Testing the Waters

Facing an unprecedented pandemic, states and cities across the U.S. issued emergency lockdown orders starting in March 2020, which shuttered hundreds of thousands of businesses across America, costing those businesses an estimated hundreds of billions of dollars. Many businesses will never recover. The year 2020 has been unlike any in our lifetime.

Given the massive interruption of businesses in 2020, it is not surprising that policyholders dusted off their business interruption policies to see exactly what it was they were paying for all of those years while never submitting a claim.

As a general matter, business-interruption coverage is not for any business interruption, but rather is a form attached to commercial-property policies, intended to cover business interruption caused by property damage. Where this occurs, property policies pay for repairs as well as resulting business-interruption losses while the repairs are pending. As many of us know already, these policies contain express virus exclusions.

American Courts Find No Coverage

It was always going to be an uphill battle to obtain coverage under property policies for business interruption caused by COVID-19 shutdown orders. Property insurers have uniformly denied coverage, and policyholders have filed more than 1,000 lawsuits, including several hundred class-actions and a request for consolidation under the multi-district litigation statute.

Starting in May 2020, U.S. courts began issuing decisions that found no business-interruption coverage for COVID-19 losses, and, as of this writing, 14 of 18 orders have found no coverage on the face of the pleadings.

A leading case out of the Central District of California, 10E LLC v. Travelers Indem. Co. of Connecticut, confirmed that temporary impaired use or diminished value from a COVID-19 lockdown does not constitute property damage and thus is not covered loss under a property policy:

[L]osses from inability to use property do not amount to “direct physical loss of or damage to property” within the ordinary and popular meaning of that phrase. Physical loss or damage occurs only when property undergoes a “distinct, demonstrable, physical alteration.”

Plaintiff’s FAC attempts to make precisely this substitution of temporary impaired use or diminished value for physical loss or damage in seeking [b]usiness [i]ncome and [e]xtra [e]xpense coverage. Plaintiff only plausibly alleges that in-person dining restrictions interfered with the use or value of its property—not that the restrictions caused direct physical loss or damage.

The four U.S. opinions that favored policyholders found that the plaintiffs had sufficiently alleged losses resulting from property damage that could trigger business-interruption coverage under a commercial-property policy. The Western District of Missouri issued two of those cases, suggesting that jurisdiction may carve out an exception. A state court in New Jersey issued the third decision, which is unpublished. The fourth case in favor of policyholders, out of the Middle District of Florida, is unlikely to have significant precedential value in COVID-19 jurisprudence because the court’s decision was based on a procedural failure by the insurer to attach the full policy to its motion to dismiss.

The first and leading pro-policyholder case, issued by the U.S. District Court for the Western District of Missouri, Studio 417, Inc. v. The Cincinnati Ins. Co., found that the policyholders “plausibly alleged that COVID-19 particles attached to and damaged their property, which made their premises unsafe and unusable,” and that such allegations were sufficient to satisfy the “direct physical loss” requirement at the motion-to-dismiss stage. However, this kind of pleading is unlikely to work for the majority of U.S. policyholders because most policies have virus exclusions.

Trouble Abroad

While the trend favoring insurers looked strong, alerts were raised on Sept. 15, 2020, when the UK High Court of Justice issued its judgment in a COVID-19 pandemic test case, The Financial Conduct Authority v. Arch Insurance (UK) Ltd., et al., generally finding coverage under a wide variety of business-interruption policies.

The judgment results from a test case brought by the UK Financial Conduct Authority (FCA), the regulatory body with authority over insurers, concerning the availability of business-interruption insurance for business owners who suffer losses caused by the pandemic. The FCA and eight insurers agreed to a streamlined process to litigate the availability of such coverage under 21 different policy forms to “provide greater clarity for all parties, both insured and insurers.”

The FCA test case addressed three categories of “extension” clauses that expand coverage to specifically named perils: (1) the presence of notifiable disease within a specified radius of the insured premises; (2) civil authority shutdowns for emergencies, including disease; and (3) prevention or hindrance of access to the insured premises due to government or other authority action, without reference to specific cause.

Because many policies reviewed were industry-specific, unlike standard ISO policies, the UK court examined the language with a view toward the industry affected in seeking to understand undefined terms. Using this particularized approach, the UK court found that most, but not all, of the extension clauses reviewed provide coverage for business interruption brought about by the COVID-19 pandemic.

Coverage and Judgment Analysis

However encouraging to policyholders, the FCA test-case decision is unlikely to have a large-scale effect on business-interruption litigation in the U.S. While the UK decision is the most consequential pro-policyholder decision on pandemic coverage to date, most courts on this side of the Atlantic are unlikely to consider the case persuasive authority because it concerns very specific policy language that is not common in U.S.-issued policies.

The FCA test case considered only non-damage policies; none of the extension clauses require physical damage as a prerequisite to coverage, unlike most U.S.-issued business-interruption policies. For example, the latest version of ISO’s “Business Income (and Extra Expense) Coverage Form” (ISO Form CG 00 30 10 12) covers business interruption where either the insured property sustains “direct physical loss,” or surrounding property suffers a “covered cause of loss,” resulting in civil-authority action that prevents access to the insured property.

The UK High Court reviewed many policies that explicitly disclaim a physical-damage requirement, and each expressly extended cover for disease, closure of premises due to emergency (including disease), or denial of access by civil-authority action. In its press release announcing the Sept. 15, 2020, judgment, the FCA acknowledged the distinction, noting that the decision applied to a minority of UK-issued policies, and that most business-interruption policies “are focused on property damage and only have basic cover for [business interruption] as a consequence of property damage.”

The distinction explains the stark difference between the UK outcome (coverage) and the contrary result in most U.S. decisions, which have found no coverage for COVID-19-related losses: The U.S. cases have involved “basic” business-interruption cover tied to property damage. The UK High Court itself noted the distinction between the provisions it considered and standard business-interruption coverage in paragraph 80 of the judgment: “There is no dispute before the court about whether there is cover under such standard ‘business interruption’ policies,” for which coverage is “contingent on the occurrence of physical or material damage to the insured premises.”

In another marked difference, the FCA test case reviewed whether social-distancing measures constitute “prevention of access,” and concluded that phrase requires mandatory rather than advisory restriction, such that certain early pandemic UK orders would not serve as triggering events. Other policy forms at issue extended cover for “hindrance in access,” which the UK High Court construed as rendering something more difficult rather than impossible, broader than “prevention of access” forms.

Depending on the specific language of the individual policies, generally the UK High Court found it covered “prevention of access” losses if a lockdown order required a business to undergo fundamental change from the business described in the policy schedule. For example, if a restaurant business began providing takeout service only after lockdown orders, the court found there was “prevention of access.” However, restaurants that already had a substantial take-out service pre-lockdown did not experience “prevention of access,” although they may have suffered “hindrance,” the UK High Court said.

In the U.S., however, the standard policy form provides interruption cover where civil-authority action “prohibits” access to premises, a far narrower coverage. The absence of a total prohibition was dispositive in at least one case, Sandy Point Dental v. The Cincinnati Ins. Co.:

[P]laintiff concedes that dental offices were deemed essential businesses for emergency and non-elective work. Consequently, plaintiff has failed to allege that access to its premises was prohibited by government order, and its claim for civil authority coverage fails.

As to extensions that cover perils within a specified radius, the UK High Court ruled a localized disease outbreak is required to trigger coverage. Many U.S.-issued policies similarly require that the insured property be within a mile of the damage, and that the “action of civil authority is taken in response to dangerous physical conditions resulting from the damage or continuation of the covered cause of loss that caused the damage.”

Thus, to the extent non-standard policies include virus or resulting disease as a covered cause of loss, a U.S. court might view the UK High Court’s FCA test case ruling as persuasive authority, limiting coverage to where administrative action responds to a local disease outbreak rather than the pandemic more generally, a potentially significant limitation.

American business-interruption policies generally do not, however, include disease as a covered cause of loss. In short, the FCA test case decision, widely expected to be appealed, is not anticipated to have significant impact in the U.S.