Manufacturers and retailers rely heavily on facilities around the globe to supply products, and any disruption in supply or distribution chains may cause significant interruption and loss to a business. The use of just-in-time supply systems significantly increases the potential loss caused by any interruption in a company’s logistics. Such systems benefit the company when operating at full capacity. But, anything less than full capacity operations may result in significant losses in the event the insured cannot acquire the materials needed to meet its production capacity, or cannot obtain the inventory needed to maintain its sales.
Further, a significant downturn in supply often results in increased costs for acquisition of the materials needed to continue operating. It can also result in partial or complete shutdown of facilities lacking the resources to operate.
“Sandy”1 struck directly at property and facilities critically important to many of the world’s leading automobile manufacturers. The timing of these recent weather events could not have been worse. The northeast accounts for 25% to 30% of all auto sales in the United States. The end-of-month sales period in which the storms struck are “when sales are typically the strongest,” according to Kelley Blue Book analyst Alex Guitierrez.
As a consequence of the storms, car dealerships throughout the East Coast were shut down as a result of property damage and/or lack of power. While the total number of automobiles destroyed is not yet known, Toyota, Chrysler, Nissan and Honda together estimate that they will be forced to scrap more than 15,000 new vehicles at dealers or at the region’s ports. Fisker Automotive, a boutique manufacturer of luxury hybrid cars, lost 338 Karma sedans stored at the port of Newark, N.J. With each car carrying a base price of over $100,000, the minimum retail value of Fisker’s losses alone is $34.8 million.
Moreover, the Port Authority of New York and New Jersey alone handled more than 738,000 vehicle shipments in 2010. These ports are a significant gateway into the North American market for automobile manufacturers. The Port Authority closed its facilities at midnight on Oct. 29, 2012. The Port of Elizabeth did not begin business again until Nov. 4, 2012, and the Port of Newark did not reopen until Nov. 5. The result was a significant interruption in shipping, and the ripple effect may be felt throughout the country for the foreseeable future.
With estimates that “tens of thousands” of automobiles in the New York region were lost because of recent weather events, and with additional expenses and delays anticipated due to delayed shipments and lingering power outages, policyholders in the automotive industry should look to their insurers to recover these storm-related losses. This article analyzes several common types of loss that may result from Sandy (or any catastrophic weather condition) with the goal of assisting policyholders in assessing the scope of available coverage to them and maximizing any potential recovery.
Companies suffering interruption losses resulting from damage to third- party facilities often do not realize that they may be protected by their insurance program. Contingent Business Interruption (CBI) insurance protects a company from business interruption losses when a logistics system fails due to a covered cause of loss. A company may be protected from such losses even if the company itself has not suffered any damage to its own property. Counsel familiar with the nuances of this type of insurance coverage can provide valuable advice to a company seeking to maximize its recovery for loss from a disruption in its supply or distribution chain.
Companies suffering such disruptions should consider whether CBI insurance covers its losses due to such supply and distribution chain problems. Making a CBI claim requires a thorough understanding of the policy and related issues, such as applicable deductibles, the scope of the business interruption, the calculation of loss, and potential applicability of exclusions. This article provides an overview of what you need to know in order to maximize recovery from a property insurance program after business is interrupted due to a supply and distribution chain disruption.
Types of Interruption Coverage
Most companies purchase first-party property insurance policies that protect against loss from fire or other destruction of company property. These policies often include business interruption coverage, which insures against loss when the insured’s “business is partially or totally interrupted as a result of a covered property damage.”2 Such coverage generally requires that the loss caused by the interruption be the result of damage to the policyholder’s own property that is covered under the policy. Therefore, any business located in the Northeast may have suffered damage during recent storms should review its business interruption coverage. If damage to the business prevents the business from operating, the resulting loss may well be covered.
CBI insurance clauses extend this business interruption coverage under certain circumstances. One such circumstance is when a peril of the type covered by a policy causes damage to a supplier of the policyholder. CBI insurance also often provides coverage when a covered peril damages a receiver or distributor of a policyholder’s goods. Alternatively, policies may provide coverage for interruption loss caused by damage at the premises of a “dependent property,” which can include operations relied upon to deliver or distribute goods or services, manufacture products or components, or even attract customers to the policyholder’s business.
In addition to CBI coverage, many property insurance policies provide coverage for extra expenses that a policyholder incurs as the result of a covered event. Policies often extend extra expense coverage to include situations where extra expense is incurred because of damage to the property of a policyholder’s suppliers, receivers, and distributors. Together, these so-called “time element” coverages can provide a policyholder with broad protection against unforeseen disruptions to its supply or distribution chain. But, insurance policy language can vary in important ways, and policyholders must be careful to scrutinize the particular language in their policies to understand the full extent of their coverage.
While CBI insurance protects against losses resulting from the damage sustained by the policyholder’s suppliers, distributors or receivers, some limitations may impact a policyholder’s ability to recover. For instance, many CBI provisions require that the damage be suffered by a “direct supplier of goods.” A policyholder should consider its supply chain and what sources may be considered a “direct supplier.” Further, the question of what constitutes a “supplier” is not always clear. Recently, in Park Electromchem,3 the court found the term “direct suppliers” to be ambiguous and ordered a trial on the issue of whether a foreign facility owned by the insured could be considered a “direct supplier” of goods for purposes of CBI coverage.
CBI insurance also typically only applies when a third party suffers loss because of a peril against which the policyholder itself would be covered. An insurer may argue that exclusions limiting a policyholder’s coverage for a loss because of windstorm or flood may preclude recovering lost income due to the closures of ports and other facilities by such causes. Policyholders that have suffered a business interruption loss should consult with experienced professionals to explore the issue of causation and the proper application of potentially applicable exclusions. A policyholder must make an extra effort when preparing a claim predicated upon damage to third parties because often critical facts are outside of the policyholder’s possession or control.
For instance, an automobile dealer with a policy that excludes “flood” losses but includes coverage for “windstorm” likely will seek compensation for vehicle damage caused by wind. But that dealer may have additional losses caused by the subsequent inability to receive inventory because of port closures or damage to inventory at port locations. Likewise, a manufacturer may have losses arising out of the inability to distribute products via such facilities. Relying on a “flood” exclusion, an insurer may deny coverage for all of these losses. It behooves a policyholder to be active early in the claim process so it can gather any available facts that would help establish that its loss was the result of a covered cause of loss.
Insurance companies also may deny CBI claims by arguing that the policyholder must suffer a total and complete cessation of business. Many courts reject this overly strict interpretation of policies providing coverage in the event of a “necessary interruption” or “suspension” of business. The rejection of this insurer argument is particularly important for a CBI claim, as a disruption in supply or distribution may only impact one aspect of a policyholder’s business. One federal court noted that use of the term “necessary interruption” in a CBI provision did not require a complete shutdown of the policyholder’s entire business.4 By contrast, at least one New York court has held that a total and complete shutdown of business operations is necessary under conventional business interruption coverage.5 It remains unclear whether this ruling will translate to CBI coverage, and policyholders should consult with counsel soon after a loss to carefully determine the impact of an interruption on the policyholder’s business and the requirements of the policy.
Extra Expense Insurance
“Extra Expense” insurance covers “reasonable and necessary extra costs” a company incurs in excess of the normal operating costs in order to keep its business running after damage to the company’s property. Often, policies with CBI provisions provide for extra expense insurance covering those additional incremental costs incurred because of damage to the facilities of a supplier, receiver, and/or distributor. Such costs include the increased costs to receive goods for sale, the increased cost to transport and distribute goods, and increased labor costs to re-establish logistics systems. It is critical that a company keep detailed records regarding such efforts at reorganization, even though its employees likely are working diligently to identify alternatives to the disrupted supply or distribution system.
Potential Pitfalls When Making A Claim
A policyholder must act in a timely fashion when seeking coverage under any insurance policy. Notice should be given immediately if the company suspects that it might suffer an interruption-related loss. Doing so prevents an insurer from denying the claim as untimely. Property insurance policies also often require that the policyholder submit a proof of loss within a specific and relatively short period of time after a loss. This often proves quite difficult if not impossible for a complicated and potentially ongoing interruption caused by damage to a third-party supplier, receiver or distributor. Accordingly, a company should keep its insurer fully informed of the status of its claim. Further, the policyholder should make written requests for extensions of time to submit a proof of loss as needed. Such requests are normal and are routinely granted by insurance companies.
Interruption losses also are difficult to quantify. Property insurance policies typically provide two different methods for calculating business interruption and CBI loss: (1) gross earnings -- the net reduction in earnings less the expenses that do not necessarily continue during the interruption; or (2) business income -- the profit that would have been earned plus continuing normal operations expenses during the period of interruption.
Proving an interruption-related loss in either case involves a complicated process of demonstrating how the policyholder would have performed had the event not occurred, the nature of the market in general, and the impact of the catastrophic event on that market. This difficulty of proof reemphasizes the need for thorough documentation of losses and expenses during the interruption so that any claim can be properly supported.
Policyholders should be wary that their own internal analytical material may become a hurdle to recovery. Insurance companies and the adjustors they retain have an incentive to reduce the amount of a claim, and they will use the policyholder’s own analytics against it, if possible. A policyholder can effectively and thoroughly track the extent of its loss by immediately hiring experts to assist in adjusting the claim. A policyholder may also retain coverage counsel early to place its own analytics in perspective and provide advice on the scope of the losses covered by the policy. Proper calculation of a CBI or extra expense claim takes time. Coordination with the adjustment team and counsel often are the most important steps. These steps should be taken at the beginning of the process to maximize potential recovery.
Companies that have suffered an interruption in their business often overlook potential CBI and extra expense claims. Sandy and the other recent storms in the Northeast have significantly disrupted shipping through the port facilities located in New York and New Jersey. Moreover, these storms have physically damaged a significant amount of inventory located at those facilities. Any company that suspects it might have suffered an interruption-related loss should give notice and implement good record keeping; should carefully track expenses; and control its internal communications.
The company should remember to maintain open communication with the third party that suffered damage, given that proving that a third party sustained damage is vital to the company’s recovery efforts. By early retention of experts and experienced counsel, a company can minimize the impact to its bottom line caused by a disruption to supply or distribution systems resulting from a catastrophic event.
John Heintz and Jeremy King are attorneys with Dickstein Shapiro LLP, in the law firm’s insurance coverage practice. Heintz is a partner at Dickstein Shapiro. He is a veteran in the fields of corporate insurance coverage and complex litigation with more than 30 years of experience. He has won numerous landmark appellate cases in state and federal courts. King’s practice focuses on insurance coverage actions and other civil litigation matters. His experience with insurance coverage matters encompasses cases involving comprehensive liability coverage, including disputes arising out of bodily injury caused by products and property damage caused by environmental contamination, as well as disputes concerning directors and officers and errors and omissions coverage.
1 We are referencing the storm that recently devastated the Northeast by its popular description. However, the popular description ought not confuse technical questions of insurance coverage including causation, application of deductibles or sub-limits, and even whether more than one storm was involved. Specific losses occurring as a result of sever weather conditions may have been caused by a number of different perils.
2 Duane Reade, Inc. v. St. Paul Fire and Marine Ins. Co., 600 F.3d 190, 192 n.2 (2d Cir. 2010) (citation omitted).
3 Park Electronchemical Corp. v. Continental Casualty Co., No. 04-cv-4916, 2011 WL 703945 (E.D.N.Y. Feb. 18, 2011).
4 Archer Daniels Midland Co. v. Aon Risk Services, Inc., 356 F.3d 850 (8th Cir. 2004).
5 54th Street Ltd. Partners, L.P. v. Fidelity and Guar. Ins. Co., 306 A.D.2d 67, 763 N.Y.S.2d 243 (1st Dep’t 2003).