By Steve Schulwolf, Schulwolf Mediation, PLLC
In Part I, I focused on the threshold “direct physical loss or damage” requirement typically contained in property policies. This follow-up article provides an update on early COVID-19 coverage rulings which may inform resolution of these disputes. While only a handful of the hundreds of pending cases have been decided, one trend is emerging—some policyholders are finding it difficult to plead that COVID-19 caused a physical loss or damage to their insured premises, particularly when their policies contain virus exclusions.
According to the University of Pennsylvania, as of August 3, 2020, there have been 1055 COVID-19 related insurance coverage lawsuits, the vast majority of which seek lost business income. https://cclt.law.upenn.edu/. On July 1, 2020, Judge Joyce Draganchuk granted Michigan Insurance Company’s motion for summary disposition in Gavrilides Management Co. et. al. v. Michigan Ins. Co., No. 20-258 CB (Ingham County, Michigan). www.youtube.com/watch?v=Dsy4pA5NoPw. Plaintiff operated the Soup Spoon restaurant and sought lost profits from its insurer due to reduced business during the pandemic. The insurer cited Universal Image Prods., Inc. v. Chubb Corp., 703 F. Supp. 2d 705, 709-10 (E.D. Mich. 2010) in arguing that there was no coverage unless the insured premises was physically damaged. The Court agreed, finding plaintiff failed to allege that the physical integrity of the Soup Spoon was altered by the coronavirus. The plaintiff also sought to circumvent the virus exclusion by arguing that a stay-at-home order by the governor was issued to protect the public welfare and not because of a virus. The Court disagreed, finding the virus exclusion unambiguously barred coverage. Finally, plaintiff’s civil authority claim failed because of a lack of any physical loss or damage.
The Superior Court of the District Court of Columbia also found no coverage in a suit brought by prominent D.C. restaurants whose policies lacked a virus or pandemic exclusion. Rose’s 1, LLC v. Erie Insurance Exchange, No. 2020 CA 002424 B (Aug. 6, 2020). Specifically, the court noted that “Plaintiffs offer no evidence that COVID-19 was actually present on their insured properties at the time they were forced to close. And the mayor’s [stay-at-home] orders did not have any effect on the material or tangible structure of the insured properties.” Id. at 5. Unlike in Gavrilides, the Rose’s 1 court could “find no published cases in this jurisdiction analyzing the exact term ‘direct physical loss.’” Id. at 8. However, after analyzing cases from multiple jurisdictions, the court noted that in order to establish coverage, the insured must demonstrate that the physical integrity of the insured premises was compromised. See id. at 6.
Insurers had less than a week to celebrate the D.C court’s ruling when, on August 12, 2020, the Western District of Missouri denied an insurer’s motion to dismiss a suit filed by hair salons and restaurants. Studio 417, Inc. v. The Cincinnati Ins. Co., — F. Supp. 3d –, No. 20-cv-03127-SRB, 2020 WL 4692385 (Aug. 12, 2020). The court analyzed the “direct physical loss or damage” requirement and, contrary to Gavrilides, stressed that the policy provided coverage for loss or damage. Id. at *1. The plaintiffs alleged that the presence of COVID-19 and closure orders “caused a direct physical loss or direct physical damage to their premises ‘by denying use of and damaging the covered property.’” Id. at *2. The insurer argued that loss of use was not sufficient because the policy required a “physical alteration of property” and “[COVID-19] does not damage property; it hurts people.” Id. at *4. The court found that plaintiffs stated a claim for direct physical loss, finding that the insurer “conflates ‘loss’ and ‘damages’ in support of its argument that the Policies require a tangible, physical alteration.” Id. at *5. The Studio 417 court stressed that because plaintiffs alleged physical loss of their premises, Gavrilides and other cases were inapplicable. Finding that there were sufficient allegations that COVID-19 was present at the insured premises, the court, in a footnote, noted that COVID-19 is “wide-spread.” Id. at *6, n. 6. The policy lacked a virus exclusion.
Policyholders barely had time to smile before the first ruling from Texas. Proceeding chronologically and not intentionally burying the lede, on August 13, 2020, the Western District of Texas dismissed a claim brought by various barbershop businesses. Diesel Barbershop, LLC et al v. State Farm Lloyds, No 5:20-CV-461-DAE, 2020 WL 4724305 (August 13, 2020). The policies at issue obligated State Farm to pay for accidental “direct physical loss” to the insured premises. The policy also contained a virus exclusion. Id. at *2-3.
With respect to “direct physical loss,” plaintiffs did not allege that COVID-19 was actually within their properties, let alone caused damage; rather, they argued that stay-at-home orders issued by Governor Abbott and Bexar County led to losses covered under the policy. Id. at *5. While the Diesel Barbershop court expressed its sympathy for plaintiffs, it granted State Farm’s motion. Notably, the Court agreed with plaintiffs that COVID-19:
is not like a hurricane or a hailstorm, but rather more like ammonia, E. coli, and/or carbon monoxide (i.e. cases in which the loss is caused by something invisible to the naked eye), and in such cases, some courts have found direct physical loss despite the lack of physical damage. …
Even so, the Court finds that the line of cases requiring tangible injury to property are more persuasive here ….
Id. (list of cases omitted). Ultimately, the court followed authority within the circuit that requires a “distinct, demonstrable physical alteration of the property.” Id. (citing Hartford Ins. Co. of Midwest v. Mississippi Valley Gas Co., 181 F. App’x 465, 470 (5th Cir. 2006)).
Diesel Barbershop also found that plaintiffs’ claims were barred by the virus exclusion. Plaintiffs argued that their losses were the result of governmental orders designed to slow the spread of COVID-19 and stressed that COVID-19 was not present in their properties. Id. at *6. The Court focused on the anti-concurrent causation clause, which stated that State Farm “does not insure for a loss regardless of ‘whether other causes acted concurrently or in any sequence within the excluded event to produce the loss.’” Id. The Court found that “it was the presence of COVID-19 in Bexar County and in Texas that was the primary root cause of Plaintiffs’ businesses temporarily closing.” Id. As such, the virus exclusion barred coverage.
Insurers are also claiming victory in two additional recent cases in Florida and California. Mama Jo’s Inc. v. Sparta Ins. Co., — F. App’x –, 2020 WL 4782369 (11th Cir. Aug. 18, 2020) (non COVID-19 case affirming district court’s ruling that insured failed to demonstrate “direct physical loss” where nearby construction caused dust to migrate to restaurant allegedly causing decreased business, because under Florida law, “an item or structure that merely needs to be cleaned has not suffered a ‘loss’ which is both ‘direct’ and physical’”); The Inns by the Sea v. California Mut. Ins. Co., Case No. 20CV001274 (Superior Ct. of Cal., Aug. 6, 2020) (granting insurer’s demurrer to policyholder’s entire complaint “without leave to amend on the grounds that the allegations fail to state facts sufficient to constitute a cause of action”).
Last week, in Malaube LLC v. Greenwich Ins. Co., No. 20-22615-Civ, 2020 WL 5051581 (S.D. Fla. Aug. 26, 2020), U.S. Magistrate Judge Edwin Torres recommended dismissing a suit brought by a restaurant owner seeking coverage under a business income exclusion. Judge Torres rejected the argument that the “or” in the phrase “direct physical loss or damage” permitted recovery for the loss of use of portions of the restaurant without actual damage, citing numerous cases including the 11th Circuit’s decision in Mama Jo’s Inc., supra. Judge Torres acknowledged that the policy did not define “physical loss” or “physical damage,” but he agreed with the insurer that under Florida authority the terms require “an actual change in insured property” that would require repair. Judge Torres found the allegations of direct physical loss in Malaube to be “far weaker” than in Mama Jo’s and explicitly determined that Studio 417 was “materially different because Plaintiff has not alleged any physical harm. There is no allegation, for example, that COVID-19 was physically present on the premises.” Judge Torres permitted Malaube to file an amended complaint within 14 days “if viable under Rule 11,” but noted that he had not ruled on the virus exclusion and any amended complaint would need to “survive any other exclusion that may exist under the policy.”
Insurers may cite to most of these recent opinions in support of their arguments that COVID-19 claims are uncovered and note that even the worst case for them, Studio 417, was not a total loss and only permitted an insured to survive a motion to dismiss. Insureds may counter with Studio 417 and note that not all jurisdictions require an actual physical alteration of the insured premises and that odors, molds and substances analogous to viruses have been deemed sufficient to trigger coverage, something acknowledged in Diesel Barbershop. While all of these cases addressed the same basic issues, subtle differences in pleadings, facts and law can be dispositive. For example, the “wide-spread” nature of COVID-19 was a basis for the Studio 417 court’s pro-coverage ruling but doomed coverage in Diesel Barbershop. Insureds may argue that Michigan, California, Florida and D.C. were favorable jurisdictions for insurers and highlight that, unlike other policyholders, these cases mostly do not involve allegations that their premises were physically damaged.
Finally, an attempt to create a COVID-19 Multidistrict Litigation (“MDL”) was rejected because each case presents unique pleadings and facts and is governed by different law. In Re: COVID-19 Business Interruption Protection Insurance Litigation, MDL No. 2942 (August 12, 2020) (the requested MDL “entails very few common questions of fact, which are outweighed by the substantial convenience and efficiency challenges posed by managing a litigation involving the entire insurance industry”). Thus, jurisdictions will likely decide similar issues differently.
The early COVID-19 coverage decisions underscore that policyholders face difficult challenges in seeking to recover lost profits during the pandemic. However, hundreds of cases are still pending, and some policyholders have been given an opportunity to replead and jurisdictions have different standards concerning whether “physical loss or damage” requires an actual alteration to the insured premises or can be satisfied by mere loss of use. Some courts may follow Studio 417 and allow cases to proceed. If so, it will be interesting to see what evidence is required to substantiate allegations of physical damage. While the current focus is on coverage, at some point parties will turn to damages. It likely is too early for many insurers to be amenable to settling disputed cases, but issues like damages can be negotiated and narrowed even as the parties pursue litigation and appeals. In the meantime, a steady stream of new decisions from new courts will provide continuing guidance.
 The Court held that Plaintiffs sufficiently alleged a “direct physical loss” and, therefore, did not need to determine whether they had also alleged “physical damage,” although in a footnote the Court noted that the insurer’s argument “appears to be persuasive.” Id. at *6, n. 7.
 While Judge Torres found the Florida Emergency Orders insufficient to establish any tangible loss or damage to the restaurant, he did not quote them in detail, making it difficult to determine whether they explicitly acknowledged property damage as alleged by other insureds. Compare Vandelay Hospitality Group LLC D/B/A Hudson House v. The Cincinnati Ins. Co., No. 3:20-cv-01348-D (N.D. Tex.) (Doc. 24-1 at 1) (Dallas County Declaration of Disaster determined that “the virus is physically causing property damage”).
 The Court was more open to multiple insurer-specific MDLs and issued a show cause order for Certain Underwriters at Lloyd’s, London, Cincinnati Ins. Co., the Hartford Insurers and Society Ins. to explain why the cases against them should not be centralized. Id. at 4.