After an appeal heard urgently under the “leapfrog” procedure, the Supreme Court handed down last Friday, 15th January 2020, a stunning victory for policyholders in the FCA’s Test Case on business interruption insurance cover for COVID-19 related losses.

You can access the judgment of the High Court and our earlier blog post here. In handing down its Judgment, the Supreme Court published an excellent and concise Press Summary. In this article, we identify the most immediate standout remarks from the Judgment, followed by some initial observations upon the broader implications of the Supreme Court’s landmark analysis.

The Supreme Court underlined the fundamental principles of English law which apply to the interpretation of insurance policies. These were authoritatively reviewed most recently by the Supreme Court in Wood v Capita Insurance Services [2017] UKSC 24. The core principle is that an insurance policy, like any other contract, must be interpreted objectively by asking what a reasonable person, with all the background knowledge which would reasonably have been available to the parties when they entered into the contract, would have understood the language of the contract to mean. Evidence about what the parties subjectively intended or understood the contract to mean is not relevant to the court’s task.

In the present case, where commercial policies were sold predominantly to SMEs, “the person to whom the document should be taken to be addressed is not a pedantic lawyer who will subject the entire policy wording to a minute textual analysis…It is an ordinary policyholder who, on entering into the contract, is taken to have read through the policy conscientiously in order to understand what cover they were getting [77].

Disease Clauses

Losses resulting from any occurrence of a notifiable disease within a specified radius of the insured premises

• Disagreeing with the High Court: “No reasonable reader of the policy would understand the words “any…occurrence of a Notifiable Disease within a radius of 25 miles…” to include any occurrence of a Notifiable Disease outside a radius of 25 miles. To seek to interpret the language of the policy as bearing such a meaning is to stand the clause on its head” [61].
• The Supreme Court followed the widely recognised meaning of “occurrence” in insurance law, which accords with its ordinary meaning as “something which happens at a particular time, at a particular place, in a particular way” [67]. “The interpretation which makes best sense of the clause…is to regard each case of illness sustained by an individual as a separate occurrence” [69]. Further, “the insured peril is not the disease generally nor an “outbreak” of the disease”. “It is not the outbreak nor the disease itself which constitutes a “notifiable disease”, but the illness sustained by any person resulting from that disease” [70] at a particular time and place which constitutes the insured peril.
• Same result, different method: “it is right that the language of the disease clause…does not confine cover to business interruption which results only from cases of a notifiable disease within the 25 mile radius…That is an important point when considering questions of causation. But it does not follow that cases of a disease occurring outside the specified radius are themselves part of the peril insured against” [72].
• Accordingly, under specimen standard policy RSA 3, the disease clause “is properly interpreted as providing cover for business interruption caused by any cases of illness resulting from COVID-19 that occur within a radius of 25 miles of the premises from which the business is carried on. The clause does not cover interruption caused by cases of illness resulting from COVID-19 that occur outside that area” [74].

Prevention of Access & Hybrid Clauses

Losses resulting from the restrictions imposed by a public authority and clauses combining disease clauses and prevention of access clauses

• Rejecting the High Court’s reasoning: “we do not accept that [“restrictions imposed”] is limited in its meaning to an exercise or threatened exercise of legal powers, as this case illustrates. When the Prime Minister…instructed named businesses to close “tonight”, that was a clear, mandatory instruction given on behalf of the UK Government. It was an instruction which both the named businesses and the public would reasonably understand had to be complied with without inquiring into the legal basis or anticipated legal basis for the instruction. We consider that such an instruction is capable of being a ”restriction imposed”, regardless of whether it was legally capable of being enforced” [120].
• Whilst an “inability to use” is not an impairment or hindrance, “we do not accept that the inability has to be an inability to use any part of the premises for any business purposes” (emphasis added) [136]. Therefore, “the requirement is satisfied either if the policyholder is unable to use the premises for a discrete part of its business activities or if it is unable to use a discrete part of its premises for [the whole or part of] its business activities. In both those situations there is a complete inability of use. In the first situation, there is a complete inability to carry on a discrete business activity. In the second situation, there is a complete inability to use a discrete part of the business premises” [137].
• The FCA accepted “that there is only cover for that part of the business for which the premises cannot be used. If, for example, a restaurant which also offers a takeaway service decides to close down the whole business it could only claim in relation to the restaurant part of the business” [141]. The same reasoning applies to the “prevention of access” [155]. But, there must be an inability of use or prevention of access, rather than a “hindrance” or “disruption”.

Causation

• The Supreme Court concluded that the specimen disease clauses only cover the effects of cases of COVID-19 occurring within the specified radius of the insured premises. “On this basis, the question of what [causal] connection must be shown between any such cases of disease and the business interruption loss for which an insurance claim is made becomes critical” [161].
• According to established authority, the choice of the real or efficient cause, from out of the whole complex set of facts, must be made by applying common sense standards [167].
• “It is no answer to a claim under a policy that covers one cause of a loss that the loss was also due to another cause that was not so covered (Board of Trade v Hain Steamship Co Ltd [1929] AC 534, 539) [171] and “where there are two effective causes, neither of which is excluded but only one of which is insured, the insurers are liable” (ENE Kos 1 Ltd, Petroleo Brasileiro SA (No 2) [2012] UKSC 17) [173]. However, “where there are two proximate causes of loss, of which one is an insured peril but the other is expressly excluded from cover under the policy…although it is always a question of interpretation, the exclusion will generally prevail” [174].
• Agreeing with the High Court that all COVID-19 cases were equal causes of the imposition of national measures and following the principle that where there are two effective causes, neither of which is excluded but only one of which is insured, the insurers are liable: “There is, in our view, no reason…why such an analysis cannot be applied to multiple causes which act in combination to bring about a loss. Thus, [whilst] it obviously could not be said that any individual case of…COVID-19, on its own, caused the UK Government to introduce restrictions…the Government measures were taken in response to information about all the cases of COVID-19 in the country as a whole” [176].
• Insurers robustly relied upon the controversial “but for” test in Orient-Express Hotels Ltd v Assicurazioni Generali SpA (trading as Generali Global Risk) [2010] EWHC 1186 Comm); “The basic, fundamental, threshold test for any factual causation inquiry is the “but for” test. X cannot be a cause of Y if Y would in any event have occurred irrespective of – but for – X.” The High Court reasoned that the Government’s response to COVID-19 “was a reaction to information about all of the cases of COVID-19 in the country and that the response was…national because the outbreak was so widespread. [Therefore], it is unlikely that the existence of an enclave with a radius of 25 miles in any particular area…which was so far free of COVID-19 would have led to that area being excepted from the national measures or otherwise have altered the Government’s response to the epidemic. [Accordingly], in the vast majority of cases, it would be difficult if not impossible for a policyholder to prove that, but for cases of COVID-19 within a radius of 25 miles of the insured premises, the interruption to its business would have been less” [179].
• The Supreme Court did agree with insurers that “in the vast majority of insurance cases, indeed in the vast majority of cases in any field of law or ordinary life, if event Y would still have occurred anyway irrespective of the occurrence of a prior event X, then X cannot be said to have caused Y” [181]. However, the Supreme Court opined that “the most conspicuous weakness of the “but for” test is not that it wrongly excludes cases in which there is a causal link, but that it fails to exclude a great many cases in which X would not be regarded as an effective or proximate cause of Y.” In other words, the main inadequacy of the “but for” test “is not that it returns false negatives but that it returns a countless number of false positives. That explains why it is often – and for most purposes correctly – described as a minimum threshold test of causation” [181].
• The Supreme Court rejected insurers’ robust arguments that “the occurrence of one or more cases of COVID-19 within the specified radius cannot be a cause of business interruption loss if the loss would not have been suffered but for those cases because the same interruption of the business would have occurred anyway as a result of other cases of COVID-19 elsewhere in the country” [197].
• Although their reasoning was slightly different, the Supreme Court reached the same conclusion by a different route. The High Court “interpreted the disease clauses as covering the effects of each case of disease wherever in the country it occurs, provided that at least one case occurs within the radius specified in the clause” whereas, the Supreme Court held that “only the effects of any case occurring within the specified radius are covered but those effects include the effects on the business of restrictions imposed in response to multiple cases of disease any one or more of which occurs within the radius” [207].
• In conclusion, on a proper construction of the disease clauses, “to show that loss from interruption of the insured business was proximately caused by one or more occurrences of illness resulting from COVID-19, it is sufficient to prove that the interruption was a result of Government action taken in response to cases of disease which included at least one case of COVID-19 within the geographical area covered” [212].

Trends Clauses & Pre-Trigger Losses

Aiming to represent as near as possible the results which would have been achieved if the damage had not occurred

• Trends clauses are a standard method, used in BI insurance coverage to quantify the insured’s financial loss. The adjustment may work for or against a policyholder (or insurer) in any specific case. The clause is intended to be in the interest of both parties in ascertaining a true calculation of the loss. Insurers argued that by reason of the application of the trends clauses, they are not liable to indemnify policyholders for losses which would have arisen irrespective of the operation of the insured perils, due to the wider consequences of the COVID-19 pandemic [251].
• The Supreme Court clarified that “trends clauses are part of the machinery contained in…policies for quantifying loss. They do not address or seek to delineate the scope of the indemnity. That is the function of the insuring clauses in the policy” [260]. Furthermore, if possible, trends clauses “should be construed so as not to take away the cover provided by the insuring clauses” [262]. On that basis, the Supreme Court held “that the trends clauses…should be construed so that…gross profit derived from previous trading is adjusted only to reflect circumstances which are unconnected with the insured peril and not circumstances which are inextricably linked with the insured peril in the sense that they have the same underlying or originating cause” (emphasis added) [287].
• Disagreeing with the High Court’s treatment of pre-trigger losses, where adjustments were allowed to reflect a downturn due to COVID-19 before the insured peril was triggered: “We cannot agree that such a downturn in turnover is a trend or circumstance for which an adjustment is permitted” [294]. “The court had correctly concluded that losses should be assessed on the assumption that there was no COVID-19 pandemic. Consistently with that conclusion, the court should have held that, in calculating loss, the assumption should be made that pre-trigger losses caused by the pandemic would not have continued during operation of the insured peril” [296].

The Orient-Express Hotels decision

• Overruling the case – in which both Lords Hamblen and Leggatt had previously come to determinations in favour of the insurer, Generali – their Lordships elegantly and generously “invoke whatever ways by which we may “gracefully and good naturedly” surrender former views to a better considered position” [312].
• Applying the causation analysis above: “when both the insured peril [damage to hotel] and the uninsured peril [damage to rest of the city] which operates concurrently with it arise from the same underlying fortuity (the hurricanes), then provided that damage proximately caused by the uninsured peril…is not excluded, loss resulting from both causes operating concurrently is covered. In the Orient-Express case the tribunal and the court were therefore wrong to hold that the business interruption loss was not covered by the insuring clause to the extent that it did not satisfy the “but for” test” [309].
• Lord Briggs: the majority “have, in effect, rescued the policyholders from the at first sight sombre consequences of a narrow definition of the insured peril by a principled application of the doctrine of concurrent cause…they have done so…by overruling the only reported case on comparable facts, namely the Orient-Express case” [319].

Commentary/Observations

The Judgment of the Supreme Court represents a major financial and reputational setback for UK insurers. The policyholders were astute in mobilising media pressure and social media to create a strong following behind their claims. Doubtless, this activity was instrumental in the FCA stepping in, with commendable initiative, resource and resolve, to use the Test Case procedure for the first time to bring legal clarity and remove commercial uncertainty upon key issues of contractual uncertainty.

Congratulations are due to the FCA, the High Court and Supreme Court Judges and the large legal teams advising each of the numerous parties, under huge pressure, in the face of the unfolding pandemic throughout 2019. It is a ground-breaking example of what can be achieved extremely quickly with the procedural collaboration of multiple stakeholders. The lessons to be learnt from this case must be applied in the speedy resolution of future major insurance disputes involving a common set of issues. Would the outcome have been different with live witness testimony or a contested phase of disclosure of documents – which often leads to significant increases in both the length and cost of cases? In some cases, these procedural phases are essential for accurate fact finding to form the basis of the judgment, but not always.

Insurers will have to be more strategically astute in future in recognising early signs of a surge tide in consumer or SME led claims which, although individually contestable, can aggregate to unmanageable financial and reputational proportions. How ironic that policyholders’ BI claims, whose businesses had been wholly or partially shut down by COVID-19, were resisted by insurance claims handlers or adjusters working from home due to the impact on their employers of COVID-19.

Strategic and prudent use of social media will increasingly become a collateral tool to promote claimant’s interests in major disputes, whether directly or to mobilise regulators or third party stakeholders into assertive action. This will level the playing field in David v Goliath cases. Insurers could previously use their financial muscle to dis-incentivise individual claimants, who could not afford the cost of bringing a promising case to trial – let alone the cost of losing. Now, group actions, and specialist litigation funders help to level up the playing field.

It will be interesting to see how quickly insurers (re)learn that their collective and competitive desire to volume sell policies must be matched by underwriting clarity of judgment, alloyed to realistic investment in specialist drafting (and regular review) of policy wordings and an understanding of the applicable law. Many modern and developing risks are far from static and the recent Test Case commendably demonstrated how the law is prepared to confront and resolve important and complex issues. Uncertainty and lack of underwriting clarity tends to lead to “hidden” risk which is unpriced in the premium calculation. Such uncertainty makes it difficult to draft a policy wording which accurately reflects the individual insurer’s underwriting risk appetite and balance sheet reserve strength.

Furthermore, the Supreme Court was unimpressed with a 93-page policy wording which sought to grant extensions to standard cover and then carve out exclusions from those extensions on page 91 of the wording. This was described as “unreasonable as it is unrealistic”. “The reasonable reader would naturally assume that, if the intention had been to put a further substantive limit on the risk of business interruption specifically insured by the extension for infectious diseases in addition to the geographical and temporal limits stated in the extension itself, this would have been done transparently as part of the wording of the extension and not buried away in the middle of a general exclusion of contamination and pollution risks at the back of the policy”. Clarity and transparency should be indelibly stamped in insurers’ minds in the creation and delivery of their product.

Following the Supreme Court Judgment, the FCA has advised insurers to make their intentions clear to policyholders quickly, in relation to disputed claims. Much work has to be done urgently. Claims monies (and certainly interim payments) should flow quickly to distressed and deserving policyholders. The FCA, and doubtless the media, will be monitoring meaningful performance. Further, Insurers should be aware of additional exposure to interest for late payment of claims under the Enterprise act 2016, now incorporated into s13A Insurance Act 2015.

Meanwhile, whilst contemplating how they can best repair their reputations, insurers will be contemplating whether they can recover all or part of their claims outlay from their reinsurers. Interestingly, reinsurers did not intervene in the FCA case. Insurers are likely to have purchased different levels of applicable reinsurance. They will be keen to secure prompt indemnification of paid losses pursuant to the Supreme Court Judgment. However, that will depend upon the precise terms and conditions (and applicable law) of their individual reinsurances. Disputes upon exactly what is covered in the individual reinsuring clauses, what is an “occurrence” and the interpretation of “aggregation” terms are some potential questions which will come under the microscope. Further disputes, between insurers and their reinsurers, can be expected. Those policyholders who purchased their policy through an insurance broker and who remain unsatisfied with the application of the Judgment to their particular claim may try to mount a negligence claim against their broker for mis-selling or failing to advise properly or at all in relation to ICOBS obligations.

Some insurers may be justifiably pleased with the outcome for themselves, if not the industry as a whole, in that they anticipated the eventual outcome, either through their own legal analysis and/or a commercial sense of which was the most advisable path to follow. Perhaps some of them recalled Cuthbert Heath’s legendary instruction to his agents to “pay all of our policyholders in full, irrespective of the terms of their policies” following the Californian earthquake of 1906!

Whilst an overwhelming victory for the FCA and policyholders, it is important to note that the Judgment does not mean that all COVID-19 BI claims should be paid in full. The Supreme Court has provided urgent and much needed clarity on how standard sample clauses should be interpreted by insurers. Policyholders should therefore check the wording of their policies carefully before getting wrapped up in the celebratory atmosphere painted by the media. Lastly, without dampening policyholders’ success further, it is ironic that in the short-term, many insurers’ knee-jerk reaction will surely be to withdraw or reduce cover and increase premiums. Either way, policyholders generally will have to bear the increased costs for cover and/or uninsured losses resulting from their own “big win”.