Superstorm Sandy caused large-scale power outages in New Jersey and elsewhere. Due to a lack of power, many businesses were forced to close temporarily even though they did not sustain any direct physical damage. The closure of these businesses often resulted in a loss of income. Some businesses had purchased coverage for losses resulting from “service interruption.” Service interruption coverage provisions typically provide coverage for a loss of income sustained by a business as a result of an interruption in utility services provided to the insured’s business premises.
Most service interruption provisions provide that the interruption of services must be caused by a covered cause of loss. Consequently, whether coverage exists depends on what caused the power interruption. Another important limitation is that service interruption provisions generally provide that the interruption must be caused by physical loss or damage to the property of the service provider.
In some cases, the interruption in power during Superstorm Sandy resulted from downed power lines caused by high winds or falling trees. In other cases, however, the power outages were caused by flood damage to the equipment owned by the power service providers. In still other cases, the power was interrupted as a result of a preemptive shut down of equipment by service providers, which was done to prevent new or additional damage.
Flood damage is excluded in many insurance policies, although it generally may be purchased by paying additional premium. However, businesses located far from flood zones or on the upper floors of high rise buildings often do not see the need to purchase flood coverage. Those businesses may be surprised to learn that although they sustained no flood damage to their own property, there may be no coverage for any service interruption losses they sustained if the interruption in service was caused by flood damage to the equipment owned by the service provider.
In addition, to the extent the interruption resulted from a preemptive shutdown, in the absence of any physical loss or damage, there also may be no coverage. But see Wakefern Food Corp. v. Liberty Mut. Fire Ins. Co., 406 N.J. Super. 524, 968 A.2d 724 (App. Div.) (the court found the term “physical damage” ambiguous in the context of the shutdown of the interconnected North American electrical power grid for four days in 2003), certif. denied, 200 N.J. 209, 976 A.2d 385 (2009).
Following Superstorm Sandy, a number of lawsuits were commenced by New Jersey insureds whose service interruption claims were denied. Although the New Jersey courts have not yet addressed the issues discussed above in connection with a Superstorm Sandy claim, the Southern District of New York has addressed those issue in two cases arising out of the storm. In the first case, Johnson Gallagher Magliery, LLC v. Charter Oak Fire Ins. Co., 2014 WL 1041831 (S.D.N.Y. Mar. 18, 2014), a law firm filed a claim seeking two months of business interruption insurance coverage arising out of, among other things, a power outage associated with Superstorm Sandy. The policy provided the following with respect to off-premises utility services coverage:
The interruption must result from direct physical loss or damage by a Covered Cause of Loss to the following property not on the described premises: (a) “Water Supply Services”; or (b) “Power Supply Services.”
Id. at *2 (emphasis in original). The term “Power Supply Services” was defined in the primary policy as:
Power Supply Services (a) means the following types of property supplying electricity, steam, or gas to the described premises: (1) Utility generating plants; (2) Switching stations; (3) Substations; (4) Transformers; and (5) Transmission lines and (b) does not mean overhead transmission lines.
Id. The insured indicated that the power outage accounted for two weeks of its business interruption claim.
The insurer relied on Con Edison’s January 11, 2013 report, entitled “Preparation and System Restoration, Sandy, October 29 through November 12, 2012,” as evidence that Con Edison preemptively shut down certain networks in Manhattan to prevent extensive damage to its systems. Id. at *3. Further, the insured relied on testimony from a Con Edison witness that “although the preemptive shutdown prevented extensive damage to the equipment, ‘there still was damage due to the salt water.’” Id. at *4. When asked if anything other than water damaged Con Edison’s equipment, the witness testified that “it appeared to him that ‘it was all due to water.’” Id.
The court found that the preemptive shutdown was not the result of physical loss or damage covered under the policy. Id. at *7. The court noted, however, that the preemptive shutdown issue only affected a few hours of the claim. The court held that a water exclusion precluded recovery during the period of time that the electrical network was down as it was clear from the evidence provided by Con Edison that the damage to the electrical network was caused by flooding. Id. at *10. Accordingly, the court ruled that there was no coverage for the insured’s loss because the power interruption was not the result of a covered cause of loss.
Similarly, in Newman Myers Kreines Gross Harris, P.C. v. Great Northern Ins. Co., 2014 WL 1642906 (S.D.N.Y. Apr. 24, 2014), the court addressed coverage for a law firm’s service interruption claim arising out of Superstorm Sandy. The law firm was located at 40 Wall Street and was without full power from October 29 until November 3, 2012. While the plaintiff’s premises did not suffer physical loss or damage, plaintiff maintained that the loss of power itself was enough to satisfy an insured’s reasonable expectations of physical loss or damage sufficient to trigger coverage under its policy. Id. at *5.
The plaintiff relied on a number of out-of-state decisions that dealt with the presence of fumes or noxious gas that made the premises unusable. Id. In those cases, the courts found that the fumes or noxious gas rendering the premises unusable was constituted physical loss or damage under the policies at issue. Id. at *6. The Newman Myers court held, however, that the preemptive shutdown of Con Edison’s network did not constitute physical loss or damage under the policy. The court explained that the:
words “direct” and “physical,” which modify the phrase “loss or damage,” ordinarily connote actual, demonstrable harm of some form to the premises itself, rather than forced closure of the premises for reasons exogenous to the premises themselves, or the adverse business consequences that flow from such closure.
Id. at *7.
Thus, to the extent that the interruption of power was caused by flood, an insured may not have coverage even though it was located on the upper floor of a high rise building and the flood waters never even came close to its property. Similarly, to the extent the loss of power resulted from a preemptive shutdown and not actual physical loss or damage, coverage also may be barred. However, in Wakefern, one panel of the Appellate Division held that a preemptive shutdown of power equipment may satisfy the physical loss or damage requirement, at least where there was evidence of some limited physical damage. There, the court concluded that the electrical grid was damaged because:
due to a physical incident or series of incidents, the grid and its component generators and transmission lines were physically incapable of performing their essential function of providing electricity. There is also undisputed evidence that the grid is an interconnected system and that, at least in some area, the power could not be turned back on until assorted individual pieces of damaged equipment were replaced.
406 N.J. Super. at 540. Thus, a New Jersey court may not be so quick to grant summary judgment where the power interruption resulted solely from a preemptive shutdown of equipment by the service provider.
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