'Probable Experience' in Business Interruption Claims

Business Interruption Generally

As a general rule, the business interruption provision of a property insurance policy is triggered if a covered peril causes physical damage or loss to insured property resulting in a necessary interruption of the insured's operations.

When an interruption occurs and operations cease, business interruption coverage steps in to “do for the insured in the event of business interruption caused by [a covered peril], just what the business itself would have done if no interruption had occurred ' no more.” Nat'l Union Fire Ins. Co. of Pittsburgh v. Anderson-Prichard Oil Corp., 141 F.2d 443, 445 (10th Cir. 1944) (citation omitted). It is often the case that “there is no prescribed formula” in the policy wording that dictates precisely how to calculate what the insured would have done in the absence of an interruption to its business “except the test of past experience and probabilities of the future.” Id. at 446. Many large commercial first-party property insurance policies frame this test by requiring that the business interruption claim be for the “actual loss sustained” by the insured, and that the claim calculation give “due consideration” to the insured's: 1) past experience, prior to the period of interruption, and 2) probable experience, during the period of interruption.

Such “due consideration” language was present in the policy at issue in Imperial Palace, and is the focus of the rulings by both the trial court and, on appeal, by the Fifth Circuit.

'Due Consideration' of Past and Probable Experience

Generally, it is a straightforward matter to give due consideration to an insured's past experience by reviewing actual, historical figures. Such figures appropriately form the bedrock of business interruption calculations. Among other things, they are readily available to the insured and verifiable.

However, to give due consideration to an insured's probable experience requires a projection of some sort. There are many ways to go about such a projection, ranging from a simple carrying-forward of past performance, to more nuanced analyses addressing issues such as projected growth and seasonal effects, to complex econometric models. Selection of an appropriate method will depend on issues including the length of the claimed interruption and the volatility of the market.

Regardless of the particular method used to project probable performance, courts have enforced certain basic requirements. For example, courts routinely confirm that the experience must be probable, not merely possible, and reject calculations of “probable experience” that are “too speculative.” See, e.g., E. Associated Coal Corp. v. Aetna Cas. & Sur. Co., 632 F.2d 1068, 1074 (3d Cir. 1980) (rejecting insured's calculation of the actual loss sustained from lost production of coal after a fire at an underground mine because it was predicated on an assumption about the sulfur content of the coal that was inadequately supported); Dictiomatic, Inc. v. U.S. Fid. & Guar. Co., 127 F. Supp. 2d 1239, 1244 (S.D. Fla. 1999) (rejecting a business interruption claim based on “speculative, inflated predictions of future profits, which had no relation to actual profits just prior to the [loss]” which reflected that the insured's current product line was not in demand and that the insured had insufficient capital to develop or manufacture new products).

As a means to avoid the “speculative” label, it has been suggested that, as a proxy for probable performance, one might look to use of actual post-resumption-of-operations figures. On the one hand, such actual post-resumption figures often fail to link to market conditions during the period of interruption, and may be artificially inflated to the extent that they reflect improved financial performance that stems from property that was, e.g., rebuilt with improvements or replaced with upgraded or newer equipment. On the other hand, actual post-resumption figures don't require any sophisticated accounting or economic techniques, and are readily available to the insured.

The insured sought to advance such actual post-reopening figures as the measure of its business interruption claim in Imperial Palace.

Imperial Palace's 'Probable Experience' Claim

When Hurricane Katrina struck in late August 2005, it heavily impacted the gambling facilities near Biloxi, MS, with most casinos remaining closed well into 2006. Imperial Palace was a notable exception, in that it was able to complete repairs and reopen by December 2005. Because it had sustained less property damage than its competitors and was one of the first casinos to reopen, Imperial Palace's revenues during the first half of 2006 were much greater than the months before the hurricane.

Imperial Palace presented a claim for business interruption for the four-month period it was shut down. The relevant policy language stated, in part, that “due consideration shall be given to the experience of the business before the loss and the probable experience thereafter had no loss occurred.” Imperial Palace contended that the policy language “probable experience thereafter had no loss occurred” meant the revenue Imperial Palace would have generated in a hypothetical scenario in which Hurricane Katrina struck the Gulf Coast, heavily damaging its competitors, but leaving Imperial Palace alone wholly unscathed. Accordingly, Imperial Palace claimed that its actual post-reopening performance in early 2006 ' when most of its competition was still shut down ' should be used as the measure of its probable performance during the four-month period in late 2005 when it was shut down.

Using post-reopening actual performance as a proxy for its probable experience during the period of interruption, Imperial Palace calculated a business interruption claim of approximately $80 million ' multiples of its revenue levels prior to the storm. And, under Imperial Palace's theory, such an extreme result would follow for each and every casino in the area that had a business interruption claim and a policy that required due consideration of “probable experience” during the period of interruption.

Existing 'Probable Experience' Case Law

The issue of law presented by Imperial Palace's theory was tested at the trial court level on cross-motions for summary judgment and reviewed de novo by the Fifth Circuit on appeal. The decisions at both the trial court and appellate level were grounded in prior case law addressing “probable experience” issues: 1) a prior Fifth Circuit decision addressing whether one can look to post-resumption earnings in calculating business interruption claims; and 2) a series of federal court decisions prior to Hurricane Katrina that examined different versions of the “probable experience” requirement.

Fifth Circuit on Use of Post-Resumption Earnings: Finger Furniture

Less than six months prior to the date Hurricane Katrina made landfall, the Fifth Circuit had considered, and rejected, an attempt by an insurer to use post-reopening profit figures to limit the insured's recovery. Finger Furniture Co. v. Commonwealth Ins. Co., 404 F.3d. 312, 314 (5th Cir. 2005).

The insured, Finger Furniture, operated stores in the Houston area, which suffered severe flooding after Tropical Storm Allison. The flooding prevented access to the company's central computer system, and so no sales were made the weekend of the flooding. The following weekend, after the stores reopened, sales soared as Finger cut prices and customers bought replacement furniture.

The policy provided that Finger's business interruption coverage would be measured by its “probable experience thereafter had no loss occurred.” The parties stipulated as to Finger's lost income during the weekend it was shut down, based on historical sales figures, but disputed whether the insurer could look to the post-reopening increase in sales figures to reduce the amount of the business interruption loss. The insurer argued that Finger did not have an “actual loss sustained” because of the high level of flood-induced sales when it was able to reopen its stores.

The court disagreed, holding that the policy language “has only one reasonable interpretation,” and that “[h]istorical sales figures reflect a business's experience before the date of the damage or destruction and predict a company's probable experience had the loss not occurred.” Id. This is so because “[t]he strongest and most reliable evidence of what a business would have done had the catastrophe not occurred is what it had been doing in the period just before the interruption.” Id. In so holding, the court squarely rejected measurement of indemnity during the business interruption period based on actual profits after reopening:

[T]he business-loss provision says nothing about taking into account actual post-damage sales to determine what the insured would have experienced had the storm not occurred. The contract language does not suggest that the insurer can look prospectively to what occurred after the loss to determine whether its insured incurred a business-interruption loss. [Footnote omitted] Instead, the policy requires due consideration of the business's experience before the date of the loss and the business's probable experience had the loss not occurred.

Id.

This analysis at the core of the Finger Furniture decision provided the basis for the Fifth Circuit's conclusion in Imperial Palace that “only historical sales figures should be considered when determining loss, and sales figures after reopening should not be taken into account.” Imperial Palace, 600 F.3d at 516. In both cases, the Fifth Circuit confirmed that where the policy language considers “probable experience,” the relevant calculation is the hypothetical, projected revenue that the insured would have earned during the period of interruption, not the “actual experience” the insured attains upon reopening.

In reaching the holdings in both Imperial Palace and Finger Furniture, the Fifth Circuit also considered the law of other jurisdictions more directly addressing “probable experience” in the wake of a widespread catastrophe. These historical precedents, reviewed below, illustrate the arguments advanced by insurers and insureds, and demonstrate how the tensions were resolved and ultimately synthesized by the Fifth Circuit's decisions in Finger Furniture and Imperial Palace.

Fourth Circuit on 'Probable Experience': Colleton

In Prudential LMI Commercial Insurance Co. v. Colleton Enterprises, Inc., 976 F.2d 727, 1992 WL 252507, at *4 (4th Cir. Oct. 5, 1992), the U.S. Court of Appeals for the Fourth Circuit considered the claim of an insured who operated Econo Lodge hotels that were damaged in Hurricane Hugo. The insured sought recovery for business interruption on the theory that the storm brought an influx of construction personnel and relief workers to the area and, but for the interruption of its business, there would have been a spike in revenue and profits by renting rooms to house them.

The policy at issue in Colleton contained a provision that called for due consideration of both prior experience and the “probable experience had no loss occurred.” A majority held that “an insured under a business interruption provision such as that here in issue may not claim as a probable source of expected earnings (or operational expenses) a source that would not itself have come into being but for the interrupting peril's occurrence.” Colleton, 1992 WL 252507, at *4 (citation omitted). The insured could not parse the hurricane, assuming it occurred for some purposes (creating the profit opportunity) but not for others (the damage to the insured property). The alternative formulation put forward by the insured, the court reasoned, would “lead to the unacceptable result of putting the insured in a better position” through insurance. Id. at *3.

In dissent, Circuit Judge Kenneth Keller Hall criticized the majority's holding, focusing particularly on the meaning of the term “loss” in the policy. Judge Hall advanced the position that “loss” had only one reasonable meaning throughout the policy ' “the loss incurred by the insured,” Id. at *4, as opposed to the loss event (i.e., the hurricane). Such a rigid reading of a single word out-of-context was not enough to convince the majority that the policy should be read to permit recovery for profit opportunities created by the interrupting peril.

Next month's installment continues the discussion of “probable experience” case law and addresses the issues that were brought to a head in Imperial Palace.

Catherine A. Mondell, a member of this newsletter's Board of Editors, is a partner at Ropes & Gray LLP, and has handled a wide range of complex insurance coverage disputes and other commercial litigation matters. She has litigated in multiple jurisdictions cases involving first-party property claims with substantial time element and contingent time element components. Seth C. Harrington is a litigation associate at the firm, with experience in both insurance and other commercial litigation. He is currently litigating multiple matters involving first-party property insurance claims made following Hurricanes Katrina, Rita and Wilma.

Part One of a Two-Part Article

The U.S. Court of Appeals for the Fifth Circuit recently weighed in on the proper measurement of business interruption claims, particularly those following a catastrophic event that affects an entire region or industry. That decision, Catlin Syndicate Ltd. v. Imperial Palace of Mississippi, Inc. , 600 F.3d 511 (5th Cir. 2010), and a review of the case law in which it is grounded, provides confirmation of a point central to the fair and accurate calculation of business interruption claims: The focus of the calculation must be on the insured's: 1) pre-loss experience, and 2) probable experience during the period of interruption.

In reaching that conclusion, the Imperial Palace decision rejects, as a means of calculating “probable experience” during the period of interruption, the use of actual business performance following the resumption of operations. This is because such post-resumption figures are often skewed. For example, in claims involving a widespread catastrophic event such as a hurricane, market conditions may change significantly. Markets for some products and services may be depressed, while others are in high demand. The Fifth Circuit correctly recognizes that such market effects are beyond the scope of what is insured by language commonly found in business interruption provisions.

Business Interruption Generally

As a general rule, the business interruption provision of a property insurance policy is triggered if a covered peril causes physical damage or loss to insured property resulting in a necessary interruption of the insured's operations.

When an interruption occurs and operations cease, business interruption coverage steps in to “do for the insured in the event of business interruption caused by [a covered peril], just what the business itself would have done if no interruption had occurred ' no more.” Nat'l Union Fire Ins. Co. of Pittsburgh v. Anderson-Prichard Oil Corp. , 141 F.2d 443, 445 (10th Cir. 1944) (citation omitted). It is often the case that “there is no prescribed formula” in the policy wording that dictates precisely how to calculate what the insured would have done in the absence of an interruption to its business “except the test of past experience and probabilities of the future.” Id. at 446. Many large commercial first-party property insurance policies frame this test by requiring that the business interruption claim be for the “actual loss sustained” by the insured, and that the claim calculation give “due consideration” to the insured's: 1) past experience, prior to the period of interruption, and 2) probable experience, during the period of interruption.

Such “due consideration” language was present in the policy at issue in Imperial Palace, and is the focus of the rulings by both the trial court and, on appeal, by the Fifth Circuit.

'Due Consideration' of Past and Probable Experience

Generally, it is a straightforward matter to give due consideration to an insured's past experience by reviewing actual, historical figures. Such figures appropriately form the bedrock of business interruption calculations. Among other things, they are readily available to the insured and verifiable.

However, to give due consideration to an insured's probable experience requires a projection of some sort. There are many ways to go about such a projection, ranging from a simple carrying-forward of past performance, to more nuanced analyses addressing issues such as projected growth and seasonal effects, to complex econometric models. Selection of an appropriate method will depend on issues including the length of the claimed interruption and the volatility of the market.

Regardless of the particular method used to project probable performance, courts have enforced certain basic requirements. For example, courts routinely confirm that the experience must be probable, not merely possible, and reject calculations of “probable experience” that are “too speculative.” See, e.g., E. Associated Coal Corp. v. Aetna Cas. & Sur. Co. , 632 F.2d 1068, 1074 (3d Cir. 1980) (rejecting insured's calculation of the actual loss sustained from lost production of coal after a fire at an underground mine because it was predicated on an assumption about the sulfur content of the coal that was inadequately supported); Dictiomatic, Inc. v. U.S. Fid. & Guar. Co. , 127 F. Supp. 2d 1239, 1244 (S.D. Fla. 1999) (rejecting a business interruption claim based on “speculative, inflated predictions of future profits, which had no relation to actual profits just prior to the [loss]” which reflected that the insured's current product line was not in demand and that the insured had insufficient capital to develop or manufacture new products).

As a means to avoid the “speculative” label, it has been suggested that, as a proxy for probable performance, one might look to use of actual post-resumption-of-operations figures. On the one hand, such actual post-resumption figures often fail to link to market conditions during the period of interruption, and may be artificially inflated to the extent that they reflect improved financial performance that stems from property that was, e.g., rebuilt with improvements or replaced with upgraded or newer equipment. On the other hand, actual post-resumption figures don't require any sophisticated accounting or economic techniques, and are readily available to the insured.

The insured sought to advance such actual post-reopening figures as the measure of its business interruption claim in Imperial Palace.

Imperial Palace's 'Probable Experience' Claim

When Hurricane Katrina struck in late August 2005, it heavily impacted the gambling facilities near Biloxi, MS, with most casinos remaining closed well into 2006. Imperial Palace was a notable exception, in that it was able to complete repairs and reopen by December 2005. Because it had sustained less property damage than its competitors and was one of the first casinos to reopen, Imperial Palace's revenues during the first half of 2006 were much greater than the months before the hurricane.

Imperial Palace presented a claim for business interruption for the four-month period it was shut down. The relevant policy language stated, in part, that “due consideration shall be given to the experience of the business before the loss and the probable experience thereafter had no loss occurred.” Imperial Palace contended that the policy language “probable experience thereafter had no loss occurred” meant the revenue Imperial Palace would have generated in a hypothetical scenario in which Hurricane Katrina struck the Gulf Coast, heavily damaging its competitors, but leaving Imperial Palace alone wholly unscathed. Accordingly, Imperial Palace claimed that its actual post-reopening performance in early 2006 ' when most of its competition was still shut down ' should be used as the measure of its probable performance during the four-month period in late 2005 when it was shut down.

Using post-reopening actual performance as a proxy for its probable experience during the period of interruption, Imperial Palace calculated a business interruption claim of approximately $80 million ' multiples of its revenue levels prior to the storm. And, under Imperial Palace's theory, such an extreme result would follow for each and every casino in the area that had a business interruption claim and a policy that required due consideration of “probable experience” during the period of interruption.

Existing 'Probable Experience' Case Law

The issue of law presented by Imperial Palace's theory was tested at the trial court level on cross-motions for summary judgment and reviewed de novo by the Fifth Circuit on appeal. The decisions at both the trial court and appellate level were grounded in prior case law addressing “probable experience” issues: 1) a prior Fifth Circuit decision addressing whether one can look to post-resumption earnings in calculating business interruption claims; and 2) a series of federal court decisions prior to Hurricane Katrina that examined different versions of the “probable experience” requirement.

Fifth Circuit on Use of Post-Resumption Earnings: Finger Furniture

Less than six months prior to the date Hurricane Katrina made landfall, the Fifth Circuit had considered, and rejected, an attempt by an insurer to use post-reopening profit figures to limit the insured's recovery. Finger Furniture Co. v. Commonwealth Ins. Co. , 404 F.3d. 312, 314 (5th Cir. 2005).

The insured, Finger Furniture, operated stores in the Houston area, which suffered severe flooding after Tropical Storm Allison. The flooding prevented access to the company's central computer system, and so no sales were made the weekend of the flooding. The following weekend, after the stores reopened, sales soared as Finger cut prices and customers bought replacement furniture.

The policy provided that Finger's business interruption coverage would be measured by its “probable experience thereafter had no loss occurred.” The parties stipulated as to Finger's lost income during the weekend it was shut down, based on historical sales figures, but disputed whether the insurer could look to the post-reopening increase in sales figures to reduce the amount of the business interruption loss. The insurer argued that Finger did not have an “actual loss sustained” because of the high level of flood-induced sales when it was able to reopen its stores.

The court disagreed, holding that the policy language “has only one reasonable interpretation,” and that “[h]istorical sales figures reflect a business's experience before the date of the damage or destruction and predict a company's probable experience had the loss not occurred.” Id. This is so because “[t]he strongest and most reliable evidence of what a business would have done had the catastrophe not occurred is what it had been doing in the period just before the interruption.” Id. In so holding, the court squarely rejected measurement of indemnity during the business interruption period based on actual profits after reopening:

[T]he business-loss provision says nothing about taking into account actual post-damage sales to determine what the insured would have experienced had the storm not occurred. The contract language does not suggest that the insurer can look prospectively to what occurred after the loss to determine whether its insured incurred a business-interruption loss. [Footnote omitted] Instead, the policy requires due consideration of the business's experience before the date of the loss and the business's probable experience had the loss not occurred.

Id.

This analysis at the core of the Finger Furniture decision provided the basis for the Fifth Circuit's conclusion in Imperial Palace that “only historical sales figures should be considered when determining loss, and sales figures after reopening should not be taken into account.” Imperial Palace, 600 F.3d at 516. In both cases, the Fifth Circuit confirmed that where the policy language considers “probable experience,” the relevant calculation is the hypothetical, projected revenue that the insured would have earned during the period of interruption, not the “actual experience” the insured attains upon reopening.

In reaching the holdings in both Imperial Palace and Finger Furniture, the Fifth Circuit also considered the law of other jurisdictions more directly addressing “probable experience” in the wake of a widespread catastrophe. These historical precedents, reviewed below, illustrate the arguments advanced by insurers and insureds, and demonstrate how the tensions were resolved and ultimately synthesized by the Fifth Circuit's decisions in Finger Furniture and Imperial Palace.

Fourth Circuit on 'Probable Experience': Colleton

In Prudential LMI Commercial Insurance Co. v. Colleton Enterprises , Inc. , 976 F.2d 727, 1992 WL 252507, at *4 (4th Cir. Oct. 5, 1992), the U.S. Court of Appeals for the Fourth Circuit considered the claim of an insured who operated Econo Lodge hotels that were damaged in Hurricane Hugo. The insured sought recovery for business interruption on the theory that the storm brought an influx of construction personnel and relief workers to the area and, but for the interruption of its business, there would have been a spike in revenue and profits by renting rooms to house them.

The policy at issue in Colleton contained a provision that called for due consideration of both prior experience and the “probable experience had no loss occurred.” A majority held that “an insured under a business interruption provision such as that here in issue may not claim as a probable source of expected earnings (or operational expenses) a source that would not itself have come into being but for the interrupting peril's occurrence.” Colleton, 1992 WL 252507, at *4 (citation omitted). The insured could not parse the hurricane, assuming it occurred for some purposes (creating the profit opportunity) but not for others (the damage to the insured property). The alternative formulation put forward by the insured, the court reasoned, would “lead to the unacceptable result of putting the insured in a better position” through insurance. Id. at *3.

In dissent, Circuit Judge Kenneth Keller Hall criticized the majority's holding, focusing particularly on the meaning of the term “loss” in the policy. Judge Hall advanced the position that “loss” had only one reasonable meaning throughout the policy ' “the loss incurred by the insured,” Id. at *4, as opposed to the loss event (i.e., the hurricane). Such a rigid reading of a single word out-of-context was not enough to convince the majority that the policy should be read to permit recovery for profit opportunities created by the interrupting peril.

Next month's installment continues the discussion of “probable experience” case law and addresses the issues that were brought to a head in Imperial Palace.

Catherine A. Mondell, a member of this newsletter's Board of Editors, is a partner at Ropes & Gray LLP, and has handled a wide range of complex insurance coverage disputes and other commercial litigation matters. She has litigated in multiple jurisdictions cases involving first-party property claims with substantial time element and contingent time element components. Seth C. Harrington is a litigation associate at the firm, with experience in both insurance and other commercial litigation. He is currently litigating multiple matters involving first-party property insurance claims made following Hurricanes Katrina, Rita and Wilma.