By its definition, the term “catastrophe” describes an event that may be both unprecedented and unexpected—neither of which are favorable conditions for attorneys working through complex insurance settlements after disaster has struck. Unfortunately, property damage from such catastrophic losses has become an increasing reality in the twenty-first century, requiring real estate lawyers to develop certain approaches and strategies in responding to these disasters and the destruction they leave in their wakes, both literally and figuratively. This article examines the major categories of catastrophic losses and identifies the types of insurance most commonly associated with recovery efforts.
Types of Catastrophic Losses
While natural disasters are perhaps the most widely recognized events characterized as “catastrophic losses,” the definition also can be interpreted to encompass non-naturally occurring events, such as terrorist attacks or infrastructure failure. Whatever the cause, such losses can strike at any time, and no area of the country is immune: hurricanes on the Gulf and Atlantic Coasts; tornadoes throughout the Southeast; wildfires in the mountain West; terrorist attacks in New York and Washington, D.C.; earthquakes on Pacific fault lines; flash-flooding in the Mississippi Valley; and snowstorms in the Midwest are just some of the recent examples that come to mind.
According to the Insurance Information Institute (III), insured property losses from both natural and man-made catastrophes typically run in the tens of billions of dollars annually—though there can be significant fluctuation. For example, losses amounted to $35 billion in 2012 but dropped to $12.9 billion in 2013. In just the first half of 2015, however, the III calculated losses owing exclusively to natural disasters at $12.6 billion—well over the $11.2 billion average calculated for the first halves of 2000 to 2014.
The causes, too, of these losses can vary significantly; in the first half of 2015, almost half of the losses resulted from severe thunderstorms, including tornadoes, which category alone caused $7 billion in damages. Typically, winter storms and flash floods join thunderstorms in accounting for the majority of insured losses. Less common events, such as earthquakes or hurricanes, do not occur as consistently but account for large portions of the total losses when they do. Hurricanes, for example, comprised only 2.6 percent of the total recorded natural disaster loss events in the United States between 2005 and 2014 but accounted for almost 51 percent of the total estimated insured losses.
This illustrates another striking point about catastrophic losses—the less commonly occurring events are typically the costliest. Of the ten most costly catastrophic losses in the United States, seven are hurricanes, while the September 11 terrorist attacks and the Northridge Earthquake clock in at numbers two and five, respectively. The most common type of catastrophic loss—that resulting from thunderstorms and tornadoes—makes its only appearance on the list at number ten—the flooding, hail, and wind damage resulting from the April 2011 Tuscaloosa, Alabama, tornado outbreak. Thus, while real estate lawyers typically may expect more consistent issues with tornadoes, winter storms, and floods, they also must be wary of the more devastating (though perhaps less common) damage resulting from hurricanes, earthquakes, and terrorist attacks.
In terms of property law, each type of catastrophe carries with it a unique set of circumstances that govern the response to the sustained damage. There are, however, common principles and issues that a property lawyer must consider in every catastrophic loss case, no matter what the triggering event may be.
Insurance Types: First-Party Property Insurance
First, the type of insurance at issue must be identified. First-party property insurance is perhaps the most commonly regarded form of insurance and is generally purchased and relied on to compensate the policyholder for the actual physical damage sustained to his or her property. Where property has been damaged, policyholders typically will hope to rely on insurance proceeds to rebuild and repair. In this context, real estate lawyers should be aware of the fact that their insured clients may face an additional cost owing to compliance with building and construction codes. This is because many building codes and regulations require that the repairs and/or reconstructions of damaged buildings comply with current building codes, which may impose additional requirements than the codes in existence when the property was originally constructed. In some cases, the requirements might even extend to the undamaged portions of the building. Under these circumstances, or in the case of extremely costly building code upgrades, it may be in the client’s best interest to demolish and reconstruct the building, rather than to repair it according to building code upgrade requirements. Accordingly, real estate lawyers should always review their clients’ insurance policies carefully for any building code upgrade provisions—and of course, advise their clients to purchase an endorsement to their policy covering these costs on the front end. These endorsements are typically available and commonly referred to as an “ordinance and law coverage” or “building code upgrade coverage.”
Insurance Types: Leases—Casualty Insurance
First-party property insurance also presents particularized challenges in the context of leases—both residential and commercial. Typically referred to as “casualty” provisions, such terms in leases define the competing rights and obligations of the tenant and landlord and are of particular relevance when real property sustains significant damage. These provisions typically permit the landlord, tenant, or both to terminate the lease if a substantial portion of the premises is damaged or destroyed by casualty. Depending on the drafters of the lease, these terms may be tenant-friendly (recognizing that the tenant desires functional space available as soon as possible) or landlord-friendly (recognizing that the landlord desires wide latitude to consider whether to repair and timing to do so). In some cases, the interests of the landlord’s or tenant’s lender may also come into play, further complicating the situation. These contractual stipulations are of particular importance to real property attorneys when representing an insured client—tenant, landlord, or lender—after a loss.
After Superstorm Sandy, for example, it became painfully apparent that necessary repair periods would be much longer than anticipated. In a widespread disaster, adjusters are overwhelmed with many claims, and a landlord may have to wait longer than anticipated to meet with its adjuster. Additionally, the areas affected by a widespread disaster will experience a high demand for reconstruction work, meaning that securing contractors, workers, and materials for restoration will take longer than usual. Because many of these parties are working on multiple reconstruction projects in the area, work also progresses more slowly. In light of these experiences, real estate lawyers should take care to review these provisions after a loss, as well as draft them in a manner favorable to their clients at the outset.
Attorneys representing landlords should ensure that a clause permitting the tenant to terminate the lease after a casualty provides a sufficient time period that will take into account these inevitable delays. Attorneys representing tenants, on the other hand, should review leases after a catastrophic loss to determine whether the casualty provisions can be interpreted to allow the tenant to terminate the lease if the restoration is in fact taking so long as to cause further damage to the tenant. Additionally, tenants’ lawyers should ensure that any lease agreement provides for relief from rent when the space is unusable, along with necessary relocation costs. These tenant-friendly coverage provisions also may permit recovery even where the property itself is not damaged but is merely inaccessible or unusable.
Another important set of terms to be aware of in leases is notice provisions. Termination provisions will have a corresponding notice period in which either of the parties must notify the other if it intends to terminate the lease. In areas damaged by Superstorm Sandy and Hurricane Katrina, however, many of the damaged properties were inaccessible for lengthy periods after the storms. Consequently, neither landlords nor tenants were able to return to assess the extent of the damage and/or costs of restoration within the typical time periods of 30 or 60 days. At that point, either party intending to terminate the lease could only select from two unattractive options: (1) provide notice without first being able to assess the damage so as to meet the time period requirement for notice or (2) let the deadline for providing notice pass, wait to assess the damage when possible, and then, if warranted, attempt to submit an “untimely” notice of termination. Obviously, property attorneys would not like to see their clients forced to make this decision. To avoid finding themselves in these situations, property attorneys should, on the front end, ensure that leases include adequate notice periods, providing language that allows for a time line based on accessibility of inspection, rather than a hard 30- or 60-day deadline. In the wake of a disaster, attorneys also should review these provisions of the lease and attempt to access the affected property as quickly as possible to determine whether termination is in their client’s best interests.
Insurance Types: Business Interruption Insurance
Business interruption insurance (BI) is another critical form of insurance that is implicated in the aftermath of a catastrophic loss. The purpose of BI is to pay the lost profits and unavoidable continuing expenses caused by an interruption of the policyholder’s business that results from otherwise covered damage to the property. Stated differently, business interruption insurance is designed to put the policyholder back in the position it would be in but for the occurrence of the property damage. For example, if a policyholder’s building is damaged and its operations must be suspended, any resulting decrease in the policyholder’s stream of income normally generated from the damaged building (or, more accurately, the policyholder’s activities at the building) might be covered under a BI policy. A typical policy will usually provide language similar to the following:
We [the insurer] will pay for the actual loss of Business Income you sustain due to the necessary suspension of your “operations” during the “period of restoration.” The suspension must be caused by direct physical loss of or damage to property. . . . The loss or damage must be caused by or result from a Covered Cause of Loss.
In addition to insuring replacement or reconstruction costs of the improvements, most parties will also want to insure against the loss of income resulting from the interruption of their business that is caused by a major catastrophe. Whether or not the BI (which is an additional coverage under a property insurance policy) is required in the lease, prudent business people (both landlords and tenants) should consider obtaining such insurance in any event. Property attorneys should encourage their clients to review the BI terms and conditions to understand what it would and would not cover if a hurricane, earthquake, or other disaster were to cause a shutdown in operations. Attorneys should also investigate whether coverage can be obtained in the event that there is no actual physical damage to the premises but instead perhaps a key customer or supplier is shut down owing to disaster damage (commonly referred to as contingent business interruption coverage).
Property attorneys must also pay close attention to exclusions—perhaps the tool most commonly used by insurers attempting to bar or curtail coverage. Flood exclusions are perhaps the most well-known to attorneys—especially those who dealt with losses in the aftermaths of Hurricane Katrina or Superstorm Sandy. Attorneys representing clients in these situations should be aware that property insurance policies, although typically drafted to cover losses from fire, theft, and even “natural disasters,” almost always expressly exclude flood losses—which usually must be covered by a separate flood policy. In dealing with flood losses, attorneys should closely examine their clients’ policies for the following issues, among others: how the policy defines “flood” or “water”; the existence of a flood deductible and its effect; and application of “flood coverage” to tsunamis and resulting inundation. These are some major exclusions in flood policies that often come into play in the wake of a natural disaster that is accompanied by flood damage.
In terms of hurricanes, storms, and associated flood damage, anticoncurrent-causation clauses also warrant careful consideration. These clauses typically provide that if damage results from two concurrent causes/events—one that is covered (e.g., wind damage) and one that is excluded (e.g., flood damage)—the loss is excluded. In the aftermath of Hurricane Katrina, the Fifth Circuit in fact upheld such a provision and denied coverage for “wind damage that occurred concurrently or in sequence with the excluded water damage.” Because such clauses can also operate to exclude other and unexpected losses from coverage, they are of particular significance when interpreting a policy for a client after a catastrophic loss.
Given the wide assortment and seemingly increasing instances of natural disasters resulting in property losses, the legal issues facing attorneys in the field are likewise numerous and varied. Although this article has identified some major applicable types of insurance and commonly accompanying issues, many other coverage concerns remain. Even so, in the broader sense, it is important for all property attorneys to understand that catastrophic losses are a very real threat and can happen to any client at any time. Understanding the coverage issues that will arise after such a loss—both on the front end in purchasing insurance and on the back end in examining how such coverage can be applied—is key. Although it will not be able to prevent catastrophic events from occurring, recognizing these major coverage issues will, one hopes, hasten the recovery process for all parties when disasters do strike—the ultimate goal for all involved.