Tuesday, May 29, 2012

Business Interruption Insurance

Business Interruption Insurance (also known as business income coverage) is a policy that may be purchased where in the event of a catastrophe, such as a fire, tornado, explosion, or other disastrous event causes your place of business to be temporarily unusable, forces you to relocate, or close down your business for a period, the policy would pay for:

1.Profits that you would have earned had you property not been damaged. This would normally be calculated based upon your past financial records of earnings.
2.Operating expenses that will still occur at the location. For example you could still have taxes, insurances, security and other expenses at the site even though you are not able to use the site.

They will normally not include labor or management costs as those costs are usually covered by unemployment benefits. Business interruption insurance may include as a separate item “extra expenses”. Extra expenses would be additional expenses that you incur that help decrease the cost of the business interruption. For example extra expense insurance could cover incremental expenses required to operate out of a temporary location if that would decrease the cost of the business interruption.

While this is not an insurance that you would require the to Supplier maintain under a contract, it’s an important concept for negotiators to understand especially when negotiating force majeure provisions.

For example: Assume that you had a contract to purchase 100,000 units of a product over a year and the supplier had a disaster such as a fire after only delivering 10,000 units. It was the only location where they produced the item. They cannot produce it in another location as the capital equipment required to produce it was destroyed in the fire. It will take them a year to recover. In a normal force majeure clause the party that suffered the force majeure event is excused from performance during the period of the force majeure. The party that did not suffer the force majeure is not excused. This means that a year from now the buyer would still have the obligation to purchase the remaining 90,000 units. You may not want that obligation and as part of the negotiation of the force majeure clause you include language that if there is a force majeure and the supplier is unable to recover within one hundred and twenty (120) calendar days, you have no obligation to purchase the remaining volume.

The Supplier seeing the potential loss of revenue and profit is opposed to agreeing to this. You then ask the supplier whether they have business interruption insurance. If they do, it becomes a simpler argument. If the insurance is already paying them for the lost profit they didn’t make for not performing, and insurance is paying them for the losses they sustained to the equipment or materials on hand that were damaged, haven’t they already been compensated? They have been made whole.

Forcing you to purchase it a year from now may:
1. Be selling you a product that you no longer need.
2. Be requiring you to shut off an alternative source of supply that helped you and that you had to invest in to not be impacted by their force majeure
3.Be selling you something that is no longer state of the art.

Any investments they made to produce the product for you will either have been paid for out of the insurance proceeds for the lost equipment or would have been paid for out of the profit they were paid by the business interruption insurance. I would then remind them that force majeure is about providing excusable delays when there are disasters. They are not there to guarantee future revenue and profits.

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