By Gary Thompson

Law360 (April 9, 2020, 2:25 PM EDT )

Gary Thompson

Hundreds of billions of dollars in business interruption coverage will turn on how courts resolve whether COVID-19 is a direct physical loss. The insurers are fast circling the wagons to argue that it is not, as argued in the April 6 Law360 guest article "Coronavirus Is Not A Direct Physical Loss Triggering Event."

Policyholders, however, can make a formidable argument, backed by multijurisdictional case law, that COVID-19 constitutes "physical loss or damage" sufficient to trigger business interruption coverage, with full policy limits (including any business interruption coverage extension that incorporates the "physical loss or damage" trigger).

As the COVID-19 crisis unfolds, commercial policyholders have already made thousands of claims under specialized coverages such as "contagious illness," "civil authority," and "loss of attraction," mostly based on state or city stay-at-home orders issued to control the spread of the virus. These tailored coverages, however, typically provide narrower coverage: with sublimits of liability, waiting periods before coverage is triggered, limits on the days of coverage provided (e.g., 30 days maximum), and policy deductibles or retentions. 

Meanwhile, there is a much deeper reservoir of coverage: regular business interruption coverage, which in most cases triggers full policy limits. "All risk" property insurance policies cover all business interruption that results from physical loss or damage that interrupts the business. This article explains why many policyholders can claim standard business interruption coverage (and related coverages) that hinge on a finding that COVID-19 constitutes physical loss or damage.

Of course, there is the usual caveat: It is critical to review the policy language. Before considering this full business interruption argument, policyholders should note that there could be an express policy exclusion, such as for all loss arising out of or related to a "contagious illness" or the Insurance Services Office exclusion for loss arising out of "any virus, bacterium or other microorganism that induces or is capable of inducing physical distress, illness or disease." But in the absence of an applicable exclusion — which insurers have had available to add to property policies since 1986 — the strong implication in an "all risk" policy is that loss resulting from COVID-19, if not expressly excluded, is thereby covered. 

Setting aside the debate about the meaning and application of any exclusions (also, e.g., for "pollution or contamination"), the threshold debate for regular business interruption coverage hinges on the meaning of "physical loss or damage," as reviewed below. This issue could be the most impactful in the history of insurance coverage debates, with hundreds of billions of dollars at stake for policyholders in the aggregate.

Principles of Policy Interpretation

Before canvassing the case law on the issue, it is important to take guidance from three core general principles of insurance policy interpretation. The state law in this regard is nearly uniform, and one can quickly marshal the necessary case cites in any state:

• Plain language governs. Courts look first to the plain language in the policy to give effect to the intention of the parties. 

• Ambiguity is construed in favor of coverage. If policy language is found to be ambiguous, a court will construe the issue in favor of coverage (also called the rule of contra proferentem). The tie goes to the runner.

• Exclusions must be narrowly construed. The insurer has the burden to show that a claim falls within exclusionary language, which is construed narrowly against the insurer.

Typical Policy Language and Limits

Commercial property policies, almost without exception, provide broad "all risk" coverage for all types of physical loss or damage not specifically excluded.[1]

The most common triggering language is the happening of "physical loss or damage" to the covered property. The interrelated time element coverages (business interruption and extra expense) are commonly triggered by "loss resulting from necessary interruption of business conducted by the Insured, whether total or partial, and caused by physical loss or damage covered herein during the term of this policy to real and personal property" as described.

There is a long-running debate in the case law as to what constitutes "physical loss" as distinct from "physical damage," with the policyholder logically arguing that the word "loss" cannot be collapsed into and mean the same thing as "damage." While "damage" might mean tangible physical damage such as inflicted by a tornado, "loss" must mean something different from "damage."

Here, COVID-19's actual or suspected physical presence at or in the vicinity of a property prevents the policyholder from making full use of the property, especially in cases where the business (such as a hotel or restaurant) has had to close in part or in full. This kind of loss constitutes a physical loss to the property in that there has been a loss of use of the property. Moreover, the COVID-19 virus is a "physical" thing, not an abstract fear. For example, a restaurant forced to close due to COVID-19 in or near the restaurant has suffered a "physical loss" of use of its property, with resulting business interruption loss.

Many courts have made this distinction between physical damage and physical loss in contexts analogous to COVID-19. For example, in Motorists Mutual Insurance Co. v. Hardinger,[2] the U.S. Court of Appeals for the Third Circuit (applying Pennsylvania law) found that bacterial contamination of a home's water supply constituted a direct physical loss to property because, despite the lack of physical damage, it rendered the home uninhabitable.

And in Cooper v. Travelers Indemnity Company of Illinois,[3] where a tavern was forced to close due to E. coli contamination in its well water, the U.S. District Court for the Northern District of California held that the E. coli constituted direct physical damage to the property and ordered the insurer to pay time element/extra expense coverage.

Many other courts have made this distinction between physical damage and physical loss in a range of other factual contexts, all of which support application here in the COVID-19 situation.

For example, in Total Intermodal Services v. Travelers Property Casualty Company of America,[4] the U.S. District Court for the Central District of California interpreted "direct physical loss of or damage to" language as encompassing "loss of use." In that case, some cargo was lost during shipment but was not physically damaged, and the court held this event constituted physical loss of insured property, stating that "'loss of' property contemplates that the property is misplaced and unrecoverable, without regard to whether it was damaged."  

And in U.S. Airways v. Commonwealth Insurance Co.,[5] an airline sought coverage for business interruption losses sustained as a result of the government's closure of National Airport during the 9/11 attacks. The insurer argued that actual damage to the airline's property was required to recover under the civil authority part of business interruption coverage. The Virginia Circuit Court rejected this argument, ruling in favor of the policyholder and distinguishing the insurer's cases that involved policies with language requiring "physical damage."

Indeed, dozens of courts across the country, both state and federal (too many to cite here) have likewise found physical loss in fact patterns where there has not been tangible physical damage to the property.

As one among many examples, in Columbiaknit Inc. v. Affiliated FM Insurance Co.,[6] the U.S. District Court for the District of Oregon found that mildew exposure qualified as direct physical loss sufficient to trigger business interruption coverage. Insurer-side articles have pointed out that the court added: "[t]he mere adherence of molecules to porous surfaces, without more, does not equate to physical loss or damage." This distinction, however, overlooks the glaring fact that in the COVID-19 context there is "more" — specifically, the prospect of illness or death due to the presence of the virus on surfaces.

Further, regarding the "physical loss" issue, there is also a long line of majority-rule cases that a property affected by an odor has experienced physical loss sufficient to trigger insurance even without physical alteration or damage to the property itself. As one example among many, in TRAVCO Insurance Co. v. Ward,[7] the U.S. Court of Appeals for the Fourth Circuit found direct physical loss where a "home was rendered uninhabitable by the toxic gases" released by defective drywall, regardless of lasting physical damage to the property itself.

In short, barring an express exclusion that cannot be overcome, policyholders can and should cite these and other cases to make the argument for regular property loss and business interruption coverage resulting from COVID-19, subject to — in most cases — the standard deductible and the full policy limits. 

Policyholders also can assert various business interruption coverage extensions, like civil authority or contingent business interruption, that incorporate the same "physical loss or damage" requirement as to other properties. Moreover, policyholders can pursue regular business interruption coverage while also claiming coverage under various, alternative coverage extensions such as for civil authority.

Case law has confirmed that where there are overlapping limits and sublimits for different coverages, a policyholder is entitled to sequence or stack its coverages so as to maximize recovery (and in the converse, the insurer cannot cap recover at a lesser sublimit). 

The Insurance Industry Counterargument

While policyholders have a strong argument that regular business interruption coverage applies here, insurers will resist the argument on every front — especially because the allowance of regular business interruption coverage from COVID-19 would mean paying hundreds of billions in insurance proceeds.

The insurer side of the bar is busy building up the basis for claim denials, dismissing the policyholder argument as "creative" despite a litany of case law. The insurer argument is that if you can clean something from a surface, there is no physical loss or damage, whether the surface contains harmless dirt or a deadly coronavirus.[8] In short, they argue, the physical presence of a deadly virus is not physical loss of use because it can be wiped away with disinfectant.      

The insurers likewise have started to assemble cases to argue that "physical loss" still means the same thing as "physical damage." Policyholders should be ready to distinguish these cases.

For example, insurers have cited Fresh Express Inc. v. Beazley Syndicate 2623/623 at Lloyd's,[9] where the California court found there was no coverage for business interruption loss from a U.S. Food and Drug Administration consumer advisory regarding potential E. coli bacteria in spinach.

And in Source Food Technology Inc. v. United States Fidelity & Guaranty Co.,[10] the U.S. Court of Appeals for the Eighth Circuit (applying Minnesota law) held that loss of income due to the mere risk of beef being contaminated with mad cow disease did not qualify as direct physical loss or damage to the beef. In these cases, of course, there was nothing more than apprehension of consuming a consumer product, whereas with COVID-19, entire properties (like hotels and restaurants) are partially or totally inaccessible due to real, physical danger.

Eventually, many courts will have to parse, cite, or distinguish many other cases to address the issue in the COVID-19 context under the facts of the particular cases — likely on summary judgment motions. In these cases, policyholders will do well to argue that if we are left with two reasonable views over the meaning of "physical loss" in the COVID-19 context, the court must (by law) resolve the issue in favor of coverage. And in these cases, insurers will have to produce pertinent information about underwriting, drafting history, and "loss of use" cases — all of which could bear on post-discovery summary disposition of the issue.

Further, state insurance commissioners may issue interpretations or rules, or legislators might also take action, directing, for public policy reasons, an interpretation that provides coverage. The insurers will resist any and all such pressure to make business interruption insurance payments.

However, at least where there is reasonable ambiguity on a matter of policy interpretation — as there is here in the unprecedented COVID-19 context — state administrators and regulators have a right and duty to provide guidance, and such guidance can and should be weighed by a court in any summary disposition of the issues.

The bigger public policy argument that Insurers are making presently is essentially that they could not possibly be expected to pay hundreds of billions of dollars of regular business interruption claims, and instead, might only be expected to pay limited claims for specialized "contagious illness" coverage. The same property insurers enjoy hundreds of billions in premium dollars annually (the entire industry collects over $1 trillion annually). There is no fixed rule, as the insurance industry seems to suggest, that the industry must always profit from the larger gamble of underwriting risk, as they managed to do even after 9/11 and Hurricane Katrina.

Here in this moment of crisis, the industry must step up and pay in accordance with their "all risk" contractual obligations. But thus far, the industry's primary reaction to the COVID-19 has been to (1) deny all claims, while simultaneously (2) raising premiums on renewals and (3) adding on new express exclusions for contagious illness (which, of course, is further evidence that the current policies exclude no such loss). In short, the insurers seek to profit from the COVID-19 crisis.

After the 1906 San Francisco earthquake, Lloyd's of London underwriter Cuthbert Heath famously cabled "pay all of our policyholders in full." Most of those policies covered the earthquake loss, and what Heath clearly meant was: This is not a time to play games with customers over esoteric policy terms and conditions.

We need this kind of leadership from the insurance industry today, more than ever in history. Instead, in time, the courts will sort out the issue, and even if the insurers have to pay business interruption claims, the industry will survive and prosper in future years. Meanwhile, these hundreds of billions in insurance proceeds could be an essential rebuilding block for our nation.

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Gary Thompson is a partner at Thompson HD.

The author thanks Julie Hammerman, Kristin Davis and Alexis Storey.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] See Parks Real Estate Purchasing Grp. v. St. Paul Fire & Marine Ins. Co. , 472 F.3d 33, 41 (2d Cir. 2006) (finding that airborne particulate from the World Trade Center was the efficient proximate cause of property damage to a nearby building); Pan Am. World Airways, Inc. v. Aetna Cas. & Sur. Co. , 505 F.2d 989, 999-1000 (2d Cir. 1974) (finding coverage for loss of use of hijacked planes, absent an explicit exclusion for loss from terrorism).

[2] Motorists Mutual Insurance Co. v. Hardinger , 131 Fed. Appx. 823 (3d Cir. 2005) (applying Pennsylvania law).

[3] Cooper v. Travelers Indemnity Company of Illinois , No. C-01-2400-VRW, 2002 WL 32775680 (N.D. Cal. Nov. 4, 2002).

[4] Total Intermodal Services v. Travelers Property Casualty Company of America , No. CV 17-04908, 2018 WL 3829767 (C.D. Cal. July 11, 2018)

[5] U.S. Airways v. Commonwealth Insurance Co. , 64 Va. Cir. 408 (Va. Cir. Ct. 2004)

[6] Columbiaknit, Inc. v. Affiliated FM Insurance Co. , No. Civ. 98-434-HU, 1999 WL 619100 (D. Or. Aug.4, 1999)

[7] TRAVCO Insurance Co. v. Ward , 715 F. Supp. 2d 699, 709 (E.D. Va.2010), aff'd, 504 F. App'x. 251 (4th Cir. 2013)

[8] See, e.g., Law360, April 6, 2020, "Coronavirus Is Not A Direct Physical Loss Triggering Event" (analogizing Covid-19 on a surface to "a spilled cup of coffee waiting to be wiped up"); "Commercial Property insurance Coverage and Coronavorus," available at https://www.zelle.com/Commercial_Property_Insurance_Coverage_ and_Coronavirus (analogizing Covid-19 on a surface to a "simple sneeze or cough" that can simply be wiped down "without essentially altering the property").

[9] Fresh Express Inc. v. Beazley Syndicate 2623/623 at Lloyd's , 131 Cal.Rptr.2d 129 (Cal. App. 2011)

[10] Source Food Technology, Inc. v. United States Fidelity & Guaranty Co. , 465 F.3d 834 (8th Cir. 2006) (applying Minnesota law)

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