Insurance Coverage for Losses Caused by Blackouts.

The summer is coming to an end, but California's energy crisis continues, While the Independent Systems Operator ("ISO") must give limited warning of impending blackouts, these warnings will not prevent all business losses. Affected companies may look to their insurers to reimburse these losses.

Accident or Planned Loss?

Insurance is intended to cover accidents, not planned or known losses, so now that the ISO must give some notice of blackouts, insurers will contend that any damages incurred result from planned events, not fortuitous ones. Insurers will assume that the ISO decision to create blackouts is the relevant "event" and, this being "intentional," say there is no coverage. However, the blackouts are a result of the deregulation of energy in California, and no one responsible for that deregulation intended to create an energy shortage or rolling blackouts. At most, the blackouts are an unintended consequence of a flawed political decision.

Even if the ISO's planned blackouts were the relevant event for insurance purposes, whether there was an "accident" still must be judged from the standpoint of the insured, not a third party the policyholder does not control. Courts have long recognized a public policy that insurance should not be provided where it would permit someone to "take advantage of his own wrong," such as by awarding life insurance to a person who commits suicide. Along the same lines, if a business pulls the plug on its own electricity, and the likely result is damage to their property, then coverage should be denied to deter such wrongdoing. But when the a utility starts a rolling blackout, if the business takes reasonable steps to minimize damage, but it occurs nevertheless, then the policyholder is not profiting from its own wrong. Under that scenario, public policy would be in favor of, not contrary to insurance coverage.

"Physical" Damage To Tangible Property?

While a business might be able to recoup its losses under to its "all risk" or "property" insurance, these policies insure only for direct "physical damage" to, or loss of use of, covered property, and the "property" at issue must be "tangible." Spoiled perishable goods, or computer crystals or precision parts, which become unusable if the manufacturing process is interrupted are tangible property and within the coverage of these insurance policies.

The same result would extend to computer data lost or damaged during a blackout. The inaccessibility of data certainly renders the computer itself, for all intents and purposes, useless, and this loss of tangible property (viz, the computer) should satisfy the policy's requirements.

A federal court has taken this one step further, finding that the data itself is tangible. In that case, a ground fault caused a half- hour power outage, that shutting down the policyholder's computers and telephones. When power was restored, the mainframe lost all programming information stored in random access memory, and because all random access memory had been lost on the tracking system, the matrix switch had to be reprogrammed with custom configurations before the mainframe could fully communicate. Although there was no "physical damage" to the computer system and matrix switch in the sense that they were still capable of performing their intended functions, the court found The Court disagreed, fthat loss of use and functionality, constitutes "physical damage," including the loss of data, the interruption of a computer's services, and the alteration of software or a computer network constitute "physical damage.". Interestingly, the court condemned Tthe insurer's restrictive definition of "physical los s" as "archaic." The court distinguished a federal case from California, i in which another court found that the incorporation of a defective drive into a personal computer was not physical damage because there had been in that case no claim that the defective drive did or could harm other components of the host computers.ii The Arizona court

Special "sue and labor" clauses in many insurance policies also may provide coverage for Insurable losses resulting from reasonable efforts to mitigate loss or damage to covered property. Mitigating measures might reasonably include purchasing backup generators, or shutting down crucial computer systems or even shutting down the entire operation to avoid damages.

Business Income Insurance

Businesses also may seek coverage from their business income insurance policies. These policies are specifically designed to cover lost business income. These policies reimburse lost business income sustained "due to the necessary suspension of your operations during the period of restoration,." and o

Often, these policies are limited to a suspension "caused by a direct physical loss of or damage to property" within a specified distance (e.g., 100 feet) of the insured's premises and caused by a "covered loss."

Some of these policies contain a "period of restoration" definition which may require a suspension of operations lasting at least 72 hours -far longer than a typical energy shortage blackout. But if blackouts become frequent or result in glitches that prevent resuming operations, and the aggregate amount of downtime may exceed 72 hours, policyholders would maintain that this cumulative figure satisfies the 72 hour requirement of these policies.

Energy Interruptible Insurance

Long before the energy crisis, Vsome companies agreed to reduce their demand imposed on the electrical system shortly after receiving a "notice of interruption" from their utility in return for lower rates. However, under this scheme they were also subject to penalties if they did not reduce demand by the requisite amount within a finite period of time.

To protect themselves from liability for non-compliance with the reduction in demand notice, some insurers have soldbusinesses bought policies whereby the insurer pays a percentage of the penalty. However, to collect on these policies, businesses may have to demonstrate that good faith efforts to cut energy consumption failed to reduce their usage enough to avoid a penalty. but despite those efforts

As discussed above, insurance may be available for losses caused by California's energy crisis. A well prepared business will consider what can be done to maximize insurance at the same time it looks for ways to minimize losses.

Scott P. DeVries is Managing Partner of Nossaman, Guthner, Knox & Elliott LLP and Alison S. Hightower is a partner of Nossaman's San Francisco office. They specialize in representing policyholders in insurance coverage disputes.