The UK Supreme Court in the Financial Conduct Authority’s business interruption test case has overturned a decade-long standing judgment relating to causation and how the “trends” clauses should be interpreted. The decision overturning Orient-Express constitutes a massive pendulum swing from an insurer-friendly interpretation to a policyholder-favoured approach, which will have far-reaching consequences on the insurance sector generally.
The eagerly anticipated UK Supreme Court judgment in the Financial Conduct Authority (FCA) business interruption test case[1] handed down on 15 January 2021 will not only ease the pressure on many businesses feeling the strains of COVID-19, but will also impact policy interpretation and disputes going forward. The judgment considered, and overruled, Orient-Express,[2] bringing a policyholder-friendly position on causation and quantification of losses.
As a reminder, Orient-Express involved business interruption losses caused to a hotel as a result of Hurricane Katrina and Hurricane Rita. In 2005 Hurricane Katrina and Hurricane Rita devastated the City of New Orleans, Louisiana, and surrounding areas, including damage to the hotel (which, like many New Orleans buildings, had to close).
The insurance policy in question covered physical damage to the property on an all-risks basis, and loss due to interruption “directly arising from Damage” (with Damage defined as “direct physical loss destruction or damage”). In addition, the “trends” clause allowed for adjustment of figures based on the projected business results, “which but for the Damage would have been obtained during the relative period after the Damage.”
In the context of the loss suffered by the insured, this was the result of two concurrent causes, namely damage to the hotel itself (an insured peril), and damage to the surrounding areas (an uninsured, but not excluded, peril), both of which were individually sufficient to cause the business interruption loss.
The following issues arose: (1) whether the policy provided coverage in respect of losses concurrently caused by (a) physical damage to the hotel and (b) damage/consequent loss of attraction to the surrounding areas; and (2) the interplay between the events causing damage and the “trends” clause, and whether the underlying cause should be excluded from any trends calculation.
Tribunal Findings in Orient-Express
As regards the concurrent causes, the insurer argued that the “but for” test applied, and the only recoverable losses were those sustained directly as a result of the damage to the hotel, i.e., not those losses that the hotel would have suffered in any event as a result of the damage to the surrounding areas. The Tribunal agreed with the insurer, that the but-for test of causation applied and could not be satisfied in this instance.
As regards the trends clause, the insurer argued the counterfactual to be considered was one where the hurricanes had caused widespread destruction to the surrounding areas but had left the hotel unscathed. In this counterfactual, the hotel could remain open; however, no guests would visit the hotel due to the destruction of the surrounding areas and as such, the hotel’s revenue would be significantly reduced, if not completely eradicated. The Tribunal again sided with the insurer.
High Court Findings in Orient-Express
The Tribunal’s findings were appealed to the High Court on two points of law: First, whether the policy provided coverage in respect of concurrent loss caused by (1) physical damage to the hotel and (2) 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 (i.e., can the same event which caused the damage to the property be considered as part of the counterfactual or “special circumstances” for the purposes of adjusting financial projections pursuant to the trends clause).
As regards the first question, then Hamblen J held that 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). In other words, one needs to consider an undamaged hotel in the otherwise damaged city.
As is clear, Orient-Express was a very insurer-friendly judgment.
Unsurprisingly, Orient-Express has played a key role in insurers’ arguments. In particular, it was argued that even if the relevant insuring clauses in question provided coverage, the subsequent losses covered are minimal given the application of the trends clauses following the decision in Orient-Express. To take a notifiable disease clause with a one-mile radius as an example, insurers have argued that the counterfactual is a situation where COVID-19, for instance, had not occurred within the one-mile radius, but had occurred everywhere outside of that radius. The insurers’ position was that even if there were no COVID-19 cases within that one-mile radius, there would have been reduced business activity and consumer spending as a result of the COVID-19 cases outside the radius, which would have meant losses would have been suffered in any event.
The High Court in the FCA test case rejected these arguments, and found that Orient-Express was distinguishable, but if necessary, the High Court would have reached the conclusion that it was wrongly decided. The issue was subsequently appealed to the UK Supreme Court.
It is worth noting that the Supreme Court made a number of observations before directly addressing the legal issues in question.
The Supreme Court moved on quickly to clearly and unequivocally rule that “on mature and considered reflection we also consider that [Orient-Express] was wrongly decided and conclude that it should be overruled.”
The Supreme Court took issue with the first stage of the High Court’s analysis. It is important first to revisit the conclusion made on but-for causation in an earlier part of the judgment. As outlined in our previous LawFlash, but-for causation can be criticised chiefly because it produces too many incorrect results, here a false negative. An example of two hunters simultaneously shooting and killing a hiker is instructive. Where it can be said that either bullet would have killed the hiker, even if the other bullet had not been fired, the but-for test would produce a false negative (i.e., that neither bullet caused the death of the hiker). Applied to notifiable disease clauses in the FCA test case, neither the insured peril (the occurrence of a notifiable disease within a one-mile radius) nor the uninsured peril (the occurrence of the notifiable disease outside of a one-mile radius) would satisfy but-for causation, leaving the loss causeless.
This was clearly an unacceptable outcome for the Supreme Court, which held that where the insured peril and the uninsured peril operate concurrently and arise from the same fortuity (whether that be hurricanes, COVID-19, flooding, or other insured damage), provided the uninsured peril is not excluded, loss resulting from both causes operating concurrently is covered.
Further, under the trends clause, the Supreme Court held that the correct approach was to exclude from any adjustment to financial projections any circumstances which had the same underlying cause.
The impact of this decision is best demonstrated as follows: Applied to a retail shop closed as a result of the COVID-19 pandemic, had Orient-Express not been overruled, the application of the trends clause would have meant that losses due to COVID-19 inside the radius would be reduced by the business interruption caused by the wider effects of COVID-19 occurring outside the specified radius. As such, the business interruption caused by the effects of COVID-19 inside the radius would be negligible compared to the wider effects in the United Kingdom as a whole. Therefore, the indemnity would be minimal (if any).
However, following the UK Supreme Court decision, both the effects of the pandemic inside and outside a specified radius would have the same underlying cause: COVID-19. Therefore, the business interruption losses could only be reduced by those effects wholly unconnected with COVID-19, as that is removed from the counterfactual when considering the trends clause. Logically, this will provide a significantly higher indemnity for the policyholder.
The consequences of this judgment are far reaching. Its effects will not be restricted to business interruption losses as a result of COVID-19, but it will apply equally to those relating to fortuities that commonly cause widespread damage and loss. Typical examples include pandemics (which we are all too familiar with), hurricanes, earthquakes, flooding, other natural disasters, and more.
Indeed, insurers will be all too aware of the impact of this decision. As recognised by Fitch Rating, “Insurers have relied on this decision for the past ten years to reduce pay-outs for BI claims.” Insurers will likely now face substantial increases in pay-outs under business interruption claims. With reports of flooding in the United Kingdom already emerging in 2021, it is clear insurers will have to contend with more than just COVID-19 business interruption losses.
It will have to be assessed at a later stage how insurers will react to this development, but it seems likely that insurers will take steps to protect their position—be that through increased premiums or policy exclusions.
The FCA has noted that the implications of the decision will take some time to determine. The FCA will therefore be seeking insurers’ thoughts and interpretations of the likely impact of the judgment on their business. Notwithstanding this, the FCA has committed to using the full range of regulatory tools and powers to ensure insurers comply with the FCA’s expectations.
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Trainee Nicholas Woolf contributed to this LawFlash.
[1] FCA v. Arch Insurance (UK) Ltd and others [2021] UKSC 1.
[2] Orient-Express Hotels Ltd. v. Assicurazioni Generali SpA [2010] EWHC 1186 (Comm).