Advisories & Insights

Business Income Coverage Shocker

March, 2010
By Samuel H. Ruby

A California Court of Appeal has decided that an insured may recover all of its continuing expenses during a period of restoration, regardless of whether the business would have been profitable had there been no loss. Amerigraphics, Inc. v. Mercury Casualty Co., Appeal No. B208654 (March 23, 2010).

The policy at issue defined "business income" as "(i) net income (net profit or loss before income taxes) that would have been earned or incurred if no physical loss or damage had occurred...and (ii) continuing normal operating expenses incurred." The insured had been operating at a severe loss before the casualty and would have continued to operate at such a loss had there been no casualty. Due to saved expenses in the wake of the casualty, the insured lost less money (i.e., performed better financially) during the period of restoration. Accordingly, the insurer concluded that the insured had not sustained an actual loss of business income.

The trial court disagreed, and the appellate court affirmed. The court held that in the definition of business income, "and" does not mean "plus," but instead signifies that net income and continuing expenses are separately covered. If the insured's net income (but for the loss) would have been negative, then the insured cannot recover under the net income clause; however, the insured can still recover under the continuing expense clause, without offset.

The court's ruling overrides the principle of indemnity, which is that an insured should not recover more than what it has actually lost as a result of a casualty. Based on that principle, other courts have interpreted definitions of "business income" as requiring that continuing expenses be offset by anticipated negative net income. See, e.g., Dictiomatic, Inc. v. U.S. Fid. & Guar. Co., 958 F. Supp. 594 (S.D. Fla. 1997). We suspect that Mercury will appeal and the California Supreme Court will restore order.

The news wasn't all bad for Mercury and other insurers. In the same opinion, the court reduced a punitive damages award. The trial court had already reduced the jury's award of $3 million to $1.7 million. Examining recent precedent on Constitutionally permissible punitive damage ratios, the appellate court further reduced the award to $500,000—bringing it down to just less than four times the amount of compensatory damages awarded. The court also held that for purposes of the ratio, attorneys' fees (at least when determined by the court, post-trial, rather than by the jury making the punitive damages award) and prejudgment interest would be ignored.

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