Calculating Business Interruption Losses Post-Katrina
Insurance Law360November 11, 2010
By Paul Sullivan and Christine Phan
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Litigation over business interruption claims arising from Hurricane Katrina is still making its way through the courts in the Gulf Region. The Deepwater Horizon Oil Spill could potentially lead to large time element claims, as effects of that tragedy continue to be felt in the Gulf Region. Three recent cases in the Fifth Circuit have analyzed the proper calculation under a first-party property insurance policy of business interruption losses after a catastrophic event. Given the number of significant losses in the Gulf area, it is worth noting how these recent decisions from the Gulf Region have addressed the issue.
The general purpose of business interruption insurance is to place the insured in the same position it would have occupied had the business not been interrupted by some insured physical damage. The question becomes how to measure or quantify the financial impact the interruption has had on the business. Typically, business interruption losses are measured by analyzing the actual pre-loss earning experience of a business to extrapolate the probable future performance of the business had there been no property damage and had the catastrophe not occurred. However, parties often argue that the appropriate measure of business interruption recovery is to attempt to place the business in the position it would have occupied had it been operating in the post-catastrophe environment. That is, one would assume for the sake of calculation that the catastrophic event had occurred, but that the insured itself had not suffered any physical damage and a resulting interruption of its business. Three recent court decisions are instructive on whether post-loss economic conditions should bear on an insured’s business interruption insurance recovery following a catastrophe.
In Catlin Syndicate Ltd. v. Imperial Palace of Mississippi, Inc., 600 F.3d 511 (5th Cir. 2010), the insurer and insured disagreed on the interpretation under Mississippi law of the "Experience of the Business" clause in the Catlin policy which provided:
Experience of the business – In determining the amount of the Time Element loss as insured against by this policy, due consideration shall be given to experience of the business before the loss and the probable experience thereafter had no loss occurred.
Imperial Palace’s casino operations were shut down after Hurricane Katrina for several months. However, because Imperial Palace was able to reopen before many of its competitors, Imperial Palace experienced greater revenues after reopening than it had before the hurricane. Imperial Palace submitted an $80 million business interruption claim to Catlin based on the increased revenues the casino experienced after Katrina. Catlin calculated that Imperial Palace’s losses were closer to $6.5 million based only on historical, pre-loss revenues.
Catlin’s formulation of the business interruption calculation did not take into account the post-Katrina spike in revenue enjoyed by Imperial Palace. Catlin argued the proper interpretation of the "Experience of the Business" clause was that Imperial Palace’s recovery under the policy should be based on the net profits Imperial Palace would had earned if Hurricane Katrina had not struck the Gulf Coast and damaged Imperial’s facilities. Conversely, Imperial Palace argued that the correct interpretation of the "Experience of the Business" clause would be one where Hurricane Katrina hypothetically struck the Gulf region but simply did not damage Imperial Palace’s facilities. The Fifth Circuit agreed with Catlin based on the language of the "Experience of the Business" clause: "[T]he [Experience of the Business] provision says nothing about taking into account actual post-damage sales to determine what the insured would have experienced had the storm not occurred."
Interestingly, in reaching its decision in Catlin, the Fifth Circuit cited Finger Furniture Co. v. Commonwealth Ins. Co., 404 F.3d 312 (5th Cir. 2005), in which the court declined to take into account post-loss revenue to the ultimate benefit of the insured. However, the Catlin court stressed that both decisions were based only on the materially similar language of the "Experience of the Business" provisions and that the divergent factual backgrounds in the respective cases were of no moment.
While the Catlin and Finger decisions were based on the court’s reading of the plain language of the "Experience of the Business" clauses, Imperial Palace argued that by failing to differentiate between the "loss" – property damage suffered by Imperial Palace – and the "occurrence" – Hurricane Katrina, the court essentially conflated the terms "loss" and "occurrence." The Fifth Circuit responded, "While we agree with Imperial Palace that the loss is distinct from the occurrence – at least in theory – we also believe that the two are inextricably intertwined under the language of the business-interruption provision. Without language in the policy instructing us to do so, we decline to interpret the business-interruption provision in such a way that the loss caused by Hurricane Katrina can be distinguished from the occurrence of Hurricane Katrina itself."
Finger and Catlin demonstrate that ignoring post-loss economic factors in calculating a business interruption loss could work to both the benefit and the detriment of an insured depending on the factual circumstances of the loss. Commentators have argued that while disregarding post-loss economic considerations may prevent windfalls, it may also result in under-compensation for an insured whose business performs better post-loss such as in Catlin. See, e.g., H. Richard Chattman & Gregory D. Miller, Measuring Business Interruption Loss in Wide-Impact Catastrophes: Insurance Against Catastrophes or Only Against Insured Damage from Catastrophes, 19 COVERAGE 1 (2009). However, if the goal of business interruption insurance is to put the insured back in the same financial position it would have been in "had no loss occurred" then precluding consideration of post-catastrophe economic conditions is a fair approach because it avoids any notion of "over" or "under" compensation. The business is simply where it would have been had the event not occurred.
The Fifth Circuit again weighed in on the interpretation of an "Experience of the Business" clause in Consolidated Companies Inc. v. Lexington Ins. Co., No. 09-30178, 2010 U.S. App. LEXIS 17146 (5th Cir. Aug. 17, 2010), this time under Louisiana Law. In Consolidated Companies, Consolidated Companies ("Conco") sustained damage to its property and equipment during Hurricane Katrina. Conco resumed partial operations within ten days after Katrina; however, Conco claimed it was not fully operative for 15 months. Conco claimed a $19 million business interruption loss. Lexington argued that Conco’s proof of damages was insufficient to support its business interruption claim as a matter of law, since Conco’s claimed lost profits would have been significantly smaller in the poor post-Katrina economy. The Fifth Circuit noted that, while styled as an evidentiary issue, the resolution of the dispute over the amount of Conco’s loss was a question of policy interpretation, specifically interpretation of an "Experience of the Business" clause similar to that in Catlin. Citing Catlin and Finger Furniture, the Fifth Circuit rejected Lexington’s position that because Conco’s customers would have reduced their spending post-loss, Conco’s profits would have been reduced even if Conco had incurred no physical damage. The Court refused to consider "the real world opportunities for profit post-Katrina," instead focusing on the amount of money required to put Conco in the position it would have been in had Katrina not occurred. The Fifth Circuit added: "We conclude that Louisiana courts would interpret this policy language in the same way as Mississippi and Texas courts."
Thus, in three separate decisions, the Fifth Circuit refused to allow for consideration of the post-loss economy in calculating the insureds’ business interruption losses, to varying results. However, in another Katrina case, the Eastern District of Louisiana recently allowed an insured to recover for business interruption losses based on a post-Katrina upswing in the rental housing market. Berk-Cohen Assocs., LLC v. Landmark Am. Ins. Co., No. 07-CV-9205, 2009 U.S. Dist. LEXIS 77300 (E.D. La. Aug. 27, 2009), judgment entered by 2010 U.S. Dist. LEXIS 90666 (E.D. La. Sept. 1, 2010). In Berk-Cohen, the insured owned an apartment complex in New Orleans that suffered property damage in a series of events, including Hurricane Katrina. Landmark insured Berk-Cohen for $4.6 million for loss of business income incurred as a result of covered property damage or loss. Landmark paid Berk-Cohen approximately $3 million for lost business income based solely on historical rents at the apartment complex. Berk-Cohen brought suit seeking the remaining $1.6 million for lost business income under the Landmark coverage, arguing that rental rates in the area had experienced a spike after Hurricane Katrina and by extrapolation, the Berk-Cohen apartments would have rented for a higher rate had the properties not been damaged.
The Court’s ultimate decision to allow Berk-Cohen to factor the post-loss economy into its business income recovery was based on the particular language of the insurance policy at issue. Based on the policy, the amount of lost business income was to be determined based on:
(1) The Net Income of the business before the direct physical loss or damage occurred;
(2) The likely Net income of the business if no physical loss had occurred, but not including any New Income that would likely have been earned as a result of an increase in the volume of business due to favorable conditions caused by the impact of the Covered Cause of Loss on customers or on other business . . . .
(emphasis added). The Court distinguished the case from Finger Furniture based on the differences between the governing policy language: "Whether market changes are appropriate considerations in calculating lost business income depends upon the language of the policy itself." Specifically, given paragraph (2) of the definition of Net Income, the Court found that the provisions describing how to calculate business income differentiated between new income resulting from a Covered Cause of Loss and new income resulting from something that did not constitute a Covered Cause of Loss. The Court then found that because flood was not a Covered Cause of Loss, Berk-Cohen could recover for favorable market conditions resulting from flooding but not those conditions resulting from wind, a Covered Cause of Loss.
Berk-Cohen established that Hurricane Katrina had caused average rents in the surrounding area to increase by approximately 35% due to the post-Katrina housing shortage. Berk-Cohen further established that approximately 5% of the rent increase was due to the wind (a Covered Cause of Loss) and the remaining 30% increase was attributable to flood (a non-covered cause of loss). The Court thus allowed Berk-Cohen to recover for lost business income based on the favorable market conditions resulting from flood but not wind.
Viewed together, Finger Furniture, Catlin, Consolidated Companies, and Berk-Cohen demonstrate that there is no general rule regarding the treatment of post-loss economic conditions in the Fifth Circuit. Instead, courts will scrutinize the particular language used in a policy’s business interruption coverage. With the numerous significant business interruption claims that have and will likely continue to arise in the Gulf Region, insurers and insureds alike should stay abreast of the legal developments regarding the proper calculation of business interruption losses following a catastrophe.
