New York Federal Court Addresses Direct Physical Loss Requirement

On April 24, 2014, the U.S. District Court for the Southern District of New York issued its decision in Newman Myers Kreines Gross v. Great N. Ins. Co., No. 13 Civ. 2177, 2014 U.S. Dist LEXIS 57338 (S.D.N.Y. Apr. 24, 2014), a Superstorm Sandy insurance dispute arising from Con Ed’s preemptive shutoff of power in certain areas of New York, including the area in which the Newman Myers law firm is located.  Con Ed’s decision to shutoff power was the result of rising floodwaters at its utility stations in an effort to preserve the integrity of its equipment.  Newman Myers was without power for several days.  While the building was not physically blocked, the building elevators were not functioning and Newman Myers employees were advised that the building was closed because the electricity had been turned off.  Newman Myers’ building did not sustain any flooding or physical damage on account of Sandy.

As a result of the multi-day shutoff, Newman Myers filed a first-party business income and extra expense claim with its insurer, Great Northern, alleging a loss under the policy.  The Great Northern Policy provided business income and extra expense coverage occasioned by “direct physical loss or damage.”  The policy also provided Ingress/Egress Coverage for loss of business income and extra expenses due to impairment of business operations when existing ingress to or egress from the insured property is prevented due to direct physical loss or damage to “property at a location contiguous to such premises.”  The policy further provided Loss of Utility Coverage for loss due to a business interruption caused by or resulting from direct physical loss or damage to the insured premises, to personal property of a utility located either inside or outside the insured premises, or to service property.  Under all policy coverages, “direct physical loss or damage” was a condition precedent to recovery.

Great Northern denied coverage on the basis that Newman Myers had not sustained a covered loss under the policy.  Newman Myers filed a declaratory judgment action, and the parties filed cross-motions for summary judgment.  At the outset of the court’s analysis, the court recognized that Newman Myers, as an insured, carried the burden of showing coverage under the Great Northern Policy, which required a showing that the insured premises experienced “direct physical loss or damage.”  Newman Myers argued that this phrase does not require actual structural damage to the insured premises, but rather only an “initial satisfactory state that was changed by some external event.”  According to Newman Myers, this standard was met by the power shutoff making ingress to their 26th floor office impossible, in addition to physical damage to the Con Edison facility providing power to the insured premises in the week following Sandy.

The court rejected Newman Myers’ argument, holding that the policy language unambiguously requires some form of physical damage to the insured’s premises to trigger business income and extra expense coverage.  The court acknowledged the existence of cases finding this language to be satisfied in the absence physical damage to the building itself (e.g., release of sulfuric gas into the insured property, the presence of an unpleasant odor rendering the property unusable, and the closure of a home following a “rockfall” due to the threat of a future “rockfall.”).  The court, however, reasoned that those cases involved closure of premises due to either a physical change for the worse in the premises or a newly discovered risk to the building’s physical integrity.  The court recognized that a utility company’s preemptive decision to shut off power to several utility networks to safeguard its equipment does not fit into either of these circumstances. As a result, the court held that Newman Myers had not met its burden of showing that the Great Northern Policy covers its loss.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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