Flooding July 2007 – Business Interruption Issues

Various issues have arisen specifically relevant to Business Interruption covers as a consequence of the widespread flooding. These were debated at a meeting of the Business Interruption Specialist Interest Group on 17th July 2007. The issues identified are set out below for the benefit of members and others.

1. Operative Peril

The inundation of water is likely to be viewed by insured businesses in the first instance as flood.

There is an alternative view, that flood only arises where there is an escape of water from its normal confines, and that the excess water caused by backing up of drains or saturated water tables is not flood but storm arising from excess rainfall. A case arose following the Carlisle floods that tested this point. It was concluded that where a river overflowed and entered the drains, causing them to surcharge, this was a flood claim not a storm claim.

The CILA notes that the definition of flood set out in Young –v- Sun Alliance (1976) formed the basis for assessment of claims for many years, but draws the attention of members to the more recent cases of Rohan Investments –v- Cunningham (1998) and the Board of Trustees of the Tate Gallery –v- Duffey Construction (2007) (Technology and Construction Court JCT 80) which appear to widen the definition of flood. Additionally, various editions of the Ombudsman News published on line by the Financial Ombudsman Service discuss the issue of flood, and particular reference is made to the October 2001 edition.

It is clear that there may be uncertainty as to the specific peril operating and adjusters should refer to their Principals if the particular peril operating will impact on policy cover (if one of the perils of storm or flood were to be excluded or some form of limit to be applied to them for example).

2. Nature of Damage

Three categories of damage might be contemplated -

Damage at the Premises
Regardless of the particular peril which is operative, Damage at the Premises should be self evident. This is likely to satisfy the Material Damage Proviso and trigger the standard Business Interruption cover available. Difficulty may however be encountered depending on the definition of Premises. In the case of the Meadowhall Shopping Centre, some policy schedules appear to list the Premises as the specific unit occupied by the insured business, and others record the Premises as the Meadowhall Centre in Sheffield. This is unlikely to be significant for ground floor units that have suffered direct Damage, but is of relevance to units on the first floor. For first floor units that have not suffered Damage, the Material Damage Proviso may still be satisfied where the Premises are defined as the Meadowhall Centre but not where the specific unit occupied is identified. Where the Material Damage Proviso is not satisfied, claims may be payable under Denial of Access or Loss of Attraction covers (discussed below).
In the vicinity
The issue of the “vicinity” has been discussed previously. Some policies specifically define the vicinity (without necessarily stating whether this is by the most direct road route or as the crow flies) but most do not. In the case of the Meadowhall Centre, if policies define Premises as the particular unit occupied, the rest of the shopping centre is likely to be considered as the vicinity.
Customers/Suppliers
A number of policies now offer cover for unspecified customers/suppliers, subject to a limit of the overall sum insured (typically 10%). Limits may apply with regards the range of perils covered, and also geographically. In some circumstances, where the customers and/or suppliers can be identified individually and where it can be evidenced that their Premises have been damaged, then cover may be available under these extensions. Such cover is unlikely to assist with regards retail shops selling to the general public as the particular customers would not be identifiable irrespective of them being unspecified.

3. Quantum Issues

Business Interruption technically covers loss arising due to Damage at the insured Premises (or loss arising from the denial/hindrance thereto) rather than to losses caused by Damage or denial/hindrance to customer’s premises. Consideration was given by the CILA to providing detailed guidance as to the application of this principle to specific business types, but it was considered that as different business will be affected in very different ways (notably in terms of turnover trend post incident), such guidance might be misleading.

However, there are a number of trend and related issues that warrant specific consideration (See also the previous CILA Masterclass paper on flooding).

Small retailers serving the immediately local population may have seen a significant downturn in business (as a consequence of their customer base suffering damage) regardless of whether they suffer Damage themselves themselves. The amount payable under the policy (relating only to the loss arising from their Damage)should technically reflect this. The extent to which customers/suppliers extensions are available should be considered.

At the other extreme, hotels and businesses offering water pumping equipment for example, would likely have enjoyed a significantly increased trend due to the widespread flooding had they themselves not suffered damage. Significantly increased trends may be justified for those businesses. Other businesses may enjoy significantly higher trends after the flood waters have abated, notably DIY multiples and furnishing stores which are likely to enjoy enhanced patronage once the process of refurbishing homes begins.

Most policies will contain an alternative trading clause. For some chains, turnover may in part be deflected to other stores rather than being lost. Claims should be credited with the value of that

The overriding principal of the measurement of quantum is that losses must be directly attributable to the Damage (or denial/hindrance) to the insured premises rather than to the general area or infrastructure.

4. Denial of Access

The denial/hindrance of access cover relates to a physical denial/hindrance rather than any disinclination to visit the premises on the part of the customer base.

Specific mention again needs to be made of the Meadowhall Centre where the first floor shops will be fully accessible in advance of the ground floor shops. It is the view of the CILA that losses arising due to unrepaired damage on the ground floor, after access to the first floor is restored, would only be payable if a loss of attraction cover was included in the policy.

Denial of Access extensions will require Damage to property in the vicinity to operate.

Damage
For the flooding generally, the issue has arisen as to whether a flooded road represents Damaged property for the purposes of triggering Denial of Access cover. It is CILA’s view that flooded roads are temporarily damaged and will trigger Denial of Access cover. Whilst no permanent repairs may be required once the flood waters abate, the CILA’s understanding of the Financial Ombudsman’s view on this matter, which is consistent with the majority of dictionary definitions of damage, is that impairment of use is likely to be held to constitute damage.

Property
It is suggested that roads are likely to be the property of the local authority or other public body, albeit it is noted that roads are unlikely to be insured (but bridges may well be). Denial of Access extensions requiring damage to insured Property in the vicinity would not respond to the flooding of roads where these are not insured.

Flood exclusions to Denial of Access covers should be discussed with Principals if there is doubt as to whether the operative peril is flood or storm (as discussed in 1. above).

The CILA notes that there are policies which specifically restrict Denial of Access indemnity periods either to the period during which physical access is denied or hindered (thereby excluding any allowance for the subsequent build up that may arise due to the pre-incident levels of turnover) or alternatively may limit the cover to a fixed number of days. Time excesses or franchises may also apply.

5. Shopping Centres

Various comments have been made above in relation to shopping centres: further specific points can also be made.

The Proactive retailer

On most retail parks/shopping centres, there is a mix of national names and local retailers.

The attitude of the retailers to the Damage resulting from the water ingress can vary, with some taking a more “can do” approach, opening their store before the landlord has fully completed the repairs to the structure within their demise. They may also be prepared to use some of their damaged fixtures until new ones can be installed at a later date, during which latter period, the shop will need to be closed again.

Other retailers on these parks may not be prepared to put their brand at risk, and may decide to wait until their store is fully repaired and their replacement fixtures installed.

Whilst most of the retailers on site remain closed, pending full repairs, the footfall to the retail park will inevitably reduce. The “can do” retailer, who opens early, consequently experiences reduced sales.

Some retailers in a shopping centre may have both denial of access and loss of attraction cover that would respond to such a reduction in turnover, but many will not. As discussed at item 4 above, it can technically be argued that any reduction in trade to the “can do” retailer results from a loss of attraction rather than from Damage, and would therefore not be covered by the policy.

There is an alternative view, which would be to consider whether it would have been reasonable for the “can do” retailer to have not re-opened until all repairs have been completed on the structure and their fittings, ( Whether this is a reasonable approach or not will depend on the merits of each case. The actions of co-tenants may be one of the relevant factors to be borne in mind. There may have been minimal damage to the Insured’s demise and they have no reason to remain shut. In those circumstances tenants without loss of attraction cover will have no recompense.). If it would have been reasonable to have delayed re-opening, the whole of the turnover shortfall would have been covered by the policy. The “can do” retailer might therefore be worse off than a retailer that stays closed.

The CILA is not suggesting that any failure to mitigate loss should be encouraged. A decision to not re-open needs to be tested for reasonableness. Irrespective of the stance of the insured retailer, it could be argued that the failure of the other shops to re-open is a deliberate action by a third party, which is a new cause, exacerbating the loss, but not flowing from the Damage.
Meadowhall
As many adjusters will be aware, Meadowhall Shopping Centre has over 270 stores, on two floors, under one roof, as well as a selection of cafes, restaurants and leisure attractions, including an 11 screen cinema complex. It also has copious free parking. The flood waters from the River Don entered the ground floor of the shopping centre and reached varying levels from 75 mm to about 1000 mm. In addition the car park, service roads , yards and areas of landscaping were under water. Damage to the centre includes fabric and mechanical and electrical services

About 100 tenants on the ground floor have had to vacate the centre, pending repairs. The top floor ,which was not directly damaged by the water, re-opened on Monday 2 July 2007 losing six days of trading (due to damage to the Meadowhall centre itself). Some ground floor tenants have also resumed trading but repairs are outstanding both to individual units and the general area, and the ambience is adversely affected).

As noted above at 2a, some of the tenants have “Meadowhall” as the policy address whilst others specify the exact unit that they occupy.

Notwithstanding the wording on the schedule, all tenants are dependant on the common facilities. They all rely on a functioning mechanical and electrical system and also availability of the free car park attached to the centre. That does not mean that adjusters can extend the definition of Premises in the absence of instructions from Principals, but it is suggested that, in these circumstances, the definition of Premises requires consideration when calculating Insured Business Interruption losses.

Ground floor tenants are likely to have a legitimate claim under the main section of the policy in view of Damage to the centre generally (as are first floor tenants listing the centre generally as the Premises – first floor tenants listing Premises as their specific unit will need specific Denial of Access cover in the absence of any alternative instruction from Insurers).

Once the top floor re-opened, the majority of the continuing losses for first floor tenants would only fall for consideration under a Loss of Attraction extension.

Inevitably, there will be a ‘tail’ to the losses arising from Denial of Access, but any reduction in turnover will primarily be a result of the reduced attraction of the centre generally. For the guidance of adjusters, it is not anticipated that the losses accruing in any ‘tail’ will exceed the losses during closure.

Turning to the ground floor, this remains in a less attractive state due to widespread closure of tenants. Most of those stores which have re-opened were slightly damaged and did not need to remain closed even though there is a lot of building works being undertaken nearby (subject to the discussion about the “can do” tenant above).

As with the first floor, the definition of Premises needs to be considered, ie. is it the Meadowhall centre overall or the specific unit. Subject to this, a point will arise where the ongoing losses after re-opening will need to be considered as loss of attraction, unless there is clear hindrance of access.

The Meadowhall situation can be summarised graphically as follows:
1. Business Interruption cover for a ground floor retailer suffering direct Damage
  
  The business interruption cover will be triggered in the normal way, potentially running to the end of the Maximum Indemnity Period. The graph above anticipates an ongoing recovery of turnover once the ground floor is fully reopened.
  
  As discussed in 3 above, business interruption loss flowing from wide area damage is technically not covered, This includes loss arising from a hindrance of access to customers premises. This may mean that there would have been a turnover shortfall regardless of Damage to the Premises. The graph reflects this by showing the policy loss in blue, but the wide area loss in green. As discussed above, insurers specific instructions as to the merits of each case (which may vary considerably according to the type of business involved) should be taken.
2. Business Interruption cover for a first floor retailer with the Meadowhall Centre listed as Premises
  
  This graph again anticipates a potential uninsured policy shortfall due to the wide area damage. The losses are likely to end sooner after the shopping centre reopens than is anticipated for the ground floor units – no direct damage will have been suffered, and the first floor units will have been closed for significant periods. A minor allowance for turnover recovery after full re-opening is allowed for. This is why the period of loss is shown on the graph as continuing after the point of full opening.
3. Business Interruption cover for a first floor retailer with the specific unit occupied in the Meadowhall Centre listed as Premises
  
  First Floor retailers that have not satisfied the Material Damage Proviso will need to look to Denial of Access or Loss of Attraction covers, if available. Once there is no hindrance of access to the first floor, any ongoing loss is likely to be attributable to the state of any unrepaired areas on the ground floor, which would require a Loss of Attraction extension. A minor allowance for turnover recovery under the denial of Access extension after full re-opening is allowed for. This is why the period of loss for Denial of Access is shown on the graph as continuing after the point of first floor re-opening, and after full opening in the case of Loss of Attraction.

It will clearly not be possible to disclose details of particular claims, but the CILA will monitor claims developments and offer further advice if any additional issues begin to present themselves during claim discussions in the coming weeks/months.