Business Interruption Coverage in the Age of COVID-19
The coronavirus pandemic has surfaced many new and interesting legal issues. Among them: What legal recourse is available to a business that lost significant profits after a governmental order forced it to close? In March 2020, for example, the Bay Area enacted a shelter in place mandate and ordered all non-essential businesses. The March 16 order from the City and County of San Francisco, for example, defined essential businesses as healthcare operations, public works and construction, emergency personnel, grocery stores, hardware stores, restaurants for delivery or carry out only service, mailing and shipping services, banks, and food cultivation businesses, among others.... to either close or severely limit their business. Other regions quickly followed suit. Almost immediately, businesses felt the economic impact of the forced closure. With little relief in sight, many turned to—and against—their commercial liability insurers.
Business Interruption Coverage
In the last year, many businesses covered by commercial liability insurance have attempted to make up for pandemic-related economic loss by filing insurance claims—and then, when their insurer ineluctably denied those claims, lawsuits—under either “business interruption,” “civil authority,” or other provisions of their policies. This essay focuses on the first of these provisions. Business interruption coverage insures businesses for lost income as a result of a covered peril or event, like theft, natural disaster, or accidents. Generally, an insured seeking business interruption coverage must show that it has suffered “direct physical loss” or “direct physical damage.” The bulk of COVID-related business interruption litigation has centered around the question of whether and how COVID closures constitute direct physical loss or damage, an issue that courts have increasingly had to contend with in the past year.
In the months following the onset of the pandemic, insureds began testing the theory that a virus (or the disease it causes, or the government actions that force closure in light of the virus) could cause the requisite physical loss or damage sufficient to avail an insured of business interruption coverage. The University of Pennsylvania Law School’s COVID Coverage Litigation Tracker shows that the number of business interruption suits filed since March has ballooned to over 1,400, with no signs of letting up.
Even before COVID-19, the prevalent sentiment in the insurance industry was that diseases could not constitute physical loss sufficient to trigger business interruption coverage. In fact, after the SARS outbreak in 2003, it was not uncommon for insurers to include virus contamination exclusions in insurance policies that barred recovery even if the insured could plead physical loss due to a virus. Therefore, it was unsurprising that insurers have usually succeeded in throwing out business interruption suits filed in response to COVID-related losses. According to the University of Pennsylvania Law School’s tracker, federal courts in the last year dismissed ten times as many business interruption lawsuits as they allowed to proceed. Where a policy contained a virus exclusion clause, a court was more likely to dismiss the suit.
“Direct Physical Loss” and COVID-19
In addition to virus-exclusion clauses, insureds face an uphill battle convincing courts that COVID-19 has caused physical damage or loss to their business in the first place. In September 2020, for instance, the Northern District of California denied a San Francisco retailer’s business interruption complaint without prejudice, holding that it failed to allege physical loss because government orders forcing stores to shut down were preventative, rather than responsive to physical loss or damage. Before the deluge of coronavirus-related business interruption suits, in March 2020, the Eleventh Circuit confirmed in Mama Jo’s, Inc. v. Sparta Insurance Co. that a restaurant’s lost income and cleaning costs spurred by debris from nearby roadwork could not constitute physical loss. The court held that a direct physical loss “contemplates an actual change in insured property then in a satisfactory state, occasioned by accident or other fortuitous event directly upon the property causing it to become unsatisfactory for future use or requiring that repairs be made to make it so.” Observers remarked that this ruling set an insurer-friendly tone for coronavirus business interruption suits insofar as it instructed trial courts within the Eleventh Circuit that coronavirus-related cleaning costs and lost income likely could not trigger business interruption coverage.
But even as commentators condemned insureds’ business interruption suits as “misguided effort[s]” by the insurance recovery bar to leverage coronavirus-related losses for monetary gain, courts did not uniformly dismiss coronavirus-related business interruption suits. This was especially true in state courts. Data suggest that state courts are more willing than federal courts to let these suits proceed on the merits, and plaintiffs are twice as likely to prevail in state court than in federal court. In any case, federal and state courts have broken with the norm and found for insureds in some business interruption cases.
In August 2020, the Western District of Missouri in Studio 417 v. The Cincinnati Insurance Co. held that the insureds’ allegation of the presence of the coronavirus satisfied the plain meaning of “direct physical loss” because the virus was a “physical substance” that “attached to and deprived Plaintiffs of their property, making it unsafe and unusable.” Taking a different approach, a North Carolina trial court in October 2020 granted summary judgment in favor of sixteen policyholders in North State Deli v. The Cincinnati Insurance Co., construing “direct physical loss” as “the inability to utilize or possess something in the real, material, or bodily world.” Therefore, in light of the coronavirus-related business closures, the policyholders suffered direct physical loss to the extent that they “los[t] the full range of rights and advantages of using or accessing their business property.” Representing a third approach, a Pennsylvania state court declined to dismiss a business interruption case by recognizing the rapidly evolving law around the issue, finding that “[a]t this very early stage, it would be premature . . . to resolve the factual determinations put forth by defendant” regarding direct physical damage. However, these cases represent a minority of court decisions on the matter and most insureds will need to look elsewhere for relief.
Where insurance law was unable or unwilling to shoulder the tremendous financial cost that businesses have incurred from the pandemic, public policy stepped in to provide some assistance. The Coronavirus Aid, Relief, and Economic Security (CARES) Act—a $2.2 trillion economic stimulus bill passed in March 2020—included relief options for businesses like the Paycheck Protection Program as well as other grant and loan programs. In January 2021, California began accepting applications from small businesses for COVID-19 relief grants up to $25,000 through the California Small Business COVID-19 Relief Grant Program. Although one study suggests that most Americans prefer government aid rather than litigation to aid small businesses, these public policies do not quite replicate the robust and individualized relief of business interruption coverage, which accounts for lost profits. Therefore, if insureds were burned by the “direct physical loss” battles, they should seek new paths within insurance law that specifically address disease outbreaks and pandemics.
Moving Insurance Law Forward
What lessons could insurance law learn from the COVID-19 era? First, as global climate change alters conditions to enable greater development and spread of infectious diseases, the possibility for the next global pandemic (or at least epidemic) looms. Thus, it is incumbent upon business owners to consider the potential for more public health-mandated closures in their business’s lifetime. Second, to avoid the headache and expense of virus-related business interruption litigation, insureds could add communicable disease riders to their business interruption insurance policies. A policy that includes communicable disease coverage could indemnify for loss of business income sustained as a result of a government-mandated shutdown of a business’s operations. It may also include coverage for the cost of cleaning up contamination or even managing public relations related to reputational issues that arise from the contamination.
On the flipside, insurers may learn to include virus exclusions to business interruption policies or clarify the language of such policies so as to avoid the expense of defending against a business interruption suit. Insurers may also seek to expand the market for communicable disease riders in their policy offerings, making infectious disease insurance accessible even to smaller businesses. Regardless of what path insurers take, they should do something in the wake of the pandemic. So long as some courts are allowing insureds to proceed—and even prevail—on business interruption suits, insurers have much to worry about.
Before the pandemic, insurers’ standard commercial liability policies typically excluded communicable disease riders to keep costs low. But after the coronavirus wreaked havoc on businesses small and large in the last year, opening the floodgates of business interruption litigation, a change is in the horizon for insurance law. Insurers and insureds must come together to engineer a solution that benefits both sides in anticipation of the next epidemic. Lest they all be caught in another tidal wave of business interruption (or other type of coverage) lawsuits, businesses should demand accessible and affordable communicable disease coverage and insurers should take advantage of this new market and offer such coverage.
Idrian Mollaneda: California Law Review Associate Editor, Vol. 109 and Berkeley Law Class of 2021.
