In the Crosshairs

COVID-19 has transformed the health and economy of our nation. Expectedly, the legislative response to this national emergency, at both the state and federal levels, has been swift and far-reaching. Some of these responses have the insurance industry in their sights—particularly insurers that issued coverage for first-party losses. A number of states have proposed legislation that, if implemented, will compel insurers to pay for COVID-19-related business losses even though such losses are not covered under most applicable insurance contracts.

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Such proposed legislation raises serious constitutional questions, among which concern the contract clause and the due process clause of the U.S. Constitution. Below is a brief summary of the proposed bills in New York, Ohio, Massachusetts, and New Jersey, as well as constitutional issues that they present. None of the bills, as of this writing, have been enacted.

New York. Assembly bill No. 10226, introduced on March 27, 2020, applies to those first-party policies of insurance in effect on March 7, 2020, that provide coverage for “loss or damage to property, which includes, but is not limited to, the loss of use and occupancy and business interruption….” More particularly, the bill requires the insurer to indemnify the insured, up to the policy limits, for any business interruption that occurred during the length of the state of emergency declared by Gov. Andrew Cuomo, no matter when that ends. The bill applies only to insureds that employ fewer than 250 full-time employees (an employee who works 25 hours or more a week) as of the effective date of the bill.

The bill also nullifies any exclusion in the policy that precludes coverage because of a “virus, bacterium, or other microorganism that causes disease, illness, or physical distress or that is capable of causing disease illness, or physical distress.” Also, any policy of insurance within the scope of the bill that is scheduled to expire during the state of emergency will be automatically renewed at the same premium.

Finally, the bill provides that any insurer that indemnifies an insured as a consequence of the bill may apply to the superintendent of financial services for potential reimbursement. The bill will take effect immediately upon passage, and will be retroactive to March 7, 2020.

Ohio. General Assembly Bill H.B. 589 applies to first-party policies issued to businesses located in Ohio that insure against “loss or damage to property, which includes the loss of use and occupancy and business interruption….” It is an emergency measure that is “necessary for the immediate preservation of the public peace, health, and safety.” The measure is designed “to protect small businesses from catastrophic losses caused by commercial decline necessary to prevent the spread of COVID-19.”

This bill requires insurers to indemnify those insureds, up to the policy limits, for any business interruption that occurred during the entire state of emergency, issued under Executive Order 2020-01D on March 9, 2020. The bill would go into effect immediately upon passage, and would apply during the entire state of emergency.

The bill would apply to policies issued to businesses in Ohio that employ 100 or fewer full-time employees (employees working 25 hours or more a week). Notably, the bill requires that the policy be “in force on the effective date of this section.” The bill provides that, when enacted, it will “go into immediate effect.” As a result, policies that expire before the effective date will not, as the bill is presently drafted, be subject to its provisions.

Any insurer that indemnifies an insured as a consequence of the bill may apply to the superintendent of insurance for reimbursement.

Massachusetts. Senate Bill 2888 applies to first-party policies “insuring against loss or damage to property…(including any endorsement thereto or exclusions to coverage)…which includes, as of the effective date of this act, the loss of use and occupancy and business interruption in force in [Massachusetts].”

The bill requires the insurer to indemnify the insured, up to the policy limits, for any business interruption that occurred during the length of the entire state of emergency, the declaration for which was issued by Gov. Charlie Baker on March 10, 2020.

The bill provides that such first-party policies “shall be construed to include among the covered perils,” coverage for business interruption resulting from the COVID-19 pandemic. Notably, the bill applies to policies “in force on the effective date of this act, or that become effective prior to the date on which Executive Order 591 is rescinded….” Thus, the bill has retroactive application to policies in effect on and after March 10, 2020, the date of the declaration by Baker. Also, the bill prohibits an insurer from denying any such claim because of a virus exclusion, or the absence of physical damage to the insured’s or other property.

The bill applies only to insureds with 150 or fewer full-time employees located in Massachusetts. Any insurer that indemnifies an insured as a consequence of the bill may apply to the Superintendent of Insurance for reimbursement.

New Jersey. Assembly Bill 3844 applies to first-party policies “insuring against loss or damage or property, which includes the loss of use and occupancy and business interruption in force in [New Jersey] on the effective date of this act….” The bill would take effect immediately upon enactment and would apply retroactively to March 9, 2020.

The bill provides that such policies “shall be construed to include among the covered perils…coverage for business interruption due to global virus transmission or pandemic…as provided in [New Jersey’s] state of emergency declared…in Executive Order 103 of 2020….” The bill requires the insurer to indemnify the insured, up to the policy limits, for loss of use and occupancy or business interruption.

The bill applies only to businesses having fewer than 100 full-time employees (employees working 25 hours or more a week). The bill provides that any insurer that indemnifies an insured as a consequence of the bill may apply to the commissioner of banking and insurance for reimbursement. The Homeland Security and State Preparedness Committee reported favorably on the bill.

The Constitutional Considerations

At the outset, the proposed legislation immediately triggers consideration of whether such legislation runs afoul of the contract clause, which prevents states from passing laws that impair contracts. Specifically, Article One, Section 10 of the U.S. Constitution identifies certain powers that are denied to the states. Within that section is the contract clause, which provides, among other things, that no state shall “...pass any...[l]aw impairing the [o]bligation of
[c]ontract.” Historically, the purpose of this clause was to prevent states from passing laws—as they had after the American Revolution—favoring colonial debtors over foreign creditors. The thought was that abolishing such laws would incentivize foreign investment and help grow our new nation.

But much has changed since 1787. Over the years, the Supreme Court has placed certain limitations on the contract clause and upheld state legislation that affected contracts, especially during times of national crises. For example, in Home Building & Loan Association v. Blaisdell, 290 U.S. 398 (1934), in the midst of the Great Depression, the Supreme Court upheld a Minnesota law that allowed homeowners additional time to prevent their homes from entering foreclosure. While this law, on its face, may have been in contravention of the contract clause, nevertheless the Supreme Court upheld it. In doing so, it sought to harmonize the state’s police power, that is, a state’s right to safeguard the vital interests of its people, with the contract clause.

Specifically, the Supreme Court looked to the following factors to determine that the state law did not violate the contract clause:

• An emergency existed that furnished a proper occasion for the exercise of state’s power to protect the vital interests of the community.

• The law sought to protect a basic societal interest.

• The law was appropriately targeted for its specific purpose.

• The law contained reasonable limitations.

• The law was only temporary in operation.

Over time, the Supreme Court refined the analysis used to determine whether a state law runs afoul of the contract clause. Today, the Supreme Court focuses on the following three issues: (1) whether there was a contractual relationship that is “substantially impaired” by the law; (2) if so, whether there is a legitimate public purpose behind the law; and (3) whether the law is reasonable and appropriate.

With respect to substantial impairment, the court in General Motors Corp. v. Romein, 503 U.S. 181, 186 (1992) asked the following questions: (1) whether there is a contractual relationship; (2) whether a change in law impairs that contractual relationship; and (3) whether the impairment is substantial. Typically, the first two factors are not disputed. Rather, the inquiry ordinarily turns on the third question—whether the impairment is substantial.

Total destruction of contractual expectations is not necessary to demonstrate a substantial impairment. Energy Reserves Group v. Kan. Power & Light Co., 459 U.S. 400, 411 (1983). One crucial factor considered in evaluating whether a contract has been substantially impaired is whether the complaining party has been regulated in the past because “[o]ne whose rights…are subject to state restriction, cannot remove them from the power of the state by making a contract about them.” Id. [citing Hudson Water Co. v. McCarter, 209 U.S. 349, 357 (1908)].

If a determination is made that the state law does constitute a substantial impairment, consistent with the limitations of its police power, the state must identify a significant and legitimate public purpose behind the law, “such as the remedying of a broad and general social or economic problem.” Id. at 411-12. This is because the police power “is paramount to any rights under contracts between individuals.” Allied Structural Steel Co. v. Spannaus, 438 U.S. 234, 241 (1978). Finally, consideration must be given to whether the law implements reasonable and appropriate conditions. Energy Reserves Group, 459 U.S. at 412.

Not surprisingly, efforts by states to pass laws that affect insurance contracts in the wake of national emergencies, like COVID-19, are nothing new. For example, in 2005, Hurricane Katrina struck the Gulf Coast, killing thousands of people and causing billions of dollars in property damage. Shortly after the hurricane, the Louisiana legislature passed a law that extended the period of time within which citizens may file certain insurance claims for hurricane damage, which was previously limited by statute.

Ten days after the new law went into effect, the state attorney general filed suit seeking a declaration of its constitutionality, naming all property and casualty insurers licensed to do business in Louisiana as defendants. The Louisiana Supreme Court upheld the law, concluding that, while it was more than a minimal alteration of insurance contracts, the law targeted a specific and legitimate public purpose—that is, hurricane relief—and contained reasonable conditions in both time and scope. State v. All Property & Casualty Insurance Carriers Authorized and Licensed to Do Business in Louisiana, 937 So. 2d. 313 (La. 2006).

Similar efforts took place after Hurricane Andrew devastated the Southeast in 1992, in which certain insurers sought to exit the Florida insurance market in order to limit their future exposures. To prevent this, Florida passed legislation that temporarily paused, and thereafter severely restricted, the ability of insurers to non-renew or cancel residential insurance contracts. Expectedly, the new legislation was challenged by an insurer seeking to exit the Florida insurance market based on, among other things, the contract clause. The Court of Appeals for the 11th Circuit, however, rejected the contract clause challenge, concluding that the legislation did serve a legitimate public purpose—namely, the protection and stabilization of the Florida economy.

Legislation that imposes upon the insuring agreement an obligation to provide coverage for losses that were not extended in the first place is rightfully viewed as a substantial impairment of the entire contractual relationship, let alone one aspect thereof. But the examples shown suggest that insurers challenging the coverage-imposing legislation, if enacted, cannot bank on invalidating the law even if a substantial impairment of the contractual relationship is shown.

The Takings Clause

The Fifth Amendment, made applicable to states through the due process clause of the 14th Amendment, provides that private property shall not be taken for public use without just compensation. Within the context of the pending COVID-19 insurance legislation, it is incumbent upon insurers to evaluate whether the proposed laws constitute an improper regulatory taking. To that end, in evaluating whether legislative action qualifies as such, courts are required to consider the economic impact of the challenged rule, regulation, or statute on the plaintiff; the extent to which the regulation interferes with investment-backed expectations; and the nature of the challenged action. Connolly v. Pension Benefit Guar. Corp., 475 U.S. 211, 224-26 (1986).

Here, while the nature of the challenged action may be targeting a legitimate public interest, that public interest must be balanced against the harm to insurers. In that connection, insurers will undoubtedly suffer a negative economic impact by having to pay claims that are otherwise not covered. Likewise, despite the highly regulated nature of the insurance marketplace, insurers will be in a position to credibly argue that their investment-backed expectations have been interfered with in light of the unforeseen state mandates to pay for otherwise uncovered claims.

Finally, the proposed COVID-19 legislation must comport with established notions of due process which, under the 14th Amendment, protects against the deprivation of property without due process of law. In particular, such proposed legislation must be carefully scrutinized given its retroactive nature that “presents problems of unfairness that are more serious than those posed by prospective legislation, because it can deprive citizens of legitimate expectations and upset settled transactions.” Romein, 503 U.S. at 191 (1992). Accordingly, such legislation must target a “legitimate legislative purpose furthered by rational means.” Id. Similar to the above-referenced “takings” analysis, such an assessment will require a careful balancing of the public interest against the interests of insurers.