24 February 2021

On 15 January 2021, the Supreme Court handed down judgement in the Covid-19 Business Interruption test cases of The Financial Conduct Authority v Arch and Others. These cases provided an opportunity for the courts to clarify much about the way in which business interruption loss cover should operate in the context of the current Covid-19 pandemic. Naturally, not every single issue could be or indeed was, resolved. However, it is fair to say that the Supreme Court has clarified many of the significant issues currently affecting businesses and those involved in the insurance sector.

So, what did we learn?

Identify what benefit the insurance policy confers on the customer

First and foremost, we were reminded that the central task when dealing with claims made under an insurance policy is to assess what benefit the policy can reasonably be said to have been intended to confer on the customer. You then look to interpret the policy in such a way as to make sure that this benefit is delivered. Against that background, the court held that:

• “Disease” clauses in insurance policies (i.e., clauses which typically provide cover when business interruption loss is caused by an outbreak of disease in insured premises, or within a 25 mile radius of those premises) will generally respond for all business interruption loss sustained due to the effects of the Covid-19 pandemic, subject to at least one case of coronavirus being identified within the specified area being established;

• “Prevention of access” clauses (which typically deal with the position where access to premises is denied by something like an order of a public authority) will generally respond, even where the restrictions affect only a discrete part of a premises, or a discrete business activity. Complete closure or cessation of trading is not necessary; and

• “Trends” clauses (which generally provide a means for adjusting the calculation of a policyholder’s business interruption loss) have to be construed in such a way as to not take away the very essence of the main cover which was provided, even where their wording might suggest otherwise.

Establish the cause of business interruption loss

Secondly, and underlying the court’s approach to the meaning of these clauses, were the judges’ opinions about what could fairly be said to be the cause of business interruption loss to the businesses impacted by Covid-19.

To understand the reason why causation came to play such an important role in the test cases, it is necessary to understand a little bit about the way in which insurance policies generally work.

In essence, in order for a policy holder to be able to establish that they are insured for loss under their policy, they must be able to show that an insured peril (for example, fire, storm, the occurrence of disease, or the prevention of access to premises) caused their loss.

Lying behind that general statement is the key legal principle that the policy holder must be able to prove an insured peril was the “effective” or “proximate” cause of their loss. To keep things simple, we will now refer to this as the “effective cause” test.

The “effective cause” test

In very broad terms the claimants in the Covid-19 test cases faced two main issues in respect of establishing causation.

Issue 1: Demonstrating that “but for” the insured peril, the loss would not have arisen

The first issue was a previous decision in a case which involved the closure of an Orient Express hotel in New Orleans following hurricanes Katrina and Rita in 2005. This case pointed to policyholders having to be able to show that, “but for” the insured peril in their policy (in that case physical damage to the hotel), the loss would not have arisen.

In the Orient Express case, the court held that the hotel could not, strictly speaking, satisfy that test in circumstances where the hurricanes caused damage to both the hotel itself and the wider city. In other words, the loss could well have arisen in any event as a result of the wider area damage.

If the “but for” test did apply in the test cases, then it would mean that a person who had cover, for example, for business interruption loss where there was an outbreak of Covid-19 within a 25 mile radius of their premises, would have to be able to establish that “but for” that outbreak, their losses would not have arisen. Therefore, the business would have to show that the losses were directly attributable to a local outbreak. That, of course, would generally be very difficult to prove.

Issue 2: The new landscape created by the global pandemic

That brings us nicely to the second issue which the claimants in the test cases faced, namely the new landscape which the global pandemic had created. The Prime Minister, as we all know, urged us all to work from home. The government also brought into force new Coronavirus Regulations and used them to force many businesses to shut. These measures were clearly taken in the national interest and helped to tackle the spread of the virus. However, they also created a world where, in the case of businesses which found they had to close, or at least were interrupted to some extent, it became harder to see what was “effectively” causing their loss. Was the loss caused by a local outbreak of the virus, or by the preventive measures put in place by the government?

The Supreme Court’s decision makes it clear that legal tests for causation must bring about results which are fair and make common sense. The judges accordingly decided to overrule the Orient Express case, pointing out that the “but for” test could lead to illogical results, and that when that happened, as it did in the test cases, the “but for” test had to be disapplied.

The Supreme Court also provided clarity on how it was that the “effective cause” test came to be satisfied in the context of Covid-19, a result which leaves the claimants in the test cases being able to press on with claims for cover. The court accepted that in the ‘new’ world which the pandemic had created, there were a number of different causes in play which were contributing to the business interruption losses that many businesses were suffering, and that there needed to be a causation test which provided fair results in these circumstances.

The Court’s view on causation

In broad terms, the court’s view about causation in the tests cases is that the law is as follows:

Where an event occurs, and with a degree of inevitably leads into a series of other events, the first event may well be seen as being an effective cause of the loss, even though it wasn’t of itself sufficient to cause the loss.

Applying that legal approach to the test cases involving Covid-19, the court found that:

• whilst no single case of Covid-19 might lead directly to business interruption and associated losses,
• the wide-ranging government restrictions put in place at the end of March 2020 were as a result of the cumulative impact of the virus across the entire country,
• accordingly, cases of coronavirus in an insured person’s local area were, along with cases elsewhere, the inevitable cause of the actions which the government took to protect the nation, and therefore, could be the “effective” cause of the losses which the business suffered.

In light of this, it followed that a person with a policy which provided cover, for example, in the event of “any… occurrence of a Notifiable Disease within a radius of 25 miles of the premises” could (if they could show a case of Covid-19 within that area) establish the effective cause of their business interruption was the insured peril and they would therefore be covered.

“Exclusion clauses”

The court’s decision in the test cases goes on to explain that if insurers want to restrict the scope of cover in situations where losses are caused “concurrently”; that is by a peril which was insured under the policy (for example, damage to property caused by a hurricane), but also by a peril which wasn’t covered by an insurance policy (for example, business interruption caused by the fact that a whole state had been destroyed by a hurricane), then there was a route open to them to do so.

Specifically, they could do so using what insurers call “exclusion clauses”. Exclusion clauses, as the name suggests, can be used by insurers to clarify for the policy holder the nature of the specific circumstances in which insurers exclude cover.

Where insurers don’t use exclusion clauses, and “concurrent losses” arise, the court said that insurers had to provide the cover which the policy provided. The Supreme Court said this was something which the court in the Orient Express case had failed to appreciate and consequently, the judges in that case had ended up reaching the wrong result.

What lies ahead?

The test cases, as we explained at the outset, have addressed some of the important issues affecting business interruption policy coverage in the context of the current pandemic. As a result, there should now be a clearer way forward for insurers and many policyholders.

Insurers

For insurers, questions arise as to whether the Supreme Court judgement has finally killed off the “but for” test. It had previously been undermined by Lord Mance in a case called BAI (Run Off) Ltd v Durham. In that case, the judge made his view clear that “but for” is to be relaxed “as a matter of legal policy” where it fails to provide proper justice, an approach which the Supreme court’s decision endorses. With the judicial pragmatism exercised by the Supreme Court, however, it is hard to avoid the conclusion that the “but for” test may have been, mortally wounded.

The court’s new test for causation is likely to have an impact which reaches far beyond the covid-19 position. Indeed, the FCA’s “Dear CEO” letter of 22 January 2021 explicitly urges insurers to be “aware” of the wider impact of the overturning of the Orient-Express case, particularly for perils resulting in wide area damage.

Policyholders

For policyholders with policy wordings identical to those in the test cases, the legal position is now clear. However, at the present time, the insurance industry has many different policy wordings and there are likely to be differences of opinion on whether there is valid cover in a number of Covid-19 related scenarios which the Supreme Court didn’t consider.

Even before the decision in the test cases, many insurers had already decided that it was time to restrict the cover which they provide. The decision highlights the significance which the “exclusions” section in many insurance policy wordings, may have.

Going forward, exclusion clauses can be expected to be designed to exclude cover for the consequences of Covid-19 and future pandemics and, possibly, for other circumstances where there is scope for wide area damage claims, or for loss to be caused concurrently by more than one factor.

Now, perhaps more than ever, it is essential to carefully work out what the policy says in order to determine what is and what is not covered.

Contact:

Mark Morton, Partner & Solicitor Advocate: macm@bto.co.uk / 0141 221 8012

Calum Sweeney, Associate: csw@bto.co.uk / 0141 221 8012