Ill Wind: Selected Insurance Issues After Hurricane Katrina

By virtually any measure, Hurricane Katrina ranks as one of the worst natural disasters in American history. It will surely be months if not years before the full toll of the storm and its aftermath, including long-term effects on the Gulf Coast, are known. It is equally sure that Hurricane Katrina will spawn an array of disputes concerning insurance coverage for losses or damage caused by the storm. Indeed, barely 2 weeks after the hurricane hit land, at least two major insurance coverage lawsuits, one in Mississippi and one in Louisiana, had already been filed.

The range of disputes promises to be wide, given that the hurricane directly affected policyholders in multiple jurisdictions and has affected or will affect policyholders in other jurisdictions indirectly; given that policy language may vary from one insured to the next; and given that damage or loss stemmed from a variety of hazards. In light of the range of potential legal issues ' and the consequences of a misstep ' policyholders with significant claims should consider retaining coverage counsel with whom they may at least consult as they evaluate, classify, present, and pursue their claims.

A comprehensive review of all the issues that may arise is beyond the scope of this article. This article will instead address two of the issues that have emerged or are reasonably likely to emerge as residents, local businesses, and others affected by the hurricane look to their insurers for help in rebuilding their lives and their livelihoods. These are: 1) what happens when an insured suffers losses due to both a covered cause and an excluded cause; and 2) what coverage may be available to insureds located outside of the area hit by Hurricane Katrina but whose businesses have nonetheless been disrupted because of property damage to suppliers, customers, or others important to their business.

Causation Confusion: The Problem of Mixed Causes of Loss

The extensive property losses caused by Hurricane Katrina arose from a multitude of perils, including, at a minimum, high-velocity winds, storm surges, flooding, levee breaches, wind-driven rains, fire, sewage overflow, toxic contamination, and looting. The storm also caused substantial interruptions in business throughout the affected area and beyond, some of which were caused by direct physical damage to the business's own buildings or equipment, and some of which were caused by other factors, such as impaired access (commonly referred to as “ingress” and “egress” in insurance policies), evacuation orders, power outages, curfews, and interruptions in the chain of supply which were themselves caused by one or more of the above factors.

Given this confluence of events, as well as the fact that any particular insurance policy may expressly or implicitly provide coverage for loss due to one or more of these perils while purporting to exclude coverage for loss caused by another such peril, or may establish separate and quite different deductibles or sublimits depending on how a given loss is classified, millions if not billions of dollars in potential insurance coverage will surely turn on questions of causation. Indeed, homeowners and their insurers are already battling over whether damage to properties along the coastal regions was caused by hurricane-force winds (typically covered under homeowners' policies) or by the flooding accompanying the storm (typically excluded under homeowners' policies).

To be insured under a first-party policy, a claimed loss must be caused by a covered peril or, in the case of “all risk” policies, a peril that is not expressly excluded. The question of causation becomes complicated where multiple factors, some covered and some not, contributed to the damage. Such factors may have worked together to cause the loss, one may have followed directly from the other, or the two may have arisen independently, and the relation between the perils lends a further twist to the legal issues.

The courts have developed various tests for situations in which an excluded peril and a non-excluded peril contributed to the loss, with the most prominent being the “efficient proximate cause” doctrine and the “concurrent causation” doctrine. Generally speaking, the efficient proximate cause doctrine allows recovery so long as the non-excluded cause was the efficient and dominant cause of the loss, notwithstanding that an excluded peril may have contributed to the loss. Under this doctrine, “[t]he cause to which the loss is attributed is the efficient, dominant cause, the one that sets the others in motion, although other and incidental causes may be even nearer in time and place to the result and may operate more immediately in producing the loss.” Sidney I. Simon, “Proximate Cause in Insurance,” 10 Am. Bus. L.J. 33, 37 (Spring 1972). By contrast, under the concurrent causation doctrine, recovery is allowed so long as one of two or more contributing causes is insured, even if other contributing causes are not.

The precise application of either doctrine will depend on both the facts of the claim and the case law in the pertinent jurisdiction. As a general proposition, and notwithstanding some federal court decisions to the contrary, the efficient proximate cause doctrine has been adopted by the highest courts of Mississippi, Louisiana, and Alabama, the three states most affected by Hurricane Katrina. See, e.g., Western Assurance Co. v. Hann, 78 So. 232, 236 (Ala. 1917); Glens Falls Ins. Co. of Glens Falls, N.Y. v. Linwood Elevator, 130 So. 2d 262, 270 (Miss. 1961); Evana Plantation, Inc. v. Yorkshire Ins. Co., 58 So. 2d 797, 798 (Miss. 1952); Roach-Strayhan-Holland Post No. 20, American Legion Club, Inc. v. Continental Ins. Co. of N.Y., 112 So. 2d 680, 683 (La. 1959). Courts in these three states have interpreted the doctrine to allow policyholders to recover for hurricane-related losses where the evidence showed that wind was the efficient proximate cause of the damage, notwithstanding that flooding contributed to the loss.

In the aftermath of Hurricane Camille, for example, which struck in 1969, the Mississippi Supreme Court heard three cases involving a dispute between a policyholder and its insurer as to whether the claimed loss was caused by wind or flood. In each case, an exclusion provided that the policy did not insure against loss “caused by, resulting from, contributed to, or aggravated by … flood, surface water, waves, tidal water, or tidal wave, overflow of streams or other bodies of water … whether driven by wind or not.” In each case, the court upheld a jury verdict for the insured finding that the efficient proximate cause of the damage at issue was the initial high-velocity winds, not, as the insurers argued, subsequent flooding. See, e.g., Commercial Union Ins. Co. v. Byrne, 248 So. 2d 777, 781 (Miss. 1971) (upholding verdict for insured under all-risks policy).

Louisiana and Alabama courts likewise have had occasion to address whether hurricane damage in a given case was caused by wind or by flooding. See, e.g., Picone v. Manhattan Fire & Marine Ins. Co. of N.Y., 50 So. 2d 188 (La. 1950); Urrate v. Argonaut Great Central Ins. Co., 881 So. 2d 787, 790-91 (La. Ct. App. 5th Cir. 2004), writ denied, 891 So. 2d 686, 690 (La. 2005); Ebert v. Pacific Nat'l. Fire Ins. Co., 40 So. 2d 40, 45 (La. Ct. App. 1949); Allstate Ins. Co. v. Fitzsimmons, 429 So. 2d 1059, 1062 (Ala. Ct. App. 1983). Although in most instances the courts have upheld coverage on the ground that high wind directly damaged the property in question before any subsequent damage was inflicted by flood, the fact that the high court of each state has adopted the efficient proximate cause test should support coverage claims by insureds who argue that the flooding in their particular case was itself caused by the high winds of a hurricane or by another covered peril.

What is clear from these cases is that the mere fact that substantial flooding occurred as a result of Hurricane Katrina, or even that a given property sustained damage that was indisputably attributable to flood waters, does not necessarily mean that coverage may properly be denied under a flood exclusion. With the proper factual basis, an insured might be able to establish coverage on the ground that the flooding in question was the last link in a chain of events whose efficient proximate cause was a covered peril such as high winds, or that significant damage occurred to the insured's property from those winds (or some other covered peril) before or independently of damage caused by flooding. In light of the variety of perils that have caused loss or damage in the wake of Hurricane Katrina, these same issues of how to deal with mixed causation presumably will arise with an array of other covered and excluded perils as well. Because of the complexities that can arise in mixed causation cases, any policyholder that arguably sustained damage from a covered peril and an excluded peril would be well advised to study the case law in the applicable jurisdiction and make a full factual inquiry, with expert assistance if necessary, in order to present its coverage claim to its insurer (or a trial court) in the most favorable light.

A final point on the issue of mixed causation. Perhaps the most contested issues in the mixed-causation arena will be the interpretation and the enforceability of so-called anti-concurrent-causation clauses now included in many policies. One common clause provides that a loss resulting from an excluded cause is not covered “regardless of any other cause or event contributing concurrently or in any sequence to the loss.” Already, the Attorney General of Mississippi has filed a suit asking that such provisions be held to be unenforceable to restrict coverage on a variety of grounds, including that they are ambiguous and confusing, that they confound a policyholder's reasonable expectations, and that they are contrary to the public policy of Mississippi as expressed in prior judicial decisions. It is reasonably likely that similar litigation will be filed in other jurisdictions, at least if, as expected, insurers rely on this prefatory language in conjunction with exclusions in order to deny or substantially restrict claim payments.

The fate of the anti-concurrent-causation clauses, and their effect on Katrina-related losses, remain to be seen. The courts that have addressed this question are divided on the issue. Courts in some jurisdictions have enforced the clauses even where a covered peril is the efficient proximate cause of the loss, reasoning that insurers may choose to contract around any applicable causation rule. See, e.g., Alf v. State Farm Fire & Cas. Co., 850 P.2d 1272, 1277 (Utah 1993). However, courts in other jurisdictions have held that insurers may not contract around the efficient proximate cause doctrine as a matter of public policy. See, e.g., Safeco Ins. Co. of Am. v. Hirschmann, 773 P.2d 413, 414, 416 (Wash. 1989) (en banc). Other courts have held that such clauses are ambiguous and to read them as precluding coverage for damage proximately caused by a covered peril is inconsistent with the reasonable expectations of the policyholder. See, e.g., Murray v. State Farm Fire & Cas. Co., 509 S.E.2d 1, 14 (W. Va. 1998).

The highest courts of Mississippi and Louisiana have not yet had occasion to examine the effect of these clauses. Although the Alabama Supreme Court has upheld such a clause, see State Farm Fire & Cas. Co. v. Slade, 747 So. 2d 293 (Ala. 1999), it is unclear whether that case will prove to be the governing law for Alabama courts examining the very different facts of Hurricane Katrina, given that the causal relationship between hurricane winds and coastal flooding is much clearer than the causal relationship between a lightning strike and subsequent earth movement alleged to have existed in Slade. Moreover, even if such clauses are held to be enforceable with respect to Katrina-related losses in Alabama or the other applicable states, a policyholder nevertheless may be able to obtain coverage in a particular instance by showing that the loss at issue would have occurred even in the absence of the contributing excluded cause. See, e.g., O'Neill v. State Farm Fire Ins. Co., No. Civ. A 94-3428, 1995 WL 214409, at *3 (E.D. Pa. Apr. 7, 1995).

Contingent Business Interruption: Coverage Based on Damage to Other People's Property

The destruction caused by Hurricane Katrina had an immediate and obvious impact on hundreds of thousands of residents of the Gulf Coast and countless businesses located there. Less obvious, perhaps, is the effect of that destruction on businesses located outside the area. Although they were spared a direct hit from the hurricane, many such businesses lost suppliers or customers, at least temporarily, as a result of the storm and its aftermath. Moreover, many have lost, at least for now, the ability to ship their products through the Port of New Orleans, one of the country's busiest before the hurricane. Businesses that find themselves affected by Hurricane Katrina notwithstanding a lack of damage to their own property should review their policies to determine whether they have a viable claim for coverage of their economic losses.

The coverage in question is often called “contingent business interruption,” although that term is not used in most policies. In the standard-form policy promulgated in 2001 by the Insurance Services Office (“ISO”) titled “Businessowners Coverage Form,” for example, the pertinent coverage is called “Business Income From Dependent Properties.” A quick review of some of its features reveals this to be a potentially very useful coverage for a properly situated policyholder.

An insurer using the ISO form promises to pay for lost “Business Income” (a defined term that roughly translates as continuing operating expenses plus net profit) due to “physical loss or damage” at the premises of a “dependent property” resulting from a “Covered Cause of Loss.” The policy goes on to define “dependent property” as property owned by others on whom the insured depends to (a) deliver materials or services (excluding water, communication, or power supply services); (b) accept the insured's products or services; (c) manufacture the insured's products for delivery to customers of the insured under contract for sale; or (d) attract customers to the insured's business.

Depending on the circumstances of a given policyholder's claim, it is foreseeable that a variety of issues may arise.

Cause of Loss. Most if not all contingent business interruption policies require that the cause of the property damage or loss to the “dependent property” be a covered cause, that is, one that would have been covered under the policy if damage had instead taken place at the insured's own premises. A policyholder that has suffered an economic loss because an entity in its supply or distribution chain was physically damaged by Hurricane Katrina will therefore need to explore the physical mechanism by which the other entity's property was damaged ' for example, wind, flood, or fire ' and to review its own policies to see whether that mechanism is clearly covered or excluded.

As discussed above, there is already litigation, and there is sure to be more, concerning the interplay of standard grants of coverage for damage due to wind and standard exclusions for damage due to water. For many policyholders whose policies contain these fairly routine provisions, the Mississippi litigation and any similar litigation in other states directly affected by Hurricane Katrina will, at a minimum, be instructive. That said, an insured may find that its coverage turns on the legal rules of a jurisdiction far from the site of the storm's damage. Moreover, a policyholder such as a grain wholesaler in the upper Midwest that cannot move its product into the export market because of damage to the Port of New Orleans ' roughly 60% of the raw grain exported from the United States last year passed through that port ' may find that it (or its insurer) seeks the application of the policyholder's home state's law. So, even an on-point opinion from the Louisiana Supreme Court may not provide the dispositive answer to an out-of-state policyholder. Fully understanding the coverage will therefore require an analysis of the law in all potentially applicable jurisdictions as well as any choice-of-law rules that might govern.

Moreover, in contrast to many homeowners, many insured businesses carry flood coverage. If the insured's policy does not exclude flood or water as a covered cause of loss, the insured should be able to sidestep much of the fighting that is taking place concerning flood exclusions and mixed causation even if its supplier or customer has been shut down due to flood, and even if that supplier or customer did not itself have flood insurance.

Obligation to Mitigate. To put it mildly, contingent business interruption policies typically encourage the insured to resume operations promptly. For example, under the ISO form, if the policyholder does not resume its operations, or does not do so quickly enough, the insurer will pay based only on the length of time that “it would have taken” to resume operations “as quickly as possible.” In addition, the insurer will reduce the amount payable to the insured to the extent that the insured can resume operations, in whole or in part, by using any other available sources of materials or outlets for its products.

It is not difficult to imagine that disputes may arise concerning how quickly an insured reasonably could have resumed its operations, and policyholders with substantial claims might experience second-guessing by insurers. Any insurer that wishes to rely on these provisions to reduce its payment to the insured should present options to the insured on a timely basis, rather than waiting until well after the fact and then arguing with hindsight that the insured could have taken a different course of action. For its part, a policyholder facing a contingent business interruption claim should document its efforts to find alternate sources of materials or outlets for its products so that, in the event of a dispute with the insurer, it can prove that it acted responsibly and that any “roads not taken” were not, in fact, viable alternatives.

Time Period. Typically, contingent business interruption insurance can outlast the policy period. Put differently, the termination of the policy will not cut off the coverage. Nor is the coverage typically limited to a fixed amount of time set forth in the policy. However, there is a cutoff of the coverage, and one that is reasonably likely to lead to disputes between insurers and their insureds: The coverage period for this coverage frequently ends when the damaged property at the “dependent” location “should be repaired, rebuilt or replaced with reasonable speed and similar quality.” (Emphasis added.) Because the repair of the dependent property is outside the control of the insured, the insured could easily find itself still suffering the economic effects of a damaged supplier or distributor and yet facing an argument from its insurer that the damage at the other business' site should have been repaired already.

Repairs following Hurricane Katrina, especially in New Orleans, can reasonably be expected to take longer than usual. Given the widespread damage as well as the massive relocation of the population of the city, one imagines that contractors, repairmen and women, plumbers, roofers, and an array of other necessary service providers will be in short supply for a long time. Many of these tradespeople, who may have lost their own businesses or homes in the hurricane, may simply decide not to return to New Orleans. Although it strikes the authors that a court would take these circumstances into account when evaluating a claim that a dependent property “should” have been repaired more quickly than it actually was, we have seen enough insurance disputes that we will not be surprised if insurers nonetheless test the waters with this defense if it turns out that they are paying large contingent business interruption claims over a long period of time. In that event, we also foresee litigation over whether it is bad faith to advance an argument that “reasonable speed” may be determined without regard to the facts on the ground or the unique circumstances of Hurricane Katrina and its aftermath.

There have been surprisingly few reported judicial decisions involving contingent business interruption coverage. However, based on the catastrophic effects of Hurricane Katrina, we expect to see a diverse assortment of policyholders availing themselves of such coverage, and we also expect to see a sharp increase in the number and nature of disputes concerning contingent business interruption insurance.

By virtually any measure, Hurricane Katrina ranks as one of the worst natural disasters in American history. It will surely be months if not years before the full toll of the storm and its aftermath, including long-term effects on the Gulf Coast, are known. It is equally sure that Hurricane Katrina will spawn an array of disputes concerning insurance coverage for losses or damage caused by the storm. Indeed, barely 2 weeks after the hurricane hit land, at least two major insurance coverage lawsuits, one in Mississippi and one in Louisiana, had already been filed.

The range of disputes promises to be wide, given that the hurricane directly affected policyholders in multiple jurisdictions and has affected or will affect policyholders in other jurisdictions indirectly; given that policy language may vary from one insured to the next; and given that damage or loss stemmed from a variety of hazards. In light of the range of potential legal issues ' and the consequences of a misstep ' policyholders with significant claims should consider retaining coverage counsel with whom they may at least consult as they evaluate, classify, present, and pursue their claims.

A comprehensive review of all the issues that may arise is beyond the scope of this article. This article will instead address two of the issues that have emerged or are reasonably likely to emerge as residents, local businesses, and others affected by the hurricane look to their insurers for help in rebuilding their lives and their livelihoods. These are: 1) what happens when an insured suffers losses due to both a covered cause and an excluded cause; and 2) what coverage may be available to insureds located outside of the area hit by Hurricane Katrina but whose businesses have nonetheless been disrupted because of property damage to suppliers, customers, or others important to their business.

Causation Confusion: The Problem of Mixed Causes of Loss

The extensive property losses caused by Hurricane Katrina arose from a multitude of perils, including, at a minimum, high-velocity winds, storm surges, flooding, levee breaches, wind-driven rains, fire, sewage overflow, toxic contamination, and looting. The storm also caused substantial interruptions in business throughout the affected area and beyond, some of which were caused by direct physical damage to the business's own buildings or equipment, and some of which were caused by other factors, such as impaired access (commonly referred to as “ingress” and “egress” in insurance policies), evacuation orders, power outages, curfews, and interruptions in the chain of supply which were themselves caused by one or more of the above factors.

Given this confluence of events, as well as the fact that any particular insurance policy may expressly or implicitly provide coverage for loss due to one or more of these perils while purporting to exclude coverage for loss caused by another such peril, or may establish separate and quite different deductibles or sublimits depending on how a given loss is classified, millions if not billions of dollars in potential insurance coverage will surely turn on questions of causation. Indeed, homeowners and their insurers are already battling over whether damage to properties along the coastal regions was caused by hurricane-force winds (typically covered under homeowners' policies) or by the flooding accompanying the storm (typically excluded under homeowners' policies).

To be insured under a first-party policy, a claimed loss must be caused by a covered peril or, in the case of “all risk” policies, a peril that is not expressly excluded. The question of causation becomes complicated where multiple factors, some covered and some not, contributed to the damage. Such factors may have worked together to cause the loss, one may have followed directly from the other, or the two may have arisen independently, and the relation between the perils lends a further twist to the legal issues.

The courts have developed various tests for situations in which an excluded peril and a non-excluded peril contributed to the loss, with the most prominent being the “efficient proximate cause” doctrine and the “concurrent causation” doctrine. Generally speaking, the efficient proximate cause doctrine allows recovery so long as the non-excluded cause was the efficient and dominant cause of the loss, notwithstanding that an excluded peril may have contributed to the loss. Under this doctrine, “[t]he cause to which the loss is attributed is the efficient, dominant cause, the one that sets the others in motion, although other and incidental causes may be even nearer in time and place to the result and may operate more immediately in producing the loss.” Sidney I. Simon, “Proximate Cause in Insurance,” 10 Am. Bus. L.J. 33, 37 (Spring 1972). By contrast, under the concurrent causation doctrine, recovery is allowed so long as one of two or more contributing causes is insured, even if other contributing causes are not.

The precise application of either doctrine will depend on both the facts of the claim and the case law in the pertinent jurisdiction. As a general proposition, and notwithstanding some federal court decisions to the contrary, the efficient proximate cause doctrine has been adopted by the highest courts of Mississippi, Louisiana, and Alabama, the three states most affected by Hurricane Katrina. See, e.g., Western Assurance Co. v. Hann , 78 So. 232, 236 (Ala. 1917); Glens Falls Ins. Co. of Glens Falls, N.Y. v. Linwood Elevator , 130 So. 2d 262, 270 (Miss. 1961); Evana Plantation, Inc. v. Yorkshire Ins. Co., 58 So. 2d 797, 798 (Miss. 1952); Roach-Strayhan-Holland Post No. 20, American Legion Club, Inc. v. Continental Ins. Co. of N.Y., 112 So. 2d 680, 683 (La. 1959). Courts in these three states have interpreted the doctrine to allow policyholders to recover for hurricane-related losses where the evidence showed that wind was the efficient proximate cause of the damage, notwithstanding that flooding contributed to the loss.

In the aftermath of Hurricane Camille, for example, which struck in 1969, the Mississippi Supreme Court heard three cases involving a dispute between a policyholder and its insurer as to whether the claimed loss was caused by wind or flood. In each case, an exclusion provided that the policy did not insure against loss “caused by, resulting from, contributed to, or aggravated by … flood, surface water, waves, tidal water, or tidal wave, overflow of streams or other bodies of water … whether driven by wind or not.” In each case, the court upheld a jury verdict for the insured finding that the efficient proximate cause of the damage at issue was the initial high-velocity winds, not, as the insurers argued, subsequent flooding. See, e.g., Commercial Union Ins. Co. v. Byrne , 248 So. 2d 777, 781 (Miss. 1971) (upholding verdict for insured under all-risks policy).

Louisiana and Alabama courts likewise have had occasion to address whether hurricane damage in a given case was caused by wind or by flooding. See, e.g., Picone v. Manhattan Fire & Marine Ins. Co. of N.Y., 50 So. 2d 188 (La. 1950); Urrate v. Argonaut Great Central Ins. Co., 881 So. 2d 787, 790-91 (La. Ct. App. 5th Cir. 2004), writ denied , 891 So. 2d 686, 690 (La. 2005); Ebert v. Pacific Nat'l. Fire Ins. Co. , 40 So. 2d 40, 45 (La. Ct. App. 1949); Allstate Ins. Co. v. Fitzsimmons , 429 So. 2d 1059, 1062 (Ala. Ct. App. 1983). Although in most instances the courts have upheld coverage on the ground that high wind directly damaged the property in question before any subsequent damage was inflicted by flood, the fact that the high court of each state has adopted the efficient proximate cause test should support coverage claims by insureds who argue that the flooding in their particular case was itself caused by the high winds of a hurricane or by another covered peril.

What is clear from these cases is that the mere fact that substantial flooding occurred as a result of Hurricane Katrina, or even that a given property sustained damage that was indisputably attributable to flood waters, does not necessarily mean that coverage may properly be denied under a flood exclusion. With the proper factual basis, an insured might be able to establish coverage on the ground that the flooding in question was the last link in a chain of events whose efficient proximate cause was a covered peril such as high winds, or that significant damage occurred to the insured's property from those winds (or some other covered peril) before or independently of damage caused by flooding. In light of the variety of perils that have caused loss or damage in the wake of Hurricane Katrina, these same issues of how to deal with mixed causation presumably will arise with an array of other covered and excluded perils as well. Because of the complexities that can arise in mixed causation cases, any policyholder that arguably sustained damage from a covered peril and an excluded peril would be well advised to study the case law in the applicable jurisdiction and make a full factual inquiry, with expert assistance if necessary, in order to present its coverage claim to its insurer (or a trial court) in the most favorable light.

A final point on the issue of mixed causation. Perhaps the most contested issues in the mixed-causation arena will be the interpretation and the enforceability of so-called anti-concurrent-causation clauses now included in many policies. One common clause provides that a loss resulting from an excluded cause is not covered “regardless of any other cause or event contributing concurrently or in any sequence to the loss.” Already, the Attorney General of Mississippi has filed a suit asking that such provisions be held to be unenforceable to restrict coverage on a variety of grounds, including that they are ambiguous and confusing, that they confound a policyholder's reasonable expectations, and that they are contrary to the public policy of Mississippi as expressed in prior judicial decisions. It is reasonably likely that similar litigation will be filed in other jurisdictions, at least if, as expected, insurers rely on this prefatory language in conjunction with exclusions in order to deny or substantially restrict claim payments.

The fate of the anti-concurrent-causation clauses, and their effect on Katrina-related losses, remain to be seen. The courts that have addressed this question are divided on the issue. Courts in some jurisdictions have enforced the clauses even where a covered peril is the efficient proximate cause of the loss, reasoning that insurers may choose to contract around any applicable causation rule. See, e.g., Alf v. State Farm Fire & Cas. Co., 850 P.2d 1272, 1277 (Utah 1993). However, courts in other jurisdictions have held that insurers may not contract around the efficient proximate cause doctrine as a matter of public policy. See, e.g., Safeco Ins. Co. of Am. v. Hirschmann , 773 P.2d 413, 414, 416 (Wash. 1989) (en banc). Other courts have held that such clauses are ambiguous and to read them as precluding coverage for damage proximately caused by a covered peril is inconsistent with the reasonable expectations of the policyholder. See, e.g., Murray v. State Farm Fire & Cas. Co., 509 S.E.2d 1, 14 (W. Va. 1998).

The highest courts of Mississippi and Louisiana have not yet had occasion to examine the effect of these clauses. Although the Alabama Supreme Court has upheld such a clause, see State Farm Fire & Cas. Co. v. Slade , 747 So. 2d 293 (Ala. 1999), it is unclear whether that case will prove to be the governing law for Alabama courts examining the very different facts of Hurricane Katrina, given that the causal relationship between hurricane winds and coastal flooding is much clearer than the causal relationship between a lightning strike and subsequent earth movement alleged to have existed in Slade . Moreover, even if such clauses are held to be enforceable with respect to Katrina-related losses in Alabama or the other applicable states, a policyholder nevertheless may be able to obtain coverage in a particular instance by showing that the loss at issue would have occurred even in the absence of the contributing excluded cause. See, e.g., O'Neill v. State Farm Fire Ins. Co., No. Civ. A 94-3428, 1995 WL 214409, at *3 (E.D. Pa. Apr. 7, 1995).

Contingent Business Interruption: Coverage Based on Damage to Other People's Property

The destruction caused by Hurricane Katrina had an immediate and obvious impact on hundreds of thousands of residents of the Gulf Coast and countless businesses located there. Less obvious, perhaps, is the effect of that destruction on businesses located outside the area. Although they were spared a direct hit from the hurricane, many such businesses lost suppliers or customers, at least temporarily, as a result of the storm and its aftermath. Moreover, many have lost, at least for now, the ability to ship their products through the Port of New Orleans, one of the country's busiest before the hurricane. Businesses that find themselves affected by Hurricane Katrina notwithstanding a lack of damage to their own property should review their policies to determine whether they have a viable claim for coverage of their economic losses.

The coverage in question is often called “contingent business interruption,” although that term is not used in most policies. In the standard-form policy promulgated in 2001 by the Insurance Services Office (“ISO”) titled “Businessowners Coverage Form,” for example, the pertinent coverage is called “Business Income From Dependent Properties.” A quick review of some of its features reveals this to be a potentially very useful coverage for a properly situated policyholder.

An insurer using the ISO form promises to pay for lost “Business Income” (a defined term that roughly translates as continuing operating expenses plus net profit) due to “physical loss or damage” at the premises of a “dependent property” resulting from a “Covered Cause of Loss.” The policy goes on to define “dependent property” as property owned by others on whom the insured depends to (a) deliver materials or services (excluding water, communication, or power supply services); (b) accept the insured's products or services; (c) manufacture the insured's products for delivery to customers of the insured under contract for sale; or (d) attract customers to the insured's business.

Depending on the circumstances of a given policyholder's claim, it is foreseeable that a variety of issues may arise.

Cause of Loss. Most if not all contingent business interruption policies require that the cause of the property damage or loss to the “dependent property” be a covered cause, that is, one that would have been covered under the policy if damage had instead taken place at the insured's own premises. A policyholder that has suffered an economic loss because an entity in its supply or distribution chain was physically damaged by Hurricane Katrina will therefore need to explore the physical mechanism by which the other entity's property was damaged ' for example, wind, flood, or fire ' and to review its own policies to see whether that mechanism is clearly covered or excluded.

As discussed above, there is already litigation, and there is sure to be more, concerning the interplay of standard grants of coverage for damage due to wind and standard exclusions for damage due to water. For many policyholders whose policies contain these fairly routine provisions, the Mississippi litigation and any similar litigation in other states directly affected by Hurricane Katrina will, at a minimum, be instructive. That said, an insured may find that its coverage turns on the legal rules of a jurisdiction far from the site of the storm's damage. Moreover, a policyholder such as a grain wholesaler in the upper Midwest that cannot move its product into the export market because of damage to the Port of New Orleans ' roughly 60% of the raw grain exported from the United States last year passed through that port ' may find that it (or its insurer) seeks the application of the policyholder's home state's law. So, even an on-point opinion from the Louisiana Supreme Court may not provide the dispositive answer to an out-of-state policyholder. Fully understanding the coverage will therefore require an analysis of the law in all potentially applicable jurisdictions as well as any choice-of-law rules that might govern.

Moreover, in contrast to many homeowners, many insured businesses carry flood coverage. If the insured's policy does not exclude flood or water as a covered cause of loss, the insured should be able to sidestep much of the fighting that is taking place concerning flood exclusions and mixed causation even if its supplier or customer has been shut down due to flood, and even if that supplier or customer did not itself have flood insurance.

Obligation to Mitigate. To put it mildly, contingent business interruption policies typically encourage the insured to resume operations promptly. For example, under the ISO form, if the policyholder does not resume its operations, or does not do so quickly enough, the insurer will pay based only on the length of time that “it would have taken” to resume operations “as quickly as possible.” In addition, the insurer will reduce the amount payable to the insured to the extent that the insured can resume operations, in whole or in part, by using any other available sources of materials or outlets for its products.

It is not difficult to imagine that disputes may arise concerning how quickly an insured reasonably could have resumed its operations, and policyholders with substantial claims might experience second-guessing by insurers. Any insurer that wishes to rely on these provisions to reduce its payment to the insured should present options to the insured on a timely basis, rather than waiting until well after the fact and then arguing with hindsight that the insured could have taken a different course of action. For its part, a policyholder facing a contingent business interruption claim should document its efforts to find alternate sources of materials or outlets for its products so that, in the event of a dispute with the insurer, it can prove that it acted responsibly and that any “roads not taken” were not, in fact, viable alternatives.

Time Period. Typically, contingent business interruption insurance can outlast the policy period. Put differently, the termination of the policy will not cut off the coverage. Nor is the coverage typically limited to a fixed amount of time set forth in the policy. However, there is a cutoff of the coverage, and one that is reasonably likely to lead to disputes between insurers and their insureds: The coverage period for this coverage frequently ends when the damaged property at the “dependent” location “should be repaired, rebuilt or replaced with reasonable speed and similar quality.” (Emphasis added.) Because the repair of the dependent property is outside the control of the insured, the insured could easily find itself still suffering the economic effects of a damaged supplier or distributor and yet facing an argument from its insurer that the damage at the other business' site should have been repaired already.

Repairs following Hurricane Katrina, especially in New Orleans, can reasonably be expected to take longer than usual. Given the widespread damage as well as the massive relocation of the population of the city, one imagines that contractors, repairmen and women, plumbers, roofers, and an array of other necessary service providers will be in short supply for a long time. Many of these tradespeople, who may have lost their own businesses or homes in the hurricane, may simply decide not to return to New Orleans. Although it strikes the authors that a court would take these circumstances into account when evaluating a claim that a dependent property “should” have been repaired more quickly than it actually was, we have seen enough insurance disputes that we will not be surprised if insurers nonetheless test the waters with this defense if it turns out that they are paying large contingent business interruption claims over a long period of time. In that event, we also foresee litigation over whether it is bad faith to advance an argument that “reasonable speed” may be determined without regard to the facts on the ground or the unique circumstances of Hurricane Katrina and its aftermath.

There have been surprisingly few reported judicial decisions involving contingent business interruption coverage. However, based on the catastrophic effects of Hurricane Katrina, we expect to see a diverse assortment of policyholders availing themselves of such coverage, and we also expect to see a sharp increase in the number and nature of disputes concerning contingent business interruption insurance.