The devastation presently occurring in Japan as a result of the earthquake and subsequent tsunami is beyond imagination. The ultimate economic impact in Japan of the disaster is far from known. We also do not yet know for how long Japanese companies will run at limited or diminished capacity. And, even if those companies can produce goods, damage to the nation’s transportation system and infrastructure could prevent those products from getting to market, or increase exponentially the price of any such goods. That damage also may make it impossible for Japanese companies to accept or obtain goods from suppliers. For companies worldwide doing business in Japan or that rely upon Japanese goods, clients or business partners to conduct their business operations, the Japanese disaster may wreak immense financial damage and losses. The extent of any such financial damage also cannot yet be ascertained.
Insurance will be a critical resource that can help reduce the potential business interruption losses for companies attempting to assess the financial impact of the Japanese disaster. In order to protect this asset and increase the likelihood that insurers will provide financial assistance, companies should consider insurance issues immediately.
Here we provide a summary of issues to help companies increase their chances of recovering under their business interruption policies. The terms of these policies may vary greatly. As with any insurance claim, the first step is to review the policy, or the likely applicable policy language if the policy itself is not available, and comply with all necessary coverage “conditions” to coverage.
Types of Coverage
- Gross Earnings Coverage: Business interruption policies typically cover lost income that otherwise would have been earned by the business had no loss occurred. Business income is generally defined as the net profit or loss before taxes, plus continuing normal operating expenses, including payroll. Many business interruption policies require damage to the insured’s property for coverage to apply. Companies with operations in Japan that are experiencing interruptions in their business activities because of physical damage to their property located in Japan should review their global business interruption policies to determine the extent to which that coverage may be available to pay for lost business income.
- “Contingent” Business Interruption Coverage: For companies without operations in Japan that thus far have not suffered actual physical damage to property located in Japan, business interruption coverage still may be available. In particular, most policies also include “contingent business interruption” coverage. Pursuant to that coverage, a company may recover lost profits due to property damage “at locations of direct suppliers or customers” of the insured. In other words, a company located outside of Japan may operate at reduced capacity or suffer financial loss because a business partner in Japan has suffered damage and cannot produce, transport or accept supplies necessary for the smooth running of the non-Japanese company’s business, or cannot otherwise perform under a relevant contract. In such a circumstance, contingent business interruption coverage may be critical to defray the extent of the company’s lost income.
- “Extra Expense” Coverage: This coverage may provide significant financial assistance. Many business interruption policies also pay for expenses incurred between the time of a covered loss causing event and before a company returns to “normal” business operations. Thus, for example, a U.S. manufacturer may typically purchase component parts from a Japanese manufacturer. However, because of the Japanese crisis, the Japanese company cannot presently ship its product. In that circumstance, in order to continue its business operations the U.S. manufacturer may be forced to conduct business with a company outside of Japan to obtain component parts, but will be required to pay more for the replacement parts that it purchases. Depending upon applicable policy language and relevant law, the U.S. manufacturer may be able to recover for some period of time this increased operating expense.
- Civil Authority Coverage: Coverage may be provided for loss of business income and extra expense if a governmental “entity” denies access to property, due to a covered loss at another location. If, for example, a company cannot access its facilities in Japan because a governmental entity has issued restrictions, this coverage may be helpful.
- Ingress/Egress Coverage: This coverage may allow companies to recover loss of business income and extra expense when they have restricted access to their facilities for multiple reasons, including reasons other than government action.
- “Period of Indemnity”: To the extent coverage applies, policyholders often debate with their insurers regarding the length of time during which they may recover lost profits--the “period of indemnity.” Many policies attempt to define that “period” based upon the nature of the damaged property that caused the business interruption loss. For example, if a product is damaged or destroyed during the manufacturing process, some policy forms will allow the insured to recover lost profits during the time required to restore the product “to the same state of manufacture in which it stood at the inception of the interruption of production or suspension of business operations or services.” In the context of a contingent business interruption loss arising out of the Japanese crisis, it may take many weeks or months for a Japanese manufacturer to return any particular product to the “same state of manufacture” as it stood at the time of the disaster. Difficult issues of proof often are involved when attempting to determine when a supplier is able to return to sufficient operations to terminate the “period of indemnity.” The question likely will be even more complicated where the supplier is located in Japan and may have lost production records during the course of this disaster. Given possible ambiguities in policy language and the importance of extending the period of indemnity, insureds should carefully review their policy language and not simply accept insurer arguments regarding the applicable period.
- Extended Period of Indemnity: This coverage extends the period of indemnity for some specified amount of time. Insureds should review their policies to determine the extent to which any such provisions may provide additional protection.
- Professional Fees: Many policies cover costs incurred by the policyholder to hire professionals to assess the extent of any lost business income. This coverage typically applies to fees incurred by accountants, auditors, engineers, experts, etc. (it also arguably can apply to pay for time spent by company employees also involved in the loss evaluation process). To increase their chances of recovery of any such fees, policyholders should (1) maintain careful records of all amounts spent in this regard, and (2) if possible obtain insurer approval in advance of retaining professionals or incurring fees.
- Policy Exclusions: Depending on the specific nature of the loss, insurers may argue that a number of policy exclusions apply to preclude coverage. Whether the insurers will succeed in relying upon particular exclusions often will be based upon the “cause” of the loss at issue. It is important to note that a loss often may be caused by multiple events some of which are covered and others that are excluded. In some jurisdictions, as long as one cause is covered, it may matter not that one or others are not. However, in others, insurers may disclaim coverage as long as any cause is excluded by the policy. Thus, when considering the extent of business interruption coverage, early in the process policyholders should seek to ascertain all possible “causes” and frame their claim in a manner that focuses on a covered as opposed to excluded cause.
- Sub-Limits: Most policies contain an aggregate policy limit, with “sub” limits that apply to particular types of losses, such as those caused by flood, earth movement and others. Insurers may seek to limit their coverage obligations by characterizing a claim as falling within one coverage, such as flood coverage that may have a low “sublimit” as opposed to earth movement coverage that may have a higher applicable limit. Thus, again, early in the process of ascertaining the nature of the loss, policyholders should be careful to understand all potentially applicable coverages and sublimits and frame the claim in a manner that protects their ability to argue in favor of maximum coverage.
- Nuclear Exclusions: Some policies preclude coverage for damage caused either directly or indirectly by nuclear radiation. And, those policies also sometimes preclude coverage even if other covered causes may have contributed to the loss. To the extent that the policy at issue contains that language, it is important that the policyholder be careful not to make any broad references to radiation if in fact its loss did not result from radiation-related damage.
Critical Post-Loss Considerations
- Be Careful About How the Loss Is Characterized in Both Internal and External Communications: The manner in which a policyholder characterizes its loss from the outset of making a coverage claim, or even before a claim is made, can haunt the policyholder throughout the claims process. Many companies presently are attempting to ascertain the extent of any losses they may suffer or have suffered because of the disaster in Japan. Employees may be communicating internally or with insurers. Company representatives may be having dialogues with insurance brokers or other consultants. The company may make statements to the public or press. In all of these communications, the employees or company may discuss or characterize the loss and its cause. None of these communications ultimately may be privileged or protected from production to the company’s insurer/s. Insurers often later seek to obtain access to these communications in an effort to avoid coverage.
For example, the policyholder may discuss with its insurance broker various possible coverage issues. In some jurisdictions unless a lawyer is involved, insurers claim that such communications may not be protected from disclosure to an insurer. Alternatively, employees responsible for deciding how to modify the company’s business activities to address an inability to reach Japanese customers may state a reason for that inability, such as nuclear radiation, that in fact is not accurate. In coverage litigation, insurers often will seek all communications regarding the loss event.
It is critical from the outset for companies to consult with counsel to understand the nature of any applicable coverage, and to both (1) include counsel on internal communications to seek to protect them via the attorney client privilege, and (2) carefully craft statements to insurers and other third-parties to avoid what insurers later may claim constitute “admissions” against coverage.
Immediately Review and Comply With All Policy Conditions
- Identify Conditions to Coverage: Insurers often will argue that an insured has forfeited coverage by not strictly complying with policy “conditions.” For example, many policies require that the insured provide “immediate” notice of “any loss.” Many policies also require that the insured “give a signed and sworn proof of loss” to the insurer within a specified number of days “after the loss,” that includes specifically identified information. And, business interruption policies also often contain a “limitations” period that requires that coverage litigation be filed within a specified period of time, often one year.
Thus, policyholders should immediately review their policies, make a list of applicable conditions and seek to ensure strict compliance. And, if policyholder cannot comply given timing issues or a possible lack of information, the policyholder should work closely with the insurer, keep the insurer informed of any such difficulties and obtain its agreement to modify applicable policy conditions.