Insurance fraud is estimated to be a billion-dollar problem, and business interruption policies are not immune to it. Whenever a natural disaster hits, commercial carriers are inundated with claims from business owners, pursuant to their business interruption policy provisions. Business interruption coverage is intended to provide the insured’s business with the amount of profit it would have earned had there been no interruption of the business or suspension of operations, but it may not be used to put the insured in a better position than it would have occupied without the interruption, as confirmed in Dictiomatic Inc. v. U.S. Fid. & Guar. Co.
When making a claim under a commercial policy, it is not uncommon for a business to overstate revenues and understate liabilities. Early on, it is important to consider retaining the appropriate expert to properly evaluate the claim. A financial expert with expertise in business claims can provide invaluable assistance in analyzing and assessing the various aspects of business interruption claims, especially three of the most common disputed areas: base period; necessity of costs incurred and ongoing expense; and cause of loss(es).
Base Period
Business interruption insurance attempts to cover losses incurred between what would have happened “but-for” the loss. If you have prepared or worked on prospective or pro-forma financial statements, then you soon realize that assessing the “but-for” scenario or conditions often leads to disagreements. The most common approach of determining the claimed loss amount is to calculate the “but-for” loss period’s operating results by using a representative benchmark or proxy base period as support for the loss-period estimate. For seasonal businesses, the same season for prior years may be used as a benchmark base period. For mature or stable businesses, an annual average of operating results prior to the claimed loss may be considered an appropriate benchmark. High-growth businesses do not have a benchmark base period; in such situations, regression analysis of historical results can be helpful. In addition, examination and consideration of large pending sales contracts during the claimed damage period for high-growth or start-up companies may be another method to analyze the “but-for” results.
Regardless of the method or approach used, there will need to be adjustments made for industry and market conditions and other factors affecting operations, such as loss of large customers or suppliers during the damage period. Courts have excluded financial experts who have not considered such adjustments in their analyses resulting in dramatically debilitating damage claims (Concord Boat Corp. v. Brunswick Corp.).
The selection of a base period can have very significant consequences on the recoverable loss calculations. Therefore, frequent disagreements arise regarding its selection. All relevant adjustments must be considered, and they must account for any differences between the base period and loss period. If business interruption claims do not consider and incorporate such adjustments, then intentional or negligent oversight should not be ruled out.
Necessity of Costs Incurred and Ongoing Expenses
The necessity of costs incurred and/or ongoing expenses in business interruption damage calculations involve potentially subjective judgments that may differ significantly between a policyholder and an insurance company. For example, a necessary expenditure may include costs for storage trailers to maintain inventory while a warehouse is being rebuilt. The policyholder may indicate that it requires 10 trailers, while the insurance company indicates that only three trailers would be adequate. The policyholder must convince the insurer that the costs incurred are reasonable, necessary, and related to the insured loss. Building this support requires analytical skills and an ability to marry the explanations to the costs incurred and the consequences avoided. Since evaluation of these costs heavily relies on subjective judgment, it is ripe for potential abuse and/or fraud.
For example, the insured must establish that the physical damage to the property is the basis for the loss of revenue. Thus, the policyholder must consider various factors, such as alternative manufacturing sites, general market conditions, alternative products, recovery of lost sales in subsequent periods, contractual relationships, and the uniqueness of the product before attributing the loss of revenue and related earnings to a covered loss event. Not doing so jeopardizes a business interruption damages claim. The insured must link the loss or physical damage of property to lost revenue and related earnings, exclusive of other causes to declines in revenue and earnings (if any). Not isolating and linking the cause of a decline in revenue and earnings or prices to a claimed event has significant consequences, as seen in Blomkest Fertilizer Inc. v. Potash Corp. of Saskatchewan.
In cases where fraud is suspected, it is imperative that, early in the case, the claims professional, defense counsel, and expert set aside the time to thoroughly review the file to determine if there are any red flags where the losses claimed appear exorbitant or unsupported. In addition to the standard investigative techniques (e.g., examinations under oath, recorded statements, discovery, and depositions), a thorough search should be conducted of the online profile of the business (both pre- and post-loss) through the business’s website, industry blogs, and social media.
When blatant inaccuracies are discovered, defense counsel should consider filing a motion to dismiss the case for fraud. Although the standard for dismissal for fraud is high, courts will entertain dismissal or other sanctions when it is shown by clear and convincing evidence that a party has undertaken a calculated effort to deceive the court. The mere filing of said motion puts the plaintiff on the defensive.
As noted in Dictiomatic Inc. v. U.S. Fid. & Guar. Co., the fact that a company has had a “proven track record” with a product or service does not necessarily mean that it will have success with the current product or service. In Dictiomatic, a company with a proven track record with several products (hand-held translators) claimed exorbitant damages for losses incurred by a subsequent but inferior product, which didn’t sell. The case was ultimately dismissed during trial. The court subsequently imposed significant sanctions against the company and its attorneys, finding that the insured’s claims for lost profits were frivolous.
In business interruption claims, early investigation by the claims professional, defense counsel, and expert can significantly limit the plaintiff’s claim and possibly set up the case to be dismissed for fraud upon the court.