The threshold issue in determining whether there is coverage for COVID-19
business interruption losses is whether there has been physical loss or damage
to covered property. Three recent federal court decisions illustrate the
different approaches that courts have taken in deciding this critical issue and
provide some guidance for policyholders seeking to make COVID-19 claims under
their property policies.
Property policies typically cover "direct physical loss" or
"direct physical loss or damage" to covered property. In the COVID-19
context, a key issue is whether these phrases include a loss of use of covered
property, even if the property is not physically injured or altered. The issue
of whether loss of use without physical alteration is covered is not unique to
COVID-19 claims, and courts have split on the issue.
For example, in TRAVCO Ins. Co. v. Ward, 715 F. Supp. 2d 699 (E.D.
Va. 2020), the court held that a homeowner's loss of use of their home as a
result of toxic gases released by the drywall was "physical loss"
within the meaning of the policy, even though the drywall was not physically
altered or injured in any way.
In contrast, in Universal Image Productions, Inc. v. Chubb Corp.,
703 F. Supp. 2d 705 (E.D. Mich. 2010), the court held that "pervasive
odor, mold, and bacteria contamination" was not "physical loss"
because it did not constitute "tangible damage to the insured
property." Recently, this issue has been addressed by courts in cases
involving coverage for replacement computer hardware following
ransomware and other cyber attacks.
The issue has become central in the fight over COVID-19 business
interruption coverage. While these cases are only just beginning to be
addressed by courts, three recent court decisions demonstrate that courts have
not reached a consensus on this critical issue.
Physical Alteration of Property Required
In Diesel Barbershop, LLC v. State Farm Lloyds, 2020 WL 4724305
(W.D. Tex. Aug. 13, 2020), plaintiff barbershops brought suit against their
insurer, seeking coverage for their business interruption losses suffered when
their businesses were forced to shut down by orders issued by the state and
county. The policies provided coverage for "direct physical loss to …
Covered Property[.]" The insurer moved to dismiss the complaint, arguing
that the policyholders failed to plead a direct physical loss because the
government orders were the cause of the loss and the property had not been
"tangibly damaged." The policyholders argued that a tangible and
complete physical loss to the insured properties was not required and that the
policies covered partial loss to the properties, including loss of use of the
properties as a result of the county and state orders.
The court, siding with the insurer, held that the policies required physical
damage to or alteration of property, not simply a loss of use. While the court
noted that other courts have found loss of use of property, even without
physical damage, to be sufficient to trigger coverage, it found "the line
of cases requiring tangible injury to property … more persuasive[.]"
Id. at *5.
In so holding, the court distinguished a First Circuit Court of Appeals'
decision, Essex Ins. Co. v. BloomSouth Flooring Corp., 562
F.3d 399 (1st Cir. 2009), in which the court held that an offensive odor
permeating a building constituted "physical injury" to the building.
According to the court, "unlike Essex Ins. Co., COVID-19 does not
produce a noxious odor that makes a business uninhabitable." In so doing,
the court seemed to acknowledge that, at least in some instances, the presence
of a substance that is invisible to the human eye can constitute "physical
loss," even where the property is not physically altered. Yet, the court
was unwilling to extend that reasoning to the presence of the COVID-19
virus.
A similar result was reached by the court in Rose's 1, LLC v. Erie
Ins. Exch., Civ. Case. No. 2020 CA 002424 (D.C. Super. Ct. Aug. 6, 2020).
In that case, the court held that restaurant owners were not entitled to
COVID-19 business interruption coverage for losses sustained when their
businesses were shut down by order of the Washington, DC, mayor. The
policyholders argued that, because the policy provided coverage for
"direct physical loss or damage," a loss of use of property
was covered, even if the property was not damaged.
The court rejected that argument, finding that "loss" does not
include "loss of use" because it is modified by the words
"direct" and "physical," and, therefore, "any
'loss of use' must be caused, without intervention of other persons or
conditions, by something pertaining to matter—in other words, a direct physical
intrusion onto the insured property." The court also found that there was
no evidence that COVID-19 was actually present on the policyholders'
property, and, therefore, their loss was not due to any physical change in the
property; rather, it was a result of a government order requiring them to
close.
Physical Alteration of Property Not Required
In contrast, in Studio 417, Inc. v. Cincinnati Ins. Co., 2020 WL
4692385 (W.D. Mo. Aug. 12, 2020), the court took a broader view of what
constitutes "direct physical loss" under a property policy. In that
case, the plaintiffs—hair salons in Missouri—were forced to suspend their
businesses as a result of government COVID-19 orders. The plaintiffs alleged
that it was likely that customers, employees, and other visitors were infected
with COVID-19 and, thus, infected their properties. The plaintiff also alleged
that COVID-19 is a "physical substance" and that the presence of
COVID-19 "renders physical property in their vicinity unsafe and
unusable."
The insurer moved to dismiss the complaint, arguing that plaintiffs did not
plead a "physical loss" as required by the policies because
"direct physical loss requires actual, tangible, permanent physical
alteration of property" and that COVID-19 "does not damage property;
it hurts people."
The court denied the insurer's motion to dismiss, holding that
plaintiffs had stated a claim for direct physical loss. In so holding, the
court applied the dictionary definition of "physical" (i.e.,
"having material existence: perceptible especially through the sense and
subject to the laws of nature") and "loss" (i.e., "the act
or losing possession" and "deprivation"). In finding that these
definitions were met, the court noted that plaintiffs had pleaded that COVID-19
"is a physical substance" that "live[s] on" and is
"active on inert physical surfaces" and that it attached to and
deprived plaintiffs of their property by making it "unsafe and
unusable."
The Takeaways
While COVID-19 coverage cases are still in their infancy and there are only
a handful of court decisions so far, these early decisions do offer some
lessons for policyholders considering whether to litigate a COVID-19 business
interruption claim.
First, differences in policy language may matter. In Diesel
Barbershop, the policy required "physical loss"; in Studio
417, the policy required "physical loss or damage." The
plaintiffs in Studio 471 were able to argue that, because the policy
uses both "loss" and "damage," the two terms are distinct
and, thus, loss of use was covered, even if the property was not physically
damaged. In the absence of that argument, the court in Diesel
Barbershop determined that "physical loss" required actual
"physical damage" to covered property, which it held to mean
"distinct, demonstrable physical alteration of the property."
However, this policy language difference may not always matter, as the court in
Rosie's 1, LLC, held that "physical loss" required some
physical alteration of the property, even though the policy covered direct
"physical loss or damage."
Second, how a lawsuit is pleaded may matter, at least at the motion to
dismiss stage. The plaintiffs in Studio 417 alleged that COVID-19 is a
physical substance, that it was present on their property, and that its
presence had deprived them of the use of their property. On a motion to
dismiss, a court generally accepts a plaintiff's allegations as true. As a
result, the court in Studio 417 found that plaintiffs had pleaded a
"physical loss."
Third, the pleadings will only take a claim so far. If a policyholder is
successful at the motion to dismiss stage, it still must prove its case. While
it remains to be seen what other courts will require by way of proof, the court
in Rosie's 1, LLC, which was decided on a motion for summary
judgment, specifically noted that the plaintiffs "offer[ed] no evidence
that COVID-19 was actually present on their insured properties at the time they
were forced to close." If a policyholder is able to show the actual
presence of COVID-19 on their property, it may strengthen their case for
coverage.
While COVID-19 business interruption cases are still in their relative
infancy, the battle lines are hardening, and, at least currently, there is no
consensus from the courts on whether these claims satisfy the threshold
requirement of "direct physical loss or damage."