Companies regularly turn to their property insurance policies to cover physical damage to their facilities following natural disasters, but physical damage is often not the only type of loss that companies face. Companies across the globe may also lose earnings because they incur additional costs and/or are unable to conduct business with companies directly impacted by the natural disaster. Such losses may be covered by contingent business interruption (“CBI”) insurance, a type of coverage that protects insureds against loss caused by damage to the property of suppliers, customers, and other third parties upon which the insured depends.
Indeed, CBI losses account for a significant percentage of overall insured losses following a natural disaster. While a fire, hurricane, or earthquake may cause significant damage in a certain location, the resulting CBI losses can have an international impact across multiple industries and sectors of the global economy.
The potentially broad reach of CBI coverage creates challenges in larger, global organizations to identify income losses that are based on damage to property owned or operated by others several steps removed from the insured. Indeed, notice of property damage at a supplier’s distant location may only reach the insured through slightly higher component costs. In the face of increasing costs, supply chain personnel may make arrangements to secure alternative components without informing the risk management department or even ascribing the increased costs to potentially covered physical damage. Similarly, businesses should not assume that CBI coverage is limited to suppliers of raw materials because most CBI provisions also cover lost earnings resulting from property damage to any supplier of services. For example, damage to employee homes that prevents employees from coming to work and thereby reduces an insured’s earnings could constitute a CBI loss because the employees’ labor is a service provided to the insured. Astute risk managers, therefore, must be diligent in identifying the root cause of income losses and should institute procedures with its supply chain personnel and other departments to ensure that potential CBI claims are not overlooked as a mere cost of doing business.
One issue that insureds must consider with respect to CBI coverage is how a policy defines the third party that must suffer property damage to trigger a claim for coverage. For example, some policies require direct physical damage to a “dependent property,” which may include “contributing locations,” “recipient locations,” “manufacturing locations,” and “leader locations.” Other policies require physical property damage to “suppliers,” “customers,” “contract manufacturers,” and “contract service providers.” While some policies may define these terms, many policies do not, resulting in disputes down the road about which third parties upon which the insured relies are included in the insured’s CBI coverage.
For example, in Millennium Inorganic Chemicals Ltd. v. National Union Fire Insurance Company of Pittsburgh, Pa, the policy provided coverage for any “direct supplier of materials to the Insured’s locations.” 744 F.3d 279 (4th Cir. 2014). A coverage dispute arose when an explosion at a natural gas production facility owned by Apache Corporation resulted in the loss of natural gas supply to Millennium’s titanium dioxide production facility, forcing Millennium to shut down for months. Alinta Sales Pty Ltd. purchased the natural gas from Apache and sold it to end users, including Millennium. The Fourth Circuit concluded that Apache was not a direct supplier to Millennium:
Whatever the relationship between Apache and Millennium, it was clearly interrupted by “an intermediary,” Alinta, who took full physical control of Apache’s gas before delivering indistinguishable commingled gas to Millennium. That relationship was also interrupted by an intervening step, the physical insertion of the gas into the DB Pipeline, at which point Apache relinquished all physical control over that gas. Under any view of the relevant facts, Apache can therefore be only an indirect contributing property to Millennium, coverage of which is not included in the terms of the Policies.
Id. at 285-86.
While Millennium is a cautionary tale for insureds, the facts of the case and the Fourth Circuit’s holding do not address the growing complexity and interdependence of many modern supply chains. For example, in DIRECTV v. Factory Mutual Insurance Company, the Ninth Circuit interpreted a CBI provision in the context of such a modern supply chain. 2017 WL 2629134 (9th Cir. June 19, 2017). The insurer promised to insure against business interruptions stemming from certain events at “contingent time element locations.” The policy defined such locations as any location “of a direct supplier, contract manufacturer or contract service provider to [DIRECTV].” Id. at *1. The critical question before the Ninth Circuit was whether Western Digital, a manufacturer of hard drives that are used in DIRECTV’s set-top boxes, qualified as a direct supplier. The insurer argued that because Western Digital’s hard drives were sent to third-party set-top box manufactures, which then assembled the set-top boxes and sent them to DIRECTV, Western Digital was not a “direct supplier” to DIRECTV. DIRECTV, however, offered extrinsic evidence showing that in the electronics supply chain industry, Western Digital would reasonably be understood as a “direct supplier” because DIRECTV exerted significant control over and directly managed design, product development, cost, production, and quality control with Western Digital. The Ninth Circuit stated “that ‘[t]he law charges insurance companies with the duty of informing themselves as to the usages of the particular business insured, and a knowledge of such usage on the part of such company will be presumed.’” Id.
Accordingly, the court held that “the phrase ‘direct supplier’ is ‘reasonably susceptible’ to the meaning urged by [DIRECTV].” Id.
Another potential issue that relates to the identity of the third party suffering property damage is whether the third party must be unrelated to the insured. Park Electrochemical Corporation. v. Continental Casualty Company is instructive on this point. 2011 WL 703945 (E.D.N.Y. Feb. 18, 2011). Park involved two companies, Nelco and Neltec, both of which were wholly-owned subsidiaries of their parent, Park. Neltec was unable to purchase its supply of a vital component due to an explosion at Nelco’s manufacturing facility. Park and Neltec were insured under a CBI policy that covered losses “caused by direct physical damage or destruction to . . . any real or personal property of direct suppliers which wholly or partially prevents the delivery of materials to the Insured or to others for the account of the Insured.” Id. at *2. The insurer argued that coverage did not apply because “subsidiaries of the insured, such as Nelco, are not considered ‘direct suppliers’ under the policy.” Id. The court noted that the “term ‘direct suppliers’ is not defined anywhere in the policy,” and concluded that the “language of the policy on this point is vague and ambiguous.” Id. at *4. Both parties provided “reasonable interpretations of the term: it could be read to include any supplier, regardless of whether the supplier is a subsidiary of the insured, or it could be read to exclude subsidiaries or sister companies of the insured.” Id. The court concluded that the “ambiguity survives the proffers of extrinsic evidence” and ruled in favor of the insured. Id. at *6.
As illustrated by DIRECTV and Park, CBI coverage is an effective tool to protect an insured against risk of loss or damage to the property of others upon which the insured depends. Accordingly, in the wake of natural disasters, insureds should pay close attention to the CBI provisions in their policies and take measures to ensure that they are maximizing the benefits provided by this valuable asset.