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Probate & Property

Mar/Apr 2023

Recent Results in Business Interruption Coverage in Commercial Leases

Alan Michael Di Sciullo

Summary

  • The trend to date is for insurers to deny coverage, with the courts supporting the insurers' denials.
  • Some insurance policies already specifically disallow coverage for events such as the COVID-19 pandemic.
  • All too often, we see new and updated provisions only in reaction to a catastrophic event rather than lawyers being creative in anticipating a future event for which their drafting may then offer adequate protection.
Recent Results in Business Interruption Coverage in Commercial Leases
LeoPatrizi via Getty Images

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One of the lessons of the COVID-19 pandemic has been that tenants looking to insurers for coverage for their losses under a business interruption (BI) policy have been losing because of either the lack of “physical damage” necessary to trigger coverage or a specific exclusion in their policy for losses due to a “virus, bacterium or microorganism resulting in physical distress, illness or disease.” Insurers became prone to add such exclusions from their standard BI policies and contingent BI policies after the SARS outbreak in 2002–2003. As a response to claims arising for losses from the COVID-19 pandemic, insurers have largely taken the position that communicable diseases not expressly defined in the policy at issue are not covered, although there may be some coverage in an environmental claim for cleanup of the building to allow tenants to safely enter and use the premises.

Some insurance policies already specifically disallow coverage for events such as the COVID-19 pandemic. The endorsement “Exclusion of Loss Due to Virus or Bacterium, CP 01 40 07 06” specifically excludes coverage for loss due to virus or other microorganism resulting in physical distress, illness, or disease. Its prohibitions apply to property damage to buildings or personal property and include business interruption, extra expenses, and civil authority actions, although it does provide coverage for losses from fungus and wet and dry rot and has been amended to include coverage for losses from bacteria.

BI coverage typically applies to reimburse an insured for “losses sustained due to the total or partial suspension of the policyholder’s operations during a period of interruption.” Although policy wordings and case law interpreting these provisions vary, business interruption policies generally require (1) a loss or damage to insured property to trigger coverage, (2) interruption of the business due to a covered loss, (3) loss of income or profits, and (4) the loss that occurs within a “period of restoration.” Companies expecting potential business interruption should review potentially applicable insurance policies and provisions, including BI and contingent BI insurance. BI insurance is intended to cover losses resulting from direct interruptions to a business’s operations and generally covers lost revenue, fixed expenses such as rent and utilities, or expenses from operating from a temporary location. Similarly, contingent BI insurance is intended to cover lost profits and costs that indirectly result from disruptions in a company’s supply chain, including failures of suppliers or downstream customers.

BI losses often present complex valuation and calculation challenges. Further coverage may require that the insured “expedite repairs, mitigate losses and/or track expenses in a way that is not consistent with your normal business practice.” Depending on policy language, there may also be coverage for “extra expense” associated with maintaining production while the property is undergoing repair or for “certain expenses incurred before physical damage to property.” Covered extra expenses generally include such costs as rent, moving and hauling expenses, overtime, temporary labor, and even advertising. An early evaluation of coverage can help smooth the path to making sure covered expenses are properly captured and presented to insurers. Many policies include coverage for outside professional fees incurred in quantifying the loss. Steven Gilford & Sheri Drucker Davis, Insurance Considerations in Hurricanes, Floods and Other Natural Disasters, Proskauer (Sept. 1, 2011). Coverage in the case of a disaster like the World Trade Center tragedy came from many types of insurance. BI insurance and rent insurance were just a couple. Generally, insurance costs are really borne by the tenant in the form of operating expenses or a combination of base rent and escalations and operating expense escalations. Landlords argue that tenants should rely on BI insurance, but tenants argue that landlords should rely on their rent insurance to cover displacements. But neither type of insurance is paid forever. There are limits. In the aftermath of the WTC disaster, certain types of insurance became very costly or even unobtainable.

Though these policies frequently require physical property damage, businesses have been submitting claims for coverage of losses due to business interruptions resulting from COVID-19. Cordish Co. Inc. v. Affiliated FM Ins. Co., Case No. 2N-1-20-002952 (Balt. City, Md., Cir. Ct. filed July 9, 2020) (alleging effects of COVID-19 constitute “physical loss or damage to the property” since the virus “renders property dangerous and potentially fatal”). The viability of these claims depends on the terms of the insurance policy at issue, but the historical trend, based on prior viral epidemics, has been against coverage for business interruptions related to a pandemic like COVID-19.

Carriers have been reluctant to provide coverage under traditional BI policies. Insurers intend BI insurance to cover actual losses resulting from direct interruptions to a business’s operations and generally covers lost revenue, fixed expenses such as rent and utilities, or expenses from operating from a temporary location. Contingent BI insurance is intended to cover lost profits and costs that indirectly result from disruptions in a company’s supply chain, including failures of suppliers or downstream customers. The typical clause will state that the insurer will pay for actual loss of business income “due to suspension of your operations during restoration period [but] the suspension must be caused by direct physical loss of or damage to property.” Despite 11 states and Puerto Rico having introduced legislation in 2020 forcing insurers to retroactively pay for BI losses from COVID shutdowns, legislation is unlikely to become law.

A few courts have held that a tenant may be entitled to BI coverage for its lost business income resulting from the COVID-19 pandemic. See, e.g., N. State Deli, LLC v. Cincinnati Co., No. 20-CVS-02569 (N.C. Sup. Ct. Cty. of Durham, Oct. 7, 2020) (holding that governmental orders mandating suspension of business operation caused a “physical loss” where policy promised to pay for loss of “business income” caused by “direct loss to property caused by . . . any Covered Cause of Loss“); Studio 417, Inc. v. The Cincinnati Ins. Co.; K.C. Hopps, Ltd. v. The Cincinnati Ins. Co., No. 20-cv-00437 (W.D. Mo. Aug 12, 2020) (court held the presence of COVID-19 satisfied plain meaning of “direct physical loss” under BI policy where a group of hairdresser salons and restaurants were shut down due to COVID); Blue Springs Dental Care, LLC v. Owners Ins. Co., No. 20-cv-00383 (W.D. Mo. Sept. 21, 2020); Optical Serv. USP/JCI v. Franklin Mut. Co., No. BER-L-3681-20 (N.J. Super. Ct. Bergen Cty., Aug 13, 2020); Queens Tower Rest. Inc. DBA Primavista v. Cincinnati Fin. Corp., No. A 2001747 (Ohio Common Pleas, Hamilton Cty. Jan. 7, 2021) (these are all instances where the courts denied insurers’ motions to dismiss for claims by dentists, optometrists, and restaurants, respectively, for BI coverage for “physical damage” COVID losses). Citations and case materials provided by Prof. Shelby Green, Jack Fersko, and George P. Bernhardt.

The trend to date is for insurers to deny coverage, however, with the courts supporting the insurers’ denials. In the most recent cases, the courts have torpedoed bids by insureds to claim BI coverage in the absence of a direct physical loss or damage to property. E.g., Zwillo V v. Lexington Ins. Co., 504 F. Supp. 3d 1034 (W.D. Mo. 2020) (policy contained a virus exclusion and no relief for “physical damage”); Henry’s La. Grill v. Allied Ins. Co. of Am., 495 F. Supp. 3d 1289 (N.D. Ga. 2020) (court rejected restaurant-insured’s argument that its losses were due to Governor Brian Kemp’s executive order closing restaurants, which constituted a physical loss or damage covered in its BI policy); Infinity Exhibits, Inc. v. Certain Underwriters at Lloyds’ London, 489 F. Supp. 3d 1303 (M.D. Fla. 2020) (no BI coverage for physical loss or damage where exhibitor suffered losses when Fla. Gov. Ronald DeSantis issued an executive order similar to Gov. Kemp’s); Oral Surgeons, P.C. v. Cincinnati Ins. Co., 491 F. Supp. 3d 455 (S.D. Iowa 2020) (no “physical” or “accidental” loss when local government suspended nonemergency dental procedures). See also It’s Nice, Inc. v. State Farm Fire & Cas. Co., No. 2020L 0000547 (18th Jud. Cir., Ill., Sept. 29, 2020); Wilson v. Hartford Cas. Co., 492 F. Supp. 3d 417 (E.D. Pa. 2020) (federal courts in Pennsylvania and Illinois granted insurers’ motions to dismiss BI coverage related to COVID closures and government orders). Other cases where coverage has been denied are Vizza Wash, LP v. Nationwide Mutual Insurance Co., 496 F. Supp. 3d 1029 (W.D. Tex. 2020), and 10e v. Travelers Indemnity Co., 483 F. Supp. 3d 828 (C.D. Cal. 2020) (no recovery to insured since policies in question required “distinct, demonstrable physical alteration [of property]”). Rose’s 1 LLC v. Erie Insurance Exchange, Case No. 2020 CA 002424B, 2020 D.C. Super. LEXIS 10 (Aug. 6, 2020), confirmed that there is no coverage for COVID-19 losses where the insured could not demonstrate a direct physical loss.

Carriers have been enjoying near unanimous success in the recent wave of BI decisions in the federal circuit courts and at the appellate level. See 10012 Holdings Inc. v. Sentinel Ins. Co., Ltd., 21 F.4th 216 (2d Cir. 2021); Terry Black’s Barbecue, L.L.C. v. State Auto. Mut. Ins. Co., 22 F.4th 450 (5th Cir. 2022): Santo’s Italian Café LLC v. Acuity Ins. Co., 15 F.4th 398 (6th Cir. 2021); Sandy Point Dental, PC v. Cincinnati Ins. Co., 20 F.4th 327 (7th Cir. 2021); Oral Surgeons, P.C. v. Cincinnati Ins. Co., 2 F.4th 1141 (8th Cir. 2021); Mudpie, Inc. v. Travelers Cas. Ins. Co., 15 F.4th 885 (9th Cir. 2021); Goodwill Indus. of Cent. Okla., Inc. v. Phila. Indem. Ins. Co., 21 F.4th 704 (10th Cir. 2021); Ascent Hosp. Mgmt. Co. v. Emps. Ins. Co. of Wausau, 2022 U.S. App. LEXIS 1161 (11th Cir. Jan. 14, 2022). See also Elizabeth Daley, Seattle Café Drops 9th Cir. Virus Coverage Appeal, Law360 (Sept. 27, 2022).

State courts have also been hard on claimants seeking BI relief without showing physical damage. See SFMB Mgmt., LLC v. Starr Surplus Lines Ins. Co., No. 653203/2021 (N.Y. Sup. Ct. Jan. 20, 2022); Inns-by-the-Sea v. Cal. Mut. Ins. Co., 71 Cal. App. 5th 688 (Nov. 15, 2021); Marshall v. Safety Ins. Co., 2021 WL 2226454 (Mass. Super. Ct. May 21, 2021). Cf. Molly Chiu, Baylor College of Medicine Wins COVID Insurance Verdict, https://www.bcm.edu (Sept. 2, 2022), describing how a Harris County, Texas, jury returned a $48.5 million verdict in August 2022 against Lloyd’s of London underwriters in favor of Baylor College of Medicine, agreeing with the plaintiffs that the COVID virus caused direct physical loss or damage to Baylor’s property and, thus, required its commercial BI policy to cover its losses. We can expect the verdict to be appealed.

The courts have consistently denied claimants’ petitions for relief under BI coverage in the absence of any physical damage. See, e.g., Zwillo V, 504 F. Supp. 3d 1034; Henry’s La. Grill, 495 F. Supp. 3d 1289; Infinity Exhibits, Inc., 489 F. Supp. 3d 1303. In June 2022, the US Supreme Court indicated that it will not hear an appeal of a decision that denied coverage for losses caused by COVID-19 shutdown orders, effectively closing the last door for such claims in the federal court system. The Court declined a petition by Goodwill Industries of Central Oklahoma to review a decision by a panel of the Tenth Circuit Court of Appeals that found there was no direct physical loss or damage to Goodwill’s property. All 11 of the regional circuit courts of appeal have issued similar opinions, as have state high courts in Iowa, Massachusetts, and Wisconsin. Jim Sams, U.S. Supreme Court Refuses to Hear COVID Business Interruption Case, Claims J. (June 8, 2022).

In the commercial leasing and insurance fields where changes often move with glacial speed, the courts have given us almost clear certainty as to how business interruption policy provisions will be interpreted and the extent to which an insured can rely upon its policy for recovery of its losses. Although only a few years ago—at the beginning of the COVID-19 pandemic in the United States—the law was unclear about the rights of insureds versus their insurers for protection under their policies for BI coverage (and similarly for tenants under their leases for rent abatement and termination rights under force majeure clauses), the law seems fairly settled at this time that insureds have few rights under these policies absent direct physical loss or damage to their property and, even then, only in the event of the absence of a virus exclusion in their policies, similar to that of endorsement CP 01 40 07 06 mentioned above. This is a fairly quick and definitive settlement of the law in a field where such certainty may take years, if not longer.

The COVID-19 virus has wrought havoc on the operations of commercial tenants. The recent bad experiences of these tenants in seeking relief under their force majeure and rent abatement clauses and of insureds for obtaining coverage under their business interruption policies for their losses indicates the need for these parties to better assess their rights and review their policies with their insurance brokers and risk managers. At the same time, tenants need to strengthen their lease clauses: first, to assure they have written these rights into their leases; and, second, to have the imagination to try to anticipate the next great “casualty” and not be caught flatfooted in being left out in the cold in trying to assert their rights under inadequate language. All too often, we see new and updated provisions only in reaction to a catastrophic event rather than lawyers being creative in anticipating a future event for which their drafting may then offer adequate protection.

For further information, the author refers readers to his book Casualty and Insurance Issues in Commercial Leases (Am. Bar Ass’n 2022), and Drafting and Negotiating Commercial Leases, co-authored with John B. Wood (Fastcase 2022).

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