When a weatherman forecasts a hurricane, the sandbags fly off the hardware stores' shelves, people board up their windows and head for higher ground, and businesses move their goods out of the hurricane's path and send employees on their way. But a company's preparations need to start long before disaster strikes.
Hurricanes Katrina and Rita have caused unprecedented devastation. According to the Insurance Information Institute--the industry's public education mouthpiece-- estimates for insured losses from Katrina alone range from $35 billion to more than $60 billion. Nearly 40 percent of these losses are expected to come from commercial flood and related business interruption claims. By comparison, insured losses from Hurricane Andrew in 1992--until now the country's costliest natural disaster--totaled less than $21 billion, and the September 11 terrorist attacks caused $20 billion in insured property losses.
Among the most important precautions a company can take in anticipation of a natural disaster is to have business interruption insurance, which covers the profits a business would have earned had a shutdown from a disaster or other event never occurred. It may not seem the domain of in-house counsel, but as the waters recede in the Gulf Coast, legal departments have a crucial role to play in a company's insurance decision-making.
This role begins with an assessment of a company's business interruption coverage and ends with the resolution of an often-messy claims process in which insurers are reluctant--and sometimes downright recalcitrant--in their interactions. The legal department's evaluation of what the company's coverage entails and an understanding of how to handle these claims after losses occur may just be what keeps a company afloat in a disaster.
"Coming up with a loss figure typically comes down to a negotiation," says Finley T. Harckham, a senior litigation stockholder in Anderson Kill & Olick's New York office.
"The insurance company is looking for a result that will give them minimum exposure, and the policyholder is looking for a result that will give them the maximum coverage," he says. "Business interruption claims are most prone to this type of wrangling because there are so many ways to look at the situation."
Planning For Disaster
Most larger companies carry some form of business interruption coverage through their commercial property insurance carrier. Assessing whether one's coverage is adequate however takes time and scrutiny.
"A business interruption insurance policy is one of the most important legal contracts your business has," says Stacy M. Andreas, a member in Lathrop & Gage's Kansas City, Mo., insurance practice. "When looking at your policy, you should be considering where your business falls on the loss continuum. When do you need your coverage to kick in? How long could your company not operate and still be profitable?"
Casinos, hotels, restaurants, retail stores and other businesses that rely on daily, on-site customer interaction have far different business interruption needs than brokerage firms and other businesses that can operate remotely. The former tend to experience longer "loss periods," meaning it takes them more time to restore operations to their pre-disaster level. Their losses also are more immediate. For example, the casinos in Mississippi rake in about $1 million per day in revenues. These companies need business interruption coverage that is long lasting (at least a year) and has short waiting periods for claims so they can begin recouping losses right away.
In-house counsel should consider a number of additional options beyond the basic coverage. The first of these is contingent business interruption insurance, which covers losses stemming from damage to a key supplier or customer. For example, Hurricane Katrina's disruption of commerce through the Port of New Orleans and its destruction of petrochemical plants and other key suppliers has wreaked havoc on supply chains of all kinds. Companies such as Minneapolis-based Cargill Inc. have been caught in the supply chain nightmare. The agribusiness company uses barges along the Mississippi to ship soybeans, corn and wheat from the Midwest to four Louisiana export facilities. After the storm, those facilities were shut down for a full two weeks, a situation that is sure to result in massive losses for the company.
Issues relating to accessing the Port of New Orleans also may fall under the "ingress/egress" or "civil authority" language in business interruption polices. The ingress/egress wording covers losses sustained from customers or employees being unable to access the policyholder's damaged property. In negotiating a policy, companies also should consider including civil authority language, which allows businesses to recoup profits lost as a result of the government blocking routes of access to the policyholder's undamaged property.
In addition, in-house counsel should evaluate the policy language relating to "extra expenses," money spent to mitigate further business losses. Ensuring this language can be interpreted to cover a wide swath of expenses is essential. Common extra expenses include the costs of moving to a temporary location, contracting out work and paying overtime. But other extra expenses might be less obvious. For Marriott International, mitigating loss in the case of Hurricane Katrina has meant taking care of its employees so they can help get damaged properties up and running again.
"A lot of our employees have lost their homes, and some have lost their families," says Bradley Wood, senior vice president for risk management at the Bethesda, Md.-based hotel company. "If the employer needs the employees to get back to work to mitigate a loss, there are costs that the employer may accept to accomplish this."
Correctly wording a policy to cover extra expenses can be murky, but Marriott and other companies are hoping the insurance companies will construe the money they have spent to keep their employees on board as loss-mitigating measures.
"There are real quandaries for policyholders right now over extra expenses," he adds. "Are temporary housing expenses reimbursable if they mitigate a business loss? If you're altruistic and you decide to continue to pay your employees [while the business is shut down], how much of that is reimbursable under the policy? At what point do these costs cross the line from reimbursable expenses to acts of goodwill?"
An assessment of business interruption risk isn't complete without a review of the company's other property-related coverage. Under business interruption insurance, policyholders can only recoup losses caused by events--such as flooding and wind damage--that are covered by their other policies. If, for example, an adjuster decides that flooding caused damage to a business, that business would have to have flood insurance to make a business interruption claim.
The current battle over whether it was wind or flood waters that caused the bulk of the damage in the Gulf Coast area has raised serious questions about whether companies will be able to file business interruption claims post-Hurricane Katrina.
"If the roof of your warehouse blows off and two days later it is flooded from a storm-related levee breach, what's the covered peril?" Harckham asks.
Harckham says state laws vary in their interpretation of this issue as it relates to business interruption. Some require that each peril involved in a loss be covered for a policyholder to have a business interruption claim. Others say that as long as there is a covered loss involved, business interruption insurance kicks in. Calling the case law in this area "largely uncharted territory," Harckham says in-house counsel have few indicators about how courts may decide such questions.
However the courts resolve these issues, plague-proofing one's company with extra insurance may be the best way to ensure effective business interruption coverage. William E. Bailey, special counsel to the Insurance Information Institute and director of the Hurricane Insurance Information Center in Jackson, Miss., urges companies to consider getting flood insurance, in particular--regardless of how high above sea level one's company sits.
"When the water comes, you don't want the Ark to pass you by," he says. "A lot of people are now saying, 'I was told I didn't need flood insurance because I was outside the flood plain.' You can't base your flood coverage on what some engineer drew on a map."
Because contingent business interruption coverage is linked to the policyholder's property insurance, a flood policy also could be important for a company whose main supplier or customer is in a flood-prone area.
"One lesson we learned from 9/11 was that you cannot collect on a contingent claim unless the peril is a covered peril under your policy," Bailey says. "When looking at property insurance, consider a supplier's or buyer's risks like you would for a subsidiary: What kinds of perils could take place for them that I would need coverage for?"
After Disaster Strikes
Adequate business interruption coverage will go a long way toward protecting a company's assets, but resolving claims effectively and efficiently is the ultimate challenge. When disaster strikes, early communication with the company's insurance company about potential losses--and about any extensions needed to document those losses--can prevent future disputes.
According to Harckham, it's also never too soon to start pushing the insurance company for payments, especially if you can argue that those payments will help mitigate further loss.
"It's a mistake when companies wait until the loss period ends--12 or 18 months down the road--to make a claim," he says. "The legal department should try to get advance payments and partial payments made upfront."
Another preventive measure is the proper documentation of losses--something that sounds far simpler than it is. Demonstrating damage to a property is relatively clear-cut. But having to account for lost profits requires a complete reconstruction of what the company's financials might have looked like had the interruption not occurred. Having an expert forensic accountant or appraiser on board to lead the documentation process is something in-house counsel should seriously consider.
Barry J. Fleishman, a partner at Dickstein Shapiro Morin & Oshinsky in Washington, D.C., who focuses on complex policyholder coverage, says the documentation provided to insurance companies in the claims process is particularly important because of its potential effect on future litigation.
"Companies should not underestimate the complexity and time involved in putting these claims together," he says. "In the documentation process, you're hoping to negotiate and settle, but you're preparing in the event you need to litigate."
Of course, good documentation is no guarantee of getting a claim paid quickly--or at all. Andreas says insurers, swamped with claims from Katrina and Rita, may need a gentle push from the policyholder's legal department to move the process along.
"It's important that your claim be on the insurance company's front burner," she says. "Your company needs to be the squeaky wheel, and in-house counsel are generally good at that."
If a company senses that the insurer is acting in bad faith by purposely delaying payment or ignoring a claim, in-house counsel also may need to take on a "bad cop" role.
"It's the legal department's job to step in and make a written record of what is happening with the adjustment of claims so it doesn't end up in an abusive situation," Harckham says. "If the insurance company knows you're documenting clearly the adjustment process, they will realize they can't get away with any delaying or harassing tactics without recourse. I think that keeps them honest."
In the event that the insurance company does act in bad faith--or if a claim is denied outright--it may be time to bring in an expert to either avert or prepare
These situations are best handled by those outside counsel who are well versed and experienced in business interruption insurance claims.
"The biggest mistake I see legal departments make is that they turn to their traditional outside counsel, who tend not to be deep in insurance knowledge," says Daniel Torpey, a partner in Ernst & Young's investigative and dispute services. "Or, they turn to outside counsel who are insurance experts but do not necessarily specialize in property and business interruption insurance. The legal department must narrow the slate to attorneys who've handled a lot of these cases."
In the end, knowing when to bring in the true experts may be in-house counsel's biggest contribution in addressing their companies' business interruption losses.
"The legal department should recognize that there are times to involve in-house counsel and times to look to outsiders for support," Wood says. "They should not feel compelled to own the claim."