A New Plan for Policies

As warmer weather arrives, some states have lifted or modified stay-at-home or shelter-in-place orders and relaxed social distancing restrictions. Many fear that the loosening restrictions, combined with cooler weather, will result in a second wave of COVID-19 in the fall.

The first wave of the pandemic saw widespread closures and significantly reduced operations of restaurants and retail establishments, along with corresponding insurance claims by those businesses trying to recover their lost business income. Some of those claims have already evolved into lawsuits, with insurers taking the position that the claims are not covered based on various terms, limitations, and exclusions in the policy. Those lawsuits are in their infancy, and their outcomes remain to be seen. In the meantime, insurers should prepare for the possibility of a second wave of COVID-19, and the claims and lawsuits that are certain to follow.

Defining “Direct Physical Loss”

Perhaps the biggest point of contention between insurers and insureds with respect to lost business income claims during the COVID-19 pandemic is whether the insureds have suffered “direct physical loss.” The standard Insurance Services Office (ISO) form for Business Income (and Extra Expense) Coverage (CP 00 30 10 12) contains two particularly relevant coverages: business income and civil authority coverage. The insuring agreement for the business income coverage provides, in pertinent part, that the insurer “will pay for the actual loss of business income you sustain due to the necessary ‘suspension’ of your ‘operations’ during the ‘period of restoration.’” However, “[t]he suspension must be caused by direct physical loss of or damage to property at the described premises. The loss or damage must be caused by or result from a covered cause of loss.” (italicized emphasis added)

Likewise, the civil authority coverage is triggered “[w]hen a covered cause of loss causes damage to property other than property at the described premises.” The phrase “covered cause of loss” is defined in a separate form— Causes of Loss, Special Form (CP 10 30 10 12)—as “direct physical loss.”

To trigger either the business income or civil authority coverage, “direct physical loss” is required, either at the premises described in the policy or at other premises. However, “direct physical loss” is not defined. What constitutes “direct physical loss” has been the subject of much litigation, with varying outcomes.

Some courts have held “direct physical loss” requires an actual change to the covered property. For example, in AFLAC Inc. v. Chubb & Sons Inc., 260 Ga. App. 306 (2003), the Georgia Court of Appeals explained that the common meaning of the words “direct physical loss or damage” and the subject policy as a whole “indicate that it contemplates an actual change in insured property then in a satisfactory state, occasioned by accident or other fortuitous event directly upon the property causing it to become unsatisfactory for future use or requiring that repairs be made to make it so.”

The same rationale was evident in cases regarding business income coverage following the 9/11 terrorist attacks. For example, in United Airlines v. Insurance Co. of the State of Pennsylvania 439 F.3d 128, 129 (2nd Cir. 2006), the insured airline sought indemnity for losses it suffered as a result of the terrorist attacks. The issue was whether the insured could recover for its lost earnings caused by the national disruption of flight service and the government’s temporary shutdown of the airport. Because the insured could not show that such lost earnings resulted from physical damage to its property or from physical damage to an adjacent property under the unambiguous language of the insurance policy, the losses were not covered. 

On the other hand, in some cases, the “direct physical loss” requirement was satisfied despite the absence of any actual change to the covered property; rather, the mere confirmed presence of a harmful substance sufficed to trigger coverage. For example, in Gregory Packaging Inc. v. Travelers Property Casualty Co. of America U.S. Dist. LEXIS 165232, at *1 (D.N.J. Nov. 25, 2014), ammonia was released inside one of the insured’s facilities. There was no genuine dispute that the ammonia discharge rendered the insured’s facility physically unfit for normal human occupancy and continued use until the ammonia was sufficiently dissipated. The U.S. District Court for the District of New Jersey found, as a matter of law, that the ammonia discharge inflicted “direct physical loss of or damage to” the insured’s facility because the ammonia physically rendered the facility unusable for a period of time.

Similarly, in Motorists Mutual Insurance Co. v. Hardinger, 131 F. App’x 823 (3rd Cir. 2005), the court found, under Pennsylvania law, that contamination of a home’s water supply constituted a “direct physical loss” when it rendered the home uninhabitable.

Further, in Essex v. BloomSouth Flooring Corp., 562 F.3d 399 (1st Cir. 2009), the court decided under Massachusetts law that an unpleasant odor rendering property unusable was held to constitute physical injury to the property.

COVID-19 and Direct Physical Loss

Policyholders seeking coverage for their loss of income as a result of the closure or reduced operation of their business during the COVID-19 pandemic argue that the “direct physical loss” requirement has been satisfied by the presence of coronavirus. In fact, some local stay-at-home orders requiring the closure of nonessential businesses include a declaration that there has been “direct physical loss.” For example, in Florida’s Broward County, the County Administrator’s Emergency Order 20-01 provides: “WHEREAS, this Emergency Order is necessary because of the propensity of the virus to spread person to person and also because the virus is physically causing property damage due to its proclivity to attach to surfaces for prolonged periods of time.”

This argument raises several issues. The business closures are due to a concerted effort to stop the spread of the virus, and not necessarily due to the confirmed presence of the virus in the insured’s facility. In addition, the virus can be cleaned from surfaces. Courts have held that where alleged damage can be remediated by cleaning, there is no “direct physical loss.”

For example, in Mama Jo’s Inc. v. Sparta Insurance Co., 2018 U.S. Dist. LEXIS 201852 (S.D. Fla. June 11, 2018), the court held that the insured restaurant did not sustain direct physical loss when dust and debris from nearby roadwork could be remediated by cleaning. Similarly, in Universal Image Productions Inc. v. Chubb Corp.., 703 F. Supp. 2d 705 (E.D. Mich. 2010), the court held that intangible harms, such as odors or the presence of mold and bacteria in an HVAC system, did not constitute physical damage to property. In Great Northern Insurance Co. v. Benjamin Franklin Federal Savings & Loan Association, 793 F. Supp. 259 (D. Or. 1990), aff’d 953 F.2d 1387 (9th Cit. 1992), the court opined that asbestos contamination was not a physical loss, as the building remained unchanged.    

Setting these issues aside, one potential way to circumvent the battle about what constitutes “direct physical loss” would be to define that phrase in the policy. For example, the definition could require a structural change to the allegedly damaged property. In addition, the definition could exclude damage that can be remediated by cleaning.

Virus or Bacteria Exclusions

Many policies also contain the standard ISO endorsement for Exclusion of Loss Due to Virus or Bacteria (Form CP 01 40 07 06), which excludes coverage for loss or damage caused by, or resulting from, any virus that is capable of inducing physical distress, illness, or disease. This endorsement was developed in response to the 2006 outbreak of SARS, another coronavirus.

There is little case law interpreting the virus or bacteria exclusion outside of mold claims, and certainly none in the context of a global pandemic. Insurers can rely on this exclusion to argue that the unambiguous language of the exclusion precludes any COVID-19-related losses. To the extent policies do not already include the virus or bacteria exclusion, those policies should be updated to include it.  

It is important to note that legislative action could undermine the enforceability of the virus or bacteria exclusion. In some states, bills have been introduced that would retroactively expand the scope of coverage under existing policies to include coverage for business interruption losses due to COVID-19. For example, the Massachusetts legislature introduced a bill that mandates coverage “for business interruption directly or indirectly resulting from the global pandemic known as COVID-19.” The bills states,“no insurer in [Massachusetts] may deny a claim for the loss of use and occupancy and business interruption on account of (i) COVID-19 being a virus (even if the relevant insurance policy excludes losses resulting from viruses); or (ii) there being no physical damage to the property of the insured or to any other relevant property.” (italicized emphasis added)

Other states are considering similar bills that may impact how insurers address business income and loss-of-use claims arising out of the pandemic.

Finally, perhaps the most effective way to ensure lost business income due to an insured’s closure or reduced operation during the COVID-19 pandemic is to specifically exclude such losses. In many states, the term “arising out of” is construed broadly. For example, the phrase “arising out of” has been interpreted by Georgia courts very broadly to mean almost any causal connection whatsoever, no matter how slight, between the alleged conduct of the insured and the resulting damage [see BBL-McCarthy LLC v. Baldwin Paving Co., 285 Ga. App. 494, 498, 646 S.E.2d 682, 686 (2007)]. The intent of an exclusion for losses arising out of COVID-19 and/or SARS-CoV-2, the virus that causes it, would be unmistakable.

In connection with the claims arising out of the first wave of the COVID-19 pandemic, policyholders have developed creative arguments in an attempt to circumvent the policy language. For example, with respect to the business income coverage insuring agreement that requires “direct physical loss of or damage to property,” policyholders argue that businesses that have been forced to close because of stay-at-home orders, but have not confirmed the presence of the coronavirus at their locations, have nonetheless experienced the loss of use of their properties, which satisfies the insuring agreement.

Updating policies in the ways suggested should make clear the insurer’s intent not to cover these types of claims and put insurers in a better position to respond to claims arising out of a potential second wave of the COVID-19 pandemic. However, policyholders will undoubtedly continue to fashion creative arguments, and judicial intervention will almost certainly be required to resolve these issues