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By Shannon M. O'Malley
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As businesses and insurers sort out the impacts of Hurricane Harvey, it will take time to assess the physical damage and resulting business interruption losses. Invariably, however, business interruption impacts from Harvey will not just be felt along the Texas Gulf Coast. Texas’ significant refining, chemical and petrochemical facilities supply critical products to businesses throughout the U.S. and abroad (and to each other). To the extent that those supplies are disrupted, businesses located far from the Lone Star State may choose to assert contingent business interruption (“CBI”) claims under their own first-party property policies.

For example, there are media reports that the “world’s most important chemical” — ethylene — will be in severe shortage in the coming weeks and months. (See “Hurricane Harvey has Endangered the Supply of the World’s Most Important Chemical”). As discussed in the article, ethylene is “one of the most basic chemical building blocks” used to make plastics. It is the “key ingredient” in manufacturing of garbage bags, food packaging, antifreeze, polyester, vinyl products, mattresses, PVC pipes, medical devices, shoe soles, foam insulation, plastic car parts, tires, house paints and even chewing gum. Ethylene and its derivatives account for about 40 percent of global chemical sales.

Hurricane Harvey shut down, at least temporarily, almost all of Texas’s ethylene plants — which account for 61 percent of the United States’ ethylene capacity. The United States accounts for 20 percent of the world’s ethylene production. More than half of that production has been interrupted in a market already at high demand.

An ethylene shortage could significantly impact manufacturers based in Hoboken, Detroit, New York, Chicago, Nashville or elsewhere. The extent to which first party policies respond to CBI claims from disruptions of this type depends, of course, on the particular facts of the loss and the policy language. But there are some general principles that typically apply.

CBI Coverage Defined

Most commercial property insureds purchase some form of business interruption (aka time element) coverage. This type of coverage is generally intended to provide protection to the insured from disruptions in business due to covered physical loss or damage to the insured’s property. In effect, this coverage supplements the insured’s lost income while its property is being repaired, rebuilt or replaced: “the purpose of a business interruption policy is to indemnify the insured for loss caused by the interruption of a going business due to the destruction of the building, plant or parts thereof.” Quality Oilfield Prods. Inc. v. Michigan Mut. Insurance Co., 971 S.W.2d 635, 638 (Tex. App.—Houston [14th Dist.] 1998, no pet.) (citation omitted).

CBI insurance is a form of business interruption coverage that does not require physical loss or damage to the insured’s property. Rather, CBI insures against a business income loss caused by damage to the property of the insured’s customers or suppliers. A typical CBI provision provides coverage for:

This policy ... is extended to cover the actual loss sustained by the Insured resulting from the necessary interruption of the business conducted by the Insured, whether partial or total, caused by loss, damage or destruction covered herein ... to:

Property that directly or indirectly prevents a supplier of goods, services or information to the Insured from rendering their goods, services or information or property that directly or indirectly prevents a receiver of goods, services or information from the Insured from accepting or receiving the Insured’s goods, services or information.

Arthur Andersen LLP v. Fed. Insurance Co., 416 N.J. Super. 334, 347, 3 A.3d 1279, 1287 (App. Div. 2010).

Under this language, and using the ethylene shortage as an example, if damage to an ethylene supplier’s property affects a Detroit business’s ability to manufacture car parts, the Detroit insured may have a CBI claim.

The CBI Claim Must Arise from a Covered Peril

Like all insurance claims, the specific policy language is key and will affect how broadly or narrowly the insured’s CBI coverage will apply. For example, policies typically require that an insured demonstrate that its CBI loss was caused by a peril that is covered under the insured’s policy. Therefore, if the customer’s or supplier’s property is damaged by a cause of loss that is excluded under the insured’s policy — like flood, for example — the insured’s CBI claim is likewise excluded.

This can present challenges for both the insured and insurer. Because the loss is once removed, the insured may have very little information as to the cause of its customer’s or supplier’s inability to receive or provide goods. And, the customer or supplier may have little incentive to cooperate in providing this information. The parties instead may have to resort to more generally available information concerning the damage to the area around the customer’s or supplier’s property, which can sometimes prove useful.

There Must be a Causal Link Between the Property Damage and the Claimed Loss

The insured must also demonstrate that its loss was actually caused by property damage to its supplier or customer. When a region suffers area-wide catastrophic damage, there may be multiple factors that affect an insured’s business — both related and unrelated to actual property damage. The insured is required to demonstrate a causal link between property damage and its loss of income. This is particularly true when the economy and market may be affected by a catastrophe.

For example, in Arthur Anderson, the court analyzed whether the insured’s decline in income was the result of property damage to the World Trade Center. Arthur Anderson argued it earned $204 million less than expected in the 3.5 months following 9/11. While Arthur Anderson did not have a direct supplier or client at the World Trade Center, it argued that its loss of income was nevertheless related to that damage. The court rejected that argument, holding the insured bears the burden to show that “the claimed business loss was caused by damage to property that ‘directly or indirectly prevent[ed]’ a client from accepting or receiving Andersen’s services.” Arthur Andersen LLP v. Fed. Insurance Co., 416 N.J. Super. 334, 349, 3 A.3d 1279, 1288 (App. Div. 2010). Because Arthur Andersen could not identify any interruption of its business due to property damage to the World Trade Center, or any customer who was unable to receive services as a result of such damage, the court granted summary judgment for the insurer.

The court specifically declined to infer from Arthur Anderson’s generalized revenue shortfall that a CBI loss occurred and concluded, “[i]n the absence of competent, credible evidence that the losses were caused by damage to property that prevented the flow of goods or services, resulting in the interruption of Andersen’s business, Andersen has failed to show the existence of a genuine issue of fact that precluded summary judgment.” Id.

The Direct Customer or Supplier Requirement

The scope of a CBI provision may also affect an insured’s recovery. For example, some policies require that the damage occur to a direct customer or supplier of goods or services. Other policies have broader coverage, and apply when there is damage to “any” customer or supplier. Courts look to the specific language of the policy and the facts of the loss to determine how direct or indirect the customer or supplier may be to the insured’s business.

In Pentair Inc. v. Am. Guarantee & Liab. Insurance Co., 400 F.3d 613, 615 (8th Cir. 2005), for example, the court analyzed the scope of the CBI provision where the covered property damage occurred to property once removed from the insured’s supplier. In Pentair, an earthquake in Taiwan, which was a covered peril, damaged an electrical substation that provided power to a Taiwanese factory. That factory, in turn, was a supplier of goods that the American insured, Pentair, used in its business. The power outage caused by the damage to the electrical substation eventually caused Pentair to sustain business losses due to the Taiwanese’s factory’s inability to supply necessary goods. The court found that the once-removed damage to the electrical substation did not trigger the CBI provision because it was not damage to Pentair’s supplier’s property.

The facts in Millennium Inorganic Chemicals Ltd. v. National Union Fire Insurance Co. of Pittsburgh, 744 F.3d 279 (4th Cir. 2014) illustrate some of the issues insureds and insurers may face in the wake of Hurricane Harvey and provide insight into how courts define a “direct” supplier or customer. Millennium used natural gas to process titanium dioxide in Australia. It had a contract in place with gas retail supplier Alinta. Alinta, in turn, purchased gas from Apache, a natural gas producer. Apache’s natural gas plant experienced an explosion, causing its production to cease. Apache’s loss of production affected Australia’s natural gas supply generally, and the Australian government intervened and imposed controls prioritizing delivery of natural gas to domestic customers and essential services. As a result of these controls, Millennium was forced to shut down its titanium dioxide manufacturing operations for months.

Millennium submitted a notice of claim under its CBI coverage to its insurers. Concluding that Apache was not a direct supplier of natural gas, the insurers denied Millennium’s claim. The insurers asked Millennium to provide any other evidence to demonstrate whether there was a direct relationship between Millennium and Apache. The insurers’ position was based on (1) the CBI’s coverage grant for “direct contributing properties”; and (2) a specific policy endorsement that stated: “there shall be no coverage for indirect suppliers/recipients.”

Millennium sued its insurers, arguing that the physical relationship between parties is more important than legal — i.e. Alinta’s contractual relationship with Apache had no effect on the “physical realities of natural gas supply between Apache and Millennium.” Id. at 284. The Fourth Circuit disagreed. Analyzing the meaning of the term “direct,” the court determined that for Apache to be considered “a direct contributing property to Millennium, it must have supplied Millennium with materials necessary to the operation of its business ‘without deviation or interruption’ from ‘an intermediary.’” Id. at 285. Because there was no dispute that Millennium received its gas from Alinta, and that Alinta, not Apache, had the sole ability to control the amount of gas directed at Millennium, the court found there was no coverage under the terms of the CBI provision.

Sublimits and Deductibles May Also Affect the CBI Claim

Other provisions in the policy may also affect an insured’s CBI claim. Most policies with CBI coverage have CBI sublimits that apply to those claims, which limit the insurer’s exposure to this type of risk. These sublimits are typically enforced, but specific factual circumstances may lead to challenges regarding their application. For example, in Zurich Am. Insurance Co. v. ABM Indus. Inc., 397 F.3d 158, 168 (2d Cir. 2005), the insured provided janitorial service to the World Trade Center. When it was destroyed on 9/11, the insured sought coverage for its lost business income. The insurer argued, in part, that the insured’s claim was limited to $10,000,000, the policy’s CBI sublimit. Because the insured’s lost business was essentially tied to the damage to its customer — i.e. the World Trade Center itself — the insurer maintained that the sublimit trumped the policy’s other limits. The court rejected the insurer’s argument. Analyzing the specific wording of the CBI provision, the court found that the insured’s general business interruption limit applied because the damage fell within that provision’s broader coverage.

Finally, CBI claims may be affected by a policy’s deductible provision. Policies may contain deductible wording that applies per CBI location. Applying a per-location deductible may not affect an insured’s claim if only one or two of the insured’s suppliers or customers sustain covered property damage. But if, for example, multiple customers sustain property damage arising from a hurricane, then a per-location (i.e. per customer) deductible could significantly reduce the insured’s coverage.

CBI claims can be complicated, especially when the insured is far removed from the damage to its customer or supplier. But whether the claim is from the plant next door or an insured that is nowhere near the Texas Gulf Coast, a careful review of the policy language is always the starting point. From there, insurers (and insureds) must fully understand and evaluate the facts to determine whether the CBI provision will respond.

Shannon M. O'Malley is a partner at Zelle LLP's Dallas office. She focuses her practice on analyzing complex and novel property insurance coverage issues.

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.