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Tuesday,
June 6, 2006
 This is the second in a three-part series touching on selected issues that should be considered in preparation for future storms and potential lawsuits as hurricane season approaches once again. This newsletter is not intended to provide a comprehensive discussion of the non-litigation/pre-litigation issues facing the Gulf Coast business community, but rather to highlight three of the most significant. In this installment, we will discuss selected insurance issues. Part Three will address certain aspects of oil spill cleanup cost recovery under the Oil Pollution Act of 1990, including the Act of God affirmative defense to liability under that statute.
The myriad insurance issues presented by the recent hurricane losses will challenge oil and gas producers, as well as other commercial policyholders, for more than a few years. No doubt, litigation will overwhelm the judicial system and law firms with a wave of issues: some new, some old, but most without a clear answer. This newsletter addresses two of the recurrent and important insurance coverage issues prevalent in the post-disaster environment: contractual and statutory deadlines for bringing a legal action against an insurer and business interruption insurance.
Statutory law in Louisiana and Texas provides for generous prescriptive periods/statutes of limitations for bringing actions against insurers. Under Louisiana law, the prescriptive period for contracts, including insurance policies, is ten years from the date of the breach of contract. In Texas, the usual statutory limitation for a breach of contract action is four years. Significantly, however, these statutory periods can be – and usually are – modified by insurance policies.
Perhaps the most typical limitation formula is the requirement that an insured bring an action against the insurer within one year from the time of loss. Faced with a short time limit within which to decide whether differences with the insurer can be satisfactorily addressed, some policyholders may be tempted to either accept less indemnity than that to which they are entitled, or to file suit against the insurer. An early lawsuit can result in unnecessary costs in terms of attorney’s fees and delay, as well as in a sour relationship with an insurer who, while perhaps moving slowly, may at least have been heading in the right direction toward satisfactorily adjusting the claim. Therefore, it is important for policyholders to understand the time limitations contained within their policies so as to avoid an early (and perhaps unnecessary) lawsuit against the insurer.
While working with an insurer to obtain adequate indemnity for property losses can be a trying task, it is somewhat straightforward due to the ability to see the actual damage for which indemnity is sought. But what happens when the losses extend beyond physical damage to property? Business interruption insurance, or BI coverage, fills the gap left by traditional property insurance, which pays to repair or replace damaged property, but which does not protect the insured against consequential damages, such as lost profits. BI coverage may also cover “extra expenses,” meaning any expenses above and beyond normal that the business necessarily incurs while property is being repaired. Properly placed business interruption coverage will put the insured in the same financial position in which he would have been had no interruption of operations occurred.
Business interruption insurance may be written on the basis of the “actual loss sustained” or as “agreed value.” The actual loss sustained is generally determined by looking at (i) past financial performance during the preceding year and (ii) forecasted revenues and market trends, but not taking account of market conditions that exist solely because of the casualty giving rise to the claim. Expert accounting consultants are generally necessary to support the appropriate indemnity. Some policies, particularly those covering Loss of Production Income (“LOPI”), are valued policies that pay indemnity based on a formula that provides $X to the policyholder for each day (minus a deductible period) the insured is unable to produce hydrocarbons.
Business interruption policies generally use the term “period of restoration” to describe the period during which the losses are covered. Although policy language differs, the period of restoration is generally understood to be the theoretical (or hypothetical) amount of time that it should take the insured in the exercise of “dispatch” or “due diligence” to repair the damage and resume operations. Here, expert construction experts are employed to determine that period. The period is often said to be hypothetical because, for a number of reasons, it might not be the same as the actual amount of time it takes the insured to resume its operations at the damaged site. The theoretical nature of this determination can provoke troublesome questions such as: what would happen if the property were not or cannot be rebuilt or must move to another location? And whether the insured, in the context of a post-disaster environment, was moving with sufficient dispatch? Some policy forms partially answer this question in the definition of the “period of restoration,” which provides that the period ends after the hypothetical deadline or on the date when the business is resumed at a new, permanent location. Calculating the period of restoration is fact-intensive, and it requires the insured to do his homework to prove the entitlement to the appropriate indemnity. There may also be a limited extra period of indemnity (so-called “extended business interruption coverage”), which indemnifies the insured for lost profits incurred after the property is restored, but which result due to the natural slow-down of business caused by having the doors closed for an extended period.
Business interruption policies vary significantly in terms of triggers, definitions, extra coverages, and valuation standards. Even subtle differences in the language may determine whether a claim is valid or invalid: it is imperative to analyze the policy and marshal facts and evidence to support the appropriate recovery. Typically, business interruption coverage must be triggered by a direct physical loss to the property, which damage is not excluded by the policy, and which in turn results from a “covered cause of loss.” The definition of “covered cause of loss” may be broad (including “all risks of direct physical loss or damage”) or it may be provided on a modified form, covering all risks of direct physical loss or damage, but subject to further exclusions. Generally, damage from flood, power outages, or other non-wind related risks are excluded. However, for an additional premium the policyholder may purchase supplemental coverages, which contain different triggers. These supplemental coverages will be subject to special sublimits.
Civil-authority orders – road closures, evacuations, business closings (or a limitation of hours or operations) – may give rise to business-interruption claims under a commercial insurance policy. Whether there is coverage for these claims depends on the policy language and the specific facts underlying the claim. Generally, the order of the civil authority must prohibit physical access to the premises. Civil orders that have the effect of preventing access to the premise may not be enough to trigger coverage. A policy may require the impairment of the insured’s business operations by an order or action of civil authority to have been caused by or result from direct physical loss or damage to property away from or within a certain distance of the insured premises. Some policies set time limitations on how long such coverage is afforded. Insurers will likely argue that once a civil authority time limit is met, covered damages cease, despite the fact that other overlapping coverage grants continue to provide coverage.
In addition to establishing the existence and duration of a suspension of operations, an insured may be challenged to show that it has suffered an actual loss of income. It may not be enough to merely show a loss of sales or production. Rather, the insured could be required to establish that, but for the suspension of its operations, it would have earned income. Insurers sometimes argue that if the insured cannot prove that it would have been profitable during the period of interruption, there can be no recovery. But if a policyholder is losing additional money as a result of the loss incident, the claim should be paid.
The various questions arising with respect to these and other insurance issues will likely be litigated extensively over the next several years. While many are now intimately (and perhaps painfully) aware of what their policies do and do not cover, it is still imperative that businesses and individuals turn a critical eye to their policies so that they are familiar with their rights, both in anticipation of the upcoming hurricane season and with the one year anniversary of Hurricane Katrina rapidly approaching.
The third and final installment of this series will discuss the Oil Pollution Act of 1990 and the potential defenses to liability for oil spill clean up and recovery of clean-up costs from the Oil Spill Liability Trust Fund by Responsible Parties.
For more information, please contact Michael Golemi at magolemi@liskow.com or Anna Knull at atknull@liskow.com or go to www.liskow.com.
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