English High Court hands down judgment in FCA non-damage business interruption insurance test case
The High Court on Tuesday handed down its highly anticipated judgment in the non-damage business interruption insurance test case.
Whilst the judges, Lord Justice Flaux and Mr Justice Butcher, found in favour of the Financial Conduct Authority on a number of important points, meaning that a large number of the policy wordings under consideration were found to respond to COVID-19 related business interruption claims, other policy wordings do not respond at all. It will be very important for insurers as well as policyholders to closely consider their wordings by reference to the detailed findings in the judgment to assess whether they respond or not.
In any case, appeals on at least some of the issues decided by the court are likely, and insurers in particular will be considering their options in this regard carefully. In the meantime, the FCA has indicated its expectation that insurers shall write to affected policyholders within 7 days of the judgment “to explain next steps”.
In this briefing we set out some of the key findings.
The case was brought by the UK Financial Conduct Authority (FCA), and was heard as a Financial Markets Test Case on an expedited basis. A number of sample policy wordings were selected and the case proceeded on the basis of agreed facts. The court was asked to consider whether cover was triggered under the policy wordings for losses due to the COVID-19 pandemic and the response to it. The FCA put forward arguments on behalf of policyholders, and eight insurers participated at the FCA’s invitation as defendants.
The policy wordings under consideration included non-damage extensions of cover to standard business interruption policies. In the test case judgment these non-damage covers have been classified into three categories of clause:
- “Disease” clauses that provide cover, broadly speaking, in respect of business interruption in consequence of, or following, or arising from, the occurrence or manifestation of a notifiable disease within the vicinity (or a specified radius) of the insured premises;
- “Prevention of Access” clauses that provide cover, broadly speaking, for a prevention or denial of access to or use of insured premises as a consequence of action by authorities; and
- So-called “Hybrid” clauses that refer to both restrictions on insured premises and the occurrence or manifestation of notifiable disease.
Summary of outcome
For both sides, the judgment was something of a “mixed bag” and it will be important for interested insurers and policyholders to consider their wordings and factual circumstances carefully against the judgment to determine how their policies should respond.
- In relation to the “Disease” and “Hybrid” sample clauses (described above), the FCA was largely but not entirely successful. Most of the clauses will in principle respond to claims on the basis that it cannot be said that those clauses respond solely when the insured can show that its business interruption was caused by merely localised occurrences of COVID-19 as opposed to the response to the nationwide epidemic. There are exceptions: where the clause describes the insured peril that must occur as an “event” or “incident” this has the effect of narrowing the cover to a localised incident with the result that the policies respond only where the business interruption can be shown to have been the result of local incidents of disease.
- Where the “Disease” or “Hybrid” clauses required the occurrence of disease within a specified geographic radius of the insured premises (eg 25 miles) it is enough if there was one case of disease within the radius irrespective of the prevalence of disease more widely. Where they cover disease in the “vicinity” of the premises, this needs to be interpreted broadly in the context of notifiable or infectious disease to a very wide area potentially covering the entire country.
- However, in relation to the “Prevention of Access” type clauses, insurers were largely but not entirely successful, on the basis that their typical wording indicated that they provided cover in respect of the effects of localised events (eg. gas explosions or bomb scares) rather than nationwide emergencies.
- On causation, the court considered that its decisions on the interpretation of the various clauses largely decided the questions of causation: causation was established under those clauses which responded but not otherwise. However, it is clear that it preferred the FCA’s case which was principally that the nationwide epidemic and the response to it represented a single indivisible insured cause. Alternatively, the correct “but for” counterfactual to apply is to ask what would have happened if all the elements of the relevant insured peril (including, under “Disease” and “Hybrid” clauses, the pandemic itself) had not occurred. In reaching this conclusion, the court considered that it did not need to follow the decision in Orient Express Hotels  EWHC 1186 which it also considered had been wrongly decided.
- For similar reasons, the FCA also won on the application of the trends clauses to covered losses: insurers are not permitted to discount a loss on adjustment to account for the possibility that the business would have suffered loss as a result of the pandemic in any case. Insurers must apply the correct counterfactual scenario and not seek to discount a claim on the basis of anything that falls within the insured peril.
Findings in more detail
The judgment is extensive at 162 pages, and considers the sample policy wordings individually. Some of the takeaway points are set out below, although of course the policy wordings at issue and the judgment must be considered as a whole.
The issue here was whether the clauses cover the effects of a pandemic or whether the requirement in the clauses that disease occur within the vicinity of insured premises, or within a specified radius (eg 25 miles) means that a more widespread outbreak of disease potentially affecting the entire country was not intended to trigger the cover.
As a preliminary point, it was decided that there was an “occurrence” of COVID-19 when one person within the area was infected with the disease; it was not necessary for the disease to have been diagnosed. It was also held that the meaning of “manifested” is where a person has symptoms or is asymptomatic and is diagnosed with the disease.
Composite nature of the insured peril
The judges found that the insured peril under the disease clauses was of a “composite” nature comprising a number of interconnected elements. For example, one of the sample clauses provided cover for “interruption or interference with the Business during the Indemnity Period following: (a) any … (iii) occurrence of a Notifiable Disease within a radius of 25 miles of the Premises”. Under this wording, the relevant insured peril is the combination of all the various factors described, namely interruption or interference with the business during the indemnity period following any occurrence of a notifiable disease within a radius of 25 miles of the premises.
This interpretation proved to be important when considering issues of proximate causation and the causal wording in the clauses (in this example represented by the word “following”). The court said that the legal concept of proximate causation arises between the loss and the insured peril. However, under the composite insured peril in these clauses, the requirement that the interruption or interference with the business should “follow” the occurrence of disease was a requirement within the insured peril, not a link between the loss and the insured peril. Therefore it was not necessary that the interruption or interference should be proximately caused by the occurrence of disease. The word “following” in this context suggested a looser causal connection, that would be satisfied by the occurrence of a case of the disease within the radius even where that was part of a wider, nationwide epidemic of disease.
In the vicinity: cover not limited to localised cases of disease
The judges rejected insurers’ argument that the express vicinity or radius requirements meant that only the effects of the disease locally and insofar as they may be distinguished from the outbreak more widely are covered. The court noted that nothing in the policies expressly confined cover to cases where interruption results only from localised occurrences of disease. In addition, the parties must have known that notifiable disease would include certain diseases capable of widespread dissemination, such as SARS, for example, and which might attract a nationwide response from government and other authorities, as opposed to a purely local response.
Against this background, the court considered that the term “vicinity”, which the court accepted implied a degree of locality, must necessarily be interpreted broadly in the specific context of notifiable disease and that the potentially very widespread nature of a disease outbreak meant that a reasonable person would understand vicinity in this context to mean an area that is very extensive, and even nationwide.
However, the context is key: see further below for the contrasting interpretation given to the same term in the Prevention of Access context.
A similar approach applied to those clauses which defined the vicinity requirement by reference to a specified radius (eg. 25 miles). So long as the insured can demonstrate that the wider outbreak of the disease extended within the specified radius, cover would be triggered.
The result was that most of the disease clauses would in principle respond to claims.
Exceptions to the general approach
The few exceptions were clauses which used the word “event” or “incident” to describe the composite peril. The inclusion of these particular words were held to indicate matters occurring at a particular time, in a particular place and in a particular way (following the English court decision in the aggregation context in Axa Reinsurance v Field  1 WLR 1026 ).
The court considered that the use of these words, in combination with other factors, indicated that the cover was expressly limited to business interruption due to purely localised (as opposed to more widespread) occurrences or outbreaks of disease. Accordingly unless the insured can show that the interruption or interference with its business was the result of the purely local incidence of disease and not the nationwide epidemic, the policies would not respond.
“Prevention of Access” clauses
Again, the court characterised the insured peril under these clauses as “composite” in nature, embracing all of the following features: interruption or interference with the insured business; due to prevention or hindrance of access or use of the premises; caused by any action of government or authority; itself due to an incident, emergency, danger or disturbance within the vicinity of the insured premises.
The court considered the meanings of the key phrases in the sample clauses and some common themes emerged. Some of the key points considered were:
“Prevention” or “hindrance” of access or use
“Prevention” and “hindrance” are not synonymous. The court decided that the touchstone of “prevention” is impossibility. This does not need to be a physical or legal impossibility to access or use the premises. For example, non-mandatory government advice could, in principle, be capable of preventing access or use. What is necessary is a closure of the business described in the policy schedule or at least a fundamental change in use of the premises.
By contrast, “hindrance” connotes access or use that was rendered particularly difficult (but not impossible).
So, for example, the pub or restaurant that started a takeaway service in lockdown for the first time may have been prevented from accessing or using its premises for its usual business because the new takeaway service is fundamentally different to its usual business. However the position is different if the pub or restaurant already had a takeaway service as a substantial part of its business. In that case, it may have been hindered from using its business for in-house dining but it hasn’t been prevented from using its premises for the other substantial part of its business. Moreover, shops and supermarkets which remained open but with social distancing measures in place may have experienced a hindrance of use but there was no prevention of access either for shop owners or customers.
Whether there has been a prevention or hindrance of access or use is a question of fact in the individual case. The court has provided helpful guidance in respect of a number of different categories of business use against the background of the regime of legal orders and government advice relating to COVID-19. However, it will be necessary to carefully apply the policy language to the particular facts of the case.
Where the restriction on access is, for example, imposed by any civil or statutory authority or by order of the government or any public authority, the word “order” conveys a restriction which is mandatory, not merely advisory - in other words a restriction which has the force of law. In this respect, only the restrictions imposed by the Health Protection (Coronavirus, Business Closure) (England) Regulations 2020 on 21 March 2020 and by the Health Protection (Coronavirus, Restrictions) (England) Regulations 2020 on 26 March 2020 qualify. Other measures, such as the Prime Minister’s earlier advice on social distancing measures, do not qualify.
“Competent local authority”
Some of the sample clauses required the prevention or hindrance of access to be ordered by a “competent local authority”. The court decided that this could extend to central government or to an authority that is competent to impose the relevant restrictions in the locality on the use of the premises.
In the “vicinity”
In this context, and in contrast to the interpretation of the same phrase in the “Disease” clauses, vicinity was held to connote neighbourhood and could not extend to the entire UK. The court emphasised that to understand the meaning of “vicinity” it was necessary to consider the nature of the occurrence that is required to happen within the vicinity. In the context of the “Prevention of Access” clauses, this is typically an “incident”, “emergency”, “danger” or “disturbance”.
By contrast with the requirement that notifiable disease occur within the vicinity, the court decided that this type of wording required something more akin to an “event” (such as a gas explosion or bomb scare) and as such indicated that the cover was limited to a localised rather than more widespread occurrence. The pandemic was held to be too geographically dispersed, variegated and prolonged to qualify under this type of wording and the government action in imposing the lockdown regulations in response to it could not be said to be following a danger, disturbance, emergency or incident in vicinity of the insured premises.
In relation to these cases the court again held that the insured perils were composite: the inability to use the insured premises; due to restrictions imposed by a public authority; following the occurrence of a human infectious or notifiable disease.
Whether or not the policies respond requires consideration of the meaning of the terms used in the policies in their context. The court again considered the various words and phrases used. Some of the key terms considered include:
“Interruption” of business
It was held that this did not require a complete cessation of business (with an exception where the wording was contained within a prevention of access clause).
Like the meaning of the term “order”, the court found that this implies something that is mandatory, and in the current circumstances would include restrictions imposed by statutory instrument. By contrast, government guidance, exhortation and advice, for example in relation to social distancing, would not qualify as mandatory “restrictions imposed”, nor would a decision to close or to refrain from accessing or visiting premises where it was not legally necessary to do so.
“Inability to use”
It was noted that this means something different to hinderance or disruption of normal use. There would not necessarily be an inability to use premises simply because an insured could not use all of the premises, nor by reason of any and every departure from normal use. The court decided that whether merely partial use would be sufficient to amount to an inability to use will depend on the facts of each case. However, the restrictions imposed did not have to be directed specifically at the insured or the insured’s use of the premises.
The court decided that its approach to the interpretation of the clauses above essentially decided any issues of causation because this answers the question of what can and cannot be regarded as uninsured independent causes of loss.
However, the court considered that even applying the insurers’ preferred approach of the “but for” test of causation, it reached the same result. This is because the court considered that a proper application of that test required it to consider what would have happened if the insured peril had not occurred. This has been described as considering the “counterfactual” scenario. If, in the counterfactual scenario, the loss would have happened anyway, then it is not covered, because the insured peril cannot be said to be the proximate cause of the loss.
Because the court decided that the insured perils in these wordings were “composite” in nature, embracing everything that the clause requires to happen for cover to be triggered, the correct approach to the counterfactual is to strip out everything. In the case of the “Disease” clauses, this meant assuming not merely that the government response to COVID-19 had not occurred, but that the disease pandemic itself had not occurred.
The court considered that to do otherwise would not give effect to the intentions of the parties, and would involve an unrealistic and artificial exercise that does not recognise that the occurrence of the disease is an essential element of what the insurance covers.
In reaching this conclusion the court addressed the parties’ arguments on the application of the controversial case of Orient Express Hotels, this was addressed in the judgment. The case related to a claim by an insured for business interruption loss following damage to a hotel in New Orleans, under an all risks policy. The case was heard by Hamblen J, on appeal from a decision of an arbitral tribunal on questions of law. It was held that the application of the “but for” test meant that the insured could not recover its losses, as the business interruption damage would have occurred anyway because the area was subject to hurricane damage. The correct approach to the “but for” counterfactual is to strip out the “damage” but not the hurricane.
Insurers relied on this case as authority for the proposition that in the context of COVID-19 the insureds would have suffered loss anyway, even if they had not been forced by government to close or change their business operations, because the pandemic itself would have resulted in a general business downturn. Namely, when considering the counterfactual, it is necessary to strip out the governmental action but not the pandemic itself.
The court decided that it did not need to follow the decision in Orient Express Hotels, because it could be distinguished on its facts. Even if this were not the case, the court considered that it had been wrongly decided. Consistent with their “composite” insured peril approach, the judges considered that, on the facts of that case, the hurricane was the cause of the loss and an integral part of the insured peril. The judges agreed with the FCA that the logical effect of Orient Express is that the more serious the fortuity the less cover the policy provides, essentially rendering business interruption cover for hurricanes illusory. It was held that this cannot have been intended.
In the circumstances, the court did not consider it necessary to examine the parties’ arguments on what happens where there are two concurrent independent causes of loss, one covered and one not. This is because the court had already decided that occurrences of disease are covered, whether they take place inside or outside the vicinity or radius of the insured premises.
The court rejected the FCA’s arguments that the trends clauses in the policies did not apply to non-property damage.
The judges emphasised that trends clauses provide a quantification machinery for a claim, and do not delineate the cover. Therefore, where the insured has prima facie established a loss caused by an insured peril, it would be contrary to principle for the loss to be limited by the inclusion of any part of the peril in the assessment of what would have happened had the insured peril not occurred (unless the wording requires otherwise).
Secondly, it was held that the object of a trends clause is to put the insured in the same position as if the insured peril had not occurred. In determining how the trends clause should operate, the court applied its general approach on causation summarised above. Therefore, it is necessary to strip out of the counterfactual everything in the insuring clause. In other words, the business interruption referable to COVID-19 as well as to the authorities’ and public response.
One further point addressed was how to deal with the fact that many businesses suffered a reduction in turnover before the insured peril operated (eg. in the case of Prevention of Access cover, before the business was required by governmental restrictions to close), as a consequence of the pandemic.
The FCA contended that the effect of the pandemic on turnover before cover was triggered should be extracted from the counterfactual so that the insured could recover for this as well. The judges held that this was wrong. Otherwise the insured would recover for loss which had not resulted from the insured peril in question.
Losses prior to disease becoming notifiable
The court did not make any binding determination of the issue of whether losses could be claimed before COVID-19 became a notifiable disease (where such a requirement was part of the trigger and there is no deeming provision). However, the view was expressed that there would be formidable difficulties in the way of suggesting there would be cover before such date.
Prevalence of the disease
The case raised an evidential issue: namely what evidence the insured might need, on the balance of probabilities, to satisfy the policy requirement that COVID-19 has, in fact, occurred or manifested within the specified vicinity of its business.
The court had earlier ordered that the trial would determine, as a matter of principle: (i) the type of evidence that would be sufficient to discharge the insured’s burden of proof and (ii) if, on the assumption that the data on which the FCA relies is the best evidence available , this is capable of discharging the burden of proof.
As to the first question, the judges noted that insurers have conceded that certain specific types of evidence, such as NHS death data and reported cases, are capable of demonstrating the presence of COVID-19, as are certain types of statistical evidence if they are reliable. The main dispute related to the inferences that could be drawn from available evidence as to timing of the presence of the disease and use of data aggregated by geographical areas that do not correspond to policy areas.
The judges found it difficult to go too far with findings on these issues without hearing evidence on these questions. It noted that insurers have conceded that the types of methodologies proposed could in principle discharge the burden of proof, and expressed hope and expectation that insurers would be able to agree on any issues of prevalence which actually arise and are relevant to particular cases.
Conclusion and next steps
We will now need to wait and see if there are to be appeals against the court’s findings.
The FCA’s Finalised Guidance on the test case requires insurers to keep policy holders who have made a potentially affected claim or complaint updated and to update their reviews of which coverage clauses are affected.
Insurers will need to notify policyholders who have made a claim or complaint of the judgment as soon as possible and in any event within 7 days (paragraphs 6.13-6.14 of the Guidance). The FCA’s press release issued at the time of the judgment indicates that it expects insurers to contact insureds who may be affected by the test case “to explain next steps”.
If there is to be no appeal, so that a “final resolution” is reached (defined by the guidance as when the Court has determined all the questions in the test case and after all rights of appeal have been concluded or if only certain parts are appealed so that some questions in the case may be said to have reached a “final resolution”) insurers must handle and assess all outstanding potentially affected claims and complaints in line with ICOBS 8 and DISP 1 applying the judgment (para 7.11 of the Guidance).
They must also reassess all potentially affected claims they rejected or where they made an adjustment or deduction for general causation, and any potentially affected complaints they did not fully uphold (except where the complaint has been accepted by the Financial Ombudsman Service).