Recent Policyholder Victories in U.S. Coronavirus Insurance Coverage Litigation

As we approach a year and a half since the World Health Organization recognized the existence of the COVID-19 pandemic, the hotly contested battles between policyholders and their insurers regarding coverage for pandemic-related losses are escalating. The key fight has been over whether the coronavirus causes “physical loss or damage” under property policies, with policyholders and insurers trading victories.     

Whether property insurance policies provide coverage is a question of state law, yet many COVID-19 insurance coverage actions are pending in federal court. And we have seen a marked difference between federal courts, which—applying their Erie-guesses as to state law—generally have rejected coverage, and state courts (especially those in California and Pennsylvania), which—applying the law only they are entitled to declare—are much more inclined to uphold a claim for coverage, depending, of course, on the specific language of the insurance policy at issue and the facts that the policyholder pleaded in the complaint.

The law is unsettled at this point on COVID-19 coverage. With the minor exception of a federal appellate ruling under Iowa law addressing a barebones complaint, all of the COVID‑19 decisions to date have been at the trial court level, so we have no binding authority yet in any jurisdiction. Moreover, although many federal court appeals are in process, one has certified a COVID-19 coverage claim to a state supreme court (Ohio), and an appeal to the Oklahoma Supreme Court awaits a hearing, we are still some time away from the first rulings that set forth the governing law: those of the state appellate and supreme courts.  

This alert provides a brief update on the status of recent COVID-19 coverage rulings in the United States, highlighting some key victories for policyholders and providing a short discussion on the ongoing divide between related and parallel state and federal litigation.^[1]

Many of the first-filed insurance cases arising out of the COVID-19 pandemic were brought by small and mid-sized businesses, often in the form of purported class actions filed by law firms that specialize in tort or securities claims. Most were dismissed in the early stages, frequently on the basis of an exclusion titled “Exclusion Of Loss Due To Virus Or Bacteria” drafted by the Insurance Services Office (the “ISO Virus Exclusion”), an insurance industry trade group, and sometimes for a failure to plead a claim that could trigger the insuring agreement. As noted, many federal courts continue to dismiss COVID-19 coverage actions out of hand.

As more state court cases were brought, however, especially those brought under property insurance policies with broader language than the Insurance Services Office forms, many courts found the insureds’ allegations of “physical loss of or damage to property” sufficient to withstand early dispositive motions and allowed the parties to proceed to discovery. Additionally, in cases that have proceeded to discovery, several courts have granted summary judgment to policyholders, holding that losses resulting from civil authority orders issued because of the coronavirus, or from presence of the virus on site, are covered under relevant property policies.

We describe some recent key state court decisions below.^[2]

• SWB Yankees, LLC v. CNA Fin. Corp.: This August 4, 2021 ruling on a motion for judgment on the pleadings by a Pennsylvania state court judge rejected the insurers’ arguments that the plaintiff failed to allege “direct physical loss or damage” sufficient to trigger coverage for its COVID-19 business interruption losses. Based on the plaintiff’s averments that its covered property was rendered “unsafe” and “unfit for its intended use” due to the “continuous presence of the coronavirus” on the covered premises, the court found that the plaintiff had adequately alleged “physical loss or damage” to its property for purposes of business interruption coverage. The court also found that principles of insurance contract construction supported this conclusion, as the policy had 30 exclusions, including those based on “contaminants,” “pollutants,” “fungi,” and “microbes,” but failed to include an exclusion for losses caused by a “virus,” suggesting that the insurers, “as the sole drafters of the policy,” did not intend to similarly exclude virus-related damages from coverage.
• *Ross Stores, Inc. v. Zurich Am. Ins. Co.: On July 13, 2021, a Superior Court judge in Alameda County, California overruled a demurrer (the equivalent of denying a motion to dismiss) filed by the excess property insurers challenging the plaintiffs’ claims for business interruption coverage for their COVID-19 losses under their property program. Those insurers argued, in part, that the presence of the coronavirus is not property damage and cannot constitute “direct physical loss,” and they further argued that the policies’ contamination exclusion precluded coverage. In refusing to dismiss the plaintiffs’ claims, the court noted that the property policies, which were written on a form drafted by insurer Factory Mutual, omitted “direct” from the insuring agreement, which undercut the insurers’ argument. Applying basic principles of contract interpretation, the court concluded that the policies’ coverage for “all risks of physical loss or damage” was broader than coverage for “direct physical loss.” The court found the policy language reasonably susceptible to include loss of physical use of plaintiffs’ stores and physical premises, particularly where, as here, the coronavirus was present in plaintiffs’ stores, even though the stores themselves were not damaged.
• *Brown’s Gym, Inc. v. The Cincinnati Ins. Co.: In July 2021, a Pennsylvania state court judge overruled an insurer’s demurrer to the plaintiff’s claims for business interruption coverage for its COVID-19-related losses. In so ruling, the court concluded that the plaintiff’s specific averments that the “continuous presence” of the coronavirus on its property rendered its property “unusable, unsafe, inaccessible, and unfit for its intended use . . . sufficiently alleged ‘direct physical loss or damage’ to its property” necessary for business interruption coverage. Additionally, the court reasoned that the policy’s “communicable disease or virus” exclusion for the policy’s coverage for “crisis event response communication expense”—which was not applicable to the policy’s business interruption insuring agreements—created “a reasonable expectation on the part of the [policyholder] that coronavirus-related damages would be covered by the policy’s business interruption coverage.”
• Schleicher & Stebbins Hotels, LLC v. Starr Surplus Lines Ins. Co.: In June 2021, a New Hampshire Superior Court judge granted the policyholders’ motion for partial summary judgment and denied all but one of the insurers’ motions for partial summary judgment (the lone prevailing insurer’s policy contained a pollution exclusion that expressly excluded coverage for losses due to “viruses”). In granting the policyholders’ motion, the court rejected the insurers’ arguments that “direct physical loss” requires “‘distinct and demonstrable’ changes to property [that] must be readily perceptible by one of the five senses, be incapable of remediation, or result in dispossession,” and concluded “that any requirement under the Policies of ‘loss or damage’ or ‘direct physical loss of or damage to property’ is met where property is contaminated by” the coronavirus.
• *P.F. Chang’s China Bistro, Inc. v. Certain Underwriters at Lloyd’s of London: On February 4, 2021, a California Superior Court judge denied an insurer’s motion for judgment on the pleadings that contended that the coronavirus does not cause (or that plaintiffs’ economic losses do not constitute) “direct physical loss of or damage to property.” Broadly interpreting the policy to cover “any physical loss of . . . property,” including the inability to access or use all or a portion of the physical premises, the court found plaintiffs’ allegations—the actual or potential presence of the coronavirus in various forms in the air surrounding the restaurants, the necessity to implement social distancing and other modified physical behaviors, and the need to mitigate the threat or actual presence of the virus on their property—sufficient to satisfy the policy’s requirement of “physical loss of or damage to” property to trigger coverage.
• *Goodwill Indus. of Orange County v. Philadelphia Indem. Ins. Co.: On January 28, 2021, a California Superior Court judge overruled an insurer’s demurrer to plaintiff’s coverage claims on the ground that it could not determine as a matter of law whether, based on the record, plaintiff’s allegations failed to show a “direct physical loss.” Despite acknowledging that California federal cases rejected arguments that business interruption losses due to COVID-19 are covered losses, the court rejected those cases as “non-binding” and distinguishable from plaintiff’s factual allegations, which sufficiently pleaded physical alteration and “direct physical loss” as required under MRI Healthcare Center of Glendale v. State Farm General Insurance Company, 187 Cal. App. 4th 766 (2010).
• Ungarean v. CNA: On March 22, 2021, a Pennsylvania state trial court granted the plaintiff’s motion for summary judgment and denied the insurers’ cross-motions for summary judgment regarding plaintiff’s pursuit of business interruption coverage and civil authority coverage. Because the disjunctive “or” separated the “concepts of ‘loss’ and ‘damage,’” the court reasoned that “loss” must “focus[] on the act of losing possession and/or deprivation of property instead of one that encompasses various forms of damage to property, i.e., destruction and ruin.” Thus, the court held that plaintiff’s loss of use of its property and the social distancing measures it implemented—whether or not specifically mandated by the government—constituted “direct physical loss of” its property. The court also determined that the governmental shutdown orders sufficiently caused “direct physical loss of or damage to” non-insured property that prohibited the insured’s ability to access its own property, triggering civil authority coverage.
• Cherokee Nation v. Lexington Ins. Co.: On January 29, 2021, a tribal judge for the District Court of Cherokee County State of Oklahoma granted the policyholder’s motion for partial summary judgment and denied the insurer’s motion for summary judgment that contended no coverage was afforded under the policy because the policyholder did not suffer physical loss or damage. In so ruling, the court agreed with the policyholder that “direct physical loss” included property rendered unusable for its intended purpose. The court held that “requiring a physical alteration of the property” was “inconsistent” with the policy’s surrounding provisions, including certain of the policy’s exclusions that did not require such physical alteration. Moreover, the day after the policyholder filed suit, the insurer added a Communicable Disease exclusion now excluding the “fear or threat (whether actual or perceived) of a Communicable Disease,” which would have been “superfluous” if the policy did not cover pandemics as a cause of loss.
• Choctaw Nation of Oklahoma v. Lexington Ins. Co.: In February 2021, an Oklahoma state trial court granted the policyholder’s motion for partial summary judgment on business interruption coverage and denied the insurers’ request for summary judgment. The court adopted the same reasoning as in the Cherokee Nation decision described above, issuing an identical decision given that the policyholder provided the court with the same proposed order as the policyholder in Cherokee Nation.^[3]

Courts Find Contamination Exclusions Ambiguous or Inapplicable

While the primary focus of the state court decisions to date has been on whether the coronavirus causes physical loss or damage to insured property sufficient to trigger coverage, some—though not all—property insurance policies contain exclusions that may apply to virus-related claims. Generally speaking, courts have rejected claims for coverage under the very broad ISO Virus Exclusion, which the Insurance Services Office issued in the wake of the SARS epidemic in the early 2000s. However, many property programs contain no exclusion at all for “virus” or contain exclusions that are limited in their scope. Several recent decisions have addressed the latter exclusions and have found the relevant policy’s contamination exclusion either inapplicable or ambiguous for various reasons.

• Thor Equities, LLC v. Factory Mutual Ins. Co.: On March 31, 2021, the U.S. District Court for the Southern District of New York denied the parties’ cross-motions for partial judgment on the pleadings on the applicability of the policy’s contamination exclusion. The policyholder argued that the contamination exclusion applied only to “cost due to contamination,” given that it did not reference “loss due to contamination.” By contrast, the insurer contended that the contamination exclusion’s reference to the “inability to use or occupy property [ ] exclude[d] losses due to contamination caused by COVID-19, including [ ] loss of rental income.” Finding both interpretations reasonable, the court found the exclusion ambiguous and not susceptible to resolution on summary judgment.
• Ross Stores, Inc. et al. v. Zurich Am. Ins. Co.: The court also assessed the same contamination exclusion examined in Thor Equities. Persuaded by the fact that the property policies contained express coverage for interruption of business by communicable disease, the court likewise found the contamination exclusion ambiguous, declining to read the exclusion in a manner that would effectively nullify the broad communicable disease coverage provisions.
• Ungarean v. CNA: The court also rejected the insurer’s arguments that the policy’s contamination and “microorganism” exclusions precluded coverage under the policy. The court determined that the contamination exclusion was inapplicable because it did not “altogether exclude loss of use of property caused by viruses.” The court held that the “microorganism” exclusion similarly was inapplicable because it neither referred to a “virus,” nor is a “virus” a microorganism (or, at minimum, the exclusion was ambiguous and that ambiguity had to be construed in favor of the policyholder).
• Cherokee Nation v. Lexington Ins. Co.: The insurer argued that, even if the policyholder suffered physical loss or damage, various policy exclusions prohibited coverage. With respect to the policy’s contamination exclusion, which included “virus” as a peril, the court found that exclusion inapplicable because the policyholder’s loss was a result of the pandemic, which “is a loss distinct from a virus” and does not require proof of the actual presence of the coronavirus on the policyholder’s qualifying premises.

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The policyholders’ victories identified above illustrate the ever-growing divide between state and federal courts’ decisions on these issues, with state courts being much more likely to permit claims to proceed to discovery and to grant summary judgment on the merits, as compared to federal courts that have often dismissed cases at the pleadings stage. For instance, it is estimated that state courts have denied approximately 32% of insurers’ motions to dismiss, whereas federal courts have denied only roughly 5% of those motions.^[4] And, at least 8 policyholders successfully have moved for summary judgment in state court, a feat that has occurred only once in the federal courts.^[5]

Several factors likely have contributed to the very different path taken by federal courts from that taken by state courts, including that early actions often involved either attempts at class actions or claims by small businesses seeking relief from a single insurer, which were likely to involve diversity jurisdiction and land in federal court, where the insureds were typically represented by counsel who were not experienced insurance coverage practitioners. At the same time, the insurance industry retained top-flight counsel to combat many of the early cases in the hope of obtaining pro-insurer rulings, to the extent that some of the largest firms in the world were defending claims presented by barber shops, dentists, and gift stores. 

The upshot is that many early federal court rulings rejected COVID-19 insurance coverage claims and most subsequent federal court rulings largely followed the early cases without questioning the reasoning and analysis of those early decisions.^[6] And, nearly all of the early cases involved property insurance forms issued to small businesses, which have language that differs in many respects from the higher-end forms used in policies issued to medium- and large-sized businesses in the United States. Whether these federal court rulings stand will depend on how the state court appeals proceed.

While most COVID-19 insurance litigation has focused on commercial property policies, other types of policies may provide large sources of insurance. One such policy that has not yet been extensively litigated is a stock throughput policy, which generally covers damage to or loss of cargo and retail store stock, but sometimes is endorsed to add business interruption coverage. A stock throughput program also is at issue in the Ross Stores case discussed above. The Superior Court’s July 13, 2021 order also overruled the demurrers of the stock throughput insurers, holding that Ross had stated a claim for coverage for its COVID-19-related losses under its stock throughput policy. The court focused on an endorsement that extended coverage to “actual loss sustained” due to “the necessary interruption of the Insured’s business due to physical prevention of ingress or egress from a location, where goods and/or merchandise and/or property of The Insured are located and which are insured under this policy.”

Rejecting the insurer’s attempts to (1) draw a distinction between a legal prevention and a physical prevention and (2) limit coverage to the forms of physical peril to the covered goods enumerated in the general policy, the court held that the endorsement could encompass the plaintiffs’ losses resulting from store closures due to civil authority orders as they physically prevented customers from entering the premises.

Other retail policyholders should check their stock throughput policies to determine whether they contain similar language.

If you have any questions concerning the material discussed in this client alert, please contact the members of our Insurance Recovery practice.