From atypical deep freezes to hurricanes, floods, and fires, natural disasters can have a significant impact on the food and beverage supply chain. Here to talk about that on this episode of the Food For Thought podcast is Michael Gehrt. Michael is an insurance recovery attorney and he works with companies to litigate on their behalf against insurance companies. He also offers advice to companies on how to plan and prepare for any business interruptions brought about by natural disasters.
Join us as we talk about what constitutes a natural disaster— the answer may surprise you. We talk about different types of policies and coverage as they pertain to food and beverage businesses, as well as how to mitigate the risks associated with operating a business in the event of a disaster.
Transcript
Erin: Michael, welcome to the Food for Thought podcast. It is great to have you on today. I want to open this episode, and have you tell the audience who you are and what you do.
Michael: Sure, and then thank you for having me. I appreciate the opportunity to speak with you today. So, my name is Michael Gehrt, and I'm a partner at Passage LLP, which is an insurance recovery law firm and we have offices in Los Angeles, Manhattan Beach in New York, and I've been practicing in this area and insurance recovery since I started practicing law, right out of law school.
I litigate against insurers on behalf of policyholders. My practice includes litigating against insurers, but it also includes providing advice to insured. If it's in respect to ongoing claims, if it's with respect to insurance placement, or insurance terms, any really insurance-related matters, that come up, I view myself as a strategic partner with my clients on all of those insurance-related matters. My approach, along with the approach that is shared by my partners, is that my clients' insurance policies are an asset and my job in a straightforward fashion is to assist my clients with maximizing the value of that asset. So, whether that's litigation, whether or not it's advice, my goal is to create a return on that asset and make sure that they're getting the full value of the asset that they've paid, in many cases, a substantial amount for.
Erin: I know, from doing the prep work for this particular episode that you deal in natural disasters, which is something that the U.S. has definitely dealt with a lot in 2021. If you could what, by legal definition, of how you work with them is a natural disaster?
Michael: Yes, we do deal quite a bit with natural disasters, and there have been quite a few recently. And we've been involved with substantial claims arising out of Hurricane Katrina, Hurricane Sandy, sinkhole claims, floods in Thailand, just to name a few. In my practice, there's no legal definition of a natural disaster. And policies, insurance policies, typically don't use that as a contractual term.
Speaking generally, the property policies, which are the types of policies that you'd be looking to in many respects for coverage for a natural disaster, including in the food processing industry, they typically are written in two ways. One is they're either "all risks," or they're "named peril." And so as the name suggests, all-risk policies cover everything, unless it's clearly conspicuously excluded.
You start with everything is covered. And then you start carving things away from that coverage through the exclusions, which are policy terms that specifically delineate what is and what is not covered. Named peril policies are slightly different. They start from the other end, which is to say, "Here is what is covered, and these are the only things that are covered, for example, wind, fire, flood, hail." They'll list out named perils. And then there are also the exclusions.
The starting point is what specifically the policy covers as opposed to all risk, which the starting point is everything. So, the question, for my purposes is not necessarily whether something qualifies as a natural disaster but whether the specific risk that is causing the loss of the damage is covered by the policy that you're dealing with. So, if it's a flood, is it under the all-risk policy? Is there an exclusion for flood? If it's under named peril policy is flood one of the perils that is included? Those are the kinds of questions that I'm asking myself, not necessarily whether or not something qualifies as a natural disaster from a legal standpoint because that's not something that's really captured in the policies.
Erin: Something that we saw happen earlier this year in Texas was the cold snap that happened in February. And it completely upended the supply chain. I know you're talking about natural disasters, and that there's not a legal textbook definition. But there's got to be ways that you've worked with clients, or given advice as well that how do natural disasters impact food manufacturing operations? How has it impacted how these food processors work?
Michael: Sure, absolutely, and before addressing those impacts, you mentioned the cold snap in Texas. And that's a good example of ways in which to maximize an insurance policy as an asset. Many policies explicitly do not cover changes in temperature. That's the language used. However, courts have found that the phrase change in temperature is ambiguous because it could apply to either indoor or outdoor changes in temperature. And that's important because when a phrase is ambiguous in an insurance policy, the courts are required to resolve that ambiguity against the insurer, and in favor of coverage. Receiving a letter from the insurance company saying, "Oh, there's no coverage here because the cold snap is a change in temperature," that's not the whole story. And so, that's an important example of really considering your policies and working with coverage counsel to make sure that you're getting the most out of those policies.
In terms of impacts, in addition to the kind of unforeseen event in Texas natural disasters cause a whole variety of impacts to the food supply industry. I'll start with the most basic ones, and kind of expand out from there. A natural disaster, as everybody can anticipate, does cause damage to the facility itself. You know, if you have a plant or a factory, a natural disaster can damage it. That can require repair and replacement of the factory. And even if the facility itself is not damaged, there may be equipment breakdown that needs to be repaired. All of that can fall within coverage of a property policy and are typical of the type of typical coverage that a property policy provides. Now, the damage to the facility and the subsequent repairs can also result in lost profits, or what is commonly referred to as business interruption. And that too is oftentimes covered by a property policy. So that's kind of the straightforward coverage that is typically provided as property coverage, and then as well as business interruption coverage.
But that's not the only story when it comes to natural disasters. You may suffer no damage to your property itself, but still have substantial impacts and substantial losses. Some policies do provide coverage for the interruption of utility services. For example, water and electrical. Those can be a significant issue, as you might imagine. During natural disasters, specifically in the food supply industry, the failure of or the interruption of electrical service can cause a breakdown of refrigeration services or the inability to use refrigeration services, which can result in spoilage or contamination. So, that type of interruption coverage, you know, may be significant in this industry specifically.
In addition to utility service interruption, there's also supply chain disruption. You mentioned that with respect to the cold snap in Texas. But supply chain disruption is significant when it comes to natural disasters, and in my experience is typically overlooked. Policies provide what is called contingent time element coverage, and what that means is it covers an insured loss. It's financial loss as a result of damage to a supplier's or a customer's location. So, the insured itself has suffered no damage. But its supplier is hit, for example, with a hurricane or a flood or a windstorm. And that causes a ripple effect in the supply chain that results in financial losses to the insurer, even though it has suffered no damage itself, and that those supplier locations or customer locations can include a service provider, as well as, you know, an actual supplier of raw material.
And the way this coverage works is that a natural disaster can hit a specific location but result in covered loss to ensure that it's halfway across the world. It's important for insurers to understand this coverage if they have it and to be cognizant of it so that they don't attribute a supply chain loss to just the cost of doing business that assists an increased cost because of things that are happening around the world. It very may very well be an insured loss under the contingent time element coverage. That's a significant issue and one that we deal with and advise clients on regularly.
In addition to the supply chain, natural disasters can also result in damages to roads and railways, which as you imagine would have a domino effect throughout the food supply chain. Foods and ingredients can take longer than they should to transport as a result of a natural disaster, which again increases the chance of spoilage or contamination. And there is coverage for specific spoilage coverage that can be purchased in the marketplace to address that risk. Natural disasters can also cause infrastructure damages. There could be damage to refrigerated storage facilities, which obviously can result in impacts in terms of spoilage and increased risk of contamination. So, all of these impacts are important to consider. They're not just the direct impact of the natural disaster, but the ripple effects down the road. And they all can fit within certain policy terms if they're purchased and if the insured has that specific type of coverage.
Erin: Are there ways for food processors to mitigate the risks associated with the natural disaster?
Michael: Mitigating against natural disasters certainly isn't easy, particularly given the scope of them and the increased prevalence of them recently. However, there are loss prevention measures that insured in the food supply chain or in the food industry can take when a natural disaster is approaching. In the case of hurricanes, there are the usual precautions when it comes to buildings in terms of sandbags and windows. Speaking to the food supply chain specifically, in the past, swine and poultry producers have moved animals out of the area in an attempt to reduce potential loss. There are things ahead of time that can be done to mitigate against the risk of a greater loss. And the insurance policies typically do have a provision that will provide coverage for the expense that it takes to do that, essentially recognizing that the efforts that the insured is making to reduce loss redound to the insurer's benefit because it reduces the potential insurance claim, and so those kinds of efforts are covered under most insurance policies.
In terms of the supply chain, you can take some steps to mitigate your supply chain as well. I think it's important to understand your supply chain; they're very complex these days. It's not just a straight line, and have alternative sources for critical suppliers. So that if there's a natural disaster, say a hurricane in one area of the country, you can then source your critical supplies from another area and therefore reduce or, again, mitigate your supply chain risk. And, oftentimes, if their cost is greater due to limited supply. For example, if a hurricane impacts one industry, but there's still a portion of the industry remaining function in another area, now, the supply is lower, the cost is greater, that extra expense that you incur, it still can be covered by your property insurance policy. And so, again understanding your supply chain and having alternative sources for critical supplies can be critical in reducing a potential loss.
I think some other areas, in the food supply chain because of the increased risk of contamination following a natural disaster, it's important for a food processor to know where their ingredients arrive from, and when they arrived, so that you can isolate products in the event there is a necessary recall due to issues arising from a natural disaster. You can easily identify which products are susceptible to that, and continue your operations as normally as possible. So that's another smaller piece of advice in terms of mitigation.
And finally, I think insureds should also be prepared to prove losses ahead of time. This involves really an assessment of how and where your financial information is stored. In the event of a natural disaster, you have backups or records in the cloud that can be accessed from another location in the event that your facility is substantially damaged. It's really preparing ahead of time so that you can maximize coverage under your policy, and therefore, mitigate your loss by being prepared before a natural disaster hits.
Erin: For those processors that have dealt with some of these disasters, what course of action should they follow, especially as it relates to their insurance and loss?
Michael: The first course of action is to assess and document the loss. And this is easier said than done because, oftentimes, insurance is the last thing on anyone's mind during a natural disaster, and for good reason. I mean, the safety of employees, the safety of your people is important. But it's important before and after losses happen to kind of keep in mind what you're going to need to do, what you're going to need to prove in terms of your loss. Photographs and records reflecting the damage and losses can prove invaluable in a subsequent insurance claim. It's critical to have a process and a team in place before a natural disaster strikes so you know exactly who's going to do what, who's going to collect what, who's going to maintain what, for purposes of a claim down the road. And part of the assessment of that loss, and this is something people don't often think about, part of the assessment should include whether or not operations can be partially resumed or fully resumed at a different location to the extent there are different locations.
And these possibilities have to be considered because the failure to do so, the failure to consider whether your operations can be partially resumed or what can be transferred can be used against an insured by an insurer during the adjustment of the business or option claim. It's important to think about those things ahead of time and make those assessments early on. And, of course, you know, the logical incident next step is to review your insurance policy and notify the insurer of the loss. And in this process, it's helpful to involve an insurance recovery attorney in order to navigate the various coverages that are provided by the policy and the various exclusions in the policy. And it may sound simple, but, you know, many property insurance policies have 5 to 10 different types of coverage or extensions of coverage and in terms of exclusions anywhere from, you know, a small amount, or a handful of 10 to 20 different exclusions, all with different limits or different sub-limits for various coverages, some based on timing, some based on amount. So, it's important to navigate all that upfront so you know exactly what is covered by your policy, and how to present that to the insurance company.
It's also helpful at this stage, given the scope of the loss or the amount of the loss, but it's helpful to retain a forensic accountant so that they can present the financial loss, at least the business interruption side loss, to the insurer in an organized and coherent manner. Oftentimes, the claim preparation costs are covered by the policy. The cost of the forensic accountant to put together the claim packages calculated, presented in a table format with supporting documentation. All of that can be reimbursed by the insurer if they accept coverage. So, the earlier the better in terms of involvement. And I know that sounds potentially self-serving, but I'm always happy when a client contacts us early because then we can provide even if it's very limited guidance, but the limited advice in the beginning steps to make sure that the claim is presented appropriately and the policy terms are complied with. So, that's how I would view the kind of initial course of action following a natural disaster.
Erin: A follow-up to that, can you outline the process for proving and calculating business interruption claims?
Michael: Yes, I can. The process is straightforward in theory, but can get certainly complicated in the details. And first, I would note, it's important to satisfy the insurance requirements in terms of the initial claim submission and how you present the claim. So, if the insurer has a specific claim form that they use, it's good to use that form. If they're going to require certain reports or certain types of proof from the insured, then, you know, it's good to know that upfront. So, we always recommend an open line of communication with the insurer so that there are no misunderstandings down the road to avoid headaches down the road so that all of the information is presented appropriately.
And there are a variety of ways to prove and calculate a business interruption loss, depending on the insured's business. You can look to the most generic ways to look at prior sales, and looked at prior years and say, you know, you would have done X in this year based on your prior history if it weren't for the natural disaster. So that's a fairly straightforward and rudimentary way of doing it. You can also look to the performance of comparable businesses to see kind of what they did without the natural disaster, as opposed to what the insured did after the natural disaster. And you can also look to financial projections. So, if the insured did financial projections prior to the natural disaster, they didn't know what was going to happen, but they projected certain profits and certain business, you can use those as a basis to determine what would have happened if not for the natural disaster. So that all, you know, makes, I think, fairly makes sense, and it's fairly straightforward.
But it gets complicated in a number of ways. One is what if the business or even just the business segment that suffered a loss is new? In that case, you don't have a past history to look to, to calculate the loss. You're really doing it based on a hypothetical. And that can create ambiguities or uncertainty with respect to the amount of the loss. If the company is was unprofitable, prior to the loss, then it can be difficult to establish a loss going forward. Now, that unprofitability might have nothing to do with the company's performance. It may be that there's a business cycle that you have to factor in that, you know, if you looked at the first three months prior to the natural disaster, we're always unprofitable during that time. But our business cycle is we have substantial sales during the next two months. And that's what would have happened if not for the natural disaster. You could explain it that way.
The other way that I've seen is that if a company was planning to expand, or it just landed a new customer that it would result in substantial profits that it had not otherwise experienced, the loss should account for that but the prior year performance won't. So, you have to factor that in and substantiate that to the insurer in order to capture that aspect of the loss. So, all of these issues, a new company, or poor performance in the immediate time prior to the loss or new expansion or new customers, that all requires factual development. And they benefit from the involvement, again, of a coverage attorney and a forensic accountant to make sure that loss is properly calculated, and that to make sure, which is the ultimate goal, to make sure that the insured receives the full coverage provided by their policy.
Erin: Whether in hindsight or foresight, are there things processors can do or be thinking about in terms of their insurance coverage?
Michael: Yeah. In terms of things to think about, I don't want to inundate you, but I would highlight some of the basics in terms of the insurance policy. I mean, one of the foundational questions would be do you have business interruption insurance? if you don't, it's probably a good idea to get them because natural disasters result in substantial losses that are independent of the damage to the structure itself and oftentimes far exceed the cost to repair the facility or the physical damage itself. And if you do have a business interruption coverage, how much coverage do you have? And, more importantly, is that amount sufficient for your operations? Oftentimes, I find insureds simply carry over their limits from year to year and don't really assess how their business has changed and expanded or contracted in various years. So, you know, notably, if a business has expanded, then the policy may not provide the necessary coverage to weather a natural disaster. So even if the insurance company fully accepts coverage, there's still a shortfall because the company hasn't reassessed its needs, its insurance needs along the way. So that's an important component thing that oftentimes insureds overlook.
And then the last thing on the insurance policy itself is do you have the right kind of coverage? You know, I mentioned earlier utility coverage and contingent time element coverage that protect against supply chain risk. Those are extensions of coverage that insureds should consider purchasing if they're exposed to those risks. And also, some insurers provide specialized policies for specific industries. And so that may be something worth exploring with a broker, as well, to get unique coverage for the food processing industry. And finally, I mentioned this earlier and touched on it earlier is plan for a business interruption plan in advance. Don't do it in hindsight. So, I mentioned you need to have a team that would be responsible for the company's response, both to the natural disaster itself, but also responsible for the subsequent insurance claim.
And I mentioned, maintain proof of your expenses and losses. Maintain it in a secure location. And this doesn't just include receipts for expenses, although that's important, but company contracts, supplier contracts, customer contracts, expense reports, financial projections. I mentioned those are a basis to substantiate a business interruption claim. So, keep those. Prior financial records to show the history of past performance, which also supports a business interruption claim. So, all of that's going to need to be assessed following a natural disaster. So, it's important to have that process in place, those secure locations in place, so that you reduce the headaches down the road, especially when you're in the midst of not only submitting a business interruption claim but let's not forget responding to a natural disaster. So, the more you can focus your business on that, the better. And the smoother your business interruption claim will ultimately be.
Erin: Do you have any examples of recent business interruption cases that you can share, share some of their outcomes? I realize it might be a big ask if you're willing to share. I don't know if you are.
Michael: I represented a client who was in the electronics industry. And one of their products required hard drives to be installed. At the time, the majority of the world's hard drives were manufactured in Thailand, and Thailand suffered substantial floods. There was an increased cost and an increased difficulty in obtaining hard drives for a period of time. Now, obviously, my client was not located in Thailand. My client was located here in the United States. But the increased cost was substantial, and they needed to incur that increased cost to continue doing their business. The policy had, as I mentioned before, this contingent time element coverage, which is essentially against supply chain coverage for physical loss or damage to locations of your suppliers. But in this case, it required that the supplier be a "direct supplier." And so, the question at issue, in this case, was whether or not this hard drive manufacturer was a direct supplier.
And the insurance company took the position that no they were not because the hard drives were not shipped directly to my client. They were sent to an assembler, a third-party assembler, that would put the product together and then provide it to my client. And we argued that although it wasn't physically shipped directly to my client, that in the electronic supply chain industry, the term direct supplier would be understood to encompass this scenario where my client had substantial input and control over the product and had input on the design and the specifics of the product. And that in this industry, the hard drive manufacturer would be considered a "direct supplier" or at the very least, that that's a reasonable interpretation and that the insurance company is obligated to or is assumed to know that industry usage.
We ultimately prevailed in the Ninth Circuit on that argument and subsequently resolved the claim. It highlights some of the very specific factual issues and the need to consult with a coverage attorney on these issues because it's not always cut and dry. And oftentimes, insurers will deny coverage on what, at least to a layman, appears to be a legitimate ground. But when you look at the specific policy language, when you look at how those terms are used in the industry, then the insurer's position becomes less reasonable and less tenable. So, I use that as a common example, particularly in this area of a contingent time element loss that has been discovered.
Erin: If a food processor wanted to get in touch with you, and let's say they wanted to talk to you, consult, maybe hire you, how could they get in contact with you?
Michael: Sure. They can email me at [email protected], pasichllp.com, or they can simply pick up the phone and call me (424) 313-7855. And I would note that you know, an initial analysis, I typically do those free of charge. I take a look, let people know if there's an issue to be dealt with. You know, my goal in every representation is to create value. So, I'm not going to, you know, put good money after bad and I regularly tell clients, if that's the case. But if it isn't, if there's something to push on, if there's a reason to push back then, you know, I certainly provide that as well. So I'm happy to chat whenever on any insurance-related issues.
