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Is Your Hotel Protected if Disaster Strikes?
Issues that May Arise in Claims for Loss of Business Income


 

By Stephen N. Goldberg and Jeremy M. King
May 2012

First-party property policies often provide coverage for an interruption of business caused by damage to the policyholder’s own property. Additionally, such policies may provide coverage for an interruption of business caused by damage to the property of the policyholder’s supplier, or the distributor or receiver of the policyholder’s goods. When a disaster strikes, this insurance can provide a business with comfort that its bottom line is protected. It is important that a business pay careful attention to the insurance it purchases to make sure that the coverage is appropriate for the risks faced by the business. Consultation with counsel or a skilled broker can be very helpful in this regard. Further, any business seeking to recover for losses resulting from an interruption must be aware of potential pitfalls and must take steps as early as possible to maximize the amount of protection available.

Calculation of Business Income Loss
A number of courts have held that the purpose of insurance for business interruptions is to place the policyholder in the position it would have been in had no loss occurred. Business interruption insurance allows a company to recover the “business income” lost due to an interruption. Business income is defined in one of two ways in insurance policies:  Gross Earnings or Net Income.
 
Gross Earnings is the calculated as the reduction in “gross earnings” less charges or expenses that do not continue during the interruption of business.
 
Net Income is the net profit or loss before income taxes that would have been earned or incurred plus continuing normal operating expenses incurred.
 
Both methods are available on the insurance market, and a policyholder should review these methods with its own revenues and expenses in mind to determine which method best fits its accounting system and business forecasting models.
 
Additionally, an interruption loss will be calculated in large part using historical data from the policyholder’s own business. Efforts should be made early in the claims process to ensure that the team supporting the policyholder’s claim fully appreciates the source and the limitations of both the data maintained by the policyholder and the data available regarding the market in general. The policyholder may have experienced events unique to it that did not impact competitors in the marketplace and should make sure it is not disadvantaged by its unique circumstances when presenting historical data supporting its claim for business income loss.

Similarly, policyholders in emerging or evolving markets should be prepared to explain any limitations of historical data in demonstrating an interruption loss.

Loss of Market
One potential pitfall for policyholders is an exclusion common in first-party property insurance policies that states that the policy does not apply to loss resulting from “delay or loss of market.” 
 
This exclusion can be particularly pernicious for a policyholder seeking to recover on a business income loss. A disaster such as a hurricane or tornado that causes a significant interruption to a policyholder’s business may also have a dramatic impact on the policyholder’s market. For example, a hotel may suffer damage resulting in an interruption of business. But, the area surrounding the hotel may also be damaged such that the market for the hotel’s services has been lost.
 
A New York federal court was presented with a similar scenario following the terrorist attacks on September 11, 2001. In that case, a pharmacy located at the site of the former World Trade Center was destroyed, and its insurer attempted to reduce size of the claimed business interruption loss by contending that the attack had also resulted in diminished customers in downtown Manhattan. The insurer argued this loss in foot traffic and potential customers was an excluded loss of market, but the court held that the exclusion only applied to changes in the marketplace that were not caused by a covered peril, such as the presence of a competitor. In reviewing that decision, the appellate court noted that the insurance company could not avoid liability for the entire business loss based upon the loss of market exclusion. It allowed the insurance company to assert its loss of market argument in an attempt to reduce the amount of the loss as determined in an appraisal hearing.
 
An insurer attempted to make a similar argument in federal court in Louisiana, alleging that a praline shop’s losses arose from lack of visitors to New Orleans after Hurricane Katrina rather than from an interruption in the shop’s business, but the court did not allow this argument because the insurer did not properly state that it would invoke the exclusion at the time it was required to set forth its defenses. Policyholders with potential interruption claims should read their insurance policies carefully and seek the advice of coverage counsel as to how the loss of market and other exclusions may limit their business interruption coverage.

Period of Restoration
The period over which an interruption loss can be calculated is another significant issue faced by a policyholder seeking to recover for a business loss. Typically, an insurance policy will limit the time during which a policyholder can claim that its business has been interrupted. A common clause limiting the amount of time for which an interruption can be claimed provides that the computation of loss “shall not exceed such length of time as would be required with the exercise of due diligence and dispatch to rebuild, repair, or replace such property that has been destroyed or damaged.” 
 
Courts applying this provision have determined that replacement of the property is not always required. In the dispute arising out of the impact of the September 11 terrorist attacks discussed above, the federal district court found that an interruption loss could be claimed for the time period it would take to rebuild a hypothetical store at the former World Trade Center site, and that the period of restoration would end when the pharmacy was able to resume “functionally equivalent operations” at its former World Trade Center location. This ruling was modified on appeal to reduce the period of restoration to only the hypothetical time it would take to build a functional equivalent of the destroyed store that could resume operations at a site reasonably equivalent to the site at the World Trade Center complex.
 
It is important to keep in mind the potential limitations on the period of restoration, and policyholders should consult with coverage counsel to create a strategy for maximizing the period of restoration available.

Additional Available Coverage
In addition to insurance that protects against lost business income because of damage to either the policyholder’s or a third-party’s property, many property insurance policies contain supplemental coverage that must be considered when preparing the submission of a claim. For instance, coverage for “extra expenses” commonly protects a policyholder from increased costs of doing business caused by the type of peril insured against by the policy.

Coverage for acts of “civil authority” also protects business income when the policyholder suffers a business loss because access to its premises is prohibited or restricted as the direct result of damage caused by a covered peril. The possibility of civil authority coverage should be analyzed carefully, because such coverage often has restricted windows of time for which a loss can be claimed and restrictive language proximity of the damage and the policyholder’s premises, sometimes requiring such damage to be “adjacent” to the policyholder’s property. 

Conclusion
Those who have suffered the effects of a natural disaster may have substantial financial protection through their insurance policies. All policyholders should promptly consider their coverage possibilities and act to recover all benefits available under that coverage.

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About the Authors:
Stephen Goldberg is a partner in Dickstein Shapiro’s Insurance Coverage Practice. Mr. Goldberg focuses his practice on complex commercial litigation, primarily insurance coverage matters that have involved coverage for asbestos liabilities, product liability claims, first party property damage and business interruption losses, alleged environmental damage, errors and omissions, and directors and officers liabilities, as well as bad faith claims.

Jeremy King is counsel in Dickstein Shapiro’s Insurance Coverage Practice. Mr. King’s practice focuses on insurance coverage actions and other civil litigation matters. He has been involved in cases concerning securities issues, anticompetitive practices, fraud and general contract disputes.

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Contact:

Dickstein Shapiro LLP

Stephen Goldberg
goldbergs@dicksteinshapiro.com

Jeremy King
kingj@dicksteinshapiro.com

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Also See:
Important Considerations when Purchasing Insurance to Protect Your Business Against Hurricane-related Loss / John E. Heintz and Kenneth Berline Trotter / April 2012


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