Stephanie Reeves, Senior Associate

Millions of businesses have been financially affected by the pandemic, and landlords and tenants are no exception. Naturally, both landlords and tenants have looked to their insurance policies to mitigate the impact of having to close their premises, disruption in supply chains, reductions in public confidence, and the implications of lockdowns and other Government mandated restrictions.

Many businesses were faced with rejected insurance claims. This prompted the Financial Conduct Authority (“FCA”) to bring a test case against a number of insurers in relation to the interpretation of their business interruption (“BI”) insurance policies in the context of the pandemic.

On 15 January 2021, the Supreme Court handed down its highly-anticipated appeal judgment in the test case. The Supreme Court dismissed most of the insurers’ appeals and, like the High Court before it, found largely in favour of insured businesses. This means thousands of policyholders may now be able to recover loss caused by Covid-19 and the decision could therefore provide a vital lifeline for businesses, including landlords and tenants.

Crucially, the Supreme Court’s decision is final. This means affected businesses now have clarity as to whether their BI policies cover their loss, and insurers will not be able to challenge the decision or delay dealing with claims.

Considerations for Landlords and Tenants

Regardless of whether the insurance policy in question is held by the landlord or the tenant, insurance policies will only cover losses which have been caused by certain triggering events. Therefore, whether a landlord or tenant has a valid insurance claim in respect of pandemic-related loss will depend on the specific policy wording. The principles from the Supreme Court’s findings, as detailed in the next section, can be applied in this respect.

Most commercial lease arrangements make the landlord the policyholder under the relevant BI policy meaning that the onus is on the landlord to advance a business interruption claim. However, where a commercial tenant runs a business from the premises, the tenant may need to provide evidence of the losses suffered to support the landlord’s insurance claim. This requires a degree of co-operation between landlord and tenant which can sometimes be difficult.

It is worth noting that a tenant may have its own BI cover too, which may mean that the tenant can recover its losses and use that money pay any outstanding rent, thus reducing the landlord’s own claim. Most commercial tenants will have taken out BI cover as part of their usual business insurance packages.

The Supreme Court’s judgment will give some landlords (and tenants) an opportunity to mitigate their losses. Where there is a contractual obligation on the tenant to pay rent, and the landlord makes a successful insurance claim, the landlord’s contractual claim for unpaid rent may be subrogated to the insurer. This could lead to tenants defending, or delaying in engaging with, a landlord’s insurance claim for rent arrears.

It is therefore important for both landlords and tenants to ask the other for copies of their insurance policies at an early stage, to check whether there is the basis of a claim in accordance with the Supreme Court’s findings.

Whilst the Court’s findings were made in the context of BI insurance, landlords’ loss of rent policies (being insurance policies which cover losses suffered by a landlord in circumstances where no physical property damage has been suffered) often contain similar language to that which was considered in the case. Therefore, the Supreme Court’s decision may assist landlords to claim for loss of rent as a result of pandemic-related factors. However, it is worth noting that pandemics are unlikely to be included as an insured risk under a standard loss of rent insurance policy. Further, many loss of rent policies are limited to circumstances where premises cannot be occupied as a result of physical property damage. As explained below, such policies are unlikely to provide cover for pandemic-related loss.

What impact will temporary rent reduction agreements have on recovery under an insurance policy?

Whilst the test case did not deal with this question, even where a landlord has the requisite BI insurance wording in their policy, insurers may argue that any concessions as to rent which were made before the June 2020 Code of Practice for Commercial Property Relationships do not constitute compliance with an instruction from a relevant authority.

In any event, insurers are likely to argue that losses suffered in accordance with rent reduction agreements reached on an entirely voluntary basis are irrecoverable. Landlords will argue that they had no choice but to reduce rents in order to mitigate loss in circumstances where all other remedies which would usually be available to them for rent arrears had been suspended by the Coronavirus Act 2020 and other legislation. We may see further litigation on these issues.

The Supreme Court’s Findings

The Parameters of the Case

It is important to note at the outset some of the limitations of the FCA test case:

1. The case only analysed a sample of 21 BI policy wordings from 8 insurers. The Supreme Court’s decision is therefore only legally binding on those 8 insurers in relation to those sample policies. However, the judgment provides authoritative guidance for the interpretation of similar policy wordings in place with other insurers. Therefore, even where a landlord has an insurance policy with an insurer other than those who were defendants in the test case, the Court’s findings can still be applied when interpreting the application of the policy to losses relating to the pandemic.
2. The sample policies considered by the Court were all so-called “non-damage” policies. This means that the cover provided by the BI policies considered was not limited to the consequences of physical property damage. In practice, cover in the majority of standard BI policies is expressly limited to property damage as a result of an incident such as a flood, fire or riot. Courts have already made clear that such BI policies without “non-damage extensions” such as disease clauses or suitable denial of access extensions, as explained below, are unlikely to respond to pandemic-related losses.
3. Many BI policies contain an exhaustive list of diseases for which cover is provided. Inevitably, as a new disease, Covid-19 is not included in the insurers’ lists. The sample of policies considered by the Court in the test case did not include any exhaustive lists of diseases. Insurers are taking the approach that the absence of Covid-19 appearing in the exhaustive list automatically means there is no cover.

Causation

In order for an insurance policy to respond, policyholders must show that the insured event, as defined in the specific policy, caused the loss they have suffered. The Supreme Court’s interpretation of causation is relevant to the operation of the various clauses that the Court was asked to consider. Consequently, it’s helpful to consider this aspect of the judgment first.

The Supreme Court found that causation could be satisfied when the insured event, along with other linked events, all caused one inevitable result. As a result, local cases of the Covid-19 disease; along with the worldwide pandemic; the actions, measures and advice of the Government; and the reaction of the public in response to the disease, could all be treated for the purposes of insurance cover as one proximate cause resulting in interruption to a business.

“Disease” clauses

Generally, these clauses cover loss caused by a notifiable or infectious disease which has occurred within a certain distance of the business’ premises.

Whilst the Supreme Court interpreted disease clauses more narrowly than the High Court, their position on causation means that disease clauses will still cover BI resulting from both local cases of Covid-19 and the wider pandemic. The Supreme Court found that local cases of Covid-19, along with the wider pandemic and the resulting action, could be treated as one cause. Disease clauses will therefore respond to interruption caused by Government action in response to the disease, provided there has been at least one occurrence of the disease within the specified radius.

This means that, if there has been a case of Covid-19 within the specified area, the policyholder will be insured for the loss caused by that local case, along with the loss caused by the nationwide pandemic and the resulting Government measures. Given the current level of confirmed cases, it is thought that most policyholders with relevant disease clauses should be able to show that Covid-19 has occurred within the required distance and, as a result, they should be entitled to cover.

Significantly, the Supreme Court’s views on disease clauses and causation mean that two additional QBE BI policies will provide cover which previously, under the High Court’s decision, did not.

"Denial of Access” clauses

Generally, these clauses cover loss resulting from the denial of access to business premises due to Government actions, advice or restrictions, as a result of an emergency or incident within a certain radius of those premises.

What must have caused the “actions, advice or restrictions”?

In relation to denial of access clauses, the Supreme Court applied its broad interpretation of causation. It was held that these clauses will be triggered if the interruption was a result of restrictions placed on the premises in response to cases of Covid-19, which included at least one case occurring within the specific radius.

Once triggered, these clauses will cover loss caused by Government action in response to a case of Covid-19 occurring within the specified distance of the premises, but they do so regardless of whether the loss was concurrently caused by other consequences of the pandemic. 

In practice, this means businesses should be covered for all losses caused by the Government action in response to the pandemic, regardless of whether the loss was specifically caused by local cases of Covid-19.

What “actions, advice or restrictions” will trigger cover?

Once again, the Supreme Court found largely in favour of businesses. The High Court considered that only restrictions carrying legal force would trigger clauses that covered loss caused by Government “action” or “restrictions”. In contrast, the Supreme Court decided that these terms could include instructions that did not carry legal force but came with an expectation that legal measures would follow, or that legal measures would be introduced if the restrictions were not followed.

The Supreme Court stopped short of confirming which precise Government announcements constituted an “action” or “restriction”. However, the Court did make it clear that the Government instructions do not need to carry legal force in order to trigger cover and, as a result, it will be significantly easier for businesses to argue that their insurers need to pay out.

Policyholders should reconsider their specific wording in light of the Supreme Court’s wider interpretation of “actions” and “restrictions”. In addition, policyholders will be required to evidence the loss they have suffered as a result of each of the specific Government restrictions which they consider caused or contributed to their loss.

Meaning of “inability to use”, “prevention” and “interruption”

The High Court found that policies which required there to be “inability to use” premises or “prevention” of access would only cover businesses that were required to completely close, rather than adapt or close part of their business. The Supreme Court disagreed. They held that a business could be covered if:

• it has been unable to use its premises for a certain part of its business activities; or
• it has been unable to use a certain part of its premises for its business activities.

This is positive for policyholders. It means that, for example, a restaurant which was able to use its premises to continue a takeaway service should be covered for the interruption caused to their usual sit-in service, or a department store which had to close all parts of the store apart from a pharmacy may be covered for the loss resulting from the parts of the business it could not open.

In addition, the Supreme Court maintained that “interruption” does not mean that all business activities are stopped. Even a slight disruption to a business would be enough to trigger cover.

Again, policyholders should reconsider their wording. The Supreme Court’s broad interpretation of “inability to use” premises and “prevention” of access may now mean that businesses have valid claims. Again, policyholders need to clearly demonstrate which of their losses have been caused by the closure of a certain part of the premises and/or from the cessation of a certain part of their business.

"Hybrid” clauses

Generally, these clauses cover losses resulting from the denial of access to business premises due to government actions, advice or restrictions, as a result of an infectious disease within a certain radius of those premises.

As with denial of access clauses, the Supreme Court interpreted hybrid clauses broadly and found that “inability to use” premises and “prevention” of access did not always require complete closure. In addition, the Supreme Court found that policies did not require Government instructions to have legal force for cover to be triggered. As a result, policyholders should reconsider their hybrid clauses to see whether they could now have a valid claim.

In addition, the Supreme Court applied their wide construction of causation to hybrid policies. As a result, these clauses will cover loss caused by restrictions imposed by the Government in response to the nationwide Covid-19 pandemic, as long as there has been a case of the disease within the specified radius which formed part of the national picture.

Trends clauses

Trends clauses operate to adjust the amount paid out under policies in light of what would have been achieved if the insured peril had not occurred. Trends clauses are intended to ensure that the amount paid out is not reduced or inflated by factors which are unrelated to the coverage granted under the policy. Put simply, the starting point is that compensation should put the insured back in to the position it would have been had the insured peril not occurred.

The Supreme Court found that trends clauses could not be used by insurers to take away the cover initially provided by the policy. In short, this means that trends clauses should only be applied by insurers to adjust losses to take into account circumstances which are unrelated to the pandemic, and not circumstances which are related to the pandemic (for example the government measures and restrictions).

Pre-trigger losses

Another positive decision for policyholders came in relation to pre-trigger losses. The High Court initially found that when adjusting pay outs, insurers could consider a downturn in the turnover of a business due to Covid-19 but before the specific insured peril occurred. This is particularly significant in relation to Denial of Access policies. For example, a pub may have experienced a drop in revenue due to the public concerns about the spread of Covid-19 before the Government issued any instructions on closure. The Government instructions would be the insured peril that triggers the policy and, as a result, the High Court’s decision would have meant that the initial drop in revenue could be considered by insurers when reducing pay outs because it occurred before the trigger event.

However, the Supreme Court disagreed and found that when making adjustments, a business’s loss should be assessed on the assumption that there was no pandemic at all. This means that insurers will not be able to reduce pay outs by factoring in the loss caused by Covid-19 that a business experienced before the relevant trigger event. 

Summary

Landlords and tenants are facing an unprecedented impact on their businesses as a result of the Covid-19 pandemic. It is natural that landlords and tenants are looking to their insurance policies for comfort.

The Supreme Court’s decision is positive for businesses; many landlords and tenants who hold relevant insurance policies will now be covered for Covid-19-related loss where they were not covered under the High Court’s decision.

The judgment is legally binding on the eight insurers that were parties to the test case and it also provides authoritative guidance for the interpretation of similar wordings. In addition, it cannot be appealed by any party. As a result, businesses now have much needed clarity as to whether they will be covered.

The Supreme Court’s construction of causation means that businesses with disease, denial of access and hybrid clauses may all be entitled to cover for loss caused by the national consequences of the Covid-19 pandemic. Further, the phrases “inability to use” and “prevention” were interpreted widely and it was also confirmed that non-legal instructions can trigger cover. This means that businesses with denial of access and hybrid policies are now more likely to be covered for Covid-19 related loss.   

That said; the limitations of the test case should not be understated. Many insurance policies held by landlords and tenants will only cover loss caused by physical property damage, and therefore the Supreme Court’s decision will not assist them in recovering losses caused by interruption to their business. It will be crucial for businesses to reconsider their BI policy wording in light of the Supreme Court’s decision. Every policy is worded differently and every business is different, so businesses should seek independent legal advice as to the interpretation of the judgment in light of their specific circumstances.

Finally, there are a number of practical hurdles faced by landlords and tenants. Both parties should ask for copies of the other’s insurance policies, and an element of co-operation between landlords and tenants will likely be required when evidencing a claim, which could be difficult in the context of ongoing rent arrears. Also, landlords should be prepared for insurers to resist claims for losses suffered as a result of voluntary rent reduction agreements.

This article first appeared in Property Law Journal