Insurance and Non-Insurance Risk Mitigation Measures for COVID-19 Related Losses
Coronavirus disease 2019, “COVID-19” for short, continues to cause serious disruptions in the world economy, and its impact has been especially severe on small businesses. Many business owners are assessing whether any risk mitigation measures are available to address these COVID-19 economic impacts. There are three categories of risk mitigation measures that business owners should consider under these circumstances, depending on specific needs and goals: (1) “business interruption” (and related types of) insurance coverage; and (2) contractual “force majeure” provisions; and (3) the common law defenses of impracticability of performance and or frustration of purpose.
What is “business interruption” and similar insurance coverage?
Many existing Commercial Property policies include coverage for “business interruption”, which refers to a loss of income from a disruption in the named insured’s business. “Contingent business interruption” coverage refers to a loss of income resulting from a disruption to a third party’s business (such as a supplier or vendor) which affects the named insured’s business. Other types of potentially applicable coverage include “civil authority” coverage, which provides coverage when there is a government-mandated disruption such as that resulting from “shelter in place” or emergency declarations preventing the business from operating. Finally, specialty coverage such as “supply chain” coverage or “event cancellation” coverage exists and is available for certain types of small businesses whose operations present special risks for such types of losses.
Does “business interruption” coverage apply to COVID-19 losses?
There will likely be two major hurdles for business owners seeking to trigger “business interruption” and related coverages in response to a COVID-19 related loss. First, most such coverages require there to be a direct physical loss or damage to property as a pre-requisite to any loss of income coverage. If a tornado occurs, for example, the disruption is the direct result of damage to the physical structure of the brick and mortar business, and the direct physical loss requirement is obviously met.
The spread of the COVID-19 virus and resulting business closures does not result in the same type of direct physical loss to property that such other storm events and other covered perils would cause. However, there are analogous cases in which perils that do not actually result in direct physical loss to property nonetheless render a business uninhabitable or unusable and therefore potentially trigger coverage under a business interruption provision. Examples include a home rendered uninhabitable by a well contaminated with E. coli bacteria, a business rendered unusable as a result of ammonia contamination, or factories without power following an earthquake. Actual contamination of a business by COVID-19 virus could similarly trigger business interruption coverages. Closure of the business as a preventative measure, without actual contamination of the business itself, presents a harder case for coverage, although every case should be evaluated in light of the specific facts applicable to the business and in light of the specific policy language in place.
Similarly, civil authority coverage applies when there is a direct physical loss resulting from a government order that forces closure of a business (such as the emergency declarations in Flagstaff and Sedona that essentially closed restaurants, bars and other businesses), but a similar analysis would apply to whether such closure was a result of actual COVID-19 contamination or was a preventative measure which may not be subject to coverage.
Force majeure provisions
For those businesses who seek to terminate an existing contractual obligation, a force majeure clause may be of use. “Force majeure” clauses provide for suspension or cancellation of the contract when an outside event beyond the control of the parties frustrates performance under the contract. The outside event must generally be extraordinary and outside the parties’ reasonable ability to foresee or control at the time of entering into the contract. Business owners who seek to terminate an existing contractual obligation should check their written agreements for a “force majeure” clause. COVID-19 related business interruptions and closures would certainly seem to potentially fall within the above definition, depending on the contractual language, and therefore a force majeure clause may provide a viable means of terminating a contract as a result of COVID-19 related disruptions. Invoking such a provision, however, will most likely be contested by the other party to the contract, and requires a careful plan that weighs the risks and benefits of such a decision.
Common law defenses to contract enforcement
In the absence of a force majeure clause, parties seeking to terminate an existing contractual arrangement may seek to rely upon the common law doctrine of impracticability of performance and or frustration of purpose. The former, impracticability of performance, applies when a party’s performance is made “impracticable” by the occurrence of an event that neither party to the contract contemplated at the time it was made. The event must not have been reasonably foreseeable and the event must so substantially impede performance under the existing contract that performance becomes truly unworkable. Performance that is merely made more difficult or expensive than the parties had originally anticipated is insufficient.
Traditionally, the doctrine of impracticability of performance has been applied to only three categories of supervening events: death or incapacity of a person necessary for performance, destruction of a specific thing necessary for performance, and prohibition or prevention by law. COVID-19 related emergency declarations may satisfy the third category of event, as the practical effect of such orders is to in large part prohibit operation of many businesses. Moreover, the modern trend is for a broader application of the doctrine and to look at other types of supervening events beyond the three mentioned.
Frustration of purpose refers to an event occurring that so frustrates the parties’ original purpose of making the contract that it essentially renders one party’s performance worthless to the others. An example might be an individual who rented an apartment in Tokyo to watch the summer 2020 Summer Olympics only to find out the summer Olympics have been postponed for a year. Under such circumstances, the entire purpose of the contract (renting an apartment to watch the 2020 Summer Olympics) has been frustrated by the fact that the Olympics have been moved and postponed for a year and a frustration of purpose defense would be viable.
Can AWD LAW® help me?
Pursuing one or more risk mitigation measures such as those described above requires analysis of the applicable insurance policy or contract language, as well as a strategic assessment of the risks and benefits of any particular course of action. For example, any party considering a force majeure or a common law contract defense such as impracticability of performance or frustration of purpose should simultaneously consider the availability of business interruption coverage. In the absence of business interruption coverage and in a situation in which the business owner wants to cancel a contract, a force majeure clause or common law contract defenses may be the best route. Alternatively, if business interruption coverage is potentially available, the business owner may want to consider a claim for such coverage rather than attempting to cancel a contract on grounds likely to be contested (and which would likely impede the ability to obtain any business interruption coverage).
AWD LAW® attorneys Jason Bliss [email protected] and Monica Pertea [email protected] are available to assist any business owners who have questions regarding these or any risk mitigation strategies to address the severe economic losses occurring from COVID-19.