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By Qianwei Fu
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The recent Tianjin port explosion, like the 2011 Japanese earthquake and Thai floods, will lead to massive supply chain disruption. The impacted area included a high concentration of multinational and technology companies. The Tianjin area is home to 285 of the Fortune 500 companies, with the United States being one of the top origins/destinations of imports and exports. Master policies and global insurance programs written out of the United States will undoubtedly be triggered due to large-scale contingent business interruption (CBI) losses. In this article, we discuss some core CBI issues stemming from the Tianjin explosion under U.S. law.

The Event and Its Impact on Supply Chains

On Aug. 12, 2015, a warehouse facility that housed large amounts of hazardous chemicals in the port of Tianjin erupted with two massive explosions, the second of which was equivalent to 21 tons of TNT detonating. The incident claimed at least 139 lives and left more than 700 injured. The series of blasts crumpled large shipping containers, incinerated several thousand new cars and damaged port buildings, distribution centers, terminal equipment and infrastructure of trains, cranes and rail tracks. According to Guy Carpenter & Co.’s initial estimates, insured losses could be between $1.6 billion and $3.3 billion.

Tianjin port is the largest integrated port in China’s industrial north and the world’s fourth largest port by total cargo throughput. It is a primary gateway to Beijing and northern inland China and an important foreign trading hub for a vast array of goods. Apart from extensive damages to the regional economic zone, the repercussions of the event will ripple well beyond local business operations and greatly impact global supply chains and logistics activities over the next few months and even years to come. Major global industries that depend on the Tianjin area include electronics, equipment manufacturing, automotive, aerospace and aviation, petrochemical and biotechnology.

Due to closures of port terminals and industrial facilities in the affected area, many businesses are forced to utilize alternative options for transporting their supplies and goods. Imports and exports of industrial materials, components and finished products have been disrupted or severely delayed. The incident will have a broad-reaching knock-on effect on many companies’ supply chains worldwide. The high insurance penetration rate in the area and the wide geographic distribution of insured losses could make the Tianjin explosion one of the most costly and complex catastrophe (re)insurance losses in recent history.

CBI Coverage Under U.S. Law

With a critical node broken in the supply chain, considerable CBI losses could result for U.S. insureds which have supply chain interdependencies. For example, Wal-Mart Stores Inc., Deere & Co. and Caterpillar Inc. are reportedly experiencing disruption to their respective supply chains because a number of shippers have storage and logistical facilities near the Tianjin port. Policyholders may argue that the aftermath of the Tianjin explosion has disrupted the shipping of supplies and products to the U.S. or into China, resulting in potential CBI claims for lost profits and/or extra expenses.

CBI insurance provides coverage when a supplier or customer of the insured suffers a direct physical loss that interrupts the insured’s own business. A critical first step in determining coverage is to review the specific policy terms, which can vary significantly. Generally, however, CBI coverage is triggered when: (1) there is physical damage to the property of a supplier or customer of the insured; (2) the peril causing the physical damage is covered by the insured’s own policy; and (3) the physical damage sustained by that supplier or customer causes an interruption to the insured’s business operation. CBI endorsements typically provide coverage for CBI losses incurred during an identified “period of restoration,” which begins at the time of the interruption and ends at the time it should reasonably take the affected supplier/customer to repair or replace the damaged property. Although CBI coverages have been around for some time, only a handful of CBI disputes have been litigated to the point of a judicial decision and, consequently, there are relatively few legal authorities addressing CBI coverage.

Types of Dependent Properties and Remoteness

CBI coverage may be triggered by direct physical damage to several categories of dependent properties. Physical damage may occur to a supplier’s property which makes the supplier unable to provide goods or services to the insured (“contributing location”). Alternatively, an insured’s customer may not be able to receive or use the insured’s goods or services due to physical damage to the customer’s property (“recipient location”). Physical destruction or damage might also occur at a fabrication plant that manufactures products for delivery to the insured’s customers under a contract for sale (“manufacturing property”). Physical damage could also be sustained at a neighboring site that attracts customers to the insured’s business (“leader property”).

One consideration in determining whether a particular loss comes within the CBI coverage is what constitutes a dependent property under the relevant policy terms. The existing case law mostly concerns the interpretation of the term “supplier.” In Archer-Daniels-Midland Co. v. Phoenix Assurance Co. of New York,[1] the Southern District of Illinois gave a very broad interpretation of what might constitute a “supplier.” The insured, a commercial farm product processor, had used the Mississippi River as a major source of cargo transportation and relied upon the crops of the farmers as a major source of its raw materials. As a result of the “unprecedented flooding” of the Mississippi River in 1993, the insured’s operations were severely interrupted. The court noted that the policies at issue did not limit CBI coverage to contractual or principal suppliers, but used the unrestricted phrase “any supplier of goods or services.” It held that the Army Corp of Engineers and the Coast Guard who provided navigable waterways as well as farmers who grew crops processed by the insured all qualified as suppliers.

More recently, however, the Eighth Circuit interpreted the phrase “a supplier of goods and/or services to the insured” to mean policyholder’s immediate and direct supplier with contractual privity. In Pentair Inc. v. American Guarantee & Liability Insurance Co.,[2] an earthquake in Taiwan disabled an electrical substation that provided power to factories, which in turn prevented those factories from supplying products to the insured. When production resumed, Pentair shipped orders from Taiwan via airfreight at additional costs in order to meet customer needs for the Christmas season. The Eighth Circuit held that because the electrical substation did not supply a product or service ultimately used by the insured, it was not a “supplier” of the insured. The court further held that a power outage did not cause direct physical damage to the insured’s Taiwanese factory suppliers.

Similarly, in Millennium Inorganic Chemicals Ltd. v. National Union Fire Insurance Co. of Pittsburgh[3] the Fourth Circuit concluded that a supplier of the policyholder’s natural gas supply could not be considered a “direct supplier” for purposes of the contingent business interruption policy. The policyholder purchased natural gas to operate its facilities through an intermediary, which in turn purchased gas from several different producers. An explosion at one producer’s facilities disrupted the supply of natural gas through the intermediary and ultimately to the policyholder. The lack of natural gas caused the policyholder to halt production. The CBI wording at issue provided coverage for losses caused by damage to the property of a “direct supplier of materials to the insured’s locations.”[4] Noting the lack of legal relationship, direct or otherwise, between the policyholder and the gas production facility that sustained the explosion, the court concluded the producer could not be deemed a “direct supplier.”

An interesting issue arises when direct physical damage occurs to an insured’s foreign subsidiary which supplies components to products manufactured by the insured in the United States. In Park Electrochemical Corp. v. Continental Casualty Co.,[5] an explosion at the insured’s Singapore subsidiary left the insured’s Arizona-based operation without supply of a vital component for one of its products, which in turn resulted in substantial lost profits. The insurer maintained that the CBI coverage did not apply, because a subsidiary of the insured could not be considered a “direct supplier” under the policy wording. The court found the undefined CBI term “direct supplier” to be ambiguous as to the insured’s foreign subsidiary, creating an issue of fact that precluded summary judgment.[6]

In addition to these opinions concerning what constitutes a “supplier” for purposes of a CBI loss, the Louisiana Court of Appeals rendered an opinion on the parameters of what constitutes a “customer” for purposes of CBI coverage. In CII Carbon LLC v. National Union Fire Insurance Co. of Louisiana Inc.,[7] the insured sought business interruption insurance coverage for losses it sustained when it was unable to sell steam to a neighboring aluminum plant following an explosion at that plant. The insured’s property insurance policy contained a CBI endorsement that provided coverage for “[l]oss directly resulting from the necessary interruption of business ... caused by damage to or destruction of any real or personal property ... referred to as CONTRIBUTING PROPERTY(IES) and/or RECIPIENT PROPERTY(IES) and which is not operated by the insured ... which wholly or partially prevents the acceptance of product(s) produced by the insured and results directly in the necessary interruption of the insured’s business.”[8] The court held that the Kaiser plant, which was neither owned nor operated by the insured, was a “recipient property” within the meaning of the policy and that the insured incurred business income losses when the Kaiser plant could not “accept” steam from the insured due to the damage to its plant. The court reasoned that such losses were “exactly the type of loss that the contingent business interruption insurance is designed to cover.”[9] Accordingly, the contingent business interruption endorsement at issue covered these losses.

Practical Considerations

The variety of policy wordings and the dearth of judicial guidance concerning the scope of and limitations on CBI coverage require proactive inquiry and investigation of any potential CBI claims stemming from the Tianjin port explosion. While the 2011 Japan earthquake and Thailand flood have not (to date) resulted in any reported judicial decisions, they did produce a myriad of CBI claims. Indeed, with the advent and proliferation of CBI wordings providing coverage for “indirect” suppliers and customers, insurers fielded many creative Japan earthquake and Thailand flood CBI claims, many of which lacked any supplier or customer that had sustained physical damage. Insurers saw untested CBI wordings contorted so as to ostensibly provide coverage in instances where earthquake or flood damage had caused a disruption in the “web” of global commerce and policyholders could correlate a financial loss with those disruptions. Claims were also asserted for financial losses supposedly triggered by earthquake or flood damage to customers of suppliers and suppliers of customers.

Given the extensive damage caused by the Tianjin port explosion and the resulting impact on such a wide variety of global industries, a proliferation of CBI claims arising out of the disaster should be expected. Considering the variety of CBI wordings presently used in the market, the scope of coverage afforded by many of those wordings and the relative scarcity of legal authority interpreting CBI coverage wordings, numerous creative CBI claims requiring careful analysis should be expected as well.

—By Qianwei Fu, Zelle Hofmann LLP

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] 936 F. Supp. 534 (S.D. Ill. 1996).

[2] 400 F.3d 613 (8th Cir. 2005).

[3] 744 F.3d 279 (4th Cir. 2014).

[4] Id. at 281-82.

[5] (E.D.N.Y. 2011).  

[6] After reviewing extrinsic evidence, the court concluded that the “ambiguity survives the proffers of extrinsic evidence” and that the question of whether subsidiaries could be “direct suppliers” under the policy would need to be resolved by a jury.  Id. at *6.

[7] 918 So.2d 1060, 1061 (La. Ct. App. 2005).

[8] Id. at 1064.

[9] Id. at 1068.