The great majority of franchise agreements contain an obligation on franchisees to comply with their franchisor’s insurance requirements. Such clauses then list the insurances that franchisees must have or refer to another document – usually set out in the manual – containing the franchisor’s insurance requirements.
Generally franchisors will require franchisees to have business interruption insurance (or loss of profit insurance) because that protects a franchisor’s ability to receive continuing fees during a period when a franchisee is unable to carry on business.
During Covid, it has been unclear the extent to which those franchisees who have business interruption insurance are able to claim on those policies by virtue of Covid and/or the government’s action in response to Covid. As a result, many franchisors have granted franchisees concessions and indeed continue to do so for those franchise businesses which are particularly affected by Covid.
The majority of business interruption insurance policies only cover interruption caused by events such as damage to premises. If your franchisees have this form of basic cover, they would not be able to claim for any losses associated with Covid. However, some businesses take out add-ons which include what are referred to as disease clauses and prevention to access clauses.
The position as to whether insurers are required to pay policyholders who have those add-ons to their business interruption insurance has been clarified by the Supreme Court in a recent case which has received a great deal of publicity. It is likely that franchisors will receive requests for information and guidance from their franchisees in respect of their ability to claim under business interruption insurance in view of the Supreme Court’s decision. The purpose of this note is to enable franchisors to give general guidance to their franchisees and to set out what franchisors should do.
The Court Case
Proceedings were brought by the Financial Conduct Authority (“FCA”) against a number of insurers which the FCA considered used a good selection of policy variations. Some lawyers acting for the insurance companies believe that the FCA choose insurers with policies which were beneficial to their claim over those that were not. The FCA issued their claim on 9 June 2020 which was followed by a trial at the end of July in the Commercial Court in respect of which judgment was given on 15 September. On 2 November permission was granted for a “leap frog” appeal to the Supreme Court which held a hearing on 16-19 November and handed down its judgment on 15 January. By the standards of litigation, and bearing in mind the complexity of the case, that is the equivalent of a world speed record!
The court considered a number of issues but focusing on the important issues for franchisors, the court analysed what are referred to as disease clauses, prevention of access clauses and hybrid clauses.
In terms of disease clauses, the “standard” wording used by insurers is “the company will also indemnify the insured as provided in the insurance of this section for such interruption as a result of any occurrence of a notifiable human disease within a radius of 25 miles of the premises.”
Covid was made a notifiable disease on 5 March 2020 so the issue was whether the insurance applied only to a local occurrence and therefore did not apply to a disease that was national or supra-national. The Supreme Court decided that cover was only in relation to a notifiable disease within the specified radius and did not apply to cases outside of that area.
In relation to prevention of access clauses – clauses which provide for cover arising from losses resulting from public authority intervention preventing access to or the use of insured premises, the Supreme Court held that an inability to use premises has to be established and it has to be an “inability” as opposed to use being difficult or hindered. Nevertheless, the Supreme Court held that “business premises” would include a discrete part of those premises. In other words a retailer which obtained 20% of its business through telephone or email enquiries would nevertheless satisfy the requirement. In other words, insurers will be required to pay even if, by way of example, a restaurant, was able to carry on providing a takeaway service in response to online orders.
A hybrid clause contains a combination of the disease and prevention of access clauses.
The insurers argued that even if their policies covered the disease or prevention of access any loss in respect of which payment would have to be made must be to the loss that would not have occurred “but for the insured peril”. The insurers further argued that Covid was widespread and so businesses would have suffered some losses in any event. The Supreme Court rejected the “but for” test. This means that in relation to disease clauses franchisees need only prove that their loss arose from an interruption caused by government measures as a result of the diseases, provided there is at least one case of Covid within the radius specified in the relevant policy. In relation to prevention of access clauses, including hybrid clauses, cover would be provided, assuming all of the required elements of the policy are satisfied, even if losses arise from other uninsured elements relating to the pandemic.
There are also important elements of the Supreme Court’s decision in relation to how the level of loss should be calculated and other elements but in order to keep this note within manageable proportions these are not discussed here.
What to do Next?
The great majority of business interruption insurance policies are taken out by small businesses such as franchisees. This means the Supreme Court’s decision has been, correctly, hailed as a great victory for small businesses. However, it is important to bear in mind that there are over 700 types of policy issued by over 60 insurers to 37,000 policyholders, and the Supreme Court’s decision relates to only 21 policies issued by six insurers. Everything will depend on whether the policy includes a disease clause and/or a prevention of access clause, and if it does, on the actual wording of the policy which would have to be looked at carefully. That having been said, the FCA would not allow insurers to, in effect, “refight” the case by way of litigation should a policyholder who is not receiving payment from its insurer and seeks to litigation. Insurers will be required to comply with the decision so far as relevant to their own policy wording.
Helpfully the FCA has announced that it will finalise guidance in the near future taking into account the Supreme Court’s judgment which it will publish and it has a dedicated web page on this issue.
Clearly, franchisors should assist their franchisees to investigate whether they can claim under their business interruption insurance, but need to do so with great care because, of course, franchisors are not experts in this area and they may well owe their franchisees a duty of care in providing advice in respect of franchisee’s business interruption insurance. This means that if advice is given it needs to be heavily caveated with appropriate disclaimers and the need for franchisees to obtain their own independent legal advice should be stressed.
A final issue to consider for franchisors is if concessions have been granted to franchisees on the basis that franchisees are unable to trade by virtue of Covid and subsequently franchisees receive pay-outs from their insurers, should the concession be withdrawn? That will depend on the wording of both any fee concession and your franchise agreement. If neither is helpful to a claw back of any concession, franchisors may wish to consider adopting an approach whereby assistance will be provided to franchisees on the basis of a negotiated and agreed claw back.
– John Pratt