Insurance for Lawyers 102

Business InterruptionInland MarineSurety Bonds

But first, a quick review• First Party Property Insurance

– Pays for loss to covered property at the Premises caused by or resulting from covered cause of loss

– Pays regardless of fault– Requires an insurable interest

• Third Party Liability Insurance– Pays damages for which policyholder is

legally liable because of bodily injury, property damage, personal injury or advertising injury caused by an occurrence to which this insurance applies

– Pays legal bills and other defense costs, usually in addition to limits of liability

Review

• Additional Insured Parties– Not good for property coverage– Can be used to ‘stack’ liability coverage

of several policyholders– RTFP

• Read the “other insurance” clauses of both policies and the contract requiring the coverage

• The language of these endorsements is in flux

• Most clients will have nothing more than an insurance certificate

Time Element Coverage

• Not covered by property insurance (unless specially endorsed)

• Two distinct coverages:– Lost Income– Extra Expense

• Three different forms– Lost Income Only– Extra Expense Only– Combination

Business Income InsuranceThe In$uringClau$e

• We will pay for the– actual loss of Business

Income you sustain due to the

– necessary suspension of your “operations” during the

– “period of restoration”

Battlefields

• Business Income– The term "business

income" means the net profit or loss before income taxes that the insured would have earned or incurred, plus continuing normal operating expenses, including payroll, that are actually incurred.

That’s the definition in ISO form CP 00 30 07 04

• Other definitions are possible– “Use & Occupancy” paid

a fixed dollar amount per diem

– “Gross Earnings” policies likewise superseded

Insuring Clause Continues

• Suspension must be caused by direct physical loss of or damage to property…at the premises…for which a Business Income Limit of Insurance is shown in the Declarations

• Loss or damage must be caused by or result from a Covered Cause of Loss

• Some physical loss is required

Still More Insuring Clause• Action by Civil AuthorityWe will pay for the actual

loss of “business income” you sustain and necessary “extra expense” caused by action of civil authority that prohibits access to the described premises due to direct physical loss to property, other than at the described premises, caused by or resulting from any Covered Cause of Loss.

There are limits…• When outbreaks of BSE

resulted in the closure of US borders to tallow being imported from Canada, there was no coverage found under the Civil Denial of Access clause

• Was this result correct?• Should the outcome

differ if the tallow was excluded at the border because it was rancid?

Important to Note• Policyholder can make a BI claim for

property it does not own• Don’t even need to have a lease• ABM had coverage for the WTC even

though it had no property interest in the buildings

• Anyone who derives economic benefit from property can recover lost business income caused by or resulting from covered casualty to the property but this is a recurrent battlefield

Battlefields• Absent damage to the

property described in the Declarations, there is no Business Income coverage– Airlines’ losses due to no

business following 9-11 did not trigger coverage

– Ongoing battles over whether contamination is physical damage that can trigger this coverage

– Lost Computer Data

Battlefields

• Sometimes, Business Income insurance is broader than property insurance– A loss that causes a building to become

unstable, but is not otherwise damaged: the property policy might not pay for the loss but the BI sometimes will

– Mechanical breakdowns may be excluded from the property coverage but an accident that causes a suspension of operations should trigger BI coverage

Battlefields

• Causation– The cessation of business can be caused

even without physical harm to the covered property

– If operation of premises rendered unsafe or unlawful, the fact that it is physically possible to operate the facility does not preclude Business Income claim

– Or the policyholder may have an interdependency claim

Battlefields

• Proof of lost income is daunting– Nearly impossible for

new businesses– Established businesses

need more and more to satisfy the Daubert standard instead of normal accountant testimony to establish amount lost

Insuring Clause: Extra Expense• We will pay Extra Expense

(other than the expense to repair or replace property) to: (1) Avoid or minimize the "suspension" of business and to continue operations at the described premises or at replacement premises or temporary locations, including relocation expenses and costs to equip and operate the replacement location or temporary location.

• (2) Minimize the "suspension" of business if you cannot continue "operations".

Battlefields

• Total Cessation Issues• Can you have extra

expense while still operating?

Battlefields• Period of Restoration

– “Virtual” Restoration• Should/Could/Would• What about off-premises

property? 100/500/1000 foot penumbra of coverage

– What is getting restored?• State of the Art or Functionally

Obsolete• There may be a difference

between Business Income and Property Damage Recovery: PD doesn’t pay to make the insured property better but Business Income might have to include bettering in the Restoration Period

Time Element Summary• Property Insurance pays the value of stuff but that may not be enough to save the

enterprise• When business is interrupted by a casualty, insurance is available to cover the lost

income and the exceptional expenses of operating from temporary facilities• Be aware that specific coverage forms exist for Civil/Military Authority, Service

Interruption, Ingress/Egress/Access Denial• Instead of deductibles, these policies have a “waiting” or “exclusion” period• If the policyholder has property insurance, review that policy or coverage part too!• Coordinate with the ‘disaster recovery’ benefits available from many commercial

property insurance companies• Consider definitions of covered property under property coverage to reinforce

claim of damage to property sufficient to trigger Business Income policy• Contingent business income insurance adopts a much broader view of the

property and can be triggered by interdependency losses• Commercial output coverage also incorporates time element coverage

Inland Marine• Commercial Property

Insurance is designed for stuff that stays put and does not change

• Automobile coverage is one exception, but the risks of owning, operating and maintaining motor vehicles are fairly simple even though they move around

Ocean Marine

• The “First” form of insurance

• Marine Cargo• Marine Hull• Generally covers the

insured objects against all perils of the sea (and more) subject only to stated exclusions

Life and Cargo Come from the Sea• By the mid-18th Century,

Lloyd’s was established as a fixture of insurance and other joint-stock or mutual companies sprang up to insure other objects, such as buildings

• Marine insurance companies saw many opportunities in coming ashore

Marine Coverage War• Marine coverage moved

onshore through two opportunities in particular– Continuing Transit

Coverage: goods continue to move inland after unloading

– Many structures, while they stay put, are subject to perils unlike those to which other properties are exposed• Bridges, piers, docks,

wharves, quays

Marine Coverage War• Marine insurance next moved

to “builders risks,” or first party property coverage for buildings under construction

• Once they had insured the building under construction, the Inland Marine insurance company might not be in a big hurry to lose the coverage and the premium, so they stuck around even after a commercial property company could and would have insured the risk

Head to Head No Contest• Inland Marine insurance

was usually written on an all-risk basis

• Commercial property insurance was legally precluded from open peril coverage

• IM can cover all of the articles used with a building

• Commercial Property insurance was exclusively monoline

Nationwide Marine DefinitionIM Can Cover These Kinds of Things

• Imports• Exports• Domestic Shipments• Bridges, Tunnels and

Other Instrumentalities of Transportation and Communication

• Personal Property Floater• Commercial Property

Floater• Professional Property

Floater

• Floater: the term suggests marine flavor– Personal Property Floater

covers furs, jewelry, fine art, cameras, silverware

– Commercial Property Floater covers builders and installation risks, mobile theatrical equipment, live animals, salesmen’s samples, contractors’ mobile construction equipment, floor plans, electronic data, inventory of musical instrument dealer, furrier, art gallery

Is Inland Marine a Dinosaur?• The emergence of the

Special Multi Peril policy in the 1950s and the Commercial Package Policy in the 1980s reduced the IM advantage

• Commercial Companies blithely ignore their limitations and write Builders Risk policies with Special Causes of Loss

• Jerry Trupin believes that it makes no difference

• New York State Insurance Department Disagrees

• Circular Letter 22 (2001)• NYS Insurance Law

governs policies sold from or into the State or covering objects located therein

Inland Marine: How to Decode

• First Principle: it’s first party property insurance• Same principles apply as to Commercial Property

Insurance– What Property is Covered?– Whose interests are covered?– What causes of loss are covered?– What payments are called for?

• ACV or Replacement Cost• Coinsurance

Inland Marine: Covered Property

• For Floater Coverage, this can be challenging because the covered property changes– Auto dealer sells a car and obtains a new one from

the manufacturer– Coin dealer, art gallery, gun dealer– Transit coverage—when does it begin and end?

• Particularly important to understand the alphabet soup of INCOTERMS

• INCOTERMS interfaces with law of sales, carriage of goods by sea, The United Nations Convention on Contracts for the International Sale of Goods

INCOTERMSGovern Risk of Loss, Duties and Rights of Parties• Remember that under the UCC there are two

basic flavors of contract: shipment and delivery– Under a shipment contract, the seller discharges his

duty by shipping the goods by common carrier to the buyer

– Under a delivery contract, the seller discharges the contract by tendering the goods at the buyer’s designated point

• There are then further layers of complexity regarding insurance, risk of loss, etc that can make international trade at risk of misunderstanding

INCOTERMSUniform Shorthand for Sales Contracts

INCOTERM Decoded Meaning

GROUP E Departure UCC Shipment Contract

EXW Ex Works Buyer picks up. If Seller loads, loading is at Buyer’s risk

GROUP F Main Carriage Unpaid Freight Collect

FCA (named places) Free Carrier Delivered to designated place cleared for export

FAS (named vessel) Free Along Side Maritime-only variant of FCA

FOB (named vessel) Free On Board Like FCA but risk of loss divides at ship’s rail

INCOTERMSUniform Shorthand for Sales Contracts

INCOTERM Decoded Meaning

GROUP D Delivrance Arrival Contract

DAF Delivered at Frontier Buyer takes delivery at frontier, Buyer clears export-import

DES Delivered Ex Ship Seller holds goods on board named ship (usually owned or chartered) Buyers pays duties and cost of unlading

DEQ Delivered Ex Quay Like DES but Seller unloads ship to quay

DDU Delivered Duty Unpaid

Like DES but delivery to point other than port

DAP Deliver at Place Tender to Buyer at stated location

DDP Deliver Duty Paid Tender to Buyer at stated location with all duties and VAT paid

INCOTERMSUniform Shorthand for Sales Contracts

INCOTERM Decoded Meaning

GROUP C Main Carriage Paid

CFR Cost and Freight Shipment contract, price includes cost of goods and freight to stated destination. Maritime only

CIF Cost Insurance Freight

Shipment contract, price includes cost of goods, freight to stated destination and marine cargo insurance on the shipment

CPT Carriage Paid To Inland/Multimodal Variant of CFR

CIP Free Along Side Inland/Multimodal Variant of CIF

Builders Risk

• Buildings Under Construction– Special risks

• Fire• Collapse!!!!!• Elements• Theft

– Multiple Parties’ Interests• Owner• General Contractor• Trade Contractors• Lenders

Builders Risk• Coordination with

Construction Contracts• Whose property is it?

– Who’s the named insured on the policy?

– Who holds the insurable risks in the project?

– Coverage for “your” materials and equipment is not the same as coverage on materials and equipment of others

• When does coverage attach?

• When does coverage terminate?

Builders Risk

• New construction is especially vulnerable when utilities are connected…

• During hookups of new mechanical equipment…

• During testing and commissioning as part of final acceptance

Coverage, Exclusions and Exceptions O My

• Exclusion for mechanical breakdown is especially troublesome– Refers to devices that use

electrical or mechanical power, centrifugal processes, compressed gas and live steam

– Exceptions often present for testing and commissioning

• Hot Testing/Cold Testing refer to running equipment with or without feedstocks

• Usually pertains to performance of an industrial project– Can the factory produce

10,000 Flow-Through Tea Bags per day or can it not?

– Commissioning usually includes heavy duty and long-cycle

Surety Bonds

• Surety bonds resemble insurance policies…

• They are sold by insurance companies…

• Insurance companies collect premiums for them…

• They do transfer some risks…

• But…

Primary Obligation• The bond is triggered by

something else• That ‘something else’ is

the primary obligation• The primary reason for

the bond is to assure that a financially-capable payor stands behind the principal’s promise

• But if you don’t show a breach by the principal you don’t have a claim against the surety

Surety Bonds ≠ Insurance

• Insurance is underwritten on the presumption that there will be some losses

• Surety bonds are underwritten on the premise that there will be no losses

• Any losses the surety does pay, it expects to get back one way or another

Tri-Partite Agreement• Quintessential surety

bond has three parties:– Principal: typically

obligated to perform an act (appear in court, finish a construction project etc)

– Beneficiary: the obligee to whom the principal’s primary obligation is owed

– Surety: deep-pocket who agrees to pay for the principal’s failure

• The obligation of the surety is strictissimi juris

• At common law, any modification of the primary contract made without the surety’s assent would exonerate the surety

• Even if the change was favorable to the principal or surety

Don’t Forget the Primary Contract• Construction Contracts

contain elaborate provisions regarding changes in the contract

• Complicated body of law and practice grew up as to the kinds of ‘minor adjustments’ that did not exonerate the surety and the ‘change orders’ that required its assent

Modern Flexibility• The “standard” form, AIA

form A312 expresses the surety’s waiver of notice of changes under the contract documents

• However, most courts recognize that changes can be so fundamental that the surety cannot be held to guarantee the changed contract

• Strictissimi juris is also attenuated by the ‘newly’ commercial surety industry

Primary Obligation

• Common drafting paradigm: principal and surety promise to pay a certain sum of money to the beneficiary but if the condition of the bond occurs, then the bond is void and without effect, but otherwise it remains in full force and effect

Penal Sum• The amount stated in the bond—

the penal sum—states the greatest amount for which the surety expects to be liable

• Usually, that is true, though a surety who simply stonewalls a project can be caught in a Bi-Economy trap

• The bond at the right is said to be “conditioned for” John Doe appearing in court on his next appearance date

• This kind of bond is in the nature of a forfeiture bond

Know all men by these presents that we are firmly bound unto Sheriff of New York County for the penal sum of one million dollars, for the payment whereof we hereby bind ourselves our heirs and assigns; and the condition of this obligation is that if the principal John Doe shall appear in Part AP-1 of the Criminal Court of the City and County of New York on June 1, 2011 at 9:30 AM then this bond shall be void, otherwise to remain in full force and effect

s/John Doe, Principals/ABC Bond Company, Surety by

E.Z.Springer, its attorney in fact

Construing the Bond• Condition or Covenant?

– A bond conditioned for the performance of an act is construed under General Obligations Law §7-301 to contain a covenant either to cause performance or to pay

– As a result, most bonds are not construed as forfeiture bonds…the surety pays the principal’s damages, up to the penal sum

Construction Bonds• Construction uses many

bonds– Bid Bond– Payment & Performance

Bond– Completion Bond– Lien Discharge Bond

• Some bonds are required by law

• Others are critical to the smooth operation of the Project Finance arrangements

Construction Bonds

• Bid Bond: used with sealed public bidding– Expensive Process– Secures against the

successful bidder failing to execute the contract, etc.

• Payment & Performance Bonds– Usually required together– Always underwritten

together

• Bear in mind that this discussion is limited to the bonds themselves. We are not getting under the hood with respect to the principal-surety relationship.

• This may be a topic for a 300-level Insurance course

Performance Bond• Conditioned for the

performance of an identified construction contract– Do not conflate

‘substantial performance’ with ‘substantial completion’

– Substantial performance is a breach of contract that partially excuses the Owner’s obligation to pay

– Failure of substantial completion is a breach of the entire contract

Performance Bond• “Owner Default” is a

condition of defeasance of the bond

• Absent owner default, the owner enforces the bond by suing the contractor for breach of contract and joining the surety as a defendant

• Liability of surety is coterminous with liability of principal

Payment Bond

• Conditioned for the payment of subcontractors, laborers and material suppliers contracted for the project

• Does not require the establishment of a mechanic’s lien, but mechanics’ lienors are almost always protected

Completion Bond

• Like a performance bond on steroids

• ‘Owner default’ does not exonerate the bond: it triggers the bond

• Most often seen in motion picture financing but now becoming popular in ‘Platform Financing’

Litigation Bonds

• Provisional Remedies– Preliminary Injunction– Order of Seizure– Vacate Notice of

Pendency

• Supersedeas (Appeal) Bonds

• Governed by Article 25 of the CPLR

Financial Institution Bonds

• Triggered by misconduct of employee entrusted with property of beneficiary

• Fills important gap in D&O coverage, which excludes unlawful acts of named insured parties