COVID-Related Shutdowns Don’t Constitute “Direct Physical Loss” Under Commercial Property Policies
In Sandy Point Dental, P.C. v. Cincinnati Insurance Co., 20 F.4th 327 (7th Cir. 2021), a consolidation of three cases, the Seventh Circuit Court of Appeals addressed whether certain losses caused by the SARS-CoV-2 virus qualified as “direct physical loss or damage.” The three businesses sought to recoup their significant losses from pandemic-related shutdowns in 2020, but the district courts dismissed their complaints for failure to state a claim. The Seventh Circuit affirmed the district court decisions, agreeing with the insurance company that the SARS-CoV-2 virus was not something that resulted in “direct physical loss or damage,” a key provision at issue in the dispute.
Facts of the Case and Procedural Background
This opinion was the first by the Seventh Circuit to address insurance claims stemming from COVID-related shutdowns. The decision concerns three separate lawsuits all brought against the Cincinnati Insurance Company. The three plaintiffs were Sandy Point Dental of Lake Zurich, the Bend Hotel Development Company, LLC, of East Moline, and the John Buck Company (TJBC), Inc., a property management firm in Chicago.
All three businesses were required to either close entirely or dramatically scale back their operations due to a series of executive orders issued by Governor Pritzker in March 2020. While the purpose of these executive orders was to attempt to curb the spread of the virus, one of the most notable effects was the serious financial toll they took on all sorts of businesses around the state.
In this case, the three plaintiffs sought to recover their losses through their commercial property insurance policies. The businesses held nearly identical policies through the same insurer, which provided coverage for income losses suffered on account of operational shutdowns caused by “direct physical loss or damage” to the covered property. The policies also provided coverage for income losses resulting from an action of civil authority prohibiting access to covered property when such action was taken in response to “direct physical loss or damage” suffered by other property.
Each business filed a claim under this policy, and each claim was denied by the Cincinnati Insurance Company, sparking litigation. At the district court level, the insurance company moved to dismiss for failure to state a claim, and its motions were granted in each instance. See Fed.R.Civ.P. 12(b)(6). Each court came to the same conclusion: none of the businesses were able to adequately allege that either the SARS-CoV-2 virus or the related closures caused “direct physical loss or damage” to the property.
By the time the Seventh Circuit held oral arguments in this case, four other circuit courts of appeal had already ruled in other, nearly identical cases. The Sixth, Eighth, Ninth, and Eleventh Circuit Courts of Appeal had all agreed that the loss of use, unaccompanied by any physical alteration to the property, does not constitute “direct physical loss or damage” under a commercial property insurance policy. See Santo’s Italian Café LLC v. Acuity Insurance Co., 15 F.4th 398 (6th Cir. 2021); Oral Surgeons, P.C. v. Cincinnati Insurance Co., 2 F.4th 1141 (8th Cir. 2021); Mudpie, Inc. v. Travelers Casualty Insurance Co., 15 F.4th 885 (9th Cir. 2021); Gilreath Family & Cosmetic Dentistry, Inc. v. Cincinnati Insurance Co., No. 21-11046, 2021 WL 3870697 (11th Cir. Aug. 31, 2021).
The Seventh Circuit’s Analysis
The Seventh Circuit began its examination of this dispute by focusing on the key provision of the businesses’ insurance policies: “direct physical loss or damage.” Because the case was in federal court based on diversity jurisdiction, the Seventh Circuit was tasked with determining how the Illinois Supreme Court would define that term if the case were before it.
The court noted that no decision of the Illinois Supreme Court had dealt with the specific policy language at issue in this case. Sandy Point Dental, supra. The state’s highest court had, however, addressed similar language twenty years ago, holding that “the term ‘physical injury’ unambiguously connotes . . . an alteration in appearance, shape, color or in other material dimension.” Travelers Insurance Co. v. Eljer Manufacturing, Inc., 197 Ill.2d 278, 757 N.E.2d 481, 502, 258 Ill.Dec. 792 (2001). The Cincinnati Insurance Company argued that this interpretation was correct. The plaintiffs offered a competing and more expansive interpretation. They argued that “direct physical loss” encompasses not just physical alterations to the covered property but also loss of use.
Plaintiffs attempted to take advantage of two textual clues to support this argument.
First, the businesses argued that “loss” must mean something different from “damage” given the disjunctive in the phrase “direct physical loss or damage.” “Damage,” they contended, refers to a physical alteration to property. On the other hand, “loss” refers to the deprivation of use or possession. While the court found this interpretation to be plausible, the court noted that it was not the only plausible interpretation, nor the most likely one. Instead, a better reading of the policy has the words “direct physical” modifying both “loss” and “damage.” Any other interpretation, the court reasoned, would make the word “physical” useless within the policy.
The court went on to explain that the Cincinnati Insurance Company offered a far more persuasive interpretation than the businesses, an interpretation adopted by many courts that better accounts for both the disjunctive and the word “physical”: the word “loss” means complete destruction, while “damage” refers to a lesser harm. See, e.g., Crescent Plaza Hotel Owner L.P. v. Zurich American Insurance Co., 520 F.Supp.3d 1066, 1069 – 1070 (N.D.Ill. 2021).
The second textual argument made by the businesses concerns certain exclusions in their policies. The insurance policy of each plaintiff contained exclusions for damage caused by nuclear reactions, radiation, and radioactive contamination. If the policy only covered “direct physical loss or damage” in which physical alteration of the premises took place, what need could there possibly be for these exclusions? According to the plaintiffs, nuclear radiation, like the SARS CoV-2 virus, “exists in, but does not physically affect, the structure of a building.” 20 F.4th at 333. The plaintiffs, however, provided no basis for this assumption. The court rejected this argument because it reasoned that it could do away with these textual arguments without delving into the science behind nuclear radiation.
According to the court, more concrete textual clues within the policy supported the insurance company’s position. For example, the policies provide coverage for losses sustained during a “period of restoration,” which is defined by reference to “[t]he date [by which] the property . . . should be repaired, rebuilt, or replaced.” In the absence of a physical alteration to the property, there would be nothing to repair, rebuild, or replace.
After exhausting their textual arguments, the plaintiffs turned to past Illinois cases to support their contentions. Lacking any support from cases dealing directly with the current pandemic, the plaintiffs asked the court to consider past cases involving termite infestation, asbestos, and gases. But the court concluded that these cases actually supported the insurance company’s position because a termite infestation is a clear example of “physical alteration” that would obviously support an insurance claim under a similar policy.
Similarly, the court reasoned that asbestos causes physical damage to property in the way that termites do. While the destructive quality of asbestos may not appear as obvious as termites literally eating through a structure, Illinois courts have been quite clear on the issue for years. See United States Fidelity & Guaranty Co. v. Wilkin Insulation Co., 144 Ill.2d 64, 578 N.E.2d 926, 930 – 931, 161 Ill.Dec. 280 (1991); Board of Education v. International Insurance Co., 308 Ill.App.3d 597, 720 N.E.2d 622, 625 – 627, 242 Ill.Dec. 1 (1st Dist. 1999). The court stated quite directly in Wilkin, supra: “[Insurers] contend that the presence of [asbestos] results only in intangible economic loss. . . . This court, however, has already found that asbestos fiber contamination constitutes physical injury to tangible property.” 578 N.E.2d at 931.
As for the gas cases cited by the plaintiffs, the court admitted that they make the case a closer call but still ultimately fall short. While gas leaks can cause a loss of use without any physical alteration just like COVID-19, courts in a variety of cases held that the policyholders who experienced gas leaks had suffered a “direct physical loss.” See Western Fire Insurance Co. v. First Presbyterian Church, 165 Colo. 34, 437 P.2d 52, 55 (1968); Gregory Packaging, Inc. v. Travelers Property Casualty Company of America, Civ. No. 2:12-cv-04418 (WHW)(CLW), 2014 WL 6675934, *1 (D.N.J. Nov. 25, 2014); Matzner v. Seaco Insurance Co., No. CIV. A. 96-0498-B, 1998 WL 566658, *3 (Mass.Super. Aug. 12, 1998). While these cases appear to support the plaintiffs’ claims, they possessed one critical element that was missing from the COVID-related claims. The courts in the gas cases ruled that the contamination was so severe that it left the premises “uninhabitable” (Western Fire, supra, 437 P.2d at 55; Gregory Packaging, supra, 2014 WL 6675934 at *6; Matzner, supra, 1998 WL 566658 at *3) and “unfit for normal human occupancy” (Gregory Packaging, supra, 2014 WL 6675934 at *3). For all the damage that COVID-19 has wreaked on society, the virus itself didn’t make the business premises uninhabitable. Only the executive orders issued to address the pandemic prohibited the premises from being used as intended.
Having worked through all the plaintiffs’ arguments, the three-member panel of the Seventh Circuit had no trouble unanimously siding with the Cincinnati Insurance Company.
Implications of the Decision
By affirming the three district court decisions, the Seventh Circuit made clear that COVID-19 and its related shutdowns do not constitute “direct physical loss or damage” under a commercial property insurance policy. Sandy Point Dental, while far from the first case to reach this result, may represent the final nail in the coffin for businesses across the country who hoped to recoup at least some of their massive losses due to COVID-related shutdowns in 2020. While for some businesses the shutdowns in 2020 were no less fiscally damaging than a tornado or a flood, the language in these policies makes a clear distinction that ultimately prevents recovery.
With five circuit courts of appeal concluding that COVID-19 doesn’t cause “direct physical loss or damage,” it appears highly unlikely that any business will find any sort of relief in their commercial property insurance policies with similar requirements. Given the newfound focus on mitigating the risks of highly transmissible viruses, perhaps businesses will begin to seek modifications to their current insurance policies so that they explicitly provide coverage for pandemic-related shutdowns.
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