Full Court of the Federal Court of Australia hands down judgment in Business Interruption Test Cases

On 5 February 2021, we reported on the highly anticipated decision of the United Kingdom Supreme Court in the COVID-19 Business Interruption (BI) insurance test case of Financial Conduct Authority v Arch Insurance (UK) Ltd & Ors [2021] UKSC 1 (Arch Insurance).

The Full Court of the Federal Court of Australia has recently issued a judgment addressing whether policyholders were entitled to cover under BI insurance policies for loss related to COVID-19 and associated lockdown measures.¹

Whereas the United Kingdom Supreme Court’s decision had been overwhelmingly positive for the insured policyholders, the Full Court’s decision was a “win” for the insurance companies. New Zealand insurers will no doubt welcome that decision.

There were six appeals. The first appellant, Star Entertainment, appealed from a first instance judgment of Allsop CJ who held that it was not entitled to indemnity under its insurance policy. The second appeal was from a judgment of Jagot J issued 8 October 2021. The background was that 15 cases had been originally selected as test cases. The insurers were successful on almost every point before Jagot J. Five of the insureds, Marrickville, Meridian Travel, Taphouse Townsville, Market Foods and the liquidator of Educational World Travel, appealed to the Full Court.

In each appeal, the essential question the Full Court had to decide was whether the events which had occasioned loss to the policyholders, which arose from the presence or threat of COVID-19 in Australia, were events in respect of which the policies, properly construed, provided cover.

The appeals considered four types of clauses that provided BI cover for loss caused by:

1. Infectious disease clauses [or disease clauses]. Cover from loss that arises by either infectious disease or the outbreak of an infectious disease at the insured premises or within a specified radius of the insured premises.
2. Prevention of access clauses. Cover for loss from orders/actions of a competent authority preventing or restricting access to insured premises because of damage or a threat of damage to property or persons (often with a specified radius of the insured premises).
3. Hybrid clauses. Cover for loss from orders/actions of a competent authority preventing or restricting access to premises, but only where those orders/actions are made or taken because of infectious disease or the outbreak of infectious disease within a specified radius of the insured premises.
4. A catastrophe clause. Cover for loss resulting from the actions of a civil authority during a catastrophe for the purpose of preventing the catastrophe.

Five of the six policyholders were denied cover for their insurance claims. The Full Court left open the question whether the other policyholder was entitled to cover.

The judgment is very long and complex which partly reflects that the policies were not identical and therefore each raised separate questions of fact and law.

In our view, one of the most contentious aspects of the Supreme Court’s decision in Arch Insurance was their Lordships’ treatment of causation. The appeals in the Australian cases also raised important questions of identifying the efficiency of an insured peril in causing BI loss in circumstances where the COVID-19 pandemic had generally detrimentally impacted the insureds’ businesses.

In Arch Insurance, the Supreme Court rejected the insurers’ “but for” arguments in relation to causation. The insurers had argued that one event cannot in law be a cause of another unless it can be said that the second event would not have occurred in the absence of (“but for”) the first. The insurers said it was necessary for the individual occurrence of COVID-19 within the relevant area to be the effective cause of the BI loss, rather than the wider Government measures. The Supreme Court instead held that the “but for” test was not an essential test of causation and can sometimes be inadequate in situations where a series of events all cause a result.

There were some important factual differences underlying the claims for cover under the policies in the United Kingdom and Australia. The Full Court discusses the Supreme Court’s decision in Arch Insurance in detail in its judgment. At first instance, Jagot J noted that in the United Kingdom, there was a national COVID-19 pandemic at the time of the Government’s actions in imposing lockdowns and other measures which affected the businesses there. The position in Australia was different. In Australia, measures had been taken by the Federal Government and the various states. The actions of the Federal Government were responsive to the threat of COVID-19 overseas and the potential for it to enter the country by persons entering or returning to Australia. They were aimed at reducing the spread of COVID-19. State measures such as shutting down premises were prompted by the threat or existence of COVID-19 cases within the state itself.

As COVID-19 had spread rapidly in the United Kingdom prior to the imposition of Government measures, it was impossible to identify that any particular outbreak or outbreaks caused the Government’s response. The Supreme Court in Arch Insurance accepted the Government measures would have been imposed regardless of whether there were any cases of the disease in the areas demarcated by the policies. This gave rise to an important dispute whether the insured peril was a cause or a proximate cause of the imposition of any relevant restrictions and, therefore, the claimed losses. For example, the insured peril in the disease clauses is the occurrence or outbreak of a disease within an identified geographical area around an insured premises, usually defined by a specified kilometre radius. The Supreme Court resolved this issue in the policyholders’ favour through a construction of the policies which treated each case of COVID-19 as a proximate cause of the Government restrictions with the consequence that the claims and losses were covered even though they would have incurred in any event.

Jagot J found that the Australian Commonwealth Government’s actions were not caused by the same underlying fortuity as the insured perils in the respective policies. The Commonwealth Government acted to prevent the entry of COVID-19 into the country and was motivated by the existence of the spread of the disease overseas and the threat presented to Australia by the uncontrolled entry of international travelers. The proximate cause of the loss was not the existence of COVID-19 at the business or in the location as required by the insuring provisions in the policies.

The Full Court critiqued the Supreme Court’s analysis of causation in Arch Insurance. In its view, the first necessary question is whether the insured peril was an effective cause of the loss which, at a minimum, is to be analysed by ascertaining whether “but for” the occurrence of the peril, the loss would have occurred. If the insured peril was not an effective cause the inquiry need go no further. If it is, the inquiry can proceed to consider the relevance of any uninsured concurrent causes. If such causes exist and are not excluded, the policy usually responds.

In broad terms, the Full Court found that there was a lack of a causal connection between the Government’s restrictions imposed in response to COVID-19 and localised disease outbreaks in the early stages of the pandemic.

The Full Court pointed out that only loss which is proximately caused by an insured peril can be recovered. It is necessary to adjust for competing uninsured causes of loss. The Full Court referred to the example of a travel agency, which has lost most of its business due to travel restrictions imposed because of the pandemic. The Supreme Court had also discussed the travel agency example in its judgment in Arch Insurance. Their Lordships said that, although customer access to the travel agency’s premises might have become impossible, the sole proximate cause of the loss of the walk-in customers was the travel restrictions imposed because of the pandemic, and not the inability of customers to enter the agency. In that example, the loss would not be covered.

The Full Court said the underlying fortuity principle removes from the hypothetical counterfactual certain competing causes of loss which would otherwise diminish the causative impact of the insured peril. It does not expand the scope of loss which might flow from the occurrence of the insured peril in the sense that it is only the loss, after making the relevant adjustments, that was proximately caused by the insured peril which can be recovered.

The Full Court held there was merit in Jagot J’s view that the usual meaning of an “outbreak” is something more than an occurrence. An “outbreak” in the community only required an active (infectious) case of COVID-19 in the community, in the sense that it occurs in a non-controlled environment, where potential transmission may occur. The Full Court added a gloss that whether an “outbreak” has occurred is disease dependent.

The Full Court held that ‘closure’ of the premises does not require that each and every person is prohibited from entering and remaining upon the whole or part of the premises. It extends to closure of part of the premises to persons who would otherwise be entitled to enter or remain on the whole or that part of the premises. This is to be applied in a common-sense way. If a premises involves a business operating as a restaurant and bar, orders preventing the premises being used in that way are effectively a closure of that premises (even if the business might have been able to operate to sell takeaways).

In relation to the question of what amounts to prevention or restriction of access to or use of the premises, the Full Court did not disturb Jagot J’s findings that:

1. Access to premises is prevented if the persons ordinarily entitled to enter the premises are no longer physically permitted to do so. For example, an order which required a restaurant and bar to close that part of the business means access to the premises is prevented because members of the public cannot attend for that purpose. Access to premises is restricted if it becomes materially more difficult for persons ordinarily entitled to enter the premises to do so.
2. There did not need to be prevention of access to the whole of the premises.

As mentioned, insurers were successful on almost every point. The outcome was the reversal of the test cases in the United Kingdom. The Full Court upheld Jagot J’s decision that the primary cause of the loss was Government action in response to the wider COVID-19 crisis rather than the outbreak of COVID-19 at any premises or within a defined geographical area.

The different outcomes in the United Kingdom and Australia reflect the different COVID-19 experiences of those countries. In Australia, the numbers were much lower, and the Government’s response was different. The New Zealand experience is largely the same or very similar to Australia. Our expectation is that the New Zealand Courts are more likely to follow their Australian counterparts if they are asked to consider the same issues. Insurers will no doubt welcome that approach.

There are reports in the media that an application for leave to appeal to the Australian High Court has been made, so watch this space.

1. LCA Marrickville Pty Ltd v Swiss Re International SE [2022] FCAFC 17 and Star Entertainment Group Ltd v Chubb Insurance Australia Ltd [2022] FCAFC 16

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