The United Kingdom Supreme Court (UKSC) handed down its judgment on 15 January 2021 in The Financial Conduct Authority v. Arch Insurance (UK) Limited and Others. This test case was brought by the FCA on behalf of SME business interruption (BI) policyholders who have suffered financial losses as a result of COVID-19. The High Court judgment was handed down on 15 September 2020, with the special direct appeal to the UKSC taking place on 16 – 19 November 2020. The UKSC decision was largely seen as a victory for policyholders. As commented by Reed Smith partner, Mark Pring, in the Financial Times, “it can be said, without fear of hyperbole, that in principle at least this really is a catastrophic outcome for insurers.”

We have been reporting on these matters closely since March of last year, and have produced several more detailed alerts, which can be found on our Perspectives platform.

The court was asked to consider three broad categories of BI policy wordings, namely:

  • Disease wordings – which provide cover for BI losses sustained in consequence of, following or arising from the occurrence of a notifiable disease within a specific radius of the insured premises (COVID-19 was made a notifiable disease in England and Wales on 5 March 2020);
  • Hybrid wordings – which provide cover for BI losses sustained where restrictions have been imposed on the insured premises in relation to a notifiable disease; and
  • Prevention of access / public authority wordings – which provide cover for BI losses sustained where access to the insured premises has been prevented or hindered as a consequence of authority action/restrictions owing to an emergency in the vicinity of the insured premises.

In this post, we summarise some of the key points of the UKSC’s most recent decision and set out our views on some of the implications of the decision for policyholders (subject always to their individual circumstances).

  • Disease wordings

The UKSC confirmed that the disease wordings provide cover for BI losses resulting from an occurrence of COVID-19 (meaning at least one case) within the specified geographical radius of the premises from which business is conducted. This is good news for policyholders, as cover should generally be available for BI losses due to COVID-19 under policies with disease wordings.

  • Prevention of access and hybrid wordings

The UKSC confirmed that there must be an “inability” to use the premises, rather than something less, such as “impairment” or “hindrance” of use, for cover to be triggered. However, “inability” may be satisfied where a policyholder is unable to use the premises for a discrete business activity or is unable to use a discrete part of the premises for its business activities.

We anticipate that this will have a positive impact for certain businesses, for example, restaurants that had to close the dining area of their premises but were able to offer some limited takeaway service. A restaurant or shop that stayed open for take-away purposes may now claim for the loss of in-person business.

Importantly, the UKSC held that an instruction given by a public authority could amount to a “restriction imposed” if it either carries the imminent threat of legal compulsion, or is an instruction in mandatory and sufficiently clear terms that the insured and the public would reasonably understand had to be complied with, regardless of whether it was legally capable of being enforced. Therefore, cover under these wordings will not necessarily be limited to losses sustained as a result of a change in the law, but will also extend to instructions or guidance given by a public authority.

  • Causation

Insurers tried to argue that policyholders would have suffered the same or similar BI losses even if the insured risk or peril had not occurred, as a result of which the claims failed either because the loss was not caused by an insured peril or because of how the trends clauses require the loss to be quantified.  This was firmly rejected by the UKSC.

The UKSC held that the disease clauses are, in principle, triggered by the occurrence of at least one case of COVID-19 within the geographical area covered by the clause. Significantly, and in a judgment that may have broad-reaching implications, the UKSC rejected the blanket applicability of the ‘but for’ causation test as a matter of interpretation of disease clauses. Specifically in relation to COVID-19, the UKSC agreed with the High Court that all of the individual cases of COVID-19 that had occurred by the date of any relevant government measure were equally effective ‘proximate’ causes of that measure (and of the public response to it).

Disagreeing with the finding of the High Court, the UKSC decision makes cover more readily available under the prevention of access and hybrid clauses. The ‘peril’ covered by these wordings comprises a series of elements that are required to occur in a sequence in order to give rise to a right of indemnity. Importantly, (i) there is no requirement for legislation ordering closure, and (ii) being prevented from using, or being unable to use, part of the premises may be sufficient (that is, complete closure may not be required). All of the elements of the clause must be met and must have a causal connection to the loss, but, helpfully, the pandemic (as the underlying or originating cause) will not be treated as a competing cause when assessing loss.

  • Trends clauses and pre-trigger losses

Trends clauses provide for BI losses to be quantified by reference to what the performance of the business would have been had the insured peril not occurred. The UKSC held that trends clauses should be construed so that the standard turnover or gross profit derived from previous trading activity is adjusted only to reflect circumstances 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). The UKSC disagreed that adjustments could be made under trends clauses to reflect the downturn of a business due to COVID-19 before the insured peril was triggered.

In practice, this means that, absent any clear wording to the contrary, insurers cannot reduce the indemnity otherwise due to the insured on the basis that the losses were caused equally by other (uninsured) perils, which includes the COVID-19 pandemic. The decision on the impact of the trends clauses cannot be underestimated. Insurers will likely have been relying on the wider economic downturn to reduce their exposure even if coverage was in principle triggered under the applicable insuring clause.

  • Orient-Express case

The UKSC held that the decision in Orient-Express Hotels Ltd v Assicurazioni General SpA [2010] EWHC 1186 (Comm) (relied upon heavily by the insurers) was wrongly decided and should be overruled.  The court in Orient-Express held that the BI was caused by two concurrent causes, neither of which was the sole cause of the loss and therefore coverage for physical damage due to Hurricane Katrina was denied. The UKSC found that the court in Orient-Express had failed to exclude from the assessment of the loss those circumstances which had the same underlying or originating cause as the damage – in that case, the hurricane.

Ultimately, we anticipate active claims management and payments out by insurers where the policy wording falls clearly within the scope of the UKSC decision. This is reinforced in the FCA’s “Dear CEO” letter published on 22 January 2021, which strongly encourages all insurers to take steps to settle claims as quickly as possible.

We also anticipate (as indicated in the “Dear CEO” letter) that the FCA will continue to closely monitor the process to ensure that insurers treat policyholders fairly.

Practical tips

There are several practical steps that all BI policyholders should take in light of the UKSC judgment.

  • Check policy wordings: Identify which of the three categories of policy wording your BI coverage contains, whether it is disease, prevention of access, or hybrid wording. The UKSC decision has confirmed that coverage for BI losses due to COVID-19 would be available under all three types of wordings, making it more likely that your BI policy will provide some cover for COVID-19-related losses.
  • Liaise with brokers and insurers: We strongly recommend that policyholders contact their brokers or insurers promptly to press for cover and an indemnity in respect of a claim, as many brokers and insurers put discussions on hold pending the decision in the test case.
  • Review any proposed offer from your insurer to settle BI claims: Policyholders engaging with their brokers or insurers regarding settling an existing BI claim should reconsider the settlement terms in light of the UKSC decision. Insurers may seek to reduce their liability by deducting any government support received from any settlement. However the FCA will intervene if they do not think insurers are being fair.
  • Record gathering: It is integral that a policyholder maintains good records of any losses sustained to their business during COVID-19 to satisfy causation and quantification requirements. Any general downturn caused by COVID-19 in the lead up to any action or decision which closed the insured business does not need to be taken into account when making adjustments under trends clauses.
  • Prevalence of COVID-19: The policyholder must prove the prevalence of COVID-19, if necessary to trigger policy coverage. We recommend that policyholders consider the FCA’s draft guidance on the types of evidence that would demonstrate the prevalence of COVID-19.
  • Renewal: We expect insurers will seek to reduce their future risk exposure by altering and amending the BI coverage they are willing to provide. In particular, (i) new policies are expected to expressly exclude losses resulting from the pandemic, and (ii) the trends clause may also be narrowed. It is therefore important to review a draft insuring clause, trends clauses, and any exclusions to ensure that you understand the coverage being offered and whether it is sufficient for the policyholder’s business needs.

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