Covid-19 has thrown our way of living into treacherous and unchartered waters. We recognize that the impact to your business and your family is severe and broad. Through no fault of your own, you could be facing dire financial circumstances. The pain inflicted on businesses is as widespread as it is deep.
It is critical that you have a trusted legal voice guiding you through your discussions with landlords, lenders and insurance companies. There is an art to filing insurance claims, for example. Specifics must be provided – with supporting language from the policy – and one size does not fit all. All franchise owners need to understand the landscape in order to make smart decisions going forward.
There are many financial relief strategies that owners of franchised businesses, among others, have already executed during this pandemic to protect cash flow and limit large expenses. As this crisis unfolded, business owners were already requesting rent relief from their landlord. Some have been able to secure temporary reductions or deferments. Business owners negotiated with lenders to defer loan payments. Some have tried asking their vendors to defer invoices for goods and services. Many franchisees have asked for and received royalty and marketing fund relief through reductions or deferments. Millions of businesses have also applied for relief from the U.S. Small Business Administration. Each of these steps requires a thoughtful approach, and possibly legal representation. For those operators lucky enough to have purchased business interruption insurance, there are many hurdles to jump in order to receive full protection—even if you thought you were all covered.
And, although most insurers are quick to deny any coverage, there are many arguments which can be utilized to overcome coverage denials. This discussion of legal principles is designed to help you understand what legal arguments and business strategies we might use to protect your economic interests in light of contractual and other business obligations.
Business Interruption Insurance
Also called income loss insurance, business interruptions insurance is an add-on policy that helps you recover lost income resulting from a covered peril, so you are able to keep your business running. As is widely the case in the insurance business, coverage policies differ from underwriter to underwriter, but nearly all insurance companies are concerned that paying claims to businesses interrupted as a result of the pandemic would be crippling. The Insurance Journal is estimating “as many as 30 million claims from small business that suffered coronavirus-related losses,” that would total “between $220-$383 billion per month — or a quarter to half of the total industry surplus available to pay all [property and casualty] claims.”
Already legislation has been introduced in several states aiming to require insurers to cover business interruption losses due to the pandemic even if the policies exclude losses due to viruses and communicable diseases. While this legislation may be challenged – under the grounds that Congress can’t rewrite business contracts – it is also possible the government may provide financial backing to insurance companies which are required to pay under such policies. What’s more, there are important legal arguments and ways to interpret policy language that can be used to compel insurance companies to pay. Let’s review a couple of those.
Civil Authority Coverage
This provision applies when a local, state, or federal government mandates by prohibition to “limit access” to any aspect of your business, which is critical to a business owner’s ability to conduct his normal operations. This coverage requires loss by an actual covered peril to other property in close proximity to the insured’s property resulting in direct physical loss or damage, not merely by threat or for preventive purposes. While this requirement of a physical loss is often cited as a reason to deny coverage from a virus, legal precedent and case law exists in some courts that a virus, communicable disease or pathogen can in fact result in physical loss or damage. Case law in several states holds that odors and substances in the air constitute direct physical loss, such as in New Jersey with ammonia, in Colorado with gasoline, and in Massachusetts where an unpleasant odor rendered properties uninhabitable, unusable and significantly reduced in value. What’s more, a policy’s requirement under civil authority that access to the property be prohibited can conflict with the policy’s other typical language that invokes the insured’s responsibility to “mitigate the loss,” such as by using an unaffected portion of the property, or offering deliveries. Loss of use and lack of functionality may be deemed to constitute physical damage.
Contingent Business Interruption Insurance
This refers to a loss that is indirect and is caused, for instance, by the inability of a supplier to perform his obligations with the insured (business owner), due to no fault of his own. Navigating the contractual obligations and legal strategies to recover the loss of revenue can be challenging in light of the coronavirus pandemic. The insured has much to consider. For example, to what extent does pursuing the claim make financial sense given the coverage limits, sub-limits, co-insurance, and deductible? Is it an All-Risk Policy? Are there exceptions, limitations to the policy, exclusions, or endorsements that were purchased to gain a particular coverage that was otherwise excluded? How long will financial damages be covered by interruption – and to what extent will this cripple the business?
Impossibility of Performance and Frustration of Purpose
Under these contract doctrines, a party is discharged from performing a contractual obligation due to no fault of their own. The reason could be the obligation is impossible or futile to perform, and the party could neither have foreseen the risk at the time of entering into the contract, nor could they have prevented the event or events in question from occurring in the first place. But one might ask, how long will it be impossible to perform? Is the situation permanent or temporary?
Franchise agreements commonly include a contract clause with the requirement to “Obey all Laws,” which one could argue is in direct conflict with the doctrine of frustration of purpose. Does the doctrine mean rent is still owed to landlords when the business was forced to shut down due to no fault of their own, and therefore there is no reason to pay rent for the location to generate income in the first place? As you see, how these doctrines are recognized by an insurance company or a court would be critically important to a franchise owner during this time.
This refers to situations when parties cannot reasonably foresee or control an event that prevents either party from performing their contractual obligations. According to Black’s Law Dictionary (11th edition, 2019), an Act of God may be considered as force majeure if it refers to a natural phenomenon that is exceptional, inevitable, and irresistible, and whose effects could not be prevented or avoided by the exercise of due care or foresight.
In light of the comments the Director General of the World Health Organization made during a March 2, 2020 media briefing: “We are in unchartered territory. We have never before seen a respiratory pathogen that is capable of community transmission, but which can also be contained with the right measures,” one would reasonably conclude businesses could not have prevented the Covid-19 outbreak simply by exercising reasonable care or foresight. When states began shutting down, forcing all but non-essential businesses to close and requiring people to shelter in place, businesses complied. They did not close because of any fault or negligence of their own. It was, instead, government imposing its authority in the face of a public health emergency, brought on by force majeure, and that fact should excuse the parties to a contract from being obligated to perform.
Even as businesses open up and try to restore our economy, the unprecedented nature of the coronavirus pandemic is sure to leave many business questions and legal questions unanswered for some time. If there was ever a time to engage a trusted legal advisor, it is now, as we move into a new paradigm, a new “normal” in our country. •
Robert Zarco is the founding partner of Zarco Einhorn Salkowski Brito, located in Miami, FL. You can reach him at 305-374-5418 or RZarco@ZarcoLaw.com.