First impression: California Court of Appeal finds no coverage for COVID-related Business Income loss


covid-19; COVID

By: Marc J. Shrake and Mary-Kate Planchet

In the first COVID-19 Business Interruption case to reach the appellate level in California, the court used long-standing insurance principles to resolve the first-impression issue, finding against coverage.

The decision in The Inns By The Sea v. California Mut. Ins. Co. (Fourth District, First Division, Case No. D079036) affirmed the trial court’s judgment that the property insurance policy at issue did not cover a lodging company’s claim for lost business income after closing its inns and motels in response to county orders restricting the business’s right to operate.

Early in the pandemic, two county governments issued orders that prohibited The Inns from selling rooms.  The counties ostensibly based their orders on the county supervisors’ conclusions that a continued and increasing presence of the coronavirus existed on The Inns’ property and around its premises, such that closing The Inns would prevent the spread of COVID-19.

The Inns presented a claim to California Mutual for loss of business income, contending the losses were covered under the Business Interruption and Civil Authority coverages of a commercial property policy.  California Mutual denied coverage.  On cue, The Inns sued for breach of contract and breach of the implied covenant of good faith and fair dealing and (separately) “bad faith” denial of insurance coverage.

The Inns argued that California Mutual committed “bad faith” and should be made to pay punitive damages for not agreeing with The Inns that it lost business income because of “direct physical loss of or damage to” property.  It based its claims on the contention that some people believed the novel coronavirus strains physically infected and stayed alive on surfaces for extended periods of time, thereby rendering potentially unsafe and dangerous the property that was exposed to the contagion.

California Mutual demurred to all causes of action, and the trial court sustained without leave to amend. 

Addressing what it called an issue of first impression in the state (“does a commercial property insurance policy provide coverage for a business’s lost income due to the COVID-19 pandemic?”) the California Court of Appeal explained that the suspension of operations by The Inns was caused by the government orders.  Furthermore, the stated basis for those orders was not direct physical loss of or damage to property, but rather the presence of the virus throughout the relevant counties.

Recognizing that the phrase “direct physical” modifies both “loss of” and “damage to,” the court first examined whether the lost business income claimed by The Inns was caused by “direct physical damage to” property of The Inns.  It asked whether the real property comprising a policyholder’s premises can sustain “direct physical damage” due to an intervening force that does not physically alter the building or any item of personal property, but simply makes the real property uninhabitable. The Inns admitted that it ceased operations as a “direct and proximate result of the Closure Orders.”  The Inns failed to identify any direct physical damage to property that caused it to suspend its operations.  The court concluded there was no direct physical damage to property.

The court next examined whether the business income loss claimed by The Inns was caused by “direct physical loss of” property of The Inns.  The court decided it was not.  The court found that The Inns’ argument would collapse coverage for “direct physical loss of” property into “loss of use” coverage.  But the inability to use property to generate business income, standing on its own, does not amount to a suspension caused by direct physical loss of property. Mere loss of use, which is all The Inns could allege, without any other physical impact to The Inns’ property, was insufficient to bring the claim within the policy’s insuring agreement.

The court also dismissed the argument that the policy’s lack of a virus exclusion changed the meaning of “direct physical loss of or damage to” property.  Under California law, the policy’s insuring clause defines coverage; when an occurrence does not fall within that clause, it need not also be specifically excluded.

Finally, the court rejected The Inns’ claim for Civil Authority coverage under the policy.  The government orders were not based on direct physical loss of or damage to the property of others, which is the threshold requirement.  The orders were simply attempts to prevent the spread of the novel coronavirus. 

For further information about this case and other pandemic-related issues relating to insurance coverage, contact Marc Shrake, co-chair of FMG’s Insurance Coverage and Litigation National Practice Section, chair of FMG’s California Insurance Coverage Team, and co-chair of FMG’s Coronavirus Task Force. 

FMG has formed a Coronavirus Task Force to provide up-to-the-minute information, strategic advice, and practical solutions for our clients.  Our group is an interdisciplinary team of attorneys who can address the multitude of legal issues arising out of the coronavirus pandemic, including issues related to Insurance Coverage, Healthcare, Product Liability, Tort Liability, Data Privacy, and Cyber and Local Governments.  For more information about the Task Force, you can contact your FMG relationship partner or email the team with any questions at

**DISCLAIMER:  The attorneys at Freeman Mathis & Gary, LLP (“FMG”) have been working hard to produce educational content to address issues arising from the concern over COVID-19.  The webinars and our written material have produced many questions.  Some we have been able to answer, but many we cannot without a specific legal engagement.  We can only give legal advice to clients.  Please be aware that your attendance at one of our webinars or receipt of our written material does not establish an attorney-client relationship between you and FMG.  An attorney-client relationship will not exist unless and until an FMG partner expressly and explicitly states IN WRITING that FMG will undertake an attorney-client relationship with you, after ascertaining that the firm does not have any legal conflicts of interest.  As a result, you should not transmit any personal or confidential information to FMG unless we have entered into a formal written agreement with you.  We will continue to produce education content for the public, but we must point out that none of our webinars, articles, blog posts, or other similar material constitutes legal advice, creates an attorney-client relationship and you cannot rely on it as such.  We hope you will continue to take advantage of the conferences and materials that may pertain to your work or interests.**