Nicole Priuli comments on the most recent UK Supreme Court ruling on lost profits.

The Supreme Court of the United Kingdom upheld the judgment in favor of the insured regarding compensation for lost profits as a result of the Covid-19 pandemic.

COVID-19 and the public health measures taken by the UK government caused financial losses for businesses across the country. Many of these companies have insurance policies that protect them against lost profits and thousands of claims were filed under such policies, however the insurers denied coverage based on the claim that their policies would not cover the effects (or certain effects) of the pandemic.

Thus, the Financial Conduct Authority (“FCA”) took a “test case” for judicial discussion under which issues of importance to the market were analyzed, without the need for a specific dispute between the parties.

The FCA instituted the process for the benefit of the insured, many of whom are small and medium-sized companies, while the defendants are the eight main insurers [1] issuing insurance policies against loss of profits in the world.

The approach taken by the FCA was to consider a representative sample of standard loss of profits policies in light of agreed and presumed facts. It is estimated that, although only eight insurers are part of the process, around 700 types of policies at more than 60 different insurers and 370,000 insured persons may be potentially affected by the outcome of this process.

The first-instance decision was handed down on 15/09/2020, allowing the filing of an appeal under the “leapfrog” model, that is, a special and relatively rare form of appeal in which the case is referred directly to the Supreme Court without being considered by the Court of Appeal.

The appeal is based on the proper interpretation of four types of clauses that can be found in the relevant policies, as follows:

i) “Sickness clauses” (clauses that, in general, provide coverage for loss of profits resulting from notifiable diseases, such as COVID-19, within a certain distance from the commercial facility);

The Supreme Court concluded that the correct interpretation is to cover only the relevant effects of COVID-19 cases that occur or have occurred in or within a specific radius of the insured facilities mentioned in the policy. They do not cover the effects of COVID-19 cases that occur or have occurred outside that geographic area.

ii) “Access prevention clauses” (clauses that, in general, provide coverage for lost profits due to the intervention of public authorities that prevent or hinder access to or use of commercial establishments) and hybrid clauses containing elements of “sickness clauses” with a distance range;

Although the contractual wording is different for each of the insured, the clauses contained in the policies sold by the insurance companies are structured in a similar way, i.e.,”injury resulting from preventing access to dependencies due to actions or advice of a government or local authority due to an emergency that could endanger lives or property” and, as a hybrid clause,”losses resulting solely and directly from an interruption of your activities caused by your impossibility of using the insured facilities due to restrictions imposed by a public authority during the insurance period after the occurrence of any infectious or contagious human disease, the outbreak of which must be notified to the local authority.”

The discussion regarding the above-mentioned clauses revolved around (i) whether a”occurrence of any infectious or contagious human disease” could be interpreted as an occurrence within a radius of the insured dependencies, being interpreted as something on a small scale that should not be applied to the pandemic (it should be noted that most of the policies used in this “test case” have territorial limitations); (ii) if the interpretation to be given to”restrictions imposed by a public authority” would be restricted to “law” in the strict sense or would encompass other types of regulations (which would impact the “trigger” of coverage for loss of profits); (iii) what would be the correct interpretation of the expression “impossibility of use”.

In this sense, in relation to the points above, the Supreme Court held that (i) each individual case of illness must be considered as an occurrence and its restriction to small-scale occurrences could not succeed because it would be too subjective, giving rise to legal uncertainty; (ii) any rules, regulations and instructions are considered to be”restrictions imposed by a public authority”, and a law in the strict sense is not essential, even when it comes to emergency situations, but to the exclusion of”advice or warnings, or social distancing and instructions for staying home”; (iii) the use must be effectively prevented, and not merely hindered. On the other hand, it was understood that the impossibility of use does not have to refer to the totality of commercial premises. The reference to”commercial outbuildings” must be interpreted as comprising a part of these dependencies that can be used separately from other parts or for a specific business object. In other words, there would be no reason not to distinguish different business objects if the corresponding activities can be conducted separately and the use of only a part of them is impossible.

Therefore, this requirement - the impediment of use - will be fulfilled if (a) the insured cannot use their dependencies to carry out a specific and discriminated part of their business activities or if (b) they cannot use a specific and discriminated part of their dependencies for their business activities. In both situations, according to the Supreme Court, there would be a total impossibility of use. In the first situation, there would be a total impossibility to carry out a specific commercial activity; in the second, there would be an impossibility of using a specific part of the business premises.

The Supreme Court decision mentions examples that help to understand this distinction, such as: 1. a restaurant that also offers services of Delivery, but who decided to close the entire deal, and could only claim the lost profits related to the restaurant; 2. a travel agent with 50% of face-to-face customers, 25% of Internet sales and 25% of sales by telephone, who could only claim lost profits resulting from the interruption of face-to-face business, even though all parties to the business may have suffered the effects of COVID-19 and the imposed government measures.

iii) “Causal Nexus”;

The Supreme Court concluded that, to prove that the lost profits were caused by one or more COVID-19 occurrences, it would suffice to prove that the interruption was the result of government action in response to at least one case of COVID-19 within the covered radius. The basis for this conclusion is that each of the individual COVID-19 cases that have occurred to the date of any government action constituted a separate and equally effective cause of that action (and the public's response to it).

Furthermore, such a conclusion does not depend on the specific terminology used in the policy to describe the causal link required between the loss and the covered risk and will apply equally if the term used is “follow” (”Following”), “arising from”, “as a result of” (”arising from” or “as a result of”), among others, since the Supreme Court's conclusion refers to the legal effect of insurance contracts insofar as they apply to the facts of this case.

iv) “Trend clauses” (clauses that generally provide that lost profits will be quantified according to the expected business performance if the insured event had not occurred).

The Supreme Court found that trend clauses must be interpreted so that standard turnover or gross profit derived from previous transactions is adjusted only to reflect circumstances that are not related to the insured risk, and not circumstances that are inextricably linked to the insured risk in the sense that they have the same underlying or original cause. This approach ensures that the trend clause is interpreted in a manner consistent with the covered risks clause, and not in such a way as to deprive the insured of insurance coverage.

Therefore, it was considered that the trend clauses do not require losses to be adjusted based on the fact that, if the insured risk had not occurred, the results of the business would still have been affected by other consequences of COVID-19.

v) Losses suffered before the “trigger”

As interpreted by the Supreme Court, the trends or circumstances for which adjustments may be made do not include the tendencies or circumstances caused by the insured risk (or its underlying or original cause). In addition, the purpose of any adjustment is to seek to ensure that the adjusted amounts represent, as far as possible, the financial results that would have been achieved during the compensation period had the insured risk (and its underlying or original cause) not occurred.

As an example, the decision mentions the following scenario:

A complaint filed by a pub owner to which access was prevented when the Prime Minister announced the closure of several businesses, including pubs, on the night of March 20 and March 21. Suppose that, as a result of the climate of general public concern about COVID-19 and warnings from the UK government before March 20, 2020, the pub's turnover for the week ending March 20 had been only 70% of its turnover in the equivalent week of the previous year.

The Court of First Instance had admitted that, when estimating what the turnover of the business would have been during the compensatory period, this reduction should be taken into account. That analysis considered that the slowdown would have continued during the compensatory period had access to the pub not been prevented.

However, the Supreme Court found that the Court of First Instance made a mistake and that it would not be allowed to reduce the compensation to reflect a slowdown caused by the pandemic, since such an attitude would mean refusing to compensate the insured for losses caused directly by the insured risk, that is to say, by the same original cause.

Thus, the Supreme Court concluded that the losses must be assessed based on the assumption that the COVID-19 pandemic did not occur. In line with this conclusion, the calculation of the loss should disregard the losses that occurred before the trigger caused by the pandemic.

In view of the above, although the Supreme Court accepted some of the insurance companies' arguments in its appeal, these arguments did not decisively influence the outcome of the process, allowing us to foresee relevant future modifications in the loss of profits clauses.

[1] (1) Arch Insurance (UK) Ltd (“Arch”); (2) Argenta Syndicate Management Ltd (“Argenta”); (3) Ecclesiastical Insurance Office Plc (“Ecclesiastical”); (4) Hiscox Insurance Company Ltd (“Hiscox”); (5) MS Amlin Underwriting Ltd (“MS Amlin”); (6) QBE UK Ltd (“QBE”); (7) Royal & Sun Alliance Insurance Plc (“RSA”); and (8) Zurich Insurance Plc (“Zurich”)). Subsequently, Hiscox Action Group (“Hiscox Interveners”) and Hospitality Insurance Group Action were included in the process as stakeholders.