Business interruption insurance – a riddle, wrapped in a mystery, inside an enigma

Owned by McCabes Marketing
Last updated: 19 Aug, 2021
5 min read

Originally Published by Andrew Sharpe on Tuesday, July 4, 2017 10:30:47 AM


SKM Industries Pty Ltd v Australian Reliance Pty Ltd [2017] VSC 159


Overview


In 1937 Winston Churchill said that trying to forecast the actions of Russia was ‘a riddle, wrapped in a mystery, inside an enigma’. Judged by the recent history of insurance brokers’ negligence actions, both in Australia and overseas, the phrase appears apt to describe business interruption insurance.

SKM Industries Pty Ltd v Australian Reliance Pty Ltd illustrates the potential dangers inherent in arranging business interruption insurance and the care needed by both brokers and their clients.

Background


The SKM Group (SKM) carried on the business of recycling general waste materials and glass. It held an Industrial Special Risk (ISR) policy with Vero Insurance Ltd (Vero) (the Policy). The Policy had been arranged by Mr Riddle of Australian Reliance (the Broker).

At renewal in 2009, the Broker obtained from MSM Loss Management (MSM) an advice in respect of the appropriate declared Insurable Gross Profit for the purpose of the business interruption section of the Policy. MSM’s calculations included ‘growth factors’ of approximately 3% p.a. arrived at by MSM following discussions with SKM’s management.

During 2009, SKM’s business manager, Robert Italiano, informed Mr Riddle of two changes to its business:

  1. SKM was starting a glass recycling business to commence in February 2011; and

  2. SKM had entered into contracts to receive and process recyclable materials from five local councils (Council Contracts) which were estimated to result in a 20% increase in tonnage processed.


Prior to the 2010 renewal, the Broker provided SKM with an Insurance Renewal Questionnaire which contained a form to be used by SKM for the calculation of the Insurable Gross Profit (Calculation Form) and notices relating to the need to advise of any change of risk circumstances and the Average/Co-insurance clause (including a worked example).

SKM’s company accountant, Mr Matheou completed the Calculation Form. His figures produced an Insurable Gross Profit as at 30 June 2009 (including a ‘growth factor’ in respect of the policy period of 10%) of $15,750,000. In response to prompts in the Calculation Form, Mr Matheou indicated further growth factors of 10% in respect of each of the two 12 month periods comprising the indemnity period.

Mr Matheou returned the Calculation Form to the Broker by email which stated:

"Please note that in both instances I have put 10% for the increase as per Robert’s advice but I was unsure whether they needed to be added together and ultimately added back to the gross profit figure and payroll figure."

The Broker renewed the Policy with an Insurable Gross Profit of $15,570,500. That figure did not include any increase to reflect Mr Matheou’s additional growth factors in respect of the indemnity period.

Fire at SKM premises

On 5 November 2010 SKM’s premises were extensively damaged by fire (the Fire).

SKM’s settlement with Vero

SKM made a claim on the Policy in respect of losses sustained as a result of the Fire. Vero had paid an amount of $24,690,000 under the Policy.

SKM sued Vero alleging that it was entitled to a further payment of $8,775,110.75 (including $4,113,820 in respect of business interruption). Those proceedings were settled, following mediation, for payment by Vero of $5,400,000 (Vero Settlement).

SKM’s claim against the Broker


SKM commenced proceedings against the Broker in the Supreme Court of Victoria alleging that the Broker had breached its duty of care by:

1. failing to increase the Insured Gross Profit figure declared to Vero by reference to:

a. the 9 month period between 30 June 2009 and the commencement of the Policy on 31 March 2010 (7.5%); and

b. the two periods of 10% growth in respect of the 24 month indemnity period as instructed by Mr Matheou on the Calculation Form.

(the Growth Factor Inclusion Issue)

2. failing to question the sufficiency of the growth factors provided by Mr Matheou having regard to the Broker’s knowledge of the SKM business including:

a. the commencement of the new glass recycling business; and

b. the Council Contracts.

(the Growth Factor Sufficiency Issue)

3. failing to advise SKM of a change to the 2010 Policy which amended the definition of Uninsured Working Expenses thereby reducing the extent of indemnity available to SKM for such items.(the Uninsured Working Expenses Issue).


Decision


Growth Factor Inclusion Issue and Uninsured Working Expenses Issue

The Broker admitted negligence in respect of each of the Growth Factor Inclusion Issue and Uninsured Working Expenses Issue.

It was agreed that SKM’s entitlement to indemnity under the ISR Policy was reduced by $1,738,041 as a result of that negligence compared to the amount which would have been properly payable by Vero in the absence of such negligence (the Agreed Shortfall Figure).

The only issue which arose, in respect of those breaches, was whether a further reduction from that agreed loss figure should be made to reflect any additional recovery obtained by SKM as a result of the Vero Settlement.

Riordan J was satisfied, based on detailed evidence as to the course of negotiations, that the Vero Settlement did not result in SKM receiving moneys in respect of its business interruption claim greater than the amount of SKM’s policy entitlement (which had been factored the calculation of the Agreed Shortfall Figure).

Growth Factor Sufficiency Issue

In relation to the issue of whether the Broker ought to have questioned the sufficiency of the growth factor estimates provided by SKM, Riordan J held that the Broker was entitled to accept the growth factor calculations provided by SKM because:

  • a reasonable broker could not be expected to be aware how the expansion in the business would flow through to revenue or gross profit;

  • the growth factor figures provided by Mr Matheou indicated a very significant growth of the business over the relevant periods (cumulatively in excess of 30%);

  • the Broker was aware that the figures had been arrived at by the company’s internal accountant based on advice from the general manager.


His Honour also rejected SKM’s claim that the reference to the growth factor in the Calculation Form was ambiguous which had led to SKM providing inadequate growth factors calculated on past, rather than future, growth trends. His Honour held that the Broker’s documentation had made it clear that the reference to ‘growth trend’ in the Calculation Form asked for an ‘expected’ trend in respect of each of the three relevant periods. In any event, SKM had not proved that it was actually misled or that, if further explanation had been provided, it would have provided different figures.

Implications


This decision provides an important reminder to insurance brokers as to the procedures and care required in arranging business interruption insurance and the importance of clearly informing clients of any relevant changes to the policy wording at any renewal.

Of some reassurance, it shows that brokers will generally be entitled to rely on instructions provided by clients provided that they have taken reasonably steps to advise the clients of matters and concepts necessary for the client to provide informed instructions and that there are no other circumstances indicating that the instructions are erroneous.