COVID-19 losses – will business interruption insurers be ordered to pay? (Part 2)

The FCA brought the Test Case (the first under the Financial Markets Test Case Scheme) by agreement, against 8 Defendant Business Interruption (BI) Insurers in June 2020, with the "mutual objective of achieving the maximum clarity possible for the maximum number of policyholders and their insurers, consistent with the need for expedition and proportionality" with respect to the application of what have been termed "Disease" and "Prevention of Access" extensions to standard property damage BI policies to the financial losses suffered by businesses as a result of the UK Government's measures to combat the spread of COVID-19.  Following an 8 day trial in July 2020, the Court handed down its judgment on 15 September 2020.  While 21 specimen policy wordings issued by the Defendant Insurers are the subject of the Test Case, the FCA believes that the findings in the judgment are relevant to a further 700 wordings, issued by another 60 insurers.  For further background information on the Test Case see: COVID-19 Losses – Will Business Interruption Insurers Be Ordered To Pay? (Part 1).

The Test Case is focused around the effects of the UK Government's response to the COVID-19 emergency, in particular the guidance issued on 16 March 2020 (16 March Guidance) which included advising the public to observe social distancing, the Health Protection (Coronavirus, Business Closure) (England) Regulations 2020 (21 March Regulations) which required the closure of certain businesses e.g. in the hospitality sector and the Health Protection (Coronavirus, Restrictions) (England) Regulations 2020 (26 March Regulations) which included the closure of non-essential retail.  For the purposes of the Test Case, affected businesses have been split between 7 business types (Fig. 1).

The specimen wordings before the Court containing Disease Clauses were issued by RSA, Argenta, MS Amlin and QBE.  Whilst the Court considered coverage under each of these clauses individually, certain themes emerge on the Court's approach as to how these clauses should be applied to COVID-19 losses. 

The coverage provided by Disease Clauses tends to include coverage for BI following the "occurrence" (or other phrasing) of a notifiable disease at or within a specified radius e.g. 25 miles of the insured premises.  The background to this type of cover has been to indemnify for BI losses e.g. where there has been a local outbreak of an infectious disease, such as e-coli, and businesses have been required to close by local health officials while a deep clean of premises takes place. 

Insurers accepted that  COVID-19 was a Notifiable Disease across the UK by 6 March 2020 but argued that coverage under the Disease Clauses in their BI policies only responds to the effects of local outbreaks of COVID-19 and the measures taken locally to deal with such local outbreaks (such as the local lockdown measures imposed in Leicester); they do not respond to a pandemic, requiring action on a nationwide basis.  They further argued that since the proximate cause of the loss was the localised occurrence of COVID-19, applying a "but for" causation requirement, meant that in the absence of the local occurrence, the business would still have suffered loss as a result of the Government's nationwide measures, with the result that policyholders could not claim for their BI losses under these Disease Clauses.

The Court looked first at the meaning of "occurrence".  It held that there was an "occurrence" of COVID-19 when it first existed within the radius requirement of the Disease Clause, whether diagnosed or not, meaning coverage could be triggered even where individuals were asymptomatic.  A slightly different approach was taken on the specimen wordings which used "manifest" rather than "occurrence".  On these policies, the Court said that "manifest" meant when COVID-19 was apparent either because an individual had symptoms of the disease or had been diagnosed (even if they were otherwise asymptomatic, since the disease would have "manifested" itself to the diagnoser).   

The Court then considered the nature of a notifiable disease, the fact that it is likely to be highly contagious and to spread in complicated, unpredictable "fluid patterns", and that the response of the authorities in these situations may be to respond to the outbreak as a whole rather than to individual cases, as happened with COVID-19.  Against this analysis, the Court noted that as the Disease Clauses contemplated that cases of a notifiable disease could occur at a distance away from the insured premises, the parties must have contemplated that there could be cover for a widespread response to an outbreak, not limited to a localised occurrence.  Since the proximate cause of the interruption suffered by businesses, for the purposes of the Disease Clause, was COVID-19, the local occurrences formed part of an indivisible widespread whole to which the Government had responded on a nationwide basis with the result that these Disease Clauses would provide cover for COVID-19 related losses – the significance of the local occurrence being to determine the date from which the period of indemnity for the loss would start to run.  Having determined that the proximate cause was COVID-19 and not just the local occurrence of COVID-19, the Court held that in determining quantum of the loss, all COVID-19 related factors (i.e. the effect of the nationwide Government measures) should be taken out of Insurers' assessment of quantum.    

In addition to the specified mileage requirement contained in the Disease Clauses referred to above, another RSA specimen wording (RSA 4) refers to the occurrence of a notifiable disease within the "Vicinity" of the insured location.  "Vicinity" is defined in RSA 4 as:

Whilst generally "vicinity" connotes an area near to the insured location, the Court accepted that in this instance, due to the nature of COVID-19 (a highly contagious and widespread disease), this definition of "Vicinity" could extend to cover potentially an entire country, with the result that COVID-19 losses were claimable under this wording. 

The availability of coverage under the Disease Clauses before the Court did not, however, go totally in favour of policyholders.  The Court found that two of QBE's Disease Clause wordings (QBE 2 & QBE 3) were unlikely to provide cover as their wording concerns the "event" of a notifiable disease, "event" having the well-recognised construction (per Lord Mustill in AXA Re v Field [1996] 1 WLR 1026 at 1035) of something that happens at a particular time, at a particular place, in a particular way.  In relation to these two wordings, the Court held that the insureds would only be able to recover if they could show that the cases of COVID-19 within the radius, as opposed to elsewhere, were the cause of the interruption to their businesses.  It did not seem to the Court that causation would be satisfied on the basis that (applying the same approach as with the other Disease Clause wordings) the cases within the area were to be regarded as part of the same cause which had caused the UK Government's nationwide measures.

"Hybrid" is the term used by the Court to refer to two types of wording issued by Hiscox and RSA which combine a restriction imposed on premises (see below) with the occurrence of disease (see example: Fig 2).  Of the Hiscox policyholders issued with this type of wording, 65% have businesses in Category 5 (businesses not specifically referred to in the 21 or 26 March Regulations and therefore not expressly subject to closure), with the remaining policyholders split between Category 2 (indoor/outdoor leisure required to close by the 21/26 March Regulations) and Category 5 (non-essential retail, required to close by 26 March Regulations).  One of the hybrid RSA wordings (Cottagesure (RSA 1)) provides cover for holiday cottage businesses (Category 6).

Whilst the Court accepted that "public authority" could cover public authorities at both a local and national level, it did not accept that "restrictions imposed" included the Government's 16 March Guidance even though businesses may have been affected by such guidance by reduced footfall as the public started to observe social distancing in line with the 16 March Guidance.  The Court said "restrictions imposed" denotes something which is mandatory, with the force of law such as the 21 March and 26 March Regulations, breach of which could result in a fine.  For RSA's "Cottagesure" policy, the relevant restrictions were the 26 March Regulations which required holiday accommodation to close.

As regards "inability to use", the Court said that this was a question of fact in each case and an insured still having a limited partial use of their premises would not necessarily mean there was not an "inability to use" for the purposes of cover.  However, the Court considered that Regulation 6 of the 26 March Regulations (restriction on the movement of individuals), although amounting to a "restriction imposed", was, in itself, very unlikely to lead to an "inability to use" since many businesses had been able to continue to operate with employees working from home.

For the "disease" element of the Hybrid Clauses, the Court adopted the same reasoning as that applied to Disease Clauses.

In assessing quantum, the Court held that the correct counterfactual to be applied to the Hybrid Clauses was to compare the actual performance of the business with what the business would have achieved in the absence of the COVID-19 outbreak which had led to the "inability to use" as a result of the "restrictions imposed".

As seen from the Hybrid Clauses above, Prevention of Access and similar wordings considered by the Court concern business interruption caused by the prevention or hindrance of access to or use of business premises as a consequence of Government or local authority action or restriction.  The specimen wordings before the Court containing these types of clauses were issued by Arch, Ecclesiastical, Hiscox, MS Amlin, RSA and Zurich.

In considering these wordings, the Court noted the well-established distinction between the meaning of "prevention" and "hindrance" based on the judgment of Lord Atkinson in Tennants (Lancashire) Ltd v CS Wilson & Co Ltd [1917] AC 495 at 518:

The FCA urged the Court not to construe the Prevention of Access wordings applying these definitions on the ground that, in the circumstances, this would be an overly strict interpretation.  The Court did not accede to this request but instead accepted the submissions made by Arch (which adopted a less rigid position than the other Defendant Insurers who considered access should be physically or legally impossible).  Arch's position was that it was sufficient for there to be a "prevention of access" where the Government/local authority action or restrictions had the effect of closing a business, being the insured business as described on the policy schedule.  Therefore, there would be a "prevention of access" where a pub or restaurant was obliged to close by the 21 March and 26 March Regulations even though it subsequently set up a takeaway business; similarly, theatres that began streaming performances for remote audiences after they had been required to close.

The position was different though for those businesses which already had a takeaway operation, or in the case of retail, an on-line or telephone order facility, as part of its business.  For these businesses, there was no "prevention" (unless the existing takeaway/on-line element was no more than de minimis, a question of fact in each case); however, a claim could still potentially succeed if an insured's wording included cover for "hindrance" which would cover loss due to a reduction in sales.  However, as not all Prevention of Access clauses include cover for "hindrance" in addition to "prevention", there are likely to be policyholders without "hindrance" cover whose claims will fall outside the terms of their cover because their existing business already included a takeaway or on-line element (even if this was not the major element of their business prior to lockdown).

Consistent with its construction of "restrictions imposed" under Hybrid Clauses, the Court found that there was no "prevention of access" by the 16 March Guidance or Regulation 6 of the 26 March Regulations.

More specifically in relation to certain of the specimen Prevention of Access wordings, the Court found:

• Ecclesiastical (issued to churches & nurseries) – the wording expressly carved-out from the cover closure or restriction due to the order of a competent local authority as a result of the occurrence of an infectious disease – meaning that there was no cover for closure or restriction due to COVID-19
  
  
• Hiscox/MS Amlin (MSA 2) – these wordings referred to an "incident" which should be treated and construed on a similar basis as "event", the effect of which meant that these wordings provided cover for a localised event such as a gas leak or bomb scare and so did not respond to claims based on the nationwide COVID-19 measures
  
  
• MS Amlin (MSA 1/MSA 3)/RSA (RSA 2)/Zurich – as used in these wordings ("in the vicinity of the premises"), "vicinity" denoted a localised cover meaning that they did not respond to claims based on the nationwide COVID-19 measures.

In calculating the quantum of claims, BI Insurers take into account factors other than the cause of the business interruption that would have affected the business during the period covered by the claim.  This aspect of what the Court called the "quantification machinery" is often referred to as "Trends" language.  In the specimen wordings before the Court, the Trends Clauses formed part of the standard property damage BI covers and were not expressly stated to form part of the Disease and Prevention of Access extensions to that cover.  The FCA contended that this meant any Trends language contained in the wordings should not be applied to quantification of claims under these extensions.  The Court disagreed and said they did apply.  In the context of COVID-19 claims, Insurers should remove any COVID-19 related factors from quantification of the loss but should still take into account any other factors such as an anticipated fall in a restaurant's takings where its Michelin-starred chef left shortly before the March lockdown (the example used by the Court).

The issue of causation was the subject of detailed joint submissions by the Defendant Insurers, focused around the decision of Hamblen J in Orient Express Hotels v Assicurazioni Generali [2010] Lloyd's Rep IR 531.  Orient Express concerned BI losses suffered by a hotel in the French Quarter of New Orleans as a result of damage caused by Hurricanes Rita and Katrina.  Hamblen J considered, applying the "but for" test, that due to the devastating damage caused to the area surrounding the hotel, it would still have suffered BI losses even if the hotel had managed to remain undamaged with the result that the BI losses claimed were not recoverable.  The Defendant Insurers contended that on the same "but for" principle, policyholders would still have suffered BI losses, absent the existence of their particular insured peril, as a result of the COVID-19 emergency situation generally.

In light of the construction of the insured peril as a composite peril encompassing COVID-19 which the Court had already applied to the insured perils under the Disease and Prevention of Access extensions, the Court said that this resolved issues of causation so that it did not need to deal with the application of Orient Express to claims under the specimen wordings.  However, it did note that in its view, Orient Express had been wrongly decided as Hamblen J had mis-identified the insured peril under the policy (hurricanes as a cause of damage were an integral part of the insured peril, not separate from it), and had wrongly focused on the "but for" causation issue and had not instead asked what was the proximate cause of the loss (hurricanes).  Had he done so, the Court considered the hotel would have been able to recover for its BI losses.

Following the judgment, the FCA wrote a "Dear CEO" letter to Insurers on 18 September 2020, advising Insurers that it expected them to assess and progress outstanding BI claims of the type that the Court had said should be paid even those which had been made under wordings which were subject to appeal so that valid claims could be paid promptly as soon as the position on coverage on any affected policy is finally determined by the Courts.

Appeals against the Judgment are being brought by the FCA, the Hiscox Action Group(an Intervener in the Test Case), Arch, Argenta, Hiscox, MS Amlin, QBE and RSA.  RSA's appeal though does not include an appeal against the Court's findings on RSA 4 (including the wider definition of "vicinity" for the purposes of the Disease Clause).  Therefore RSA 4 affected policyholders can treat the Court's findings on this policy as final and determinative as can any affected Ecclesiastical policyholders.

The issues before the Supreme Court on the appeals include:

• The scope of Disease Clauses – are they a localised cover or can they respond (as the Court found) to a pandemic? What is the insured peril under these clauses?
  
  
• Can Prevention of Access Clauses be triggered by non-mandatory measures such as the 16 March Guidance? To what extent does access need to be "prevented"?
  
  
• What is the effect, if any, of Regulation 6 of the 26 March Regulations on coverage?
  
  
• What is the proper construction of Trends Clauses? Should Insurers be entitled to take into account COVID-19 factors affecting business revenue prior to its BI cover being triggered to reduce the amount of indemnity?
  
  
• Was the Court correct to say that Orient Express was wrongly decided?
  
  

The appeals are due to be heard by Lord Reed, Lord Hodge, Lord Kitchen, Lord Hamblen (who gave the judgment in Orient Express) and Lord Leggatt.  As with the judgment at first instance, it is likely that the Supreme Court will not delay in giving its judgment on the appeals given the pressing need for clarity, both for policyholders and Insurers, on outstanding claims so that those claims which prove to be valid can be settled and paid by Insurers as soon as possible.

Fig 1: Business Types