Article by Professor Rob Merkin, QC.
On Friday 15 January 2021 the UK Supreme Court handed down Financial Conduct Authority v Arch Insurance and Others  UKSC 1, its much anticipated judgment on the operation of business interruption policies in the face of a pandemic. The appeal analysed the wording of 21 policies broadly representative of 7000 others, and affecting some 380,000 policyholders. The general message from the judgment is that insurance will be available in the vast majority of cases and that coverage is more extensive than was held to be the case in the first instance decision in September 2020.
The first UK response to COVID-19 was on 10 February 2020 when regulations were made under the Public Health (Control of Diseases) Act 1984 permitting the detention and screening of persons reasonably suspected to have been infected or contaminated with COVID-19. On 4 March 2020 the UK Government published guidance on social distancing, on 5 March COVID-19 was made a “notifiable disease” and on 12 March 2020 those with symptoms were told to self-isolate for 7 days. On 16 March 2020 guidelines on social distancing were published, under which vulnerable people were advised avoid social mixing and to work from home, and advice was given against the holding of large gatherings. Further announcements were made on 18 and 20 March, and on 21 March 2020 the Health Protection (Coronavirus, Business Closure) (England) Regulations 2020, made under the 1984 Act, imposed an obligation on business premises selling food and drink. On 23 Marc 2020 British people were ordered to stay at home, on 24 March 2020 holiday accommodation providers were told to close their premises for commercial use and on 26 March 2020 the Health Protection (Coronavirus, Restrictions) (England) Regulations 2020, made under the 1984 Act, were adopted. These revoked the earlier measures and required the closure of all businesses and facilities offering goods and services to the public while banning people leaving their residences without reasonable excuse.
The business interruption policies were all triggered primarily by material damage to the premises, but it was never suggested that COVID-19 damaged premises. Instead, policyholders relied upon a series of extension triggers, which fell into three broad types: disease clauses; access clauses; and hybrid clauses. The three clauses all required “interruption” of the business, and some referred in the alternative to “interference” with the business. The Supreme Court agreed with the Divisional Court that the word “interruption” did not require a complete closure of the business. The “hybrid” clauses are subsumed by the disease and access clauses, and there is no need for separate discussion of them.
There were two broad forms of disease clauses. The first type covered loss resulting from interruption of or interference with the business during the indemnity period following any occurrence/manifestation of a notifiable disease on or within a given radius of the premises, most commonly 25 miles or the vicinity. The second type covered loss resulting from interruption of or interference with the business in consequence of one or more specified events or incidents, including occurrence of a notifiable disease within a radius of 25 miles of the premises.
The Supreme Court agreed with the Divisional Court that a disease was “manifested” when the victim had symptoms or was diagnosed, and that a disease “occurred” when it was contracted even though asymptomatic and undiagnosed.
The key issue was the effect of the geographical limitation in the form of the specified radius. The Divisional Court had drawn a distinction between the two forms of disease wording. The former class was satisfied by a generalised outbreak as long as there was a single case within the specified radius, the trigger was satisfied. The latter case, which focused on the specific local event or incident, required the local outbreak to be causative of the loss: as that was never the case in a pandemic, the clause prevented recovery even though there were outbreaks within the agreed radius.
The judgment was supportable on narrow linguistic grounds, but the distinction drawn by it was, from the point of view of policyholders, arbitrary. It was a matter of pure chance which of the two forms of wording had been used, and that varied from insurer to insurer and indeed between policies covering different activities issued by the same insurer.
The Supreme Court rejected the Divisional Court’s linguistic analysis. The Supreme Court could see no distinction between “occurrence” and “event/incident” wording, and it preferred the view that cover was required as long as the illness was proximately caused by an outbreak of COVID-19 within the agreed radius. Neither form of wording covered interruption caused by illness occurring outside the agreed radius. The sole question in the each of the disease clause cases was whether the local outbreak had caused the business interruption loss suffered by the assured.
The trigger for recovery by reason of loss of access was provided for by wording to the effect that there had to be prevention of access to the premise, or inability to use the premises due to restrictions imposed by a public authority, or the actions or advice of a public authority, due to an emergency which was likely to endanger life or property.
The Supreme Court, reversing the lower court on this point, held that the terms “prevention” and “inability to use” did not require total closure of the premises. In its view the requirement was satisfied either if the assured could not use the premises for a discrete part of the business, or if the assured could not use a discrete part of its premises for its business activities. Thus, if any divisible part of the business or the premises could not be carried on, there was prevention of access to, inability to use, the premises.
The Supreme Court also reversed the lower court on the meaning of the phrases “restrictions imposed by” and “action of” a public authority. The Supreme Court’s view was that although these words normally referred to mandatory rules derived from legislation, in the present context they extended to instructions issued by a public authority even though they did not have the force of law. The test was whether, from the terms and context of the instruction, compliance with it was required, and would reasonably be understood to be required, without the need for recourse to legal powers. Thus, instructions by the government to stay at home were within the clause even though they were unenforceable pending the passing of legislation. The effect was that the clauses were triggered in advance of legislation so that early losses were covered.
Finally, the Supreme Court ruled that a restriction was covered by the wording even though it was aimed at a third party. Therefore, if the public were required to stay at home, that was a restriction which triggered the insuring clause.
The Divisional Court had faced the argument that a local outbreak (the trigger of coverage under a disease clause) or a restriction of access (the trigger of cover under access clause) could not have caused any loss. That was because even without a local outbreak or a restriction of access, losses would have been suffered. In the case of a disease clause, the fact that the disease had broken out was enough to damage the business whether or not there had been a local outbreak. In the case of an access clause, people would have refrained from visiting commercial premises by reason of the existence of the disease itself, so once again it could not be shown that government action had caused any loss
The Divisional Court overcame this problem in two ways. Its primary analysis was to define the insured peril as the outbreak of disease coupled with the triggering provisions of the relevant insuring clause. It did this by adopting a “counterfactual” approach. In order to determine whether the insured peril was the proximate cause of loss, it was necessary to compare the position that the assured would have been in had there been no disease with the position faced by the assured in the pandemic. It was not correct to compare the position that the assured would have been in following the outbreak of disease but with no local outbreak or restriction of access, as against the position the assured was actually in following the pandemic. By “stripping out” the disease and treating it as part of the proximate cause of the loss, the causation requirement for the disease clauses was satisfied by disease with at least one local outbreak and the causation requirement for the access clauses was satisfied by disease followed by state-ordered lockdown. Thus, the wider effects of the disease were stripped out and to be left out of account.
The Divisional Court’s alternative but less favoured analysis was to treat each outbreak of the disease as a proximate cause in its own right. So, in the case of a disease clause, as long as there was one occurrence or manifestation of the disease within the agreed radius, that occurrence or manifestation was the proximate cause of the loss and the fact that there had been outbreaks outside the agreed radius that had also contributed to the loss could be disregarded. In the case of an access clause, the proximate cause of the loss was the lockdown following by any one incidence of the disease even though the generalised outbreak of the disease would have reduced revenue without the lockdown.
The Supreme Court by a 3:2 majority opted for the latter analysis. The majority held that the disease itself was not the insured peril. Instead, the insured peril was each individual outbreak of the disease. On the basis that each case was the proximate cause, there was no justification for seeking to apportion the loss as between local and other outbreaks, or as between loss with and without lockdown. The minority of the Supreme Court was of the view that the outcome was the same whichever approach was adopted, and expressed a slight preference for the counterfactual approach.
To reach that conclusion, the Supreme Court had to consider the decision in Orient-Express Hotels Ltd v Assicurazioni Generali SpA  EWHC 1186 (Comm). In that case the assured’s hotel in New Orleans was seriously damaged by Hurricanes Katrina and Rita, and was closed for some months. The City itself was closed down and the hotel would not have received visitors even if it had not suffered damage. The insurance on the hotel provided business interruption cover if directly arising from material damage. An arbitral tribunal, upheld by Hamblen J, held that the correct approach was to apply the “but for” test of causation, asking the question, what business interruption loss would have been suffered but for the damage to the hotel, ie, on the assumption that the hotel had not suffered any damage but the City itself had been damaged. In those circumstances the damage to the City would have deprived the hotel of its revenue so it could not be said that the cause of the business interruption loss was damage to the hotel.
The Divisional Court expressed the view that Orient-Express was wrongly decided, but did so by reference to the definition of insured peril rather than causation. The insured peril was not damage as such but the cause of the damage, namely, damage by the hurricanes. It was necessary to strip out not just the damage to the hotel but also the fact that the hurricanes had occurred. Thus, the correct counterfactual for comparison purposes was the revenue that would have been earned but for the hurricanes, measured against the revenue that was earned after the material damage caused by the hurricanes.
The Supreme Court confirmed that Orient-Express should be overruled, but on the distinct ground that the “but for” test should not be applied to cases involving concurrent but independent causes of loss resulting from the same fortuity. In its view, in a case when both an insured peril and an uninsured peril operated concurrently as a result of the same underlying fortuity then as long as the uninsured peril was not actually excluded from cover, the policy would respond. The correct analysis of the facts in Orient-Express was, therefore, that the business interruption losses were concurrently caused by the damage to the hotel and the damage to the City, that both had been the result of the hurricanes and that in the absence of any operative exclusion, there should have been recovery.
The Supreme Court applied the same analysis to the COVID-19 claims. In the case of a policy that responded to interruption by reason of illness sustained by any person on or within a specified radius of the premises, it sufficed to show that illness had occurred within that specified radius. The fact that there had been disease outside the specified radius was simply a concurrent cause and, because it was not excluded from the policy, the insured peril prevailed. In the case of a lockdown policy, the fact that losses were caused by lockdown and without the lockdown meant that there were concurrent causes of the loss but in the absence of any exclusion of liability the loss was recoverable.
The trends clause
Under the trends clause, which was present in one or other form in every policy, the sum payable is to be amended to reflect any special circumstances or business trends affecting the business, either before or after the loss, so that the sum paid amount paid reflected as near as possible, the result that would have been achieved if the damage had not occurred. The Supreme Court noted that the clause had nothing to do with the definition of the insured peril or the cause of the loss, but was simply a means of quantifying loss. The correct approach was to identify the activities that had been interrupted and to quantify the actual income earned from those activities in the indemnity period. That figure would then be compared with the sum that would have been earned without the occurrence of the pandemic as the insured peril, and the fact that other consequences of the pandemic would have reduced revenue was to be left out of account. In other words, only those matters external to the pandemic were relevant in assessing the amount of lost revenue.
That analysis overturned the approach in Orient-Express, which had construed the words “but for” in the trends clause as meaning that the comparison to be made was between the revenue that was actually obtained in the indemnity period with the revenue that would have been obtained had there been no damage to the premises but damage to the City as a result of the hurricane. The proper comparison in the view of the Supreme Court was between the revenue that was actually obtained in the indemnity period measured against the revenue that would have been earned had there not been a hurricane. Similarly, with COVID-19, loss of revenue was the difference between the revenue actually earned in the indemnity period and the revenue that would have been earned in the indemnity period had there not been any disease.
A second aspect of the trends clause was whether the effects of the pandemic could be taken into account in assessing the revenue of the assured before the occurrence of the trigger for coverage. The Supreme Court here held that the trends clause was concerned only with matters affecting revenue external to the cause of the loss, and so the pandemic was to be disregarded. The amount of revenue earned by the assured before the commencement of the indemnity period was not to be reduced by the effects of the pandemic and it was to be assumed for the purpose of the trends clause that the pandemic had not occurred.
Rob Merkin QC
Special Counsel, Duncan Cotterill
Professor of Law, Universities of Reading and Exeter