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Recently, the California Court of Appeals, Second District, became only the second appellate court in the country—state or federal—to rule favor of a policyholder on a Covid-19 business interruption claim by holding that the policyholder sufficiently pleaded “direct physical loss or damage” under a commercial property insurance policy.
In Marina Pacific Hotel & Suites, LLC v. Fireman’s Fund Insurance Co., the insured hotel operator alleged that COVID-19 caused “a distinct, demonstrable, or physical alteration to property” at its hotel and restaurant, which resulted in “closures or suspension in operations as well as precautionary and remedial measures resulting in decontamination or disposal of impacted property.” The policy did not have a traditional virus exclusion, but the insurer demurred arguing, among other things, that the complaint did not plead a “direct physical loss or damage” under the policy. The trial court sustained the demurrer without leave to amend.
The appellate court reversed, noting that the state trial court must accept the complaint’s well-pleaded allegations as true, contrary to the more demanding federal pleading standard, without passing judgment on their plausibility. The court concluded that the plaintiff had sufficiently alleged facts that, if true, could establish a “physical alteration” of property. To that end, the court cited the complaint’s allegations that “COVID-19 … not only lives on surfaces but also bonds to surfaces through physicochemical reactions involving cells and surface proteins, which transform the physical condition of the property.” The court also referenced the complaint’s allegations that the “the virus was present on surfaces throughout the insured properties” and had resulted in disposal of property damaged by the virus.
The court found the policy’s communicable disease endorsement, which extended coverage for “’direct physical loss or damage’ to insured property ‘caused by or resulting from a covered communicable disease event,’” to be consistent with the court’s broad interpretation of “direct physical loss.” The language of the endorsement, the Court noted, contemplates that a virus can cause “damage or destruction to property,” because otherwise the coverage would be illusory.
This decision from California’s Second District places it at odds not only with most state and federal appellate courts that have considered the issue, but also with at least three other California appellate courts, which have held that mere contamination by a virus is not “physical loss or damage” under the typical commercial property policy.
Although the Marina Pacific court remains in the minority, a recent order from a Colorado state court serves as a reminder that it is not alone. In Spectrum Retirement Communities LLC et al. v. Continental Casualty Company, a Colorado state court judge denied a motion to dismiss a Covid-19 business interruption claim filed by an operator of senior living centers. The trial judge found that the complaint’s allegation that the virus was physically present on its properties was enough to establish a “direct physical loss.” The court reasoned that in Colorado, unlike other jurisdictions, “direct physical loss or damage” did not require a physical alteration of property.
Marina Pacific indeed may present a low bar for pleading Covid-19 business interruption claims where there is a communicable disease endorsement and no virus exclusion. Although Marina Pacific stakes out a minority position, and surviving demurrer is still a long way from prevailing on the merits of the claims, it at least presents the possibility of more Covid-19 business interruption lawsuits surviving the demurrer stage in California. Further, its reasoning may have some persuasive effect in other jurisdictions where the law is still unsettled. Though few and far between, rulings like Marina Pacific create uncertainty as to when and how Covid-19 business interruption claims will be disposed. Therefore, insurers should be prepared, in certain jurisdictions, to engage in discovery and set their sights on summary judgment, at least until more state appellate courts weigh in on these questions.