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By Darren Thompson, Deepa Sutherland and Jason Reeves
To read this article in PDF format, please click here.

On 15 January 2021 the UK Supreme Court handed down its highly anticipated judgment in the FCA Test Case.  The COVID-19 pandemic has forced the UK Government to introduce public health measures which have resulted in significant losses for many businesses.  Many businesses have turned to their business interruption insurance policies to indemnify them for their losses.  Insurers have often declined cover, insisting that the policies do not respond to the economic impact of the pandemic.  The Financial Conduct Authority (“the FCA”), as the UK’s insurance regulator, stepped in to represent the interests of the policyholders and was the named claimant in the Test Case.

In its judgment, the Supreme Court found the non-damage extensions generally respond because that is what was plainly intended in the wording(s).  The Supreme Court suggested that properly construing the policy wording resolves any ambiguity as to what it might cover in practice.  Further, the much-maligned Orient Express decision, on which the defendant insurers relied, was overruled.  English law now has a precedent for how the economic climate created by a loss impacts the measurement of losses during the indemnity period.  English law will follow the approach set out in the parallel Finger Furniture line of U.S. cases.

It is important to note, however, that the judgment exclusively concerns policy wordings which contain “non-damage” coverage extensions under gross profit business interruption forms.  The decision does not concern traditional “All-Risk” property policies where coverage for business interruption losses must be triggered by physical damage and do not contain such “non-damage” coverage extensions.  The English Courts have ruled that those policies are not triggered by the COVID-19 pandemic.[1]

Background

The FCA Test Case was brought in the High Court on behalf of out-of-pocket policyholders, to determine the availability of coverage under various specimen policy wordings underwritten by the defendant insurers in respect of claims for business interruption losses arising in the context of the COVID-19 pandemic, including those alleged to have been caused by the restrictions imposed by the UK Government.  The court of first instance, comprised of a High Court judge and a Court of Appeal judge (the “lower Court”), was asked to interpret the policy wordings and determine whether cover is available in principle.  (Where we refer to “the Court” this means the lower Court together with the Supreme Court.)

The broad scope of the Court’s task illustrates the importance of this case: the Court considered 21 “lead” policies issued by a number of UK insurers comprising 700 policy types affecting 370,000 policyholders.

The lower Court accepted many of the FCA’s arguments as to the correct understanding of the policy wordings in its 15 September 2020 judgment.  As anticipated, six of the insurers and the FCA appealed the Court’s decision.  Given the importance and urgency of the issues raised, the appeals bypassed the Court of Appeal and were heard by the Supreme Court under the ‘leapfrog’ procedure.  The Supreme Court judgment brings clarity to some long-contested points of business interruption caselaw.

Key dates

Certain dates are of particular relevance for this case.  They are: 6 March 2020 - COVID-19 was made a notifiable disease across the UK; 20 March 2020 - the UK Government directed certain categories of business to close; 21 March 2020 - regulations came into force directing certain categories of business to close; 23 March 2020 - the UK Government announced the first lockdown, including the closure of additional businesses and restrictions on individual movement; and 26 March 2020 - regulations came into force in respect of the same. 

Wordings

The different policy wordings examined by the Court were all “non-damage” coverage extensions, referred to as (1) Disease clauses, (2) Prevention of Access clauses and (3) Hybrid clauses.  The Court considered the proper construction of these clauses and how they respond, if at all, in the context of the UK Government’s pandemic response which impacted policyholders in different ways (although there were general common themes).  Critically, all three categories of clauses involved composite insured perils.    

(1) Disease clauses typically provide cover for business interruption following any occurrence of a notifiable disease within a particular radius (usually 25 miles) of the insured property.  Compared with other non-damage coverage extensions, Disease clauses potentially provide the broadest coverage, making these provisions an attractive target for policyholders.

The lower Court generally interpreted the Disease clauses as covering business interruption losses resulting from COVID-19 as long as there had been an occurrence (i.e. at least one case) of the disease within the geographical radius. 

As with all the provisions, the lower Court found that the language of the specific clause was fundamental. For instance, the Court observed that the term “following” denotes a looser causal connection than “resulting from” and does not require proximate causation.  The lower Court reasoned that an outbreak of notifiable disease would not of itself directly cause business interruption or interference, but only has this effect because of the authorities’ and/or public’s response to it.  Similarly, the lower Court’s construction of the term “vicinity” was informed by its observation that notifiable diseases by their nature spread in complicated and unpredictable ways and may lead to epidemics and produce a response from wider authorities. The lower Court rejected the insurers’ contention that cover was intended only for specific localised occurrences, noting that such a construction would produce a nonsensical result: that is, providing cover if localised measures were taken in response to an outbreak within the stipulated radius, but not providing cover if the local outbreak was part of wider outbreak (thus placing the policyholder in a better position if the Government did not take steps to stop the spread of the notifiable disease).

The lower Court found that the correct construction of the wording was that cover is not confined only to the effects of a localised occurrence of a notifiable disease.  However, the specific wording was key to the lower Court’s conclusion and it  distinguished between (1) the broadest policy wordings, which provide cover for business interruption a policyholder can show resulted from COVID-19, including due to Government actions and advice and public reaction, from the date the disease occurred within the relevant radius, and (2) narrower wordings that confined cover to the consequences of specific, localised events.

On appeal, the Supreme Court came to a similar conclusion as to scope of cover albeit by a different reasoning (because of the causation analysis – see below); the main judgment of the Supreme Court (handed down by two of the four judges) rejected the lower Court’s interpretation of the Disease clause, holding that:

“the interpretation which makes best sense of the clause… is to regard each case of illness sustained by an individual as a separate occurrence.  On this basis there is no difficulty in principle and unlikely in most instances to be difficulty in practice in determining whether a particular occurrence was within or outside the specified geographical area.”

Therefore, the main judgment of the Supreme Court found that the term “occurrence”, as it appears in the Disease clause, refers to something happening at a particular date and is not something capable of extending over more than one date.[2]  Further, the spread of a disease is not something that occurs in a particular place at a given time; instead it occurs in many different places at different times.  Likewise, an outbreak of a disease cannot be regarded as having a sufficient degree of unity in relation to time, locality and cause.

(2) Prevention of Access (“PoA”) clauses typically provide cover where access to the insured premises is prevented by Government action as a result of the occurrence of a notifiable disease.

The Supreme Court agreed with the lower Court that the insured peril contemplated by such clauses was a composite peril involving three elements: (i) prevention or hindrance (where expressly provided for) of access to or use of premises; (ii) by any action of the Government; (iii) due to an emergency which could endanger human life.  For policies with PoA wording, any business interruption or interference must be caused by this composite peril in order for there to be cover.

The scope of cover and language used varies between the wordings, but again, the Supreme Court’s ruling provides general guidance as to what claims might be covered under a PoA provision. 

The lower Court distinguished between the terms “Prevention of access” and “hindrance” to access – which, in the absence of express cover, is not encompassed by the words “prevention of access” - and only refers to circumstances where premises were closed pursuant to the Government advice of 20 and 23 March 2020 or the Regulations of 21 and 26 March 2020.  The Supreme Court did not disagree.

The Supreme Court did not disturb the lower Court’s finding that where a PoA clause contains “emergency in the vicinity”, specified radius wordings or the like, the clauses are construed narrowly and cover is unlikely to be triggered by the Government’s measures to manage the pandemic.  In particular, the lower Court found that cover provided by such PoA clauses is only intended to respond to an event that happens at a given time in the area local to the insured premises.  By contrast, measures put in place by an authority in response to the pandemic throughout the entire country (as was the case here) are not “local” in this sense, so government measures would not trigger cover under PoA clauses with this type of vicinity or specified radius wording.

For wordings without the narrow vicinity or specified radius requirements, the question of whether coverage is triggered is fact-sensitive.  It is access to the business in the policy schedule that must be prevented in order for there to be coverage. Therefore, where a business changed its operations (for example, a pub starting a takeaway service), this would not preclude there being “prevention of access” to its use of premises; however, if prior to the Government actions, a pub already had a takeaway service that was more than de minimis, the policyholder might have suffered a hindrance, but not a prevention of access.  Similarly, for business that were permitted to stay open, suffering from fewer customers would not constitute prevention of access; even if the policyholder closed its business due to reduced footfall or some other reason, that is not a qualifying prevention of access because the closure was not by Government action or advice.  This might seem like a tough result for policyholders operating businesses that became more expensive or even untenable due to social distancing, for example, but it demonstrates the Court’s emphasis on construing the plain language of the provision.

(3) Hybrid clauses refer to provisions that, generally speaking, are triggered by both restrictions imposed on the premises and an occurrence or manifestation of a notifiable disease.

The lower Court found the insured peril in hybrid clauses to be a composite peril involving three elements: (i) an inability to use premises; (ii) due to restrictions imposed by a public authority; (iii) following an occurrence of human infectious or contagious disease.  Any business interruption or interference must be caused by this composite peril to trigger coverage.

While the availability of coverage for any given claim depends on the specific wording at issue, again the Supreme Court made some general findings with respect to the wording(s) before it.

An issue raised on appeal was whether the lower Court was correct to find that “restrictions imposed” by a public authority denotes mandatory restrictions which have the force of law but excludes government advice or the public staying away by choice.  The significance relates to when cover is triggered and what losses can be recovered under the policies.  The FCA argued that the Court’s interpretation creates the anomalous prospect that a socially responsible policyholder who complies voluntarily with the instruction of a public authority may be put in a significantly worse position than one who refuses to comply unless the instruction is given legally binding force.  The Supreme Court found that while the lower Court was right that the wording “restrictions imposed” by a public authority means mandatory measures, the restriction need not always have the force of law before it can be so described.  An instruction given by a public authority may be correctly categorised as a “restriction imposed” if the terms and context of the instruction show compliance is required and would be reasonably understood to be required without the need for recourse to legal powers.  The Supreme Court found that this was only likely in emergencies, as in the case of the COVID-19 pandemic.  Under such circumstances, the instruction would be in mandatory terms and would be sufficiently clear to enable the addressee to know what compliance requires.

The Supreme Court did not disturb the lower Court’s finding that the term “inability to use” is fact-sensitive and means more than “impairment”, “hinderance” or “disruption to normal use”.  The Supreme Court found that inability to use need not be an inability to use any part of the premises for any business purpose whatever.  That is, “inability to use” the business premises may include inability to use the whole, or a certain part of the premises, for all or a discrete part of the business pursuits.

Likewise, the Supreme Court did not disagree with the lower Court’s finding that the term “manifestation” requires symptoms or diagnosed cases of COVID-19 and does not include asymptomatic or undiagnosed cases.  “Enforced closure” means the closure of all or part of the premises pursuant to the 21 and 26 March 2020 Regulations; guidance, stay at home advice or instructions are not enough to satisfy this wording.

Key Takeaways

(1) Construction is key

Both the Court and the Supreme Court emphasised repeatedly the importance of contract construction, as well as the significance of the specific language (what the words say and mean in context), the nature of the insurance (for example, the inherent qualities of a notifiable disease), the nature of the business (particularly important in relation to the PoA provisions), and the intention of the insurance overall (a construction that rendered it illusory cover, nonsensical or that withdrew cover expressly granted – for example, in the reading of an exclusion – could not be reasonable).  Contractual construction in English law is not a four corners approach; a court must ascertain what a reasonable person, that is, a person who has all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract, would have understood the contracting parties to have meant by the language used in the policy.

(2) Causation from construction

The Court also made clear that contractual construction is fundamental to determining the insured peril and causation.  The Court summarised “Most, if not all, of the issues of causation… are answered by the correct construction of the wordings.”

Taking this approach, the Supreme Court agreed with the lower Court that the proximate cause of the business interruption in question was the “notifiable disease” of which individual outbreaks form indivisible parts; in other words, there is only one indivisible cause of loss, the outbreak of COVID-19 in the UK.  Therefore, it is enough for a policyholder to prove that the interruption was caused by Government measures taken in response to cases of COVID-19, including at least one case of the disease within the geographical area covered by the clause at the time those Government measures were implemented.  The Supreme Court’s finding applies regardless of the particular wording used to characterise the causal connection between loss and insured peril; the finding applies equally to wording using the formulae “arising from”, “as a result of”, “following” or some other terminology.   

(3) Orient Express was wrongly decided

The defendant insurers relied heavily on the first instance decision Orient-Express Hotels Ltd v Assicurazioni Generali SpA [2010] EWHC 1186 (Comm) to support their case on “but for” causation: that even if policyholders had not been forced by the UK Government to close or change their business operations, they would have suffered loss anyway as a result of COVID-19 because the pandemic itself would have resulted in a general downturn.  

Orient Express was a case involving property damage and business interruption loss to a hotel caused by Hurricanes Rita and Katrina where the business interruption loss was disputed.  In that case the court agreed with the insurer’s reliance on the policy’s “trends” clause (which aimed to put the insured in the same position had the insured peril not occurred) to find that the policyholder could only recover for business interruption losses it could show would not have arisen had physical damage to the hotel not occurred. Since the hurricanes at issue had devastated the entire surrounding area, the court concluded that the policyholder would have suffered the same business interruption losses even if there had not been any damage to the hotel, since the devastation to the area meant that no one would have visited in any event. 

The Orient Express decision has been subject to criticism, at least academically, but has been law for many years.  Given the reliance the defendant insurers placed on Orient Express here, the Court’s analysis of that case is significant.

The lower Court distinguished Orient Express from the present case in relation to those wordings which provide cover in principle, as Orient Express was not concerned with the type of insured perils involved here.  The lower Court therefore found that Orient Express was not relevant to its decision and had no impact on the construction of the wordings in question.  However, notwithstanding that finding, the lower Court said, obiter dicta, that had the Orient Express been relevant to the issues at hand, it would have concluded that it was wrongly decided and would not have followed it.  

The lower Court set out the fundamental problem with Orient Express, namely that the insurer and judge in that case misidentified the insured peril as “damage” in the abstract, when it was in fact “damage caused by a covered fortuity (hurricanes);”in other words, the hurricanes were an integral part of the insured peril.  The judge in Orient Express only looked at the factual causation (the “but for”) and not at the proximate (or dominant) cause of loss, which is the primary question in insurance contracts, and was business interruption arising from damage caused by hurricanes. 

According to the lower Court, Orient Express leads to the illogical conclusion that the worse the fortuity, the less the insurance responds: i.e. if the hurricanes had only damaged the hotel, the policyholder would have recovered in full for its business interruption loss; however, because there was damage to the surrounding area, the policyholder was effectively treated as if the hotel had escaped damage and so was much worse off.  This was absurd:  the very nature of the covered fortuity (a hurricane) is that it causes widespread damage and the result effectively rendered the business interruption cover illusory, which could not have been the intention of the policy.

The Supreme Court did not disagree with the lower Court’s reasoning but went further and expressly held that Orient Express was wrongly decided and should be overruled.  It is noteworthy that two of the four Supreme Court judges had been involved in the Orient Express decision[3] but agreed with the lower Court that the case was wrongly decided and quoted Lord Westbury, who apparently rejected a barrister’s reliance on his Lordship’s earlier decision saying: “I can only say that I am amazed that a man of my intelligence should have been guilty of giving such an opinion.”

In the FCA Test Case, the importance of looking at the insured peril – here composite perils – was emphasised, and the Supreme Court found that the correct application of any trends clause would compare the actual performance of the business with what it would have achieved in the absence of COVID-19 outbreak which led to the restrictions.

The result is that insurers should no longer expect to be able rely on Orient Express and should adjust their future strategies accordingly.

(4) Clarity

The aim of the FCA Test Case was to determine issues as to the correct constructions of policy terms and whether cover is available in principle, thereby providing clarity for policyholders and insurers.  While coverage depends on the wording at issue and the facts in each case, the FCA Test Case has provided some clarity on the meaning of certain policy language and matters of construction, guidance for those bringing claims or considering those already made, and an indication of what arguments run by both policyholders and insurers are likely to be successful.   

(5) Causation: Proving the prevalence of COVID-19

The Supreme Court agreed with the lower Court that proven COVID-19 cases in the country are enough to demonstrate that COVID-19 was prevalent on the insured premises or within the relevant radius, thereby making it easier for policyholders to demonstrate the prevalence of the disease on the insured premises or within the relevant radius to satisfy the requirement of the wording in question.

(6) Next steps

In the wake of the Supreme Court ruling which substantially allows the FCA’s appeal, the FCA has said it will be working with insurers to ensure that they now move quickly to pay claims that the judgment says should be paid, making interim payments wherever possible.  Insurers should also communicate directly and quickly with policyholders who have made claims affected by the judgment to explain next steps.

[1] TKC London Limited v Allianz Insurance plc [2020] EWHC 2710 (Comm).

[2] The other two judges in the Supreme Court would have upheld the lower Court’s interpretation of the disease clause, otherwise they agreed with the main judgment.

[3] Justice Nicholas Hamblen was the High Court judge who ruled in favour of the insurer on appeal from a decision of an arbitral tribunal which included Justice George Leggatt.