Connection Between Physical Damage and Business Interruption Coverage[dagger], The

Downs, Andrew B

I.

INTRODUCTION

Hurricanes, earthquakes, and floods. Urban riots and other civil disturbances. Terrorist threats and terrorist activity. Such events may require limited access to business or may require businesses to close altogether - either independently or by order of civil authority. Insureds facing loss from such events may seek coverage under business interruption insurance policies or under the "Civil Authority" provisions generally found in such policies. Those provisions typically cover losses resulting from prohibited access to covered property due to other property damage. Insureds, however, have become more assertive in presenting access claims arising out of events much more distant and remote than those traditionally envisioned in underwriting business interruption exposures. Given that trend, this article explores the connection required between covered physical damage and coverage for business interruption or denial of access caused by the action of civil authorities.

II.

BUSINESS INTERRUPTION INSURANCE

"The nature of business interruption insurance is to indemnify the insured for any loss sustained because of the insured's inability to continue to use specified premises as a result of the destruction of the premises or parts thereof."1

In its most basic form, commercial property insurance covers loss or damage to the real and personal property of a business. However, loss or damage to business property often leads to consequential economic losses, such as loss of income or increased expenses. To cover those consequential losses, businesses may obtain "business interruption" insurance.

"Business interruption" insurance "is designed to do for the business what the business would have done for itself had no loss occurred."2 Such insurance typically covers business interruptions resulting from physical loss or damage to covered property caused by a covered cause of loss.3

A. Contract Language

There is a wide variety of business interruption clauses in use - many of them manuscript forms. The ISO Business Income and Extra Expense Coverage Form, for example, provides as follows:

We will pay for the actual loss of Business Income you sustain due to the necessary "suspension" of your "operations" during the "period of restoration." The "suspension" must be caused by direct physical loss of or damage to property at premises which are described in the Declarations and for which a Business Income Limit of Insurance is shown in the Declarations.4

B. Physical Damage to Covered Property

Many business interruption policies contain language similar to that of the current ISO form, quoted above. Most notably, this language ties a duty to pay under business interruption coverage to the occurrence of covered physical damage to covered property. Most courts will enforce that language. For example, in Harry's Cadillac-Pontiac-GMC Truck Co. v. Motors Insurance Corp.,* a snowstorm damaged the insured's automobile dealership. That snowstorm also made the dealership inaccessible for a week. The North Carolina appellate court rejected the insured's attempt to recover under its business interruption coverage for the week the business was inaccessible. The court held:

Plaintiff neither alleged nor offered proof that its lost business income was due to damage to or the destruction of the property, rather all the evidence shows that the loss was proximately caused by plaintiff's inability to access the dealership due to the snowstorm. There was no suspension of business due to the roof damage or the repairs thereto. We hold that, under the language of the business interruption clause of the policy, coverage is provided only when loss results from suspension of operations due to damage to, or destruction of, the business property by reason of a peril insured against.6

Similarly, in Roundabout Theatre Co. v. Continental Casualty Co.,7 scaffolding on a building under construction partially collapsed into the street and onto adjacent buildings. Separated from the building and partially-collapsed scaffolding by another building, the insured theatre suffered only minor damage, which was repaired within one day. However, after the collapse, the City of New York closed the street for almost a month because of substantial damage to the area and the danger presented by the partially-collapsed scaffolding. As a consequence of the street closure, the theatre became inaccessible to the public and was forced to cancel thirty-five performances. The insured sought coverage under its business interruption insurance, which provided in part that the insurer would pay for loss incurred as a result of a '"postponement or cancellation of an insured Production as a direct and sole result of loss of, damage to or destruction of property or facilities ... .'"8 The court held that the insured had not met its burden of showing a covered loss, concluding that "the language in the instant policy clearly and unambiguously provides coverage only where the insured's property suffers direct physical damage."9

C. How Far Can You Go without Losing Coverage?

Business interruption insurance generally covers losses resulting from suspension of the insured's business operations due to,direct physical loss of, or damage to, property at the insured's premises. Relevant to such coverage is the question whether the location of the physical damage and the location of the insured's business operations must be the same, and if not, what degree of separation is permissible.

1. Close Enough to Home: Damage to a Common Structure

Damage to the structure occupied by the insured, but not to the particular portion occupied by the insured, may support a business interruption claim when it results in a suspension of operations. The leading case is Datatab, Inc. v. St. Paul Fire & Marine insurance Co.10 There, the insured (Datatab) occupied the fifth and sixth floors of a commercial building. After a water main broke in the basement of the building, damaging the building's air conditioning system, the insured had to shut down its data processing and computer equipment. The insured's business interruption policy covered, in part, '"actual loss as covered hereunder when as a direct result of a peril insured against the premises in which the property is located is so damaged as to prevent access to such property."'11

The insurer argued that, because there was no direct physical damage to the insured's premises on the fifth and sixth floors, and because physical access to the equipment was not impaired after the water main broke, the above provision did not apply. The insured contended, however, that the term "premises" within its policy applied to the entire building, not just to the fifth and sixth floors. Datatab also argued and that the term "access" referred to the insured's ability "to utilize the equipment normally in the operation of its business."12

The court found both the terms "access" and "premises" ambiguous, construing the ambiguities in favor of the insured as required under New York law. Finding as well that the insurer's construction of the terms was "bizarre" and "strained,"13 the court concluded:

Obviously, what was relevant and important to Datatab when it bought the St. Paul policy was the ability to utilize the computers in its business on a normal basis. Datatab could not have been less interested in whether, following a peril insured against, it had the ability to physically touch a non-functioning mass of metal.14

2. So Near, Yet So Far: Things the Insured Failed to Insure

Sometimes insureds buy both physical loss coverage and business interruption coverage for only some of their property. As illustrated by the following cases, the general rule that governs these situations provides that if the source of the business interruption at the insured location is damage to an uninsured (for business interruption) location, business interruption losses at the undamaged location for which that coverage was purchased are not covered.

For example, in Swedish Crucible Steel Co. v. Travelers Indemnity Co.,15 the insured operated a plastics and foundry manufacturing facility. The facility consisted of eight buildings. For reasons not explained in the opinion, the insured purchased a business interruption policy for the foundiy building (Building 1), which was separate from the business interruption policy it had purchased to cover the other seven buildings. A fire in Building 2 damaged various molds, dyes, and patterns used in the operation of the foundiy (Building 1). The insured sought to recover its business interruption losses for Building 1 under the policy insuring that building.

The court held that business interruption coverage under the policy for Building 1 applied only to interruptions caused by covered physical damage to Building 1, and not to interruptions caused by physical damage to Building 2. In reaching that conclusion, the court expressed the fear that finding coverage would encourage insureds to obtain coverage only for their most important property, expecting that business interruption coverage on that property would provide them with some protection, regardless of which property was damaged. The court found it "clear" that the policy at issue "was intended to insure against business losses occasioned by the destruction of the described premises, and no more."16

Similarly, in Gregory v. Continental Insurance Co.,17 the court declined to extend business interruption coverage beyond the premises specified. In that case, the insured operated a golf course. The insured purchased a property policy covering the golf course office, pro shop, and restaurant building (listed on the policy as Building 1), which included business interruption coverage for that structure. (Other structures were also insured, apparently without business interruption coverage.)

A hurricane later seriously damaged the building in question (housing the office, pro shop and restaurant). More importantly to the insured's business, the hurricane blew trees and other debris onto the golf course. The course was closed for about two weeks while the debris was cleared. The insured then sought to recover business interruption losses not only for the pro shop and restaurant, but also for the course as a whole. The Mississippi Supreme Court held that the business interruption coverage on the office/pro shop/restaurant did not extend to losses caused by the closure of the entire golf course.18

3. Mutually Beneficial Relationship or Mutual Dependency?

In recent years, a 1931 decision of the New Hampshire Supreme Court in Studley Box & Lumber Co. v. National Fire Insurance Co.,19 has inspired more insureds' attorneys than courts. In that case, Studley Box and Lumber Company ("Studley Box") occupied a series of more or less adjacent buildings as part of its box factory and mill. Portions of the facility were operated by horses. The stable and some of the horses were destroyed in a fire. The insured sought to recover for the additional expense of hiring horses to operate the mill until it could replace those horses that it had lost. The insured's business interruption policy described the principal structures at the facility in general terms, but did not identify various secondary structures, including the stable. The court held that the policy's description of the insured property was general only and extended to the entirety of the insured's facilities. More importantly, the court also held that the various structures were mutually dependent so that business interruption losses at all of them could be recovered when damage occurred to a single insured structure.20

Modern courts have distinguished Studley. The leading case is Ramada Inn Ramogreen, Inc. v. Travelers Indemnity Co.21 There, the Court of Appeals for the Eleventh Circuit applied Florida law and determined that a hotel owner could not recover under its business interruption coverage for reductions in its hotel room occupancy caused by the destruction of the on-premises restaurant. The hotel and restaurant had been insured by a single policy, but different limits applied for each.

The court rejected the insured's argument that the mutual dependency doctrine of Studley should control. The court examined the structure of the policy, observing that the restaurant was insured with a separate limit of liability. It also noted that the insured had failed to rebuild the restaurant after the fire, which constituted evidence that there was no mutual dependency between the restaurant and the hotel. In reaching its decision, the court observed:

The concept of mutual dependency is more appropriately applied to the four hotel buildings, which together comprise a single unit. If any one of them were [sic] sufficiently damaged, a portion of the hotel operation would be suspended. The insurance policy clearly provides for this situation by allotting an aggregate sum which encompasses damage to any one of the four buildings.22

In deciding Ramogreen, the Eleventh Circuit relied heavily on hotel Properties, Ltd. v. Heritage Insurance Co.23 As in Ramogreen, hotel Properties involved damage to a hotel restaurant, but the case did not address the mutual dependency issue. Instead, a tenant of the insured operated the restaurant. The insured then claimed a business interruption loss based on the reduction in hotel occupancy following closure of the restaurant. The Court of Appeal of Florida held that the business interruption policy did not cover a "diminution" in volume of the insured's hotel business.24

The insured fared even more poorly in Royal Indemnity Insurance Co. v. Mikob Properties, Inc.25 The insured property in that case was a three-building waterfront apartment complex near Houston, Texas. When the building closest to the water burned, asbestos was discovered in the debris, and access to the waterfront amenities disappeared for an extended period of time. Not surprisingly, the complex in its post-loss condition was less attractive to tenants, and occupancy rates in the two undamaged buildings dropped significantly in the months following the fire.

The insured sought to recover for the diminution of business in the two undamaged buildings. The Texas federal district court held that there was no mutual dependency and no covered loss because operations in the undamaged buildings were not suspended. Citing Ramogreen in part, the court determined that "the amenities which attract customers may be affected by a covered loss, but if the insured premises are still operating, the business interruption clause does not cover a decrease in income."26

4. For the Want of a Nail: Damage to Suppliers

Whether damage to an insured's suppliers is covered under the insured's business interruption insurance depends upon the language of the policy. Some policies cover losses resulting from damage to supplier facilities while others do not. Even where damage to supplier facilities is covered, the existence of coverage depends on the relationship between the insured and the entity claimed to be a supplier. In that regard, physical distance is less important than the actual policy language.

Archer-Daniels-Midland Co. v. Phoenix Assurance Co.21 is the best-known of the modern cases addressing this issue. Archer-Daniels-Midland ("ADM") involved the "unprecedented flooding"28 of the Mississippi River in 1993. The floods disrupted ADM's supply chain. A "substantial part" of ADM's raw materials traveled by barge on the Mississippi River and its tributaries, but as a result of the flood, barge traffic was halted. This forced ADM to arrange alternate and more expensive rail transport. ADM also incurred increased costs for raw materials.

In part, ADM sought coverage for its increased costs under the "Contingent Business Interruption and Extra Expense Coverage" in its policies. The applicable language provided as follows:

This policy covers against loss of earnings and necessary extra expense resulting from necessary interruption of business of the insured caused by damage to or destruction of real or personal property, by the perils insured against under this policy, of any supplier of goods or services which results in the inability of such supplier to supply an insured locations [sic].29

In particular, ADM contended that the Army Corps of Engineers ("Corps"), which operates and maintains the Mississippi River system, and the U.S. Coast Guard, which provides aids to marine navigation (e.g., visual, audible, and electronic signals), were "suppliers of goods or services" under the policy. The court agreed with ADM, holding that both the Corps and the Coast Guard were "suppliers" to ADM within the meaning of its policies. The court reasoned that the Corps' and the Coast Guard's "funding [of] the construction and maintenance of the physical infrastructure of the Mississippi River system through fuel taxes imposed on the users ofthat system easily [brought] the Corps and the Coast Guard within the plain meaning of the term 'any supplier of goods and services.'"30

ADM also argued that Midwest farmers were "suppliers" under the subject policy provisions. The court agreed with ADM on that issue as well, rejecting the defendant's argument that the farmers were not "suppliers" because ADM did not contract directly with individual farmers to purchase their grain. Rather, ADM purchased its grain from licensed grain dealers. Finding that the policy language did not limit coverage to those suppliers "in direct contractual privity" with ADM, the court ruled that the farmers were "suppliers" under the policies, notwithstanding that they were "indirect" suppliers to ADM.31 In reaching its decision, the court commented that, "[h]ad either of the parties wanted to limit the coverage to 'direct' suppliers, they easily could have added language to that effect."32

By contrast, the court in Pentair Inc. v. American Guarantee & Liability Insurance Co.,33 found that the insured could not recover under policy language similar to that at issue in ADM because the relationships involved were too remote. In the Pentair case, an earthquake in Taiwan damaged an electric substation, which in turn caused a power failure at the insured's "sole and exclusive suppliers" of one of its products.34 As a result of the power failure, the supplier could not manufacture the subject product for two weeks. Because the insured's retailers were stocking the product for Christmas, the insured shipped the product from Taiwan to the United States by air, rather than by ship, to ensure that the product would arrive in time.

Since the insured incurred significant additional expenses for shipping by air, it sought to recover those expenses under policy language limiting coverage to the risk of "'direct physical loss or damage'" to the "'property of a supplier of goods and/or services to the Insured.' "35 The court denied coverage, however, concluding that the insured's loss did not fall within the meaning of that language. The court determined that the insured's loss resulted from physical loss or damage occurring at the electrical substations that provided electricity to the insured's suppliers; therefore, the electrical substations were not "suppliers" within the meaning of the policy. The court noted that,

[h]ad the direct physical loss or damage occurred to [the insured's suppliers], the Policy clearly would have provided coverage, because [the insured's suppliers] "supplie[d] goods and/or services to the Insured." However, under the plain language of the Policy, the physical damage that occurred to the electrical substations that, in turn, supplied electricity to [the insured's] suppliers is too far removed to entitle [the insured] to coverage.36

The court distinguished ADM, supra, on the basis that the policy language at issue in the instant case was more limiting. As noted, that policy provided coverage for losses resulting from "direct physical loss or damage" to the "property of a supplier of goods and/or services to the Insured." Furthermore, there was no coverage because no direct physical loss occurred to the insured's suppliers.37 In contrast, the policy in ADM applied to "any supplier of goods or services," and the court there agreed that the use of the term "any" did not limit coverage to particular suppliers, such as principal suppliers or suppliers with whom ADM had a written contract.38

III.

CIVIL AUTHORITY PROVISIONS

As noted earlier, business interruption insurance proper ties a duty to pay to the occurrence of covered physical damage to covered property. Similarly, the extension of business interruption coverage to losses resulting from the action of civil authorities generally requires the occurrence of direct physical damage, but it requires damage to property other than the insured property.

A. Evolution of Civil Authority Provisions

Questions of coverage related to the actions of civil authorities have a long history stretching back more than 100 years. Several of the earliest cases arose in what were then the Hawai'i Territories, but they involved insurance policy exclusions for losses caused by orders of civil authority.

For example, in Hawaii Land Co. v. Lion Fire Insurance Co.,39 the Board of Health ordered certain buildings burned to control an outbreak of bubonic plague. The fire spread to and destroyed the insured's building. The fire policy at issue excluded "loss caused directly or indirectly ... by order of any civil authority."40 The court held that the insured's loss was caused by the order of the Board of Health and therefore was not covered under the policy.41

Although early policies often contained civil authority exclusions, coverage was available for losses caused by the order of civil authority. In Princess Garment Co. v. Fireman 's Fund Insurance Co.,42 the insured held a fire policy that excluded coverage for "loss caused directly or indirectly ... by order of any civil authority."43 Subsequent to the issuance of the policy, the insured added a rider to cover "loss or damage by fire caused by order of military or civil authority exercised to prevent the spread of fire."44

In January 1937, the Ohio River overflowed its banks and entered the insured's buildings. As the flood waters rose, the insured's employees began moving the buildings' contents to higher floors. During the same interval, a gasoline tank was torn from its moorings and exploded, causing a fire to edge toward the insured's building. Members of the Police and Fire Departments ordered all the employees in the buildings to leave, fearing that the buildings were in imminent danger of catching on fire. Pursuant to a police cordon, no one could enter the buildings. Although the fire eventually was checked and never reached the insured premises, the flood waters continued to rise and damaged the buildings' contents. The trial court responded to the insured's claim of coverage by ruling that the loss was an uncovered flood loss; not a covered fire loss.

The Sixth Circuit reversed and remanded, finding a question of fact as to whether the proximate cause of the insured's loss was not the flood, but the fire, which prompted the civil authority to act. The court commented that the phrase "civil authority" as used in the policy "should be construed to carry out its purpose. It is to the interest of insurers to enlarge the good faith efforts of public agencies to prevent the spread of fires."45

Thus, at least initially, it was the "common intent" of civil authority coverage to extend business interruption coverage to situations where the insured's own property had not itself been damaged (or was not sufficiently damaged to cause as severe a business income loss as would be caused by a total inability to occupy) but to which access had been officially restricted. Because of damage to nearby property, the police or fire fighters would cordon off the area and prohibit access, perhaps even to premises that had not been directly involved in the loss. The prohibition might extend beyond the time of the actual fire if, for instance, there was danger to adjacent buildings from collapse of the damaged property. In the case of extensive wind damage, an entire disaster area might be cordoned off for an extended period after the actual loss in order to prevent looting or possible danger to on-lookers, until the damage could be assessed and order restored.46

Civil rights unrest during the 1960's led many cities to impose curfews or to order that certain types of businesses cease operation. Affected business owners thereafter made claims under their civil authority coverage, contending that the orders of civil authorities to close their businesses resulted directly from the riots, a peril against which they were insured. However, this was "an interpretation of the civil authority clause that was probably never envisioned by its original drafters" and "not contemplated in the rating structure."47

As a consequence, the civil authority provision was modified in 1969, adding language which required that "the order of civil authority result from damage to or destruction of property adjacent to the insured premises."48 In 1986, however, the coverage for civil authority losses was enlarged by deleting the adjacent-property language and requiring only that the order of civil authority prohibit access to the covered property due to property damage "other than at the described premises."49

1. No Express Requirement for Damage to Property

As noted above, early civil authority provisions covered loss of business income where an order of civil authority prohibited access to the insured premises. Those provisions did not include any express requirement for physical damage to adjacent property or to the insured premises. Notwithstanding the absence of a damage requirement, courts disagreed as to whether property damage was necessary to trigger the coverage.

a. Property Damage Required

Generally, those courts that have required damage to the insured premises or to adjacent property have looked to other policy provisions in addition to the particular civil authority provision at issue. For example, in Cleland Simpson Co. v. Firemen 's Insurance Co.,50 Hurricane Diane wreaked havoc in northeastern Pennsylvania. The hurricane caused severe flooding, which interrupted the water supply to the city of Scranton, Pennsylvania. Without water, and concerned about the danger of fire, the mayor declared a state of emergency, ordering all stores in the city to close. As a result of the prohibition the insured could not access its business premises for three business days. The insured thus sought coverage under its business interruption policy for the losses incurred.

The policy was a standard form, insuring against "all direct loss" by fire or lightning and excluding coverage for any indirect or consequential damage caused by those perils.51 The policy also contained a business interruption form, which provided coverage for "loss directly resulting from necessary interruption of business caused by destruction or damage by the perils insured against."52 In addition, the business interruption form provided:

Interruption by civil authority: Liability under this policy is extended to include actual loss as covered hereunder sustained during the period of time, not exceeding two weeks, when as a direct result of a peril insured against access to the premises described is prohibited by order of civil authority.53

Examining the policy as a whole, the court concluded that the civil authority provision covered only those additional losses incurred after the insured property was damaged by an insured peril and a subsequent order of civil authority barred access. In reaching its decision, the court analyzed "the buildup of the [insurance] contract."54 First, the policy specified the perils against which the holder was insured (fire and lightning) and limited the coverage to "direct" loss from those perils. second, the policy included a business interruption coverage form, which substituted business interruption coverage for coverage of direct loss from fire or lightning, but limited coverage to loss caused by "destruction or damage by the perils insured against."55 Finally the policy extended the coverage to include "a time limited loss" due to prohibited access by order of civil authority, "but again as a direct result of a peril insured against."56

Based upon its analysis of the policy structure, the court concluded that "the clear language of the policy restricts the loss to that following a direct invasion of the property by fire or another specified peril and the subsequent prohibition by civil authority of access to the properties."57 The court reasoned:

Here the specified peril is fire; the risk insured against is loss of profit through business interruption caused directly by fire and extended for a period of time to continued interruption caused by the action of civil authorities in preventing access to the business premises as a direct result of fire.

By no process of logic can we read into the policy that the risk includes prohibition of access because of apprehension of either the possibility or probability of a fire which never occurred. We have no doubt that a policy could be written to cover such a contingency, but this policy was not so written.58

Similarly, in Two Caesars Corp. v. Jefferson Insurance Co.,59 the District of Columbia Court of Appeals held that an "access" civil authority provision did not provide coverage absent damage to the insured premises. In that case, which arose out of civil disturbances following the death of Dr. Martin Luther King, Jr., the Commissioner of the District of Columbia issued an emergency proclamation that imposed a curfew on the District and prohibited "[t]he sale or dispensing of alcoholic beverages, including beer and wine."60 The insured restaurant, which served both food and alcoholic beverages, allegedly sustained business losses during the curfew due to the curfew restrictions on the use of public places and the prohibited sale of alcoholic beverages. The insured sought coverage, in part, under the civil authority provision in its policy, which provided:

Interruption by Civil Authority. This policy is extended to include the actual loss as covered hereunder, during the period of time, not exceeding 2 consecutive weeks, when as a direct result of the peril(s) insured against, access to the premises described is prohibited by order of civil authority.61

In reaching its decision that the civil authority provision did not apply to provide coverage, the court relied upon its earlier decision in Brothers, Inc. v. Liberty Mutual Fire Insurance Co.,62 in which it had determined that there was no coverage under a civil authority provision absent damage to or destruction of adjacent property. Like the situation in Two Caesars, Brothers arose out of the 1968 riots following the assassination of Dr. King. The restaurant in Brothers similarly claimed that the curfew and the restrictions on the sale of alcoholic beverages resulted in a covered loss under the civil authority provision in its policy.

The policy at issue in Brothers provided coverage for a business interruption loss "when, as a direct result of damage to or destruction of property adjacent to the premises herein described by the peril(s) insured against, access to such described premises is specifically prohibited by order of civil authority."63 The plaintiff did not allege physical damage to its premises or to adjacent property. Rather, it based its claim upon the loss of business due "solely" to the curfew and accompanying municipal regulations.64 The court therefore concluded that, although the alleged loss resulted from the curfew and municipal regulations, "these did not prohibit access to the premises because of damage to or destruction of adjacent property" as required under the civil authority provision at issue in the case.65

Returning to the analysis in Two Caesars, the plaintiff there had argued that the civil authority provision in its case and that at issue in Brothers, supra, were distinguishable. The civil authority provision in Two Caesars did not contain the language providing coverage only where a civil authority order prohibited access to the insured's property because of damage or destruction to adjacent property. The Two Caesars court, however, rejected plaintiff's distinction.

The basic policy at issue in Two Caesars provided coverage "to the extent of the actual cash value of the property at the time of loss, but not exceeding the amount which it would cost to repair or replace the property;" it did not insure against loss caused by "order of any civil authority except acts of destruction at the time of and for the purpose of preventing the spread of fire."66 The court found that this policy language supported its conclusion that an order of civil authority prohibiting access did not provide coverage in the instant case:

It is true, of course, that one of the perils insured against was interruption of business by Order of Civil Authority and that the loss claimed by [the insured] resulted from the interruption of its business during the effective periods of the curfew. The inescapable fact is, however, that, by the clear provisions of the policy, the loss is compensable only when the Order of Civil Authority, which prohibits access, is predicated upon damage to or destruction of the business property.67

Construing the same civil authority provision as that in Two Caesars, the Wisconsin Supreme Court in Adelman Laundry & Cleaners, Inc. v. Factory Insurance Ass'n68 followed the Two Caesars court. It therefore required physical damage to the insured property even though the civil authority provision in Adelman, as in Two Caesars, did not expressly require such damage. In reaching its decision, the Adelman court noted that the basic policy at issue covered business interruption losses "due to damage to or destruction of described property caused directly by riot, . . . civil commotion, [etc.] . . . ."69 The policy limited recovery of such losses to that "length of time as would be required with the exercise of due diligence and dispatch to rebuild, repair or replace such described property as had been damaged or destroyed . . . ."70

Finding that the civil authority provision had to be considered in light of the "length of time ... to rebuild" language, the court concluded that the civil authority language was "not an extension of coverage to delete the requirement of damage or destruction."71 Instead, it was "an extension of the time within which an otherwise compensable loss may be sustained."72

b. Property Damage Not Required

Cases like Cleland and Two Caesars, discussed above, have required property damage to trigger civil authority provisions not expressly containing such a requirement. In contrast, the Michigan Court of Appeals, construing a similar provision, has concluded otherwise.

In Sloan v. Phoenix of Hartford Insurance Co.,13 the insureds operated movie theaters in Detroit, Michigan. The theaters were open for matinees and from 7:30 p.m. until midnight as well. During the summer of 1967, riots occurred in and around Detroit. However, none of the plaintiffs' theaters was physically damaged. Because of the riots, the Governor of Michigan issued an executive order that established a 9:00 p.m. to 5:30 a.m. curfew and closed all places of amusement in Detroit for eight days. Pursuant to the curfew, the insureds closed their theatres and sustained a loss of business income.

The insureds sought coverage for their losses under their business interruption insurance. Under paragraphs 1 and 2 of the policy, losses "resulting directly from necessary interruption of business caused by damage to or destruction of real or person property by peril[s] insured against" were covered, but "for only such length of time as would be required ... to rebuild, repair or replace such part of the property ... damaged or destroyed."74 In the ensuing paragraph 7, the policy contained the following civil authority coverage:

Interruption by Civil Authority. This policy is extended to include the actual loss as covered hereunder, during the period of time, not exceeding 2 consecutive weeks, when as a direct result of the peril(s) insured against, access to the premises described is prohibited by order of civil authority.75

The insurer had argued that there was no coverage because there was no direct physical loss to the insureds' property. On the other hand, the insureds contended that the risk against which they were insured was the prohibition of access to their premises by order of a civil authority resulting from a covered peril (here, riot and civil commotion), and that physical damage to the insured property was not required.

The court agreed with the insureds, concluding that the plain language of the civil authority provision did not require physical damage to the insured property as a condition of payment under the policy. The court observed that paragraphs 1 and 2 of the policy specifically addressed business interruption losses " '[cjaused by damage to or destruction of the insured property."76 In contrast, paragraph 7 addressed business interruption losses resulting from denial of access by order of civil authority. Furthermore, the paragraph made "no mention ... of the necessity for physical damage to the premises before paragraph 7 can become operative."77 The court noted that it was "too late" to rewrite the policy to add that condition.78 The court also found "no rational relationship" between the two-week maximum benefit period under paragraph 7 and coverage for losses based upon the "length of time as would be required with the exercise of due diligence and dispatch" to make repairs under paragraph 2.79

2. Express Requirement for Damage to "Adjacent" Property

As noted earlier, more recent civil authority provisions prohibit access to the described premises due to direct physical loss of or damage to property other than, or adjacent to, the insured property caused by a covered cause of loss.80 In Syufy Enterprises v. Home Insurance Co.,8' the court narrowly construed such a provision, barring coverage where damage to other property was more than two blocks away from the insured property. In Syufy, the insured owned and operated movie theaters throughout the West Coast. Following the riots and looting after the Rodney King verdict, civil authorities in various cities imposed a dawn-to-dusk curfew for several days. As a result, the insured closed its theaters during the curfew period.

Subsequently, the insured submitted a claim under its business interruption policy, which provided coverage for actual loss of business income for up to two weeks when, as a direct result of damage to or destruction of property "adjacent" to the insured premises caused by a covered peril, an order of civil authority "specifically prohibits]" access to that insured premises.82 Based on the following facts, the insurance company denied coverage:

(1) no civil authority ever specifically prohibited access to a Syufy theater as a result of the Rodney King riots;

(2) no Syufy theater nor any property next door to or across the street from a Syufy theater was physically damaged as a direct result of the riots; and

(3) no property located within two blocks of any Syufy theater was physically damaged as a direct result of the riots.83

The court agreed with the insurance company that, under the facts of the case, there was no coverage. The insured had argued that the term "adjacent" was ambiguous and should be construed in favor of the insured to mean that property damage occurring anywhere in the curfew zones would be "sufficiently 'adjacent'" to the insured's theaters for purposes of triggering coverage.84 The court rejected the insured's argument, however, noting that the " Ordinary and popular' reading of the term 'adjacent' denotes a sense of physical proximity" and that "[djamage occurring in an unspecified area at least two blocks from a Syufy theater is clearly and plainly not 'adjacent' to the theater."85

The court also emphasized that the insured had not met any of the other conditions for coverage. That is, no civil authority "specifically" denied access to the insured's theaters.86 Moreover, there was no causal link between damage to adjacent property and denial of access. As the court noted, the insured closed its theaters as a direct result of the curfews and not, as required by the policy, as a direct result of adjacent property damage. The court did provide an example illustrating circumstances under which coverage would be "clearly" available, however:

A building next door to a Syufy theater is damaged by fire; for safety reasons, the civil authorities issue an order closing the Syufy theater during repairs to the adjacent building. Any business loss suffered by Syufy for up to two weeks would be covered under the business interruption provision.87

3. Express Requirement for Damage to Property "Other Than at the Described Premises"

The most recent civil authority provisions typically delete the adjacent-property language and require instead that the order of civil authority respond to damage to property "other than at the described premises."88 For example, ISO Form CP 0030 provides:

Civil Authority. We will pay for the actual loss of Business Income you sustain and necessary Extra Expense caused by action of civil authority that prohibits access to the described premises due to direct physical loss of or damage to property, other than at the described premises, caused by or resulting from any Covered Cause of Loss.

This coverage for Business Income will begin immediately after the time of that action and will end:

(1) 3 consecutive weeks after the time of that action; or

(2) When your Business Income coverage ends;

which ever is later.89

By its terms, the civil authority provision quoted above extends business income and extra expense coverage to loss caused by any action of civil authority "that prohibits access to the described premises due to direct physical loss of or damage to property, other than at the described premises, caused by or resulting from any Covered Cause of Eoss." The coverage becomes effective seventy-two hours after the action of the civil authority has commenced - not after any physical loss to the property - and continues for up to three weeks after that action or whenever the insured's business income coverage ends, "which ever is later."

As discussed previously, courts construing older policy language disagreed as to whether property damage was required to trigger a civil authority provision that did not expressly contain such a requirement. However, the current language is clear in requiring "direct physical loss or damage to property," thereby resolving that issue. The current language also clarifies which property must be damaged - delineating property "other than at the described premises."

In addition, the current language is much broader in scope than previous language, which typically limited coverage to loss involving "adjacent" property. The current language provides coverage not only for loss involving adjacent property, but for loss involving any property other than the insured property. That is,

[w]ith the current language, the property damage producing the action of civil authority need not be in the insured's immediate vicinity. Loss from a fire or explosion in a chemical plant several miles upwind of the insured's premises, for example, forcing evacuation of a large area downwind from the plant, is covered by the new language but not the old.90

Thus, the current version of the civil authority provision is triggered only where

1) an insured peril

2) causes direct physical loss or damage

3) to property other than the insured property,

and

4) that property damage causes civil authorities to issue an order,

5) prohibiting access to the insured property,

6) which causes an interruption of the insured's business,

7) which, in turn, causes a loss of business income or causes extra expense as defined by the policy at issue.

The denial of access by civil authorities may extend beyond the time of the insured's actual loss if, for example, there is a danger to adjacent buildings from collapse of the damaged property. Alternatively, in the case of extensive wind damage, an entire disaster area may be cordoned off for an extended period after the loss to prevent looting or possible danger to onlookers until the damage can be assessed and order restored. "As long as the interruption is caused by damage due to an insured peril to any property other than that noted on the insured's declaration page, this clause applies."91

Assurance Co. of America v. BBB Service Co92 illustrates the application of the property-damage requirement in a "Civil Authority" provision. In that case, Brevard County, Florida, issued an evacuation order due to Hurricane Floyd. As a result of the evacuation order, the insured restaurant owner closed its restaurants in Brevard County and evacuated the area for two and a half days. The insured sought coverage under a "Civil Authority" provision for the income it lost during the time it could not operate its businesses. The provision at issue stated:

We will pay for the actual loss of "business income" you sustain and necessary "extra expense" caused by action of civil authority that prohibits access to your premises due to direct physical loss or damage to property, other than at the "covered premises," caused by or resulting from any Covered Cause of Loss.93

The insurer rejected the claim, asserting that the evacuation order was issued due to the "threat" of property damage to other property, rather than the actual property damage required under the policy. The insured then brought suit, in part, for breach of contract. The trial court found in favor of the insurer on that claim. The Georgia Court of Appeals reversed, finding issues of fact regarding whether there was damage to other property, even though the evacuation order was based on the threat of damage from the hurricane.94 On remand, the trial court found in favor of the insured, and the insurer appealed.

The same appellate court then affirmed the trial court's decision, finding that the evidence supported the existence of the requisite property damage. At trial, the parties had stipulated that the evacuation order was in effect for two and a half days; that the insured's restaurants were closed because of the evacuation order and that the insured lost business income during that time; and that property damage occurred during the term of the evacuation order when the hurricane came on land. The insured introduced photographs of the hurricane's landfall in the Bahamas and presented testimony that '"there was a lot of damage being done to the south of us [Brevard County] at the various islands that it crossed.' "95 The insured also presented testimony that the evacuation was based on "the fact that the storm had been causing damage in its path, the forecast that the storm was headed to Brevard County, and the anticipated impact of the storm if it reached Brevard County."96

The appeals court concluded that the trial court's ruling in favor of the insured was an "implicit[ ] finding that a basis for the evacuation order was actual damage to property other than the insured premises."97 Noting that the trial judge's findings were not "clearly erroneous," the appellate court affirmed the trial court's ruling.98

By contrast, in Santa Monica Amusements, LLC v. Royal Indemnity Co.," the court found that a "Civil Authority" provision did not apply because there was no damage "to property other than insured premises."100 In that case, one of the suspects barricaded himself with hostages in an arcade on the Santa Monica Pier during a shootout with police. Consequently, the police prohibited public access to the Pier for some eighteen hours.

The insured lost income during the Pier closure and during the thirty days following the closure because of a decline in attendance. The insured then sought coverage under the "Civil Authority" provision in its policy. The insurer paid for the loss of earnings incurred by the insured during the actual closure of the Pier, but not for the alleged loss of earnings incurred after the Pier reopened. The insured brought suit, contending that the "Civil Authority" provision was unambiguous and did not limit coverage only to income lost during the closure and consequent denial of access.

The court disagreed with the insured, concluding that the "Civil Authority" provision was not triggered because the Pier had not closed due to property damage, as required. (Note that the insurer paid for the insured's lost income during the closure even though the "Civil Authority" provision was never triggered.) In holding that the insured was not entitled to coverage, the court observed:

The undisputed evidence indicates that the police prohibited public access to the pier for 18 hours to apprehend a suspect who had barricaded himself with hostages in an arcade on the pier. Although a shootout resulted in bullet holes in property other than the insured property, there is no evidence in the record to indicate that the pier was closed due to bullet holes or any other property damage.101

B. Physical Damage and "Denial of Access"

In the wake of September 11, one case of special interest has addressed the scope of civil authority provisions and ruled in favor of the insurance company. In 730 Bienville Partners Ltd. v. Assurance Co. of America,102 the owner of two hotels in New Orleans, Louisiana, sought coverage under the "Civil Authority Extension" of its commercial property policy for loss of business income allegedly incurred because of the post-9/11 Federal Aviation Administration's ("FAA") order closing all the airports in the United States. The insurance company denied coverage, and the insured brought suit.103 The "Civil Authority" provision at issue stated:

We will pay for the actual loss of 'business income' you sustain and necessary 'extra expense' caused by action of civil authority that prohibits access to your premises due to direct physical loss of or damage to property, other than at the 'covered premises,' caused by or resulting from any Covered Cause of Loss. This coverage will apply for a period of up to 4 consecutive weeks from the date ofthat action.104

The insured had argued that the FA As closure of the nation's airports after September 11, and the subsequent cancellation of numerous flights, kept many guests from getting to its hotels. Although the insured argued that the civil authority provision in its policy covered the loss of business income and necessary expenses, the court disagreed.

As noted in the quotation above, the loss of business income and necessary expenses were covered only if "caused by the action of civil authority that prohibits access to your premises." In granting the insurance company's motion for summary judgment, the court looked to the ordinary meaning of the policy text. It then concluded: "While the FAA's closure of the airports and cancellation of flights may have prevented many guests from getting to New Orleans and ultimately to plaintiff's hotels, the FAA hardly 'prohibited' access to the hotels."105

The court noted that Webster's Third New International Dictionary defined the word "prohibit" as meaning "to forbid by authority or command."106 The court offered that "[t]he FAA did not forbid travelers from staying at the hotels if other than air transportation was available. Any other interpretation of the policy would pervert the ordinary meaning of words and stretch the notion of causation beyond any doctrine."107

Thus, in reaching its decision to deny coverage, the Bienville court strictly construed the term "prohibit" as used in the civil authority provision at issue. By doing so, Bienville indicates that civil authoritative action resulting in something less than actual prohibition of access - such as impairment of access - will be insufficient to support civil authority coverage. Moreover, Bienville demonstrates that courts may be unwilling to stretch the causal relationship between a civil authority order and the loss of access to encompass an insured's remote, but undamaged property.

Similarly, in 54th Street Limited Partners v. Fidelity & Guaranty Insurance Co.,108 the city denied access to the insured restaurant on December 7 and 8. Thereafter, both vehicular and pedestrian traffic was diverted, but access to the restaurant was not denied. The insured sought coverage, in part, under the "civil authority" provision of its business interruption policy. Although the court did not repeat the language ofthat provision in its decision, the court held that the provision applied only to the income lost while access to the restaurant was denied by the act of civil authority - i.e., December 7 and 8. However, the provision did not cover the loss of income allegedly due to the subsequent diversion of vehicular and pedestrian traffic because "the restaurant was accessible to the public, plaintiff's employees and its vendors."109

IV.

CONCLUSION

Circumstances arise in which losses that might not be covered under most commercial property policies are covered as a consequence of unusual policy language. In addition, there are instances in which result-oriented jurisprudence prevails over contractual language and majority precedent. As a general proposition, however, the "physical damage" requirement is still alive and well, though it may be tested in pending cases arising out of September 11, 2001 or recent natural disasters, such as the California fires.

As the world becomes increasingly globalized and interdependent, events occurring thousands of miles away to perfect strangers can affect businesses to some significant degree. Although a causal relationship may exist between these distant events and business slowdowns or closures, insureds cannot hope to substitute the often infinite results of causation analysis for finite contractual conditions precedent. Commercial property insurance cannot be used as financial guarantee insurance.

Andrew B. Downs is a shareholder in the firm of Bullivant Houser Bailey, PC, residing primarily in its San Francisco, California and Las Vegas, Nevada, offices. Mr. Downs is admitted to practice in California and Nevada and specializes in the representation of first-party property, inland marine and ocean marine insurers in connection with coverage and extra-contractual claims throughout California and Nevada. He was formerly Chair of the Property Insurance Law Committee of TIPS, and is currently a Vice Chair of the Property Insurance section of the Federation of Defense & Corporate Counsel. Mr. Downs is a member of the Editorial Board of West 's Insurance Litigation Reporter and authored the chapter on concurrent causation in the West/TIPS multi-volume treatise, Law and Practice of Insurance Coverage Litigation. He is a frequent speaker and author on property insurance and extra-contractual liability issues and is a regular panelist at the Property Loss Research Bureau 's Claims Conference.

Linda M. Bolduan is an associate with Bullivant Houser Bailey, PC. She is a member of the American Bar Association and is admitted to practice in the Oregon state and federal courts. Ms. Bolduan s practice focuses on insurance coverage.

Copyright Federation of Defense & Corporate Counsel, Inc. Summer 2004
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