Exporters and sellers in every industry are feeling the effects of COVID-19, and they will look to their trade credit insurance to cover amounts that their buyers no longer can pay. It has been only ten weeks since the first US resident was reported to be infected with novel coronavirus COVID-19, and the virus has wreaked havoc on businesses in nearly every sector since then.
Trade credit insurance (sometimes called accounts receivable insurance) protects sellers against a buyer’s non-payment of debt, up to a certain percentage – typically 80 to 90 percent of the bill. Most trade credit insurance policies include a “waiting period” after a bill is due before a policyholder can make a claim, and 180 days is typical. It is expected that the first wave of COVID-19 trade credit claims will arrive by early summer and continue throughout the year. The anticipated surge in trade credit claims will likely be met with forceful efforts by insurance companies to get out of paying claims.
PUTTING TRADE CREDIT CLAIMS IN CONTEXT
Economists predict that the country’s GDP will shrink by 34% in the second quarter of 2020. One of the largest trade credit insurance companies estimates that in a typical market, 1 in 10 invoices go unpaid. Even less than a year ago, an industry association counting the world’s largest trade credit insurance companies among its members (ICISA) reported an 8% increase in amounts covered by insurance, coupled with a 1.5% increase in claims paid. In other words, more accounts were being insured, leading to more claims for insurance companies to pay. This increase in paid claims, ICISA noted, occurred “despite favorable economic conditions.”
Economic conditions have certainly taken an unfavorable turn since then.
With a worldwide pandemic that has brought the global economy to a nearly grinding halt, sellers in every industry will be unable to pay bills as they come due. Trade credit policyholders will be making more claims – and they will be making those claims to insurance companies whose investment accounts are suddenly worth much less than they were three months ago.
Insurance companies selling property and liability insurance have already staked out their positions on why policies supposedly will not cover COVID-19 losses. There is good reason to believe their trade credit counterparts will respond similarly.
BE PREPARED FOR INSURANCE COMPANY CHALLENGES TO YOUR CLAIM
Trade credit policies generally promise to indemnify a buyer for a specified percentage of unpaid amounts that become due and payable during the policy period. Trade credit insurance is intended to protect a seller from non-payment caused by many things, including a buyer’s default, insolvency, or inability to pay because of catastrophe or acts of God. Policyholders will have strong arguments that buyers who default on payments because of COVID-19 impacts are amounts that the trade credit policy promises to pay.
But policyholders should be wary of insurance company efforts to break those promises. The following are some expected challenges based on concepts addressed in many trade credit insurance policies.
Trade credit insurers often raise the defense of “non-disclosure” to avoid paying claims. The argument goes that if the insurance company had known about some fact or another, it would not have sold you the policy it did. In some jurisdictions, insurance companies can void policies altogether if they successfully prove that a representation or omission in the application process was “material,” meaning it caused the insurance company to take a position it would not have taken otherwise.
In the COVID-19 context, policyholders should expect challenges to what they knew about the creditworthiness of the buyer at the time of contracting. Insurance companies may blame a buyer’s failure to pay on facts about the buyer that are unrelated to coronavirus, arguing that the policyholder failed to disclose things about the buyer that would have changed the insurance picture. Some insurance companies analyze and investigate a buyer’s creditworthiness before underwriting the risk. In those cases, an insurance company will have a harder time using non-disclosure to avoid its obligations.
But in response to any non-disclosure challenges, policyholders will want to look to the insurance company’s prior conduct in similar circumstances. Had they insured contracts involving the same seller before? Has the newly “material” information been asked of the seller before? While it is fact-intensive and likely time-consuming to establish, an insurance company’s previous conduct or silence can go a long way toward discrediting a non-disclosure argument.
Depending on the specific policy period and payment dates, trade credit insurance companies may attempt to raise a “prior knowledge” defense to get out of paying a trade credit claim. Insurance covers risks that are unforeseen at the time the contract is made. Insurance companies will likely seize on the evolving nature of the coronavirus pandemic to argue that sellers had “prior knowledge of facts or conditions” that would alert them to a buyer’s nonpayment.
Any response to the argument that a seller was aware that COVID-19 would impact the buyer’s ability to pay will need to take into account the dates of key pandemic events, both global and local. The dates of COVID-19 actions in the buyer’s home state or country will also likely be at play. As with a response to a “non-disclosure” defense, combating a “prior knowledge” defense is highly fact-specific.
Policyholders may find that the “reasonable expectations” doctrine of insurance interpretation aids them in this scenario. In many jurisdictions, insurance policies must be interpreted to give effect to the reasonable expectations of the average policyholder. It is fair to say that most policyholders reasonably expect their insurance policies to respond to the losses following the sudden and unprecedented spread of COVID-19, whose impact was not appreciated at the time the policy was entered.
Challenges to the Underlying Sales Contract
While the defenses of non-disclosure and prior knowledge rely largely on what was said, done, or known during the application and underwriting process, policyholders should also anticipate challenges to the insured sales contract.
Trade credit insurance policies contain several provisions that limit insurance company obligations if the underlying sales contract is not compliant with the insurance policy. Successful challenges to the validity of the contract – such as that it was never properly executed or that the transaction at issue was not covered by the insured contract – may jeopardize coverage. Some policies specifically exclude coverage if there is any “express or implied agreement . . . to excuse nonpayment.”
To avoid or rebut a challenge about the sales contract itself, trade credit policyholders should take special care to follow and apply the payment terms and credit control provisions in the contract. While there is no policy exclusion for being a conscientious seller, be prudent in your communications with buyers about your payment expectations.
Like so much about the legal impact of COVID-19, coverage for trade credit insurance claims stemming from COVID-19 losses will be fact-specific and potentially hard-fought. Trade credit policyholders should give prompt notice of their claim, document their losses, and prepare to respond to any insurance company challenges with the assistance of their broker or trusted insurance expert.
Vivian Costandy Michael is an attorney in the New York office of Anderson Kill P.C. and a member of the firm’s Insurance Recovery Group. Through jury trials, summary judgment, mediation, and settlements, Vivian has helped to recover millions of dollars in insurance assets under liability and property insurance policies sold to corporate policyholders.