Federal And State Appellate Tribunals Continue To Rule For Insurers On COVID-19 Business Interruption Claims

January 18, 2022 / CM Reports / Writing and Speaking

by Melinda S. Kollross

In Volume 3 of our 2021 CM Report, I reported on a growing body of federal appellate precedent holding that first-party property policies do not cover COVID-19 business interruption losses. That body of federal appellate precedent keeps growing, as discussed below. And significantly, the state reviewing courts have begun speaking on the issue too and, following the federal precedent, these state reviewing courts are likewise holding that there is no coverage for these pandemic related losses.

Dakota Girls, LLC v. Philadelphia Indem. Ins. Co., 2021 U.S. App. LEXIS 33002 (6th Cir. 2021)

The insureds operated preschools. The insureds conceded that Santo’s Italian Café LLC v. Acuity Ins. Co., 15 F.4th 398 (6th Cir. 2021), resolved issues against it on business income due to lack of property damage. The insureds argued, however, that a communicable disease endorsement was triggered simply when there was a shutdown order in response to a communicable disease found somewhere, and not necessarily at its premises. Applying Ohio law and predicting how the Ohio Supreme Court might rule, the Sixth Circuit disagreed with the insureds, holding that the policy had a definite legal meaning—that coverage is triggered only by a shutdown order that stemmed from an actual illness caused by a communicable disease at the insured’s preschools.

The Sixth Circuit further ruled that although it was sympathetic to the plight of the insureds, that sympathy did not enable it to rewrite the policy and give the insured coverage to which it was not entitled:

Like the Santo’s court, we appreciate the ‘singular challenges’ that COVID-19 has caused for businesses like Dakota Girls. Santo’s Italian Café, 15 F.4th at 407. But those challenges do not give us license to rewrite the plain terms of an insurance policy to confer upon the [insureds] a form of coverage for which they never contracted.

Inns-by-the-Sea v. California Mutual Ins. Co., 71 Cal. App. 5th 688 (Cal. App. 2021)

As the court noted, this appeal presented an issue of first impression for a California appellate court: does a commercial property insurance policy provide coverage for a business’s lost income due to the COVID-19 pandemic? The California Appellate Court ruled there was no such coverage because the was no direct physical loss of property.

According to the Appellate Court, the words “direct” and “physical” preclude the argument that coverage arises in a situation where the loss incurred by the policyholder stems solely from an inability to use the physical premises to generate income, without any other physical impact to the property. Accordingly, the mere loss of use, without any other physical impact to property is not sufficient to trigger the business income coverage terms of the policy. This conclusion was buttressed by the policy’s reference to the “period of restoration” and its focus on repairing, rebuilding, or replacing property. This policy language assumes physical alteration of the property and not just loss of use.

Bridal Expressions LLC v. Owners Ins. Co., 2021 U.S. App. LEXIS 35676 (6th Cir. 2021)

This Sixth Circuit decision relied upon Santo’s Italian Café LLC v. Acuity Ins. Co., 15 F.4th 398 (6th Cir. 2021), in holding that the insured failed to show any physical loss of or damage to property enabling it to obtain loss of business income coverage. According to the Court, the insured’s bridal shop had not been tangibly destroyed, whether in part or in full. And the insured had not been tangibly or concretely deprived of any of it. Put another way, a direct physical alteration of the property was needed to show damage to it, and some form of complete destruction or dispossession was needed to show loss of the property, and none of this existed here.

The Court further ruled that the insured’s allegation that the presence of COVID altered the structure of the Bridal Shop’s air, space and property was too conclusory to allow it to proceed further. For this theory to have traction, the complaint would need to allege that coronavirus was present in the shop and materially altered specific property at the time. If that were the theory of coverage, moreover, the complaint presumably would seek coverage for replacing that property and only for the time that property was damaged or lost, but nothing like this was alleged by the insured.

Nail Nook, Inc. v. Hiscox Ins. Co., 2021 Ohio 4211 (Ohio App. 8th Dist. 2021)

This decision by the Ohio Court of Appeals for the Eighth District in Nail Nook was the first Ohio state reviewing court decision to rule on an insured’s claim for business interruption coverage arising out of the pandemic. The court made two rulings. First, it held that the policy’s virus exclusion excluding losses from any virus, bacterium or other microorganism that induces or can induce physical distress, illness or disease barred all coverage under the policy for any claim by the insured. And secondly, the Court of Appeals ruled that even assuming all the allegations in Nail Nook’s complaint were true, Nail Nook did not have a valid claim for coverage because it could not prove direct physical loss of or damage to property required for business income coverage under the policy.

Finally, the Ohio Court of Appeals cited to the Sixth Circuit’s decision in Santo’s Italian Café LLC v. Acuity Ins. Co., 15 F.4th 398 (6th Cir. 2021), finding the Sixth Circuit’s policy argument most persuasive in justifying the denial of coverage:

Efforts to push coverage beyond its terms creates a mismatch, an insurance product that covers something no one paid for and, worse, runs the risk of leaving insufficient funds to pay for perils that insureds did pay for. That is why courts must honor the coverage the parties did—and did not—provide for in their written contracts of insurance.

Sanzo Enterprises v. Erie Ins. Exchange, 2021 Ohio 4268 (Ohio App. 5th Dist. 2021)

Five days after Nail Nook, the Ohio Court of Appeals for the Fifth District ruled in favor of an insurer on a claim for business income losses arising from the pandemic. The Sanzo Court relied upon the burgeoning federal precedent in holding that the plain and ordinary meaning of the phrase “direct physical loss of or damage to” unambiguously required a tangible and structural damage to the property to trigger the income loss provisions of the policy. According to the Court, the policy as a whole supported that conclusion. The Court found that the use of the words “repair, rebuild, restore, and replace” supported the determination that a mere loss of use, without any physical or tangible impact to the property, was not sufficient to trigger the income loss coverage. The Court stated that “[a]n intangible loss cannot be repaired, rebuilt, restored, or replaced”.

Finally, echoing the policy argument made by the Sixth Circuit in Santo’s Italian Cafe, the Court held that although it was unfortunate that these insured businesses suffered such losses because of the pandemic, the policies could not be construed in the manner that the insureds wanted to find coverage because it was contrary to the “plain and ordinary meaning” of the policy terms.

Sandy Point Dental v. The Cincinnati Ins. Co., 2021 U.S. App. LEXIS 36399 (7th Cir. 2021)

The Seventh Circuit in a flurry of 4 separate opinions issued on 12-10-21 all found in favor of various insurers that there was no coverage for any of the economic losses businesses have suffered because of the pandemic.

Sandy Point Dental was the lead insured with two others (The Bend Hotel Development Company and TJBC, Inc.) where the Seventh Circuit ruled that the insureds’ economic losses were not covered under the plain terms of the property policies. Applying Illinois law, the Court found that the policies were replete with textual clues that reinforce the conclusion that “direct physical loss” requires a physical alteration to property. The Court noted, for example, that the policies provided coverage for losses sustained during a “period of restoration,” which is defined by reference to “[t]he date [by which] the property … should be repaired, rebuilt, or replaced.” Without a physical alteration to property, there would be nothing to repair, rebuild, or replace. The Seventh Circuit stated that given this clear meaning of the policy terms, it was “no surprise” that the “overwhelming majority of the courts” have adopted this view that economic losses arising from mere loss of use did not fall within the ambit of policy coverage.

Crescent Plaza Hotel Owner, L.P. v. Zurich Am. Ins. Co., 2021 U.S. App. LEXIS 36396 (7th Cir. 2021)

Crescent Plaza followed Sandy Point Dental in holding that the insured failed to show any physical loss or damage to property to trigger the lost income provision because there was no showing that the insured’s property underwent any physical alterations. But the Court here went further and then addressed the applicability of the microorganism exclusion in the Zurich policy.

The exclusion barred coverage for losses “directly or indirectly arising out of or relating to: mold, mildew, fungus, spores or other microorganism of any type, nature, or description, including but not limited to any substance whose presence poses an actual or potential threat to human health.” The Court held that the COVID-19 virus qualified as a microorganism under the terms of the exclusion and provided an independent basis to hold that all of the insured’s claims were barred under the Zurich policy. In so holding, the Court soundly rejected all of the insured’s arguments against the applicability of the exclusion: it was not ambiguous; it could not be considered mere surplusage because of other exclusions in the policy; and the addition of a communicable disease exclusion in later policies was not an admission that this exclusion did not bar losses due to COVID-19.

Bradley Hotel Corp. v. Aspen Specialty Ins. Co., 2021 U.S. App. LEXIS 36398 (7th Cir. 2021)

Bradley Hotel followed Sandy Point Dentalin holding that the insured failed to show any physical loss or damage to property to trigger the lost income provision because there was no showing that the insured’s property underwent any physical alterations. Like Crescent Plaza though, the Court went further and addressed the loss of use exclusion and an ordinance and law exclusion, finding that they each provided independent grounds to hold that the entirety of the insured’s claim was barred.

The loss of use exclusion barred coverage for “loss or damage caused by or resulting from . . . [d]elay, loss of use or loss of market,” indicating that a mere loss of use cannot be the cause of a policyholder’s losses. The Court rejected the insured’s argument that applying the loss of use exclusion rendered the policy’s coverage for direct physical loss or damage superfluous. The insured’s argument was flawed because the exclusion was triggered only when, as here, loss of use was the alleged cause of loss—not when it was the result of a covered cause of loss. The ordinance or law exclusion in the Aspen policy also barred “loss or damage caused directly or indirectly by . . . enforcement of or compliance with any ordinance or law . . . [r]egulating the construction, use or repair of any property.” According to the Court, the closure orders issued to stem the spread of the virus qualified as an “ordinance or law” within the meaning of the exclusion, barring the insured’s claim.

Mashallah Inc. and Ranalli’s Park Ridge, LLC v. West Bend Mut. Ins. Co., 2021 U.S. App. LEXIS 36400 (7th Cir. 2021)

The Court here affirmed a district court’s dismissal of the insureds’ actions for business income losses due to the pandemic based upon a virus exclusion barring losses arising from any virus that can induce physical distress, illness, or disease. The Court found that the district court was correct in ruling based on the virus exclusion alone, rejecting the insureds’ arguments that Illinois law required a court to resolve the scope of an insurance policy’s coverage before addressing the applicability of potentially relevant exclusions. As to the exclusion itself, the Court ruled it was unambiguous, clearly precluding insurance coverage for losses and expenses allegedly caused by the COVID-19 pandemic and government orders issued to stem its tide.

Additionally, the Court rejected the insureds’ arguments that they were entitled to premium rebates, claiming they had reduced insurance risks because of the COVID-19 closure orders. The Seventh Circuit agreed with the district court that the insurer was not guilty of any unjust enrichment in not giving such a rebate because no misconduct on the insurer’s part was reasonably alleged and because a valid insurance contract governed the parties’ relationship.

Goodwill Indus. of Central OK v. Philadelphia Indem. Ins. Co., No. 21-6045 (10th Cir. 2021)

On 12-21-21, the Tenth Circuit issued a decision in line with the prior decisions of the Sixth, Seventh, Eighth, Ninth, and Eleventh Circuits holding that there was no insurance coverage from the losses an insured suffered because of pandemic closure orders.

Applying Oklahoma law, the Tenth Circuit ruled that the insured was not entitled to any lost business income coverage because its losses did not stem from any physical alteration or tangible dispossession of insured property. The Court found that the policy’s “Period of Restoration” requirements demonstrated that only a physical alteration or tangible dispossession could trigger the lost business income coverage provision of the policy. According to the Court, the “Period of Restoration” clause provided coverage until property is repaired, rebuilt, or replaced or until the insured resumes business elsewhere. The Court concluded that this policy language presumed a physical alteration of the property, and not just mere loss of use. The Court stated, “after suspending business due to COVID restrictions, [the insured] had nothing to repair, rebuild, or replace before it could resume operations” because nothing “physical” happened to its property.

The Tenth Circuit also ruled that in any event, the entirety of the insured’s coverage claim was barred by a virus exclusion barring payment for loss or damage caused by or resulting from any virus, bacterium or other microorganism that can induce physical distress, illness, or disease. The Court found that the virus exclusion was valid, enforceable, and barred coverage both under its plain language and under the efficient proximate cause doctrine.

10012 Holdings, Inc. D/B/A Guy Hepner v. Sentinel Ins. Co., Ltd., No. 21-80 (2d Cir. 2021)

On 12-27-21, the Second Circuit added its name to the growing list of federal and state appellate tribunals finding that there is no first-party property coverage for business income losses arising from closure orders issued to stem the spread of COVID-19 during this pandemic.

As the Second Circuit put it, the “central question” to be answered under New York law was whether the policy provided coverage for the insured’s financial losses even though the insured did not allege its closure resulted from physical damage to its property or the adjoining property of its neighbors. The Second Circuit found that the decision by the New York Supreme Court, First Department in Roundabout Theatre Co. v. Cont’l Cas. Co., 751 N.Y.S.2d 4 (App. Div. 1st Dep’t 2002), provided a simple, straightforward answer to the question. Business closures did not constitute physical loss or damage to property, and the Second Circuit found that “all New York courts applying New York law” have ruled that way. The Second Circuit stated: “We therefore hold, in accord with Roundabout Theatre and every New York state court to have decided the issue, that under New York law the terms ‘direct physical loss’ and ‘physical damage’ in the Business Income and Extra Expense provisions do not extend to mere loss of use of a premises, where there has been no physical damage to such premises; those terms instead require actual physical loss of or damage to the insured’s property.”

The Second Circuit also rejected the insured’s claim for coverage under the policy’s civil authority provision. To recover under this provision, the insured had to show that the closure orders resulted from a risk of direct physical loss to property in the vicinity of the insured’s property. The insured could not show this as matter of law because the closure orders were issued because of the risk COVID-19 posed to humans, and not out of any risk of direct physical loss of property. Additionally, the civil authority provision contemplated that the orders prohibiting access to the insured’s premises were prompted by risk of harm to neighboring premises. But the insured did not allege this, alleging instead that the closure was the direct result of the risk of COVID-19 at its property.

Indiana Repertory Theatre Inc. v. The Cincinnati Casualty Co., 21A-PL-628 (Ind. App. 2022)

The Indiana Court of Appeals rang in the New Year by issuing an opinion on 1-4-22 supporting the position taken by insurers that closure orders issued to stop the spread of the COVID-19 virus did not cause physical loss or damage under a property policy.

The Court found the New York decision in Roundabout Theatre Co. v. Cont’l Cas. Co., 302 A.D.2d 1 (N.Y. App. Div. 2002), persuasive. According to the Court, the Roundabout business had to close because of damage at a nearby construction site, and not because of any damage to the Roundabout business property. The New York Court thus held that there was no lost business income coverage because the Roundabout insured’s closure did not result from any physical loss or damage to its own property. The Indiana Court of Appeals found that the same reasoning applied in this case, as the insured had to close because of the pandemic and not because of any physical loss or damage to any of its property.

The Court further found that the insured’s interpretation of “physical loss or physical damage” was unreasonable because it parsed and dichotomized the policy language. According to the Court, the insured did not consider the whole policy, as it did not reconcile its interpretation of “physical loss or physical damage” with the “period of restoration” provision of the policy, which outlines the time when coverage begins and ends based on when the covered premises is “repaired, rebuilt or replaced” or the “business is resumed at a new permanent location.” Without physical alteration or impact to the insured’s premises, there could be no period of restoration.

Finally, echoing the policy reasons advanced by other tribunals for upholding orders denying coverage, the Court noted the plight the insured faced from the pandemic and others like the insured worldwide who faced similar dire business consequences. Yet the Court ruled that it could not let its sympathies for the insured cause it to “ignore well-established principles of insurance contract interpretation and add provisions in the Policy that do not exist”.

Terry Black’s Barbecue L.L.C. v. State Automobile Mutual Ins. Co., No. 21-50078 (5th Cir. 2022)

The Fifth Circuit continued to build on this favorable precedent in the New Year with a decision issued on 1-5-22, following the lead of every Federal and State appellate tribunal to date in holding that there was no first-party property coverage for the business income losses this insured sustained because of the pandemic.

Applying Texas law, the Fifth Circuit held that the insured was not entitled to any coverage for lost business income/extra expense because it did not show that it sustained any loss of or damage to property at its premises. According to the Court, prior Texas decisional law construing these words “physical loss or damage” showed that those terms were understood to mean distinct, demonstrable physical alteration and destruction. Nothing of that nature, however, occurred to the insured’s property. The Court further found that the nature of the policy itself, a commercial property policy, supported its conclusion. The business income/extra expense provision covered business interruption that was caused by loss or damage to the commercial property. The insured’s claimed loss however was not about its property, but about its inability to provide dine-in services because of the closure orders issued to stem the spread of the virus. This economic loss, however, did not have any tangible effect on the property itself.

The Court also held that no coverage was owed under a restaurant extension endorsement providing coverage for the suspension of operations at the described premises due to a civil authority order resulting from the actual or alleged exposure of the described premises to a contagious or infectious disease. According to the Court, the closure orders had to result from the insured’s actual or alleged exposure to a contagious disease for this provision to apply. The Court held that this provision did not apply because the orders were not caused, even tangentially, by the insured’s alleged or actual exposure to a contagious disease. The closure orders resulted instead from the global pandemic and the need to take measures to contain and prevent the spread of COVID-19.

Learning Point: In my previous summary of appellate decisions, I recommended that the policy argument articulated by the Sixth Circuit in Santo’s Italian Café LLC v. Acuity Ins. Co., 15 F.4th 398 (6th Cir. 2021), be included in all future briefing as that policy argument goes to the very heart of why all these COVID-19 business interruption claims should be rejected by the courts. The decisions in Dakota Girls by another panel of the Sixth Circuit, Nail Nook by the Eighth District Ohio Appellate Court, Sanzo by the Fifth District Ohio Appellate Court, and Indiana Repertory Theatre by the Indiana Court of Appeals prove the wisdom of this advice, as these appellate tribunals found that policy argument crucial to their decisions. Thus, in future briefing, not only should the Santo’s policy argument be featured prominently, but these subsequent decisions should be cited showing the growing acceptance of this policy argument by other panels of appellate jurists for rejecting these pandemic related claims for business interruption coverage.

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