- A razor-thin majority held that the virus causing COVID-19 could give rise to coverage for “direct physical loss or damage to property”.
In a first-of-its-kind ruling by a state’s highest court, a razor-thin majority of the Vermont Supreme Court held that the virus causing COVID-19 could give rise to coverage for “direct physical loss or damage to property”. That reversed a Vermont trial court determination that coverage was absent as a matter of law. Huntington Ingalls Industries, Inc., et al. v. Ace American Insurance Co., et al., 2022 WL 4396475 (Sept. 23, 2022). Two judges of the five-member court dissented.
In Huntington, Huntington Ingalls Industries, Inc. (Huntington Industries) was insured by a captive subsidiary, Huntington Ingalls Industries Risk Management LLC (Huntington Risk), who together filed a declaratory action to establish coverage on the part of the captive’s reinsurers for costs associated with the COVID 19 pandemic. The facts revealed that Huntington Industries is the largest U.S. ship building company for the U.S. military, employing over 42,000 people. Because the company is designated as Essential Critical Infrastructure pursuant to federal law, Huntington Industries was required to maintain a normal work schedule in the face of the COVID 19 crisis, while still following the guidance of the CDC and state and local government to limit workplace spread of the virus. The company’s shipyards therefore remained open, but its operations were significantly modified to meet public health guidelines.
These efforts included the quarantine of employees testing positive for COVID-19, and it was alleged that within a month of initial testing of employees, there were more than 6000 positive employee tests, effectively preventing the company from performing essential functions at intended capacity. The company alleged that from the start of the COVID 19 crisis in March 2020, the virus was continuously present at shipyard facilities, with dispersion occurring through breathing, coughing, sneezing, and speaking, and the adherence of viral droplets (“fomites”) on work surfaces which could spread to humans through surface contact and subsequently touching their eyes, noses, or mouths. Among the facts before the court were scientific studies revealing that a surface can remain a source of transmission for the virus for up to six days, or even up to seventeen days, depending on conditions.
Huntington Industries and Huntington Risk asserted in their declaratory action a right to coverage for property damage, loss in the form of business interruption, and other losses, specifically alleging “direct physical loss or damage to property” as a result of the adherence of the virus to surfaces at the company’s facilities. Reinsurers responded to the action with motions for judgment on the pleadings, leading to the submission of further evidence of the impact of COVID-19 on the company’s facilities. The trial court granted the reinsurer’s motions for judgment on the pleadings, and Huntington Industries and Huntington Risk appealed.
The focus on appeal to the Vermont Supreme Court was the meaning of “direct physical loss or damage to property”, a series of terms the Supreme Court noted was not defined in the policy. The court acknowledged that the trial court’s judgment was consistent with the determinations of a majority of courts which have found that the presence of COVID-19 on a property is not covered loss as a matter of law. The court began its own analysis with consideration of the dictionary definitions of the terms “direct”, “physical”, “loss” and “damage”, and considering these terms, agreed that “something must occur affecting personal or real property for ‘direct physical loss or damage to property’ to occur.” The court also said that in properly applying the policy’s terms under Vermont law, all words in the phrase at issue needed to be given meaning, and noted that the rule of ejusdem generis applied, as did the rule against surplusage.
Applying these tenets of Vermont law, the court concluded that “direct physical damage” requires a distinct, demonstrable, physical change to property, and immediate or proximate causation in terms of an articulable change to the property. But the court also found that an alteration to property did not have to be visible, and that “alterations at the microscopic level may meet this threshold”. Noting the business interruption coverage for loss 1) in the time period necessary rebuild, repair or replace the damaged property and 2) the additional time period needed to restore insured’s business to its pre-loss condition, the court stated that “if a distinct, demonstrable change to property occurred that caused an interruption in business operations, that change will likely need some type of physical remediation or repair to address that alteration.” With this observation, the court determined that “the existence of a need for remediation therefore enforces the allegation that damage has occurred”.
Noting that motions for judgment on the pleadings were disfavored and rarely to be granted, the court found that the Complaint adequately alleged that the virus physically altered property in insured’s shipyards when it adhered to surfaces, and that this met the minimum “bare bones statement” requirement of Vermont law that the virus can cause “direct physical loss or damage to property. Finding that the statement went beyond a mere “conclusory allegation”, the court observed that if the insured could prove an alteration occurred, it could further constitute “direct physical damage” within the meaning of the policy, albeit microscopic in nature.
The court observed that the alleged physical alterations required not just sanitization/cleaning procedures, but installation of physical barriers and the redesign of physical spaces, which in the court’s view bolstered the argument that “a distinct, demonstrable physical alteration occurred and is something that is in need of ‘repair’ to restore business operations.” Responding to a contention of the dissenting judges that adherence of the virus to surfaces could not infer damage, the majority said that it was “inclined to allow experts and evidence to come in to evaluate the validity of insured’s novel legal argument before dismissing this case based on a layperson’s understanding of the physical and scientific properties of a novel virus.” The court continued:
This concern is paramount for cases involving novel legal theories such as the one before us, where developing the factual basis to support a theory for coverage under a complicated insurance policy requires scientific evidence on a relatively recent and evolving phenomenon. . . To end this litigation based on the limited information before us, simply because the alleged facts and the inferences therefrom may seem implausible at first based on what we think we know about COVID-19, would be premature.
Although the court acknowledged that there may ultimately be an absence of scientific support for the insured’s contentions of physical alteration, this was not determinative: “it is not the Court’s role at this stage in the proceedings to test the facts or evidence. . . We cannot say ‘beyond doubt’ that the virus does not physically damage surfaces in the way insured alleges.”
The court hastened to note that it was not concluding that “direct physical loss or damage to property”, actually occurred, but only that the insured “has alleged enough to survive a Rule 12(c) motion under our extremely liberal pleading standards.” Since the possibility of “direct physical damage” alone was sufficient to reverse the trial court’s judgement, the court did not address whether the alternative concept of “direct physical loss” could also be established by the insured.
There was a vigorous dissent, which found “beyond doubt” “that Huntington Industries could not state a cognizable claim upon which relief could be granted. Addressing the business interruption coverage on which the majority relied for some of its analysis, the dissent stated that there could only be physical damage to property under the terms of the policy if the property had to be repaired, rebuilt, or replaced because of tangible alteration to the property. The dissent turned to the contention that the presence of droplets/fomites on surfaces rendered the property incapable of functioning for its intended purpose, and acknowledged in making all reasonable inferences for the insured, that infected droplets become fomites when they contact surfaces, and that fomites can be contagious for up to twenty-eight days, and also accepted that the virus has been continually present at insured’s facilities since the start of the pandemic.
Parting from the majority, however, the dissent rejected the conclusion that the adherence of droplets/fomites to property tangibly alters and impairs it “altering and impairing”. The court agreed that this was a ‘bare bones” allegation, and found it insufficient: “Indeed, the emperor has no clothes. Whether the fomite remains contagious for three or three-hundred days, it cannot cause damage to property if damage is defined as a ‘distinct, demonstrable, physical change.’ SARS-CoV-2 does not ‘alter the appearance, shape, color, structure, or other material dimension of the property.’”
The dissent accepted that the policy could reach microscopic damage but rejected the majority’s “dead-end” inference that it was present based upon the ability to remove the fomites with materials commonly available in the workplace. As the dissent saw it, something that can be readily cleaned is not damaged. Furthermore, “[t]he virus does not infect lightbulbs or desks or walls; these objects cannot develop COVID-19. The virus infects humans and causes COVID-19 in humans.” Rather than being a “novel” claim, the dissent characterized the insured’s claim as “metaphysical” legally insufficient to survive the pleadings stage.
The dissent found no allegations by the insured of measures to rebuild, repair, or replace any covered property, and rejected the insured’s contention that the business interruption coverage required no direct physical loss or damage and rejected the claim that having to restore the property to a “healthy state” constituted repair. Furthermore, the court found that cleaning, temperature checks of employees, health screenings, contact tracing, social distancing and other policies also did not constitute “repair” of damaged property. In its view, the insured took measures to protect people and did not sustain loss in response to measures to repair damaged property. It rejected the majority’s conclusion that the installation of physical barriers/devices and the redesign of physical spaces as a repair, rebuild or replacement, noting that a barrier separating employees does not “repair” any damage at all.
According to the dissent, “[n]o expert testimony and no amount of discovery will change this commonsense fact.” In its view, the majority’s conclusion that expert evidence should precede consideration of a Rule 12 dismissal effectively rendered the rule “useless”.