording expressly covered “hindrance” to the use or access of insured locations. This policy wording could be triggered where the insured closed in response to the government advice on 16 March 2020. The social distancing measures advised on 16 March 2020 could also be said to be a “hindrance”.

Policy Wordings That Respond Only to Local Incidence

Although the majority of policy wordings were held to respond to the national Covid-19 situation, certain insurers were successfully able to argue that some of their policies only responded to local incidences.

The Zurich policies and MSA 1 and 3 contained “prevention of access” provisions similar to the Arch wording but in those cases the regulations leading to the closures had to have resulted from the risk of Covid-19 in the immediate vicinity of the insured premises as opposed to the country as a whole. It was therefore highly unlikely that closures due to government regulations would be covered.

The Hiscox Non-Damage Denial of Access clause and MSA 2 covered denial of access or hindrance caused by a specific incident of the disease within a specified radius of the premises.

Causation and the “Orient Express” Case

Of some legal interest is the insurers’ argument on causation, relying on the “Orient Express” case. The argument was along the same lines as the causation argument advanced in relation to the construction of the policy provisions – namely that the insurers should only be required to pay for losses directly caused by the insured event and not by the wider effects of the coronavirus pandemic and response.

The Court held that this argument would not affect the outcome as the answer to the case lay in the construction of the policy provisions. If the reasoning in the Orient Express case did apply to the policy wordings under consideration, the Court have held that it was wrongly decided.

Prevalence

The Court was asked to give guidance on the kinds of evidence that could be relied upon to establish cases of Covid-19 within a particular area. Four types of evidence were identified as capable of discharging the burden on the insured:

• Specific evidence of a case within a relevant policy area – e.g. a report of an outbreak at a care home down the road.
• NHS Deaths Data –provided the relevant NHS trust had only one hospital and it was within the policy area.
• ONS Deaths Data –provided the recorded death was within a local authority or health board that was entirely within the policy area.
• Reported Cases –publicly available online. The smallest available unit of data covers cases within a “Lower Tier Local Authority (LTTA)”. This can be relied upon provided there is at least one wholly within the policy area.
• Other statistical evidence – provided it is reliable.

There may remain cases where a LTTA (or other unit of data) is partially inside and partially outside of a policy area. To address this, two methodologies were proposed by the FCA:

• Averaging methodology –involves taking an average number of cases or deaths per square mile within a region, weighted according to the population level within the policy area, and using that average to show that there was at least one case within the policy area. An example is set out at para. 555 of the judgment.
• Undercounting methodology – involves using an “undercounting ratio” to extrapolate the extent to which actual cases of COVID-19 exceeded the reported figures in particular areas and across the UK and using an “uplift” to accommodate for this.

The FCA sought to draw guidance from the Court as to whether such evidence would be sufficient to discharge the burden of proof. The Court refused to draw any definite conclusions in the abstract.

Therefore it remains open to insurers to challenge whether the evidence presented in a particular case discharges the burden of proof. The Court did, however, draw attention to the concessions that were made by the insurers – the types of evidence and methodologies under discussion were capable of discharging the burden of proof and absolute precision is not required for claims to succeed.

We will report again on the outcome of the next hearing, and on any other significant developments including the likely appeal by the insurers.

Tom Emslie-Smith & John Meredith-Hardy

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