First Department Holds That Proof of Direct Physical Loss or Damage to Insured Property is a Prerequisite to Recovery for Business Interruption Loss
The Appellate Division - First Department has held that an insured must prove direct physical loss to insured property as a prerequisite to recovery for business interruption loss. Roundabout Theatre Co. v. 1830 Continental Casualty Co., 2002 WL 31662563, *4, 2002 N.Y. Slip Op. 08839 (N.Y. App. Div., 1st Dep’t).
In February, 1998, the insured, Roundabout Theater Company (“Roundabout”), began performing a production of the musical Cabaret at the Kit Kat Club (the “theater”), a facility contracted for use by Roundabout for the production. On July 21, 1998, an exterior elevator at a nearby building under construction collapsed into the street and adjacent buildings. The theater sustained only minor damage to its roof and air conditioning system which was repaired within one day. However, because of damage to surrounding buildings, New York City’s Office of Emergency Management ordered the entire street closed from July 21 through August 18, 1998. As a result of the street closing, Roundabout was forced to cancel 35 performances of Cabaret. Roundabout sought coverage under a policy issued by Continental Casualty Company (“Continental”) for business interruption losses related to the canceled performances.
Continental had issued an “all risk” policy, including business interruption coverage (the “policy”), to Roundabout. The “Insuring Agreement” stated:
The company agrees to pay to the insured such loss ... as the Insured shall necessarily incur in the event of interruption, postponement or cancellation of an insured Production as a direct and sole result of loss of, damage to or destruction of property or facilities (including the theatre building occupied ... by the Insured, and [certain equipment] ), contracted by the insured for use in connection with such Production, caused by the perils insured against, and occurring during the term of coverage . . .
Continental denied Roundabout’s claim.
In February, 2000, an action was commenced by an assignee of Roundabout’s rights against Continental for breach of contract. Continental moved for summary judgment arguing that the policy did not provide coverage for business interruption caused by property damage to uninsured property. The court denied Continental’s motion.
Roundabout cross-moved for summary judgment, which motion was granted by the court. The court found that because Continental had issued an “all risk” policy, the burden was on Continental to demonstrate that the loss was expressly excluded by terms of the policy. The court rejected Continental’s argument that the policy required actual physical damage to insured property and held that a mere “ loss of use” of the property qualified as a “loss of, damage to, or destruction of property or facilities” as required by the Insuring Agreement. To hold otherwise, reasoned the court, would make the phrase “loss of” redundant to “destruction of” property.
The Appellate Division, First Department, reversed the lower court’s decision and granted summary judgment in favor of Continental. The First Department held that the IAS court deviated from the well-established principle that the insured “bears the initial burden of showing that the insurance contract covers the loss.” The court stated that labeling an insurance policy as “all risk” does not relieve the insured of its burden of establishing a “covered loss.” The court found that Roundabout presented no evidence of a covered loss to insured property, thus failing to meet that burden.
The First Department held that the language in the Roundabout insurance policy was not ambiguous and clearly provided coverage for business interruption losses only where such losses are caused by direct physical damage to insured property. The court cited the Insuring Agreement which provided coverage for “loss of, damage to, or destruction of property or facilities . . . contracted by the insured for use in connection with such Production, caused by the perils insured against.” In addition, the “Perils Insured” clause covers “all risks of direct physical loss or damage to the [insured’s] property.” There was clearly no damage to the insured’s property that forced the cancellation of any performances.
Moreover, the court reasoned, “[t]he plain meaning of the words ‘direct’ and ‘physical’ narrow the scope of coverage and mandate the conclusion that losses resulting from off-site property damage do not constitute covered perils under the policy.” The First Department disagreed with the IAS court that the term “loss of” would be redundant to “destruction of.” “Loss of,” explained the court, envisions situations in which insured property is lost or stolen, but not destroyed, and cancellation of performances is required.
In addition, the Appellate Division pointed to other provisions in the policy that serve to limit coverage to physical damage to the property. The “Definition of Loss” section stated that the measure of recovery is limited to “such length of time as would be required with exercise of due diligence and dispatch to rebuild, repair, or replace” damaged property. Furthermore, the “Substitute Theatre” provision required the insured to “exercise due diligence . . . following the loss of, damage to, or destruction of the theatre,” and that the new theatre must be of comparable size to the theatre that was “damaged or destroyed.”
Insurers should be aware of claimants attempting to find coverage for loss of access to or use of property where no such coverage is expressly provided by the policy. While the term “direct physical loss or damage to property” appears to clearly require identifiable physical loss or damage to insured property, there are decisions in other jurisdictions that have found that loss of property’s use or function constitutes physical loss. See Datatab, Inc. v. St. Paul Fire & Marine Ins. Co., 347 F. Supp. 36 (S.D.N.Y. 1972); Sentinel Management Co. v. New Hampshire Ins. Co., 563 N.W.2d 296 (Minn. Ct. App. 1997); Hughes v. Potomac Ins. Co., 18 Cal.Rptr. 650 (Cal Ct. App. 1962). We will continue to monitor this important coverage issue and provide updates to readers as they occur. •