By Kyla Thornton
State and federal courts across the country are grappling with insurance coverage litigation, as insureds who suffered business losses due to government-mandated shutdowns look to their property insurers for relief.
These cases present the following key issue for courts: does the alleged presence of the COVID-19 virus on property constitute physical damage to that property?
On January 14, 2021, the U.S. District Court for the Eastern District of Pennsylvania found that the presence of COVID-19 on property does not constitute property damage.
In Independence Restaurant Group v. Certain Underwriters at Lloyd’s, London, Independent Restaurant Group, the owner/operator of Independence Beer Garden in Philadelphia, alleged that it was unable to operate its business as a result of government shutdown orders.
IRG had a policy with Lloyd’s providing that Lloyd’s would pay for direct physical loss or damage to property caused by a covered cause of loss. IRG claimed that the presence of COVID-19 on its property caused physical damage and that the virus remained present in various forms for certain periods of time, e.g., in airborne aerosols for up to three hours, on certain surfaces for between four hours and three days, and on fomites (objects or materials that are likely to carry infection) for up to 28 days.
Lloyd’s moved to dismiss the complaint, arguing that there was no physical loss or damage to the property from a covered cause of loss. IRG opposed, contending that “direct physical loss of … property” is different from “direct physical … damage to” property, and that the former includes “direct physical loss of use of … property.” According to IRG, its loss of use of the restaurant was covered.
The court was guided by Port Authority of New York & New Jersey v. Affiliated FM Insurance Company, 311 F.3d 226 (3d Cir. 2002). There, in determining whether the presence of asbestos in a building constituted “direct physical loss or damage,” the court held that “physical damage to property means distinct, demonstrable, and physical alteration of its structure.” According to the court, damage by sources unnoticeable to the naked eye must “meet a higher threshold” than “typical examples of physical damage from an outside source that may demonstrably alter the components of a building.” The Third Circuit held that the proper standard for physical loss or damage is one that triggers coverage “only if an actual release of asbestos fibers from asbestos containing materials has resulted in contamination of the property such that its function is nearly eliminated or destroyed, or the structure is made useless or uninhabitable….”
Finding this precedent instructive, the Independent Restaurant Group court rejected IRG’s argument that loss of use constituted physical loss or damage to property:
[R]eading the Policy to cover mere loss of use untethered to any physical condition of the property would render two other Policy provisions superfluous or nonsensical…[f]irst, allowing mere loss of use to constitute direct physical loss of property would create discord between the “physical loss or damage to” requirement and the Civil Authority provision. For example, if a government order barring access to a premises or mandating its closure could create a “direct physical loss” triggering business income coverage because it “nearly eliminated or destroyed” the property’s functionality or rendered it uninhabitable, there would be no need for a separate Civil Authority provision granting coverage where civil authority orders bar access to premises under more limited circumstances. Second, the Policy only provides Business Income Coverage during the “Period of Restoration”…[b]uilt into coverage for business income losses…is the idea that there must be something to “repair, rebuild, or replace”—none of which exists for mere loss of use untethered to a physical condition affection the property.”
The court held that IRG’s claimed losses were not covered under the policy, noting that while IRG’s property allegedly suffered a complete loss of functionality, IRG did not show that the virus, or the threat of presence of the virus, “nearly eliminated or destroyed” the property’s functionality or rendered it “useless or uninhabitable.” In fact, IRG’s business subsequently reopened, “showing that the government orders addressing the virus rather than the virus itself were the source seriously affecting the property’s functionality.” The court further observed that by IRG’s own admission, surfaces containing the virus were able to be cleaned and sanitized.
Regarding the policy’s civil authority coverage, the court held that for the provision to apply, a civil order must have prohibited access to IRG’s property due to physical loss of, or damage to, other property caused by a risk of direct physical loss. The court found that: (1) the government orders did not prohibit access to the described premises, because IRG was allowed to continue serving takeout orders, and (2) IRG had not plausibly pleaded the necessary elements (relating to physical loss of/damage to other property) required to trigger coverage.
Having determined that there was no physical loss or damage to property, the court granted Lloyd’s motion to dismiss.
Not all courts have agreed with this reasoning, however. Elegant Massage, LLC v. State Farm Mutual Automobile Insurance Company (decided on December 9, 2020 by the U.S. District Court for the Eastern District of Virginia) involved a class action brought by a massage parlor against its insurer, State Farm, after State Farm denied the massage parlor’s claim for loss of business income and extra expense due to closures resulting from the COVID-19 pandemic.
Elegant Massage owned and operated a spa in Virginia Beach and was issued an “all risk” commercial property policy, which provided coverage for loss of business income sustained as a result of the suspension of business operations, including the actions of a civil authority that prohibited access to Elegant Massage’s property. The policy contained exclusions for “Fungi, Virus or Bacteria,” “Ordinance or Law,” and “Acts or Decisions.”
State Farm moved to dismiss the complaint, citing a host of cases finding that the presence of COVID-19 did not constitute direct physical loss or damage to property. State Farm argued that direct physical loss required that there be structural damage to covered property. Elegant Massage, on the other hand, contended that direct physical loss meant the inability to use the premises due to uncontrollable forces, and that applicable executive orders prohibited it from using its premises, which resulted in a suspension of business operations and loss of income.
The court denied State Farm’s motion, finding that the policy covered all “accidental or fortuitous direct physical losses” unless they were expressly excluded. The court then narrowed the issue to the evaluation of whether the mandated business closures qualified as a fortuitous loss that caused a direct physical loss to the property. In the court’s view, if it found ambiguity or multiple interpretations of the policy that could plausibly permit recovery, then State Farm’s motion to dismiss had to be denied. Reviewing case law from across the country, the court concluded that there was a range of definitions for “direct physical loss,” including structural damage, distinct and demonstrable physical alteration, and damage that resulted in property becoming uninhabitable, inaccessible, and dangerous to use.
Based on the “spectrum of accepted interpretations,” the court interpreted the phrase “direct physical loss” “most favorably to the insured to grant more coverage.” “[W]hile the [spa] was not structurally damaged, it was plausible that plaintiffs experienced a direct physical loss when the property was deemed uninhabitable, inaccessible, and dangerous to use by the Executive Orders because of its high risk for spreading COVID-19, an invisible but highly lethal virus.” Accordingly, the court found that Elegant Massage had submitted a good faith plausible claim.
Next, the court evaluated the civil authority coverage, and held that it did not apply because Elegant Massage had not shown a causal link between physically damaged property and a civil authority order prohibiting it from accessing or using the property.
Since Elegant Massage had established a plausible claim for a fortuitous direct physical loss, the burden shifted to State Farm to show the loss was excluded.
The court discussed the relevant exclusions and concluded that the “Fungi, Virus or Bacteria” exclusion did not apply:
Here, Plaintiff is neither alleging that there is a presence of a virus at the covered property nor that a virus is the direct cause of the property’s physical loss. Also, Plaintiff does not allege that the Executive Orders the Commonwealth of Virginia issued were as a result of “growth, proliferation, spread or presence” of virus contamination at the Plaintiff’s property. Rather, Plaintiff alleges that the Orders were the “sole cause of the Plaintiff’s […] loss of business income and extra expense.”
The court also concluded that the “Ordinance and Law” exclusion did not apply because the executive orders shutting down Elegant Massage’s business were not ordinances or laws passed by a legislative body that prohibited the physical use of Elegant Massage’s covered property.
Finally, the “Acts or Decisions” exclusion was held to be so ambiguous and broad that under any plain reading “the Policy would be worthless as any act from any character of all persons, groups, or entities would prohibit coverage.” Thus, the exclusion was inapplicable.
Ultimately, State Farm’s motion to dismiss was granted in part, on the ground that civil authority coverage did not apply, and denied in part.
These two decisions represent a small sample of the “spectrum of interpretations” of some of the novel insurance coverage issues presented by the COVID-19 pandemic. The good news for insurers is that many recent federal court decisions mirror the reasoning set forth in Independence Restaurant Group in determining that the presence of the COVID-19 virus on surfaces does not present physical damage to property. See, e.g., Legal Sea Foods, LLC v. Strathmore Ins. Co., No. 20-10850-NMG (D. Mass. Mar. 08. 2021); Food For Thought Caterers Corp. v. Sentinel Ins. Co., Ltd., No. 20-cv-3418 (S.D.N.Y. Mar. 06, 2021); Wellness Eatery La Jolla LLC v. Hanover Ins. Grp., No. 20cv1277-AJB-RBB, 2021 WL 389215 (S.D. Cal. Feb. 03, 2021); Frank Van’s Auto Tag, LLC v. Selective Ins. Co. of the Se., No. 20-2740, 2021 WL 289547 (E.D. Pa. Jan. 28, 2021); 7th Inning Stretch LLC v. Arch Ins. Co., No. 20-8161 (D.N.J. Jan. 19, 2021); 1 S.A.N.T., Inc. v. Berkshire Hathaway, Inc., No. 2:20-cv-862, 2021 WL 147139 (W.D. Pa. Jan. 15, 2021); ATCM Optical, Inc. v. Twin City Fire Ins., No. 20-4238, 2021 WL 131282 (E.D. Pa. Jan. 14, 2021).
 Indep. Rest. Grp. v. Certain Underwriters at Lloyd’s, London, No. CV 20-2365, 2021 WL 131339, at *1 (E.D. Pa. Jan. 14, 2021).
 Id. at *1.
 Under this provision, the suspension must have been caused by direct physical loss or damage to property, and the loss or damage must have been caused by or resulted from a covered cause of loss. Id. at *5.
 Id. at 235.
 Id. at 236.
 Indep. Rest. Grp. at *6.
 Id. at *7.
 Id. at *8.
 Id. at *9.
 Elegant Massage, LLC v. State Farm Mutual Automobile Insurance Co., No. 2:20-CV-265, 2020 WL 7249624 (E.D. Va. Dec. 9, 2020).
 Id. at *1.
 Id. at *8.
 Id. at *6.
 Id. at *8-9.
 Id. at *10.
 Id. at *11.
 Id. at *13.
 The “Acts or Decisions” exclusion precluded coverage for “conduct, acts or decisions, including the failure to act or decide, of any person, group, organization or governmental body whether intentional, wrongful, negligent or without fault.” Id.
 Id. at *14.