The novel coronavirus (COVID-19) pandemic presents a number of significant insurance issues that are likely to be litigated as entire sectors of the U.S. economy are impacted. Property insurers should be well versed on these issues as they face a rising number of loss claims.

Business-Interruption Policies’ Physical Damage Requirement

Businesses shuttered in the wake of COVID-19 may seek coverage under “business interruption” provisions of their all-risk policies. Under such provisions, the insurer “will pay for the actual loss of Business Income you sustain due to the necessary ‘suspension’ of your ‘operations’ during the ‘period of restoration’. The ‘suspension’ must be caused by direct physical loss or damage to property at premises.” (emphasis supplied).

Insurers reviewing coronavirus-related business-loss claims should be aware of how courts have interpreted the “physical loss” requirement. Claims arising from COVID-19 business interruptions may differ based on whether a business was forced to close by government mandate or chose to close, or whether an insured can demonstrate that an employee or patron at the covered premises tested positive for the coronavirus.

The plain language of policies, like the one cited above, requires that an insured demonstrate a physical loss to the covered property as a threshold matter, before an insurer should consider paying for an alleged business loss or interruption. See, e.g., Universal Image Productions, Inc. v. Chubb Corp., 703 F. Supp. 2d 705, 710–11 (E.D. Mich. 2010). A divergence occurs, however, with regard to what constitutes a “physical loss.”

Federal courts in the Sixth, Ninth and Eleventh Circuits have taken a stricter approach, interpreting physical loss as tangible, structural damage to the covered premises. In Universal Image Productions, Inc. v. Chubb Corp., 703 F. Supp. 2d 705 (E.D. Mich. 2010), a federal court applying Michigan law determined that a foul odor caused by bacteria contamination in the air was not covered physical damage. There, the court rejected the insured’s argument that “such intangible harms as strong odors and the presence of mold and/or bacteria in the air” were covered because there was no structural alteration to the subject property. Similarly, affirming the District of Oregon’s declaratory judgment for an insurer, the Ninth Circuit held that asbestos contamination was an economic—but not physical—loss, because the covered premises remained unchanged. Northern Ins. Co. v. Benjamin Franklin Fed. Sav. & Loan Ass’n, 953 F.2d 1387 (9th Cir. 1992).

In a case arising when construction debris blew onto the covered premises, the Southern District of Florida granted summary judgment for defendant-insurer, because “a direct physical loss contemplates an actual change in insured property . . . causing it to become unsatisfactory for future use or requiring that repairs be made to make it so.” Mama Jo’s Inc. v. Sparta Ins. Co., 2018 WL 3412974 (S.D. Fla. June 11, 2018). See also, Mastellone v. Lightning Rod Mut. Ins. Co., 884 N.E.2d 1130 (Ohio Ct. App. 2008) (rejecting a claim arising from mold damage because the insured could not show “a harm to the property that adversely affects the structural integrity” of the covered premises).

Federal courts in the First and Third Circuit have construed the physical loss requirement more liberally, requiring coverage for business interruption in cases concerning odors, bacteria contamination and gaseous leaks.

The Third Circuit has defined physical damage as “distinct, demonstrable, and physical alteration” to covered premises. Port Authority of N.Y. and N.J. v. Affiliated FM Ins. Co., 311 F.3d 226, 235 (3d Cir. 2002). However, in an unpublished opinion, the District of New Jersey held that a structural alteration was not necessary for coverage in a business interruption claim. Gregory Packaging v. Travelers Property Cas. Co. of Am., 2014 WL 6675934 (D.N.J. Nov. 25, 2014) citing Western Fire Ins. Co. v. First Presbyterian Church, 437 P.2d 52 (Colo. 1968) (gas vapors); and Wakefern Food Corp. v. Liberty Mutual Fire Ins. Co., 968 A.2d 724 (N.J. Super. App. Div. 2009) (electric grid downed by a blackout).

In Gregory Packaging, the court found the insured’s factory was physically damaged by an ammonia release that caused the factory to be temporarily unfit for occupancy, but did not physically alter the premise. The focus on inhabitability—as opposed to structural damage—within the physical loss analysis relied on a Third Circuit case, Motorist Mutual Ins. Co. v. Hardinger, 131 F. App’x 823 (3d Cir. 2005). In Motorist Mutual, the bacteria contamination of a home’s water supply constituted a direct physical loss because it rendered the home uninhabitable. See also, Essex Ins. Co. v. Bloom South Flooring Corp., 562 F.3d 399, 406 (1st Cir. 2009) (denying insurer’s motion to dismiss because “odor can constitute physical injury to property under Massachusetts law”).

Civil Authority Claims

Another source of coverage within business-interruption provisions is Civil Authority coverage. Under these provisions, the insurer will afford coverage “when a Covered Cause of Loss causes damage to property” other than the covered property, where business income is lost due to “action of civil authority that prohibits access” to the covered property. For coverage to apply, “access to the area immediately surrounding the damaged property must be prohibited by civil authority as a result of the damage.” The civil action must also be made “in response to dangerous physical conditions resulting from the damage or continuation of the Covered Cause of Loss.”

Civil Authority clauses are interpreted to have a four-element test: “(1) The losses must be caused by an action of civil authority that (2) prohibits access to the described premises (3) due to a direct physical loss or damage to property other than at the described premises, and (4) the loss or damage to the property other than at the described premises must be caused by a “covered cause of loss.” Narricot Indus., Inc. v. Fireman’s Fund Ins. Co., 2002 WL 31247972 at *4 (E.D. Pa. 2002); Dickie Brennan & Co., Inc. v. Lexington Ins. Co., 636 F.3d 683, 685 (5th Cir. 2011).

First and foremost relevant to potential COVID-19 claims, courts have held that Civil Authority clauses do not require a formal order to be issued by civil authorities; advisories to the remain off the streets could be considered a civil action. See, Kean, Miller, Hawthornes, D’Armond McCown & Jarman, LLP v. National Fire Ins. Co. of Hartford, 2007 WL 2489711 *3 (M.D. La. 2007) citing Narricot, supra, 2002 WL at *4 (where the court held that Civil Authority clause requiring “action of civil authority” did not require a formal order or a written order because the clause did not mention an order).

One issue that arises with these provisions is the temporal aspect of the closure. Whether the closure is to made prevent future harm rather than a reaction to damage to a nearby property can change whether coverage is afforded or not. In United Air Lines, Inc. v. Insurance Co. of the State of Pennsylvania, 439 F.3d 128 (2d Cir. 2006), the Second Circuit, applying New York Law, determined that interruptions to a commercial airline’s business following the September 11th attacks were not a “direct result” of damage to an adjacent premises. There, the Insured argued that it was entitled to recover for lost earnings arising from the post-attack shut down of Ronald Reagan Airport. The insured believed the Civil Authority clause covered the loss because the closure was the direct result of the physical damage to the Pentagon, which was an “adjacent premises.” In order to prove Civil Authority, the insured had to “show that was denied access to its ‘locations’ at the airport “as a direct result of damage to adjacent premises.” Id. at 134. The court found that there was a temporary halt in flights prior to when the Pentagon was struck. Further closures for the months following of the attack were for fear of future attacks rather than a result of the damage to the Pentagon. As a result, the court concluded that United could not show that the airport was shut down a “direct result of damage” to the Pentagon.

Other courts have followed the United Air Lines reasoning. A Fifth Circuit panel noted that the United Air Lines decision was well reasoned, and that without prior physical damage, an insured fails to establish the necessary causal link between prior property damage and a civil authority order. Dickie Brennan, supra, 636 F.3d at 686. In Assurance Co. of America v. BBB Serv. Co., Inc., 265 Ga. App. 35 (2003), the court noted that if a hurricane evacuation order was issued due to the threat of future injury to persons and property and not because of an existing physical loss or damage to property, the insured would be barred from recovery.

These decisions are notable for potential COVID-19 claims because many closures across the United States have been civil orders issued before there were any tested positive cases. Most civil orders have been issued to prevent the future spread of the virus rather than the result of a contaminated individual being in a certain location, which was then shut down. Without an existing physical loss to hinge their claim upon, most if not all insureds would fail to prove that their closure was a direct physical damage to a nearby property.

There is also tension in how much the civil action must prohibit access to the insured premises. Some courts have found that there must be a direct nexus between the action of the civil authority and the prohibition of access to the insured premises. See, Abner, Herman & Brock, Inc. v. Great N. Ins. Co., 308 F. Supp. 2d 331 (S.D.N.Y. 2004) (finding civil authority provision applies only when civil authority actually and completely prohibits access to the insured premises and not later days when traffic restrictions merely made access more difficult); 54th St. Ltd. Partners, L.P. v. Fidelity and Guaranty Ins. Co., 763 N.Y.S.2d 243 (1st Dep’t 2003) (holding that civil authority provision only applied for two days when access to premises was denied but not for later days when vehicle and pedestrian traffic was diverted because access to the public, employees, etc. was not completely denied); St. Paul Mercury Ins. Co. v. Magnolia Lady, Inc., 1999 WL 33537191 (N.D. Miss. 1999) (no coverage when state authorities hampered access to a casino by closing a damaged bridge, because the casino was still accessible by other routes during the time the bridge was under repair); Syufy Enter. v. Home Ins. Co. of Indiana, 1995 WL 129229 (N.D. Cal. 1995) (dawn-to-dusk curfews imposed to reduce chance of rioting and loots were held to not be an order by civil authority specifically prohibiting access to a movie theatre).

On the other hand, some courts have held that access to the insured premises is “prohibited” where the order or civil action requires the insured’s premises to close. See, Narricot, supra, 2002 WL 31247972 at *4 (order of town authorities required plaintiff to suspend plant operations due to a hurricane); Altru Health Sys. v. American Protection Ins. Co., 238 F.2d 961 (8th Cir. 2001) (claim for business interruption covered where the state health department ordered hospitals to evacuate and close during a flood where the city’s water supply failed); Assurance Co. of Am. v. BBB Serv. Co., 265 Ga. App. 35 (2003) (county ordered to evacuate a hurricane approached requiring the closure of plaintiffs restaurant); Keane, Miller, Hawthorne, D’Armond McCowan & Jarman, LLP, supra, 2007 WL 2489711 (finding that Governor’s declaration of a state of emergency in reaction to Hurricane Katrina did not prohibit access to the insured’s premises because evacuation was a suggestion rather than requirement because the Insured’s employees were still able to access the property).

This tension and conflicting law may be relevant to future COVID-19 claims. The difference between prohibiting access to an insured’s property and orders of closure of all businesses during certain times may be the difference between coverage and no coverage, depending upon the jurisdiction. Further, it will be difficult for an insured to show that there was some physical impossibility to accessing the property. Although businesses have been shuttered, the buildings are still accessible and employees are still capable of entering if they have keys. Without a complete physical restriction due to Civil Authority, in some jurisdictions it will be impossible to gain coverage under the provisions.

Virus Exclusion

In addition to the threshold requirement of “physical damage” for business interruption coverage, many commercial property policies exclude losses caused by a virus. As one endorsement states: “We 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 or disease.”

The Insurance Services Office (ISO) promulgated a virus and bacteria exclusion in 2006 in the aftermath of the SARS epidemic. The purpose of the exclusion is to expressly state that business losses caused by temporary contamination or disease are not covered. Notably, the virus exclusion was not intended to minimize the scope of commercial property policies. Rather, the purpose was to preemptively clarify that business interruption caused by disease is not covered because viruses and bacteria do not cause physical property damage.

ISO articulated the purpose of the virus exclusion, stating: “Although building and personal property could arguably become contaminated (often temporarily) by such viruses and bacteria, the nature of the property itself would have a bearing on whether there is actual property damage. An allegation of property damage may be a point of disagreement in a particular case. In addition, pollution exclusions are at times narrowly applied by certain courts.”

The virus exclusion has not been extensively litigated since its inception. One federal court, however, has enforced the plain language of a similar exclusion in favor of the insurer in Meyer Natural Foods, LLC v. Liberty Mutual Fire Insurance Co., 218 F. Supp. 3d 1034 (D. Neb. 2016). In Meyer, the insured’s coverage excluded “loss attributable to contamination,” which, the court found, encompassed an E. coli bacterial outbreak in the covered premises even though E. coli was not specifically mentioned in the policy or its exclusions. A similar, plain language approach to future cases concerning the novel coronavirus and the virus exclusion would likely bar COVID-19 business-interruption claims.

At least one state legislature is attempting an end run around virus exclusions and, for that matter, the policy’s “physical damage” requirement. New Jersey Assembly bill A-3844 would force insurers to cover business losses attributable to COVID-19 retroactive to March 9, 2020. The bill would only apply to small and medium-size businesses with less than 100 employees, but has raised numerous constitutional questions relating to the Contracts Clause, which limits the government’s ability to interfere with private contracts. As of this writing, the substance of the proposed legislation is still being discussed.

Communicable Disease Exclusion

Many commercial property policies exclude losses caused by the actual or alleged transmission of a communicable disease. These provisions are broad, including omissions such as failure to prevent the spread of a disease or the failure to report the disease to the authorities. Communicable Disease Exclusions have not been heavily litigated in either State or Federal Court Jurisdictions.

One issue that arises with communicable disease exclusions is whether a disease is “communicable.” Many authorities, including the American Public Health Association, consider COVID-19 a communicable disease.

In Pasternostro v. Choice Hotel Inter. Services Corp., 2014 WL 64660844 (E.D.La. 2014), insurers were sued after they denied coverage to an insured hotel after an outbreak of Legionnaires’ disease and Pseudomonas aeruginosa in the hotel’s pool. The policy excluded coverage for injuries “arising in whole or in part, directly or indirectly out of, or which is in any way related to a communicable disease.” The parties disputed whether Legionnaires’ disease and Pseudomonas aeruginosa were communicable diseases because they are transmitted environmentally rather than from person to person.

The insurer cited the Center for Disease Control’s dictionary definition of a communicable disease in support of its argument that the diseases fell within the plain meaning of a communicable disease. The insured argued that the diseases were not excluded because communicable diseases require person-to-person transmission, whereas Legionella is spread from environmental contact.

The court held that the insurer did not unambiguously demonstrate the applicability of the communicable-disease exclusion because discovery may reveal that Legionnaires’ disease and Pseudomonas aeruginosa are not communicable and it was unclear if the injuries would fall within the exclusion.

Similarly, various courts have found that homeowners’ policies exclude coverage for communicable diseases exclude coverage for the transmission of sexually transmitted diseases because they are transferred from person-to-person. See, Lambi v. American Family Mut. Ins. Co., 2012 WL 2049915 (W.D.Mo. 2012) (finding HIV transmitted via sexual contact to be a communicable disease excluded by a Communicable Disease exclusion.); Plaza v. General Assur. Co., 664 N.Y.S.2d 444 (1st Dep’t 1997) (precluding coverage for personal injuries sustained as a result of transmission of HIV, even though New York’s Public health Law excluded AIDS and HIV from its list of communicable diseases because any disease that is communicable is covered.).

Insurers have also been able to deny the duty to defend or indemnify an underlying suit when the basis of the suit was the possible transmission of a communicable disease. See, Fe-Ma Enterprises v. James River Ins. Co., 2009 WL 10693571 (S.D. Texas 2009).

For more information, please contact John Clark at 856-288-2404 or jclark@clarkfoxlaw.com or Michael Savett at 856-345-0386 or msavett@clarkfoxlaw.com.