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By Dan Millea
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“In this world, nothing can be said to be certain, except death and taxes." — Benjamin Franklin

On Dec. 12, 2015, in LeBourget, France, world leaders announced an agreement on a climate change accord which they touted as a major step in avoiding a global climate disaster. Much uncertainty remains, however, concerning the degree to which nations will actually comply with the accord, the impact that full compliance (or partial compliance) will ultimately have on climate change and the frequency, severity and geographic locations of future natural disasters. For commercial insureds seeking protection from such disasters, and for commercial property insurers providing coverage, this uncertainty poses obvious threats. And these uncertainties are compounded even further for parties to property insurance policies that offer contingent business interruption coverage, because of the unpredictable nature of U.S. courts in adjudicating CBI claims.

The Paris agreement essentially requires the 195 represented nations to publicly set specific goals and monitor and report on their progress (the so-called “name and shame” approach to compliance). The extent of their actual compliance is speculative and largely in the hands of future leaders who are presently unknown. Even assuming the objectives of the Paris agreement are actually met, those objectives would only reduce carbon emissions by half of the total reduction climate scientists estimate is needed to avoid locking the globe into “a future of devastating consequences, including rising sea levels, severe droughts and flooding, widespread food and water shortages and more destructive storms.” “Nations Approve Landmark Climate Accord in Paris,” New York Times, Dec. 13, 2015, page A.1 (Coral Davenport).

Predictions of more frequent, more widespread and more severe climate events have long had the attention of the insurance and risk management industries. Are the risks increasing, and if so, to what degree? Are policyholders more exposed than they realize? Are insurers adequately anticipating future losses? Will governmental efforts and industry efforts to reduce carbon emissions succeed? Will commitments like the Paris accord make a significant difference? Will future agreements more aggressively attack the problem?

Whatever the ultimate impact of climate change and whatever the level of success in combating its causes, we do know that catastrophic events will always be with us. So how effectively can policyholders and insurers assess the risks and adequately protect against them? It is a daunting challenge, due to the impossibility of predicting future catastrophic events and their likely impact on a given insured. Adding to these uncertainties is a final and, as yet, unavoidable unknown: how will the U.S. courts address and resolve the inevitable coverage disputes, particularly with respect to CBI losses where there is a dearth of case law?

Contingent business interruption and extra expense coverages are an extension of traditional time element coverages. The latter require physical loss or damage to the insured’s property. CBI, by contrast, applies to losses resulting from physical loss or damage to the property of third parties, typically the suppliers or customers of the insured. If the insured can demonstrate that the damage to the supplier or customer’s property caused the insured’s losses, CBI coverage may apply to lost sales or extra expenses incurred by the insured.

CBI claims by large commercial insureds are common following major catastrophes. The global economy and the complex nature of international supply chains have made it increasingly likely that physical damage to property in one location will have a downstream impact on other companies. These risks are particularly difficult to assess in advance and particularly troublesome to investigate and confirm after a catastrophe. And if climate change is delivering more disasters that are more widespread and more severe, we can expect to see an ever-increasing incidence of CBI claims and CBI disputes.

Following the 2011 Japan earthquake and the Thailand floods, for example, insurers received a raft of CBI claims, including claims of downstream losses incurred in the United States. None of those claims were litigated in U.S. courts. In fact, there are very few reported decisions in the U.S. on any CBI issues. So how are insurers and policyholders to know how a court will rule on a CBI dispute following a natural disaster (or any disastrous loss, for that matter)? Unfortunately, guidance is lacking and certainty is largely absent. One of the more recent U.S. CBI cases provides an instructive, albeit disheartening, example — disheartening if the reader is seeking certainty.

In Millennium Inorganic Chemicals Ltd. v. National Union Fire Insurance Co. of Pittsburgh, 744 F.3d 279 (4th Cir. 2014), a district court’s finding of coverage for a CBI loss was reversed by a three-judge appellate panel. The issue at hand was whether the third party suffering property damage qualified as a “supplier” under the policy’s definition. Some policies provide CBI coverage only where the property damage was incurred by a direct supplier or direct customer. Other policies extend the coverage to instances of property damage to indirect suppliers and customers. The Millennium policy limited CBI coverage to losses caused by damage to the property of “direct supplier[s] of materials to the insured’s locations.” Id. at 281-82 (emphasis added).

Millennium purchased natural gas to power its titanium dioxide processing facility in Western Australia and it bought the gas from Alinta. Alinta bought its supply from several natural gas producers, including Apache Corp., with Apache’s natural gas commingling with the gas purchased from other suppliers. Alinta’s contract specified that it acquired ownership of Apache’s natural gas at the time it was injected into the commingled pipeline.

In June 2008, there was an explosion at Apache’s plant and its natural gas production ceased as a result. This, in turn, led to the shutdown of Millennium’s facility and a loss of income.

The insurers argued that Alinta was the only “direct supplier” to Millennium. Millennium countered that despite the fact that it had no direct contractual relationship with Apache, Apache was nonetheless a “direct supplier” of the natural gas materials “because Alinta provided only a service, the delivery of natural gas, whereas Apache provide the actual material at issue.” Id. at 283.

The District Court ultimately sided with Millennium. First, it concluded that the policy language was ambiguous and the extrinsic evidence of intent was inconclusive. The court then applied the doctrine of contra proferentum and construed the ambiguous language against the insurers. But the appellate panel came to the opposite conclusion on the ambiguity issue, finding the language clear and concluding that Apache was not a “direct supplier” because after Alinta took title to the natural gas, Apache lacked ownership and control over the material actually supplied to Millennium, and Apache had no contractual relationship with Millennium of any sort. However, even the appellate panel was split on the issues. One of the three judges wrote a dissenting opinion that sided with the district court on the question of ambiguity.

These differing conclusions regarding the same issue by four federal judges highlights how problematic CBI coverage issues can be: even when the policy explicitly restricts coverage only to “direct” suppliers, judges can differ on what it means to be a “direct” versus an “indirect” supplier. Judges likely will differ on other core CBI issues, such as: how far up and down the supply chain does CBI coverage flow (and is it limited to third parties in direct privity to the insured, or does it extend to “tier two” suppliers and beyond); what exactly must be “supplied” for the third party to qualify as a “supplier”; and do high hazard zone deductibles and sublimits apply to a claim resulting from damage to the property of a third party in a high hazard zone where the loss is incurred outside of the high hazard zone.

Insurance policies are designed to protect insureds against uncertainty and risk. Those concepts are unavoidably bound up with the property insurance concept. Nonetheless, the more predictability — statistical or otherwise — that insureds and insurers can introduce to risk assessment, the better positioned they are to tailor coverages and pricing to that risk. When considering the scope of risk posed by future catastrophes, climate change is a powerful wildcard, and government commitments (on paper) to reduce the effect of climate change introduce yet another set of wildcards.

These uncertainties are particularly acute when it comes to CBI risks in an increasingly complex and interrelated global economy that is more prone than ever to catastrophic natural disasters. And if that picture weren’t troubling enough for policyholders, brokers and insurers, the reality is that even if one accurately assesses the risks, accurately guesses the degree to which 195 governments will follow through on their Paris commitments, accurately measures the impact of those measures on global carbon emissions, and accurately gauges the net impact of climate change on CBI risks, one’s ultimate economic fate is still inevitably subject to the vicissitudes of American judges in a field of law that remains undeveloped and unpredictable. Buyer (and seller) beware.

—By Dan Millea, Zelle Hofmann Voelbel & Mason LLP

Dan Millea is a partner in Zelle Hofmann's Minneapolis office.

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.