Destroyed House

In previous blog posts and articles, we have discussed “business interruption” insurance and the typical requirement that there be “direct physical loss of or damage to property” for that coverage potentially to apply.  In this blog post, we examine the physical damage trigger further.  Why?  Because it is a central issue in the rapidly multiplying court proceedings brought throughout the country by policyholders seeking coverage for COVID-19-related business interruption.

With massive numbers of businesses closing their doors in response to the novel coronavirus pandemic, business interruption coverage has received significant attention. On April 10, after being lobbied by a group of restaurant owners who have been suing insurers for business interruption coverage, President Trump stated that insurers needed to “step up” and provide that coverage for COVID-19-related disruptions of business.

Most traditional insurance policies were never meant to provide coverage for a global pandemic.  Simply put, the damage caused by a pandemic, a global event, is prohibitively large for any amount of underwriting to account for it.  Moreover, premiums were never collected for that exposure, except in rare cases.  As recently stated in the Wall Street Journal, “[p]andemics pose a special challenge because insurance works only when some companies need to draw cash; when a great many need the money at the same time, the system breaks down.”

So what kind of claim is potentially covered under business interruption provisions?  One example is a restaurant’s claim for compensation for loss of income after it closed for two weeks because a hurricane destroyed most of its premises. Broken down, the hurricane caused the physical destruction of the premises, the “direct physical loss” to covered property, and the severity of that “direct physical loss” necessitated the closure of the restaurant.  That situation, however, is significantly different from one where a virus spread by a pandemic causes a restaurant to close (or reduce its operations) and there has been no direct physical damage to property.

Cases that have addressed the issue of “physical damage” demonstrate that, for insurance coverage purposes, the loss has to be caused by direct physical loss of or damage to property.  Courts have generally interpreted direct physical loss as the actual destruction of property, affecting its structural integrity or its function, or, in an expanded interpretation, an actual, demonstrable contamination so pervasive that it renders the property uninhabitable and unusable.

For example, in Mama Jo’s, Inc. v. Sparta Insurance Co., No. 17-cv-23362-KMM, 2018 U.S. Dist. LEXIS 201852 (S.D. Fla. Jun. 11, 2018), the court found there was no “direct physical loss” after a restaurant underwent extensive cleaning to remove dust, debris, and “possibly noxious and toxic chemicals” from its floors, walls, tables, chairs, and countertops due to a nearby construction project.  The court considered two interpretations of “direct physical loss.”

First, interpreting “direct physical loss” to mean “an actual change in insured property” so it is “unsatisfactory for future use or requiring that repairs be made to make it so,” the court found there was no “direct physical loss.”  The court opined “cleaning is not considered direct physical loss.” Id. at *24.   The court quoted from Couch on Insurance:

The requirement that loss be “physical,” given the ordinary definition of that term, is widely held to exclude alleged losses that are intangible or incorporeal and, thereby, to preclude any claim against the property insurer when the insured merely suffers a detrimental economic impact unaccompanied by a distinct, demonstrable, physical alteration of the property.

See 10A Couch on Ins. § 148.46 (3d Ed. West 1998).

Second, the court also concluded that there was no “direct physical loss” under even “a more expansive definition” of the term that would include circumstances where the insured property becomes “uninhabitable” or “substantially unusable.”  Id. at *24 (internal quotations omitted).  The court pointed to Port Authority v. Affiliated FM Insurance Co., 311 F.3d 226, 236 (3d Cir. 2002), an asbestos case where the Third Circuit had opined that “direct physical loss” also could occur when a premises was rendered “uninhabitable” or “unusable.”  Even under this expanded interpretation of “direct physical loss,” the Mama Jo’s court still declined to find coverage, stating, “[t]he fact that the restaurant needed to be cleaned more frequently does not mean Plaintiff suffered a direct physical loss or damage and thus, summary judgment is appropriate.”  2018 U.S. Dist. LEXIS 201852, at *25.

In Mastellone v. Lightning Rod Mutual Insurance Co., 884 N.E.2d 1130 (Ohio 2008), the court declined to interpret mold staining on the exterior of the house as “physical loss.”  The court “construe[d] the term ‘physical injury’ to mean a harm to the property that adversely affects the structural integrity of the house.”  Id. at 1143.  It opined that mold staining on the exterior of the house “did not rise to the level of ‘physical injury’ to the siding, because it was only temporary and did not affect the structure of the wood.” Id. at 1144.  (Emphasis added).  The court also cited an expert witness that the wood would not be “structurally altered such that it would need to be replaced.”  Like mold, the presence of the novel coronavirus is temporary and will not affect the structure of a building.

In Columbiaknit, Inc. v. Affiliated FM Insurance Co., No. 98-434, 1999 U.S. Dist. LEXIS 11873 (D. Or. Aug. 4, 1999), a clothing manufacturer developed a mildew infestation after prolonged exposure to high humidity created mildew on its garments.  Although the court denied partial summary judgment to the insurer on whether mildew exposure was “direct physical loss,” the court’s language strongly suggests that microscopic contamination would not be “direct physical loss.” Specifically, the court stated:

The recognition that physical damage or alteration of property may occur at the microscopic level does not obviate the requirement that physical damage need be distinct and demonstrable . . . [t]he mere adherence of molecules to porous surfaces, without more, does not equate physical loss or damage.

 Id. at *18.  (Emphasis added).

Echoing Columbiaknit, other courts have opined that “direct physical loss” requires material structural damage.  In Universal Image Productions v. Federal Insurance Co., 475 Fed. Appx. 569 (6th Cir. 2012), the court found that bacterial and mold contamination was not “direct physical loss.” Heavy rainstorms caused a bacterial and mold infestation in the ventilation system of a leased office building. Experts determined there was no “notable airborne contamination” and that an evacuation was not necessary, but still recommended the insured move its operations from the first floor. The insured eventually vacated the entire building for two months.

The court declined to find coverage under both interpretations of “direct physical loss” examined in Mama Jo’s.  First, it found there was no “direct physical loss” because “not a single piece” of the insured’s property “was lost or damaged as a result of mold or bacterial contamination.” Id. at 573.  The court commented that the insured wanted coverage for “cleaning and moving expenses,” which was not “tangible, physical losses.”  Id.  Second, there was no loss because the contamination did not render the building “uninhabitable” or “substantially unusable.”  The court stated:

Certainly, there is evidence in the record indicating that working in the Evergreen building during remediation was difficult. Through no fault of its own, Universal was forced to work in a hot and crowded space. However, Universal has not put forth any evidence indicating that such temporary conditions rendered the building “uninhabitable” or substantially “unusable.”

Id. at 574-75.

In Universal Image Productions, Inc. v. Chubb Corp., 703 F. Supp. 2d 705 (E.D. Mich. 2010), an employee had been infected with bacterial pneumonia after a heavy rainfall created mold, there were “high levels of bacteria” on the premises, and an independent air quality expert recommended that employees wear respirators. Even then, the court found the mold contamination did not constitute “direct physical loss,” specifically holding that the insured “has not shown that it suffered any structural or any other tangible damage to the insured property.” Id. at 710.

Another court declined to find “physical loss or damage” to property with the mere presence of a substance harmful to human health. In Port Authority v. Affiliated FM Insurance Co., 311 F.3d 226 (3d Cir. 2002), when evaluating whether the presence of asbestos in the insured premises was “physical loss or damage,” the court rejected the idea that the mere presence of asbestos could be “physical loss or damage” to property.  The Third Circuit affirmed the district court, stating:

[T]he [District] Court reasoned that “physical loss or damage” could be found only if an imminent threat of asbestos release existed, or actual release of asbestos resulted in contamination of the property so as to nearly eliminate or destroy its function, or render it uninhabitable. The mere presence of asbestos, on the other hand, was not enough to trigger coverage.

Id. at 230.

While there are some cases that policyholders may cite to support an argument that viral contamination is “direct physical loss,” those cases are inapposite.  For example, in Cooper v. Travelers Indemnity Co. of Illinois, No. 01-2400, 2002 U.S. LEXIS 29085 (N.D. Cal. Nov. 4, 2002) and Motorists Mutual Insurance Co. v. Hardinger, 131 Fed. Appx. 823 (3d Cir. 2005), courts evaluated whether E.coli contamination constituted “direct physical loss.” In Cooper, the court held that E.coli contamination found in a well was “direct physical loss.” In Motorists, the court reversed summary judgment for the insurer over whether similar E.coli contamination in a well was “direct physical loss.”

The Cooper court commented that the E.coli contamination was extensive, difficult to remove, and noted that the policyholder made “repeated, but ultimately unsuccessful, efforts to disinfect the well.”  The affected facility, a bar, was closed for six months.  The novel coronavirus can be eliminated from surfaces with common, inexpensive cleaners, such as washing hands  with soap and water or wiping a non-porous surface down with bleach or another disinfectant.  Moreover, in Motorists, the court did not actually hold that E.coli contamination was “direct physical loss,” but instead, reversed summary judgment for the insurer.

As the novel coronavirus pandemic continues, business interruption coverage will continue to dominate the national conversation.  The key coverage question is whether the virus causes “direct physical loss” to property.  Based on the case law and the nature of the novel coronavirus, it appears unlikely that courts will conclude that viral contamination causes “direct physical loss.”