The Insured’s Duty to Mitigate – Understanding Business Interruption Claims, Part 30 | SLG

The insured’s duty to mitigate its damages after a loss is a well-recognized principle in property insurance law. In business interruption claims insureds are required to take affirmative steps to reduce their loss of earnings after a loss. While an actual business loss occurs only where the insured is unable to reduce or eliminate lost profits, insureds are not necessarily required to engage in super-heroic-acts to mitigate their business interruption loss.

In Gordon Chemical Co. v. Aetna Cas. & Sur. Co., 266 N.E. 2d 653 (1971), there was an explosion at the insured’s manufacturing plant which forced the insured to shut down operations for 15 months after the loss. In this case, the insured manufactured high impact polystyrene and sold its entire output to another manufacturing plant next door, which converted the polystyrene into different byproducts. The insured was unable to continue servicing its sole customer for 15 months and thus sustained a net profit loss of $215,350.00. Aetna contended that in order to mitigate its losses, the insured was obligated to purchase manufacturing materials from its competitors in the open market and resell the materials to its sole customer. The court did not find that such a feat was required under the terms and conditions of the policy.

Gordon was required to continue or to resume manufacture of polystyrene from monomer liquid plastic when and if possible and to sell the product manufactured by it as it would have done if no fire had occurred. However, it was not required to buy from competing manufacturers and resell their product, which it would never have done had no fire occurred. The purpose of the policy is to preserve the continuity of the insured’s earnings. The policy does not accomplish that purpose if the insured manufacturer is required to act as a distributor for its competitors in order to reduce its business interruption loss.

Alternatively, most policies provide as part of an insured’s duties to mitigate that existing inventory should serve as a means for reducing a business loss. In Northwestern State Portland Cement Co. v. Hartford Fire Ins. Co., 360 F.2d 531 (8th Cir. 1966), a cement company suffered a loss of production at one of two clinker plants. However, the insured did not suffer a loss in sales because there was a large inventory of finished cement and stock pile clinker. In this case, the court did not allow recovery for the loss of clinker production, but it did, however, allow recovery for extra expenses necessarily incurred in replacing finished stock to reduce to the loss.

Under the terms of [the policy] the insured is not permitted to sit idly by during a business interruption but must take affirmative action to reduce the loss of earnings. It must reduce the loss resulting from the interruption of business, if possible, by partial or complete resumption of the business; by making use of other property at the location; by making use of stock, raw, in process or finished. Such reduction is to be taken into account in arriving at the amount of loss.

It is clear that there would have been a loss of sales (income) except that plaintiff took the steps required of it by Paragraph 3 to reduce, and in fact to prevent, any loss of sales from occurring. Thus, the actual loss sustained by plaintiff was its loss of stock used to prevent loss of sales and thereby protect its earnings which would result in the normal uninterrupted operation of the business. The policies specifically state what is to be paid an insured for taking these required steps to prevent loss. Paragraph 4 provides the insured is to be compensated therefore by receiving such expenses, in excess of normal, as would necessarily be incurred in replacing any finished stock used to reduce the loss.

Further, on the subject of inventory, a court has found that if an insured is able to sell its entire damaged inventory, the insured may not have a viable business interruption loss. In Baxter Inter., Inc. v. American Guarantee and Liability ins. Co., 861 N.E. 2d 263 (1st Dist. 2d 2006), the insured sustained property and inventory damage after a hurricane suspended its pharmaceutical manufacturing operations.

In this case, Baxter submitted claims to recover losses resulting from property damage and business interruption. American indemnified Baxter for the property damage portion of its claim, including losses to Baxter’s damaged finished goods inventory. American paid Baxter the amount Baxter would have received had Baxter been able to sell the inventory. Of the $30.7 million American paid in damages to Baxter’s inventory, about $15 million accounted for lost profit. Baxter did not claim business interruption losses resulting from the damaged inventory. Baxter, however, claimed it suffered business interruption losses due to damage of other property. American maintained the profit component of the damaged inventory payment must be considered in calculating Baxter’s total actual loss during the period of interruption. Baxter maintained American could not consider payments it made under the personal property provision of the policy to reduce its obligation under the business interruption provision. The parties filed cross-declaratory actions.

Baxter sought a declaration that American’s liability for losses due to business interruption is independent of its liability for damaged inventory. American asserted the policy covered only “actual loss” due to business interruption, which must be calculated by considering profits Baxter realized from American’s “purchase” of the damaged inventory.

On summary judgment the court held that:

[A]n insured cannot recover for lost profit due to business interruption where there has been no actual loss. In other words, business interruption is not itself a loss. An actual loss occurs only where the insured is unable to reduce or eliminate lost profit caused by the interruption. Baxter was able to reduce its lost profits by selling its damaged inventory to American during the business interruption.

Without citation to authority, Baxter contends its business interruption loss is independent from the profit it realized from selling its damaged inventory to American. Baxter explains the profit it realized from the sale of the damaged inventory was not the result of business interruption but the result of property damage. We fail to see how this distinction matters. The business interruption provision provides coverage for actual loss resulting from business interruption but not exceeding “gross earnings.” “Gross earnings” is defined in the policy as “total” sales and other earnings minus costs. It is not defined, as Baxter suggests, as “only the gains or losses resulting from such business interruption.” In other words, there is no suggestion from the language in the policy that a distinction can be made between different types of profit.

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