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Business Interruption Insurance Update

As the world continues to grapple with the public health ramifications of the unprecedented COVID-19 pandemic, a key dispute with significant economic consequences has developed between businesses and their insurance providers. Namely, are the losses sustained over the last several months covered, in whole or in part, by their business interruption insurance policies? Because most commercial insurance policies never contemplated a global pandemic – and the substantial losses occasioned by related economic shutdowns – the answer is unclear. In principle, the coverage provided by these policies is seemingly straightforward. In practice, however, the answer is fact-specific to the circumstances of each business interruption and the specific language governing each insurance policy. This is the key question that federal and state courts are dealing with now.

Most commercial insurance policies protect insured businesses against reduced earnings or the suspension of operations based on physical damage to the property. Many policyholders have filed suit on the ground that contamination (or potential contamination) of the coronavirus and related closure orders constitute a “direct physical loss” that satisfies this coverage requirement. See, e.g., Cajun Conti LLC et al. v. Certain Underwriters at Lloyd’s, London et al., No. 2020-02558 (La. Dist. Ct., Orleans Parish, Mar. 16, 2020).

Because it is still very early on, there are few decisions addressing these arguments. Some courts have been receptive to the claim that the coronavirus causes “direct physical loss” that triggers insurance coverage. As covered in an earlier update, in Studio 417, Inc. et al. v. The Cincinnati Ins. Co., No. 20-cv-03127 (W.D. Mo. Aug. 12, 2020), the District Court rejected the insurers’ contention that there must be tangible or structural damage, and that the plaintiffs adequately alleged a direct physical loss because the coronavirus made their property “unsafe and unusable.” Internationally, a Paris court ruled that insurer AXA was required to pay restaurant owners for business interruption coverage because of the closures resulting from the novel coronavirus.

Most courts, though, have been less receptive to plaintiffs’ claims of physical loss. On August 28, 2020, the Central District of California granted Defendant Travelers Indemnity Co.’s motion to dismiss and held that the Complaint as plead failed to establish any direct physical loss to the property. 10E, LLC v. Travelers Indemnity Co. of Connecticut et al., No. 2:20-cv-04418 (C.D. Cal. Aug. 28, 2020). The District Court determined that, under California law, “losses from inability to use property do not amount to ‘direct physical loss of or damage to property’” and that physical damage only occurs when property undergoes a “distinct, demonstrable physical, alteration.” Mere economic impact would be insufficient. Judge Wilson found that, as plead, plaintiffs failed to allege that the virus “infected” or “stayed on” the surfaces of the property and nothing supported the inference that the virus physically altered the property.

Similarly, in Social Life Magazine, Inc. v. Sentinel Ins. Co., No. 1:20-cv-03311 (S.D.N.Y. 2020), a magazine publisher sued for insurance coverage because it had to suspend its operations due to COVID-19 and, in a motion for preliminary injunction, sought immediate payment. The District Court for the Southern District of New York found that plaintiff failed to show a likelihood of success of the merits of its claim. The District Court concluded that, even if the coronavirus had actually been present on the property – a fact that the plaintiff had difficulty establishing – it could not cause “direct physical loss.” Judge Caproni, in fact, opined that the coronavirus “damages lungs. It doesn’t damage printing presses.” While the plaintiff initially filed an interlocutory appeal to the Second Circuit, it has since voluntarily dismissed its claim without prejudice.

In Diesel Barbershop, LLC et al. v. State Farm Lloyds, No. 5:20-cv-00461 (W.D. Tex. Aug. 13, 2020), the Western District of Texas found much the same. The District Court granted defendant’s motion to dismiss and found that the plaintiffs failed to plead any “direct physical loss” because they could not allege any “distinct, demonstrable, physical alteration” to the property. As with the Central District of California, mere detrimental economic impact was not enough. The court also noted that the insurance policy in question also included “virus exclusion” to coverage so that, even in the event of physical damage, the insurance policy would not apply.

At the state court level, many courts also took a cautious view towards any “physical loss” argument. A D.C. Superior Court disagreed with plaintiff’s assertion that the mayor’s closure order constituted a “direct physical loss” under its commercial insurance policy and granted summary judgment for the defendant. On August, 6, 2020, the court found that a governmental order, by itself, could not, as a matter of law, be considered a “direct physical loss” triggering insurance coverage. Rose’s 1, LLC et al. v. Erie Ins. Exch., Case No. 2020 CA 002424 B (D.C. Super. Ct. Aug. 6, 2020). In any event, the court determined that a “direct physical loss” implies some form of “direct physical change to the insured property.” Because plaintiff could not show that the presence of the coronavirus or the mayoral closure order created any sort of physical change to its property, there could be no insurance coverage.

A Michigan state court also found no direct loss from the coronavirus because there was no “tangible alteration to the property” that was required to trigger coverage. Gavrilides Mgmt. Co. v. Michigan Insurance Co., No. 20-258-CB-C30 (Mich. Co. Ct. July 1, 2020). The court also concluded that, even if there were tangible and noticeable changes to the property, the policy’s “virus exclusion” would bar coverage.

These cases evidence a prevailing trend that would appear to be in favor of the insurance companies on this argument. While one federal court found that the coronavirus could cause “physical and direct loss” due to its physical presence on the insured property, the majority of courts to consider this question found no coverage. The cases also show that insurance coverage depends substantially on the specific provisions of each insurance policy. As recognized in Diesel Barbershop and Gavrilides, even if the plaintiffs were able to plead direct loss or physical damage from the presence of the coronavirus, the plaintiffs would be unable to obtain coverage because their insurance policies excluded losses proximately caused from “viruses.” Policyholders, therefore, must consider the unique language of their policy and factual circumstances, which may strengthen or weaken their coverage claims.