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Construction Litigation

DSU Primer: Valuable Coverage When a Project Goes Wrong

By Jim Warren, Doug Morgan, and Scott Murray – December 22, 2015

Delay in start-up (DSU) coverage is often purchased with a builder’s risk, construction all risk, or erection all risk policy, and is sold by many insurance companies and marketed by many brokers; however, few truly understand how the coverage works. DSU coverage is also known or marketed as advanced loss of profits, or ALOP; anticipated profits coverage; delayed earnings coverage; delayed profits coverage; delayed completion insurance; and delayed opening insurance. The purpose of this article is to familiarize the construction lawyer with DSU insurance and point out some of the issues that often arise in connection with this coverage. Most practitioners and their clients do not understand DSU insurance, and the mystery is further exacerbated by the lack of case law in the United States construing the coverage. Even so, if care is taken on the front end to accurately describe what is covered and not covered, DSU insurance can be a valuable product to the owner of a project under construction.

DSU coverage is typically purchased with a builder’s risk policy covering the construction of a project, such as a refinery, plant, factory, or apartment building. Very few insurers offer DSU coverage as a stand-alone policy. It is typically an endorsement to a policy providing coverage for property damage. DSU coverage is designed to insure the portion of the revenue that the owner will need to service debt and cover certain other fixed costs of the project. This anticipated revenue is generally referred to as turnover in the DSU endorsement and by the insurers that market the product. DSU coverage may insure principal payments on loans, interest on loans, and property taxes, but not amortization of finance costs. The definition of fixed costs in the DSU coverage may also cover the fees associated with take-or-pay contracts with suppliers. There is sometimes a schedule of the covered fixed costs that the insurer intends to cover under the DSU endorsement. If there is such a schedule, the policy or the DSU endorsement needs to clearly incorporate that document, in order to help avoid potential disputes down the road. By endorsement or memorandum, the DSU coverage may also provide coverage for losses resulting from damage to a supplier’s or customer’s property.

DSU coverage will also cover increased cost of working (ICOW) expenses, which are additional expenses necessarily and reasonably incurred by the owner or on its behalf for the sole purpose of preventing or mitigating a delay. To be covered, these ICOW expenses must also meet an “economic test,” i.e., the expenditure must be less than the amount that the insurer would have been otherwise liable to pay under the DSU endorsement. Usually, the DSU endorsement provides that these ICOW expenses are covered only if the insurer gives its consent to the expenditure.

It is important to always keep in mind that DSU coverage will indemnify the owner only for the financial loss arising from a delay in start-up directly caused by physical loss that is covered by the builder’s risk policy. In other words, there must be an event indemnifiable under the builder’s risk policy, as well as a resulting delay or loss that exceeds the time excess deductible and a loss in turnover that would have been earned had the delay not occurred, in order for there to be coverage under a typical DSU endorsement. London Market Working Party, Delay in Start Up Insurance 1 (IMIA & London Eng’g Grp. 2012)  (last visited July 17, 2015).

DSU coverage is similar to business interruption coverage in certain respects; however, there are some very important differences. For example, DSU coverage provides only one period of delay and only one-time excess deductible that will be applied, regardless of the number of covered losses. Unlike business interruption coverage, the DSU coverage will apply once to the cumulative effect of several covered incidents of property damage. The time excess deductible under the DSU coverage may be applied as a number of days that are excluded from the calculation of the loss or a monetary amount based on the average daily value of the loss. There may also be a daily or monthly cap on the amount of indemnity payable to the insured under the DSU coverage.

Typically, DSU coverage is purchased for a project that has no sales or production history. So, if there is a delay in completion of the project, the determination of the loss of revenue will be difficult. This determination may be based on theoretical estimates and projections. It may also be based on how the project, plant, factory, etc., actually performs after it becomes operational.

Growing Popularity of DSU Coverage
The popularity of DSU coverage has grown dramatically in the past 15 years, primarily because banks and financiers of projects have required the owner or borrower to insure the anticipated revenue stream from the project. A serious delay to the operation of the plant, factory, refinery, etc., may be fatal to the project—particularly where the debt servicing of the loan may be based solely on the projected earnings from the project. According to an insurance industry publication, the number of policies providing DSU coverage has doubled over the last 10 to 12 years. Christopher Hoch, “Construction Delays Are Expensive, But Insurable,” Topics Risk Solutions (Munich Re), Feb. 2013,at 5(last visited July 17, 2015). In addition, the frequency of DSU claims is increasing with approximately 6.5 percent of all DSU risks encountering a loss. Id. at 8. From 1980 to 2008, a majority of the DSU losses involved power plants (27 percent), building and construction (27 percent), and industrial process plants (13 percent).

Policy Language Is Important
Given the lack of case law on DSU coverage in the United States, a court addressing coverage issues that may arise following a claimed DSU loss will most likely analyze those issues based strictly on the four corners of the policy. That is why having clear policy language on the front end is key. Of course, in some instances, the court may look to extrinsic evidence to determine the intentions of the parties with regard to coverage, but it is always better to be in a position to argue (with a straight face) that the language clearly supports your argument concerning the construction of the applicable DSU wording and the application or effect of that wording on the coverage issue. Below is a discussion of a handful of issues that may arise during a DSU claim.

Who are the insureds? Typically, DSU insurance will cover only the owner or owners of the project. It may provide additional insured or loss payee status to the banks or lenders. While this does not always happen, the language in the policy should be specific with regard to the additional insureds under the DSU coverage. Neither the insured nor the insurer should want to utilize a DSU policy or endorsement that uses the typical list of generic affiliates, as this lack of detail by all parties involved (owner, broker, underwriter, etc.) may create confusion over the proper entity or entities that can recover under the DSU endorsement. Similarly, if there are several owners, that fact needs to be referenced in any schedule regarding the covered fixed costs, and that schedule should make clear what costs are being covered for each owner.

An issue that is sometimes overlooked is that the contractor should not be listed as an additional insured under the DSU coverage as the contractor does not have an insurable interest in the project’s turnover; however, there is an exception where the contractor is a partner with the owner or where there is a concession contract and the contractor is a concessionaire. See London Market Working Party, supra, at 1; Max Bommeli, Delay in Start-Up Insurance 11 (Swiss Re Technical Commc’ns & Chief Underwriting Office eds. 2003)(last visited July 17, 2015). To have coverage for delay-related costs, such as additional insurance premiums, the contractor typically needs to obtain coverage for soft costs caused by delay via a contractor’s extra expense endorsement to the builder’s risk policy. See Hunt Constr. Grp., Inc. v. Allianz Global Risks U.S. Ins. Co., No. 1:04-cv-2126-JDT-TAB, 2007 WL 2286128, at *5–6 (S.D. Ind. Aug. 7, 2007) (applying Tennessee law); see also TIC-The Indus. Co. Wyo., Inc. v. Factory Mut. Ins. Co., No. 4:10CV3153, 2012 WL 2859912, at *2, *6 (D. Neb. July 11, 2012) (allowing use of affidavit from “insurance consultant” stating that “[i]t is not standard in the industry for delay in startup coverage to be obtained for a contractor such as TIC” as permissible lay opinion testimony). Usually, the contractor’s extra expense endorsement will have fairly low sub-limits for such soft costs.

What is the “project”? There will be no DSU coverage if the project is not delayed. If a portion of a project or several rooms in an apartment complex have an earlier planned completion date than the scheduled completion date for the entire project set forth in the DSU endorsement, there will not be coverage for a delay to that portion of the project, unless there is language in the endorsement regarding a phased handover and a scheduled completion date for that portion of the project. See, e.g., W2001Z/15 CWP Realty, LLC v. Lexington Ins. Co., No. 650593/2010, 2014 WL 264468, at *4–6 (N.Y. Sup. Ct. Jan. 22, 2014); see also James F. Campenella Constr. Co., Inc. v. Great Am. Ins. Co. of N.Y., No. 10-681, 2010 WL 4812990, at *5 (E.D. Pa. Nov. 24, 2010). In other words, even if a portion of the project is damaged prior to the scheduled completion date in the DSU endorsement, there will be no coverage if the physical damage is repaired prior to the scheduled completion date for the entire project. Thus, the “project” should be well defined, and if a phased handover is intended by the parties, that should be clearly addressed in the DSU endorsement.

Who owns the “float”—the insured or the insurer? If a loss occurs and the DSU endorsement’s scheduled date of completion has not been revised, then an argument may arise as to whether it is the insured or the insurer that gets the benefit of any “float” in the schedule (the planned completion date was earlier than the scheduled completion date in the DSU endorsement). Based on the typical language in the DSU endorsement, as well as the purpose of the cover, any float should go to the insurer’s benefit because the insured did not have the scheduled date of completion modified. See In re Elec. Mach. Enters., Inc., 416 B.R. 801, 845 (Bankr. M.D. Fla. 2009) (finding no “delay” under “Delay in Completion” endorsement to builder’s risk policy because project was substantially completed several months prior to “Anticipated Date of Completion”); Roger D. Branigin & Daniel N. West, “Coverage for Delay and ‘Soft Costs’ under Builder’s Risk Policies: Avoiding the Pitfalls,” 31 Constr. Litig. Rep. No. 7, at 1, 7 (2010), available at Westlaw, 31 NO. 7 CONLITR 1 (“[C]overage for soft costs following an event of physical loss or damage generally begins on the anticipated completion date. Thus, if a project is behind schedule at the time the physical loss or damage occurs, the insurer may be liable for a much longer period of indemnity than it intended. . . . Conversely, if a project is ahead of schedule at the time of the loss, the insured could lose coverage it would otherwise have been entitled to if the anticipated completion date [stated in the policy] is not modified.”). This is why an owner may want to monitor the project to determine whether the contractor has built any considerable amount of float into the schedule. If this is the case, the owner may want the scheduled completion date set forth in the DSU endorsement moved up.

Obviously, insurers providing DSU coverage are also interested in project or program monitoring during construction of the project. This monitoring may be accomplished by site visits by representatives of the insurer, remote monitoring of the schedule, or a combination of these and other methods. The builder’s risk policy, including the DSU endorsement, may even require the insureds (contractors and owners) to submit monthly reports that set forth the latest substantial completion date as well as require the monthly submission of the current project schedule in native format. The submission of this type of information may be a condition precedent to recovery under the policy. Insurer representatives who are on site or otherwise monitoring the project remotely are likely in a better position to determine whether the project was behind schedule due to other issues besides a covered loss. In other words, the insurer’s consultants may be able to determine that the delay was actually due to scope or schedule creep. Insurers are also interested in the project schedule because if there is a covered incident of physical damage, insurer representatives may be able to assist in minimizing the impact to the project schedule.

However, even if there is no delay under the DSU coverage, an insurer may still have to make a payment to the owner or the contractor under a policy’s loss mitigation provision or the DSU endorsement’s ICOW provision, if expenses are incurred to avoid a loss recoverable under the DSU coverage. See Assicurazioni Generali S.P.A. v. Black & Veatch Corp., 362 F.3d 1108, 1115–16 (8th Cir. 2004) (applying Missouri law).

When does the DSU indemnity or delay period end? Under a DSU endorsement, the indemnity or delay period can generally be described as “the period between the scheduled and the actual business commencement dates less any time resulting from delays caused by loss, damage or events for which the insurer is not liable.” See Bommeli, supra, at 15. The DSU endorsement will usually have a maximum indemnity period (12 or 24 months). Typically, the DSU endorsement will provide that the DSU indemnity period begins at the scheduled date of completion as set forth in the endorsement, unless this date is changed by a subsequent endorsement. The scheduled date of completion may need to be revised during the insurance period due to an abundant amount of “float” in the contractor’s schedule or due to schedule or scope “creep” (construction schedule falling behind). This is why program monitoring may be important for both the owner and the insurer.

The DSU endorsement may state that the DSU delay period concludes as of substantial completion, as defined in the engineering, procurement, and construction (EPC) agreement, or commercial operation of the project. These terms, unless very well defined in the applicable documents, may cause problems during the claim process and disputes over the proper date to conclude the delay period may arise. If the parties to the contract of insurance merely use terms such as “placed into commercial service,” “put to its intended use,” or “the actual date on which commercial operations . . . can commence” to describe the conclusion of the delay period, this may not provide enough clarity for the parties—or the court. See generally E3 Biofuels-Mead, LLC v. Zurich Am. Ins. Co., No. 08-CV-2674-CM, 2012 WL 6554437, at *3–4 (D. Kan. Dec. 14, 2012) (applying Nebraska law); see also One Place Condo., LLC v. Travelers Prop. Cas. Co. of Am., No. 11 C 2520, 2014 WL 1018192, at *13 (N.D. Ill. Mar. 17, 2014) (parties disputing the meaning of “planned completion date” and whether completion of the “project” means the construction of all the buildings and structures on the job site or also includes “post-construction project close out and punch list work”).

Will the DSU recovery be offset by the owner’s recovery of liquidated damages from the contractor? An issue sometimes faced during the claims process is whether the owner’s DSU recovery will be offset by its recovery of liquidated damages from the contractor. A related issue is who should pay first, the insurer under the DSU endorsement or the contractor per the EPC agreement? Typically, the parties will want the insurer to pay first as there may be an extended period of time until the issue of liquidated damages is resolved by the owner and the contractor. These two issues can be resolved through clear offset language in the DSU endorsement stating that the parties intend for the DSU recovery to be offset by the recovery of liquidated damages and that the insurer should pay first if there is a covered loss.

Navigating the DSU Claims Process
 If the parties want to avoid disputes, it is important that they work together closely shortly after a covered incident of property damage that has, or will, result in a delay covered by the DSU endorsement. Below are some suggested steps the parties can take to make the DSU claims process smoother for all involved:

  • Early in the claims process, have on-site meetings with the involved parties (insurer, adjuster, owner, and contractor) to discuss the key aspects of the loss, the necessary investigation into the cause of the loss, as well the details of the owner’s DSU claim.

  • Understand that the insurer’s adjustment team will need to investigate the cause of the loss and delay and confirm that the delay was caused by a covered cause of loss. As part of this process, the adjustment team will also try to determine the actual status of the project at the time the physical damage occurred. This is another reason that insurers should monitor the progress of the project, either through regular updates from the owner or contractor, site visits, or remote monitoring of the contractor’s schedule. It is important to note that issues that are unrelated to the covered property damage, such as manpower shortages caused by damages to uncovered property or delays in having the undamaged portion of the project approved by local officials, have been found not to be a valid basis for extending the DSU delay period. See Diamond Beach, VP, L.P. v. Lexington Ins. Co., 748 F. Supp. 2d 648, 655 (S.D. Tex. 2010); Tocci Bldg. Corp. v. Zurich Am. Ins. Co., 659 F. Supp. 2d 251, 259–61 (D. Mass. 2009); see also Delay in Start Up Insurance,” Const. & Real Estate Technical & Legal Bull. Supp. (Jardine Lloyd Thompson Ltd.), Feb. 2012, at 2 (last visited July 17, 2015) (“Delays can also occur to a project from events that are not covered by insurance, such as strikes, industrial action, slow progress or late supply of materials. . . . The DSU insurance will only respond to the insured element of the delay and therefore the uninsured element of the delay will be excluded from the claim when the insured delay . . . is assessed.”). Furthermore, to the extent possible, the adjustment team will try to determine what the plant, factory, apartment complex, etc., would have done but for the delay, considering the economic climate during the DSU delay period. Market conditions may have changed since the DSU coverage was obtained or underwritten, and the actual market conditions prevailing during the delay period will likely need to be examined, as there will need to be a determination that, had no delay occurred, the project could have generated sufficient revenue to cover the owner’s debt servicing and fixed costs covered by the DSU endorsement. This in no way implies that it is the insurer’s burden to show what the project would have generated during the delay period. This just notes the fact that the adjustment team may undertake such a task in evaluating the owner’s DSU claim. Depending on the law in the jurisdiction that the parties are in, it may likely be the owner’s burden to show the actual loss sustained during the delay period, i.e., the turnover the project would have generated but for the delay.

  • Work together early on to prepare a written schedule for the submission of claims under the DSU endorsement and the review and adjustment by the insurer, the adjustment team, or both, of those claim submissions. Such an agreement on the schedule for the submission and evaluation of claims will keep the parties’ expectations of the claims process at a reasonable level. This is important when dealing with the evaluation and adjustment of a DSU claim, which is often a very complicated and complex task.

  • Finally, consider preparing a written agreement to provide an incentive for expediting the reinstatement work. This is sometimes referred to as an “expedited reinstatement agreement.” By entering into this type of an agreement, the parties could, for example, consider using bonus payments to the contractor under the builder’s risk policy’s expediting expense provision and the DSU endorsement’s ICOW provision to get the project operational as quickly as possible. Presumably, such an agreement would benefit all parties involved.

Keywords:  construction litigation, delay in start-up, DSU, builder’s risk policy, property damage

Jim Warren, Doug Morgan, and Scott Murray are members of Carroll, Warren & Parker in Jackson, Mississippi.

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