Direct Physical Loss and Business Interruption Coverage in the Wake of COVID-19

Just over a week ago, Michelman & Robinson reported on the countless entities nationwide that are being denied the benefits of business interruption coverage their insurance policies provide—this despite the losses they are suffering due to COVID-19-related shutdowns and disruptions to business. While our prior alert focused on the failure of carriers to conduct thorough and proper investigations before denying these claims, here we discuss a recent judicial decision that pertains to a frequent basis for the refusal of coverage: the concepts of “direct physical loss” to property, as well as the “virus” exclusion that many policies contain.

It is true that standard business property policies may include business interruption coverage that only applies in the event of “direct physical loss” to property; however, that term in and of itself is rather vague and ambiguous, especially when it is not defined. That was precisely the circumstance in North State Deli LLC v. The Cincinnati Insurance Co., a business interruption case recently decided in North Carolina.

The North State Deli litigation involved a claim denied by Cincinnati Insurance. Like most first-party property loss policies, the one issued by Cincinnati Insurance required a “direct physical loss” to the deli's property in order to trigger business interruption coverage, yet that term was not defined in the policy at issue (which, for purposes of context, did not include a “virus” exclusion).

In support of its argument that North State Deli’s business interruption claim should have been paid, its counsel pointed to North Carolina’s COVID-19 stay-at-home orders and the various county stay-at-home mandates that essentially caused the closure of the deli’s 17 restaurants. In response, Cincinnati Insurance maintained that those governmental orders could not, by themselves, cause direct damage to any insured structure, which is why the insurer denied coverage.

By virtue of that denial, North State Deli initiated its lawsuit, and cross-motions for summary judgment were ultimately filed. At the heart of the deli’s motion was the idea that the term “direct physical loss” was not defined in the policy, rendering it ambiguous and subject to resolution in favor of coverage. At the same time, North State Deli advised the court of the following definitions set forth in the Merriam-Webster Dictionary: “physical” which simply relates to “material things that are perceptible through the senses”; “direct,” meaning “stemming from a source” or “cause”; and “loss” which includes the “inability to utilize something.”

Last week, the superior court judge presiding over the North State Deli litigation ruled on the motions for summary judgment, and the decision is great news for insureds. In ordering Cincinnati Insurance to pay policy benefits (lost profits) to the deli, the court latched onto the plaintiff’s arguments and not only found the policy language to be ambiguous (given the absence of a definition of “direct physical loss”), but also concluded that the stay-at-home-orders resulted in North State Deli’s “inability to utilize” the restaurant properties in question. Taken together, the court found that the deli did, in fact, suffer a “direct physical loss” to insured property, and since the insured’s policy did not contain any “virus’ or similar exclusion, Cincinnati Insurance was required to pay business interruption losses.

Based on this important ruling, we anticipate that additional courts may give a broader meaning to “direct physical loss,” and thus find in favor of other businesses fighting back against the denial of their business interruption claims. That being said, if you are having difficulty processing a business interruption claim arising out of the pandemic (or, for that matter, are being forced to navigate any other insurance-related challenges), please feel free to contact M&R for assistance.

This blog post is not offered, and should not be relied on, as legal advice. You should consult an attorney for advice in specific situations.