When the COVID-19 Pandemic incepted, and issues arose as to whether affected policyholders could seek Business Income and Civil Authority coverage from the presence or suspected presence of SARS-CoV-2 and consequent orders of Civil Authority, I thought that the easiest question to answer was whether such policyholders had suffered physical loss or damage (“PLOD”) to their property. 

The Majority PLOD Rule Prior to COVID-19

With my colleague, Nicholas Insua, I write and annually update a book discussing every Business Income (or Business Interruption) case decided in the United States. Many issues arising under policies providing “time element” coverage have but a handful of cases discussing them, but whether unusual circumstances – i.e., events other than fire, windstorm, etc. – cause “physical loss or damage” to property had been the subject of more than two score cases by March 2020. In about three quarters of those cases, courts held that such unusual circumstances – falling rocks which threatened but had not yet hit a property, temporary infusion of smoke or ammonia or gas fumes, risk of collapse caused by collapse of neighboring building – caused “physical loss or damage” if property could not be safely used as it had been used previously. I thought the same results would obtain in COVID-19 cases.

Courts Accept Insurers “PLOD” Arguments in the COVID-19 Context

Unfortunately, this prediction was incorrect. Largely, courts have accepted insurance company arguments that SARS-CoV-2 and consequent orders of Civil Authority do not cause PLOD. In the wake of these decisions, there have been two interesting, if wholly predictable, developments since then. 

Courts Continued To Apply the Majority PLOD Rule in Other Contexts

First, in the first few non-COVID-19 coverage cases decided after March 2020, courts continued to interpret PLOD as including covered loss from events rendering property unfit for its intended use. See James W. Fowler Co. v. QBE Ins. Corp., No. 20-35926, 2021 U.S. App. LEXIS 31714, at *2 (9th Cir. Oct. 21, 2021) (unpublished) (agreeing on appeal that a micro-tunnel boring machine which was undamaged but trapped underground would suffer “direct physical loss” if it “either impossible or unreasonably expensive to recover”); Crisco v. Foremost Ins. Co., No. C 19-07320 WHA, 2020 WL 7122476, at *4-5 (N.D. Cal. Dec. 4, 2020) (finding mobile homes suffered PLOD when a fire destroyed the electric, gas, sewer, and potable water infrastructure which serviced them but did not damage the mobile homes themselves); National Ink & Stitch, LLC v. State Auto Prop. & Cas. Ins. Co., No. SAG-18-2138, 2020 WL 374460, at *5 (D. Md. Jan. 23, 2020) (finding policyholder which suffered a ransomware attack on its computer server causing permanently lost access to its art files and other data had suffered loss of “functionality” and thus PLOD); and EMOI Servs., LLC v. Owners Ins. Co., 2021-Ohio-3942, P5-7 (Ohio App. 2021) (rejecting insurer’s argument that PLOD “does not occur when the insured merely loses access or use,” concluding that “[a]s a result of the encryption, [the policyholder] and its clients were unable to access [the policyholder’s computer] system for a significant period of time”).

In all of these cases, there was not tangible damage or alteration of property; what was lost was instead the use of property for its intended purpose. The result in these cases indicates that something other than application of the common law as it existed in March 2020 was motivating courts ruling against policyholders in cases addressing insurance coverage for PLOD from SARS-CoV-2: concern about the solvency of the insurance industry.

Insurers Are Leveraging PLOD Rulings in the COVID-19 Context to Win in All Similar Contexts

Two, not satisfied with pleading poverty to win in COVID-19 cases, the insurance industry is using results in COVID-19 cases to affect a major restriction in the coverage they provide without securing regulatory approval (and incur a cut in rates). And this has now occurred. In EMOI, on appeal, the Supreme Court of Ohio reversed (EMOI Servs., L.L.C. v. Owners Ins. Co., 208 N.E.3d 818 (Ohio Dec. 27, 2022) (applying Ohio law), citing a COVID-19 case. Insurers have made arguments citing COVID-19 cases in other contexts:

  • NMA Investments L.L.C. v. Fidelity & Guar. Ins. Co., No. 22-cv-1618, 2022 U.S. Dist. LEXIS 164606, at *8-10 (D. Minn. Sept. 13, 2022) (citing a COVID-19 case and rejecting Business Income claim of laundromat whose operations were affected by government and non-government barricades erected on streets in the wake of riots caused by the murder of George Floyd because the barricades did not cause PLOD to the policyholder’s property);
  • Cup Foods, Inc. v. Travelers Cas. Ins. Co., No. 22-cv-1620, 2023 U.S. Dist. LEXIS 10711 (D. Minn. Jan. 23, 2023) (rejecting Business Income claim for loss from barriers set up by government and private citizens citing COVID-19 case);
  • Garland Connect, LLC v. Travelers Cas. Ins. Co., No. CV-20-09252, 2022 U.S. Dist. LEXIS 33960, at *9-11 (C.D. Cal. Feb. 3, 2022) (applying California law) (citing COVID-19 case and finding that policyholder who was unable to access its former business premises when the landlord refused to extend its contract to perform operations there did not suffer PLOD);
  • Meridian Park Radiation Oncology Ctr., Inc. v. Allied Ins. Co. of Am., No. 3:21-cv-1471-AR, 2024 U.S. Dist. LEXIS 53178, at *10-14 (D. Or. Feb. 13, 2024) (applying Oregon law) (finding that facility administering radiation treatment which had to take its linear accelerator off line when its third-party cloud-network service provider went off line due to a cyberattack not suffered PLOD to its linear accelerator because that phrase requires “physical alteration or dispossession of the covered property” and citing COVID-19 cases);
  • Archer Western-De Moya J.V. v. Ace Am. Ins. Co. 87 Uptown Road, No. 1:22-CV-21160, 2024 U.S. Dist. LEXIS 51943, at *36-40 (S.D. Fla. Jan. 12, 2024) (applying Florida law) (noting the insurance company’s reliance on COVID-19 cases concluding that PLOD “requires a tangible alteration to the covered property” in arguing that the policyholder’s bridge components did not suffer PLOD from defective concrete);
  • 87 Uptown Road, LLC  v. Country Mut. Ins. Co., 207 N.Y.S.3d 241, 244-45 (N.Y. App. Div. Mar. 14, 2024) (applying New York law) (citing COVID-19 case and concluding that loss at an apartment complex attributable to tenants moving, not because their apartments had been damaged by fire but rather because of “various inconveniences” accompanying rebuilding of damaged units, was not a loss caused by PLOD because “inconvenience alone, absent direct damage, is not enough to afford coverage”); and
  • Century Aluminum Co. v. Certain Underwriters at Lloyd’s, 97 F.4th 1019, 1023 (6th Cir. 2024) (applying Kentucky law) (rejecting policyholder’s claim for loss from PLOD to its alumina ore when closure of inland waterways prevented it from timely receiving ore, citing cases addressing the effect of COVID-19, to find “[t]he temporary delay never threatened to deprive [the policyholder] of its ownership or control of the alumina,” and policyholder did not suffer PLOD).

One court rejected the insurance company’s argument: Tiffany & Co. v. Lloyd’s of London Syndicates 33, 510, 609, 780, 1084, 1225, 1414, 1686, 1861, 1969, 2001, 2012, 2232, 2488, 2987, 3000, 3623, 4444, 4472, & 4711, No. 651544/2023, 2024 N.Y. Misc. LEXIS 2433, at *66-67 (N.Y. Supr. May 3, 2024)(applying New York law) (finding “loss” of ore not controlled by COVID-19 case).

Inevitably, however, insurance companies will leverage cases giving them relief in the COVID-19 context to reverse the former majority rule on PLOD in all contexts. This will dramatically restrict coverage for thousands of policyholders, given that the vast majority of property insurance claims are resolved by negotiation, not litigation, on the basis of the law set forth by courts. If any party is to accept this dramatic restriction of historic coverage, it is the regulator, who can impose a commensurate reduction in insurance rates.

Introduction

The Eleventh Circuit Court of Appeals’ recent decision in ECB USA, Inc. v. Chubb provides several important lessons for corporate policyholders faced with potential coverage issues arising from their consulting or professional services.

The issue in ECB was whether Chubb’s professional services liability policy applied to claims against an accounting firm for a faulty audit performed for a food services company, Schratter Foods. Looking to rules of grammar and canons of construction to interpret the policy, the court ruled in favor of Chubb and found that coverage was restricted to accounting services “for financial institutions,” and thus did not apply to the Schratter Foods audit.

As we explain below, the ECB decision highlights the complexities and uncertainty that can arise when insurance policies are interpreted based on technical rules of grammar and linguistics, which can be deployed to reach a result at odds with the policyholder’s expectations of coverage. The decision also serves as a reminder about the importance of ensuring that policy language aligns with the company’s current business activities—particularly at the time of renewal. Finally, the decision illustrates the risks for corporate policyholders in jurisdictions that construe policy language differently depending on whether the insured is deemed “sophisticated.”

The ECB USA v. Chubb Opinion

In 2001, Chubb sold a professional services liability policy to the accounting firm Constantin Associates LLP. Constantin renewed its Chubb policy for several years, ultimately culminating in a renewal policy issued in December 2017. ECB USA, Inc. v. Chubb Ins. Co. of N.J., No. 22-10811, 2024 U.S. App. LEXIS 19221, at *3 (11th Cir. Aug. 1, 2024). The policy provided liability coverage for “Wrongful Acts” in the performance of “Computer Consulting including computer system architecture and design”; “Temporary Placement Agency Services”; and (relevant here) “Management consulting services.” Id. at *4.

Chubb defined “[m]anagement consulting services” as: “services directed toward expertise in banking finance, accounting, risk and systems analysis, design and implementation, asset recovery and strategy planning for financial institutions.” Id.

Constantin performed an audit for Schratter Foods in connection with an acquisition between Schratter and a third party—ECB. Id. at *5. According to the opinion, the audit “allegedly did not go well,” and ECB sued Constantin for alleged negligence in auditing Schratter’s financial statements, which ultimately led to a settlement. Id. ECB then sued Chubb to enforce Constantin’s rights under the policy, arguing that Chubb breached the policy by refusing to defend and indemnify Constantin for the underlying suit and settlement. Id.

As framed by the Eleventh Circuit, the case came down to “grammar and canons of construction.” Id. at *2. Specifically, the issue under New Jersey law was framed as “whether the phrase ‘for financial institutions’ modifies ‘accounting.’” Id. at *11. (The parties agreed that New Jersey law governed the dispute.) To answer that question, the court first weighed different grammatical canons of construction, starting with the “last-antecedent canon” and the “nearest-reasonable-referent canon.” Under those canons, ECB argued that the phrase “for financial institutions” only refers to the immediately preceding phrase (“asset recovery and strategy planning”). Id. at *3. Thus, ECB argued that “for financial institutions” did not limit the scope of covered “accounting” services listed as a standalone service in the same provision. ECB also argued that, under the doctrine of contra proferentem, the ambiguity in Chubb’s policy must be resolved against the insurer and in favor of coverage. Id. at *13.

Chubb, on the other hand, urged the court to apply the “series-qualifier canon.” Under the series-qualifier canon, Chubb argued, “a postpositive modifier like ‘for financial institutions’ modifies all the terms in a list of parallel items”—including “accounting.” Id. at *2-3. So, Chubb argued that the accounting firm was not entitled to coverage, because the audit in question was performed for Schratter Foods, not a financial institution.

Weighing the grammatical implications of the policy language, the court ultimately found that Chubb had the better reading. Id. at *22. For instance, the court found that the canons advanced by ECB were not on point, because the parts of speech typically associated with those canons (including pronouns, relative pronouns, and demonstrative adjectives) were missing from the policy. Id. ECB also conceded that “for financial institutions” applied at least to “asset recovery and strategy planning,” which the court viewed as “more than the nearest reasonable referent.” Id. at *23. More importantly, ECB conceded that the policy language contained “parallel terms,” and the court concluded that these canons don’t apply “when the syntax involves a parallel series of nouns or verbs.” Id. Focusing on ECB’s concession, the court instead found the series-qualifier canon appropriate for resolving the dispute. Id. Specifically, the court reasoned that “the parallel nature of the terms links them together so that the postpositive modifier ‘for financial institutions’ can naturally apply to every item in the list, not just the last one or two.” Id. at *24. Because the audit was not performed for a financial institution, the court held that there was no coverage for the underlying claims arising from the Schratter Foods audit, though conceding that this limitation could have more clearly been stated by the addition of a comma.

The court next analyzed whether to apply the doctrine of contra proferentem, which provides that courts should construe ambiguous policy language against the party that drafted the policy—inevitably, the insurance company. Id. at *29. But despite what fairly can be described (at best) as sloppy policy language drafted by Chubb, the court declined to construe the policy against Chubb, finding that Chubb had the better reading, and emphasizing that Constantin was also a “sophisticated commercial entity.” Id.

Key Lessons for Corporate Policyholders

The decision in ECB USA, Inc. v. Chubb offers several important takeaways, particularly for corporate policyholders.

First, the decision highlights the complexities and uncertainty that can arise when courts interpret insurance policy language based on grammatical canons. These are obscure, linguistic presumptions that few, if any, policyholders (or their brokers) are familiar with. There is also no indication that insurance companies themselves consider grammar or linguistics in drafting insurance policies. On a more practical level, the decision illustrates the difficulty in predicting how a court might resolve any given dispute using these canons of construction—a growing concern in modern textualism. See William N. Eskridge, Jr., Brian G. Slocum & Kevin Tobia, Textualism’s Defining Moment, 123 Colum. L. Rev. 1611, 1648-49 (2023) (explaining that “more systematic research . . . should be done to test the reliability of canons that purport to show ordinary meaning”).

In ECB, the court resolved the coverage dispute by choosing between competing canons of construction that turned on the parts of speech and linguistic structure of the policy provision, leading to an outcome where the very last phrase in the provision applied to (and restricted) the earlier reference to “accounting,” removing coverage for any accounting services performed for non-financial institutions. Further highlighting the range of outcomes here, the court seemingly could have looked to an entirely different canon—the canon against surplusage—to find that coverage did exist. Because some of the services listed in the policy already referred to banking or finance, applying the financial institutions modifier to those same terms would be entirely redundant. 

Compounding this issue is the court’s comment about commas. While the court acknowledged that placing a comma before the phrase “for financial institutions” certainly would have established “with more certainty that it applies across every term in the list,” the court opined that commas are “discretionary.” ECB USA, Inc., 2024 U.S. App. LEXIS 19221, at *26. (The “let’s eat, grandma” example suggests this is not always the case.) But the court cited a 1971 Supreme Court case, which did not involve insurance policy interpretation. In the insurance context, courts have explained that an insurer seeking to limit coverage “must clearly and unambiguously draft a policy provision to achieve that result.” See Geico Gen. Ins. Co. v. Virtual Imaging Servs., 141 So. 3d 147, 157 (Fla. 2013). While commas might be discretionary from a pure linguistics standpoint, they should not be discretionary from an insurance policy drafting standpoint. Suggesting that insurers have discretion to draft less-than-clear policy language incentivizes insurers to make careless drafting choices in their insurance policies.

Equally important is the court’s discussion on ambiguities in insurance policy language and how those ambiguities are resolved (at least under New Jersey law and similar jurisdictions).

Let’s take the second question first: The court found that, even assuming the policy contained an ambiguity on the “for financial institutions” issue, New Jersey law did not require the policy to be construed in favor of coverage to resolve that ambiguity, because the accounting firm was also a “sophisticated commercial entity.” Id. at *31. To be sure, some jurisdictions (including Florida) do not recognize a “sophisticated insured” exception, and instead apply the general rule that ambiguous policy language will be construed against the insurance company that drafted and sold the policy; other jurisdictions recognize a limited carve-out but with additional caveats (such as California, which requires evidence that the policyholder was actually involved in negotiating and drafting the policy). See Cachet Fin. Servs. v. Berkley Ins. Co., No. 23-55217, 2024 U.S. App. LEXIS 5765, at *5-6 (9th Cir. 2024). In fact, the Eleventh Circuit itself has recognized that the policyholder’s interpretation need not be the most reasonable one (or even the correct one) in order for the policy to be deemed ambiguous and construed against the insurer. See Cont’l Ins. Co. v. Roberts, 410 F.3d 1331, 1333-34 (11th Cir. 2005).

And as the ECB decision illustrates, there are good reasons to be wary of “sophisticated insured” exceptions.

The opinion indicates that Constantin had “many different options to purchase liability insurance,” but those options are never specifically discussed, and the reality is that policyholders often have very few choices (and even less bargaining power) when it comes to negotiating actual policy language. See ECB USA, Inc., 2024 U.S. App. LEXIS 19221, at *31.There is no indication, for example, that this was a manuscript-type policy where Constantin actually had a say in crafting the precise policy language. Even sophisticated insureds who negotiate for better pricing or cover are typically negotiating over insurance-industry form language, not writing from scratch. The opinion also glosses over the fact that the policyholder was a “relatively small office with few employees.” Id. The court brushed this aside by observing that “size does not necessarily equate to a lack of commercial sophistication,” but the converse is also true: just because Constantin was “composed of accounting professionals” does not mean the firm was “sophisticated” from an insurance coverage standpoint.

Thus, the ECB decision highlights significant risks policyholders face in jurisdictions that consider the sophistication of the insured in determining coverage, including the risk that a court will deem the company “sophisticated” regardless of size, and regardless of their actual level of sophistication, areas of sophistication, or whether they had any actual bargaining power or involvement in negotiating or drafting the policy. In jurisdictions that follow the approach reflected by ECB, these policyholders may not get the benefit of the doubt when later seeking coverage under their insurance policies. Policyholders with operations in these jurisdictions (or across multiple jurisdictions) should consider contacting coverage counsel to assist with mitigating these risks. 

Finally, the ECB decision serves as a cautionary tale for corporate policyholders with evolving or wide-ranging business operations. When Constantin first obtained insurance from Chubb in 2001, the company might have been performing accounting services solely or primarily for financial institutions and wouldn’t think twice about the “financial institutions” phrase at the end of the policy’s definition of management consulting services. By 2017, when the policy came up for renewal, Constantin might have expanded its client-base to other industries (including food service companies like Schratter Foods), without re-examining the Chubb policy against its current operations. In that respect, ECB also highlights the importance of carefully and continuously examining coverage against the company’s current business activities—particularly at the time of renewal.

In what is described as the largest cyber loss event in years, on Friday, July 19, 2024, customers of CrowdStrike and many others throughout the world discovered that they could not access critical software and enterprise systems to run their businesses.

The mass outage was due to a defective CrowdStrike software update. The outage notably affected airlines throughout the world, causing the cancellation of thousands of flights, but disrupted many other entities, including government agencies (including transportation and emergency services), banks and financial services companies, hospitals and managed care providers, manufacturers, retail stores, and broadcasting and entertainment companies.

Businesses impacted by the CrowdStrike outage should carefully review their insurance programs to determine whether any policies may cover financial losses caused by the incident or potential claims from affected clients, customers, patients, or others:

  • Companies that carry cyberliability insurance should review whether their policies provide contingent business interruption coverage, which may cover lost income and other losses due to an outage or incident at a critical IT vendor. 
  • Supply chain insurance may respond to interruptions at other businesses in the company’s supply chain.
  • Businesses providing professional services should review the scope of any professional liability and technology errors & omissions coverage to determine how those policies may respond in the event of a claim, and whether the company should put its carriers on notice of circumstances (or a potential claim).

Companies also should carefully review any service or vendor agreements to determine whether they have rights under policies issued to the service provider or vendor, and whether they have any other rights of recovery independent of insurance.

Reed Smith’s Insurance Recovery Group is one of its premier practice groups. With insurance recovery lawyers across the globe, we are uniquely positioned to serve our clients in all aspects related to losses arising from system and network outages and failures, cyber events, and other tech-related business interruptions. Our expertise in this space allows us to provide our clients with the most up-to-date knowledge and experience in identifying and accessing your insurance recovery options.   

Hurricane Beryl has caused destruction in the Caribbean, Mexico and Texas. Continuing issues include power outages, both rolling and continuous, issues regarding access to clean water, severed communications, roads that remain impassable and issues accessing necessities like food and fuel.

Hurricanes cause dramatic damage to businesses and commercial properties every year, totaling some $9 billion according to the Congressional Budget Losses, and hurricanes are increasing in both frequency and severity. The 2024 hurricane season is expected to be more severe—including between 8 and 13 hurricanes, 4 to 7 of which are expected to be severe—due to La Nina and warmer ocean temperatures. Beryl was just the second of the Atlantic Tropical Cyclone storm names, so more damage can be expected.

Several Policies May Provide Coverage

While there is no stand-alone hurricane policy, riders to commercial property or business owners’ policies for named perils may be purchased, and several coverage types can address damages caused by hurricanes.  

Most “all risk” policies cover damage caused by wind and wind-driven rain, but typically exclude flood damage. Flood insurance can be purchased as a rider or stand-alone policy, and covers losses from flooding, including buildings and their contents. For named peril policies, both wind and flood may be excluded. In this case, wind insurance, sometimes called named storm or named peril coverage, can help cover damage caused by gales, winds and hail if wind is excluded.

Business Income and Extra Expense

Lost business income coverage is vital. It generally is subject to a waiting period of 24-72 hours before coverage kicks in. Since it is subject to the exclusions in the policy, businesses may need to ensure business income coverage is covered by their flood insurance. If your business depends on third parties to operate, contingent business interruption coverage is important. If you rely on suppliers or distributors, contingent business interruption coverage may help cover losses caused by property damage to contingent businesses. Similarly, if your business relies on component parts, suppliers, or distributors, specialized supply chain coverage (whether as a rider to a commercial policy or standalone) may cover hurricane-related supply chain interruptions that result in lost business income.

Extra expense coverage may help defray costs to continue operating and mitigate damages, including continuing production at the current site, moving to a temporary location, using other facilities, paying contractors, overtime, and bonuses.

Other Important Coverages

Sewer backup cover also is vital, as hurricanes frequently wreak havoc on sewer systems. Sewer backup insurance can cover losses caused by water or waterborne material discharged by a sewer, drain or sump. Offsite utility interruption coverage also is important, and frequently is excluded.

Other policies also may provide cover following a hurricane:

  • General liability can protect against injury to customers or damage to their property.
  • Workers’ compensation can help if an employee is injured by a hurricane while on the job.
  • Finished stock insurance may help cover lost inventory damaged by a hurricane.

A few years ago, a new law in Texas went into effect limiting policyholder remedies for improper insurance claims handling and added several requirements for submissions for claims arising from “damage to or loss of covered property caused, wholly or partly, by forces of nature” including hurricane, tornado, flood, wind or rainstorm. Texas policyholders also must provide a high level of detail when disputing a carrier’s coverage determination and they must consent to inspection by the carrier. Failure to meet either the detail or consent requirement can lead to dismissal of a suit. It requires a policyholder’s attorney to provide notice to a carrier that if the claim issues are not resolved within 60 days, the policyholder will file suit. Currently, policyholders are only able to get a 10% interest rate from a late-paying carrier, and there also are limits on the attorneys’ fees a policyholder can recover if they are forced to file suit. 

Tips for Policyholders Following a Hurricane

  1. Notify the insurer and the broker of any property damage and business interruption.
  2. Preserve evidence of the damage.
  3. Obtain approval from your carriers before replacing or removing damaged property.
  4. Get the proper Proof of Loss form and fill it out within the requisite time.
  5. Communicate with your carrier regarding the need to submit a partial proof of loss due to the nature of continuing investigations into losses caused by hurricanes.
  6.  Gather all documentation relating to any business interruption or extra expenses.
  7. Consider retaining an accounting firm. Some policies provide coverage for loss preparation costs.
  8. Communicate with the insurer, being sure to provide all necessary and relevant documentation, and be sure to log those communications.

Conclusion

Hurricane losses raise complex issues including those relating to causation and overlapping coverage provisions. Hire experienced coverage counsel to review all insurance policies for potential coverage and to evaluate potential coverage issues before submitting any claim.

For additional thoughts from Reed Smith’s Insurance Recovery Group on natural disaster coverage, we recommend listening to the recent Insured Success podcast episode titled Navigating Insurance Claims After Natural Disasters. An upcoming episode of Insured Success will focus specifically on hurricane recovery and expand on the thoughts discussed in this blog.

Key Take-aways

  1. The wording in insurance policies is often taken from precedent wording that has evolved over time. Accordingly, we often see inconsistencies in the wording of policies and/or ambiguity in the provisions setting out the scope of cover. There are often many different interpretations that can be applied to inconsistent wording in a policy, and it should not be assumed that the correct interpretation of any inconsistency is obvious or clear. When reviewing insurance policies, policyholders should look out for any inconsistencies between provisions in the policy and discuss them as a matter of priority with the broker and insurers in order to remedy the inconsistency.
  2. Parties should pay particular attention to provisions setting out the order of priority in the event of a conflict, particularly regarding the scope of cover, to ensure that they understand how the provisions of the policy will be interpreted in the event of a conflict.
  3. The English Court of Appeal’s judgment handed down in May this year, offers a timely reminder of the limited circumstances in which the English Courts will intervene in altering contractual terms agreed between the parties. In short, the Court will not re-write a bad bargain or correct drafting errors; in order for a court to intervene it must be shown that there is a clear and obvious drafting error and that there is a clear and obvious correction to that error.

Factual background

On 19 November 2019, Project Angel Bidco Ltd (the “Buyer”) acquired the entire issued share capital of a civil engineering and general construction company (the “Target Company”). The Buyer took out a buyer-side warranty and indemnity insurance policy (the “Policy”), which provided an indemnity for breach of the bribery and corruption warranties in a share and purchase agreement (“SPA“).  

The purpose of a buyer’s side warranty and indemnity policy is to insure against the risk that the target company or business was not in the state warranted by the sellers and, therefore, worth less than the purchase price at the date when the sale took place. 

Following the acquisition, the Buyer alleged that the sellers had breached certain warranties in the SPA relating to the Target Company’s compliance with anti-bribery and anti-corruption legislation (“ABC Legislation”) and made a claim under the Policy.

Nature of the drafting error

The Buyer sought to argue that the cover provided by the Policy extended to cover the warranties given in respect of compliance with ABC Legislation by virtue of the warranties being listed and marked as being “covered” in the “Cover Spreadsheet”, which was appended to the Policy.

However, the Policy included certain exclusions, including losses arising out of “any ABC Liability”, which was defined as:

“any liability or actual or alleged non-compliance by any member of the Target Group or any agent, affiliate or other third party in respect of Anti-Bribery and Anti-Corruption Laws”.

The Buyer argued that there was a plain contradiction between the “Cover Spreadsheet”, which identified the ABC Legislation warranties as being covered, and the exclusion of “ABC Liability”, which stemmed from a mistake in the draft of the definition of “ABC Liability”. The Buyer argued that the “ABC Liability” definition was missing a letter and should have read:

“any liability for actual oralleged non-compliance by any member of the Target Group or any agent, affiliate or other third party in respect of Anti-Bribery and Anti-Corruption Laws.” 

The Buyer contended that this amendment would have confined the exclusion to liability only.

At first instance, the English Commercial Court ruled in favour of the Insurers holding that in order for the Policy to be re-written in the manner suggested by the Buyer, the Buyer would have needed to have demonstrated either (i) that there was a mistake that is “obvious on the face of the document” or (ii) that the “language is clear but makes no rational sense or leads to an irrational outcome that could not possibly have been what is meant”.  This was a high threshold, that the Court held was not overcome in the circumstances of this case.

In particular, the Court found that there was no contradiction between the Cover Spreadsheet and the Policy wording, when read together. In reaching this conclusion, the Court pointed to the introductory wording of the Cover Spreadsheet, which expressly addressed the order in which the sections of the Policy were to be read if there was a conflict:  

“Notwithstanding that a particular Insured Obligation is marked as “Covered” or “Partially Covered”, certain Loss arising from a Breach of such Insured Obligation may be excluded from cover pursuant to Clause 5 of the Policy.”

The Court of Appeal’s Judgment

The Buyer went on to appeal. The crux of the appeal was whether there was a drafting error so stark that it gave the Court permission to wade into the commercial realm of negotiations and alter the terms that had been recorded between the parties. For the Court to change the wording of the Policy, the a) drafting error needed to be clear; and b) the correction needed to be obvious.

Lord Justice Lewison of the Court of Appeal held that there was an apparent conflict between the inclusion of the whole of the relevant warranty in the Cover Spreadsheet on the one hand, and the scope of the definition of “ABC Liability” on the other. Nevertheless, Lewison LJ concluded that the alleged drafting error was not clear enough to warrant the Court’s intervention. In particular, it was noted that the Insurers had coherent and rational reasons for wanting to exclude losses arising out of ABC Liability and, as such, it was not clear whether, if there was any mistake, it lay in the drafting of the ABC Liability exclusion or the inclusion of the relevant warranty in the Cover Spreadsheet. Lewison LJ also noted that the ABC Liability clause had been specifically negotiated and that the Court should not lose sight of the fact that the provision may have been a compromise or that the parties were unable to agree more precise terms; inconsistency can exist in such complex policies and the Policy in question should be considered as a whole, within its contractual context.  Accordingly, the appeal was dismissed.

Conclusion

Buyers of complex commercial insurance should read policies carefully. The English courts are reluctant to intervene in cases where lengthy negotiations would, or should, have taken place. Policyholders should work closely with their brokers and insurers to understand the exact scope of coverage and what would happen in the event of an inconsistency between the policy provisions.  

In this post, we take a look at an insurer’s right to subrogation – the mechanism that allows them to step into the shoes of the insured – and how, in particular circumstances, that right can be restricted.

We look first at how subrogation applies where there are joint or co-insureds, depending on the specifics of that cover and then consider the interaction between a contractual prohibition on assignment and the insurer’s right to subrogation.

Joint and Co-Insureds

In cases where there is joint insurance cover over a common interest, an insurer is prevented from pursuing a subrogated claim against one insured for a loss sustained by a co-insured. It is not difficult to see the barrier to an insurer pursuing a subrogated claim – if they are successful, they will have to indemnify the defendant as well.

This restriction on an insurer’s right to subrogation is applied practically and rather narrowly. If the two parties are co-insured under the same policy, but each have a different scope of cover, then where the loss is something which is covered for one party but not the other, a subrogated claim can still be brought between them. The onus is on the insurer to establish that the defendant to the proposed subrogated claim is not covered for the loss.

This requires close analysis of the detail in the scope of cover for each insured under an insurance policy. It may be common ground that the parties are each insured under the policy, but the crucial question is the extent of that cover in relation to the specific loss.

It is the intention of the parties, with respect to the scope of the cover and position on subrogation, that will be the court’s primary consideration when determining whether or not a right of subrogation exists. If the position is not clear from the policy, then the court will look at all contractual documentation in the round and give weight to factors such as the relationship between the parties and any evidence that the parties had intended to prevent subrogated claims. If the evidence is that the intention of the co-insured parties in obtaining insurance for certain losses was to displace claims based on civil liabilities between them, then a term preventing subrogated claims against a co-insured will be implied into the policy.

Contractual Prohibition on Assignment

It is not uncommon for an agreement governed by English law to include, as part of the boilerplate clauses, a non-assignment clause, preventing any assignment of rights to a third party (such as an insurer). The interaction between a non-assignment clause and a subrogation clause, generally found in separate contracts, is an important one but perhaps too often overlooked.

The question that arises is, is subrogation a form of assignment of a right? If so, is a subrogated claim prohibited under such a non-assignment clause?

Under English law, if the insured assigns rights to a claim contractually, for example, by way of security, then the insurer can bring the claim in its own name. On the other hand, a subrogated claim is brought by the insurer stepping into the shoes of the insured and brought in the name of the insured. It should be noted that this position may differ in other jurisdictions, where the English law concept of subrogation is not available.

It is important to know whether the right to subrogation has arisen as a matter of law, or through another channel, such as through contract. If the right to bring a claim was transferred to the insurer by the party contractually, then it would appear to fall under the non-assignment clause. The prohibition on assignment in a contractual clause typically explicitly refers to the assignment by one party or another.

However, if the right to subrogation arises by operation of law in the jurisdiction, then it would not be prevented by the non-assignment clause.

The wording of the contract between the parties and specifically the non-assignment clause will be critical. When looking at the contract between the parties as a whole, if there is provision for each party to obtain their own insurance, then it appears likely that the court will not find that a non-assignment clause was intended to prevent subrogated claims. Rather than relying on boilerplate language, it would be wise to make sure that any non-assignment provisions are drafted with particular clarity and considered in the context of any relevant insurance cover.

In 1942, the Luftwaffe dropped a 1000kg high-explosive bomb onto farmland in the outskirts of Exeter.

Some 82 years later, the Court of Appeal has dismissed the University of Exeter’s appeal against the High Court decision in Allianz Insurance Plc v University of Exeter (see our previous commentary) The Judge at first instance (HHJ Bird) had found that damage to halls of residence caused by the bomb’s controlled detonation was not covered under the University’s insurance policy with Allianz.

Continue Reading A blast from the past – unearthed: Court of Appeal dismisses University of Exeter’s appeal

The shocking and tragic collapse of the Francis Scott Key Bridge over Baltimore Harbor on Tuesday is already having significant impacts on trade and transportation throughout the East Coast region, with ship traffic in and out of the Port of Baltimore suspended until further notice. As a result, businesses that depend on the Port of Baltimore and its supporting infrastructure for shipment and distribution of cargo are facing significant financial losses in the coming weeks and months. Similarly, as the issues surrounding liability related to the collapse become more clear in the coming weeks and months, companies may find themselves at the center of legal liability claims arising from various aspects of the disaster.   

Continue Reading Francis Scott Key Bridge collapse implicates several insurances types

Online retailers have changed the way we shop. No longer do we spend hours in line queuing for a can opener or, perhaps more appropriately in current times, an air fryer. Nowadays, at the click of a button, we have items expeditiously delivered straight to our door. And soon, it will be straight to our door without a human touch.

Last year, certain retailers began trialling drone delivery, marking the dawn of a new era of deliveries.

This latest development is one the insurance market cannot ignore. The drone insurance market is growing, and it looks like it will continue to do so as technology develops and retailers rely on drones to deliver parcels.

Continue Reading Delivery by drone? Insurance needed!

The “Four Corners rule” (a.k.a. the “Eight Corners rule”) is the foundation for many states’ common law regarding the Duty to Defend under liability policies. Under that regime, the court treats “the underlying complaint and the insurance policy” as “the only documents relevant” to deciding whether an insurer owes the policyholder a duty to defend.  Badger Mining Corp. v. First Am. Title Ins. Co., 534 F. Supp. 3d 1011, 1020 (W.D. Wis. 2021); 1 General Liability Insurance Coverage § 5.02 (5th ed.) (providing a “50-State Survey: Duty to Defend Standard: ‘Four Corners’ or Extrinsic Evidence?”).

The rule presents a problem for policyholders when the complaint’s allegations do not raise a duty to defend on their face, however, during the course of the litigation, it becomes apparent that claims that do give rise to a duty to defend are, in fact, at issue.  If the case is pending in federal court, policyholders can assert the “constructive amendment doctrine”; that is, that the complaint has been effectively amended to include the unpleaded claims and, therefore, the insurance company should provide a defense.

Continue Reading Expanding the “Four Corners” rule through constructive amendment