Governmental Closure Orders Not “Direct Physical Loss”

While it is still in the beginning stages, the early results in the coronavirus insurance litigation over losses related to governmental closure orders have favored insurers.  In the two recent opinions described below, the courts each noted that while it sympathized with the policyholders’ situation, it found that as a matter of law it had to rule for the insurer.

Dist. Columbia:  The District of Columbia Superior Court, applying D.C. law, granted an insurer’s cross motion for summary judgment finding that a governmental order, standing alone, does not constitute “direct physical loss” under an insurance policy.  The policyholders own and operate a number of prominent restaurants in the District of Columbia.  Each policyholder is insured under an Ultrapack Plus Commercial Property Coverage policy issued by Erie Insurance Exchange (“Erie”).  The Erie policies include coverage for “loss of ‘income’ and/or ‘rental income’” sustained “due to partial or total ‘interruption of business’ resulting directly from ‘loss or damage’ to the property insured.”

D.C. Mayor Muriel Bowser declared a state of emergency and a public health emergency due to the “imminent hazard of or actual occurrence of widespread exposure” to COVID-19.   Mayor Bowser then issued orders prohibiting table seating and standing at restaurants and bars in D.C., ordered the closure of all non-essential businesses, and ordered all D.C. residences to stay in their home except for limited “essential” reasons.  As a result of Mayor Bowser’s orders, the policyholders were forced to close their businesses and suffered revenue losses.  The policyholders filed insurance claims with Erie to recoup their losses.  Erie denied the claims, and the policyholders filed a lawsuit seeking a declaratory judgment that their claims were covered by the express language of the Erie policies.  Both the policyholders and the insurer moved for summary judgment.

The parties disputed whether the closure of the restaurants due to Mayor Bowser’s orders constituted a “direct physical loss” under the policy.  The policyholders used the dictionary definition of “direct” and “physical” and “loss” to argue that their losses are covered under the Erie policies.  The court disagreed with each of the policyholders arguments finding (1) that the governmental orders standing alone and absent the intervening actions by individuals and business did not affect any direct changes to the properties; (2) that the policyholders offered no evidence that COVID-19 was actually present at the insured properties at the time they were forced to close and the mayor’s orders did not have any effect on the material or tangible structure of the insured properties; and (3) any “loss of use” must be caused, without the intervention of other persons or conditions, by something pertaining to matter – in other words, a direct physical intrusion on to the insured property.

The court found the term “direct loss” implies some form of direct physical change to the insured property, which could not be based on the governmental orders alone.  Rose’s 1, LLC v. Erie Insurance Exchange, Case No. 2020 CA 002424 B (D.C. Super. Ct. Aug. 6, 2020).

TX Dist. Ct:  The Texas District Court, applying Texas law, granted an insurer’s motion to dismiss for failure to state a claim for breach of contract based on the insurer’s denial of claims for business interruption.  To stop community spread of COVID-19, Bexar County Judge Nelson Wolff and Texas Governor Greg Abbott have issued executive orders that limit the opening of certain businesses and require social distancing.  The policyholders run barbershops; a type of business deemed non-exempt and non-essential under the executive orders.  The policyholders’ properties that are the subject of the dispute are insured by State Farm Lloyds (“State Farm”).

Under the policies at issue, State Farm will “insure for accidental direct physical loss to Covered Property” unless the loss is otherwise excluded.  The State Farm policies contain a “Fungi, Virus, or Bacteria” exclusion (the “Virus Exclusion”), which states in relevant part, “We do not insure under any coverage for any loss which would not have occurred in the absence of one or more of the following excluded events … whether other causes acted concurrently or in any sequence within the excluded event to produce the loss … (2) Virus, bacteria or other microorganism that induces or is capable of inducing physical distress, illness or disease.”  The State Farm policies also include a coverage related to a Civil Authority provision.

The policyholders filed claims with State Farm seeking coverage for business interruption.  State Farm denied the policyholders’ claims stating that the “policy specifically excludes loss caused by enforcement of ordinance or law, virus, and consequential losses.”  State Farm also stated that the policies require “that there be physical damage, within one mile of the described property” and “that the damage be the result of a Covered Cause of Loss,” which according to State Farm, a “virus is not.”

The policyholders sued State Farm for breach of contract.  State Farm moved to dismiss for failure to state a claim.  According to State Farm, for business income coverage to apply its policies require (1) an accidental direct physical loss to the insured property and (2) that the loss is not excluded.  The policyholders failed to properly plead direct physical loss or show that the properties have been tangibly “damaged.”  Moreover, State Farm argued that the policyholders’ pleading failed to overcome the Virus Exclusion.

According to the policyholders, the State Farm policies do not require a tangible and complete physical loss to the properties, but rather the policies allow for a partial loss to the properties, which includes the loss of use due to the executive orders restricting usage.  As to the Virus Exclusion, the policyholders argued that it should not apply because it was the executive orders that caused the direct physical loss, not COVID-19.  The policyholders also argued that because the executive orders were issued to protect public health and welfare, their claims fall under the Civil Authority provision within the State Farm policies.

The district court found that accidental direct physical loss requires tangible injury to property, thus, the loss needs to have been a “distinct, demonstratable physical alteration of the property.”  Therefore, the district court held that the policyholders failed to plead a direct physical loss.  The district court also noted that even if it found that the language of the policies was ambiguous or that the policyholders had properly pleaded direct physical loss, the Virus Exclusion barred the policyholders’ claims.  The policyholders’ pleaded that COVID-19 was the reason the executive orders were issued and the underlying cause of their losses.  Thus, it was the presence of COVID-19 that was the primary root cause of the policyholders’ businesses temporarily closing.  Finally, the district court also found that the Civil Authority provision in the policies was not triggered: “Plaintiffs’ recovery remains barred due to the unambiguous nature of the events that occurred, causing the Virus Exclusion to apply such that [the Policyholders] fail to allege a legally cognizable ‘Covered Cause of Loss.’”  Thus, given the plain language of the insurance policies, the district court found that it could not deviate from its finding without in effect re-writing the policies in question.  Diesel Barbershop, LLC v. State Farm Lloyds, Case No. 5:20-CV-461-DAE (E.D. Tex. Aug. 13, 2020).