Rare Exercise of Pendent Jurisdiction Shuts Down COVID Claim

COVID-19 business closures are not covered losses under commercial property policies even if the closures were the result of executive shut down orders, according to a recent decision. An appellate court held that the lack of physical harm to the covered premises forecloses recovery for business losses, despite that issue not being directly before the court in the appeal. ABA Litigation Section leaders are not surprised by this decision and urge practitioners to exercise vigilance in monitoring cases similar to those matters they are already litigating.

Massage Parlor Claims Loss from COVID-19 Shut Down

In Elegant Massage, LLC v. State Farm Mut. Auto. Ins. Co., the plaintiff, a massage parlor and spa in Virginia Beach, VA, voluntarily shut down due to the COVID-19 virus on March 16, 2020. That same day, the plaintiff filed a claim for loss of business under its commercial property insurance policy, issued by the defendant State Farm Automobile Insurance Company. Four days later, on March 20, 2020, the Virginia governor issued an executive order shutting down “recreational and entertainment” businesses, which included massage parlors and spas. In May 2020, the governor amended the executive order to allow “massage centers” to open under certain conditions.

The policy covered loss or damage to the plaintiff’s premises, including loss of income during the “suspension” of operations during a “period of restoration.” The policy defined “period of restoration” as beginning “immediately after the direct physical loss caused by any Covered Cause of Loss” at the premises and ending when the premises were repaired or the business moved to a new location. Losses caused by “virus” were specifically excluded from coverage. The insurer denied the plaintiff’s claim because the business closed voluntarily, the property was not physically damaged, and “virus” losses were excluded from coverage.

The plaintiff filed a putative class action against the insurer on behalf of itself and similarly situated insureds for breach of contract and breach of the duty of good faith and fair dealing and sought a declaration that the virus exclusion did not apply. The plaintiff alleged that the executive orders requiring businesses to shut down caused a covered loss. The insurer moved to dismiss the case, arguing that the property had not suffered an “accidental direct physical loss” requiring a “period of restoration.”

The U.S. District Court for the Eastern District of Virginia denied the insurer’s motion, finding that a “direct physical loss” under the policy could include property that was unusable due to “intangible, or non-structural sources” under Virginia law. The court also found that the virus exclusion did not bar the plaintiff’s claims.

The plaintiff proceeded to move for class certification, which the trial court granted. The insurer petitioned the U.S. Court of Appeals for the Fourth Circuit for permission to appeal the class certification, which it granted.

The Court Exercises Pendent Appellate Jurisdiction

In its appeal, the insurer urged the appellate court to review the trial court’s denial of its motion to dismiss, in addition to the grant of class certification. Appellate courts exercise pendent appellate jurisdiction sparingly, and only when an issue not subject to immediate appeal is “so interconnected” with a matter properly before the appeals court that it justifies concurrent review of the non-appealable issue. In this case, the appellate court held that review of the motion to dismiss decision was “necessary to ensure meaningful review” of the class certification issue. Accordingly, the appeals court reviewed the motion to dismiss as well.

Under Rule 23 of the Federal Rules of Civil Procedure, class certification requires findings of commonality among class members and that “questions of law or fact common to members of the class predominated over any questions affecting individual members.” In this case, the district court relied upon its decision on the insurer’s motion to dismiss to inform its finding that the Rule 23 predominance requirement had been satisfied.

Specifically, the trial court’s decision on the motion to dismiss was integral to its later class certification because the motion to dismiss decision stated that the executive orders caused the plaintiff to suffer a covered loss. When considering the plaintiff’s motion to certify the class, the trial court relied upon its decision that the plaintiff suffered a covered loss to conclude that the class members would be insureds (i) covered by an identical insurance policy, (ii) whose businesses were closed due to the executive orders, (iii) who submitted claims to the insurer, and (iv) whose claims were denied by the insurer.

Later Precedent Compels Different Interpretation of “Physical Loss”

Two weeks after the insurer filed its notice of appeal in this case, the Fourth Circuit issued its decision in Uncork & Create LLC v. Cincinnati Ins. Co. In Uncork, the appellate court held that West Virginia’s closure orders due to COVID-19 did not cause a “physical loss” or “physical harm” to the policyholder and, therefore, the policy’s coverage for lost business income did not apply to the plaintiff’s claim.

The policy at issue in Uncork contained nearly identical language to the policy at issue in Elegant Massage. It contemplated coverage for direct physical loss, as well as business income during a “period of restoration.” The appeals court held that the plain language of the policy—the “physical loss” or “physical damage” to specific premises—required that the premises suffer some material harm or destruction. The court explained that any other interpretation of “physical loss” or “physical damage” rendered the phrase “period of restoration” meaningless.

The appeals court in Elegant Massage found that it could not review the class certification question while ignoring its decision in Uncork. The class certification decision relied heavily on the trial court’s decision denying the insurer’s motion to dismiss, and the appellate court’s decision in Uncork commanded the opposition decision for the motion to dismiss.

The plaintiff in Elegant Massage argued that because Uncork applied West Virginia law, rather than Virginia law, it did not govern the insurance policy at issue. The appeals court disagreed, noting that the rules of policy construction in West Virginia mirror those of Virginia. The appeals court held that the plain and unambiguous language of the Elegant Massage policy required finding that the loss from “physical harm” or “physical damage” involve a physical alteration of the covered premises. Thus, the appeals court reversed the trial court’s class certification and remanded the case with instructions to grant the defendant’s motion to dismiss.

The End of COVID-19 Property Insurance Claims

Litigation Section leaders are not surprised by the manner in which Elegant Massage unfolded. “I think the majority reasonably concluded that the resolution of the merits of the case was ‘necessary’ to resolve the question of class certification,” considers John C. Bonnie, Atlanta, GA, Co-Chair of the Section’s Insurance Coverage Litigation Committee. “I do not predict that the exercise of pendent appellate jurisdiction in this case will result in a sea change in the rare exercise of pendent jurisdiction over otherwise unappealable issues.”

“In class action practice, it seems to happen approximately once a year that something occurs precipitating a series of similar cases,” explains Jason Kellogg, Miami, FL, Co-Chair of the Section’s Class Action & Derivative Suits Committee. “Then somebody gets an appellate ruling and it changes everything that had come before it in the district courts,” he acknowledges. “Where I am litigating one of these mass class actions, I will be even more vigilant tracking the outcomes of similar cases.”