About a year ago, a California Court of Appeals published an opinion that invigorated the debate over the proper methodology or calculation of a business income loss. In Amerigraphics v. Mercury Casualty Company, 182 Cal. App. 4th 1538 (March 23, 2010), the court held that under the traditional Business Income Form (CP 00 30),

Business Income” has two distinct components: (i) net income, and (ii) continuing normal expenses. Given its placement in the policy and the plain language of the provision, it would be objectively reasonable for an insured purchasing the policy to construe it as protecting both its lost income stream and as defraying the costs of ongoing expenses until operations were restored. 

According to the Amerigraphics opinion, if a business is operating at a “net loss” that is greater than its “continuing normal expenses,” the insurance company owes $0.00, but, if the business is operating at a “net loss” that is lesser than the “continuing normal expenses,” the insurance company should disregard the “net loss” from the equation and should pay the “continuing operating expenses” in full.

The Amerigraphics opinion has proponents and dissidents, and the issue is being tested in many states. Thus far, the only published opinion on the issue is HTI Holdings, Inc. v. Hartford Cas. Ins. Co., 2011 WL 6205903 (Dec. 8, 2011), in which a federal district court in Oregon declined to follow Amerigraphics.

HTI operated a manufacturing facility in Linn County, Oregon, and produced water purification products using specialized technology and equipment. HTI was insured by Hartford for almost 10 years. On March 20, 2007, a fire caused significant damage to the manufacturing facility. Hartford paid the property damages in full, but declined to pay HTI’s calculation of its business income losses.

On June 5, 2007, HTI submitted a preliminary report, estimating $8.8 million in business interruption losses through December 31, 2007. Hartford initially advanced $150,000 in September 2007, and then another payment of $279,000 in November 2008.

In 2006 and early 2007, HTI did not perform as well as projected because it was not able to secure an expected contract with the United States military. Notwithstanding, HTI redirected its sales and marketing to commercial and retail markets to regain performance. HTI was unable to cover the operating expenses while the manufacturing facility was being rebuilt. After construction of the facility was complete, HTI sold its key assets at less than market prices due to its financial situation and retained rights and benefits associated with the insurance coverage proceeds.

HTI filed suit against Hartford, claiming that its failure to compensate the loss of HTI’s business income and extra expenses caused the demise of HTI’s business and loss to its shareholders.

HTI asserted that the policy required Hartford to pay its continuing operating expenses during the period of restoration independently from its “net losses.” Hartford maintained that the Policy language only requires payment for “actual lost profits:”

We will pay for the actual loss of Business Income you sustain due to the necessary suspension of your ‘operations’ during the ‘period of restoration.

The policy defined “business income” as:

(a) Net Income (Net Profit or Loss before income taxes) that would have been earned or incurred if no direct physical loss or physical damage had occurred; and
(b) Continuing normal operating expenses incurred, including payroll.

Hartford argued that business income should be interpreted to mean net income “plus” or “added to” normal operating expenses, as in a mathematical equation. If so, business income would be calculated as the sum of net profit or loss and continuing operating expenses. Accordingly, a negative net income (a loss) could offset the amount of operating expenses paid on a claim.

Relying on Amerigraphics, HTI argued that business income is defined as net income “as well as” normal operating expenses. Under HTI’s interpretation, the net income and continuing operating expenses would be calculated independently and paid out separately on a claim. Therefore, a negative net income (loss) would not affect the amount paid for operating expenses.

The Court granted Hartford’s Motion for Summary Judgment holding that:

While “actual loss” is not specifically defined in the Policy, the plain meaning of the phrase is consistent with Hartford’s interpretation that a net loss must be included in the calculation of business income.

[…] the only plausible interpretation of the Policy—which gives meaning to all of its terms and places an insured in the same economic position as it would have been in absent property damage—is that business income is the sum of the net profit or loss and continuing operating expenses[…]

The court questioned “[…] if net loss is never considered when calculating business income, why include the term in the Policy at all?” Amerigraphics supporters would say that the offset should always occur if the “net loss” is greater than “operating expenses,” otherwise, the policy would yield an abhorrent windfall. But Amerigraphics supporters insist that the business income provision protects the incoming stream of revenue and the outgoing flow of expenses, separately. Otherwise, the business income provision is worthless if a business sustains damage from a covered peril at the unfortunate time when stream of income is not as powerful as it was a few months before the peril and it cannot pay its normal operating expenses before it fully recovers.