The High Court Hands Down Its Judgment in the FCA Test Case on Business Interruption Insurance

COVID-19 led to unprecedented disruption for UK businesses and a number of businesses made claims on their business interruption insurance. At the time, many insurers circulated generic communications to policyholders or announced publicly that their business interruption insurance policies with non-damage cover would not respond to COVID-19 losses. The FCA decided that, due to the uncertainty in the market, it would seek court declarations as part of a test case, aimed at resolving the contractual uncertainty around the validity of many business interruption claims.

Business interruption cover is usually included as an extension to a property damage insurance policy. Typically the cover is only available where there has been physical damage to property resulting in interruption to the policyholder's business. However, the test case was concerned with “non-damage” business interruption cover (i.e. business interruption cover that is available even where there is no physical damage). For the purposes of the test case, these non-damage wordings fell into three categories: disease clauses, public authority action clauses and hybrid clauses. The High Court considered a representative sample of policy wordings (identified by the name of the insurer and a number, e.g. “RSA 1”) to create a binding judgment on the interpretation of the wordings. On 15 September 2020, the Court handed down its judgment. Policyholders and insurers should be aware that the decision might be subject to appeal, and therefore the final resolution of the case may not be until later this year or even 2021.We have summarised the main aspects of the judgment below. However, policyholders and insurers should bear in mind that whether losses are covered under a policy will depend on the particular wording of the policy and the facts of each case. As such, it may be possible to distinguish particular circumstances and losses from the general points discussed below.In general the decision was favourable to policyholders, especially those claiming under disease clauses. The position was potentially less favourable, and certainly more nuanced, in relation to public authority action clauses. As the Court applied much the same reasoning to hybrid clauses as it did in relation to disease and public authority action clauses, we have not commented in detail on hybrid clauses, except where the decision made a specific point only relating to hybrid clauses.[tela_accordion title="General policy construction"]The case has confirmed that the ordinary principles of contractual construction apply to insurance policies. The Court highlighted that this “means disregarding evidence about the subjective intentions of the parties”. Policyholders will be able to deploy this argument to counter an insurer that argues that it did not intend to provide pandemic cover. Similarly, policyholders will come up against this argument if they try and use any arguments relating to what they expected the policy should cover. The meaning of the words used in the policy will need to be considered in the context of each policy wording.

Exclusions

 In relation to exclusions, the Court held that where an exclusion expressly applies to one insuring clause, but not another, the lack of an exclusion is not decisive to the scope of the cover of the clause does not include the exclusion. As such, the absence of a pandemic exclusion applying to a particular insuring clause will not be decisive in suggesting the clause intended to cover pandemics, even where other clauses in the policy are subject to an express pandemic exclusion. In “RSA 3”, the policy wording containing general exclusions for “epidemic” and “disease” was construed by the Court as not having intended to override express grants of cover for these in the policy, such as in the notifiable disease clause.

The contra proferentum rule

The Court stated that the contra proferentum rule, a longstanding doctrine of contractual interpretation that any ambiguity in a contract will be interpreted against the party that drafted the contract, can only apply there is “genuine ambiguity” and “it should not be relied on to create ambiguity where there is none”.Interestingly the Court initially appeared to query whether the principle “still has any validity”. However, the Court stated later in the judgment, that the discord between the exclusions and express coverage for “epidemic” and “disease” in policy wording “RSA 3” (discussed above) was “one of the few cases in which it would be appropriate to apply a principle of contra proferentem”.

The relevant background

The Court made it clear that it can only take into account facts or circumstances which existed at the time that the contract was entered into, which is not likely to be controversial. This includes the relevant legal background, so that where a relevant expression has been given a settled meaning by the Courts, the Court should construe it as such. However, the Court rejected the insurers' argument that Orient Express[1] was settled law that formed part of the relevant legal background. The court reasoned that it is a reasonably recent and first instance decision and “does not give a particular meaning to a specific clause which is of relevance here”.[ela_accordion][tela_accordion title="Disease clauses"]Some of the policies considered contained disease clauses which, for example, provided cover for business interruption arising from notifiable or infectious diseases. It was not in dispute in the case that COVID-19 was made a notifiable disease in all parts of the UK by 6 March 2020. We have highlighted the Court's key decisions on the interpretation of certain words and clauses below:

• “Occurrence” and “manifested”

The Court held that there will have been an “occurrence” of COVID-19 within an area when at least one person who was infected with COVID-19 was in the relevant geographical area. Specifically, “occurrence” only requires one person to be infected and the case of COVID-19 does not have to be diagnosed.

However, for a disease to have “manifested” the Court held that a person must be showing symptoms of the disease or (despite being asymptomatic) must have been diagnosed with the disease. The disease would not have manifested if a person was asymptomatic and had not been diagnosed with it.

The Court, however, only provided its opinion on the meaning of these words and did not provide a clear decision on how policyholders would prove there was, in fact, an “occurrence” or “manifestation” of COVID-19 (known in the test case as the “prevalence” argument). Our opinion is that the consequence of the judgment is that, where a policyholder can prove that there was a recorded case of COVID-19 in the relevant geographical area specified in the policy, this is likely to satisfy the burden of proof that there was an “occurrence” or “manifestation” of COVID-19. However, the court declined to give any generally applicable guidance as to what evidence may prove actual prevalence, and it was not in dispute in the case that the types of methodologies that the FCA had suggested (such as using methodologies for averaging and dealing with undercounting of cases) could in principle discharge the burden of proof. The court was not willing to go any further and therefore policyholders may still face arguments over whether the policyholder has proved that there was an “occurrence” or “manifestation” of COVID-19.

• “Follows” and “in consequence of”

If a policy states that business interruption should “follow” specified insured events, the Court held that it is not enough for the business interruption to simply follow the insured event in time. There must be some causal connection between the insured event (here the disease) and the business interruption. However, the insurers were not successful in arguing that it must be a proximate cause.

The Court held “in consequence of” is intended to include indirect causation.

• “Directly affected”

Where the policy states that it only covers losses that are directly affected by the insured event, the Court held that this is unlikely to narrow the scope of cover because there was an indirect effect. This is because a disease occurring within a certain geographical area would only be likely to have an effect on businesses indirectly (such as through adverse public reaction).

• Geographical Limits

A number of disease clauses include a geographical limit. The Court rejected the insurers' arguments that this must mean that only a local outbreak is covered. Instead the Court held that a geographical limit only requires one case of the disease to occur within the specified geographical limit.

Usefully for policyholders, the Court also rejected the insurers' arguments that including a geographical limit means that policyholders' claims will fail where COVID-19 was both within and outside of the geographical limit (as opposed to just within the specified geographical limit). Further the Court held that the insurers were wrong in saying that cases of COVID-19 within the geographical limit are independent and separate of cases outside the geographical limit.

However, the Court's decision in relation to policy wordings “QBE 2” and “QBE 3” was less helpful to policyholders, and will likely be a part of the judgment that insurers will attempt to draw parallels with. The Court held that, when construed alongside the geographical limit of a 1-mile radius, the use of the words “incident” and “events” reinforced the fact that the clause was concerned with specific events that were limited in time and place. Therefore, the Court held that the words “in consequence of” in these clauses implies a direct causal relationship. Policyholders with these policies would therefore have to show that the cases within the geographical area, as opposed to any cases elsewhere, were the cause of the business interruption.

The difference between the policy wordings “QBE 2” and “QBE 3” and the other wordings in the test case demonstrates how each claim will come down to the specific policy wording that is being considered.

• “Vicinity”

The Court opined that the ordinary meaning of “vicinity” is a near area. However, in “RSA 4” the policy defined “Vicinity” as “an area surrounding or adjacent to an Insured Location in which events that occur within such area would be reasonably expected to have an impact on an Insured or the Insured's Business”. The Court held that this definition meant that the whole country was the “Vicinity” for COVID-19 related claims. However, the application of this part of the decision is likely to be confined to the specific wording of this policy.

Our conclusion on disease clauses

Broadly, the Court's decision is positive for policyholders, especially those with large geographical limits in the policy, as these policyholders should be able to easily prove that there was an occurrence or manifestation of COVID-19 in the broad geographical limit. However, the viability of policyholders' claims will depend on the precise policy wording.

Public authority action clauses

Some of the policies considered contained public authority action clauses, which provided cover for losses arising in relation to certain actions taken by public authorities (such as a public authority requiring a business to close). We have highlighted the Court's key decisions on the interpretation of certain words and clauses below:

• “Occurrence”, “manifested” and “follows”

As with disease clauses (discussed above), the Court held that the COVID-19 outbreak in the UK could qualify as “an occurrence” of a notifiable disease and “follows” imports the need for there to be a causal connection with the interruption to the policyholder's business. “Manifested” was also determined to have the same meaning as for disease clauses.

• “Incident”, “emergency” and “danger”

The Court held that “an incident” is not synonymous with “emergency” or “danger”. Whereas the Court considered that the COVID-19 pandemic could be properly described as “an emergency which is likely to endanger life”, referring to the “Hiscox NDDA clause”, the Court held that where a policy refers to an incident, this is not likely to refer to a pandemic. Further, when read with a requirement for the incident to occur “within the vicinity” of an insured premises or within a small geographical area, this infers a narrow, localised cover.

• “In the vicinity” and geographical limits

The meaning of “in the vicinity” or the inclusion of a small geographical limit is likely to be crucial in respect of many public authority action clauses. If the policy includes that the emergency, danger or disturbance, injury or incident must be within the vicinity (and vicinity is undefined) or if it must occur within a small geographical limit, the Court held that this infers that the clause was intended to only extend to local events, such as those in the neighbourhood of the premises. What constitutes local may depend on what is being described, but it would require that it was the risk of COVID-19 in the vicinity of the insured premises, as opposed to in the country as a whole, which led to the action of the government in imposing restrictions. The Court stated that it is highly unlikely that this could be demonstrated in any particular case.

Again, careful consideration of each policy wording is required.  For instance, in respect of “RSA 4”, the policy wording stated that the actions or advice of the government needed to be within the vicinity of the property. The Court held that because the actions or advice of the government were not required to be “following” or “due to” an “emergency” or “danger”, and because there was no requirement for the action or advice to be directed at or specific to the vicinity of the insured premises, then as government actions were taken nationally and affected all insured businesses, the government action or advice would inevitably be in the vicinity of the premises.

• “Advice” or “action”

The Court held that certain government announcements regarding COVID-19 did amount to “advice” or an “action” and therefore policy wordings are likely to provide cover in the context where the clause provides cover for “hindrance of use”.

• “Restrictions imposed” or “requirements imposed”

The Court held that “restrictions imposed” or “requirements imposed” by a public authority requires something that is mandatory (i.e. a statutory instrument) and therefore does not include government guidance. The restrictions imposed do not, however, necessarily need to be directed at the insured.

Specifically in relation to hybrid wordings, the Court held that the restrictions imposed by the government in the UK did follow the occurrence of a notifiable disease, however depending on the wording of the policy, when considering causation, the causal link required may need to be between the restrictions imposed and a disease of which there has been an “occurrence” within the specific geographical area (such as in “RSA 1”) or the causal link may need to be between the restrictions and the specific local instances of the disease (such as in “Hiscox 4”).

• “Enforced closure”

The Court held that an “enforced closure” only extends to a closure that is legally capable of being enforced and that requires part or all of the policyholder's premises to be closed. Government guidance does not amount to an enforced closure and therefore an enforced closure only took place if, following regulations put in place either on the 21 or 26 March, part or all of the policyholder's premises had to be closed.

• “Inability to use” and “interruption”

The Court held that the meaning of “inability to use” was something that must be decided on the facts as it would differ depending on the type of business and its use of the premises. However, the Court's guidance is that this wording does have a more restrictive meaning than “hindering in using”. For example, the requirement of an “inability to use” is not likely to be met merely because the insured cannot use all of the premises. Therefore, a restaurant that offered takeaway services prior to the pandemic is unlikely to be able to argue that there was an “inability to use” the premises merely because diners could not sit in the restaurant.

The Court also held that the word “interruption” in the Hiscox policies should be interpreted generally as including disruption or interference, and not just as a complete cessation, as it was to be interpreted in the context of business interruption.

• “Prevention of access” or “hindrance”

The Court held that, although physical prevention was not required for “prevention of access”, there had to have been a closure of the policyholder's premises for the policy to provide coverage. As such, the government actions or advice must have required or recommended complete, as opposed to partial, closure of the business. The Court stated that prevention requires impossibility, whereas hindrance means access is rendered particularly difficult.

Our conclusion on public authority action clauses

The Court's decision is not as straightforward for these clauses. It is likely that the difference between the court's approach for disease clauses and public authority action clauses arises from the fact that many public authority action clauses are worded in such a way that has led the Court to be persuaded that these should often only cover localised incidents. However, as with disease clauses, the viability of policyholders' claims will depend on the precise policy wording.

Causation and Orient Express

The general rule is that policyholders must prove that the insured peril (i.e. is the trigger for cover under the policy) is the main or dominant (known as “proximate”) cause of their loss.The Court stated that, for COVID-19 related business interruption losses, the requirement for proximate causation is between the loss suffered and the interruption or interference with the business. In respect of the majority of disease clauses the Court held that the proximate cause test will have been satisfied if the disease was in the relevant geographical area as the interruption was caused by the national response to the widespread outbreak of the disease. Alternatively, the Court stated that each individual case was a separate but effective cause of the loss as it appeared to the Court that “all the cases were equal causes of the imposition of national measures”.However, the Court did not set out an extensive analysis of causation as it considered that the issues were resolved by the construction of the policy wordings. By defining the insured peril in the way the Court did (set out in our analysis of the Court's decision in relation to disease clauses and public authority action clauses above), many of the causation arguments raised in the case fell away (either the insured peril was defined broadly and the causation test easily satisfied, or the losses fell outside of the scope of cover and therefore no analysis of the causation test was required).However, the Court commented on and criticised the Orient Express decision as the insurers had relied on it so heavily. In Orient Express, a hotel had been damaged by hurricanes that had also damaged the surrounding area. The physical damage to the hotel caused by the hurricanes was clearly covered. However, in relation to the business interruption losses, the insurers denied cover as, even if the hotel had not been damaged, the hurricane damage to the area surrounding the hotel caused by the hurricanes would have meant that business interruption losses would have been suffered in any event.The Court stated that there were several problems with the reasoning in Orient Express. Its main problem was that the Orient Express decision mis-identified the insured peril, which the Court suggested may have arisen from the focus in the decision on the “but for” test instead of considering what the proximate cause of the loss was.  The Court held that in Orient Express the decision separated the damage caused and the hurricanes, which was incorrect. The hurricanes, as the cause of the damage, were an integral part of the insured peril. The Court therefore stated that if it had been determinative, the Court would have reached the conclusion that Orient Express was wrongly decided. However, as Orient Express was not concerned with the type of insured perils involved in the test case, the test case was distinguished from Orient Express as, due to the way that the Court had defined the insured peril, the quantification of losses applied in Orient Express would not have led to a different conclusion in the test case. We have considered the Court's application of quantification and trends clauses below.

[Quantification and trends clauses

Trends clauses appear in most business interruption insurance policies. These clauses are used to quantify the loss that the insured has suffered due to the business interruption. These clauses allow the insurer to adjust the amount that will be paid out for the loss where other factors outside of the scope of the coverage of the policy have affected the loss suffered. These clauses seek to quantify the difference between the business results and what the results would have been had the loss covered by the policy not occurred.The Court held that even where the trends clause refers to damage as this is the main operative clause of the policy, there is no good reason why the trends clause should not apply to the non-damage claims extensions in the policy. As such, the operation of a trends clause is not automatically stopped by the trends clause itself only being drafted in terms of adjustments had the “damage” not occurred.The Court made it clear that a trends clause is part of the quantification machinery (and not determinative of whether a loss is covered). Subject to the policy wording stating otherwise, the Court held that the object of quantification machinery is to put the policyholder in the same position as it would have been in if the insured peril had not occurred. The Court therefore held that where a party has, on the face of it, established a loss is caused by an insured peril, unless the wording requires it, the loss should not be limited by including any part of the insured peril in the assessment of what the position would have been had it not occurred.Particularly helpful in relation to disease clauses was the Court's definition of the insured peril as the interruption or interference with the business following the occurrence of a notifiable disease within the relevant geographical limit. As such, the Court considered the correct application of a trends clause would be to consider the position had the business interruption due to COVID-19 (including the action of public authorities and the response of members of the public) not occurred. The Court held similarly in respect of public authority action clauses, stating that the parties should consider the actual performance of the business had the COVID-19 outbreak and the resulting restrictions and inability to use the premises not occurred.In respect of Orient Express, as explained above, the Court held that Orient Express had identified incorrectly the insured peril. On the basis that the hurricanes were an integral part of the insured peril, the counterfactual to apply in the trends clause was the situation where both the damage to the hotel and the hurricanes and their effect generally had not happened.[ela_accordion]

How we can help

The judgment has provided binding authority on how a number of clauses will be interpreted. However, the Court was clear that every policy will need to be interpreted separately and on its own wording. Our Financial Services Regulation team has extensive experience acting for both policyholders and insurers on a range of multi-jurisdictional insurance coverage and defence work and advising insurers on managing down specific exposures, including advising on coverage issues arising from business interruption insurance losses arising from COVID-19.If you have any queries in relation to business interruption insurance losses arising from COVID-19 or the effects of the judgment, please contact Adam Edwards.

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If you would like to talk through the consequences for your business, please email us and one of our team will get in touch.