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Contingent Business Interruption Coverage: District of Maryland Federal Court Finds Policy Terms Ambiguous As Basis For Finding Coverage

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In Millennium Inorganic Chemicals Ltd v. National Union Fire Ins. Co., 2012 U.S. Dist. LEXIS 140257 (D.Md., Sept. 28, 2012) [insert link], the federal district court for the district of Maryland addressed an important issue regarding contingent business interruption coverage – what is a “direct” supplier of goods or services. As is explained in the opinion, contingent business interruption coverage (often referred to by the acronym “CBI coverage”) provides coverage for loss of business income caused by an interruption of business operations caused by physical loss or damage to property of an insured’s supplier or customer if that physical damage is caused by a covered cause of loss. An issue that has arisen in determining whether coverage exists under this provision is whether the supplier or customer is a “direct” or “indirect” supplier or customer. Some policies identify the specific suppliers and/or customers whose property damage could trigger CBI coverage, others require that the supplier and/or customer be a “direct” supplier or customer, and yet others simply provide for coverage for losses caused by damage to suppliers or customers without specifying whether the supplier or customer must be “direct.” Before Millennium, there were only three reported cases addressing the issue of whether a “direct” relationship between the insured and the claimed supplier or customer is required in order to establish CBI coverage. 

In Archer-Daniels-Midland Co. v. Phoenix Assurance Co., 936 F.Supp. 534 (S.D.Ill. 1996), the global agribusiness of the insured, ADM, sustained losses of income due to flooding of farmland in the Mississippi River valley. ADM purchased its grain from wholesalers who, in turn, purchased the grain from farmers whose land was flooded. Sometimes, multiple wholesalers were involved, but the farmers were the source of the grain. The policies at issue in ADM provided that they covered loss of business income “caused by damage to or destruction of real or personal property…of any supplier of goods or services which results in the inability of such supplier to supply an insured location.” The court noted that although the farmers may be “indirect” suppliers of ADM, they were suppliers nonetheless, and that since the policy provided coverage for losses of “any” supplier of goods or services, CBI coverage was available to ADM. In Pentair Inc. v. Amer. Guar. & Liab. Ins. Co., 400 F.3d 613 (8th Cir. 2005), an earthquake disabled an electrical substation that provided electric power to two factories which manufactured products that were supplied to the insured. The insured needed to “cover” by purchasing substitute supplies from a different supplier for a higher cost. The insured sought to recover for its contingent extra expenses (extra expenses caused by damage to a supplier) under a policy that provided coverage for “losses incurred by Pentair as the result of damage to property of a supplier of goods and/or services to the Insured that is caused by a covered peril.” The Eighth Circuit held that the power substation was not a “supplier of goods and/or services” to Pentair, and that CBI coverage was therefore not available. In Park Electrochemical Corp. v. Continental Cas. Co., 2011 WL 703945 (E.D.N.Y. 2011), a manufacturing facility owned by a subsidiary of the insured supplied component parts needed for the insured’s manufacturing operations. The subsidiary’s facility sustained physical damage that prevented it from supplying its parent. The policy in issue provided CBI coverage for loss of income “caused by direct physical damage or destruction to…any real or personal property of direct suppliers which wholly or partially prevents the delivery of materials to the insured or to others for the account of the insured.” The court found that the term “direct suppliers” was ambiguous, and found that there was no CBI coverage available for the parent/insured’s losses. 

In Millennium, the insured produced titanium dioxide, a white pigment used in manufacturing a range of products such as paint, plastics and paper. The insured’s manufacturing facility, located in Western Australia, was fueled by natural gas. The gas was produced by two entities: a joint venture headed up by Apache and an entity named the North West Shelf Joint Venture. The two joint venture suppliers sent their gas product into a single pipeline, where it was comingled, and ultimately delivered to end users.  Both joint ventures ceased to hold title to the gas when it entered the pipeline, and title passed to a third party, named Alinta.  Neither of the gas producers nor Alinta owned the pipeline, which was owned by a different entity. Alinta entered into contracts with end users, including Millennium, and sold the gas to them. Alinta, however, never technically had possession of the gas. An explosion at the Apache facility interrupted Apache’s supply of gas into the pipeline, and had the effect of interrupting the supply of gas to Millennium. Millennium made claim with its insurer under its CBI coverage. Although the policy language used different terms in different places, the parties appear to have agreed that coverage was provided for loss of income caused by damage to a “direct contributing property.” The insurers argued that “direct contributing property” required that the property be a “direct supplier.” Although the insured disputed this, the court undertook its analysis based on an assumption (“arguendo”) that the direct supplier language in another part of the policy applied in determining whether a property was a “direct contributing property.” The “direct supplier” language provided that “the following locations must be direct suppliers of materials to the Insured’s locations or coverage is deemed to be void.” The court then held that even under this assumption, the policy language was ambiguous, and could reasonably be interpreted to provide coverage. The court noted that the words in the policy referenced properties, and not people or entities. Thus the policy referenced “direct contributing property” and required that “locations must be direct suppliers” instead of “damage to property of a supplier.” The court also noted that the insurers had conceded that contractual privity was not required to prove that a location was a “direct contributing property” or “direct supplier.” The reason for this concession by the insurers is not clear from the opinion. The court noted

“The Insurers argue that, if there is no contractual relationship, some other ‘direct relationship’ between Apache and Millennium would be necessary for Apache to be a direct contributing property to Millennium. But, the Insurers are unable to explain what they mean by the phrase ‘direct relationship,’ aside from a contractual relationship.” 

The court found that because Apache put the gas into the pipeline and that uninterrupted physical forces moved the gases into the possession of Millennium, this was sufficient to make the Apache property a “direct contributing property.” 

In light of the ADM case, many insurers have changed the language of their CBI coverage language to restrict coverage to losses caused by damage to the property of a “direct supplier and/or customer.” The Millennium case may be cited by insureds to support an argument that the “direct” requirement in these policies can be avoided if the product being supplied is unaltered while it is being transported to the insured. Such an argument, however, would be misplaced, as the language in the Millennium policy and the facts in issue in Millennium ar fairly unique. First, as the court noted, the policy language spoke in terms of properties, not people or entities. The result of Millenniummight be different if the policy language referred to damage to property of suppliers and/or customers. Second, the court relied heavily on the physical process by which the gas was transported to Millennium, and noted that neither the owner of the pipeline nor Alinta did anything to transport the gas, and that the gas was transported by natural physical forces. That is not true in the case of most other commercial transactions. Finally, the Millennium decision relies heavily on the fact that the insurers conceded that privity of contract is not required to make a supplier a “direct supplier.” The court also noted that the policy in issue contained other provisions that did require contractual privity, thus making it clear (in the court’s eyes) that privity was not required to establish CBI coverage. Depending on the policy language in issue, insurers may be able to make a persuasive argument that contractual privity is required.   

Finally, even given the unique policy language and factual background presented, it is not at all clear that Millennium was correctly decided. Missing from the opinion is any consideration as to whether there can be more than one “direct” supplier of a particular material. A good argument can be made that there can only be one direct supplier and that, in this case, given the unusual policy wording, the “direct contributing property” was the pipeline. If the pipeline, instead of the Apache property, had been damaged, it is pretty clear that the pipeline would have been considered a “direct contributing property.”


Business Interruption Requires Complete Cessation of Operations: Fifth Circuit Affirms, In Part, Southern District of Texas Grant of Summary Judgment to Insurer

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In GBP Partners Ltd. v. Maryland Casualty Company, 2013 U.S.App.LEXIS 563 (5th Cir. Jan. 4, 2013), the U.S. Court of Appeals for the Fifth Circuit reviewed the entry of summary judgment by the trial court in favor of the insurer. GBP arose out of damage to the roof of a shopping center caused by the winds from Hurricane Ike. The insured, GBP, was the owner of the shopping center, and made claim with its insurer for the cost of replacing the roof, loss of rent under the rental income/business interruption coverage, loss of rent in the form of rent abatements for tenants, management fees, and window damage. The insurer paid $2.3 million for the replacement of the roof but denied the remaining claims. The federal district court for the Southern District of Texas entered summary judgment in favor of Maryland Casualty. On appeal, the Fifth Circuit found that: 

1) there was no coverage under the rental income/business interruption coverage because there was no complete cessation of the insured’s operations. The Fifth Circuit noted that several tenants remained doing business in the shopping center and continued paying rent. The court cited to Apartment Movers of Am., Inc. v. One Beacon Lloyds, 170 Fed.Appx. 901, 2006 WL 678675 (5th Cir. 2006); H&H Hospitality LLC v. Discover Specialty Ins. Co., 2011 U.S.Dist. LEXIS 146055 (S.D. Tex. 12/20/11); and Quality Oilfield Prods.Inc. v. Mich. Mut. Ins. Co., 971 S.W.2d 635, 637 (Tex.App. – Houston, 1998) in support of this proposition. 

2) coverage was potentially available for rent abatements under the Extra Expense coverage in the policy. The Fifth Circuit noted that the insured had produced evidence that the rent abatements were necessary to keep their tenants from moving out after the roof damage, and found that “The Policy covers not just extra expense associated with a suspension of operations but extra expense necessary to avoid a suspension of operations.” The Fifth Circuit, however, also found that “GBP must still establish that the extra expense was due to a covered loss. The court noted that although there was conflicting evidence in the record as to whether the need for the rent abatements was caused by the (covered) roof damage or the (excluded)  loss of utility service, the conflicting evidence was sufficient to create a genuine issue of material fact which should have precluded the entry of summary judgment on this part of the claim. The Fifth Circuit therefore reversed the entry of summary judgment on the rent abatement issue, and remanded to the district court for a trial on the issue of whether need for the rent abatements were caused by the roof damage. 

3) summary judgment in favor of the insurer on the claim for the recovery of increased management fees was proper. The insured’s contract with the management company was up for renewal shortly after the loss. When the contract was renewed, the management fees were increased over the fees paid under the earlier term of the contract. The Fifth Circuit found that the insured had failed to produce sufficient evidence showing that the increase in fees was caused by the greater management demands caused by the Hurricane Ike roof damage. 

4) summary judgment in favor of the insurer on the window damage claim was proper.  Almost three years after Hurricane Ike, the insured retained a consultant to inspect the windows at the shopping center, and subsequently submitted a proof of loss claiming that the hurricane had caused damage to the windows. The district court entered summary judgment for the insurer on this claim, finding that the insured had failed to provide timely notice of loss and had failed to create a genuine issue that the damage to the windows was caused by Hurricane Ike rather than a non-covered peril. The Fifth Circuit affirmed, finding that “Regardless of the timeliness of its notice, GBP’s claim for window damage must fail because GBP did not offer evidence to establish what part of the damage to the windows was caused by Hurricane Ike as opposed to some other non-covered event.” The court also found that GBP waived its argument on this issue by inadequately briefing the issue on appeal.” 

The GBP decision is significant in three respects

- First, it adds to a growing body of authority that under Texas law, an insured must establish a complete cessation of operations in order to recover under the business interruption coverage in its policy. While there is support for this proposition in Kansas and California (see Home Indem. Co. v. Hyplains Beef, 893 F.Supp. 987 (D. Kan. 1995) and Buxbaum v. Aetna Life & Cas. Co.,126 Cal.Rptr.2d 682 (2002)), this continues to be the minority rule, as the majority of jurisdictions have found that a complete cessation of one part of the insured’s total operations is required. Nonetheless, virtually all jurisdictions hold that a simple slowdown of operations, or a simple loss of business income is not sufficient to trigger coverage.

- Second, the Fifth Circuit reaffirmed the basic, but too often overlooked, proposition that recovery for extra expense requires proof that the expenses be caused by covered physical damage.  See Imperial Trading Co., Inc. v. Travelers Prop. Cas. Co. of Amer., 2009 U.S.Dist. LEXIS 64010 (E.D.La. 2009). 

- Third, in its ruling regarding the window claim, the Fifth Circuit found that the insured was required to show which part of the loss was caused by a covered peril as opposed to a non-covered peril. While seeming to acknowledge that the insured had produced evidence that some part of the window damage may have been caused by Hurricane Ike, the court found that this was insufficient because the insured was obligated to show how much of the damage was caused by the hurricane. This seems to parallel the Hurricane Katrina cases regarding who has the burden of separating covered from excluded loss, although some of those cases were decided based on the anti-concurrent causation clause in the policy. See Bayle v. Allstate Ins. Co., 615 F.3d 350 (5th Cir. 2010); Leonard v. Nationwide Ins.Co., 499 F.3d 419 (5th Cir. 2007); Tuepker v State Farm Fire & Cas. Co, 507 F.3d 346 (5th Cir. 2007).

Contingent Business Interruption Coverage: Fourth Circuit Determines “Direct” Is Unambiguous In Reversal Of District Of Maryland

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You may recall that we posted a summary of Millennium Inorganic Chemicals Ltd v. National Union Fire Ins. Co., 2012 U.S. Dist. LEXIS 140257 (D. Md. Sept. 28, 2012), where the federal district court of the district of Maryland analyzed whether contingent business interruption coverage was triggered where coverage applied only to “direct” contributing properties. In Millennium, the insured’s manufacturing facility was located in Australia, and was fueled by natural gas. Two entities (Apache and North West Shelf Joint Venture) produced the natural gas, which was then transferred into a pipeline which was owned by another entity. Once the gas entered the pipeline, title to the gas transferred to the other entity, Alinta. Millennium contracted with Alinta for delivery and purchase of the gas. An explosion occurred at the Apache facility, which resulted in an interruption of the supply of the gas to Millennium. The district court determined that the term “direct” was ambiguous, construed the policy in favor of Millennium, and found that Millennium’s claim for loss of business income was covered because it was caused by the damage to Apache’s property, which was, according to the district court, damage to a “direct” supplier of Millennium.

In our posting, we predicted that perhaps Millennium was not correctly decided. The Fourth Circuit recently reversed Millennium, and directed summary judgment to enter for the insurer. Millennium Inorganic Chemicals Ltd., et al. v. National Union Fire Ins. Co, et al, 2014 U.S. App. LEXIS 3096 (4th Cir. Feb. 20, 2014). The Fourth Circuit determined that the term “direct” is unambiguous and defined that term as “proceeding from one point to another in time or space without deviation or interruption,” “transmitted back and forth without an intermediary,” or “operating or guided without digression or obstruction.” Relying on this definition, the Fourth Circuit stated succinctly:

“Whatever the relationship between Apache and Millennium, it was interrupted by an intermediary, Alinta.”

As we noted in our summary of the district court’s decision, there is a dearth of case law on contingent business interruption coverage, and the Fourth Circuit’s decision may be useful to insurers in Superstorm Sandy litigation in addition to other catastrophic losses. It should be remembered, however, that not all contingent business interruption coverages include the word “direct” in describing suppliers and/or customers. The question of whether damage to property of “indirect” customers or suppliers can trigger contingent business interruption coverage when the policy language does not specify whether the customer or supplier must be “direct” remains largely unresolved in the caselaw.

 





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