chevron-down Created with Sketch Beta.
September 28, 2018 Practice Points

Court Tangles with Thorny Issue of Business Income Loss Measurement

The New York Appellate Division’s ruling addresses how a business income loss should be measured when the insured’s business is suspended due to a covered loss, but income from the lost work would not be realized until well after the end of the period of restoration

by John P. Malloy

A typical business income coverage grant provides that the insurer will pay for the “actual loss of Business Income [the insured] sustains due to the necessary suspension of [its] operations during the period of restoration.” An issue that frequently arises, but for which there is very little guidance in the case law, is how this language applies when the insured loses business opportunities during the period of restoration, but the revenue and profit from that work would have been realized and earned after the period of restoration ends, and perhaps years later. The New York Appellate Division recently addressed this issue in an important case, Bernstein Liebhard, LLP v. Sentinel Insurance Co., Ltd., 162 A.D.3d 605, 78 N.Y.S.3d 339 (N.Y. App. Div. 2018), in which the court unanimously reversed the entry of summary judgment in favor of the insured and ordered judgment entered in favor of the insurer, finding that although the insured may have lost clients during the period of restoration, it could not recover for the loss of income the firm would have received years later from cases handled for those clients.

The insured in Bernstein was a law firm with a large mass tort plaintiff’s practice that operated on a contingency-fee basis. The insured suffered a fire, which it claimed disrupted its business and prevented it from advertising for mass tort plaintiffs, resulting in a loss of cases it would have brought in if it were able to advertise, and causing a loss of $27 million in income. The firm looked to its insurer to recover this claimed loss, arguing that its loss of income was “sustained” during the period of restoration, even though the fees from those cases would not have been realized until years later. In addition to the above-referenced coverage grant, the policy at issue, like standard ISO forms, defined “business income,” in relevant part, as the “net income that would have been earned.” Bernstein Liebhard LLP v Sentinel Ins. Co., Ltd., No. 652726/2015, 2018 WL 623535, at *1 (Sup. Ct. Jan. 30, 2018). The parties agreed that “earned” means “become entitled to.” The policy at issue allowed for a 12-month recovery period following the fire loss.  Bernstein Liebhard, 162 A.D.3d at 605.

Despite the fact that the insured would not have become “entitled to” fees from the foregone cases until well after 12 months following the fire, the trial court granted the insured’s motion for summary judgment, finding that the firm “had the capacity, lawyers, and staff to prosecute the cases for which it would have been retained during the applicable period, but the equipment damaged by the fire prevented it from taking those cases. Thus, but for the fire, Bernstein would have earned its fees when those cases settled or were tried to verdict, possibly years later.” Bernstein Liebhard , 2018 WL 623535, at *1. Relying on an earlier First Department case, National Union Fire Ins. Co. of Pittsburgh, Pa. v TransCanada Energy USA, Inc., 153 AD3d 1153 (1st Dept. 2017), the trial court rejected the insurer’s argument that finding in favor of coverage would render the 12-month limitation meaningless. Rather, the lower court held that under TransCanada, “recovery is not precluded where there is a certain loss within the applicable period, even if the loss cannot be quantified until sometime thereafter.” Id., at *2. Significantly, the court also held that “[t]o deny Bernstein coverage would be to punish it for its business model; that is, a mass tort business that is paid on a contingency-fee basis, as opposed to a traditional hourly basis.” Id., at 1-2. In this regard, the trial court further found that because the insured was a law firm and “nothing it does is concluded in one year,” and the insurer knew this when it issued the policy, the coverage provided would have been illusory. Id., at *4.

On appeal, the Appellate Division unanimously reversed the lower court’s decision. The appellate court held that as a matter of law, “lost fees from prospective clients that plaintiff law firm had to forego, but which would have resulted from work performed after the 12–month cutoff, are not covered by the policy.” The court further held that, by its plain terms, the policy only provided coverage for fees that, “if not for the suspension of advertising due to the fire… would have earned for services actually performed for such new clients within 12 months of the fire or from such new cases that resolved within 12 months of the fire.” Bernstein Liebhard, 162 A.D.3d at 606. In other words, the insured’s recovery was limited to: fees it would have earned at some point after the 12-month period for work performed during the 12-month period following the fire; and fees from cases that resolved within 12 months of the fire. Here, however, the insured did not present its claim or argument in that manner, but rather sought to recover fees for the foregone cases, even though the bulk of the work on those cases would have been performed long after the end of the 12-month period specified in the policy. As a result, the insured recovered nothing, and judgment was entered in the insurer’s favor.

Bernstein Liebhard is instructive and important for policyholders and insurers for a number of reasons. First, it addresses directly how a business income loss should be measured when the insured’s business is suspended due to a covered loss, but income from the lost work would not be realized until well after the end of the period of restoration. Under Bernstein Liebhard, the insured is likely entitled to recover for the value of work it was unable to perform during the period of restoration, even though the revenue for that work would not have been received until later. Although not discussed in the Bernstein Liebhard decisions, it was undisputed that the average lifespan of the foregone cases was eight years. Thus, the insured could have potentially recovered one-eighth of the lost fees, representing the value of work that would have been performed in the first year, but it could not recover for eight years of work when the period of restoration was only one year. Second, the holding in Bernstein Liebhard should serve to caution insureds regarding how such claims are presented, and insurers in how such claims are handled. Insureds should realistically value lost business opportunities and recognize that it may strain the bounds of reason and policy language to insist on recovering for work that would have been performed many years after the end of the period of restoration, as in the case of Bernstein Liebhard. At the same time, insurers should recognize that the fact that revenue would have been received by an insured after the end of the period of restoration does not necessarily mean that the insured did not sustain an actual loss of income as the result of a suspension due to a covered loss. Ultimately, the best solution for thorny business income loss measurement issues for many businesses is likely in the underwriting process. A policy that provides coverage for a specific amount for each day the insured’s operations are suspended (e.g., $5,000 per day per lawyer, or, for doctors, $5,000 per day per examination room), for example, would go a long way towards avoiding complicated valuation and loss measurement disputes. Such products already exist, and it would serve insureds and insurers well to utilize such an approach more broadly than appears to be the case currently.

John P. Malloy is with LeClairRyan PLLC, Hartford, CT. This case report is presented for informational purposes only, and is not intended to provide legal advice. The views expressed in this case report are not necessarily those of the author’s firm, or its clients.

Copyright © 2018, American Bar Association. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. The views expressed in this article are those of the author(s) and do not necessarily reflect the positions or policies of the American Bar Association, the Section of Litigation, this committee, or the employer(s) of the author(s).