This article is written by Kavana Rao from Symbiosis Law School, Noida. This article gives an overview of Business Interruption Insurance policies and Rent Loss Insurance policies which have the most relevance in the present times.
In recent times, many businesses have faced uncertain and unforeseen situations with the inability to operate their businesses. In this particular article, we shall see two alternatives to face this uncertainty, particularly in the case of landlords and tenants. Many tenants were and still are unable to pay rent to their landlords because of the Covid restrictions and the fall in their revenues. Coverage for such losses largely depends on the insurance policy terms, lease terms, the circumstance where loss has occurred or proposed legislation.
What is rent loss insurance
In situations when an unprecedented event occurs and the tenant is unable to pay rent, then there can be two outcomes with respect to the lease. One of the two of them is that the lease exempts the tenant to cease paying rent temporarily for the period of the uncertain event. In the present case, it is required of the landlord to compensate for the rent that it does not receive during the period of abatement. Rent loss is a means to cover the risk associated with the loss of rent. An example of one such situation is when there is an unprecedented event like an Emergency put in the country because of a war, and there is a total restriction in movement.
What is business interruption insurance
It can also happen that the lease may require the tenant to continue paying the rent despite the unprecedented event or casualty. In this circumstance, the tenant requires a source of funds it loses due to the disturbance in its business, to ensure that it can continue paying the rents. These are the losses that business interruption insurances are intended to cover.
A business income insurance policy primarily consists of an agreement by the insurer to pay for the actual loss of business income that the insured sustains due to the temporary suspension of operations during the period of an unprecedented event. For the purpose of loss of business income to be covered, the suspension of the operations must cause direct physical loss or damage to the insured property.
What are the perils covered
In order to understand the coverage of these insurances and to understand how it would respond to potential losses, it is essential for risk professionals to focus on certain key concepts.
Actual loss sustained
Business interruption coverage protects against an actual loss sustained by an insured as a result of direct physical loss or damage to the insured property by a peril that is not excluded from the policy. For example, fire, floods, theft, etc. The insurer is bound to pay only if the insured sustains an actual loss.
The insurer is often responsible for the reduction that arises as a result of the suspension of operations due to the physical loss to an insured’s premises. The insurer covers Net income that could have been earned by the insured and normal operating expenses incurred.
Period of restoration
Insurers will be liable for the loss of business income only during the period of restoration. The period of restoration is the length of time required to rebuild, repair or replace damaged property, and it begins when the damage occurs and ends when the property is repaired. It should also be noted that the property must be restored within a reasonable time.
A business interruption insurance can cover and provide coverage for extra expenses. The insurer covers these extra expenses that occur during the restoration period, as these extra expenses would not have been incurred had there been no physical loss.
The insurance also covers those extra expenses that are incurred to reduce the loss, as long as they do not exceed the loss itself.
Any kind of service interruption that is incurred due to the direct physical loss or damage which results in loss of business income will be covered by the business interruption insurance.
Interruption by civil or military authority
The business interruption coverage will also provide coverage to an insured for loss of business income it incurs during the time when access to its premises is prohibited by an order issued by the civil authority as a result of physical damage.
Contingent business interruption
Business interruption insurance also covers business income loss that is incurred due to the loss, damage or destruction of property owned by others. The insurer only covers this when the damage has happened on the insured’s premises.
Business interruption vs. rent loss insurance
Rent loss insurance is a way to cover the risk associated with the lost rent. However, the business interruption insurance merely covers those risks which cause physical damage to the premises. Rent loss Insurance fails to cover certain kinds of damages. For example, certain rent loss insurance does not cover water damage that has caused mould in the premises, as it was the landlord who failed to remedy the problem. One of the most significant facts about Rent loss insurance is that it pays the fair market rental value of the leased premises, which may be less than the amount of rent that the tenant is mostly obliged to pay under the lease.
Present day relevance of this issue
In the present times, with Covid-19 engulfing the world where it has not only affected the health of people but also affected businesses at large. Shops, restaurants, malls, and most commercial establishments were shut down around the world, deeply affecting their revenues. In such situations, the rent control insurance and the Business interruption insurance play a great role in retaining the premises for the tenants and retaining the tenants for the landlords.
It is essential for the landlords and tenants to ensure that they have these insurances, business interruption insurances in case of tenants to avoid non-payment of rents when they are ordered to pay and other expenses and Rent loss insurance incase of landlords to prevent loss of income when the tenants are unable to pay.
FCA v Arch Insurance (UK) Ltd and others  UKSC 1
In the case of FCA v Arch Insurance (UK) Ltd and others (2021) UK’s Financial Conduct Authority, as the conduct regulator of insurers, placed a test case before the High Court based on a representative sample of insurance policy provisions and put forward arguments with the aim of attaining clarity of whether the losses occurred due to closure of operation during the Covid-19 lockdown and restrictions can be covered by the Business Interruption Insurance.
- The primary issue dealt with in this case was whether the losses related to Covid -19 can be covered under the certain “non-damage” extensions to Business Interruption Policies.
- The Court was also asked to observe whether there was a necessary causal link between the Covid-19 pandemic and the policyholders’ losses.
Supreme Court order
The UK Supreme Court gave its judgment on the appeal of the FCA’s business interruption insurance test case. The Court dismissed the main appeals by the insurers and allowed the FCA’s appeals. The judgment broadens the circumstances in which they may recover the losses. The court confirmed that the insurance can cover the losses under the disease clauses on the basis that all individual Covid-19 cases and the lockdown measures imposed were.
What are the clauses covered
- Disease clause
Disease clauses are the ones that provide cover for businesses that are gravely affected by notifiable diseases, like an epidemic or a pandemic like Covid-19. For the disease clause to apply there must be losses because of the onset of a particular disease at or within a specified distance of the business premises.
- Prevention of access clause
These are clauses, which in general provide cover for businesses that incur losses resulting from the intervention of the public authority which prevents or restrains the use or access to the business premises.
- Hybrid clause
The Hybrid clause combines the elements of both the disease clause and the prevention clause.
- Trends clause
Clauses which in general allow the business loss to be quantified by reference to how the performance would have been if the insured peril had not occurred.
In the present case, the Court gave the correct interpretation of the disease clause. In the disease clause, there is a requirement for the occurrence of a notifiable disease within a specified vicinity of insured premises.
The Court observed that if there are multiple series of events and none of the events is sufficient on its own to cause that result, the claim can still succeed. Therefore, the policyholders will be able to get their loss due to Covid-19 covered under policies that contain disease clauses.
The Court also interpreted the denial of access clause as a more narrow approach. To apply the denial of access clause, there must be an emergency, incident, danger, or disturbance and when properly interpreted, the court notes that the wording of the clause provides a narrow localized cover and that action taken in response to Covid-19 would not be sufficient.
The FCA gave the final strike when they applied the causation and trends clause. The Supreme Court found that the trend clause issues should be considered so that the gross profit from earlier trading is adjusted, only to reflect circumstances that are unconnected with the perils that were insured and not those circumstances which are remotely linked to the insured peril. This ensures that the trend clause is construed consistently and the prima facie provided by the insuring clause is not taken away.
Commercial landlords and tenants should consider whether their property insurance and other insurance policies cover lost rent and other coronavirus-related business interruptions as the COVID-19 pandemic continues to disrupt their ability to collect and pay rent due to tenants’ inability to operate and produce income from their leased premises.
It is important that the landlords and tenants document all the Covid-19 related events and conditions which affected their operations to notify and have sufficient proof to pursue coverage for their losses.
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