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19 July 202016 minute read

FCA business interruption insurance test case: Summary of the opening legal submissions

Ahead of the start of the Financial Conduct Authority (FCA) test case hearing which commenced today, Monday 20 July in the English High Court, the parties in the test case have published their written opening legal submissions. The submissions are very voluminous, running in total to many hundreds of pages of legal argument, building on the already very detailed statements of case which have been served (see our earlier note)

In addition, the parties in the test case have today published additional documents, including summaries of the issues which are agreed and in dispute, and details of agreed facts.

In this note, we summarise the main themes and arguments on each side in what is shaping up to be a landmark case for the insurance markets in the UK and, potentially, internationally too, given the often persuasive quality of English judgments in other jurisdictions and the indications by other regulatory authorities (such as in Ireland and Australia) that they are considering their own test case processes.

The FCA characterises its purpose in bringing the test case as clearing away coverage “road blocks” in the way of insureds which it says have been erected by insurers’ denials under non-damage business interruption (“BI”) policies. By doing this, they say that insurers will then be able to assess policyholders’ claims on their individual merits. Insurers object that the FCA’s position in relation to the policies is fundamentally legally flawed and starts from the very presumption that the FCA’s case is intended to establish, namely that there should be cover under the policies for pandemic risk such as COVID-19.

The approach to interpretation of the policies

The parties’ knowledge

The FCA argues that, when applying the general well-established legal principles of interpretation of contracts to the policies, the court should approach the exercise objectively, albeit from the perspective of an SME business (e,g, a “restaurant in the suburbs”) with limited knowledge of insurance matters. The FCA says that most of the policyholders at issue are not sophisticated or well-resourced insurance buyers, and specifically makes references the thematic review published in May 2015 on the handling of claims for SMEs, which concluded that SMEs may exhibit similar knowledge to retail customers when buying general insurance products.

Insurers object to the characterization that all the relevant policyholders are, in essence, unsophisticated consumers. One defendant observes that “insurers are not to be regarded as equivalent to overbearing corporations foisting unreasonable clauses upon the unwitting victims of personal injury or negligent conduct. Insurance is about agreed transfer of risk and the ambit of the risks which the insurer is willing to assume is defined by the contract.”. In any case most if not all of the policies in issue would have been placed with insureds having the assistance of a professional broker, who would owe duties to policyholder clients to advise on and explain their cover. Further the insurers say that this is, in any case, irrelevant, as the wordings are clear and capable of straightforward objective interpretation.

The FCA also attacks at the outset what it says is the insurers’ starting premise, that covers such as the BI policies in issue were not intended to cover the effects of disease pandemics. The FCA argues that the long history of other pandemics, and at least the potential for governmental response, has been long known by the insurance industry, referencing other pandemics such as Spanish flu and SARS. The FCA takes the point insurers could have expressly excluded cover for those risks if they had wished to.

In response, insurers make the point that, in previous disease pandemics in the UK, such as in the 1950/60s, and in the current COVID-19 crisis in places such as Sweden, governmental response has been muted or very low key. The insurers reject the FCA’s characterisation of the unprecedented UK government action in the context of COVID-19 as in some way an inevitable, inextricable consequence of a global pandemic.

As to the point that the policies do not exclude pandemics, insurers argue that this is a weak and circular argument: it is not necessary to exclude risks that are not covered in the first place, and it is the fact of coverage that the FCA must establish on the basis of what the parties have agreed in the policies; not what they haven’t agreed.

Interpretation of individual terms

At issue in the case is the interpretation of a number of key terms used as policy triggers in the non-damage BI clauses in issue. Generally, the FCA argues for a very broad approach to the interpretation of such terms. This is stridently opposed by insurers.

Public authority “orders” and “prohibitions”

By way of example, the FCA argues that where the policies require a public authority “prohibition” this is not something that necessarily requires legal force, but merely something that is forbidden by someone with authority, and that a “reasonable citizen” would understand the UK government’s guidance and announcements around COVID-19 to be a prohibition even where, such as in relation to the 2m social distancing guidance, some instructions have never been given legal force.

Insurers counter that the perspective of the “reasonable citizen” has no legal relevance to this exercise; the FCA’s resort to it merely underlines that the measures were not mandatory. As one insurer observes, if Prime Minister Boris Johnson were to suddenly announce that everyone should stop smoking, this could not be considered in any meaningful sense a “prohibition” on smoking.

“Prevention” or “hindrance” of access or use of premises

The FCA’s approach is reflected in its interpretation of other terms, such as what it says is required to establish a “prevention” or “hindrance” of access to or use of insured business premises. In summary, it argues that “hindrance” should mean anything that makes access to or use of the premises more difficult, including the UK government’s requirement that people stay at home during lockdown. Insurers say this is too broad – what is necessary is a physical or legal impossibility or difficulty in reaching the premises.

Similarly with regard to “prevention” of use or access, the FCA argues that even businesses which were permitted to stay open, either fully or partially, to supply essential goods and services, experienced a “prevention” of use and access, because the government’s instructions to social distance, self-isolate, restrict travel and activities, and work from home, were aimed at preventing people from accessing businesses either entirely or at least to a defined extent. Any measure which prevented the business from operating as it normally would qualifies for the purpose of the policies, in the FCA’s view.

Insurers reject this approach: apart from anything else, it is the insured’s inability to access or use the premises for the purposes of its business which is in issue, and which in many cases was unimpeded by lockdown measures, not the ability or otherwise of customers to visit them.

“Vicinity” requirements

Some of the policy coverages in issue require the insured to establish the occurrence or incidence of COVID-19 (or an “emergency” or “danger”) within a specified vicinity or radius (e,g, 25 miles) of the insured premises, often as causative of public authority action, advice or orders which interrupt or interfere with the insured’s business at its premises.

In the context of the COVID-19 epidemic in the UK, this raises the question whether COVID-19 disease which is widespread across the entire country, both within and without the specified vicinity or radius of the premises, qualifies to trigger coverage or whether cover is limited to purely localised incidents, emergencies or dangers which occur close to the insured premises.

In support of the latter contention, insurers argue that the policies envisage an specific incident such as a gas explosion, or a terrorist incident (e.g. the oft-referenced Borough Market scenario) when insured premises might, for example, find themselves falling behind a police cordon for a period of time. They say that the UK government actions, advice or orders cannot, in any meaningful sense, be regarded as consequential upon any such specific localised incidence of disease, as compared with the nationwide epidemic as a whole.

The FCA, on the other hand, rejects the insurers’ contention that the causative incidence of disease must be a localised incident. It says that any vicinity requirement does not preclude the possibility that the presence of COVID-19 within the vicinity of the insured premises might be a localised manifestation of a wider problem and that, if there is disease prevailing both within the vicinity, as required by the policies, but also outside the vicinity, in respect of which the policies are silent, then this should not deprive the insureds of cover.

Prevalence of the disease

The particular circumstances of the current crisis has also given rise to a specific 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 FCA observes wryly that “it might be thought that proof of COVID-19 was obvious, especially since one of the principal defences being run by the [insurers] is that the cause of loss was a pandemic”. Nevertheless it argues for a finding that a case of COVID-19 within the relevant radius of the insured premises specified by the policy may be proven, amongst other things, through use of specific examples or hospital data, by a methodology whereby the reported number of cases in a local area may be uplifted by an undercounting ratio, and averaged across the area. The ratio is to be determined using analysis by Imperial College, London and Cambridge University. The FCA states that many of the claims will be sub-limited to GBP10,000 or GBP25,000 and it would be regrettable if insureds faced a barrage of technical and scientific hurdles to establish that COVID-19 had occurred in the requisite vicinity of their premises.

At the first case management conference, the court ordered that the trial will determine, as a matter of principle, the type of evidence that would be sufficient to discharge the insured’s burden of proof. 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, then it may be necessary to hold a further hearing in September on the application of the methodology.

Insurers point to the need to use such complex methods as an indication that the wordings were not intended to cover these circumstances. Insurers set out the difficulties with the analysis and the need for their own expert evidence to determine whether it is correct that undercounting ratios can reasonably be derived from these analyses, and indeed whether the Imperial and Cambridge analyses represent the best evidence available. Insurers have indicated that, in the very short time available since the commencement of the test case proceedings in May 2020, they have been unable to obtain their own expert evidence, and they continue to look for an appropriate expert.

Causation

The FCA characterises the insurers’ defences as conforming to a common theme on the critical issue of causation – namely that the proximate cause of the insured’s losses (or the “but for” cause by comparison with a relevant counterfactual scenario) is not the relevant “insured peril” in each case but something else, namely the nationwide outbreak of COVID-19 and the impact of it and/or of the UK government response to it.

The FCA says this is the wrong approach: for those with disease clauses, the presence of COVID-19 in each locality is an integral part of one single broad and indivisible cause, being the COVID-19 pandemic and all its consequences; alternatively that the outbreak in each locality made its own concurrent causative contribution to the overall picture of a pandemic, which prompted the UK government response. Either way, the losses were caused by an insured peril.

Further, for those with public authority/prevention of access clauses or other clauses which require multiple factors to be established, the FCA criticises the insurers for what it describes as a “salami slice” approach; meaning that, where the policy covers public authority action in response to an emergency, the insurers’ approach is to ask whether the loss would have happened but for just one of those elements, namely the governmental action. The FCA says that this leaves the counterfactual (i.e. the hypothetical scenario which must be compared against to understand what loss has been caused by the peril insured) to be the very emergency (i.e. the COVID-19 epidemic) contemplated by the insuring provisions. In the FCA’s view, the correct “but for” counterfactual scenario is a world in which there is no COVID-19 and no UK government intervention related to it – not one in which there was, for example, COVID-19 but no UK government intervention or vice versa, which the FCA says is an “artificial” and “unreal” scenario.

Insurers are highly critical of this approach, regarding it as an assault on some of the most fundamental tenets of insurance law, intended to achieve a purposive result, and they describe it as “the most transparent reverse-engineering, designed to shoe-horn all the possible causes of loss into the narrow and limited insured perils.”.

Insurers argue that all that is required in this case is an orthodox application of the legal principles of causation. The purpose of contractual damages is to put the claimant in the position it would have been if the contract (here, the relevant insurance policies) had been properly performed, to the extent that the breach of contract was a cause of the loss. This requires an analysis of “but for” (or factual) causation. Insurers say that this is a necessary legal step, and that the FCA’s approach represents a departure from this, which the courts will only contemplate in narrow, rare and exceptional circumstances, none of which are said to apply here.

Insurers say that the test requires the court to compare the insureds’ actual position against a counterfactual scenario in which the insured peril does not operate. Nothing else other than the insured peril should be “reversed” for this purpose. Because none of the policies expressly describes the existence of the epidemic as an insured peril in itself, the FCA’s approach of using a world without COVID-19 as the appropriate counterfactual is wrong.

The insurers contend that, applying this approach, it is clear that “but for” the relevant insured peril (e.g. prevention of access to premises as a result of public authority action) many insured businesses would have experienced loss anyway, because the existence of the epidemic would have resulted in a downturn in trade, irrespective of the governmental action.

They also argue that applying orthodox principles relating to independent concurrent causes results in there being no cover. This is because English law says that, where loss can be said to have been proximately caused by more than one independent cause, one insured and one not, such that the loss would have happened anyway even if one of the causes were not present, the policy will not respond because the loss cannot be said to have been caused by the insured peril.

Trends clauses

The causation arguments re-emerge in relation to the operation of the “trends” clauses, which appear in certain of the policies. These clauses typically require adjustment of any insured business interruption loss to take account of the circumstances or trends of the business before and after the loss.

The arguments here focus on the application or otherwise of the English case decision in Orient-Express Hotels [2010] EWHC 1186 (Comm), which is discussed in detail by both. That case related to the recovery of business interruption loss arising from damage to a hotel as a result of Hurricane Katrina in 2005. There was a trends clause in the policy that provided that adjustments should be made to allow for trends which would have affected the business had the damage not occurred. The case was arbitrated, and the tribunal’s decision appealed. The judge upheld the decision of the tribunal that there were two independent causes of the loss, the damage to the hotel on the one hand, and the wider damage to the surrounding area on the other hand which would have adversely impacted the hotels’ business anyway, even if the hotel had escaped undamaged. Because of this, the court decided that the insured could not establish that it would not have suffered loss “but for” the insured peril.

The FCA’s position is that Orient-Express Hotels is not applicable to the current test case, as it considered property damage, and was not a full re-consideration of the case but a limited appeal under s69 of the Arbitration Act 1996. In any case, the FCA says that Orient-Express Hotels is incorrectly decided and should not be followed. The FCA criticises it for applying an “unreal” counterfactual scenario which could not happen: namely, the “miraculously” undamaged hotel in an otherwise devastated city. The FCA says that the law does not (or should not) require the application of unrealistic tests.

Insurers argue the decision in Orient-Express Hotels was correct and consistent with legal principle, describing the trends clauses as simply acknowledgements of the orthodox principles which would apply anyway in light of the need to run the “but for” test of causation. An orthodox approach in the Orient-Express Hotel case required only the damage to the hotel to be “reversed” in the counterfactual scenario, not the cause of the damage (the hurricane). To do otherwise would be to indemnify the insured for the interruption loss caused by the hurricane itself, not merely the interruption loss caused by the physical damage to the hotel. By analogy in the current case, insurers object that the FCA’s approach is to permit indemnification of the insureds for all the consequences of the COVID-19 pandemic, when they were only ever insured for certain, narrowly defined consequences, in circumstances where the BI loss would have happened anyway even if the peril insured against had not happened.

Conclusion

The FCA test case raises a wide range of issues which are of significant importance to the operation of business interruption policies issued by insurers to both SMEs and larger commercial policyholders alike. The disputes in relation to the appropriate approach to causation and the proper interpretation of insurance policies mean that the court’s decision could be of even wider impact. The test case hearing is scheduled to continue until Thursday, 30 July 2020. The court’s judgment is very likely to be reserved and handed down at a later date.

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