Blog Question – Goodwill

A question came through this morning on Goodwill. The broker thought that Goodwill covered an Insured’s existing goodwill, which is a common misconception.

So let me start with explaining what goodwill is. Most businesses, not all, develop a reputation that generates income through their good name. This can be due to their proven performance, their reliability and/or the quality of their product or service. The established reputation of a business is regarded as a quantifiable asset and calculated as part of its value when it is sold.

Goodwill is, therefore, a future benefit flowing from the assets of a business (refer Australian Accounting Standard (“AAS”) 18). There is an inevitable adverse effect on goodwill whenever a business is interrupted by damage to assets, so that its performance falls away. Usually, this loss can be recouped as part of a consequential loss claim for loss of Gross Profit, because the extra time needed to regain market share once production and sales resume is a factor in selecting an adequate Indemnity Period. But a retailer with a prime site, or with a liquor licence “tied” to the site, is likely to suffer permanent loss of business if prevented from re-opening at that site, following damage.

While the value of goodwill of an existing business affected by a disruption is not typically able to be insured for a number or reasons, a form of Goodwill is able to be insured by endorsement under an Industrial Special Risks (“ISR”) Policy and by some quality business packs.

This Goodwill endorsement to Section 2 of an ISR policy (whilst not a panacea), provides compensation by helping such enterprises to acquire the goodwill and/or licence of a similar business elsewhere. If the sub-limit selected is adequate, it will pay the acquisition costs in excess of the value of the tangible assets. This excess amount is effectively made towards the purchase to the goodwill of the business being purchased, not the one being affected by the disruption.

Due to the inter-relationship, no cover applies under the goodwill endorsement, unless an insurance on gross profit or gross revenue is also in force.

The actual endorsement reads:

GOODWILL

The Basis of Settlement clauses in Section 2 are extended to include the following provision:

Subject to the Sub-Limit of Liability stated in the Schedule against Goodwill, in the event of Damage (other than in circumstances where cover is excluded) occurring during the Period of Insurance to any building or other property or any part thereof used by the Insured at the Premises for the purposes of the Business, which results in one of the following circumstances:

(a)  the rebuilding or reinstatement, whether total or partial, of the premises at the site being prohibited by, or not being commercially viable because of, any Act of Parliament or regulation made thereunder or any by-law or regulation of any municipal or statutory authority,

(b)  the lessor’s neglect, refusal or inability to rebuild or reinstate the Premises or to renew the Insured’s lease or monthly tenancy,

(c)   the refusal of any liquor licensing authority to grant an extension to carry on the Business at the Premises under the licence held by the Insured, the Insurer(s) will compensate the Insured under this Item for the cost expended by the Insured to purchase Goodwill and/or a liquor licence upon acquisition of a similar business, within a reasonable time after the Damage, less that part of any amount(s) recoverable under any other Item or Items of Section 2 of this Policy which represent(s) the actual loss sustained by the Insured resulting directly from the interruption of the Business for such additional time, beyond the period required with the exercise of due diligence and dispatch to rebuild or reinstate the Damage, required to restore the Business to the condition that would have existed had no Damage occurred. 

GOODWILL means the future benefit from unidentifiable assets.

Special Conditions

1.    The Insurer(s) shall not be liable under this Item unless the Insured shall also have maintained in force an insurance on Gross Profit or Gross Revenue.

2.    The Insurer(s) shall not be liable under circumstance (c) unless the Insured has used due diligence to ensure the observance of all licensing laws.

3.    The insurance by this Endorsement shall not be prejudiced if any of the circumstances stated in Clauses (a), (b) or (c) of Condition 13 of this Policy arise due to the Damage.

This insurance is not for every business but is invaluable for some, particularly those with a hard-to-get licence that could be lost, or a very special location.

To learn more, refer to my book Understanding the ISR Policy, Volume 1.