Businesses continue to face a myriad of challenges in today’s economy. Initially, the COVID-19 pandemic resulted in the widespread closure of multiple businesses. Now, U.S. consumer demand for goods is strong, but supply chain woes persist. Compensation costs have increased, while inflation hinders the benefit to workers from that higher pay. The COVID-19 vaccination rate continues to climb, but business owners experience continued disruption from emerging COVID-19 variants.
Prudent risk-management, including maintaining essential insurance coverage on an ongoing and uninterrupted basis, can help business owners mitigate the negative impact of certain events. However, insurance companies are denying business owners’ claims for business-interruption losses due to the COVID-19 pandemic, and insurance coverages and policy exclusions are now being challenged in court.
Business Insurance Policies and Coverage Options
Business insurance policies protect business owners against financial losses, including lost income and costs of operating expenses, after a covered loss. A standard business owner’s policy combines business property and business liability insurance to cover real and personal property from covered losses, such as fire, theft and other disasters, [1] and to provide coverage for potential liability related to incidents that may occur at the physical location of the business.
The extent of coverage necessary depends on, among other things, the size, location and nature of the covered business. As such, policies can be tailored to include optional coverages such as workers’ compensation insurance, directors’ and officers’ insurance (D&O), cyber liability insurance and business-interruption insurance.
Business-interruption insurance, or business-income insurance, whether bundled in a business owners’ policy or purchased as separate coverage, is a subset of property insurance that covers direct physical loss, damage or destruction to the insured real and personal property.
At issue here are the specific provisions governing various exclusions and limitations to that coverage. A business-interruption insurance policy generally covers lost income and operating expenses resulting from the necessary suspension of business operations during a set period of restoration. [2] Certain insurance policies include provisions for extra expense coverage and civil authority coverage (discussed in more detail below). [3]
Tracking Insurance Coverage Disputes
The continued impact of the COVID-19 pandemic has drawn attention to exclusions under business-interruption insurance policies. Insurance carriers have overwhelmingly rejected business-interruption insurance claims related to COVID-19 shutdowns, and litigation against insurance companies has increased as a result.
According to the University of Pennsylvania Carey Law School’s COVID Coverage Litigation Tracker (CCLT), approximately 2,100 cases related to insurance-coverage disputes have been filed since Dec. 20, 2021. [4] Policyholders have asserted claims for breach of contract and relief thereunder, alleging that the insurance companies have wrongfully denied coverage for business losses incurred from the suspension of business operations resulting from the COVID-19 pandemic.
Courts across the country have considered whether insurance companies are required to provide coverage to policyholders for business interruptions caused by government shutdown orders related to COVID-19. Many of the policies at issue have included virus-specific exclusions, which resulted in early motions to dismiss for small businesses. [5] The decisions are also largely based on similar interpretations of “physical loss or damage,” with courts finding that insureds have failed to show direct physical loss of or damage to the insured property. [6] On appeal, every federal circuit court to address the issue to date has ruled in favor of the insurance company. [7] The following case study provides an example of the interpretation of the direct-physical-loss requirement under New York law.
Getting to the He(art) of the Dispute
The U.S. Court of Appeals for the Second Circuit recently reviewed a decision by the U.S. District Court for the Southern District of New York dismissing a policyholder’s complaint against its insurance company. [8] The plaintiff, 10012 Holdings, Inc. d/b/a Guy Hepner, is the owner and operator of a fine arts gallery and dealership in New York City. [9] In 2019, 10012 Holdings purchased a business property insurance policy from the defendant, Sentinel Insurance Company Ltd. [10] The policy included three types of coverage relevant to the dispute: “Business Income,” “Extra Expense” and “Civil Authority.” [11]
Beginning in March 2020, 10012 Holdings suspended the gallery’s operations in accordance with executive orders issued by the Governor of New York and Mayor of New York City limiting operations for nonessential businesses. As a result, 10012 Holdings claimed it sustained business losses and expenses, and it submitted an insurance claim under the policy. Sentinel denied the claim on the grounds that 10012 Holdings did not suffer direct physical loss of, or physical damage to, its property or to property within its vicinity.
In June 2020, 10012 Holdings filed a complaint alleging that as a result of COVID-19 and the order of civil authorities, 10012 Holdings suffered a loss of use of its property that triggered Business Income, Civil Authority and Extra Expenses coverage under the policy. 10012 Holdings requested a judgment declaring that the policy provides coverage for its business losses, as well as compensatory damages resulting from the defendants’ alleged breaches of the policy. In response, Sentinel filed a motion to dismiss, stating that the three grounds of insurance coverage are triggered only when the cause of a business suspension is a result of “direct physical loss” to property at the insured’s premises (or, in the case of Civil Authority coverage, in the “immediate area”).
On Dec. 15, 2020, the district court granted Sentinel’s motion to dismiss with prejudice, holding that under New York Law, business-interruption coverage for “loss of, damage to, or destruction of property or facilities” is limited to losses involving physical damage to the insured’s property, which 10012 Holdings did not allege it suffered. [12]
On appeal, the Second Circuit considered whether the policy provided coverage for 10012 Holdings’ financial losses, even though 10012 Holdings did not allege that its closure resulted from physical damage to its property or the adjoining property of its neighbors. [13] The Second Circuit affirmed the judgment of the district court, noting “all New York courts applying New York law … have soundly rejected the argument that business closures … due to New York State Executive Orders constitute physical loss or damage to property.” [14]
The Second Circuit cited its decision in 10012 Holdings Inc. v. Sentinel Ins. Co. in another recent ruling against a policyholder. [15] Noting that the common question among cases of this type “is whether the coronavirus and the government restrictions responding to it caused ‘direct physical loss of or damage to’ property,” the Second Circuit reiterated that the policyholder “cannot base its business interruption claim on loss of possession or access.” [16]
The Next Phase
While claims continue to be denied for many businesses with similar business-interruption insurance policies, companies will likely continue to litigate their business-interruption claims resulting from the COVID-19 pandemic. As larger companies and organizations with expensive tailored insurance policies and more resources file claims, more high-stakes litigation may be at play.
The inherent risks of owning and operating a business continue to evolve. Sound business practices include maintaining various liability, property, casualty, workers’ compensation and other insurance programs in the ordinary course of business to limit exposure to a variety of risks. Certain businesses may also be obligated to remain current with certain insurance programs pursuant to contractual obligations with numerous third-party property owners, customers, suppliers, distributors, contractors and lenders. Business owners should carefully assess the changing risks to their businesses and industry, and review policy language, coverages and deductibles on at least an annual basis to ensure that they are adequately insured.
[1] Coverages and additional coverage options vary from one insurance provider to another. Business owners should carefully assess their risks and review their policy language on an annual basis. See, e.g., U.S. Small Business Administration, Get business insurance, available at https://www.sba.gov/business-guide/launch-your-business/get-business-in… (last visited Jan. 30, 2022).
[2] The beginning date and endpoint of a restoration calculation varies by policy and insurer. Generally, the period of restoration begins anywhere from immediately to 72 hours after the covered event and ends on the earlier of (1) the date when the property at the described premises should be repaired, rebuilt or replaced with reasonable speed and similar quantity; or (2) the date when the business is resumed at a new permanent location. See Insurance Services Office, Inc., Commercial Property – Business Income and Extra Expense Coverage Form CP 00 30 10 12, 2011.
[3] A civil authority, or public authority, clause is a provision included in property insurance policies outlining the situations in which an insured may be covered if civil authorities (defined as local, state or federal governments) bar access to an insured’s property as the result of a covered cause of loss. See Insurance Services Office, Inc., Business Income and Extra Expense Coverage Form CP 00 30 10 12, 2011.
[4] University of Pennsylvania Carey Law School, COVID Coverage Litigation Tracker, available at https://cclt.law.upenn.edu/ (last visited Jan. 30, 2022). The Covid Coverage Litigation Tracker (CCLT) database and dashboards provide information on and legal analytics for insurance-coverage cases filed beginning March 16, 2020.
[5] In July 2006, in response to the severe acute respiratory syndrome (SARS) outbreak, the Insurance Services Offices, Inc. (ISO) introduced an endorsement titled, “Exclusion of Loss Due to Virus or Bacteria” (the “Virus Exclusion”). Intended for inclusion in commercial property policies, the Virus Exclusion states, in part, “We will not pay for loss or damage caused by or resulting from any virus, bacterium or other micro-organism that induces or is capable of inducing physical distress, illness or disease.” See ISO Circular, New Endorsement Filed to Address Exclusion Due to Virus or Bacteria, July 6, 2006.
[6] For example, in determining whether Philadelphia Indemnity Insurance Company was required to cover losses suffered by Goodwill Industries of Central Oklahoma Inc., pursuant to a commercial lines policy, the U.S. Court of Appeals for the Tenth Circuit stated, “Although the COVID orders temporarily restricted Goodwill’s use of its property, Goodwill never lost physical control of its buildings or merchandise from its stores. It thus was not deprived of its property. Nor did COVID destroy Goodwill’s property. The policy therefore did not cover its loss.” Goodwill Industries Central v. Philadelphia Indemnity, No. 21-6045 (10th Cir. 2021).
[7] Including the Second, Fifth, Sixth, Seventh, Eighth, Ninth, Tenth and Eleventh Circuits.
[8] 10012 Holdings Inc. v. Sentinel Ins. Co., 21-80-cv (2d Cir. Dec. 27, 2021).
[9] 10012 Holdings Inc. DBA Guy Hepner, https://www.guyhepner.com (last visited Jan. 23, 2022).
[10] Sentinel Insurance Company Ltd. is a wholly owned subsidiary of The Hartford Financial Services Group, Inc.
[11] The Business Income provision requires the defendant to cover certain business losses incurred if the plaintiff suspended its operations due to “direct physical loss of or physical damage to” its property “caused by or resulting from a Covered Cause of Loss.” The Extra Expense provision reimburses “reasonable and necessary Extra Expense” incurred during a “period of restoration” of the premises following “direct physical loss or physical damage to” the Plaintiff’s property “caused by or resulting from a Covered Cause of Loss.” The Civil Authority provision extends coverage for business income losses if access to the plaintiff’s premises “is specifically prohibited by order of a civil authority as the direct result of a Covered Cause of Loss to property in the immediate area of” the plaintiff’s premises. 10012 Holdings Inc. v. Sentinel Ins. Co., 507 F. Supp. 3d 482, 485 (S.D.N.Y. 2020).
[12] 10012 Holdings Inc. v. Sentinel Ins. Co., 507 F. Supp. 3d 482, 487 (S.D.N.Y. 2020) (citing Roundabout Theatre Co. v. Cont’l Cas. Co., 751 N.Y.S.2d 4, 8 (1st Dep’t 2002)).
[13] 10012 Holdings Inc. v. Sentinel Insurance Co. Ltd., No. 21-80-cv (2d Cir. Dec. 27, 2021).
[14] 10012 Holdings Inc. v. Sentinel Insurance Co. Ltd., No. 21-80-cv (2d Cir. Dec. 27, 2021) (citing Benny’s Famous Pizza Plus Inc. v. Sec. Nat'l Ins. Co., 72 Misc.3d 1209(A), slip op. at 4 (N.Y. Sup. Ct., Kings Cnty. July 1, 2021)).
[15] Kim-Chee LLC v. Philadelphia Indemnity Insurance Company, 21-1082-cv (2d Cir. Jan. 28, 2022).
[16] Id. Kim-Chee LLC also indicated that the underlying “all-risk” policy did not “include an exclusion of loss due to virus or bacteria in the policy language” and argued that this was “evidence of the parties’ intent to cover loss or damage resulting from a pandemic.” In dismissing the policyholder’s complaint, the U.S. District Court for the Western District of New York held that the insurance company’s failure to include an ISO standard-form virus exclusion “does not alter the limits the direct physical loss clause places on the coverage.” See Kim-Chee LLC v. Phila. Indem. Ins. Co., 535 F. Supp. 3d 152 (W.D.N.Y. 2021).