Underinsurance for BI losses

In Eurokey Recycling Limited v Giles Insurance Brokers Limited [2014] EWHC 2989 (Comm), the Commercial Court was presented with a broker negligence claim relating to the vexed issue of underinsurance in a business interruption policy.

In a dispute which turned heavily on the quality of the evidence presented by the parties, the Court declined to hold the brokers liable for any failure properly to advise and arrange adequate levels of cover.

BACKGROUND

The Claimant, Eurokey Recycling Limited (Eurokey), is a waste recycling company established in 1995 which had its principal place of business at premises in Enderby, Leicestershire. Eurokey's insurance arrangements were handled by the Defendant insurance brokers (Giles). Eurokey's premises were insured under a property policy and a commercial combined policy which included cover for stock, machinery and business interruption (BI). The BI cover was declaration-linked, and written on a gross profit basis with a 12 month indemnity period.

On 2 May 2010, there was a fire at the Enderby premises. The fire caused extensive damage and the site was not subsequently rebuilt. After the fire, it became apparent that Eurokey was
significantly underinsured for both stock and machinery cover and for BI cover. Eurokey's position was that the value of the stock on the premises was some £400,000, but it was insured for only
£25,000. Replacement costs for machinery at the site were said to amount to some £1million, against a sum insured of some £460,000, and the anticipated gross profit generated from the site
was put at £7-8 million, against a sum insured of just £2.5 million.

Following the claim, insurers threatened avoidance of cover by reason of underinsurance. In July 2010, a without prejudice settlement was reached in the sum of £1.5million. Eurokey's property policy paid out in full, but only £820,000 was paid on the commercial combined policy. Eurokey subsequently commenced proceedings against Giles, seeking to recover the shortfall between the settlement and the recovery it would have made had it been fully insured. Eurokey's claim was put on the basis that Giles had negligently advised it as to how the sums insured should be calculated, and negligently failed to arrange adequate cover. The focus of the dispute was on the sums insured for BI; the underinsurance in respect of stock and machinery did not feature heavily in Eurokey's submissions.

The exchanges between Eurokey and Giles leading up to the renewal of the commercial combined policy in 2010 were the principal area of factual dispute between the parties. The meetings primarily took place between Mr Bisland, the commercial director of Eurokey, and Mr Evans, a senior broker at Giles.

Eurokey's insurance year ran from April to April. Giles' procedure on renewal was to prepare a pre-renewal report and schedule a pre-renewal meeting with Eurokey to discuss the report. Giles then presented the risk to insurers based on the pre-renewal report, prepared a renewal report and scheduled a further meeting with Eurokey to discuss the terms of the renewal before binding cover.

The 2009 pre-renewal report was dated 10 February 2009, and the pre-renewal meeting was held shortly thereafter. As a result of the meeting, the BI sum insured was increased from £800,000 to £2 million, although the estimated turnover to be declared to insurers was reduced from £11 million to £9 million. In fact, these figures were incorrect, and Eurokey's most recent available accounts at the time recorded substantially higher figures for turnover and gross profit. The figures amended as a result of the pre-renewal meeting formed the basis of Giles' market presentation, and cover was bound for the 2009 policy year with Quinn Insurance Limited, at a premium of £29,600.

In 2010, Giles prepared a pre-renewal report dated 4 March 2010 and the pre-renewal meeting was held on 5 March 2010. As a result of the discussions at the pre-renewal meeting, the risk was
presented for 2010 on the basis of turnover of £11 million and a sum insured for BI of £2.5 million. Before the policy was renewed, Quinn Insurance Limited entered Irish administration proceedings. Accordingly, Giles sought renewal with other insurers. The only quote received was from Paladin, at a significantly increased premium. Notably, Eurokey was concerned about the premium increase, and itself sought quotes from other insurers on the basis of the Giles documentation (which contained the turnover and gross profit figures). In the event, however, those approaches were unsuccessful, and on 13 April 2010, cover was placed with Paladin.

Eurokey financed the premium through a finance company, Premium Credit Limited. In connection with the finance application, Eurokey sent its draft accounts for the year ending 31 August 2009 to Giles. Those accounts showed that the turnover of Eurokey was significantly more than the estimate provided to Paladin. Giles' case was that it never reviewed the accounts, as they were provided solely in connection with the premium finance.

DECISION

Eurokey contended that the incorrect figures provided to insurers had been generated by Giles, and there were significant issues of fact between the parties as to the discussions that had taken place at the meetings in 2009 and 2010. However, the Court preferred the evidence of Mr Evans of Giles to that of Mr Bisland. The Court found that the stock, machinery, turnover and gross profit figures presented to insurers had all been provided by Mr Bisland to Mr Evans at the meetings. The Court further found that the 12 month indemnity period had been fixed based on Mr Bisland's instructions, reflecting Eurokey's view of how long it would take to get the business up and running again in the event of a loss.

The Court noted that in the course of Eurokey's own attempts to secure alternative quotes in 2010, it had seen and itself used Giles' renewal documents, which showed the turnover figures provided to insurers. The Court found that Eurokey could and should have corrected the documents at that stage if it believed that the figures were incorrect.

The second limb of Eurokey's case was that Giles had failed properly to give advice as to the mechanics of BI cover and, in particular, how to calculate the sums to be insured. Ultimately, very little was in issue between the parties as to the relevant legal principles concerning the scope of brokers' duties generally. The Court accepted that Giles was under a duty properly to advise Eurokey as to the type and scope of the cover which it required and to match as closely as possible the risk exposures identified with the cover available.

With regard to the legal principles which apply to BI insurance, the Court appreciated that fixing an appropriate amount of cover is not necessarily a simple task, and held that, whilst calculating the sum insured and choosing an indemnity period did not fall within the scope of a broker's duties, the broker was required to provide a sufficient explanation of BI cover to allow his client to do so. Such an explanation would likely require the broker to take reasonable steps to satisfy himself that his client understood terms and concepts relevant to BI cover, including:

• that "insurable" gross profit (being turnover less fixed costs) is a different concept to "gross profits" in the accounting sense; and
• that the maximum indemnity period is the period of time over which insurers will pay for any shortfall in the insurable gross profit, such that it must be sufficiently long to allow the business to return to trading at its pre-loss level, if the policy is to provide a proper indemnity to the insured.

Ultimately, the scope of the broker's obligation will depend on the particular circumstances of the case, including the sophistication of the client and the number of times he has met with the broker. It should be noted that the broker is not generally expected to conduct a detailed investigation into his client's business. Where a client who appears to be well-informed as to his business provides information to the broker, the broker is not himself expected to investigate the position.

On the facts, the Court found that Giles had satisfied its duty to provide a proper explanation of the basis of BI cover (and how to fix the sums insured) to Eurokey in 2009. The Judge's approach to the 2010 pre-renewal meeting was informed by his finding that adequate advice had previously been given to Mr Bisland in 2009. Consequently, in 2010 there was no reason for Mr Evans of Giles to verify the sums insured provided by Mr Bisland, which were ultimately passed on to insurers.

A final point canvassed by the Court was whether receipt by Giles of the draft accounts to be passed to Premium Credit should have put it on notice of the underinsurance. Eurokey contended that the accounts had been supplied to Giles partially for the purpose of confirming the turnover figures (a point rejected by the judge) but that even if the accounts had been provided solely for the purpose of obtaining finance, Giles was nonetheless under a duty to review them. It would have been an easy step to allow Giles to better understand Eurokey's business, in the context of an ongoing duty of disclosure and to allow Giles to identify potential policy issues. Blair J found "little force" in Eurokey's submissions: he considered that Giles had no reason to believe that the
accounts would be inconsistent with the figures it had been given and, in the circumstances, its role was simply to act as a postbox for the documents.

Giles additionally raised three causation arguments in relation to the losses claimed by Eurokey. First, if the Court found that the shortfall in the BI sums insured was the responsibility of Giles, it would not have made any material difference to the settlement achieved by Eurokey. Secondly, even absent BI underinsurance Paladin would have threatened to avoid the policy on the basis of the underinsurance of stock and machinery in any event. Thirdly, alternative cover for Eurokey would not have been available on the market, or would have been only available on significantly more onerous terms. All three of these points were rejected by the Court.

COMMENT

Whilst the outcome in this case turned heavily on its own facts, the decision is nonetheless an object lesson in the importance of insureds understanding the basis on which the sums to be insured under BI policies are calculated. The decision gives a helpful summary of the scope of a broker's duties as they apply in the context of placing BI cover. Importantly, whilst brokers are under a duty to assist their clients with the process of insuring against BI risks by explaining the operation of the policy cover (and taking reasonable steps to ensure that such explanations are understood), the duty does not extend to carrying out the calculation of sums insured or selection of maximum indemnity periods from the information provided by
the insured.

Insureds therefore continue to be faced with the difficult task of setting the appropriate level of cover for BI, in particular, as this case highlights, setting sums insured for insurable gross profit, and defining the necessary maximum indemnity period. Misjudging the level of cover required risks underinsurance, and in particular the risk of the application of average to reduce the insured's loss in proportion to any such underinsurance. It might be hoped that this case will provide further encouragement (if any were needed) for insureds and brokers to sit down together and address these issues.