Insurers should keep an eye on business interruption policies

In this article we explore the ramifications of business interruption, the legal framework relating to business interruption and how, through business continuity planning, those issues can be managed.

According to the Allianz Risk Barometer, business interruption alongside cyber incidents is the top threat for companies for the seventh year running. Business Interruption (BI) cover is a necessary protection against revenue losses which arise as a result of significant disruptive events which occur during the normal course of business. The interruption can take many forms from cyber-attacks, data breach, data theft, machinery breakdown, product recall or quality incidents, outage issues, environmental pollution, protests and rioting (to name a few).

As a result, BI Insurance is one of the most complex insurance products a business can purchase. Unfortunately, due to a lack of awareness or consideration of the risks and potential implications on the business, many SMEs do not have appropriate cover in place.  As a consequence, they find themselves significantly financially penalised when faced with an unexpected interruption to the business.

Terrorism risks have not gone away and in the event that an Insured’s business premises, or vehicles, are involved in an act of terror, their business could suffer BI. Five out of the ten most costly global terrorist attacks of recent years have taken place in the UK. Often, the losses can be far higher than a business originally envisaged, for example if a police cordon remains in place for a lengthy period of time (Borough Market) or in cases where customers have concerns about visiting a particular location (Salisbury). After the Borough Market attack in June 2010, the police cordon prevented access to the market for ten days. This had a significant impact on the market traders and surrounding shops and bars/restaurants.

In 2018, the Grenfell Tower tragedy, extreme weather conditions at both ends of the spectrum and the Salisbury Novichok poisoning have shown how businesses can be affected and suffer losses through no fault of their own. The losses suffered by a business will be influenced by a number of factors, such as the length of time the business was unable to operate on normal terms or the extent of the physical damage caused. Over factors that may contribute to losses include restrictions on opening hours and/or access, and confiscation of items of property (for Police investigation, for example).

In addition to terrorism related issues, businesses should consider BI cover as a necessary protection against revenue losses arising from a variety of sources. Recently, a fire at an Ocado warehouse in February 2019 meant that shares in Ocado dropped 6% and sales were hit due to the damage that was caused. In March 2019 Facebook suffered more than a 14-hour disruption to all of its products that left them mostly inaccessible across the world. The drone incidents at Gatwick and Heathrow airports caused thousands of incoming and outgoing flights to be disrupted. Even businesses that do not consider themselves to be directly affected by terrorism, could feel the effects on their suppliers, customers or even neighbouring businesses.

Under English law, contractual obligations are absolute and the contracting parties are bound to fulfil these obligations (Paradine v Jane (1646) Alleyn 26). Therefore, a party that is unwilling or unable to perform its contractual obligations resulting from a business interruption event will be in breach of contract, which would entitle the other party to terminate the contract and/or claim damages. Under common law, the only way to avoid termination of the contract or the payment of damages in these circumstances is for the non-performing party to demonstrate that a "frustrating event" has occurred, such that the common law principle of frustration applies.

Frustration

A frustrating event is an event that occurs after the contract has been formed, is so fundamental as to be regarded by law both as striking at the root of the contract and as entirely beyond what was contemplated by the parties when they entered the contract, is not due to the fault of either party and renders further performance impossible, illegal or makes it radically different from that contemplated by the parties at the time of the contract. If a contract is frustrated, the parties will not have to perform any further obligation under it, provided neither party can be blamed for the frustrating event. Accordingly, neither party will be in breach of the contract and, consequently, liable for damages.

An additional difficulty for a business to take into account is what happens if it becomes unable to perform its existing contractual duties to third parties as a result of a business interruption. This could result in claims against the business for failing to comply with deadlines and fulfil orders, with an additional impact on future business from the same source. It is important therefore that SMEs take some time to analyse the strength of their supply chain in the event of a business interruption. This is particularly the case in the current climate where interruptions in business and the delivery of goods are anticipated consequences following Brexit.

Even if a business does have BI cover in place, it important that this is regularly assessed to make sure that it is fit for purpose and covers risks as they continue to emerge and develop.  A good example of this is the case of HHJ Davis in Contact (Print and Packaging) Ltd v Travelers Insurance Co Ltd [2018] EWHC 83 (TCC); [2018]. The claimant printing company had proved its case on liability against the defendant insurance company, following the breakdown of a printer at the claimant's premises, which caused loss and damage. The Technology and Construction Court held that the most obvious explanation for the damage to the press was a subsidence event, which was not excluded by the insurance policy between the parties. The claimant was entitled to damages for property damage as claimed, coming to £824,683.07, and consequential losses in the sum of £18,900. However, its claim for business interruption failed entirely, as the evidence supporting it was inadequate. The case highlights the importance that Insureds preserve documentary evidence relating to the interruption of the business.

Every UK company faces major liability risks and exposure not covered, due to limitations on the policies it has in place. Insurers need to carefully analyse the risk and educate policyholders as many still do not fully understand the risks that could be financially crippling to them. It is important that people are aware of the threat that business interruption poses. The insurer should ensure that the Insured’s needs are fully understood and translated into the right products, with appropriate cover. Insureds need to be proactive and ensure that they have adequate security, business continuity and disaster recovery procedures in place to cope with the risk of major operational disruptions. They must preserve all relevant documentation and any evidence relating to their business interruption claims to ensure that they are covered, as illustrated in the HHJ Davis case above.

In addition, businesses should consider a supplier’s extension to their BI policy, which would cover losses arising from a supplier’s difficulties, whether caused by terrorism or otherwise.

It is important that policy wording is regularly checked and kept up-to-date, so that businesses are able to cope with interruptions to their business, without this causing additional financial pressure at a time when a business least needs it.    

This article was first published by Insurance Day on 24 April 2019.