COVID-19 Is Not Direct Physical Loss Or Damage

Is a cash register that is not being used damaged property? When you need to wash a table, a chair, or a section of flooring with readily available cleaning products to make them safe and useable, are you repairing damaged property? Is a spilled cup of coffee waiting to be wiped up actual damage to the premises? If your customers stay home to help stop the spread of a virus, has there been a physical loss inside your shuttered store or restaurant?

The insuring agreements typically found in commercial property insurance policies require “direct physical loss of or damage to” covered property as the triggering event. Without establishing direct physical loss or damage a policyholder cannot meet its burden to trigger coverage for a purely economic loss of business income resulting from shuttering its business due to concerns over exposure to—or even the actual presence of—COVID-19. Despite this well-understood policy language, it is already beyond question that insurers will confront creative—albeit strained—arguments from policyholder firms attempting to trigger coverage for pure economic loss. The scope of the human and economic tragedy we all face will be matched by the scope of the effort to force the financial harm onto insurance companies.

The plaintiffs in what appears to be the first-filed case seeking a declaratory judgment in the context of first-party insurance coverage rely on the assertion that “contamination of the insured premises by the Coronavirus would be a direct physical loss needing remediation to clean the surfaces” of its establishment, a New Orleans restaurant, to trigger coverage for business interruption.[1] See Cajun Conti, LLC, et. al. v. Certain Underwriters at Lloyd’s, London, et. al. Civil District Court for the Parish of Orleans, State of Louisiana. The complaint alleges that the property is insured under an “all risk policy” defining “covered causes of loss” as “direct physical loss.” The plaintiffs rely on the alleged presence of the virus on “the surface of objects” in certain conditions and the need to clean those surfaces. They go so far as to claim that “[a]ny effort by [the insurer] to deny the reality that the virus causes physical damage and loss would constitute a false and potentially fraudulent misrepresentation. . . .”

The complaint cites a case from the Court of Appeal of Louisiana, Widder v. Louisiana Citizens Property Insurance Corporation, 82 So. 3d 294 (La. App. 2011), writ denied, 76 So. 3d 1179 (La. 2011), for the proposition that “[s]imilar to the Coronavirus, Louisiana Courts have interpreted that the intrusion of lead or gaseous fumes constitute a direct physical loss under insurance policies that would need to be remediated.”

The assertion of fraudulent misrepresentation seems to be largely a matter of projection, as the truth seems to have been stretched by the claims that the possible presence of an easily cleaned virus damaged the restaurant sufficiently to trigger coverage for business interruption at the plaintiffs’ restaurant. As an initial matter, Widder involved a house contaminated with “inorganic lead which makes it uninhabitable until it has been gutted and remediated.” 82 So. 3d 294, 296. Gutting and remediating a home to remove materials which must be treated as hazardous waste is a far cry from cleaning property with disinfectant. In Widder an inspection revealed the presence of lead dust on walls, which originated in part from lead paint outside of the house. Id. at 295. Apparently without any scientific foundation, the Widder court compared the loss before it to the emission of gaseous fumes from Chinese drywall and reversed the trial court’s summary judgment in favor of the insurer.

Glaringly, the alleged presence of a virus on objects is not analogous to noxious odors or gaseous releases. In Widder the alleged physical harm involved tangible damage. Further, gaseous emissions from Chinese drywall corroded building components and in some instances required demolition and rebuilding of entire physical structures to remediate the condition. The proposition that the alleged presence of Coronavirus is somehow analogous to this type of harm is, at best, a contrived argument to attempt to trigger coverage. Indeed, whether and to what extent Coronavirus stays present on physical surfaces is as yet untested under Daubert. We do know that government health officials believe that proper cleaning with standard disinfectants will kill the virus. In any event, there is no indication or evidence that the virus corrodes physical surfaces.

Courts in other jurisdictions have addressed more analogous circumstances and found a lack of coverage. For instance, a federal district court applying Michigan law found that the presence of mold and bacteria in ductwork and a resulting odor did not constitute direct physical harm despite that the ductwork needed to be physically cleaned as part of remediation. Universal Image Productions, Inc. v. Chubb Corp., 703 F. Supp. 2d 705 (E.D. Mich. 2010). A water leak caused the mold, bacteria, and odor, and the policyholder argued that the “pervasive odor, mold and bacterial contamination (both visual and aerosolized), as well as water damage” constituted direct physical loss. The court concluded that the policyholder did not demonstrate “that it suffered any structural or any other tangible damage to the insured property. Rather, the bulk of [the policyholder’s] argument relies upon proof that it suffered such intangible harms as strong odors and the presence of mold and/or bacteria in the air and ventilation system within its Building which, in its judgment, rendered the insured premises useless.” Id. at 719. Citing a case from Oregon, the court stated that “even physical damage that occurs at the molecular or microscopic level must be ‘distinct and demonstrable.’” Id. (citing Columbiaknit, Inc. v. Affiliated FM Ins. Co., No. Civil No. 98-434-HU 1999, U.S. Dist. LEXIS 11873 (D. Or. Aug. 4, 1999)).

At least two courts—a federal court in Florida and an appellate court in Ohio—have recognized that if the alleged physical harm can be cleaned, then there is no physical harm. Mama Jo’s, Inc. v. Sparta Ins. Co., No. 17-CV-23362-KMM, 2018 U.S. Dist. LEXIS 201852 (S.D. Fla. June 11, 2018) (debris and dust from road work required the insured to clean its floors, walls, tables, chairs, and countertops and the court held that “cleaning is not considered direct physical loss.”); Mastellone v. Lightning Rod Mut. Ins. Co., 884 N.E.2d 1130 (Ohio 2008) (affirming lower court’s ruling that dark staining from mold did not constitute “physical loss” where plaintiff’s expert testified that mold could be removed from wood surface by cleaning).

Further, the mere risk of contamination has been deemed insufficient to trigger coverage. Specifically, loss of income due to an embargo by the United States Department of Agriculture because of the risk that “mad cow disease” contaminated beef product was not “direct physical loss” to beef product. Source Food Tech., Inc. v. United States Fid. & Guar. Co., 465 F.3d 834 (8th Cir. 2006) (applying Minnesota law). The Eighth Circuit distinguished between the actual presence of contamination and the inability to sell a product because of the fear of contamination. “Although Source Food’s beef product in the truck could not be transported to the United States due to the closing of the border to Canadian beef products, the beef product on the truck was not—as Source Foods concedes—physically contaminated or damaged in any manner. To characterize Source Food’s inability to transport its truckload of beef product across the border and sell the beef product in the United States as direct physical loss to property would render the word ‘physical’ meaningless.” Id. at 838.

As of this writing the insurers had not yet moved to dismiss the Cajun Conti complaint. However, we believe that on the face of the complaint, which expressly incorporates the policy language requiring direct physical loss or damage, there is no triggering event. Even assuming that COVID-19 is, at a molecular level, present on physical surfaces, we also believe that disinfecting of surfaces does not constitute physical harm sufficient to trigger coverage.

Gordon & Rees is carefully tracking the coronavirus (COVID-19) pandemic and working to assist clients with the evolving legal ramifications of the outbreak to their businesses.

Visit our COVID-19 Hub for ongoing updates.

Emerging Coverage Considerations for Insurers Relating to Claims in Connection with COVID-19

The only thing equally inevitable to the spread of the novel coronavirus 2019 disease (“COVID-19”) will be the resulting onslaught of first-party and third-party insurance claims and insurance coverage litigation seeking to mitigate business losses through recoveries from the insurance industry. Prominent policyholder firms are already pitching corporate America to seek coverage first and ask questions later. The immediacy of claims and litigation will be expedited and their impact multiplied because of the economic downturn. Policy language and actual coverage will be subject to sustained attacks and creative arguments reflecting the huge sums of money that will be at stake. The impact and aftermath of the COVID-19 pandemic stands to present coverage questions for insurers under a variety of coverage forms, including Commercial Property, Commercial General Liability, Professional Liability and Healthcare Liability, and Directors and Officers Liability coverage forms. We summarize below the issues that have already arisen, as well as those that we expect to arise as policyholders submit claims under their insurance assets in connection with COVID-19.

First Business Income Claim Filed

Louisiana appears to be the first state in which an insured filed a lawsuit seeking first-party insurance coverage for business income loss related toCOVID-19. Cajun Conti, LLC, et al. v. Certain Underwriters at Lloyd’s London, et al., Civil District Court for the Parish of Orleans, Louisiana. In response to the New Orleans mayor’s restrictions on restaurant operation in relation to the public health emergency, the restaurant owner sought coverage under its “all risks” policy, which provides coverage for “direct physical loss unless the loss is specifically excluded or limited.” In its complaint the policyholder asks the court to declare that s “because the policy provided by Lloyd’s does not contain an exclusion for a viral pandemic, the policy provides coverage to [the business] for any future civil authority shutdowns of restaurants in the New Orleans area due to physical loss from Coronavirus contamination and that the policy provides business income coverage in the event that the contamination has contaminated the insured premises.” Notably, however, the declaratory judgment specifically “do[es] not seek any determination of whether the Coronavirus is physically present in the insured premises, amount of damages, or any other remedy besides the declaratory relief.” Gordon Rees Scully Mansukhani will continue to monitor this developing litigation and advise of developments that may impact insurers.

ISO Commercial Property Forms Typically Exclude Coverage for Communicable Diseases

Essential to the resolution of the Cajun Conti case and future claims like it will be the scope of coverage afforded under ISO Commercial Property forms. In 2006, after learning from prior major viral outbreaks, ISO adopted a mandatory exclusion for business interruption policies that specifically excludes coverage for lost business income arising from viruses. ISO form CP 01 40 07 06, “Exclusion for Loss Due To Virus Or Bacteria,” specifically applies to business income, and provides in relevant part that the underwriter “will not pay for loss or damage caused by or resulting from any virus, bacterium or other microorganism that induces or is capable of inducing physical distress, illness or disease.”

Absent this exclusion, however, triggering business interruption coverage under the ISO form fundamentally requires “direct physical loss of or damage to property at premises which are described in the Declarations.” Needless to say the proper interpretation of the terms “direct physical loss of or damage to property at premises” is expected to be one of the foremost topics of disagreement between policyholders and their insurers as these claims begin to mount. From a policyholder advocate perspective, the presence of COVID-19 in the building may be sufficient. In this regard, recent articles published by policyholder firms point to cases in which courts have held that the presence of gaseous or other non-visible substances constituted a “direct physical loss” to premises where the substance rendered the premises uninhabitable, even absent physical alteration to the structure itself. These arguments unreasonably expand the plain meaning of the language used in property policies. Indeed, many courts confronted with coverage disagreements involving similar conditions—such as the presence of asbestos, mold, or other debris in a building–concluded that the requisite “direct physical loss of or damage to” covered property was lacking

In Some Instances Manuscript Policies May Present A Closer Question

The focus of coverage disputes under manuscript policies are far less easy to predict, as they contain terms negotiated by the insured or its broker. One such area of attention may be the applicability of Civil Authority Coverage, which in some cases may extend business interruption coverage to orders or actions of a governmental agency or other civil authority. With everything from auto production factories to nail salons closing pursuant to state government emergency orders this will likely be hot button issue in the courts. As is the case with all coverage questions, the scope of coverage will be determined by the particular facts and circumstances of the loss and the plain meaning of the terms of the policy.

State Efforts to Extend Coverage

Insurers are cautioned to pay particular attention to state efforts to mandate the payment of business income losses related to COVID-19 under the property provisions of the Commercial Package and Business owner policies. The first state to offer legislation of this type is New Jersey, which has proposed a law titled as an act “concerning certain covered perils under business interruption insurance.” The draft bill in the state is aimed to force insurers to cover business income loss relating to COVID-19 and the governmental efforts to prevent its spread—including for policies that explicitly exclude viral coverage (such as policies bearing the ISO exclusion)—regardless of the policy terms and provisions.

Despite the legislature’s effort to hold harmless a segment of the business sector with the foresight to purchase business interruption coverage, this proposed legislation seemingly shifts the burden of compensating businesses for virus-related losses from the state or federal government onto private insurers, including those who have specifically contracted out of this coverage. It also raises a significant question of due process and the freedom of insurers to contract to limit the coverage provided under their policies.

The State of New York has also entered the fray, but not to coerce insurers to pay uninsured losses. On March 10, 2020, the New York Department of Financial Services (NYDFS) issued a letter directing insurers who write business interruption coverage to “explain” to policyholders the benefits under their policies and the protections provided in connection with COVID-19. While the directive is targeted to preemptively address insured questions concerning the scope of business interruption coverage, it fosters an erroneous “one size fits all” approach to construing policy coverage and it arguably requires insurers to issue advisory opinions concerning the interpretation of “covered perils” and “physical loss or damage” in their policies without first knowing the particular facts and circumstances of any given loss or claim. Notably, in October 2019, NYDFS implemented Section 308 of the Insurance Law requiring insurers to complete a questionnaire in order to ascertain the level of pandemic influenza preparedness, purportedly in the hope that this information would help raise the general level of preparedness of our licensees.

Most recently the Maryland Insurance Administration released and Advisory or Business Interruption on Business Interruption Insurance on March 18, 2020, which states that it has been received a high volume of inquiries related to business interruption insurance. The Advisory states in pertinent part:

Business Interruption coverage is typically triggered under a commercial insurance policy when a covered risk / peril causes physical damage to the insured premises resulting in the need to shut down business operations. For example, if a fire damages a business and the business cannot operate during repairs, business interruption coverage would be available subject to the terms and limits in the policy.

. . .

Some commercial policies provide Business Interruption coverage when a business is shut down due to an Order by a civil authority. However, the policy still typically requires a physical loss from a covered peril as the underlying cause of the business shut down to apply.

. . .

All insurance policies have exclusions of coverage for risks that are too great to be underwritten at an affordable price. For example, commercial and personal property insurance policies typically contain specific exclusions for loss or damage caused by war, nuclear action and radiation. The potential loss costs from such perils are so extreme that providing coverage would jeopardize the financial solvency of property insurers. Global pandemics like COVID-19 usually fall into this category. However, policies can be different. We recommend that businesses review their policies and reach out to their insurance professionals with any questions.

This approach is less aggressive than those taken by New Jersey and New York, and at least at this time Maryland has not required insurers to take on obligations for which they did not contract or otherwise issue advisory opinions. We will provided updates as other states and insurance departments begin to take positions on insurance coverage related to COVID-19.

Commercial General Liability

Commercial General Liability (“CGL”) policies will surely also be noticed by insureds and lead to extensive coverage litigation given the myriad of possible factual situations that will arise. Since CGL provides coverage for liability to third parties arising from “bodily injury” or “property damage” resulting from unintentional acts, there are many potential avenues for negligence claims around issues of exposure to COVID-19.

In CGL policies, the definition of “bodily injury” generally includes “sickness” or “disease.” The most likely avenue for claims will most likely be parties alleging liability for the spread of the coronavirus. Considering the ubiquitous effects of the virus on businesses worldwide, claims could come in many forms: restaurants, bars, or gyms that did not close, or theaters or concert venues that did not postpone events, are just a few examples. The early outbreak at the nursing home in Washington will raise many questions about the standard of care that should have been in place in any facility handling vulnerable populations. Airlines, hotels, conference centers, travel agents, or cruise ship companies could also be targets for moving forward with events or bookings in the face of worldwide news cycle warning of dangers. All of these entities could face liability for failing to take appropriate action to prevent infection from employees that appeared sick, or high-touch surfaces that were not appropriately de-contaminated. Similar claims could allege a lack of preparedness or training of employees that led to the spread of infection.

Other claims not directly related to the spread of disease, but rather as a result of the actions taken to prevent the spread, may arise. For example, if a real estate owner closes a building, there may be claims for wrongful eviction. This would fit within the standard definition of “personal and advertising injury.”

While it is true that CGL policies often include pollution exclusions, the effect of such exclusions will depend largely on the precise language of the exclusion and law of the state where it is being applied. Some CGL policies also contain exclusions for viruses or communicable diseases. The most difficult obstacle for claims will be sickened individuals attempting to pinpoint where they were sickened, and by whom. However, even the smallest claims that stick past the motion to dismiss stage may lead to a copycat effect. There are many jurisdictions where the insurance industry struggles to get fair treatment in the courts, which will present even greater peril if COVID-19 impacts a measurable percentage of the local population with serious permanent impairment or death.

Directors & Officers Liability

It is also worth considering the potential for claims against Directors & Officers, Errors & Omissions, Management Liability, or any form of Professional Liability Insurance policies, including Healthcare Professional Liability policies. Claims could be made against managers, directors, officers, or professionals for a failure to make decisions that would have prevented the spread of disease. Potentially more costly could be claims by investors, who have seen the value of their holdings dwindle, seeking to assert claims against officers alleging that a lack of response (or inadequate response) led to a reduction in share price. Policyholders will argue that pollution exclusions have limited effect against such claims.

Visit our COVID-19 Hub for ongoing updates.

Policy Exhaustion Can Limit the Duty to Defend Under Connecticut Law

Assessing whether the duty to defend terminates on policy exhaustion can become a complex analysis when a claim involves multiple plaintiffs and exposure unquestionably exceeds the policy limits, yet the insured desires a continuing defense.

A common policy provision provides that an insurer has a duty to “settle or defend” a covered claim but that upon payment of the policy limits for “judgment or settlement” the insurer no longer has an obligation to provide a defense. Connecticut appellate courts have not squarely addressed in what circumstances exhaustion of policy limits will terminate the duty to defend, but at least one Connecticut Superior Court has recognized that exhaustion of policy limits would terminate the duty to defend based on the following policy language in a commercial policy: In Aetna Life & Cas. Co. v. Gentile, No. 0122259, 1995 Conn. Super. LEXIS 3444, 5 (Dec. 12, 1995), the insurer sought a declaratory judgment that it did not have a duty to defend following payment of the policy limits in response to seven separate claims. Id. at 4, 6. The court ultimately concluded that the payment was not the result of a “settlement” because the insurer failed to obtain a full release of the insured for one of the seven claims. Id. at 6-7. Despite its conclusion, the court plainly recognized that “if [the payment was a “settlement”] the policy limits are exhausted and there is no further duty to defend.” Id. at 7. The court concluded that the failure to obtain a release as to one of the claims precluded a finding that the payment was the result of a “settlement.” Id. at 9, 11. Thus, even though the insurer had made a payment in the amount of policy limits, the duty to defend was not terminated. Id.

Though the Gentile court initially acknowledged the potential enforceability of the exhaustion provision to terminate the duty to defend, the fact that the insurer left the insured to face excess exposure resulted in a finding that it had a continuing duty to defend and indemnify. Id. at 13. Notably, the court denied declaratory relief to the insured and awarded attorneys’ fees to the insured for both the underlying action and the declaratory judgment action. Id. at 13, 17.

Another instructive case is Chicago Title Insurance Company v. Kent School Corporation, 361 F. Supp. 2d 4, 7 (D. Conn. 2005). In that case, the United States District Court for the District of Connecticut addressed whether a policy of title insurance permitted the insurer to tender its policy limits to its insured and thereby terminate its duty to defend. The policy provided that the insurer “may terminate its liability hereunder by paying or tendering the full amount of this policy.” Id. at 8. Despite this clause, because the policy provided that “the costs and expenses of defending the title” were in addition to the policy limits and the policy was ambiguous in its failure to define the term “liability,” the court found that the insurer had a continuing duty to defend. Id. at 9-10. In so concluding, however, the court did not rule out a different conclusion based on clearer policy language.

While it does not appear that any Connecticut court has actually applied the rule permitting an insurer to terminate its duty to defend by making full payment of policy limits to enforce such a result, both the Gentile court and Chicago Title court clearly recognize this rule and the enforceability of exhaustion clauses. Gentile, 1995 Conn. Super. LEXIS 3444, 7; Chicago Title, 361 F. Supp. 2d 4, 9. Such recognition is found in other jurisdictions, as well. Further, though such decisions are presently absent from Connecticut jurisprudence, courts in other jurisdictions have allowed an insurer to exhaust limits and terminate its duty to defend.  Seem e.g. In Re: East 51st Street Crane Collapse Litigation, No. 769000/08, 2010 N.Y. Misc. LEXIS 6310 (N.Y. Sup. Ct. Feb. 18, 2010).

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