By agreement, the Financial Conduct Authority and eight private insurers in UK applied to the Court to seek clarification on the application of a number of Business Interruption (BI) policies related to losses suffered by UK businesses as a result of the COVID-19 pandemic. This was a test case. The judgment was released on 15 September 2020 and you can find it online by searching The Financial Conduct Authority v Arch Insurance (UK) Limited & Others  EWHC 2448 (Comm). In short, the Court found in favour of the policyholders represented by the Financial Conduct Authority.
Before we go any further, we should explain that the main purpose of BI policies is to help policyholders when they suffer physical damage to their premises and that damage causes interruption to their business. So BI policies are linked with material damage policies and require some sort of damage in the first place. However, a lot of BI policies today offer various extensions that do not require damage. The test case only considered the non-damage extensions.
The judgment is 162 pages long and raises many important points of law. We do not intend to cover every aspect raised in the judgment but rather focus on three main points.
1. The first is the causal connection required between the peril insured and the business interruption loss. The relevant clause in many policies that the Court looked at was along these lines:
We shall indemnify You in respect of interruption or interference with the Business during the Indemnity Period following any i. occurrence of a Notifiable Disease (as defined below) at the Premises; discovery of an organism at the Premises likely to result in the occurrence of a Notifiable Disease; iii. occurrence of a Notifiable Disease within a radius of 25 miles of the Premises. (underlying is our emphasis)
The Court said that the word “following” denotes a looser form of link than that of proximate causation. The Court also interpreted the word in the context of the full clause and noted that the matters referred to in the extension would not of themselves directly cause interruption to or interference with the business, but would have an effect only via the reaction of the authorities and of the public, in other words, an indirect effect. So, while the insured peril was required to have a causal connection to the business interruption, it was not necessarily one of proximate causation. The situation was different in a couple of QBE policies which used words such as “in consequences of” and “event”. The Court found that the effect was that cover was limited to matters occurring at a particular time, in a particular place and in a particular way. Like it is often the case with insurance policies, the words used in the wording make a difference.
2. The second point is the interpretation of the word “Vicinity”. Several policies required a peril (in this case the happening of a Notifiable Disease) to occur in the vicinity of the policyholders’ location, sometimes stipulated as a 25-mile radius. The insurers argued that the cover was only against business interruption or interference proximately caused by a local outbreak of a Notifiable Disease within 25 miles of the premises. The Court disagreed and said that the interpretation of the word could, depending on the facts, embrace a very extensive area, including possibly, in the case of a disease such as COVID-19, the whole country. The Court further said it was a fallacy to treat the occurrence of COVID-19 within the relevant radius as separate from its occurrence elsewhere in the country. It noted that it could lead to an absurd result whereby the more serious the peril, the less cover would be available under the policy. On the insurers’ argument, there would be cover if the Notifiable Disease occurred within a 25-mile radius but if the Notifiable Disease spread out in the whole country, there would be no cover because it was no longer localised. However, the word “Vicinity” was interpreted much narrower when the Court dealt with Prevention of Access clauses that required a localised occurrence. So the context in which the word was interpreted was important.
3. The third point is related to the deductions that an insurer could make from a payment to policyholders if the businesses are affected by causes other than the peril insured against. This was referred to as the “trends clause”. The insurers argued that even if there been no occurrence of COVID-19 within a 25-mile radius of the policyholders’ premises, the businesses would still have suffered from a general reduction of demand due to the government’s social distancing measures and closure measures, and a general economic downturn due to lack of consumer confidence. So in effect, the insurers said that “but for” the local disease there would have been the same interruption or interference and therefore there should be no cover.
The Court went to great lengths to reject this argument. First, it clarified that the trends clause only applies once it has been established that there is a valid claim under the policy; the clause only assisted with calculating how much it is payable. Second, it said that the peril was a composite peril involving interconnected elements. For example, for prevention of access, the peril was a combination of factors including prevention or hindrance of access to the premises, by any action of government, due to an emergency which could endanger human life. So when the insurers take into account other causes, they cannot deduct the downturn in business brought about by these interrelated causes because they are all part of the same peril for which there is cover. So if there is a closure of business caused by pandemic, the insurers are not allowed to deduct the results of the economic downturn caused by the pandemic but they would be allowed to take into account other non-related causes. The Court gave an example of a Michelin star restaurant where the chef handed in her resignation at the beginning of the pandemic and this was expected to create a downturn in business, alongside the downturn created by the pandemic.
The Court refused to follow and disagreed with the decision in Orient-Express Hotels Ltd v Assicurazioni Generali SpA  Lloyd’s Rep IR 531. It said that the Court in that case misidentified the peril insured. That case involved a claim for business interruption losses to a hotel that was damaged by Hurricane Katrina. In that case, the judge held that the peril was the damage to the hotel rather than the hurricane. It therefore held that the hotel was not entitled to business interruption losses because there would have been no business anyway as the entire area surrounding it was badly affected by the hurricane. The Court held the Orient-Express decision relied on a fallacy, and that the peril insured against was the hurricane rather than the damage itself. The hurricane brought about not only physical damage but also depopulation and cessation of business in the surrounding areas, and these additional elements of the composite peril should not have been taken as independent causes of loss. It noted that it would lead to an absurd result whereby if the damage would have been limited to the hotel alone, there would have been full cover, but because the devastation was widespread, there would be no cover.
So how does this relate to the situation in New Zealand?
We have looked at a few policies available online, including the QBE Steadfast Business Interruption policy, NZI Business Interruption policy, Vero Steadfast Business Interruption policy, and a Crombie Lockwood-branded Business Interruption policy. All these policies have an outright exclusion for business interruption caused by Notifiable Diseases. So, while the UK policies have an extension for losses following a Notifiable Disease, the New Zealand policies we looked at have a complete exclusion. So it is important to check the terms of an individual policy to see what it provides for.
Also, most New Zealand policies we looked at require the loss to “result from” rather than just “follow” an insured peril, so a must stronger causal connection is required.
The UK test case is important for New Zealand especially when it comes to interpreting the word vicinity and in the application of the “but for” test when quantifying the loss.
We understand that the UK insurers are preparing for an appeal so there might be more to come on this topic.