The Washington Supreme Court Issues an Important Decision Regarding Insurance Coverage for Covid-Related Claims

The Washington Supreme Court recently issued an important decision that provides guidance on coverage for Covid-related claims and the application of Washington’s efficient proximate cause rule in Hill & Stout, PLLC v. Mut. of Enumclaw Ins. Co., 515 P.3d 525 (2022). In Hill & Stout, the Washington Supreme Court held that (1) Covid-related damages are not a “direct physical loss” and thus are not subject to property coverage, (2) the Virus Exclusion also precludes coverage, and (3) the efficient proximate cause rule does not mandate coverage.

The Hill & Stout case involved a dentist office (“HS”) that was insured under a property insurance policy (the “Policy”) issued by Mutual of Enumclaw Insurance Company (“MOE”). The Policy covered lost business income caused by a “direct physical loss of or damage to” the dentist office properties. The Policy also contained a Virus Exclusion that barred coverage “for loss or damage caused directly or indirectly by [a]ny virus … that induces or is capable of inducing physical distress, illness or disease.” The Virus Exclusion was amended by the Washington Changes Endorsement which, in relevant part, requires that in order for the exclusion to apply, the virus must “directly and solely result[] in [the] loss or damage,” or “initiate[] a sequence of events that result[] in loss or damage, regardless of the nature of any intermediate or final event in that sequence.”

HS tendered a claim to MOE for lost business income due to Governor Jay Inslee’s proclamation that prohibited non-emergency dental care for several months because of Covid (the “Covid Proclamation”). Notably, HS had actually ceased all non-emergency dental procedures several days before Governor Inslee issued the Covid Proclamation, and HS continued to have receptionists in its offices while the Covid Proclamation was in effect. MOE denied HS’s claim on the grounds that HS had not suffered a “direct physical loss” and that any alleged damages were barred by the Virus Exclusion. HS commenced a declaratory judgment class action lawsuit against MOE, and alleged that HS’s loss of business income due to Covid was covered since it was a “direct physical loss or damage as a result of the [Governor’s] proclamation[.]”

The primary issue in the case involved the meaning of the phrase “direct physical loss of or damage to” the insured properties, and whether HS’s inability to use its dentist offices due to the Covid Proclamation fell within this grant of coverage. Because the terms “physical” and “loss” were not defined in the Policy, the Supreme Court turned to a standard English dictionary to determine their meanings, and concluded that “physical loss of property” means “property that has been physically destroyed or that one is deprived of in that the property is no longer physically in their possession.” Hill & Stout, 515 P.3d at 532. The Supreme Court noted that the Covid Proclamation did not physically prevent HS from using its dental offices, especially given that HS’s offices remained open for emergency services and administrative staff continued to work there. As a result, the Supreme Court held that HS’s claim was not covered because there was no “direct physical loss of or damage to” its dental offices, holding as follows:

Accordingly, under the facts of this case we hold that the claim for loss of intended use and loss of business income is not a physical loss of property. HS was still able to physically use the property at issue. The property was in HS’s possession, the property was still functional and able to be used, and HS was not prevented from entering the property. Under the Proclamation, HS was not able to use the property in the way that it wanted, but this alleged “loss” is not “physical.” It is more akin to an abstract or intangible loss than a “physical” one.

Hill & Stout, 515 P.3d at 532.

The Washington Supreme Court also rejected HS’s request to apply the “loss of functionality test” for determining whether there had been a direct physical loss, as opposed to requiring that there be a physical alteration of the property. The Supreme Court recognized that the loss of functionality test had been applied in asbestos cases where the release of asbestos fibers contaminates property to such a degree “that its function is nearly eliminated or destroyed[.]” Hill & Stout, 515 P.3d at 532-33 (quoting Port Authority of New York & New Jersey v. Affiliated FM Insurance Co., 311 F.3d 226, 236 (3d Cir. 2002)). However, the Washington Supreme Court found that the “loss of functionality test” was inappropriate with respect to the subject claim “because there is no physical loss of functionality to the property.” Id. at 533 (emphasis original). The Washington Supreme Court held that the Covid “Proclamation did not physically cause a loss of functionality of the property because it continued to be functional.” Id. (emphasis original). Moreover, the Supreme Court held that “even under a loss of functionality test there must be some physical effect on the property” in order for there to be coverage under a property insurance policy. Hill & Stout, 515 P.3d at 534 (emphasis original).

The Washington Supreme Court further held that coverage was barred by the Policy’s Virus Exclusion and that the efficient proximate cause rule did not restore coverage. The Supreme Court noted that “the efficient proximate cause rule applies to mandate coverage when an initial covered peril sets a causal chain in motion and that causal chain includes later excluded perils.” Hill & Stout, 515 P.3d at 535. However, the rule does not operate in reverse, such that it does not “mandate exclusion [of coverage] when the casual chain is initiated by an excluded peril.” Id. Nonetheless, the Supreme Court noted that in its prior decisions “[w]e have left open the possibility that an insurer may draft policy language to deny coverage when an excluded peril initiates an unbroken causal chain.” Id. (quoting Vision One, LLC v. Phila. Indem. Ins. Co., 276 P.3d 300, 309 (2012)). The Washington Supreme Court found that the Virus Exclusion did in fact contain policy language that barred coverage when an excluded peril initiated the loss, because the Virus Exclusion had been amended by the Washington Changes Endorsement which, in relevant part, stated as follows:

We will not pay for loss or damage caused by any of the excluded events described below. Loss or damage will be considered to have been caused by an excluded event if the occurrence of that event:

b. Initiates a sequence of events that results in loss or damage, regardless of the nature of any intermediate or final event in that sequence.

Hill & Stout, 515 P.3d at 536.

The Washington Supreme Court held that “insurers can [include language in the insurance policy] contract to say that coverage is excluded for a causal chain initiated by an excluded peril. The exclusionary language in the policy does just that.” Id. The Supreme Court further found that it could not be reasonably disputed that Covid-19 caused Governor Inslee to issue the Covid Proclamation and HS’s loss. Accordingly, the Supreme Court held that the Virus Exclusion barred coverage, and reasoned as follows:

There is no issue of material fact needed to determine that COVID-19, an excluded peril, initiated the causal chain in this case and that the policy excludes the causal chain of losses initiated by an excluded peril. As the causal chain is initiated by an excluded peril, the efficient proximate cause rule does not apply to mandate coverage, and, under the language of this policy, the virus exclusion applies.

Hill & Stout, 515 P.3d at 537.

The Hill & Stout decision provides important guidance on coverage for Covid-related claims. However, the Washington Supreme Court’s holding regarding the efficient proximate cause rule is of even greater significance beyond just Covid-related claims because as the Supreme Court stated, “this issue will likely repeat in other cases regarding the interpretation of similar insurance policies[.]” Id. at 535. To the extent you have any questions regarding the Hill & Stout case or other issues involving insurance coverage, please feel free to contact the attorneys in the insurance coverage group at Gordon Rees Scully Mansukhani in Seattle.

Recent Developments Involving Cedell v. Farmers Insurance Company of Washington

Ever since the Washington Supreme Court’s 2013 decision in Cedell v. Farmers Insurance Company of Washington, 176 Wn.2d 686, 295 P.3d 239 (2013), insurance coverage attorneys have been struggling to define the exact parameters of the Cedell ruling in order to safeguard the attorney-client privilege as to the communications between the insurer and its counsel.  As a brief background, the Washington Supreme Court held in Cedell that there is a presumption of no attorney-client privilege in a lawsuit involving bad faith claims handling.  However, an insurer can overcome the presumption of no attorney-client privilege by showing that its counsel provided legal advice regarding the insurer’s potential liability under the policy and law, and did not engage in any quasi-fiduciary activities, i.e. claims handling activities, such as investigating, evaluating, adjusting or processing the insured’s claim.

Since Cedell, various trial courts have held that the following activities by an insurer’s counsel constitute quasi-fiduciary conduct that do not overcome the presumption of no attorney-client privilege, resulting in an order to produce documents and/or to permit the deposition of the insurer’s counsel:

  • Insurer’s attorney being the primary or sole point of contact with the insured for the insurer;
  • Insurer’s attorney requesting documents from the insured that are relevant to the investigation of the claim;
  • Insurer’s attorney communicating directly with the insured or the insured’s counsel regarding claims handling issues or payments;
  • Insurer’s attorney interviewing witnesses for purposes of the investigation of the claim;
  • Insurer’s attorney conducting an examination under oath of the insured;
  • Insurer’s attorney drafting proposed or final reservation of rights letter or denial letter to the insured; and
  • Insurer’s attorney conducting settlement negotiations in an underlying litigation.

Conversely, some trial courts have held that the following activities by an insurer’s counsel are not quasi-fiduciary activities, in that insurer’s counsel is providing legal advice and opinion, resulting in a valid assertion of the attorney-client privilege:

  • Insurer’s attorney drafting a coverage opinion on the insurer’s own potential liability, such as whether or not the insured is entitled to coverage under the policy and law;
  • Insurer’s attorney drafting a response to an insured’s Insurance Fair Conduct Act (“IFCA”) Notice.

With respect to drafting a response to an insured’s IFCA Notice, however, there are cases that have held that such an activity is a quasi-fiduciary one, to the extent the insurer’s counsel was also involved in claims-handling activities, such as drafting a proposed denial letter and/or coverage position/Reservation of Rights letter to the insured. 

Recently, in Young v. Safeco Ins. Co. of America, 2022 WL 1404650 (W.D. Wash. May 4, 2022), the Western District Court of Washington provided additional clarification on what qualifies as a quasi-fiduciary activity in terms of an IFCA Notice response drafted by insurer’s counsel.  In Young, the insured made a claim to Safeco under a Landlord Protection Policy as a result of the tenant, who was found deceased in the insured’s rental property, making modifications to the property without the insured’s permission.  The insured sought coverage for renovations due to the tenant’s vandalism and for biohazard damage from the decomposition of the deceased tenant’s body.  Safeco initially denied coverage.  Subsequently, however, in the IFCA Notice response, Safeco’s coverage counsel advised the insured’s counsel that Safeco would like “to cure” its breach by accepting coverage, that the two losses appeared to be “two separate claims”, that Safeco would “set up a second claim to address the renovations[,]” and asked the insured to provide an estimate to repair the renovations to the rental property at issue.  Id. at *3.  The Court further noted that the insurer’s coverage counsel wrote to insured’s counsel to dispute whether the estimate provided by the insured included damage to the rental property not covered by the policy, outlined the coverage and exclusions contained in that policy (similar to what would be in a Reservation of Rights letter or coverage position letter sent to the insured), and requested a second inspection of the rental property, none of which pertained to the provision of legal advice or counsel to the insurer.  Id.  Rather, the Court characterized such tasks as the insurer’s renewed attempts to evaluate and process the insured’s vandalism claim.  Id.  The Court ordered the production of documents that had originally been redacted as attorney-client privilege.

In light of the Young case, it appears that an IFCA Notice response drafted by insurer’s counsel should not include anything that could be construed as pertaining to claims-handling, i.e. a reversal of coverage position and a request for additional information related to a claim.  Moreover, it is recommended that any communications with the insured about the claim, i.e. a dispute the insured’s estimate including non-covered damage or to request an inspection, should be done by the adjuster, not the insurer’s counsel, in order to protect the attorney-client privilege as to the communications between the insurer and its counsel.

Another recent case that deserves attention is Water’s Edge, A Condominium Owners Association v. Affiliated FM Insurance Company, 2022 WL 3054209 (W.D. Wash. August 2, 2022).  In Water’s Edge, the Federal District Court for the Western District of Washington ordered the deposition of the insurer’s counsel as the Court found that the counsel had engaged in claims processing and handling (quasi-fiduciary) tasks by reviewing, on behalf of the insurer, the documents that Water’s Edge submitted to the insurer in support of its claim; participating in the investigation into the nature and extent of the property damage; and drafting the denial letter on behalf of the insurer. Id. at *3.  The deposition of insurer’s counsel was limited to those three categories. 

At first glance, this decision seems to indicate that reviewing materials submitted by the insured would qualify as a quasi-fiduciary task.  However, we believe that context is important in this regard – in Water’s Edge, the documents were reviewed presumably to draft the denial letter, which has already been established as a quasi-fiduciary activity.  As a result, to the extent the insurer’s counsel is reviewing insured’s documents in order to draft anything other than a coverage opinion that outlines and evaluates the insurer’s potential legal liability under the policy, then such activity could presumably be deemed as claims-handling.  If insurer’s counsel is reviewing the insured’s documents for purposes of coverage assessment and drafting a coverage opinion, such conduct and all documents related to that conduct would be protected by the attorney-client privilege. 

There is some ambiguity in the Water’s Edge decision with respect to the Court’s identification of insurer’s counsel’s participation in the investigation into the nature and extent of the damage as a quasi-fiduciary task.  Generally, an analysis of the “nature” of damage is conducted in order to assess coverage under the policy, i.e. is the damage covered property damage or precluded under an exclusion?  An analysis of the “extent” of damage, though, would presumably involve some aspect of claims handling in that it generally addresses the repair costs of damage.  We can only hope that other decisions will eventually shed some light on the issue of “nature” versus “extent” of damage.

This area of the law is ever-evolving and complex.  If you have questions about the implications of Cedell or any of the cases discussed herein, or have any general questions in regard to pending insurance claims and compliance with Washington insurance law, please feel free to contact our office.

Leveraging the 50-State Initiative, Connecticut and Maine Team Secure Full Dismissal of Coverage Claim for Catastrophic Property Loss

On behalf of Gordon & Rees’ surplus lines insurer client, Hartford insurance coverage attorneys Dennis Brown, Joseph Blyskal, and Regen O’Malley, with the assistance of associates Kelcie Reid, Alexandria McFarlane, and Justyn Stokely, and Maine counsel Lauren Thomas, secured a full dismissal of a $15 million commercial property loss claim before the Maine Business and Consumer Court on January 23, 2020. The insured, a wood pellet manufacturer, sustained catastrophic fire loss to its plant in 2018 – just one day after its surplus lines policy expired.

Following the insurer’s declination of coverage for the loss, the wood pellet manufacturer brought suit against both its agent, claiming it had failed to timely secure property coverage, as well as the insurer, alleging that it had had failed to comply with Maine’s statutory notice requirements. The surplus lines insurer agreed to extend the prior policy several times by endorsement, but declined to do so again. Notably, the insured alleged that the agent received written notice of the non-renewal prior to the policy’s expiration 13 days before the policy’s expiration. However, the insured (as well as the agent by way of a cross-claim) asserted that the policy remained effective at the time of the loss as the insured did not receive direct notice of the decision not to renew coverage and notice to the agent was not timely. Although Maine’s Attorney General and Superintendent intervened in support of the insured’s and agent’s argument that the statute’s notice provision applied such that coverage would still be owed under the expired policy, Gordon & Rees convinced the Court otherwise.

At issue, specifically, was whether the alleged violation of the 14-day notice provision in Section 2009-A of the Surplus Lines Law (24-A M.R.S. § 2009-A), which governs the “cancellation and nonrenewal” of surplus lines policies, required coverage notwithstanding the expiration of the policy. The insured, the agent, and the State of Maine intervenors argued that “cancellation or nonrenewal” was sufficient to trigger the statute’s notice requirement, and thus Section 2009-A required the insurer to notify the insured directly of nonrenewal. In its motion to dismiss, Gordon & Rees argued on behalf of its client that Section 2009-A requires both “cancellation and nonrenewal” in order for the statute to apply. Since there was no cancellation in this case – only nonrenewal – Gordon & Rees argued that Section 2009-A is inapt and that the insurer is not obligated to provide the manufacturer with notice of nonrenewal. Alternatively, it argued that the statute is unconstitutionally vague and unenforceable.

The Court agreed with Gordon & Rees’ client that the statue is unambiguous because the terms “cancellation and nonrenewal” are not “mutually exclusive,” as was argued by the insured, agent and State intervenors. In doing so, the Court held that it was not bound by the definitions of “cancellation” and “non-renewal” found in Maine’s personal lines statutes (the definitions there expressly do not apply) and must interpret those terms based on their plain and common meanings. Based on this, the Court held: “the phrase ‘cancellation and non-renewal’ refers to the termination of a surplus lines insurance policy prior to the end of the policy period, with a failure to renew the policy.” The Court dismissed the complaint and cross-claim as no cancellation occurred, and the statute does not apply. Accordingly, there was no need to reach the arguments regarding constitutional infirmity.