The Interruption of Business Interruption Claims in the Covid Pandemic
September 17, 2020
In the first two months of this year, the Covid virus rolled in like silently gathering storm clouds, subtle and menacing, but with no obvious effect on businesses. In March, however, its effect was sudden and severe; an unleashed hurricane that has relentlessly battered the service industry in particular. Shuttered overnight, with near total layoffs, restaurants, salons and entertainment venues turned to their insurance companies to fortify themselves. As a result, every business insurer in this country saw a swell of business interruption claims and hastened to address them.
Some states even began drafting statutes aimed at ordering insurers to pay business interruption claims, whether qualifying as covered losses or not. Lawsuits were filed, gathering steam and moving into class action status. Claims are far down now, and the number of states drafting reparatory statutes has lessened. What happened to stem the flow of business interruption claims? The short answer is: the law.
By way of background, business interruption (BI) insurance coverage is generally found in property damage policies. These polices are often composed of standard clauses generated by Insurance Services Office (ISO), a company which prepares and disseminates the vast majority of insurance forms used in the United States. An insured can elect to purchase BI coverage, for a premium.
As with all insurance contracts, the extent of that coverage, and when it applies, is governed by the terms of the insurance contract. A typical BI clause or endorsement will provide coverage for certain business losses for a temporary closure. The coverage is subject to policy dollar limits and certain explicit exclusions. There is also coverage a business can buy to cover a shutdown by operation of “civil authority,” when exercise of that authority prohibits access to one’s business premises.
Most of the time, an insured who purchases business interruption coverage is under the impression that all business losses will be covered, for as long as required, hence the flood of BI claims since March. This lamentable presumption is seldom the case, however, even under the broadest of coverages. The devil is in the details, and those details include not only limitations on what scenarios trigger this coverage in the first place, but also limitations on the duration, amount and type of coverage. There are often also specific exclusions including, most relevantly, an exclusion for damages caused by viruses.
The triggering event – direct physical loss
Let’s unwrap coverage then. The typical ISO policy that does provide some business interruption coverage requires a covered triggering event, more specifically, “direct physical loss or damage.” This is because business interruption coverage was initially created to cover a certain type of loss triggered by some accident that caused “damage to property,” for example a temporary closure because a tree fell on the building, or a fire damaged it. In the decades since this type of coverage was first offered, however, claimants and their attorneys have attempted to twist and turn the language of the coverage to fit all manner of fact scenarios that have departed significantly from the original scope of coverage contemplated by insurers. Some notable examples are beef shipping interruption due to Mad Cow Disease, 9/11 airport closures and E-coli contamination. Coverage for these claims generally were not upheld by courts around the country because there was no “direct physical loss.”1
The “Civil Authority” Clause
Also affecting coverage is the plain language of the “civil authority” clause. There is limited coverage where operation of civil authority shuts down access to a business’s premises, but again, it was created for a specific set of circumstances, for example, a street being closed, which prevents an insured from opening its business. Trying to apply to it to a scenario where a governor’s order requires businesses to close does not generally trigger the coverage because the specific conditions are not met.
Perhaps most importantly, in the wake of the last corona virus to hit this country — SARS-Cov-1, which hit the United States in 2002-04 — most insurers include the ISO form excluding coverage for “any virus, bacterium or other microorganism that induces or is capable of inducing physical distress, illness or disease.” This is a comprehensive exclusion that exactly fits the wave of covid-19 we are now facing and its effect on business. There are also exclusions for “pollutants,” again arguably precluding damage resulting from the covid-19 virus.
So what happened to the initial waive of BI claims? Part of the answer is that insurance companies and agents that sell those policies began explaining the terms of the coverage to insureds. Unless overruled by state or federal mandate – which, as will be addressed below would largely be unconstitutional – the standard for interpretation of a private contract is to review and enforce its plain language. From there, different states have different views on how ambiguities should be interpreted and whether extrinsic evidence should be admitted. Here, if a policy contains a virus exclusion, it is hard to imagine a scenario where that would not apply to covid-19 closures. Likewise, while some intrepid plaintiff lawyers are arguing that a virus causes “microscopic physical damage” to a surface, this is quite a stretch of logic. Thus, the straightforward application of contract interpretation law has in large part stemmed the tide of BI claims.
States’ Remedial Legislation – Constitutional Issues
Another reason for the reduction in claims is constitutional law analysis of new proposed statutes that have been circulating in various states, including New Jersey, New York, Massachusetts, Pennsylvania, Louisiana, South Carolina and Ohio. Although their format does vary, they all appear to try to compel private insurance companies to provide coverage to private businesses by rewriting or manipulating the terms of private contracts; the insurance policies. That would require the retroactive amendment of a private contract, and that is not permitted under the contracts clause of Article I of the United States Constitution. Contractual rights and obligations are generally binding under the law, and the United States Supreme Court has ruled that a sudden and substantial retroactive obligation on private parties is not permitted.2 Likewise, the takings clause prohibits any law as a per se taking when it confiscates an established pool of funds or renders private property worthless.3 Regulatory taking is also prohibited, and the proposed legislation might fall under that category.4 Substantive due process might also be violated by retroactive rewriting of a private contract. Retroactive laws change the legal consequences of transactions long closed, and this change can destroy the reasonable certainty and security which are the very objects of property ownership.5 Once again, then, the law in this country does not favor BI coverage where none was purchased.
There is one last reason why claims have died down: the practical legal mechanism as to how insurance actually works. Insurance exists because there is way for insurers to evaluate risk and pool insurance premiums to provide coverage. They use underwriting principles to determine how likely a risk is to manifest, and how extensive it will be, and they then formulate a premium to spread across a pool of insureds. Asking, or requiring, insurers to cover losses for which they never charged premiums would destroy the insurance industry. There is just no way to do it. Insurance provides valuable assistance to businesses and private citizens alike. Even those legislators who have the best of intentions in trying to “create coverage” where there is none to help this country, recognize that, in the long run, doing so will not help this country at all.
So where did all the BI claims go? They were analyzed and addressed, and insureds and agents went back to read the policies, and the vast majority have understood the legal reasons why BI coverage is not generally available for covid-19 losses.
1 See e.g. Source Food Technology v U.S. Fidelity & Guaranty Corp, 465 F3d 834 (8th Cir, 2006; United Airlines Inc v Ins Co of State of Penn, 385 FSupp 3d 343 (SDNY 2005), aff’d 439 F3d 128 (2nd Cir 2006); Penton Media v Affiliated, 2006 WL 2504907; Meyer Natural Foods LLC v Liberty Mutual, 218 FSupp 3rd 1034 (DC NE, 2016).
2 Allied Structural Steel Co v Spannaus, 438 US 234 (1978).
3 Koontz v St. Johns River Waste Management Dist, 570 US 595 (2013); Lucas v South Carolina Coastal Council, 505 US 1003 (1992).
4 Penn Central Transp Co v City of New York, 438 US 104, 124 (1978).
5 Eastern Enterprises v Apfel, 524 US 498 (1988), Kennedy, J,concurring).