Business Interruption Insurance in the Wake of COVID-19: Do Civil Authority Provisions Mean Businesses Stay in the Red While We Stay at Home?
Shelby Akerley, Notes Editor (‘21)
The arrival of COVID-19 in the United States caused a country-wide pause of virtually all activities and created an unprecedented level of uncertainty.[1] Parents wondered how their children would receive schooling; grocery stores implemented limits on basic goods including toilet paper, bleach, and eggs; and college students said goodbye to their friends and dorm rooms as they returned home.[2] But one of the most notable changes during this time was the ever increasing “closed” signs displayed in the windows of businesses.[3] While closures were permanent for many establishments, they also resulted in a significant loss of revenue for others.[4] Accordingly, many businesses looked to the fine print of their business interruption insurance policies to determine whether they could recover for their loss of revenue caused by COVID-19.[5]
Business Interruption Insurance
Business interruption insurance protects a business’s income when a covered peril stops its operations.[6] In most cases, business interruption insurance is not sold as a separate policy.[7] Rather, business interruption insurance is either added to an existing property policy or included in a comprehensive package policy as a rider.[8] The purpose of business interruption insurance is to return the business to the position it would have been in had the peril not occurred.[9] While policies vary across insurance providers, a typical business interruption clause within an insurance policy requires the loss to be a direct result of a covered peril.[10] Additionally, the covered peril must cause damage or destruction to a specified property resulting in an actual loss of income due to a necessary suspension of operations.[11]
Many business interruption policies also provide civil authority coverage, which protects against income losses caused by an order of civil authority that limits or prohibits access to the specified property.[12] While the language of these civil authority provisions can vary between policies, most policy language also requires that the order of civil authority be issued as a result of “physical loss or damage” to property other than the specified insured property.[13] Further, for civil authority coverage to apply, it is typically necessary that the business operations be suspended.[14] While some policies define suspension as a complete cessation of activity, others allow for coverage in cases where an order of civil authority merely results in a reduction of operations.[15] Specifically, a standard civil authority provision may read as follows:
When a Covered Cause of Loss causes damage to property other than property at the described premises, we will pay for the actual loss of Business Income you sustain and necessary Extra Expense caused by action of civil authority that prohibits access to the described premises, provided that both of the following apply:
(1) Access to the area immediately surrounding the damaged property is prohibited by civil authority as a result of the damage, and the described premises are within that area but are not more than one mile from the damaged property; and
(2) The action of civil authority is taken in response to dangerous physical conditions resulting from the damage or continuation of the Covered Cause of Loss that caused the damage, or the action is taken to enable a civil authority to have unimpeded access to the damaged property.[16]
It is this kind of civil authority provision that has sparked great debate regarding an insurer’s ability to deny a business interruption claim based on losses sustained due to mandatory stay-at-home orders.[17] Much of this debate is centered on whether “physical loss or damage” should be interpreted solely as actual structural damage, or whether the definition should encompass loss of access functionality, and/or value as well.[18]
Business Interruption Claims Filed as a Result of Stay-at-Home Orders Issued in Response to COVID-19
In 2020, the 2019 novel coronavirus, commonly expressed in its abbreviated form of COVID-19, began to pose serious risks due to its highly contagious and transmittable nature.[19] In response, governors across the United States issued executive stay-at-home orders.[20] While these stay-at-home orders were deemed necessary to slow the transmission of COVID-19, they also prevented businesses from operating or reduced the capacity at which businesses could operate.[21] As a result, businesses began reporting huge revenue losses and unemployment reached levels the United States had not seen since the Great Depression.[22] In hopes of securing the insurance they had been paying premiums on—some for many years—business owners began to file business interruption claims with their insurers.[23]
The insurance industry responded on the defensive, arguing, in turn, that (1) losses caused by COVID-19 were not covered by their respective policies, (2) pandemic losses were uninsurable on their face, (3) and requiring insurers to pay out for losses caused by COVID-19 would bankrupt an industry that collected a mere $6 billion per month in premiums.[24] Specifically, insurers argued that the language of their civil authority provisions unambiguously require that a loss of business revenue be caused by physical loss or damage to property in order for an insurer to provide coverage and that a government order requiring businesses to close in response to COVID-19 does not fall under this qualification.[25] Insured business owners alternatively argued that the rules of policy interpretation require that the currently undefined phrase “physical loss or damage” be interpreted in line with the reasonable expectation of the policyholder.[26] Thus, business owners argue that, under the civil authority provision present in many business interruption clauses, a government order requiring businesses to shut down due to the threat of COVID-19 contamination in the air or on the surfaces of the insured property and properties around it would unquestionably qualify as “physical loss or damage.”[27]
The Shift in Defining “Physical Loss or Damage”
Recent federal appellate cases have shown a shift away from defining “physical loss” as only those losses resulting from damage or physical alteration of an insured property.[28] In BY Development, Inc. v. United Fire & Casualty. Co., the District of South Dakota held that civil authority coverage was applicable where a town was evacuated due to the threat of an approaching wildfire, and this decision was affirmed by the Eighth Circuit.[29] Similarly, in TRAVCO Insurance. Co. v. Ward, the Fourth Circuit affirmed the Eastern District of Virginia’s holding that physical loss had been sustained by a home that was deemed uninhabitable due to toxic gases resulting from defective drywall.[30] Other federal district cases also appear to follow this trend, as seen in Cooper v. Travelers Indemnity Co. of Illinois, where the Northern District of California held that an E-Coli contamination in the water supply of a business constituted direct physical damage to the property, triggering coverage.[31] Similarly, in Oregon Shakespeare Festival Ass’n v. Great American Insurance Co., the District of Oregon found that structural damage was not necessary to bring a claim for business interruption coverage for a business property that had to improve air quality before operations could resume.[32] Given this recent trend, business owners who suffer a loss of use of their business properties as a result of government mandated stay-at-home orders may be covered by business interruption and civil authority coverage provisions if such owners can establish that COVID-19-related stay-at-home orders constitute direct physical loss or damage to property even without causing actual structural or physical damage to business property.[33]
Conclusion
While these types of cases may create the precedent necessary for a future victory for business owners suffering COVID-19 losses amid government orders, many questions remain as to whether and to what extent insurers can deny business interruption coverage for COVID-19 related losses.[34] For this reason, it is now more important than ever for business owners to closely read the fine print of their business interruption coverage and for insurers to clearly define the terms “physical loss or damage” in their business interruption and civil authority provisions.[35]
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[1] See Larry Buchanan, 54 Ways Coronavirus Has Changed Our WorldI, N.Y. Times (May 27, 2020), https://www.nytimes.com/interactive/2020/05/27/sunday-review/coronavirus-effects.html (commenting that “[t]he coronavirus pandemic has altered the world immeasurably”).
[2] See Ella Torres, How Life Has Changed Since Coronavirus Struck, ABC News (Apr. 10, 2020), https://abcnews.go.com/Health/10-ways-life-changed-coronavirus-struck/story?id=69535464 (explaining that “major cities have closed schools for extended periods,” and “photos of empty aisles and lines out the door circulated in the early days of the spread in the U.S.”).
[3] See Alexander W. Bartik et al., The Impact of COVID-19 on Small Business Outcomes and Expectations, PNAS (July 28, 2020), https://www.pnas.org/content/117/30/17656 (“mass layoffs and closures had already occurred – just a few weeks into the crisis.”).
[4] See id. (“Across the sample [of 5,800 businesses], 41.3% of businesses reported that they were temporarily closed because of COVID-19.”).
[5] See Christopher C. French, COVID-19 Business Interruption Insurance Losses: The Case for and Against Coverage, 27 Conn. Ins. L.J. 1, 3 (“Naturally, these businesses turned to their insurers for help when faced with the devastating losses caused by COVID-19.”).
[6] Id. at 6 (“Business Interruption Insurance protects a business’ income stream when its operations are shut down by a covered peril.”).
[7] See David Pollin, Recovery Under Business Interruption Insurance, 41 Am. Jur. Proof of Facts 3d 319 (“Business Interruption . . . refers to a provision common in commercial property policies.”).
[8] See id.
[9] See id. (“[T]he object of such provision is to insure against loss from the interruption of business as a whole, whatever part of it may be conducted in or with the property which suffers from the peril insured against.”).
[10] See id.
[11] See id. (“Where the policy limits the liability to actual loss resulting from a business suspension due to a specified risk, the insurer is not liable, unless it is shown that the risk insured against directly produced the los for which a recovery is sought.”).
[12] See Charles S. LiMandri et al., Business Interruption Coverage for the COVID-19 Pandemic: Insurance Industry Fights Biggest Battle Ever Against Difficult Odds, 41 No. 10 Ins. Litig. Rep. NL 1, 3 (“Many business interruption policies provide for ‘Civil Authority’ coverage.”).
[13] See id. (“Civil Authority provisions often have different requirements and conditions for coverage to trigger and apply. For example, some policies require that access to the insured’s property be ‘prevented or prohibited by an order of civil authority issued as a direct result of physical damage,’ while other policies require that the order be issued as a result of physical loss or damage.”).
[14] See id. (“[F]or civil authority coverage to typically apply, the business owner’s operations must generally be suspended.”).
[15] See id. (“[S]ome civil authority provisions expressly require that there be a ‘temporary, but complete, cessation of activity,’ . . . . [o]ther policies do not require a complete cessation, interruption or suspension of operations.”).
[16] See Douglas Berry, COVID-19 – When Civil Authorities Take Over, Are You Covered?, IRMI, (Mar. 2020), https://www.irmi.com/articles/expert-commentary/when-civil-authorities-take-over-are-you-covered.
[17] See generally John DiMugno, The Implications of COVID-19 for the Insurance Industry and Its Consumers, 42 No. 8 Ins. Lit. Rep. NL 1 (“Civil Authority coverage will be at the forefront of disputes over coverage for pandemic-related business income losses.”).
[18] See LiMandri, supra note 12, at 5 (“Although such a term of art is determinative, insurance policies do not normally define ‘direct physical loss or damage.’”).
[19] See French, supra note 5, at 3 (“As of June 30, 2020, over 500,000 people had died worldwide, including more than 126,000 deaths in the United States.”).
[20] See id. (“Governors across the country issued stay-at-home orders, which prevented countless businesses from operating and caused massive layoffs.”).
[21] See id.
[22] See id. (“The unemployment rate in the U.S. reached Great Depression numbers that have been projected to average at least 15 percent during the second and third quarters, and the gross domestic product (GDP) has been projected to be down at least 12 percent in the second quarter.”).
[23] See id. (“Many businesses have been paying premiums on such policies for years. Naturally, these businesses turned to their insurers for help when faced with the devastating losses caused by COVID-19.”).
[24] See generally DiMugno, supra note 17, at 1 (“The insurance industry, anticipating claims under business interruption policies, launched a preemptive campaign to discourage claims, with industry leaders announcing before any claims were filed that their policies do not cover pandemic-related losses.”).
[25] See id. (“To insurers, the policyholder attorneys’ claims seemed unmoored to the language of property and business interruption insurance policies—which insure against ‘physical loss or damage.’ Insurers maintain that the word ‘physical’ contemplates coverage for natural disasters such as hurricanes that destroy or damage the structure of an insured building.”).
[26] See French, supra note 5, at 20-21 (“Under the rules of policy interpretation, COVID-19 business interruption losses are covered because they were caused by government orders shutting down policyholders' businesses due to ‘physical loss of or damage’ to the policyholders' property. The phrase ‘physical loss of or damage’ is undefined, so it should be interpreted expansively as a layperson would understand the phrase. It should also be interpreted in accordance with the reasonable expectations of policyholders.”).
[27] See LiMandri, supra note 12, at 12 (“Additionally, as a result of the COVID-19 Pandemic and related closure orders, business properties are ‘without employees, without necessary supplies and without consumers,’ which crosses the threshold from ‘mere pecuniary diminution in value to the tangible and palpable realm of physical loss or damage.’”).
[28] See LiMandri, supra note 12, at 5 (“The First, Third, Fourth and Eighth Circuits have each affirmed decisions by federal district courts finding ‘direct physical loss’ to property without any actual physical structural damage or physical alteration to the insured property itself.”).
[29] See generally BY Dev., Inc. v. United Fire & Cas. Co., No. CIV. 04-5116, 2006 WL 694991 (D.S.D. Mar. 14, 2006), aff’d sub nom. BY Dev., Inc. v. United Fire & Cas. Co., 206 F. App’x 609 (8th Cir. 2006).
[30] See generally TRAVCO Ins. Co. v. Ward, 715 F. Supp. 2d 699, 709 (E.D. Va. 2010), aff’d, 504 F. App’x 251 (4th Cir. 2013).
[31] See generally Cooper v. Travelers Indem. Co. of Ill., No. C-01-2400-VRW, 2002 WL 32775680, at *1 (N.D. Cal. Nov. 4, 2002), aff’d, 113 F. App’x 198 (9th Cir. 2004).
[32] See generally Or. Shakespeare Festival Ass’n v. Great Am. Ins. Co., No 1:15-CV-01932-CL, 2019 WL 3267247, at *9 (D. Or. June 7, 2016), vacated on other grounds, No. 1:15-CV-01932-CL, 2017 WL 1034203 (D. Or. Mar. 6, 2017).
[33] See LiMandri, supra note 12, at 11 (“[T]he government-mandated closures by civil authorities are evidence in and of themselves that the coronavirus is ‘physically touching and linked with’ buildings and people inside of these business establishments, and therefore the coronavirus physically affects the insured’s business property.”).
[34] See French, supra note 5, at 35 (“Ultimately, whether COVID-19 business interruption losses are covered by insurance will be dictated by the policy language at issue and the applicable state law, which may vary considerably from state to state.”).
[35] See French, supra note 5, at 1 (“The financial implications of this battle, and its implications for America’s economy, cannot be overstated.”).