Litigators and Insurers Face-Off over Business Interruption Insurance during COVID-19

2020-10-26 | 7 min read

photo by jason mowry

As businesses suffer the financial consequences of COVID-19, one possible avenue of relief is recovering lost income under a business interruption insurance (BII) policy.  While COVID-19 seems like the exact scenario BII was meant to cover, many insurance carriers are denying claims, taking the stance that COVID-19 is not a “disaster” within the meaning of their policy.  Many states are responding by introducing legislation that would require carriers to cover COVID-19 losses. Personal injury firms are quickly taking up BII litigation in anticipation of the impending flood.

Prior to the pandemic, policies were generally silent on the subject of viruses, but many insurance carriers have since put out statements informing policyholders that COVID-19-related losses are not covered.

What Is Business Interruption Insurance?

Business interruption insurance is an add-on to an insurance policy that covers lost income when businesses suffer a “disaster.”  The intention behind this type of coverage was to reimburse costs related to fire, theft, or some other physical loss.  Typically, the coverage begins the day of the disaster and runs through the “business interruption period.”  The payout could include anything from lost income, wages, the cost of a temporary location, debts and taxes due, to damaged property.[1]

Direct Physical Loss

Though each policy is unique, and the individual terms will be analyzed and applied, there are a few terms and exclusions consistent throughout BII policies around the country.  Generally, the policy will cover lost business income suffered as a result of a suspension caused by “direct physical loss or damage.”  This phrase appears to be the most commonly litigated so far.  The language calls to mind scenarios where the business shuts down because the roof caved in or the kitchen caught on fire, not necessarily because of the presence of microscopic pathogens.  The effect, policyholders say, is the same.  By a stretch of the imagination, coverage claims are equating property rendered unusable by a fire to property rendered unusable by a virus.  Either way, it’s a direct business loss.  There is some logic to it, and many legislators seem to agree.

Civil Authority Provisions

Business insurance policies usually contain a civil authority provision, which sometimes covers lost business income when a governmental entity shuts a business down.[2]  Usually, this clause applies to evacuation orders or when a business is shut down due to road work or a nearby fire.  But what about when the government issues a stay-at-home order, or a mandatory shut-down of all non-essential businesses?  Prior to COVID-19, courts construed this provision very narrowly, sometimes requiring that the order specifically apply to the policyholder’s business, rather than a generally applicable order.[3]  Though this may seem an obvious avenue of relief for businesses, chances are the order of civil authority provision will not be the cleanest path to seeking coverage.

Why Are Claims Getting Denied?

The National Association of Insurance Carriers (NAIC) explained that the business interruption insurance framework was not built to handle a situation where almost every policyholder has a claim:

Business interruption policies were generally not designed or priced to provide coverage against communicable diseases, such as COVID-19 and therefore include exclusions for that risk.  Insurance works well and remains affordable when a relatively small number of claims are spread across a broader group, and therefore it is not typically well suited for a global pandemic where virtually every policyholder suffers significant losses at the same time for an extended period.  While the U.S. insurance sector remains strong, if insurance companies are required to cover such claims, such an action would create substantial solvency risks for the sector, significantly undermine the ability of insurers to pay other types of claims, and potentially exacerbate the negative financial and economic impacts the country is currently experiencing.[4]

In other words, insurance companies will go bankrupt if they have to cover lost income for every business suffering during COVID-19.  The NAIC strongly opposes legislation that would require them to do so.  Regardless, many states are considering legislation to this effect.

State Legislation

Several states and the federal government are considering legislation to require insurance carriers to pay BII claims.  While they all vary slightly, California’s is one of the most progressive.  The bill would shift the burden to the insurer to overcome a rebuttable presumption that when a business was closed due to an order of civil authority, COVID-19 was in fact present on the business’s property and caused physical damage.[5]  In construing their own policies, insurers would have to consider the presence of COVID-19 to be physical damage.  The bill would retroactively apply to March 4, the date the governor declared a state of emergency in California.

Pennsylvania’s proposed legislation similarly imposes a rule of construction upon insurance carriers.  The current bill would qualify as “property damage” any building, office, or retail space that either has had one person who tested positive for COVID-19, or is located in a municipality where one person in that municipality tested positive for COVID-19.[6]  The legislation specifies that mandates from the governor constitute an order of civil authority for purposes of interpreting the policy.

The uncertainty around this legislation compounded by the hit-or-miss experiences of policyholders makes mass litigation a near guarantee.

Where Are We Now?

There are already over 800 COVID-19 business interruption lawsuits filed, and counting.[7]  Many are in the motion to dismiss phase, whether it be because there was no physical damage, or because a specific exclusion applies, such as the virus exclusion or the ordinance or law exclusion.[8]  Because most of them are still in early stages, it’s difficult to predict how they will turn out, but there have been a few notable rulings so far.

Earlier cases tended to favor the insurer’s argument that there was no direct physical loss or damage to property, so the policy doesn’t apply.  In July, a judge in Michigan dismissed the case of two restaurants, which had failed to allege a direct loss in their complaint.[9]  While this is facially a win for insurers, the dismissal seems to have taught future plaintiffs a lesson: make sure you highlight your direct losses in your complaint.

In the Western District of Texas, a barber shop sued State Farm seeking coverage for its lost business income.  State Farm’s denial letter probably resembles many others:

‘[The] policy specifically excludes loss caused by enforcement of ordinance or law, virus, and consequential losses.’ State Farm argued that there is a requirement ‘that there be physical damage, within one mile of the described property’ and ‘that the damage be the result of a Covered Cause of Loss’ which, State Farm asserted, a ‘virus is not.’[10]

The court held that not only was the policy language unambiguous about the need for a direct physical loss, but there is also a specific exclusion for viruses:

We do not insure under any coverage for any loss which would not have occurred in the absence of one or more of the following excluded events

  1. Fungi, Virus Or Bacteria

(2) Virus, bacteria or other microorganism that induces or is capable of inducing physical distress, illness or disease.[11]

When the court puts it so plainly, it’s pretty clear that many of these policies will not cover losses from the pandemic, so why are businesses still trying?  It seems that there is hope for some policyholders.

One Missouri court denied an insurer’s motion to dismiss, which is seen as a huge win for businesses seeking coverage.[12]  The motion alleged that the policyholder did not experience “direct physical loss or damage,” as required by the policy, but this was not sufficient for the court to dismiss.  This refusal to dismiss marks a potential turning point for policyholders, many of which suffered dismissals early on in the wave of litigation.  The ruling is so significant because the argument that COVID-19 exposure does not constitute a physical loss has been the boilerplate response for nearly all insurer-defendants.  Courts are likely desperately seeking precedent to cling to, so as more courts – and proposed legislation – define coronavirus exposure as physical damage, there may be a shift in the conventional wisdom of what BII will cover.