VERRILL FARMS, LLC vs. FARM FAMILY CASUALTY INSURANCE COMPANY.
No. 13-P-1747.
Appeals Court of Massachusetts, Middlesex.
May 2, 2014.
November 4, 2014.
Barry P. Fogel for the plaintiff.
William A. Schneider for the defendant.
Present: Trainor, Fecteau, & Carhart, JJ.
TRAINOR, J.
The plaintiff, Verrill Farms, LLC (Verrill Farms), owns and
operates a retail farm store in Concord. The defendant, Farm Family Casualty
Insurance Company (Farm Family), issued a "Businessowners Advantage
Insurance Policy" (policy) effective August 4, 2008, to August 4, 2009, to
Verrill Farms. On September 20, 2008, Verrill Farms suffered a fire loss to its
farm store. Within two days of the fire, Verrill Farms reopened its business at
alternate locations at reduced capacity. Within another month, the business had
resumed nearly full capacity in temporary facilities at nearby locations. After
the fire and during the process of restarting the business at the alternate
locations, no employees were laid off. All employees who remained on the
payroll were involved in operations that allowed Verrill Farms to maintain its
business and generate income.
Verrill Farms submitted a claim under the policy for loss of
business income, based on its loss of net income (net profit or loss) in the
year after the fire, which it believed the policy covered under the loss of
business income coverage. Farm Family paid a sum considerably less than the
claim made by Verrill Farms, based on its interpretation of what expenses can
be included in a calculation of net profit or loss in order to determine loss
of business income under the policy.[1] Farm Family
describes the question as whether it has to "pay" Verrill Farms for
the cost of its ordinary payroll expense during the period of restoration,
beyond the sixty-day limit contained in the policy. See note 7, infra. The
Superior Court judge declared that Farm Family did not have to pay the cost of
ordinary payroll beyond the sixty-day limit and granted summary judgment in Farm
Family's favor. This, however, is not what Verrill Farms was seeking to recover
and misapprehends what the policy provision was intended to accomplish.
Verrill Farms never made a claim for a direct payment of the
cost of its ordinary payroll; it sought only to include the cost in its
calculation of net profit or loss for the appropriate time period. The sole
question before us, therefore, is whether the cost of ordinary payroll can be
included in the calculation of net profit or loss in order to determine the
loss of business income, when the business has resumed operations at temporary
locations during the restoration period. We conclude that it can, and that
under the factual circumstances of this case, loss of business income can only
be determined by including the expense of ordinary payroll, and other
unreimbursed continuing expenses required by the resumption of operations, in
the calculation of net profit or loss.
Standard of review.
The interpretation of an insurance contract is a question of
law, Boston Gas Co. v. Century Indem. Co., 454 Mass. 337, 355 (2009), which we
review de novo.[2] See Rhodes v. AIG Domestic Claims, Inc.,
461 Mass. 486, 495 (2012). "The interpretation of language in an insurance
contract `is no different from the interpretation of any other contract, and we
must construe the words of the policy in their usual and ordinary sense.'"
Metropolitan Property & Cas. Ins. Co. v. Morrison, 460 Mass. 352, 362 (2011),
quoting from Boston Gas Co. v. Century Indem. Co., supra. "Every word in
an insurance contract `must be presumed to have been employed with a purpose
and must be given meaning and effect whenever practicable.'" Allmerica
Fin. Corp. v. Certain Underwriters at Lloyd's, London, 449 Mass. 621, 628
(2007), quoting from Jacobs v. United States Fid. & Guar. Co., 417 Mass.
75, 77 (1994). "The objective is to `construe the contract as a whole, in
a reasonable and practical way, consistent with its language, background, and
purpose.'" Massachusetts Property Ins. Underwriting Assn. v. Wynn, 60
Mass. App. Ct. 824, 827 (2004), quoting from Gross v. Prudential Ins. Co. of
America, 48 Mass. App. Ct. 115, 119 (1999). "If the meaning of the
contract language is unclear, we `consider what an objectively reasonable insured,
reading the relevant policy language, would expect to be covered.'" Metropolitan
Life Ins. Co. v. Cotter, 464 Mass. 623, 635 (2013), quoting from Hazen Paper
Co. v. United States Fid. & Guar. Co., 407 Mass. 689, 700 (1990).
Discussion.
We begin our analysis with a brief outline and explanation of
the relevant policy provisions. The specific policy at issue here is termed a
business owners special property coverage form. In addition to coverage for
physical loss or damage to the covered party, the policy contains, as relevant
to our inquiry, additional coverage for loss of business income and extra
expense.
In its most basic form, a commercial property casualty policy
insures against the risk of damage or loss of a business's real and personal
property. See 1 Cozen, Insuring Real Property §§ 1.05 & 3.01 (2014). When a
business's property is damaged or lost, it often incurs additional
consequential losses such as increased costs or lost profits which are the
direct result of their inability, or partial inability, to conduct their
business operations. Id. at § 3.01. Additional coverage can be negotiated to
cover those economic losses.
Loss of business income.[3] The general
nature of loss of business income, or business interruption,[4]
insurance is that it acts in concert with, and as a supplement to, commercial
property casualty insurance. Cozen, supra at §§ 1.06(4) & 3.01. The
business income or business interruption insurance is designed to do for the
business what the business would have done for itself had no loss occurred. See
Gordon Chem. Co. v. Aetna Cas. & Sur. Co., 358 Mass. 632, 636 (1971)
(acknowledging that "`the policy [of insurance (Business Interruption)] is
designed to do for the insured in the event of business interruption caused by
fire, just what the business itself would have done if no interruption had
occurred — no more.' No more certainly, but also no less" [citation
omitted]). See also National Union Fire Ins. Co. of Pittsburgh v.
Anderson-Prichard Oil Corp., 141 F.2d 443, 445 (10th Cir. 1944) ("The
purpose, scope and legal effect of the insurance contract is to protect the
prospective earnings of the insured business only to the extent that they would
have been earned if no interruption had occurred. . . . In other words, the
policy is designed to do for the insured in the event of business interruption
. . . just what the business itself would have done if no interruption had
occurred — no more"). Usually the additional coverage is tied to the
underlying property damage coverage because only business interruptions or
income losses resulting directly from physical loss or damage to the insured property
will be covered.
Extra expense.[5]
Extra expense coverage is
intended for businesses that cannot allow their operations to cease because of
damage to their property. Verrill Farms is typical of the kind of business
"that [would] suffer a permanent loss of customer goodwill as a result of
even the temporary curtailment of operations. Continuity of service is the key
to success for [these] businesses. . . . Extra expense insurance meets this
need for it reimburses the insured for those expenditures in excess of normal
operating costs that are required to keep the business going while repairs to
the physical property are made" (emphasis in original). Cozen, supra at §
3.04[1], at 3-82 to 3-83. Additionally, the policy includes the appropriate
adjunct requirement that Verrill Farms "[r]esume all or part of [its]
`operations' as quickly as possible."[6]
Most businesses obtain either business interruption coverage or
extra expense coverage. There are situations, however, where a business would
want to have both types of insurance protection. Cozen, supra at § 3.04[3]. Verrill
Farms purchased coverage, by virtue of these additional endorsements, that
would allow it to resume operations as quickly as possible as well as cover any
loss of income suffered for a maximum of twelve months when operations were
resumed at a temporary location.
Ordinary payroll endorsement.[7]
The policy provision providing for loss of business income
contains an additional endorsement providing direct payment to Verrill Farms
for the cost of "ordinary payroll expenses." It is the interpretation
and application of this provision that is the focus of the dispute between the
parties.
In these types of insurance contracts there are basically two
types of payroll expenses. First, there are a business's key employees —
directors, executives, managers, employees under contract, and other employees
who are so important that they must be retained even if the business does not
immediately resume operations. Second, there are ordinary payroll employees,
which are generally all other employees.[8] For many
businesses there is no need to purchase additional insurance to cover the cost
of "ordinary payroll" during a prolonged shut down.
"In many firms, there are some employees for whom the
employer will not feel a need to continue wages or salary during an extended
interruption. . . . Two endorsements are generally available that give the
insured flexibility with regard to `Ordinary Payroll.' These are: (1) ordinary
payroll exclusion endorsement, and (2) ordinary payroll limited coverage
endorsement" (emphasis added).
Huebner, Black, & Cline, Property & Liability Insurance
244 (3d ed. 1982). Here, Verrill Farms, apparently in an abundance of caution
and business planning, purchased an ordinary payroll limited coverage
endorsement. "With the Ordinary Limited Payroll Coverage Endorsement, it
is possible to add back ordinary payroll coverage for a limited period of time
[here for 60 days]. The reasoning here is that the insured may not desire to continue
to pay employees in the ordinary payroll classification should the interruption
be of long duration; but if it were relatively short, it would be advantageous
to keep the work force together." Ibid.
The purpose of this coverage is to
make a direct payment to the insured of the cost of ordinary payroll, for a
specified period of time, in the event that the business cannot resume its
operations immediately or not at all during the period of restoration. When the
business is able to restart its operations, a direct payment of the expense of
ordinary payroll is no longer necessary because the business is generating
income which pays its payroll expenses. Cf. Cozen, supra at § 3.02[3][d].
Here, Verrill Farms was able to resume its business operations
at alternate locations, within two days of the fire at its store. If the
business had been unable to resume operations immediately and therefore unable
to generate revenue to cover the cost of these employees, the limited ordinary
payroll endorsement would have allowed Verrill Farms to receive direct payment
for the cost of ordinary payroll employees, not to exceed sixty days. If there
had been no resumption of operations and the ordinary payroll employees had
been laid off, there would have been no continuing ordinary payroll expense.
However, because business operations resumed almost immediately, it was not
necessary to lay off any employees. Since the salaries of ordinary payroll
employees were being paid, at all times, from revenues generated by the
resumption of operations, Verrill Farms made no claim for direct payment
pursuant to the limited ordinary payroll endorsement.
Calculating loss of business income.
Both parties agree that operations covered by the policy were
suspended for the entire period of restoration and that the suspension was the
direct result of physical loss or damage to property at the described premises.[9] Both parties also agree that the policy not only requires
the resumption of operations as soon as possible, see notes 5 & 6, supra,
but also that such a resumption of operations does not prevent a recovery for
loss of business income. The only issue before us, as we have stated earlier,
is therefore the method of calculating loss of business income.
The policy sets out two seemingly contradictory provisions.
First, the policy provision that provides the methodology to calculate loss of
business income presumes that Verrill Farms will not resume operations during
the period of restoration. See note 3, supra. The policy defines business income
as net profit or loss that would have been earned if there had been no fire and
"continuing normal operating expenses incurred, including payroll."
By defining business income as net profit or loss and "continuing normal
operating expenses incurred, including payroll" (but not including
ordinary payroll), the policy is providing two separate payments, one for each
category. In this scenario, loss of net income is not calculated but is
determined by projecting what net profit or loss would have been if there had
been no damage to the business property.
Since net profit or loss is not
calculated by subtracting expenses from gross income, an additional direct
payment is provided for the costs of continuing normal operating expenses,
which is allowed by the policy when business operations do not resume during
the period of restoration. In an operating business, however, net profit or
loss is always determined by subtracting the costs of materials, wages
(including ordinary payroll), and other charges from gross income.[10] The policy's payment plan must presume that there has
been no resumption of business operations. The policy here would pay the amount
of the projected net profit or loss and an additional payment of unavoidable
continuing expenses during the period of restoration. See Amerigraphics, Inc.
v. Mercury Cas. Co., 182 Cal. App. 4th 1538, 1554 (2010). Ordinary payroll
expenses are not included in this calculation because they have presumably been
paid separately for a period not to exceed sixty days and, since the business
has not resumed operations, the employees have been laid off.[11]
The policy does not provide a methodology to calculate loss of business income
in the event that Verrill Farms is able to resume operations at an alternate
location.
Second, and at the same time, the policy requires Verrill Farms
to resume operations as soon as possible, at the same or alternate location.
This requires Verrill Farms to incur the actual expense of ordinary payroll
because these employees are necessary to continue operations once they have
resumed.
The United States Court of Appeals for the Fifth Circuit, when
considering the same apparent contradiction in a policy, repeated the trial
judge's observation that "[t]he policy does not address `charges and
expenses' in the event of a resumption of operations and does not clearly state
the effect that a resumption of operations has on the calculation of charges
and expenses." Consolidated Cos. v. Lexington Ins. Co., 616 F.3d 422, 429
(5th Cir. 2010). The court had already noted that the policy required the
resumption of operations as soon as possible.[12] Id. at
427.
The court concluded that "[t]he proper reading of a policy term is
the one that gives it the meaning that `best conforms to the object of the
contract.'" Id. at 430, quoting from In re Katrina Canal Breaches
Litigation, 495 F.3d 191, 207 (5th Cir. 2007). "The fundamental principle
of a property insurance contract is to indemnify the owner against loss, that
is to place him or her in the same position in which he would have been if no
[fire] had occurred." Ibid., quoting from Bradley v. Allstate Ins. Co.,
606 F.3d 215, 227 (5th Cir. 2010). "This represents `the reasonable
expectations of the parties in light of the customs and usages of the
industry,' In re Katrina Canal Breaches Litig., 495 F.3d at 207, and the policy
should be construed in accordance with them." Ibid. The court in
Consolidated Cos. determined that "[i]f the charges and expenses had
already been paid by the revenue of the business, requiring the policy also to
pay them is not placing [the insured] in the same position it would have been
had no damage been suffered. In other words, the only `reasonable' reading of
the policy in the light of the goal of making [the insured] whole is that the
policy requires reduction of `actual loss' by income earned during the partial
resumption of operations. Just as [the insured] would have paid the charges and
expenses out of its revenue if Katrina had never struck, the policy provides
for [the insured] to pay them, to the extent it could do so, out of the revenue
from partially resumed operations. Only if revenue did not offset the charges
and expenses would the insurance policy be called upon for payment."
Ibid.
Here, Farm Family argues that the necessary expense of ordinary
payroll cannot be included as a deduction from gross revenue earned during the
resumption of operations by Verrill Farms in order to calculate net profit or
loss. The judge agreed and concluded that the cost of ordinary payroll could
only be reimbursed directly by Farm Family for a sixty-day period and could not
be included as an expense to offset revenue earned during the period of
restoration when Verrill Farms had resumed operations. The judge's conclusion
would have been correct if Verrill Farms had been unable to resume operations
during the period of restoration. See Amerigraphics, Inc. v. Mercury Cas. Co.,
182 Cal. App. 4th at 1552. The judge's interpretation, however, does not
"construe the contract as a whole, in a reasonable and practical way,
consistent with its language, background, and purpose." Massachusetts
Property Ins. Underwriting Assn. v. Wynn, 60 Mass. App. Ct. at 827, quoting
from Gross v. Prudential Ins. Co. of America, 48 Mass. App. Ct. at 119. The
judge's interpretation would not put Verrill Farms in the position it would
have been in if no fire had occurred. This interpretation also does not account
for the policy requirement that Verrill Farms resume operations as soon as
possible. The policy requires Verrill Farms to resume operations as soon as
possible but only provides a methodology to calculate loss of business income
which assumes that business operations would not be resumed. The policy
provides no methodology to calculate loss of business income in the event, as
required by the policy, that Verrill Farms resumed operations.
By refusing to include the cost of ordinary payroll as a
deduction from gross revenue in the calculation of net profit or loss, which is
the basis to determine loss of business income, Farm Family is artificially
inflating Verrill Farms's net revenue for the year after the fire. The
artificial increase to net revenue also incorrectly decreases Verrill Farms's
actual loss of business income. Unlike the claim made in Consolidated Cos. by
the insured, Verrill Farms made no claim for direct payment of the cost of
ordinary payroll. Instead it used the cost of ordinary payroll as an operating
expense to offset its revenue in determining net profit or loss during the
period of restoration.
The only rational reading of the policy, considering the
contract as a whole as well as its purpose of making Verrill Farms whole, is
that it requires the loss of business income to be determined by the difference
between the amount of net profit or loss earned during the partial resumption
of operations and the amount of net profit or loss that Verrill Farms would
have earned had no fire occurred. The gross income earned during the period of
partial resumption of operations (the restoration period) has to be reduced by
the amount of legitimate and necessary expenses for that period, including ordinary
payroll, in order to determine net profit or loss. Simply put, gross income
must be reduced by the expenses required to earn it in order to determine net
income. Just as Verrill Farms would have paid the cost of its ordinary payroll
(and other continuing expenses) out of income earned if the fire had never
occurred, the policy requires Verrill Farms to pay these expenses, to the
extent possible, out of income earned during the partial resumption of
operations. Only if the net profit or loss for this period was less than the
net profit that Verrill Farms would have earned if no fire had occurred would
the policy be called upon to make the payment for loss of business income.[13]
The judgment is vacated, and the matter is remanded to the
Superior Court for entry of a new judgment allowing Verrill Farms's motion for
summary judgment and denying Farm Family's motion for summary judgment. The new
judgment shall include a declaration that in the circumstances of this case,
loss of business income can only be determined by including the expense of
ordinary payroll, and other unreimbursed continuing expenses required by the
resumption of Verrill Farms's operation, in the calculation of net profit or
loss.
So ordered.
[1] On January 30, 2010, Verrill Farms made a
claim of $626,219 to Farm Family for loss of business income, on which Farm
Family paid $317,825. Verrill Farms filed a complaint seeking the balance of
that claim, and a declaration that its interpretation of the Policy was
correct. Farm Family filed a counterclaim for declaratory relief. The parties
filed cross motions for summary judgment, stipulating that "this case does
not concern any dispute between the parties over the amount of the loss, and
that issue is not before the Court. . . . After the Court interprets the policy
the parties can revisit the issue concerning the amount of loss and conclude
the claim."
[2] In an action with cross motions for
summary judgment, "[w]e ask whether the evidence, in the light most
favorable to the party losing the contest of cross motions, and the controlling
law entitle the prevailing party to judgment." Audubon Hill S. Condominium
Assn. v. Community Assn. Underwriters of America, Inc., 82 Mass. App. Ct. 461,
465 (2012). The parties assert there are no issues of material fact, and as a
result, we review the pure issue of law.
[3] Section A.5.f. of the policy reads in
pertinent part:
"Business Income
"(1) Business Income
"We will pay for the actual loss of Business Income you
sustain due to the necessary suspension of your `operations' during the `period
of restoration.' The suspension must be caused by direct physical loss of or
damage to property at the described premises.
". . .
"We will only pay for loss of Business Income that you
sustain during the `period of restoration' and that occurs within 12
consecutive months after the date of direct physical loss or damage. We will
only pay for ordinary payroll expenses for 60 days following the date of direct
physical loss or damage.
"Business Income means the:
"(i) Net Income (Net Profit or Loss before income taxes)
that would have been earned or incurred if no physical loss or damage had
occurred, but not including any Net Income that would likely have been earned
as a result of an increase in the volume of business due to favorable business
conditions caused by the impact of the Covered Cause of Loss on customers or on
other businesses; and
"(ii) Continuing normal operating expenses incurred,
including payroll."
[4] See, e.g., Buxbaum v. Aetna Life &
Cas. Co., 103 Cal. App. 4th 434, 437 (2002) ("The policy also provided
coverage for loss of business income, commonly called business interruption
insurance"); Wood Goods Galore, Inc. v. Reinsurance Assn. of Minnesota,
478 N.W.2d 205, 207 (Minn. Ct. App. 1991) (using both terms to describe
coverage in a property loss policy).
[5] Section A.5.g. of the policy reads in
pertinent part:
"Extra Expense
"(1) We will pay necessary Extra Expense you incur during
the `period of restoration' that you would not have incurred if there had been
no direct physical loss or damage to property at the described premises. The
loss or damage must be caused by or result from a Covered Cause of Loss.
". . .
"(2) Extra Expense means expense incurred:
"(a) To avoid or minimize the suspension of business and
to continue `operations':
"(i) At the described premises; or
"(ii) At replacement premises or at temporary locations,
including relocation expenses, and costs to equip and operate the replacement
or temporary locations.
"(b) To minimize the suspension of business if you cannot
continue `operations.'"
[6] This duty is reinforced throughout the
policy by means of economic incentives and disincentives. Here, Verrill Farms
immediately moved to a temporary location, following the policy's directive,
and resumed operations elsewhere on a temporary basis.
[7] The provision for "ordinary payroll
expenses" contained in section A.5.f. of the policy reads: "We will
only pay for ordinary payroll expenses for 60 days following the date of direct
physical loss or damage."
[8] The policy here contains the following
definition:
"Ordinary payroll expenses mean payroll expenses for all
your employees except:
"(a) Officers;
"(b) Executives;
"(c) Department Managers;
"(d) Employees under contract; and
"(e) Additional Exemptions shown in the Declarations as:
"(i) Job Classifications; or
"(ii) Employees.
"Ordinary payroll expenses include:
"(a) Payroll;
"(b) Employee benefits, if directly related to payroll;
"(c) FICA payments you pay;
"(d) Union dues you pay; and
"(e) Workers' compensation premiums."
[9] The policy defines "operations"
as "your business activities occurring at the described premises." Verrill
Farms was therefore able, and required, to restart operations at an alternate
location and still be covered for loss of business income until it was able to
restart operations at the covered premises.
[10] Gross income has been
"distinguished from `net income,' which is that portion of the receipts
which remain after paying wages and paying for materials." Black's Law
Dictionary 832 (4th ed. 1968). Net profit is "that which remains as clear
gain of [the] corporation, after deducting from its income all expenses
incurred and losses sustained in the conduct and prosecution of its
business." Id. at 1192. Net profit is now defined as "[t]otal sales
revenue less the costs of the goods sold and all additional expenses."
Black's Law Dictionary 1404 (10th ed. 2014).
[11] If the business did not resume
operations within sixty days but chose to continue paying its ordinary payroll
employees, that expense would similarly not be covered as an additional expense
and could not be used to reduce any projected net profit. The business would
bear the cost entirely of any retained ordinary employees.
[12] The facts in Consolidated Cos. differ
from ours only in that the insured was attempting to use the expenses in
"charges and expenses" in the calculation of lost profits while also
being paid separately for the same expenses by the insurer. The insured was, in
effect, attempting to be paid twice for the same expenses; once in the
calculation of net profit by reducing gross income and again by a direct
payment for those expenses.
[13] Here Verrill Farms claims a net loss in
its business income when compared to the previous year. Even if Verrill Farms
had realized a net profit during the period of restoration, the policy may
still have been required to make up any short fall of net profit when compared
to the net profit of the previous year.