U.S. District Judge Marilyn L. Huff found that the policy's "physical loss or damage" requirement is not ambiguous, and that the case is like others in which California courts have arrived at a construction of the phrase that excludes losses like those experienced by Islands.
California courts consistently interpret the coverage triggers to require a "distinct, demonstrable, physical alteration" to property, which was not the case for Islands, she said. Islands' suit focused on the losses it took as a result of government-mandated closures.
"As plaintiffs point out, some of the California cases that interpreted the meaning of similar physical loss or damage terms did so in the context of property insurance, not business interruption insurance," Judge Huff said. "But this distinction is not persuasive because property and business interruption coverage commonly go hand in hand. In fact, the policy itself also has property insurance provisions, insuring plaintiffs' property against all non-excluded risks of 'physical loss or damage.'"
Further, she said, Islands failed to adequately explain why the uniqueness of the COVID-19 pandemic should create a distinction from past cases in which courts have required a physical alteration to the property to trigger coverage.
"The court complements the parties for their thoughtful discussion during the hearing on this matter," Judge Huff said. "The court also sympathizes with plaintiffs and other businesses suffering financial hardships during the COVID-19 pandemic. Nevertheless, the issue before the court is whether plaintiffs' alleged losses are covered by the policy, which they are not."
According to Islands' complaint, it operated 59 restaurants in California and other Western states. In 2015, it formed a partnership, CFBC LLC, and took ownership of seven California cafes called Champagne French Bakery Cafés. Islands and CFBC held a policy with Affiliated that covers all 66 restaurants and cafes, the suit said.
In the complaint, Islands said that government closure orders, which prohibited on-site dining, have devastated its business, which is centered on the dining experience. Takeout only constitutes a very small part of its revenue, Islands said.
Although its eateries and cafes experienced an increase in revenue once in-person dining resumed, Islands still suffered a severe revenue reduction compared to previous years because the government orders limit indoor dining, the company added.
Islands said Affiliated denied coverage for all of its locations in late July, saying that the communicable disease provision is potentially available only for its Agoura Hills, California, location because two employees tested positive for COVID-19 around March.
Affiliated said in the July coverage denial letter that "COVID-19 does not cause any distinct, demonstrable, physical change to property," and that the virus "constitutes contamination excluded under the policy," according to the suit.
Islands sued the carrier in California state court in September before Affiliated moved the suit to federal court in October.
Islands is represented by Michael J. Bidart of Shernoff Bidart Echeverria Bentley LLP.
Affiliated is represented by Daniel Allender and Amy Churan of Robins Kaplan LLP.
The case is Islands Restaurants LP et al. v. Affiliated FM Insurance Co. et al., case number 3:20-cv-02013, in the U.S. District Court for the Southern District of California.
--Additional reporting by Daphne Zhang. Editing by Breda Lund.
Update: This story has been updated to include additional counsel information for Affiliated.
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