5/22/2017

Peace Nix

With riots at home and abroad ramping up, claims of loss at construction sites are more dependent than ever on clear definitions of perils.

By Barry Huber , Dan Riordan

This article originally appeared in the Spring 2017 issue of CLM sister publication, Construction Claims magazine. All rights reserved.

By the looks of it, public discourse—and propensity to demonstrate concerns in large groups of like-minded people—may be on the rise. At the University of Southern California, Berkeley, students and others took to the streets to protest a speaking engagement, damaging property and looting local businesses in the process. Others elsewhere have voiced their concerns about the planned Dakota Access pipeline in protests that grew heated. And crowds converged on airports nationwide to protest an executive order on immigration.

Social protests, riots and other “civil commotions” are not new. Historians can trace evidence back to ancient Rome, Greece and Egypt. Throughout the world, peace marches, environmental rallies and other events host alliances intent on campaigning against many issues—government policies, racial and sexual discrimination, working conditions, and environmental policies, to name a few—and they have been able to set or change important political agendas for decades. But they have also left behind some damage.

For homeowners, businesses and, yes, even construction sites that fall in the path of these demonstrations, the consequences can be costly. For instance, during the riots that erupted at USC Berkley, CNN reported damage of approximately $100,000 to a new dorm’s construction site. In North Dakota, there are reports of $2 million dollars in damage to construction equipment resulting from the pipeline protests. Other instances, of course, have tallied heavier damages. According to state and city officials, unrest after police shootings cost Ferguson, Mo., at least $5 million, and Baltimore at least $20 million.

Commotion vs. Terrorism vs. Political Risk
The increase in riots, protests and other volatile public gatherings is prompting many business owners—including contractors—to review their risk exposure and how their coverage will respond. It is important to understand which public disturbances might be deemed political in nature; how an event teeters on terrorism but may not be classified as a terrorism event; and how insurance coverage would respond in such events. Additionally, for construction companies involved in activity abroad, it’s essential to understand when commotions or riots become political uprisings or actions that commercial property or other coverages are not designed to cover.

According to a 2015 McKinsey report, “Megaprojects: the Good, the Bad and the Better,” the world needs to spend an estimated $57 trillion on infrastructure by 2030 to enable the anticipated levels of GDP growth globally. The report notes that two thirds of this infrastructure activity will be required in developing markets. These developing markets have rising middle classes, population growth, urbanization, and increased economic growth that need infrastructure. Given the opportunity for contractors to take advantage of international infrastructure projects, it is extremely important that they understand how their insurance coverage addresses international coverage needs such as property, project delays, and the threat of political violence and terrorism, as well as other political risks.

In many instances, commercial property insurance policies and builders risk policies offer some protection against “riot, strike or civil commotion,” the common phrase used in these insurance policies. If included, they often cover property damage for owned and non-owned property as well as possible business interruption costs. If a loss causes damage to property, pushing back the date of completion for the project, it is likely to be covered under a delay-in-completion policy form or endorsement in a builders risk policy. Delayed completion coverage, typically written as part of a builders risk or marine cargo policy, insures against income loss or specified additional expenses (such as additional interest charges) that result from a delay in the completion of a construction project beyond the expected completion. Typical policy forms require any delay in completion to be caused by direct physical loss or direct physical damage to insured property. “Delay” may be defined as “the period of time between the Scheduled Date of Completion, as stated in the Declarations, and the actual date on which commercial operations or use and occupancy commenced or should have commenced.”

Commotion Defined
But what exactly constitutes a riot, strike or civil commotion? The definitions of each have not always been so cut and dried, with many court decisions variously interpreting the meaning of riot and civil commotion and the scope and limitations of insurance coverage.

For one, in Blackledge v. Omega Insurance Company, the Mississippi Supreme Court listed the four elements necessary for a riot or civil commotion to exist within the meaning of a property insurance policy:

(1) unlawful assembly of three or more people (or lawful assembly that due to its violence and tumult becomes unlawful); (2) acts of violence; and (3) intent to mutually assist against lawful authority. The common law clearly indicates that lawful authority is not limited to official law enforcement but extends to those whose rights are or may be injured and seeks to protect those rights. In addition, there must be some degree of (4) public terror.

A 1992 California Court of Appeals decision, in North Bay School Authority v. Industrial Indemnity Company, clarified the difference between riot and vandalism and its significance. Four people broke into two of the insured’s neighboring buildings on three separate occasions over a five-hour period, vandalizing property and setting fires. The court found that such acts, committed out of public view by four people with the intent that they not be observed, do not constitute a riot. The distinction highlights the importance of coverage for the vandalism peril as an endorsement with riot or civil commotion coverage.

A common exclusion directed to damage caused by riot or civil commotion is loss caused by war, civil war, insurrection, rebellion, attack and defense by any government using military personnel or other agents. “Civil commotion” has been described in courtrooms as an “uprising among a mass of people which occasions a serious and prolonged disturbance and an infraction of civil order, not attaining the status of war or armed insurrection. It requires the wild or irregular action of many persons assembled together.”

The United States Court of Appeals for the 3rd District, in its 1996 decision in Younis v. Cigna Worldwide Insurance, clarified the difference between a covered riot or civil commotion and an excluded insurrection. It was unquestioned that losses to business property owned by a corporation in Liberia occurred when two individuals led their respective armies in a violent uprising to overthrow the government. The court found the events to be within the scope of the war risk exclusion in the applicable policies.

In yet another case, in 2010, nearly 100 people were killed and more than US$1 billion in property was damaged in Bangkok during political protests against the Thai government. The government declared these events acts of terrorism. Some insurers, however, claimed that the demonstrations fell under the definition of political violence or strikes, riot and civil commotion rather than terrorism.

Politically Speaking
Politically motivated attacks, civil unrest and government actions continue to threaten global businesses’ operations, assets and people. Many multinational companies—large corporations, both public and private, involved in foreign direct investment, cross-border lending or international business—manage the risk of political instability and violence with stand-alone terrorism, political violence, traditional political risk insurance, or a combination of these coverages.

Again, it’s important to understand the difference. Political violence is broadly defined as the use of violence as political expression. Therefore, some activities around the inauguration might be labeled acts of political violence because of their tie to a political event. However, violence that occurs after the home sports team loses the championship—because it is not tied to a political event—would more than likely be defined a civil commotion or riot. On the other hand, terrorism is typically defined as “the unlawful use or threat of violence especially against the state or the public as a politically motivated means of attack or coercion.” And there is still considerable debate as to when political violence is considered terrorism. For instance, the Boston Marathon bombing was not certified as an act of terrorism by the U.S. government because it did not meet the damage thresholds required to trigger federal terrorism coverage.

Disagreements over how to label turmoil will likely find their way into courts. After all, a fire is a fire. But is a violent group gathering a riot covered by a property or builders risk policy, or is it an insurrection that requires political violence coverage? Is a violent protest civil commotion or an act of homegrown terrorism?

When Governments Act
Traditional political risk insurance, however, addresses a different kind of exposure. Political risk is the risk that a company’s strategic equity investment could suffer as a result of acts by a foreign government due to political changes or instability in a country. Political risk insurance policies provide coverage for several perils, including expropriation, currency inconvertibility, non-payment, and contract frustration. Political violence coverage is often added to political risk policies as an additional peril. Political risk policies are most commonly purchased by exporters, manufacturers, global financial institutions, commodity traders and engineering, procurement, and construction contractors. Also note that political risk policies are offered to cover a company’s foreign political exposures, not its domestic exposures.

For investors and multinational construction firms, the biggest risks appear in developing countries with immature or volatile political systems. One concern, for instance, is “expropriation risk,” or the possibility that host governments would seize foreign-owned assets. In 2015, for example, an Argentine judge ordered the seizure of assets of oil-drilling companies operating in the disputed Falkland Islands, which included $156 million of boats and other property. Under the late president Hugo Chavez, Venezuela seized assets for some 60 oil companies to nationalize the industry in 2009.

Because of growing precedents in international law, asset seizures are uncommon. However, as interest in emerging markets has climbed, other political risks have emerged. In many emerging markets, there is a risk that a government will discriminatorily change the laws, regulations or contracts governing an investment. This should especially be a concern for contractors involved in infrastructure projects where such an action can result in delay and reduce investors’ financial returns. In fact, this risk is why financial institutions rely on political risk insurance if they are involved in foreign infrastructure investments.

Consider a situation in India. The newly elected government of the state of Maharashtra in India canceled the contract for a $2.8 billion electric power generation plant to be built and owned by a consortium. While new negotiations led to a revised deal, local media continued to criticize the arrangement as too generous for the foreign investor. Inevitably, disputes between the power purchaser and the consortium continued and led to the termination of the project.

For contracts, it is important to note that political risks can take many forms and affect various phases of an infrastructure project’s life cycle. Early on in a project, the risks can include delayed construction permits and community protests. Later on, risks can include breach of contract and tightened regulations. And end-of-life risks include the nonrenewal of licenses and revised decommissioning requirements.

Construction Projects, Protests and Politics
Given the need for infrastructure projects, contractors must understand their exposure on all fronts. In February 2015, the World Economic Forum issued a report in collaboration with The Boston Consulting Group as part of the Strategic Infrastructure Knowledge Series. Strategic Infrastructure: Mitigation of Political & Regulatory Risk in Infrastructure Projects addresses key challenges to bridging the global infrastructure gap. After analyzing political and regulatory risk facing infrastructure investors and operators, the report’s authors outlined a holistic risk-mitigation framework. It consists of 20 actionable measures to be taken by the various parties—some by the public sector, some by the private sector, and some by the two sectors jointly. It provides further guidance in the form of 25 international best practices from different infrastructure sectors—such as roads, railroads, airports, and electricity supply—where political and regulatory risk has effectively been mitigated.

To make infrastructure projects attractive and safe for all involved, the public sector, such as national governments, need to create a stable environment for private investors and operators, according to the report. This includes ensuring that changes to sector rules, laws or regulations are as predictable as possible. Other actions noted include measures to protect investors, fair and fast dispute-resolution mechanisms, and strong anti-corruption policies.

Contractors interested in taking advantage of construction project opportunities have to do their part in mitigating political and regulatory exposure, which often means managing, transferring, and reducing these risks. This includes learning about how these political and regulatory systems work and putting in place adequate safeguards. For example, according to the World Economic Forum report, investors and operators can seek political-risk insurance as one way to protect their interests.

As it is not uncommon for large infrastructure projects to trigger public controversy among the public, special interest groups and local governments, construction professionals on all sides can expect threats to projects and ensuing claims to remain top of mind. Claims professionals and risk managers will be continuously challenged to undertake a thorough analysis of policyholder exposures, a detailed evaluation of insurance contracts, and a careful untangling of complex coverages when a loss event occurs.



Barry Huber is global practice leader for Political Risk, Credit & Bond (PRCB) Claims at XL Catlin.

Dan Riordan is president of XL Catlin’s Global Political Risk, Credit & Bond (PRCB) insurance business.

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