The eagerly anticipated judgment of Lord Justice Flaux and Mr. Justice Butcher in the Financial Conduct Authority’s (FCA’s) test case in relation to cover afforded under various business interruption wordings has now been handed down and the ramifications of the judgment will begin. Two key aspects of the court’s ruling are in relation to causation and “trends clauses.” Ultimately, the court considers that questions of causation are largely answered by the issue of construction.
When considering cover under a policy two key questions will come up. First, was the loss caused by an “insured peril?” If the answer to that question is yes, second, what is the extent of insurers’ liability under the policy? The answer to the second question may be impacted by a “trends clause” in the policy (which itself will be impacted by the “insured peril”).
In short, a policy will only cover loss caused by the “insured peril.” Linked to this is the “trends clause” which will seek to limit the liability of an insurer to losses which would have been sustained (caused) had the “insured peril” not occurred. If the losses would have been sustained even if the “insured peril” had not occurred, there will be no (or limited) liability. The objective is to put the insured in the same position as if the “insured peril” had not occurred.
It is therefore necessary to be clear as to what the extent of the “insured peril” and, similarly, what should be stripped out of the “counter-factual” when considering issues of causation and the level of an insurer’s liability.
It is crucial to note that the “insurers place[d] heavy reliance on the decision of Hamblen J … in Orient Express” [504]. In this context, the position set out in the Orient Express has come under heavy criticism from Flaux LJ and Butcher J.
As a recap – the insured (Orient Express Hotels) was the owner of a hotel in the French Quarter of New Orleans. Following the devastation of Hurricanes Katrina and Rita in 2005, the insured made a claim for material damage and business interruption loss.
The causation argument raised by insurers in relation to the main business interruption provision was that the insured peril was the damage to the property. The insured peril did not include the events which caused the damage (the hurricanes). These were, therefore, competing causes of the business interruption and the “but for” causation test could not be satisfied.
Further, insurers argued the “trends clause” in the policy applied the “but for” approach. As such, the counter-factual to be considered was one in which Hurricanes Rita and Katrina devastated New Orleans, but had not damaged the hotel. In that counter-factual, insurers argued the same business interruption loss would have been suffered - nobody would have visited the hotel because of the damage to the rest of the area.
The insured appealed the arbitration award on two questions of law. First, whether the policy provided cover in respect of concurrent loss caused by: (i) physical damage to the property; and (ii) damage to or consequent loss of attraction to the surrounding area (i.e., does the “but for” causation test apply). Second, the interplay between the events giving rise to the damage and the “trends clause” in the policy.
Hamblen J (as he then was) held, as regards the first question, the tribunal had not erred in law by adopting the “but for” causation test. As regards the second question, Hamblen J held that the “trends clause” in the policy considered only the damage to the hotel (which he considered the insured peril), and not the events giving rise to the insured peril (the hurricanes).
Put simply, one had to consider a counter-factual in which despite Hurricanes Katrina and Rita devastating the city of New Orleans, the hotel suffered no damage.
Flaux LJ and Butcher J noted “several problems” [523] with the reasoning in Orient Express.
First was, as the judges put it, the “misidentification of the insured peril.” The decision in the Orient Express resulted in the “insured peril” being only the damage to the hotel – this is incorrect. Rather, the “insured peril” is the damage caused by a covered fortuity. In the context of the Orient Express, the insured peril was the damage caused by the hurricanes.
The judges’ view is that the “error in reasoning” may have arisen as Hamblen J focussed only on the “but for” causation issue and did not consider the proximate cause of the loss. This, the judges note, should be the primary question in relation to claims under insurance contracts.
Second, the judges determine that if the “insured peril” was only the damage to the hotel, this renders the business interruption cover in question illusory as damage caused by a serious fortuity will rarely be exclusive to the insured’s property. The decision reads into the nature of the “insured peril” in question, concluding that hurricanes by their very nature “will inevitably have caused widespread damage to the area and not be confined to the insured’s property” [526]. The judges conclude it is unlikely and counterintuitive that the cover intended was illusory.
The judges concluded that “…[Hamblen J] should have concluded that the words: “had the Damage not occurred” meant that the counterfactual was one where both the damage to the hotel and the hurricanes and their effect generally were to be stripped out” [527].
While the judges said they would have, if needed, “…reached the conclusion that [the Orient Express] was wrongly decided and declined to follow it…”, they were able to distinguish the current case and so did not need to “…go that far…”
It is clear from the judgment that the nature and extent of the “insured peril” is key for both causation and the “trends clause.”
In this instance, the judges found the “insured peril” followed from the construction of the wordings before it and that a broader approach (as advocated by the FCA) was taken.
The judges set out examples of the “insured peril” for the three (broad) categories of wordings and these could be termed as the “COVID-19 counter-factual.”
As regards prevention of access clauses – the “insured peril” contains three interconnected elements: (i) prevention or hindrance of access to or use of the premises; (ii) by any action of the government; (iii) due to an emergency which could endanger human life [530].
As regards hybrid clauses – the “insured peril” again contains three connected elements: (i) the inability to use the insured premises; (ii) due to restrictions imposed by a public authority; (iii) following (in the case of COVID-19) the occurrence of a human infectious or contagious disease [531].
As regards disease clauses – the “insured peril” is the effects of COVID-19 both inside and outside of the particular radius that may be specified in a particular policy [532].
In each case, when considering causation and the “trends clause” the “insured peril” must be stripped out of the counter-factual.
It must be stressed that much will still turn on the policy wording. The judgment as it relates to causation and “trends clauses” certainly does not mean that all policyholders have “won.” Rather, it provides clear guidance as to how you assess causation and, once that has been established, the level of liability.
Although Flaux LJ and Butcher J did not conclude that the Orient Express was wrongly decided, they would have done so if needed. It will be interesting to see what happens the next time the Orient Express is relied upon in the context of coverage disputes and the weight placed on Flaux LJ and Butcher J’s comments.
As regards COVID-19, the decision on causation and “trends clauses” will likely be welcomed by the policyholder community.
It is expected that at least certain insurers will appeal the judgment to the UK Supreme Court, so this is unlikely to be the end of the story.
Morgan Lewis continues to monitor the developments and issues surrounding the case and we will publish further client updates accordingly.
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[1] Orient-Express Hotels Ltd v Assicurazioni Generali SpA [2010] EWHC 1186 (Comm)