Monday, January 23, 2012

Business Interruption Coverage

While most procurement contracts may include insurance requirements for Comprehensive general liability, Comprehensive Automobile Liability, Workers Compensation or Employers Liability, and Property Liability there is another type of insurance that many companies carry that negotiators should be aware of. That insurance is Business Interruption Coverage. Business Interruption insurance deals with situations where the company has a natural disaster or force majeure event where it can’t operate. Those insurances can be written to include the profit that would have been earned during the period in which they were unable to operate, any fixed costs still being incurred at the location that wasn’t usable, cost to move to and operate from a temporary facility and other reasonable expenses to continue operation while the property is being repaired.

Where you would use this knowledge is in negotiating a cancellation or termination right in the force majeure section for situations where there will be an extended recovery period. If the supplier’s recovery time is six months or a year, do you really want to be obligated to honor orders you made? You may not need them at that point in time. As force majeure is an excusable delay you would be obligated to honor them unless you build in the right to terminate if the recovery period will be long. As the supplier has done nothing wrong and hasn’t breached the agreement you can’t terminate for cause. What you could do is include language that allows you to terminate without cause and without liability to either party in the event there is an extended force majeure. Making it without liability differentiates that use of termination without liability from a general termination without cause where you would have agreed to reimburse certain of the suppliers costs for things like work in process, materials that are unique or can’t be re-used.

If a Supplier has regular insurance coverage all of the materials that were damaged or no longer usable would be covered by their property insurance. The profits they would lose by not selling to you during the force majeure period would be covered by the Business Interruption insurance. The only way they would be impacted would be if they made a major investment based upon a firm purchase commitment. In that situation they would not want to allow the termination to be without liability. How I would deal with that would be to pursue the right to cancel any open orders so I don’t have liability for those. I would also want the right to have all orders that I would have made during the period of the force majeure count against any volume purchase commitment. With Business Interruption coverage they would be making profit as if they were selling those anyway. That would reduce the potential liability you would have if you failed to meet the commitment or later decided to terminate without cause. I would also want to have any period that I needed to make the purchases within be extended by the period of the force majeure. The reason for that is if there was a long force majeure you probably brought on an alternative supplier. Having the longer period allows you to phase the original supplier back into your supply gradually. It would also give you time to allocate volumes between them based upon what was best for you financially based upon any commitments you needed to make to the alternative supplier.

If a supplier asks you whether your company carries business interruption insurance coverage its most likely because they want you to use that before you have any claim against them. There are two problems with that. Your business interruption coverage should be used for natural disasters or for your negligence, not for the negligence of the supplier or contractor. Second, always remember that the premium your company will pay in the future will be based upon the incidence or claims. To keep your future costs of that insurance down, you want the supplier or the supplier’s insurance to be the primary protection for damages, injuries or losses that they cause.

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