The outcome of the FCA business interruption test case

Introduction

The High Court has handed down its judgment in the much anticipated business interruption insurance test case brought by the Financial Conduct Authority (FCA) to clarify whether policy wording in business interruption (BI) insurance policies covers losses as a result of COVID-19 lockdowns and the enforced closure of business premises and other venues to the public. The FCA asked the High Court to rule on the meaning of a representative sample of BI policy wording from eight different insurers, who were asked to take part in the test case.

The policy wordings under consideration were those purchased primarily by small and medium size business but a number of parts of the judgment will have wider application for those more bespoke policies purchased by larger corporates.

The result of the test case is, of course, legally binding on the insurers that are parties to the case as regards the interpretation of the policy wording considered by the Court. However it also represents persuasive guidance for the interpretation of similar policy wording in other claims. In its submissions to the Court the FCA noted that the outcome of the case has the potential to affect over 60 insurers with 700 types of policy and potentially 370,000 policyholders.

Key Points

The Court's ruling favours the FCA (representing policyholders) on the key issues of coverage, causation and trends clauses.

The Court decided that most, but not all, of the disease clauses (including hybrid clauses) in the sample provide cover.  

It also found that certain denial of access clauses in the sample provide cover, but this depends on the detailed wording of the clause and how the business was affected by the Government response to the pandemic, including for example whether the business was subject to a mandatory closure order and whether the business was ordered to close completely.

The test case has also clarified that the COVID-19 pandemic and the Government and public response were a single cause of the covered loss, which is a key requirement for claims to be paid.

Why this case is important for landlords and tenants.

The World Health Organisation declared COVID-19 a pandemic on 11 March 2020.  Shortly afterwards the Government introduced a number of emergency measures including regulations requiring the mandatory closure of all "non-essential" premises.  Notwithstanding the enforced closure of their premises tenants were, in most cases, still liable to pay rent and perform their obligations under the terms of their leases.

Commercial leases in England do not typically contain ‘force majeure’ termination provisions – whether automatic or at the tenant’s election. An argument that COVID-19  has frustrated the lease is theoretically possible under English law but is difficult to prove.  To prove frustration, a tenant must show that, due to an unforeseen event which is not the fault of either party, the obligations under the lease are radically different from those the parties contemplated and can no longer be performed. While the outbreak of COVID-19 was not anticipated, and is not the fault of either party, it will still be difficult for tenants to successfully claim their lease has been frustrated  and there is no reported case to date where a lease has successfully been frustrated.  

Whilst most commercial leases will have a rent suspension provision which is triggered when the premises are incapable of beneficial use/occupation, these clauses are typically linked to physical damage or destruction to the property.  COVID-19 itself does not cause physical damage to or destruction of premises, so these provisions are unlikely to be engaged.

Therefore, in the circumstances it would be advisable for both landlords and tenants to check what  insurance cover they might have in place to cover loss of income whilst premises were closed.  Policies often include business interruption cover but this may only be triggered where there is physical damage to property.  However businesses might have taken out extensions to BI cover, including cover for non-physical damage such as closure of premises or denial of access, or specific cover for infectious or contagious diseases.  

However the interpretation of the particular wording of BI policies in relation to COVID-19 claims has resulted in disputes between insurers and policy holders.  This led to the FCA taking the unprecedented step of bringing a test case in the High Court seeking to resolve the ongoing uncertainty for both insurers and policy holders. Before bringing the case the FCA stated that:

"the variation in the types of cover provided and wordings used mean it can be difficult to determine whether customers have cover and can make a valid claim. There are genuine doubts over the appropriate interpretation of the wording in some cases. This has led to uncertainty and disputes, with many customers who believe they have valid claims having these rejected by their insurer.  We believe the circumstances of the current coronavirus emergency, and its effect on businesses holding BI policies means this uncertainty needs to be resolved as quickly as possible."

What were the legal issues in the case?

The test case focused on the two common extensions to BI cover mentioned above:

• “infectious disease” cover where a notifiable disease has occurred  in the vicinity or at or within a given radius of the premises;
• “prevention/denial of access” cover where access to the business premises is prevented by restrictions imposed by a public authority.
• "Hybrid" cover where restrictions are imposed on the premises in relation to a notifiable disease.

Coverage

The court had to rule on how 21 different policy wordings from  8 insurers applied  to a set of illustrative assumed facts. This involved eight days of legal argument.  Importantly the Court was asked to clarify what constitutes a prevention/denial of access (e.g. will this apply if the premises remain open for takeaway or online delivery services?)  and what does it mean if a policy requires the disease to have occurred “in the vicinity”, or within a certain radius of, the insured premises?

Causation

The so called "trends and variation" clause also came under the court's scrutiny. This type of clause is fairly standard in BI policies and essentially adjusts the amount recoverable under the policy where wider factors have influenced the ability to trade. The trends clause aims to adjust the loss to represent income which would have been achieved "but for" the damage in the period after the trigger event.

This follows the case of Orient Express Hotels Ltd v Assicurazioni Generali SpA [2010] where it was held that loss of income caused by physical damage to hotel premises in New Orleans after Hurricane Katrina was not recoverable because the area had already been evacuated (the application of the  "but for" test).

It is therefore valuable to have guidance from the Court on how this should be applied in the context of a pandemic.

Outcome of the case

Being a test case, the case did not address all the issues that may be in dispute for a given policyholder, such as quantum of loss, aggregation of losses and any issues of conduct that may debar recovery. Nevertheless, many policyholders were waiting for the outcome of the case before taking stock of their position. 

Construction of the policy wording

Although the Court heard highly detailed arguments from both sides the Court's approach when analysing the policy wording was largely based on the correct construction of the words used.  The Court applied the well-known legal principles in Rainy Sky v Kookmin Bank (2011) that the 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”.

As might be expected the FCA was looking for the widest interpretation of the policy terms and the judgment includes a number of interesting conclusions.

• Notifiable disease wording
  
  The Court favoured the FCA's approach to the interpretation of this type of clause.
  
  Where the occurrence of COVID-19 was required in the vicinity or within a specified radius of the insured's premises the FCA argued that this did not mean cover was limited to a local incident.  The Court agreed.  If the incident was present both inside and outside the vicinity because it was part of a nationwide occurrence then cover would still be triggered and the fact that COVID-19 was a nationwide pandemic meant that it could be assumed there would be an "occurrence" in the vicinity of the premises. The policy wording, properly construed, did not require the occurrence to be only in the local area.  This reflects the nature of a notifiable disease which spreads widely.
  
  Therefore occurrences within the policy area could not be separated from those outside the policy area and each individual outbreak forms an indivisible part of the disease.
• Prevention of access /hindrance of use wording
  

  Local action

  The FCA had less success with these types of clauses which require the prevention or hindrance of access by the action of a public authority.  Generally the type of wording required the action by the local authority to be directly related to the occurrence of the disease in the local area of the insured premises.  Therefore, the insured may find cover is denied under this type of wording more often than not.
  
  

  Meaning of prevention

  Prevention was held to mean closure as oppose to hindrance which would simply necessitate some restriction of access.  However when considering whether access has been prevented will be very fact specific.  Although it is clear a physical obstruction is not necessary it does require the complete closure of the premises.  So, a restaurant which is closed to diners may not be said to be closed where it continues to offer a take away service.
  
  

  The nature of the Government action

  Government "actions" during the pandemic have taken a number of different forms.  Some announcements have been advisory only whilst others have had the force of law and are therefore mandatory.  The Court determined that in order for access to be prevented this must be as a result of a mandatory action of the public authority.  On the other hand issuing advice may be sufficient to amount to action which could be a hindrance of use.
  
  The Court held that for the purpose of the policy wordings under consideration only the requirements of the actual regulations (i.e. The Health Protection (Coronavirus Restrictions)(England) Regulations 2020 and The Health Protection (Coronavirus Business Closure)(England) Regulations 2020 which restricted movement and closed premises) amounted to mandatory action (in the sense that these actions had the force of law).  The Court said the wider social distancing guidance was not mandatory in this sense.
  
  This demonstrates that the precise words used in the context of what action has been taken by the public authority in the vicinity of the premises will be key factors in deciding if cover is available.
• Causation
  
  Although causation issues will be dependent on the facts of a particular case the Court drew a number of interesting conclusions here too.
  
  Insurers argued that policyholders could not prove that the insured risk (the occurrence of COVID-19 in the locality) was the proximate cause of the loss because, notwithstanding the presence of COVID-19 in the locality the loss would still have been sustained due to the nationwide presence of COVID-19 and the subsequent national response by the Government.  The Court concluded that the proximate cause of the loss was the notifiable disease  which constituted a single effective cause of which the individual occurrences were indivisible parts or if that was not the case then each individual occurrence was a separate effective cause of the national response.
  
  In relation to the application of the "trends and variation" wording the Court  found that it would apply to losses from non-damage extensions but gave guidance in the judgment as to how it should be applied in respect of each category of wording.
  
  Of particular interest was the Court's finding that it was not bound to follow the case of Orient Express in terms of the effect of trends clauses and,  in obiter comment stated that the case was wrongly decided. 

Comment

While the test case cannot address all possible disputes and will not determine how much is payable under individual policies, it has addressed a number of key contractual uncertainties.  However with so many overlapping issues being considered,  there is still potential for further uncertainty and disputes regarding how the judgment should be applied in individual cases.  

Given the significance of the decision  it would not be surprising if it was appealed by insurers.  We understand that this would leapfrog the Court of Appeal and be heard in the Supreme Court.  Pending the outcome of any appeal considerable uncertainty remains.