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."
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."
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