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In COVID-19 Business Interruption Case, Court Finds Business Cannot Show Insurer’s Coverage Denial Breached Contract

03.02.2021

Turek Enterprises, Inc. v. State Farm Mutual Automobile Insurance Co., 2020 U.S. Dist. LEXIS 161198 (Sept. 3, 2020)

This COVID-19-related damages case, which involved a Michigan business, followed a well-known script and again resulted in the dismissal of the plaintiff’s case. Specifically, after the plaintiff was denied coverage for business interruption losses by a State Farm insurer, the plaintiff filed a lawsuit claiming the insurer breached its contract when it declined to cover damages resulting from the business’s loss of use during a government-mandated temporary shutdown. The court found the plaintiff failed to meet the policy’s requirement to show accidental direct physical loss to the premises and, more importantly, failed to overcome a virus exclusion that was written into the policy.

Background. The plaintiff was a Michigan corporation that operated a chiropractic clinic. The defendant insurance company, State Farm Casualty (State Farm), issued a one-year “all-risk” policy to the plaintiff.

On March 11, 2020, the World Health Organization declared that COVID-19 was a global pandemic. In the United States, the outbreak, in its early stages, caused many local and state governments to shut down nonessential businesses to limit the spread of the virus. On March 24, 2020, Michigan’s governor issued an executive order that said, in part, that no nonessential person or entity was allowed to operate a business. On May 21, 2020, the state amended the order to require businesses such as the plaintiff’s to perform structural alterations to the premises before resuming operations.

The plaintiff suspended its business activities from March 24, 2020, until, at least, May 28, 2020.

On May 22, 2020, the plaintiff renewed its policy with State Farm for another year. In early June 2020, the plaintiff filed a claim with State Farm for lost income and expenses resulting from the governor’s orders. State Farm denied the claim.

The denial letter stated that State Farm’s investigation found there was no “accidental direct physical loss” to the insured property, as required under the policy. Further, the policy included “exclusions for virus, enforcement of ordinance or law, and consequential losses.”

In a lawsuit in federal court, the plaintiff claimed State Farm breached the policy. The plaintiff advanced various arguments why the policy provided coverage in this situation and why the virus exclusion did not apply here. In response, the defendant filed a motion to dismiss, which the court granted.

Relevant policy provisions. The parties argued over the language in several policy provisions.

Under the “Covered Causes of Loss” section, the policy “insur[es] for accidental direct physical loss to Covered Property” unless the loss is excluded. The policy divided “Covered Property” into two groups: Coverage A—Buildings and Coverage B—Business Personal Property. The policy also covered loss of income and extra expenses (business interruption losses).

The policy contained an express exclusion for “Fungi, Virus, Or Bacteria.” This was the “virus exclusion” that insurers began to add in 2006 following the SARS outbreak. A 2006 Insurance Services Office circular explained that insurers were “presenting an exclusion relating to contamination by disease-causing viruses or bacteria or other disease-causing microorganisms.”

Regarding the exclusions, the policy also said that State Farm would not insure for a loss “regardless of: (a) the cause of the excluded event; or (b) other causes of the loss; or (c) whether other causes acted concurrently or in any sequence within the excluded event to produce the loss.”

Applicable legal principles. This breach of contract case was subject to Michigan law. Under the state’s principles of contract interpretation, the court must enforce a contract in accordance with its terms and must give the terms their plain meaning. In other words, the court must not create ambiguity where there is none.

Under case law, courts in determining coverage under an insurance policy follow a two-step analysis: “(1) whether the general insuring agreements cover the loss and, if so, (2) whether an exclusion negates coverage.” See Auto-Owners Ins. Co. v. Harrington, 565 N.W.2d 839 (Mich. 1997).

Here, the insurer argued the business interruption losses the plaintiff claimed because of the mandatory shutdown were not caused by a “Covered Cause of Loss” for two reasons. One, the losses were not the result of an “accidental direct physical loss to Covered Property”; further, even if they were, the policy contained a virus exclusion that precluded coverage for the losses.

Direct physical loss requirement. The court said the “threshold question” was whether the plaintiff suffered an “accidental direct physical loss to Covered Property.” However, the policy itself did not define “direct physical loss.” Unsurprisingly, the parties interpreted the term differently. The defendant said it meant “tangible damage” to the property; an example would be damage resulting from fire. In contrast, the plaintiff said, “direct physical loss” also included “loss of use.” Any event that rendered the covered property unusable or uninhabitable triggered coverage, the plaintiff contended.

The court noted that the plaintiff (likely keeping in mind the virus exclusion) was “adamant” that COVID-19 did not enter its premises. Under the plaintiff’s theory, the loss of income stemmed only from having to suspend operations as a result of the governor’s shutdown orders. “As a result, Plaintiff’s entire case turns on the construction of ‘direct physical loss,’” the court said.

The court noted with approval case law from the 6th Circuit that found “direct physical loss” required a showing of “tangible damage.” The court also noted a recent COVID-19-related insurance case arising in state court, in which a Michigan trial court dismissed as “simply nonsense” a restaurant owner’s claim that his business suffered direct physical loss because the government’s shutdown orders prevented customers from indoor dining. See Gavrilides Management Co. LLC v. Michigan Insurance Co., Case No. 20-258-CB-C30. In rejecting the plaintiff’s loss of use argument, the court in Gavrilides said “accidental direct loss of or damage to property” meant “some physical alteration to or physical damage or tangible damage to the integrity of the building.”

Further, here, the court found the insurer’s interpretation of this key phrase also aligned with the court’s decision in Diesel Barbershop, LLC v. State Farm Lloyds, 2020 U.S. Dist. LEXIS 147276; 2020 WL 4724305 (Aug. 13, 2020). The Diesel case arose in the Western District of Texas and had similar facts, including an insurance policy from a State Farm insurer that was almost identical to the one at issue here. The court in Diesel rejected the plaintiffs’ loss of use argument. (A digest of Diesel Barbershop and the court’s opinion are available at BVLaw).

In the instant case, the court held that “accidental direct physical loss to Covered Property” was an unambiguous term and required the plaintiff to show there was “some tangible damage” to the business’s property.

The court also waved away the plaintiff’s related argument that the property did suffer some “tangible damage” because it deteriorated during the months it could not be used. “Plaintiff is simply adding an extra step to its original theory. Rather than the loss of use being the ‘direct physical loss,’ the ‘direct physical loss’ is now the passive depreciation caused by the loss of use,” the court said. It found the plaintiff did not provide support for this theory.

The plaintiff failed to allege a “Covered Cause of Loss” under the policy, the court concluded.

Virus exclusion. The next hurdle to recovery for the plaintiff was the express virus exclusion contained in the policy.

The plaintiff sought to overcome this obstacle by making two arguments. For one, the plaintiff said, the shutdown order, not the virus, was the proximate cause for its business losses. The court did not find this argument “compelling.” It noted the governmental order expressly said that it was issued to “suppress the spread of COVID-19” and health risks associated with the virus. “The only reasonable conclusion is that the Order—and, by extension, Plaintiff’s business interruption losses—would not have occurred but for COVID-19,” the court said.

It pointed out that the policy also expressly extended the virus exclusion to all losses for which the virus was part of the causal chain.

Secondly, the plaintiff argued the exclusion did not apply here because the exclusion only applied to losses related to viral, bacterial, or fungal contamination. As noted above, the plaintiff argued that COVID-19 did not enter its premises; therefore, there were no losses related to virus contamination.

The court dismissed this claim, noting, under policy terms, the policy did not limit the exclusion to contamination by the virus.

Agreeing with the defendant, the court concluded the plaintiff failed to prove breach of contract.

Source note: This article originally appeared in BVLaw and is reprinted with permission from Business Valuation Resources. This article is intended for informational purposes only

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