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First Round Goes to Insurers in COVID-19 Court Fight

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More than 140 lawsuits have been filed against insurers over claims for business interruptions caused by the COVID-19 pandemic. Photo by Matthew Henry from Burst

An insurer scored a significant win in what is believed to be the first court decision involving a COVID-19-related business interruption claim. 

On July 1, 2020, 30th Circuit Judge Joyce Draganchuk in Ingham County, Michigan, dismissed a lawsuit by the owner of two restaurants in Lansing Michigan, siding with the insurer’s decision to deny a claim for business-interruption coverage because the eateries did not sustain “direct physical loss or damage.”

The decision in Gavrilides Management Company v. Michigan Insurance Co. was previously reported by the National Law Review, among others.  Gavrilides Management sought $650,000 from Michigan Insurance Co. for losses it sustained after Gov. Gretchen Whitmer issued executive orders in March that limited its two restaurants to delivery and take-out orders.

Judge Draganchuck said it is clear from the wording of the insurance policy that only direct physical loss to the properties is covered. She rejected as “simply nonsense” the plaintiff’s claim that the restaurants were damaged “because people were physically restricted from dine-in services.”

“Direct physical loss of or damage to the property has to be something with material existence, something that is tangible, something … that alters the physical integrity of the property. The complaint here does not allege any physical loss of or damage to the property,” the judge said during the July 1 video court session. “The complaint alleges a loss of business due to executive orders shutting down the restaurants for dining … in the restaurant due to the COVID-19 threat, but the complaint also states that, at no time has COVID-19 entered the Soup Spoon or the Bistro through any employee or customer.”

The judge noted that the insurance policy also has a virus and bacteria exclusion, and that loss of access to the premises due to government action is not covered. 

You can watch a recording of the virtual court appearance here.

Testing the Limits of Coverage

Business interruption insurance typically covers the loss of income that a business suffers due to the disaster-related closing of the business and the rebuilding process after a disaster. The COVID-19 pandemic is testing the limits of this coverage and its applicability to unprecedented circumstances.
Countless businesses were forced to close as a result of the COVID-19 pandemic and the ensuing emergency orders. While many businesses have been able to reopen since, often on a limited basis, the losses sustained have been steep and, in many cases, ongoing. 

Several state legislatures, including New York’s, have introduced bills that would require insurers to cover business-interruption losses stemming from COVID-19, even if the policies specifically exclude such coverage. Meanwhile, more than 140 COVID-19-related business interruption cases have been filed in federal courts nationwide, including several filed in U.S. District Court for the Southern District of New York. To read three of the complaints, click on the links below.

Broadway 104, LLC, dba Café Du Soleil, v. Axa Financial, Inc.; XL Insurance America, Inc., No. 1:20-cv-03813, SDNY

Food for Thought Caterers Corp. v. The Hartford Financial Services Group, Inc., and Sentinel Insurance Company, LTD., No. 1:20-cv-03418, SDNY

Gio Pizzeria & Bar Hospitality LLC v. Certain Underwriters at Lloyd’s, London, No. 1:20-cv-03107, SDNY

Advent Valuation Advisors provides a variety of litigation support services, including the assessment of damages from business interruption. For more information on business interruption claims, read our blog posts here and here. If you have any questions, please contact us.

Divorce Decision Reversed After Double Dipping

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Divorce cases involving family businesses can pose unique challenges. Photo by Kelly Sikkema on Unsplash

A Connecticut appellate court recently delivered a resounding rebuke to a trial judge for “double-dipping” in a divorce case.

The court hearing the appeal in Oudheusden v. Oudheusden determined that the trial judge acted unfairly in dividing the couple’s assets and setting alimony, despite warnings from the lawyers for both sides regarding the risk of double-dipping.

According to the appellate decision, Mr. Oudheusden built two businesses during the couple’s decades-long marriage, and they represented his only sources of income. The trial judge awarded Mrs. Oudheusden $452,000, representing half the fair market value of the two businesses, as well as lifetime alimony of $18,000 per month.

In its decision, the appellate court stressed that the lump sum award and the stream of alimony payments were drawn from the same source.

“We agree with the defendant that, under the circumstances of this case, the court effectively deprived the defendant of his ability to pay the $18,000 monthly alimony award to the plaintiff by also distributing to the plaintiff 50 percent of the value of his businesses from which he derives his income,” the decision reads. “The general principle is that a court may not take an income producing asset into account in its property division and also award alimony based on that same income.”

Second bite of the apple

In divorce cases where the assets include a business, the value of the business and its profitability are key considerations in dividing the estate. In Oudheusden v. Oudheusden, the judge sided with the wife’s valuation expert in determining that the businesses were worth a total of $904,000, and that the husband’s annual gross income from them was $550,000.

Under the income approach to valuing a closely held business, the valuation is derived by calculating the present value of future benefits (often cash flow or some variant thereof) that the business is expected to generate. First, the business’s operating results are adjusted, or normalized, for nonrecurring or unrealistic items. In many small, closely held businesses, it is not unusual for the amount of compensation the business pays to its owner-operator to be motivated by tax considerations. In such a case, a business appraiser should normalize the owner’s compensation to reflect a fair market salary for the owner’s job duties. This formalizes the distinction between the reasonable compensation for the owner’s efforts and the business’s return on investment after deducting that compensation.

Next, a multiple of the normalized earnings is calculated based on the perceived risk to the company’s future performance and the expected growth rate of its earnings. The result of that calculation represents the present value of the future benefits to be generated by the business.

When a couple gets divorced, a judge who awards the nonowner spouse half the value of the family business has in essence given that spouse half of the future benefits to be generated by the business, discounted into today’s dollars. Awarding alimony based on a percentage of the same future benefits to be generated by the business would be taking a second bite from the apple, since that stream of benefits has already been divided.

Mrs. Oudheusden’s attorney explained the concept nicely in his closing statement, when he warned the judge of the perils of double-counting a single stream of income:

“Whatever value the court attributes to the business, the court has to, and should back out a reasonable salary for the officer and owner of the company. Because if the court is going to set a support order based on his income, it would not be fair and equitable to also ask that he pay an equitable distribution based on that as well,” he said. “That would be double-dipping.”

Decision reversed

After the trial court issued its decision, Mr. Oudheusden filed a post-judgment motion for clarification, asking if the judge considered $550,000 to be his income from his businesses, or his earning capacity if employed elsewhere. The judge responded that the figure was not a measurement of earning capacity, but rather of income from the two businesses.

The appeals court found that the trial judge “failed to take into account that the defendant’s annual gross income was included in the fair market value of his businesses.”

The appeals court also took issue with the trial court’s award of non-modifiable, lifetime alimony, because it barred Mr. Oudheusden from seeking a modification if he became ill or decided to retire, or if his businesses saw a reduction in their earning capacity. But that is a topic for another day.

The appeals court reversed the trial judge’s financial orders in their entirety and returned the case for a new trial on those issues.

The doctrine against double-dipping is largely settled law in many states, including New York, where a substantial body of case law has refined its application to various scenarios, such as the acquisition by one spouse of a professional license during the marriage. Notable cases include McSparrow v. McSparrow (Court of Appeals, 1995) and Grunfeld v. Grunfeld (Court of Appeals, 2000). That said, attorneys and valuation professionals who work in the matrimonial arena should be aware of the potential for a poorly executed valuation, or a misguided judge, to tilt the scales of justice.

Advent Valuation Advisors has a wealth of experience and a variety of research tools and resources at its disposal to help determine the value of a business and a reasonable salary for its owner-operator. For more information, contact Advent at info@adventvalue.com.

Read the appellate decision in Oudheusden v. Oudheusden here: jud.ct.gov/oudheusen-v-oudheusen.pdf