Insurer’s Denial of Mitigation Claim for Extra Costs to Prevent Cancellation of Contract Upheld

specialized piping outsideMany property insurance policies that provide coverage for business interruption losses also include “extra expense” coverage for reasonable and necessary extra costs to temporarily continue as nearly as possible normal business operations, or to reduce the period of time necessary to resume normal business operations. Some policies also include provisions, sometimes referred to as mitigation provisions, which afford coverage for additional costs incurred by an insured to reduce its business income losses in the event its business operations are disrupted because of a covered loss. The differences between the two coverages, and how they might apply in the event of an otherwise covered business interruption loss, will depend on the wording of the provisions and the facts of the claim.

The U.S. District Court for the Eastern District of Arkansas recently addressed these issues in Welspun Pipes v. Liberty Mut. Ins. Co., in which the court granted Liberty Mutual summary judgment dismissing Welspun’s claim for additional costs to transfer production of specialized piping to an affiliate’s facility in India because the insured had not established the required elements for a covered “mitigation” claim.

Welspun suffered an interruption in its business due to a fire that damaged its facility in Little Rock, Arkansas, while the facility was covered by a commercial policy issued by Liberty Mutual. Before the fire, Welspun had entered into a lucrative contract with Enterprise Products Partners to provide specialized piping to be used in the Seaway Expansion Project. A fire damaged Welspun’s Little Rock facility before production of the piping began. Following the fire, Welspun asked Enterprise if it could shift production of the piping to an affiliate’s Indian facility, with all additional costs to be borne by Welspun. Enterprise agreed.

Welspun submitted claims under its Liberty Mutual policy for its business income loss of approximately $28,000,000 as well as an estimated $14,500,000 in what Welspun characterized as mitigation expenses for the incremental costs associated with the shift of production to its affiliate’s manufacturing facility. Welspun claimed that had it not spent the $14,500,000 to shift the pipe production to its affiliate’s Indian facility, it would have been at risk of losing the entire Seaway order. Liberty disagreed with Welspun’s calculation of its loss of business income and its characterization of the expenses associated with the shift of production as necessary expenses. The parties reached a partial settlement in which Liberty paid $22,300,000 for Welspun’s business income loss, and $1,000,000 (the policy’s extra expense sublimit of liability) for “extra expenses”, but agreed to litigate the dispute over the insured’s $13.5 million unpaid claim for mitigation costs.

The central issue addressed by the court was whether the expenses incurred by Welspun in shifting the cost of production of a portion of the pipes for the Seaway project to India were covered mitigation expenses as defined in the following provision:

The necessary expense you incur in excess of your normal operating expenses that reduces your loss of business income. We will not pay for more than we would pay if you had been unable to make up lost production or continue operations or services.

The court noted that this provision affords “coverage for necessary expenses incurred by an insured to reduce the loss of business income, with the caveat that Liberty Mutual will not pay more than it would have paid if the insured had been unable to make up the lost production or continue operations or services.” To show a covered loss of business income under the policy a manufacturer must show a decrease in the net sales value of production during the period of restoration (the time reasonably necessary to repair the damage) and the following 60-day extended period of restoration. Accordingly, in order to establish a claim for necessary expenses under the mitigation provision, Welspun had to show that it necessarily incurred expenses in excess of its normal operating expenses that lessened a decrease in the net sales value of production, i.e. business income loss, through the extended period of restoration.

Plaintiffs attempted to avoid this conclusion by pointing out that the mitigation provision did not use the term “covered” nor the terms “period of restoration” or “extended period of restoration.” But the court rejected that argument reasoning that the provision says that Liberty Mutual:

… will not pay more in mitigation expenses than it would have paid if the insured had been unable to make up lost production or continue operations or services, which means that Liberty Mutual will not pay more than it would have paid had the business loss occurred rather than been averted. Liberty Mutual will pay nothing for a business loss that is not covered, so it will pay nothing to mitigate a business loss that is not covered. (Opinion, at p. 13).

In short, if an insured incurs mitigation expenses to avoid a business loss that would have occurred after the extended period of restoration, those mitigation expenses are not covered. Because the insured had presented no evidence that the mitigation expenses at issue averted a net decrease in production value during the period of restoration or the extended period of restoration, it had not established an essential element of their claim.

The policy also contained a provision which provided that Liberty Mutual “will not pay for any increase in loss due to the suspension, cancellation or lapse of any contract.” Plaintiffs interpreted this provision to mean that the policy did not cover loss for cancellation of a contract if the loss occurs after the period of restoration or the extended period of restoration. The court found that under this interpretation of the cancelled contract exclusion, there would have been no coverage for loss of the Seaway order except to the extent that cancellation of the contract caused a decrease in net sales value of production during the period of restoration or the extended period of restoration.

Claim professionals handling large business interruption losses may often be confronted with claims for costs to reduce business income losses due to the disruption of normal business operations following a loss, as well as extra expenses to reduce and shorten the disruption of business operations. As demonstrated in the Welspun decision, when evaluating such claims the claims handler must carefully consider the language of the policy to identify the elements of the available coverages for extra expense and mitigation costs, as well as the precise nature of the claimed expenses, in order to determine the extent of coverage for such additional expenses.

Welspun Pipes, Inc., and Welspun Tubular, LLC. V. Liberty Mutual Insurance Company, No. 4:13CV00418 JLH, U.S.D.C. E.D. Ark. (February 2, 2017)

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About The Property Insurance Law Observer
For more than four decades, Cozen O’Connor has represented all types of property insurers in jurisdictions throughout the United States, and it is dedicated to keeping its clients abreast of developments that impact the insurance industry. The Property Insurance Law Observer will survey court decisions, enacted or proposed legislation, and regulatory activities from all 50 states. We will also include commentary on current issues and developing trends of interest to first-party insurers.
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