Business Interruption Coverage – When has the Insurer Satisfied Its Obligation?

One of the most problematic insurance questions that developed following the destruction of the World Trade Center on Sept. 11, 2001, involved business interruption coverage.

With the destruction of the World Trade Center complex, there was significant disagreement as to when an insurer’s obligation to provide business interruption was terminated. A recent decision by the Second Circuit Court of Appeals provides some instruction regarding that query. Duane Reade, Inc. v. St. Paul Fire and Marine Insurance Co., __ F.3d __, 2005 WL 1460641 (2nd Cir. 2005).

The facts of the case are relatively straight-forward. Duane Reade owns and operates more than two hundred drugstores in and around New York City. Prior to Sept. 11, 2001, its single most profitable store occupied lease premises on the main concourse of the World Trade Center. On Sept. 11, Duane Reade was insured under a $150 million property insurance policy written by St. Paul.

After the destruction of the World Trade Center, St. Paul adjusted Duane Reade’s claim in an attempt to indemnify it for Duane Reade’s property damage and business interruption losses. Following its theory of how to adjust Duane Reade’s losses, St. Paul paid $9.8 million to cover nine months of lost profits (in St. Paul’s view) “to locate, furnish, and open a new drugstore,” and paid an additional twelve months of profits to compensate for the lowered profits Duane Reade was likely to receive when its store re-opened. Duane Reade took a different view concerning the operation of its business interruption coverage and filed a declaratory judgment action.

Fundamentally, Duane Reade sought a declaratory judgment that its recovery for business interruption losses caused by the store’s destruction should continue until the entire World Trade Center complex was rebuilt.

In response, St. Paul maintained that the business interruption coverage was properly terminated 21 months after Sept. 11. During this 21-month period, St. Paul claimed Duane Reade would have been able to relocate its store to a new location and resume operations. The district court rejected both views of how the St. Paul policy was intended to address the problem.

Instead, the district court held the period for business interruption coverage was to be measured by the hypothetical or constructive (as opposed to actual) time from for rebuilding the World Trade Center store itself, not the entire complex that once surrounded it and the Restoration Period would end once Duane Reade could resume functionally equivalent operations in the location where its World Trade Center store once stood.

Although the Second Circuit Court of Appeals had to address several issues concerning whether the district court lacked jurisdiction to hear the case as well as the operation of the “No Action” clause in the policy, the principal focus of the opinion is the policy’s Restoration Period clause.

After closely analyzing the St. Paul policy, the Second Circuit concluded that the district court’s interpretation of the Restoration Period could not be reconciled with the policy’s other provisions, particularly the Extended Recovery Period, and determined that the district court’s opinion had to be modified to eliminate the terms “functionally equivalent” to define the type of operations that would terminate the Restoration Period.

However, the Second Circuit was also unpersuaded by Duane Reade’s argument that the parties specifically intended to provide business interruption coverage until Duane Reade could resume operations at the site of its former World Trade Center location. The Court noted that the St. Paul policy was a general policy addressing two hundred different stores and did not make specific reference to the World Trade Center store. Since it was a policy intended to cover numerous locations, the Second Circuit found no support for a conclusion that the parties intended to treat the World Trade Center location with any special particularity.

In sum, the Second Circuit held that St. Paul was not obligated to provide business interruption coverage until Duane Reade could restore operations at a store located at its former World Trade Center location. Instead, the Court ruled that coverage only extends for the hypothetical time it would reasonably take Duane Reade to repair, rebuild, or replace its World Trade Center store at a suitable location.

To the extent there was a difference in terms of benefits between the location of the new drugstore and the former World Trade Center location, the Court directed the parties to the operation of the Leasehold Interest Clause in the St. Paul policy. Per the direction of the Court, the Leasehold Interest Clause provided coverage for any actual loss sustained in the event that a lease is terminated due to necessary untenantability arising from destruction of leased premises by a covered peril.

Claims for business interruption coverage can quickly become areas of dispute between policyholders and insurers. The opinion highlights that it may be difficult for a policyholder to maintain that the parties had agreed a policy’s business interruption coverage would continue until the business entity could be re-opened at its former location, regardless of how long that may take.

In the alternative, policyholders and insurers may be mindful that policies may need to be tailored and priced to provide for such specific terms, if the policyholder is intent on needing such coverage.

Andrew S. Boris is a partner in the Chicago office of Tressler Soderstrom Maloney & Priess. His practice is focused on litigation and arbitration of insurance coverage and reinsurance matters throughout the country, including general coverage, directors and officers liability, professional liability, environmental, and asbestos cases. Questions and responses to this article are welcome at aboris@tsmp.com The Tip of the Month runs each month on claimsguides.com