Whether builders’ risk claims are associated with constructing a new building or renovating an existing one, their quantification can be very complex. Forensic accountants regularly disagree on the valuation of insured claims. Builders’ risk claims are subjective by nature, but by understanding some of the computational issues, a policyholder can maximize recovery and minimize disputes.
Calculating DIC/DSU loss through benchmarking. Conceptually, DIC/DSU coverage is similar to traditional business interruption coverage. It is intended to put the policyholder back in the financial position it would have occupied had the insured loss event not occurred. When calculating the value of a DIC/DSU claim, there are two key questions that need to be answered: How much revenue was lost due to the delay? What variable expenses were saved due to the business not operating during the delay?
There are a variety of acceptable methodologies to calculate lost business income depending on the nature of the business. A company’s historical financials, future projections, and industry data should all be evaluated when determining a benchmark. Benchmarking indicates what the business results would have been if the loss event did not occur. However, new construction will not have historical financials, and extensive renovation may result in the historical data being irrelevant for benchmarking. In the absence of data on the property’s historical performance, management’s financial projections or the performance of comparable businesses in similar industries and markets should be used as a benchmark.
Management’s financial projections can be influenced by a number of factors; therefore, it is common practice for forensic accountants to perform analyses that evaluate management’s forecasting accuracy. This evaluation may include reviewing past openings by the same management team, comparing the company’s forecast against actual for other locations, or evaluating the results after the affected property begins operations. The financial data that become available after the business resumes operations can be helpful in determining how a business may have performed, if no delay occurred. However, the effects of the delay may have an ongoing impact on the business even after it opens. For example, a business with seasonality may have planned to open during an optimal time of the year, a business may not have been able to retain key employees during the delay, or the delay allowed competitors to enter the market. These conditions can be challenging to quantify and must be given thorough consideration in a lost revenue calculation.
In addition to management’s projections, financial data from comparable businesses in similar industries can be used as a benchmark. However, depending on the business, industry data will vary in relevancy and availability. For example, in the hospitality industry, STR, Inc., produces reports that benchmark a property’s performance against a comparable set of hotels in the market. The statistics from the comparable properties can be used to estimate the expected performance of an affected hotel.
Evaluating continuing expenses. After a benchmark has been established, lost business income is measured by adding continuing expenses to net profit or by deducting saved expenses from gross earnings. Because there are no historical operating results in many cases, the saved expenses associated with a DIS loss can be calculated in a fashion similar to the way lost revenue is calculated, by using budgets or forecasts derived from similar businesses or possibly other facilities operated by the policyholder. Typically, when a business has not opened, more expenses will be considered saved. Each expense line item should be evaluated carefully, however. An expense may be characterized as variable in a company’s cost reports, but a fraction of that expense could be fixed. For example, a nonoperating manufacturing plant may have an administrative building that continues to use electricity. Utilities are typically considered variable in cost accounting terms. However, in this scenario, the portion of the utilities associated with the administrative offices should be measured as a continuing cost. Only the utilities that would be feeding the manufacturing plant should be treated as saved.
Calculating interest expense. Interest is a “soft cost” that is rarely considered in a traditional business interruption claim. For traditional business interruption claims, policy limits are normally limited to one year so the time value of money is not significant. However, for builders’ risk claims, interest can be substantial, and the quantification can be complicated. Interest and loan payments will continue even if there is a loss affecting the construction schedule. The construction loan will likely be extended for a longer period than initially anticipated. There may also be additional interest on loans that are converted to long-term loans due to varying interest rates. In other situations, interest may also mitigate a claim, depending on rates and policy language. For a construction loan with a fixed interest rate, it is possible that at the end of the claim, interest rates could be lower on the long-term loan. The reduction in interest could be taken as an offset to the claim.
Accounting for uncovered risks. For DIC/DSU losses, coverage begins at the scheduled completion date for the project, which is when the policyholder would expect to begin operations and generate revenue. The “scheduled completion date” is not the date that was determined at the project’s commencement. It is the expected completion date listed in the latest project schedule created prior to the loss occurring. Construction and renovation projects rarely follow the original timeline drafted in the early stages of a job. However, these normal course of business construction delays need to be identified and excluded from the calculation of insured loss. Using the most recent construction schedule will remove the impact from the unrelated delays, assuming the construction schedules are updated regularly. The project’s progress prior to the event should be analyzed, and all missed deadlines need to be considered. Assume, for example, a project is delayed due to an insured event, and during the period of indemnity the construction workers’ labor union goes on strike. Normally, the delay associated with the strike may be excluded from the applicable policy’s coverage. However, if the construction project was supposed to be completed before the strike but, due to the delay from the insured event, the project is affected by the strike, the additional delay could be covered.
Typically, changes in market conditions are excluded within most builders’ risk policies. If, hypothetically, an apartment project was supposed to be completed in December 2017 but a major loss event delayed the completion of the project until December 2018, the owner likely had secured renters for the property, who expected the property to be completed in December 2017. The owner would also expect to rent more units once the building opened. Assuming no changes in the market, the property owner would be entitled to recover for the lost profits associated with the delay.
However, if market conditions are not static over the course of the year following the loss event, December 2018 may paint a much different picture than December 2017. If the economy weakens substantially into December 2018, the owner’s initial rental projections may have been overstated. Depending on the coverage, the DIC/DSU carrier may look to limit recovery for the owner’s rental income claim. Alternatively, if market conditions improve in 2018, it is possible that the demand for rentals will be greater than anticipated.
In addition to “non-continuing expenses,” some policy forms will also specifically exclude from the value of DIC/DSU coverage the amount of any liquidated damages the insured is entitled to recover from other third parties. In some cases, this exclusion is stated to apply whether the liquidated damages are “collectible or not.” The rationale behind this limitation is that if the delay contractually permits the insured to recover “liquidated damages,” the insured should not be permitted to recover its loss twice—once from the DIC/DSU carrier and again from the contractor or subcontractor liable for such damages.
However, despite the presumption that “liquidated damages,” by definition, should be readily determinable, accounting for such an exclusion may not be straightforward, even if the policy removes from the equation any issues regarding collectibility. Whether or not a contracting party, otherwise liable for liquidated damages, can respond financially for purposes of collectibility, that same party may have multiple defenses to liability—particularly if the loss event precipitating the DIC/DSU claim involves force majeure issues that could relieve the contractor or other responsible party from liability.
Moreover, if the insured’s actual loss of gross earnings or rental income does not factually or financially overlap with the “liquidated damages” otherwise recoverable from the insured’s counterparty or if the counterparty’s liability for indemnity or “liquidated damages” is contractually limited by proceeds of builders’ risk coverage, determining the amount of the insured’s claim for DIC/DSU loss may require a detailed legal and financial analysis.
The “ramp-up” effect. Depending on the type of the insured project at issue, many policyholders will anticipate some period of time between the completion of construction or the commencement of operations and the point at which the insured’s income has reached optimal capacity. For purposes of rental income coverage, housing and commercial spaces take time to fill. For manufacturing, retail, or other operations, it takes some time for revenues to build to a stable level. This “ramp-up” period can be a source of confusion and disputes over valuation of DIC/DSU claims for insurers and insureds alike.
In evaluating DIC/DSU claims, many insurers will instinctively attempt to reduce the insured’s claim by discounting the insured’s initial revenues during the period of indemnity to account for the “ramp-up” effect. However, doing so inevitably short-changes the insured. In every case, had the insured not experienced a covered loss event, completion would have occurred, and, all other things being equal, the insured would experience one discounted period of revenue during only one “ramp-up” period.
If the insurer is permitted to discount a DIC/DSU claim to account for a “ramp-up” period, the insured’s “ramp-up” loss will be doubled. In other words, the insured will recover revenues below capacity once during the insured period of indemnity and again after construction is completed and operations have begun. With a “ramp-up” deduction, the insured’s loss is compounded, and the insured is not made whole. While policy terms may vary and oftentimes do not even address this issue with any specificity, to the extent that the purpose and intent of DIC/DSU coverage is to put the insured in the same financial condition that would have existed absent a loss event, discounting revenues for a “ramp-up” effect should not be claimed by insurers and should be resisted by policyholders.
Disputes over DIC/DSU claims and the types of coverage issues likely to arise out of such matters are as varied as the facts and circumstances giving rise to individual policyholders’ losses. That said, there are some disputes that arise with more frequency than others. A few of the more commonplace coverage issues with which insureds should be familiar involve the trigger of coverage for DIC/DSU claims, attribution of policy proceeds, and “consequential loss” exclusions.
Trigger of coverage: Loss as distinct from damage. While individual policies are unique, most builders’ risk policies, including DIC/DSU coverage, make indemnity for gross earnings, rental income, and the like contingent on some occurrence of “loss or damage” to covered property by a covered or nonexcluded peril. The reference to “loss or damage” as the impetus for either a claim involving the repair or replacement of covered property or the recovery of lost income begs the question: Is there a distinction between loss and damage and, if so, what loss is needed to justify a DIC/DSU claim? Similar issues have been litigated repeatedly in the context of claims under commercial property policies. In the world of DIC/DSU coverage, parties have also sparred over whether a loss absent physical damage to property can justify the recovery of gross earnings or rental income.
In some cases, the dispute is more a factual disagreement about whether a loss of use caused a loss of income than it is about whether the loss exists in the first place. Nonetheless, in the appropriate factual context, policyholders should not forgo or be denied DIC/DSU coverage when a loss distinct from physical damage results in a delay in completion of the insured project.
Attribution of DIC/DSU proceeds. While there are many ways in which DIC/DSU coverage differs from business interruption coverage under a traditional commercial property policy, a DIC/DSU claim often involves more third-party interests, including lenders, contractors, and subcontractors, not implicated by a claim for loss or damage to a completed property. The variety of interests represented in a single claim inevitably leads to questions over the proper attribution of proceeds, including those for loss of income. Many of the allocation issues can be anticipated and addressed through appropriate limitations on insured status for DIC/DSU coverage, in addition to well-specified loss payee provisions.
However, at least one area in which disputes may still arise between parties with competing financial interests involves claims in bankruptcy. For example, when physical loss or damage to covered property under construction results in a delay and accompanying loss of income to a degree forcing the project owner into bankruptcy, who, as between the debtor estate or a lender loss payee, is entitled to recover the loss of income benefit otherwise owed under a DIC/DSU form? Again, different cases have led to divergent results on this question.
For example, the bankruptcy court in In re Hereford Biofuels, L.P., reasoned that the proceeds of a builders’ risk policy issued to the now-bankrupt owner of an ethanol plant were property of the bankruptcy estate in preference to the claims of the owner’s corporate parent, even “[i]f the Builder’s Risk Insurance Policy had named [the parent] Big Panda as a co-insured.” Other courts, however, have concluded that a lender or other loss payee may be entitled to the proceeds of similar coverage, particularly when the loss occurs pre-petition.
To the extent possible, in order to avoid similar disputes, insureds and their contractual counterparties should be vigilant, both in the underwriting of DIC/DSU coverage and in transacting and perfecting interests in DIC/DSU proceeds. Some risk and uncertainty can potentially be negated by simplifying the number of interests with a claim on policy proceeds. Subject to the intent of the parties, where possible, lenders or others intended to benefit from a DIC/DSU policy other than the insured project owner could not only be granted “additional insured” status but also be made the sole “loss payee.” Such parties may also negotiate specific contractual terms (beyond the requisite designation of “additional insured” or “loss payee” status) giving priority to insurance proceeds in bankruptcy. Alternatively, some courts have recognized that a perfected security interest in collateral will automatically become a perfected security interest in the proceeds of insurance for the loss of such collateral. Nonetheless, even a perfected security interest in the collateral and loss payee status for some lenders have been found to be insufficient to avoid an award of casualty insurance proceeds to the debtor estate.
“Consequential loss” exclusions. The “consequential loss” exclusions in many DIC/DSU policies are tersely worded provisions, many times simply denying coverage for “any consequential loss.” By definition, a DIC/DSU form is intended to provide coverage for loss of income that occurs as a consequence of covered loss or damage. Thus, without further elaboration or qualification, a consequential loss exclusion can facially appear to be in conflict with the very loss of income and soft cost coverage a DIC/DSU policy is expressly intended to provide. These sorts of intrinsic inconsistencies in policy terms are fertile ground for sowing conflict between policyholders and insurers.
Such was the case in Diamond Beach, VP, L.P. v. Lexington Insurance Company. There, a property developer sought to recover under a “delay in completion” endorsement for a “supplemental soft cost” claim for certain taxes, interest expense, and professional fees associated with the delay arising out of Hurricane Ike in 2008. While the insured developer, Diamond Beach, was able to reach agreement with its insurer, Lexington, over coverage for repairs associated with flood damage caused by the storm, as well as the soft costs associated with such damage, the parties did not have agreement over soft costs associated with a separate delay period. This second delay period, according to Diamond Beach, resulted from (1) the unavailability of a subcontractor to perform roofing work at the project due to competing demands for other Hurricane Ike–related damage to third-party properties, and (2) a backlog of other property inspections, which delayed inspection by the City of Galveston Building Department and completion of drywall installation at the insured project. Despite the delay in completion coverage expressly afforded by Lexington’s policy, the district court ultimately found that coverage was precluded by the policy’s competing consequential loss exclusion.
Parties and courts in other cases have struggled with similar issues before and since Diamond Beach. But closer examination of these cases confirms again that causation questions are at the heart of both the parties’ disputes and what might otherwise appear to be inconsistent results. It was not the quality of the “supplemental soft costs” at issue in Diamond Beach, for example, that made such costs subject to the policy’s consequential loss exclusion; rather, it was the fact that the supplemental costs and the attendant delays were the result of damage to the uninsured property of others, as opposed to direct physical loss or damage to the insured’s property from Hurricane Ike. Thus, consequential loss is not the same and cannot be equated with the loss of income or soft costs otherwise insured by DIC/DSU forms. Rather, this limitation on coverage is better understood as a further expression of the requirement that covered loss of income and other insured loss under DIC/DSU must bear an appropriate causal relationship with insured loss or damage to covered property.
Pursuing DIC/DSU coverage can involve complex legal and computational questions. The higher the value of the claim, the greater the incentive for insurers and insureds to exploit the available nuances in policy terms and in the calculation of insured loss. But policyholders pursuing such coverage can stand on the shoulders of precedent and past experience. By becoming familiar with key policy terms and anticipating the valuation and legal issues likely to arise in any given claim, insureds can maximize coverage and avoid double jeopardy—delayed or diminished recovery of “delay in completion” or “delay in start-up” insurance.
Brad Murlick and Kirsten Ambroze are with BDO USA. Micah Skidmore is with Haynes and Boone, LLP.
 Micah E. Skidmore is a partner in the Insurance Coverage Group at Haynes and Boone, LLP. He represents corporate policyholders in significant insurance coverage disputes, including assistance in recovering defense costs, settlements, judgments, and other losses under various types of insurance policies. In addition to representing clients in general business litigation matters, Mr. Skidmore also advises clients on insurance and indemnity issues in corporate transactions, including mergers, acquisitions, and real estate transactions. He is a past chair of the Tort and Insurance Practice Section of the Dallas Bar Association and a member of the Insurance Law Council of the State Bar of Texas. Mr. Skidmore is also a frequent author and speaker on insurance coverage issues. He graduated magna cum laude from the J. Reuben Clark Law School at Brigham Young University in 2004, where he was the lead articles editor of the B.Y.U. Law Review and a member of the Order of the Coif.
Brad Murlick, MBA, is a managing director in BDO USA’s Forensic Insurance & Recovery Services practice with more than 30 years of experience advising domestic and global organizations on the preparation, negotiation, and settlement of claims associated with catastrophic or other triggering events. He works closely with policyholders to assist with timely and successful claims resolution, having facilitated billions of dollars in recoveries related to property and business interruption; construction/builder’s risk; product recall; fidelity/employee dishonesty; cyber/data breach; and political risk, among others.
Kirsten Ambroze, CPA, is a senior associate dedicated to the Forensic Insurance & Recovery practice at BDO. Ms. Ambroze is experienced in quantifying insurance claims for domestic and global clients in various industries, including energy, manufacturing, hospitality, health care, and commercial real estate.
 DIC/DSU coverage is also sometimes referred to as advanced loss of profits (ALOP) insurance.
 See, e.g., Ochsner Clinic Found. v. Lexington Ins. Co., 226 F. Supp. 3d 658, 679 (E.D. La. 2017) (addressing a dispute over coverage for so-called “ramp-up” costs by finding that “Ochsner’s ‘ramp up’ cost damages claim seeks to put Ochsner in the position that would have existed had no loss occurred, i.e. opening the clinic in September 2012 and being fully operational by February 2014”).
 See, e.g., General Mills, Inc. v. Gold Medal Ins. Co., 622 N.W.2d 147, 152 (Minn. Ct. App. 2001) (citing Sentinel Mgmt. Co. v. N.H. Ins. Co., 563 N.W.2d 296, 300 (Minn. Ct. App. 1997)) (direct physical loss can exist without destruction of property or structural damage to property); Customized Dist. Servs. v. Zurich Ins. Co., 862 A.2d 560, 565 (N.J. Super. Ct. 2004) (finding that mis-rotation of goods having no effect on the material composition of the goods but rendering them unfit for sale was “direct physical loss”); see also Adams-Arapahoe Joint Sch. Dist. No. 28-J v. Cont’l Ins. Co., 891 F.2d 772 (10th Cir. 1989) (partial collapse of roof rendered all corroded portions of school roof unsafe); Murray v. State Farm Fire & Cas. Co., 509 S.E.2d 1, 17 (W. Va. 1998) (landslide near homes rendered residences unsafe for habitation where additional “rocks and boulders could come crashing down at any time”); cf. Lambrecht & Assocs., Inc. v. State Farm Lloyds, 119 S.W.3d 16 (Tex. Ct. App. 2003) (construing “physical loss” to include loss of server functionality following computer virus); Fid. S. Fire Ins. Co. v. Crow, 390 S.W.2d 788, 792 (Tex. Ct. App. 1965) (refusing to define “all risks of physical loss” narrowly to include only “damage or harm to the building or structure” described in the policy).
 See, e.g., W2001Z/15 CPW Realty, LLC v. Lexington Ins. Co., 2014 N.Y. Misc. LEXIS 349, at *15 (N.Y. Sup. Ct. Jan. 22, 2014) (“Here, inasmuch as the only direct physical loss or damage caused by the August 2007 leak was to units 4E, 5E, 3B, and 3C, the lobby and concierge space, the alleged ‘domino effect’ of these losses or damage to the other 80 units is not covered under the policies. Contrary to plaintiff’s contention, once the first covered delay occurred, not all subsequent delays were covered, unless that delay was caused by a direct physical loss or direct physical damage.”); Tocci Bldg. Corp. v. Zurich Am. Ins. Co., 659 F. Supp. 2d 251, 261 (D. Mass. 2009) (holding that when a portion of a wall was damaged, and city inspectors ordered the remainder of the wall replaced because it had not been originally installed according to approved plans, only the damaged portion of the wall was covered for purposes of the policy’s rental income coverage); cf. Oceanside Pier View, L.P. v. Travelers Prop. Cas. Co. of Am., 2008 U.S. Dist. LEXIS 37755, at *28–29 (S.D. Cal. May 2008) (“[T]he Court concludes that Plaintiff is not entitled to recover for the increased costs of construction materials and labor for previously un-constructed portions of the Project under the ‘Builders’ Risk’ or ‘Business Income’ provisions of the Policy.”).
 In re Hereford Biofuels, L.P., 466 B.R. 841, 856 (Bankr. N.D. Tex. 2012).
 In re Hereford Biofuels, L.P., 466 B.R. at 856–57 (“Big Panda—even if it was or should have been a named insured on the Factory Mutual policy—would not have had rights or an interest in the proceeds of the policy (for losses regarding the settlement of the tanks and Q fever) in addition to the Debtor’s rights in the proceeds. At the end of the day, the court believes that it really does not matter whether Big Panda was a named insured or co-insured beneficiary on the Builder’s Risk Policy or not. The proceeds on any claim adjusted on the policy would have properly gone to the Debtor, as the owner of the plant.”); see also McConnell Const. Co. v. Ins. Co. of St. Louis, 428 S.W.2d 659, 662 (Tex. 1968) (allowing the mortgagor to recover proceeds under a builders’ risk policy in its own name despite the existence of a loss-payee clause benefiting the mortgagee).
 See, e.g., In re Amiel Rest. Partners, LLC, 510 B.R. 744, 753 (Bankr. D.N.J. 2014); see also In re West, 343 B.R. 541 (Bankr. E.D. Va. 2006) (proceeds under a policy purchased post-petition and naming the lender as “loss payee” were not property of the bankruptcy estate, but payable to the lender); In re Suter, 181 B.R. 116, 119 (N.D. Ala. 1994) (“Because AmSouth was the loss payee of the insurance policy, the proceeds of the policy are not property of the bankruptcy estate and are payable to AmSouth, at least to the extent of AmSouth’s interest in the property insured.”).
 See, e.g., In re Jones, 179 B.R. 450, 455 (Bankr. E.D. Pa. 1995) (“[E]ven though the hazard insurance proceeds in issue are property of the debtor’s estate, the debtor’s estate holds that property interest subject to the contractual, state laws rights which the mortgagee holds in the proceeds. Therefore, the parties’ rights to the proceeds must be ascertained by reference to the parties’ contractual rights pursuant to the interpretation of the pertinent contractual provisions under applicable state law.”). The contractual language at issue in Jones specifically provided for sole loss payee status in favor of the mortgagee and that “[t]he insurance proceeds, or any part hereof, may be applied by Mortgagee at its option either to the reduction of the indebtedness or to the restoration or repair of the property damaged.” 179 B.R. at 454.
 See, e.g., In re Tower Air, Inc., 397 F.3d 191, 196 (3d Cir. 2005) (stating the “default rule” that “a security interest in property includes an interest in the proceeds of that property” and holding that insurance recoveries for casualty loss constitute “proceeds” under Arizona’s Uniform Commercial Code (UCC)); In re Turnbull, 350 B.R. 429, 433 (Bankr. N.D. Ill. 2006) (“Insurance proceeds that flow from the destruction of the creditor’s security interest serve as a replacement of that collateral in a different form,” but “[t]he other unsecured creditors of the Debtors, who had no interest in the Vehicle, were not entitled to share in the insurance proceeds”); In re McLean Indus., Inc., 132 B.R. 271, 283 (Bankr. S.D.N.Y. 1991).
 See, e.g., Wheeling & Lake Erie Ry. Co. v. Keach, 521 B.R. 703, 713 (B.A.P. 1st Cir. 2015) (“[W]e conclude that the bankruptcy court correctly determined that Maine UCC § 9-1109 excluded the Settlement Payment from the scope of the UCC for perfection purposes, such that Wheeling’s filing of a financing statement did not perfect its security interest in the Settlement Payment.”); In re Holtslander, 507 B.R. 779, 784–85 (Bankr. N.D.N.Y. 2014) (following the “substitution” approach followed in the Second Circuit, whereby “the insurance payment for [post-petition] repairs to an automobile that is property of the estate unquestionably is also property of the estate”).
 Diamond Beach, VP, L.P. v. Lexington Ins. Co., 748 F. Supp. 2d 648 (S.D. Tex. Sept. 20, 2010).
 Diamond Beach, 748 F. Supp. 2d at 650.
 Diamond Beach, 748 F. Supp. 2d at 651.
 Diamond Beach, 748 F. Supp. 2d at 655 (“Here, the supplemental soft costs sought by Diamond are by definition consequential damages or losses and are specifically excluded by the language of the policy.”).
 Cf. Zurich Am. Ins. Co. v. Keating Bldg. Corp., 513 F. Supp. 2d 55, 71 (D.N.J. 2007) (holding that certain “additional costs” relating to the collapse of a hotel were not excluded consequential loss); One Place Condo., LLC v. Travelers Prop. Cas. Co. of Am., 2015 U.S. Dist. LEXIS 56565, at *30–40 (N.D. Ill. Apr. 22, 2015) (distinguishing Zurich Am. Ins. Co. v. Keating Bldg. Corp., 513 F. Supp. 2d 55 (D.N.J. 2007)).
 Diamond Beach, 748 F. Supp. 2d at 655 (“Delay in Completion losses are those ‘caused by direct physical loss or direct physical damage to [the] Insured Property. . . .’ The evidence shows that some damage was incurred by the Subject Location as a result of Hurricane Ike. However, the damage was not associated with the roof or in the interior gypsum board; the basis for Diamond’s supplemental claim.”).