July 15, 2016 by Heather Sanderson
Prior to May 3, 2016, financial watchers wondered if a wildfire could burn one-third of Slave Lake, a town of 7,000, and cause $742 million in insured losses, what would happen if a wildfire burned into Fort McMurray, a city eight to nine times the size of Slave Lake and also situated deep within Canada’s boreal forest?
We are in the process of finding out.
The Fort Mac wildfire claims will sorely test the key concepts underlying the business interruption, civil authority coverage and contingent business interruption coverages used by the Canadian P&C industry
Business Interruption Coverage
There is no standard BI policy, but most contain language along the following lines: “We will pay for the actual loss of ‘business income’ due to the ‘necessary suspension’ of your operations during ‘the period of restoration’. There are key concepts within this wording.
i) The Physical Damage Requirement
The usual pre-requisite to coverage is proof that insured premises sustained covered physical damage (such as fire, heat, flooding or other damage from firefighting efforts) causing an interruption, resulting in a loss of business income.
A business that is interrupted due to the loss of data, or a loss of utilities, may not have sustained a physical loss.
A significant coverage issue will be whether smoke damage and the presence of toxic ash qualifies as ‘physical damage’ from a covered cause of loss.
Ash laden with dioxins, furans, metals and polyaromatic hydrocarbons has likely travelled down roof vents, infiltrated insulation and HVAC systems in almost every structure left standing in Fort McMurray. The ash may be a contaminant or pollutant under some policies and therefore an excluded cause of loss. Smoke may also be a contaminant in those policies that don’t specifically cover fire and smoke.
If ash and smoke damage is covered, most policies require proof that the presence of ash and smoke has resulted in an interruption causing a loss of business income.
Discolouration of tile, marble, granite and siding due to smoke may be physical damage. However, even if that damage is covered, to claim business interruption cover, the insured must prove that the physical damage has caused an interruption and a resulting loss of business income.
ii) Business Income Loss is Not Resultant Damage
A loss of business income arising from damaged equipment and business infrastructure is not resultant damage to that damaged equipment and infrastructure. Lost business income that is not payable under the business interruption coverage (or the civil authority coverage, or the contingent business interruption coverage) is usually uninsurable business loss.
ii) Period of Restoration
If the business interruption coverage is triggered, a significant issue will be defining the period of indemnity or, as some policies refer to it, as the period of restoration. Most policies will pay business income loss through to the point that the business is restored from a physical damage point of view or when the coverage – usually 12 months from the beginning of the interruption – expires. In some policies coverage is keyed to restoring prior cash flows.
Cash flows may never return to pre-wildfire levels, as the population may not return to its pre-wildfire levels and the current downturn in the oil industry may deepen. Whether any of that loss is covered will turn on the wording of individual policies.
iii) Duty to Mitigate
Most policies offering business interruption require the insured to take reasonable steps to mitigate the loss of business income. This requirement is expressed in different ways depending upon the policy. In most policies, the income less extra expense that could have been derived from reasonable mitigation is deducted from the amount payable, even if the mitigation did not occur.
Most policies encourage mitigation by covering the extra expense involved in continuing business operations elsewhere.
If a business is in leased space and the landlord elects not to rebuild, then the business must relocate to reasonably similar accommodation that may not be available in Fort McMurray. Whether the obligation to mitigate will require the insured business to move to another location away from Fort McMurray or reorganize its business to mitigate the loss of the Fort McMurray location will depend upon the wording of the policy and whether the coverage is tied to the location that sustained the covered physical damage.
The insurer has the burden to prove a lack of mitigation. An expert familiar with the business and a forensic accountant are essential to establish this important defence.
Civil Authority Coverage
A business that lost income solely because access was denied due to the mandatory evacuation order may be able to claim civil authority coverage that is separate and apart from the business interruption coverage.
If it is available, the coverage will usually be made out if an insured affected by a mandatory evacuation order proves: (a) the issuance of the order and that it prohibited access to the covered premises; (c) the action was the result of damage that occurred away from the covered premises; or, the action taken was in view of the risk that property away from the covered premises would be damaged, and (d) that the risk of physical damage that generated the order would have been covered under the policy if that risk materialized at the covered premises; (e) the order causes a business loss.
i) Geographical and Time Limits
Some policies state that the coverage only applies if the order is issued with respect to adjacent property or property within a certain geographical radius of an insured location.
Some policies state that the indemnity period begins 72 hours after the issuance of the order and extends for a period of weeks (usually three or four weeks) but seldom for a period beyond that.
The coverage terminates when the civil authority order that denies access is lifted, or the limits have been exhausted – whatever comes first. It is highly likely that all Fort McMurray businesses that qualify for this coverage exhausted their limits before the orders were lifted.
ii) Subsequent or Consequential Losses Outside the Time Limit
The wording used in the majority of policies is clear that losses that continue outside the time limit specified in the policy or losses that arise from covered losses are uninsured.
Contingent Business Interruption Coverage
The Fort McMurray firestorm has likely disrupted the supply chains of innumerable businesses in Alberta outside the fire zone, elsewhere within Canada and internationally.
The most likely source of coverage against that disruption is contingent business interruption coverage (CBI), also described in some polices as “dependent business coverage”.
Most CBI policies provide coverage for economic losses caused by property damage to a supplier’s premises and contain very precise definitions of what is a supplier. Usually such policies only apply to direct suppliers – not a supplier’s supplier.
CBI coverage seldom applies to losses suffered by subsidiaries of the named insured that are economically impacted by the Fort McMurray firestorm but physically unaffected by it. The Fort McMurray firestorm may reduce the business income of a Calgary location that is economically interdependent with the Fort McMurray location.
As the Fort McMurray and Calgary locations are owned by the named insured, the Fort McMurray location does not qualify as a “supplier” (or, as they are called in some policies “dependent business”). As a result, the Calgary location cannot access the CBI coverage. Further, as the Calgary location has not sustained physical damage, it is unlikely that the Calgary location can access the business interruption limit applicable to that location.
The specific wording will determine if the CBI coverage applies to a shutdown of a supplier due to the evacuation orders.
iii) Duty to Mitigate
CBI coverage contains mitigation requirements that must be respected by the insured.
The insurer has the burden to prove that the loss would have been less if the insured had exercised reasonable diligence to locate alternate suppliers. The net difference between the loss incurred on one hand and the net income that could have been earned through reasonable mitigation is usually deducted from any amount claimable.
The coverage gaps for the business losses that flow from the Fort McMurray firestorm render brokers vulnerable to negligence actions for failing to arrange the placement of coverage that could have met those gaps or the failure to recommend higher limits. Those same gaps may motivate insureds to press bad faith claims against their insurers regarding the adjustment of the claims.
The bad faith risk is best met by following each insurer’s first party claims manuals, careful policy interpretation and timely communication with the insureds that focuses on realistic expectations of recovery.
The reputation and institutional good will of each individual insurer and the industry as a whole ride on the fair and reasonable resolution of each claim arising from the Fort McMurray wildfire.
Heather Sanderson, a member of the Alberta bar, is a nationally recognized coverage lawyer and author who provides coverage litigation services, opinions and support to Canadian and American insurers for incidents occurring throughout Canada. She is a member and director of Canadian Defence Lawyers, active with the Defense Research Institute and a member of the invitation only Federation of Defense and Corporate Counsel.