Client Alert: Business Interruption and Civil Authority Insurance
Provisions in the Wake of COVID-19
Following the restrictions imposed limiting crowd sizes and shuttering companies’ operations across seemingly every industry, business owners are turning to their insurance coverage policies for guidance in navigating these difficult and uncertain times. One possible aid to business owners facing new challenges associated with the pandemic caused by the novel coronavirus, COVID-19, is business interruption insurance. Business interruption insurance is generally intended to cover losses from direct interruptions to a business’s operation, and has traditionally been employed to cover losses from fires, floods, and other natural disasters. The coverage may extend to lost revenues, rent, and/or utilities, among other things. A contingent business interruption provision generally provides coverage for a loss of income or profits caused by issues related suppliers, vendors, and other major business partners.
The determination now must be made whether these policies will cover businesses suffering losses in the wake of shutdowns due to the COVID-19 pandemic. One hurdle facing business owners is the exclusion for loss due to viral infections that insurers began including in policies written following the outbreak of SARS (another type of coronavirus) in the early 2000s. That exclusion bars first-party property coverage for loss or damage caused by or resulting from any virus that induces or is capable of inducing physical distress, illness or disease.
In light of the directives being issued by local and state governments closing restaurants, bars, and businesses generally, many are turning to the “civil authority” provisions contained in their insurance policies for protection. This coverage can be triggered when a state, local or federal government entity prohibits access to an insured’s premise(s) due to direct physical loss of or damage to property other than at the insured’s premises, from a covered cause of loss.
However, policyholders are not necessarily entitled to coverage simply by virtue of the sweeping government mandates. Coverage determinations have to be made on a case-by-case basis to determine whether the specific terms and conditions of individual insurance policies will prevail in the face of growing numbers of exclusions. Even with government-imposed shutdowns specifically restricting access to an insured’s premise(s), the insurance policy may still require a nexus to a direct physical loss before triggering coverage. Fortunately, ambiguities are generally resolved in favor of the insured.
To the extent the insured can establish that a facility was shut down or property was quarantined due to health concerns involving the actual property itself, the insured will have a stronger argument that the facility or other property suffered physical loss or damage. Importantly, the CDC has noted that while it is not thought to be the main way the virus spreads, it may be possible that a person can contract the virus by touching a surface or object that has the virus on it, and then touching his or her own mouth, nose, or possibly their eyes. If a business is shutdown or property is quarantined because of concerns that the property itself will serve as the mechanism for the spread of the coronavirus, the insured will have a much stronger argument that there is physical loss or damage.
Civil Authority Coverage In The Contamination Context
Civil authority coverage is intended to apply to situations where access to an insured’s property is prevented or prohibited by an order of civil authority issued as a direct result of physical damage to other premises in the proximity of the insured’s property.
Although property damage in terms of business interruption coverage typically only includes physical damage to the property, many courts have held that the definition of “property damage” includes anything that makes the property uninhabitable, including contamination from infectious bacteria, viruses, mold, and the like. For instance, in Motorists Mut. Ins. Co. v. Hardinger, 131 F. App’x 823 (3d Cir. 2005) (applying Pennsylvania law), the Third Circuit determined that the presence of E. coli bacteria in the well of a house, which made the inhabitants of the house ill with respiratory, viral and skin conditions, could constitute physical loss or damage to the property. The key question turned on whether the “functionality of the property was eliminated or destroyed or whether the property was useless and uninhabitable.”
The Motorists court found Port Authority instructive in a case where sources unnoticeable to the naked eye allegedly reduced the use of the property to a substantial degree. In Port Authority of New York & New Jersey v. Affiliated FM Ins. Co., 311 F.3d 226 (3d Cir.2002), at issue was a similar policy that insured against “physical loss or damage” as it applied to existence of asbestos in the insured buildings. There, the insurer was only required to cover the expense of correcting the problem insofar as the asbestos made the structure unusable.
Along similar lines, the court in Gregory Packaging Inc. v. Travelers Property Casualty Co., No. 2:12-cv-04418, 2014 WL 667 5934 (D. N.J. Nov. 25, 2014) held that ammonia discharge in a building inflicted direct physical loss of or damage to the insured’s facility because the release, which made the air unsafe, rendered the facility unfit for occupancy until the ammonia dissipated. They noted that courts considering non-structural property damage claims have found that buildings rendered uninhabitable by dangerous gases or bacteria suffered direct physical loss or damage.
Furthermore, in Essex Ins. Co. v. BloomSouth Flooring Corp., 562 F.3d 399 (1st Cir. 2009), the First Circuit found that an unpleasant odor rendering the property unusable constituted physical injury to the property. Similarly, a Virginia federal court determined in its ruling in TRAVCO Ins. Co. v. Ward, 715 F.Supp.2d 699 (E.D. Va. 2010) that physical loss occurred when property was rendered uninhabitable by toxic gases. Finally, in another contamination case involving a USDA embargo on beef imports from Canada following a cow’s positive test for Mad Cow Disease, the Eighth Circuit examined an insured’s recovery following the termination of a supply contract. Source Food Tech., Inc. v. United States Fidelity & Guar. Co., 465 F.3d 834 (8th Cir. 2006). The court held there was no coverage under these circumstances, however, because the beef was not physically contaminated or damaged, so there could be no “direct physical loss” to property and, therefore, no coverage for business interruption.
As illustrated above, the court’s decision depends on whether the functionality of the property was eliminated or destroyed or whether the property was useless and uninhabitable. Therefore, in the same way that the courts determined business interruption coverage was appropriate due to property damage caused by E. coli, ammonia, and unpleasant odors, business interruption coverage could also be triggered by the presence of COVID-19 in the insured restaurants as it is undeniable that the functionality of the restaurants has been eliminated due to the presence of COVID-19.
What Other Events Trigger Civil Authority Coverage?
Given the unprecedented and nuanced issue facing business owners today, it is worth examining the application of business interruption and civil authority provisions in other contexts, as the courts will likely use case law from several jurisdictions, in varying circumstances, to guide their opinions in cases ruling on losses caused by COVID-19.
Following the September 11 terrorist attacks, airlines sought recovery under civil authority provisions for business interruption and operating losses. In United Airlines, Inc. v. Ins. Co. of State of Pa., 439 F.3d 128 (2d Cir. 2006), the court held that United Airlines was not entitled to civil authority coverage resulting from the interruption of its business following the 9/11 attacks. The court determined that if a civil authority order is caused by fears of future attacks, not by the need to repair, mitigate, or respond to physical damage inflicted on property other than the insured’s there is no coverage.
However, another airline, U.S. Airways, was able to obtain coverage and recover profit losses as a result of the nearly month-long closure of Reagan National Airport because of its more favorable policy. U.S. Airways’ policy provided coverage if access to insured property was prohibited by order of civil authority “as a direct result of a peril insured against,” including “all risk of direct physical loss of or damage to property described herein.” A Virginia state court in US Airways, Inc. v. Commonwealth Insurance Company, 65 Va. Cir. 238 (Va. Cir. Ct. 2004), held that coverage was available because its policy did “not require actual damage or loss of property to invoke coverage,” but only the risk of actual damage. The FAA order was issued in response to the risk of an imminent attack on Reagan National Airport.
In Allen Park Theatre Co., Inc. v. Michigan Millers Mutual Insurance Co., 48 Mich.App. 199, 210 (1973), the Governor of Michigan issued an executive order following several civil disturbances after the death of Dr. Martin Luther King, Jr., closing all “places of amusement” until further notice. A theatre owner impacted by the order sought coverage from the insurer under the civil authority order provision. The provision at issue allowed coverage of actual loss incurred, “[w]hen as a direct result of the peril(s) insured against, access to the premises described is prohibited by order of civil authority.” The Michigan Court of Appeals held that insured theatre owners were entitled to recover under the policies for business losses, unaccompanied by physical damage, resulting from the closing of the theatres for a six-day period in compliance with executive orders declaring a state of emergency.
Courts in the Gulf States have consistently been asked to interpret business interruption and civil authority insurance provisions in the wake of natural disasters. In Louisiana, the Eastern District ruled a law firm in New Orleans damaged during Hurricane Katrina was covered under a business income loss provision, but only those losses attributable to the destruction of the office in question were covered because those were the only losses that resulted from physical damage to the insured’s property. E. Eric Guirard & Assoc. v. American First Ins. Co., 2010 WL 989174 (E.D. La. Mar. 15, 2010). Underscoring how fact-specific these cases can be, this same federal court in Louisiana ruled in favor of the insured under similar circumstances just seven months later. In Jones, Walker, Waechter, Poitevent, Carrere & Denegre, LLP v. Chubb Corp., No. 09-6057, 2010 WL 4026375 (E.D. La. Oct. 12, 2010), the Mayor of New Orleans issued a mandatory evacuation order in preparation for Hurricane Gustav. The plaintiff law firm evacuated and sought coverage, which the defendant insurance company denied. The court found that the provision did not insure against impairment of operations that occurs simply because a civil authority prohibits access. Instead, the civil authority order must meet the requirements of the policy, one being “a nexus between the order and certain physical damage.”
In South Texas Medical Clinics, P.A. v. CNA Financial Corp., 2008 WL 450012 (S.D. Tex. Feb. 15, 2008), an evacuation order was issued by the County Judge of Wharton County due to the damage Hurricane Rita had caused in the Florida Keys and Gulf of Mexico and fear that Rita would strike nearby, which prohibited the plaintiff from accessing its property, resulting in lost business income. The court denied the plaintiff’s recovery under Order of Civil Authority Coverage, reasoning that when the only relevance of prior damage to other property in deciding whether to issue a civil authority order that would preclude access to the insured’s property is to provide a basis for fearing future damage to the area where the insured property is located, the causal link between the prior damage and the civil authority order is missing.
Finally, a Georgia court in Assurance Co. of America v. BBB Service Co., Inc., 265 Ga.App. 35 (2003) conducted a bench trial on the issue of “whether the evacuation order was issued because of damage to … property other than the insured premise.” The trial court found in favor of the plaintiff, relying on the testimony of a member of the emergency decision-making team that one factor it considered in advising the Chairman of the County Commission to sign the evacuation order was the “fact that the storm had been causing damage in its path.” This decision was affirmed by the Georgia Court of Appeals.
What Am I Entitled To Recover?
If the insured has suffered a business interruption loss as a result of physical damage, the next step for any court (or appraisal panel) is measuring the covered loss. “The purpose of business interruption insurance is to indemnify the insured against losses arising from an inability to continue normal business operations and functions due to damage sustained as a result of the hazard insured against. In other words, the goal is to preserve the continuity of the insured’s earnings.” N.Y. Jur. Insurance § 539 (2005); see also Archer Daniels Midland Co. v. Hartford Fire Ins. Co., 243 F.3d 369, 371 (7th Cir. 2001).
Under standard business interruption coverage, an insured can recover its lost earnings during a “period of indemnity,” which is generally defined as the amount of time necessary to repair the physical damage. SR Int’l Bus. Ins. Co. Ltd. v. World Trade Ctr. Props. LLC, No. 01-cv-9291, 2005 WL 827074 (S.D.N.Y. Feb. 15, 2005) (holding that the period of restoration is “the theoretical, not the actual, time needed to repair, rebuild, or replace” the damaged premises). This determination can, of course, become highly fact-specific, particularly when the time it takes the insured to complete actual repairs falls behind the time it should have taken a reasonable insured.
It is not uncommon for commercial policies to provide that the insured may recover the “actual loss” of Business Income sustained due to the necessary suspension of operations during the period of restoration when the insured’s operations are suspended because of “direct physical loss of or damage to property.” The calculation of business interruption loss is often based, at least in part, on the policyholder’s pre-catastrophe sales figures. Finally, the courts have also ruled that Business Income coverage continues until physical operations are restored, and not when profits return.
Force Majeure clauses provide an additional avenue for seeking relief in circumstances such as these. We anticipate companies may seek to invoke such clauses to excuse performance due to the COVID-19 outbreak and the government reactions at the federal and state levels. Whether these force majeure declarations will withstand judicial scrutiny is yet to be seen, particularly given that the language of force majeure clauses can vary widely from contract to contract. Specifically, whether this pandemic constitutes a force majeure event may vary depending on whether the clause: (1) limits such events to circumstances that prevent performance (i.e., performance is legally or physically impossible); or (2) includes events that merely hinder or delay performance (a far less onerous standard than “prevents performance”).
This is clearly a rapidly evolving area of the law, and an issue we are monitoring in real-time. We close by noting one positive recent development has come out of New Jersey: in spite of the use of the “virus” exclusion, New Jersey proposed legislation that would impose virus coverage on insurers that specifically excluded it (for policies in effect as of March 9). The law would force insurers of certain businesses to provide business interruption coverage for COVID-19 losses. We will be monitoring the proposed bill’s advancement through the legislature, and whether other states will follow suit.
About Our Firm
The attorneys of Rock Fusco & Connelly, LLC advise business owners and corporate clients on legal issues related to the areas of insurance coverage, labor and employment, tort and product liability, and commercial transactions. We are currently assisting clients in the hospitality industry and related sectors with navigating this unique insurance coverage issue. We welcome the opportunity to speak with anyone who has questions about this topic, or how it relates to the operation of their business, without fear of being billed for the conversation. If you have any questions, or if you would like to discuss the matters contained in this article, please contact Matt Connelly by phone (312-251-2265) or e-mail (email@example.com). Rock Fusco & Connelly, LLC is located at 321 North Clark Street, Suite 2200, Chicago, IL 60654.