Federal Court Holds Allegations of Coronavirus on Premises Sufficiently Allege Physical Loss of or Damage to Property

Pillsbury - Policyholder Pulse blog

In Novant Health, Inc. v. American Guarantee and Liability Insurance Co., Judge Catherine C. Eagles of the U.S. District Court for the Middle District of North Carolina made the right call by allowing a large hospital system policyholder to litigate the merits of its COVID-19 business interruption claim to recovery, resisting the urge to follow the herd of decisions that have improperly and prematurely shut that door.

Too many courts have chosen to swap their black robes for lab coats, invoking unsubstantiated scientific assumptions to reach prebaked legal conclusions on motions to dismiss when they should be accepting the well pled facts in the complaints as true and allowing discovery. In such cases, the following critique from Purdue University’s amicus brief in the Seventh Circuit review of Circle Block Partners, LLC v. Fireman’s Fund Insurance Company stands sadly true:

“Law lags science; it does not lead it.” Rosen v. Ciba-Geigy Corp., 78 F.3d 316, 319 (7th Cir. 1996) [(Posner, J.)].… Rather than assuming the truth of the profoundly factual allegations in a complaint—and leaving their proof (or disproof) to expert scientists—the court invented scientific findings that favored its preferred legal conclusion. That was error.

This was not true for Judge Eagles, though.

In a measured decision, Judge Eagles rejected the motion by American Guarantee and Liability Insurance Company (a Zurich American Insurance Company subsidiary (“Zurich”)) to dismiss Novant Health’s claim to recovery for losses arising from the presence of the coronavirus in its hospital and outpatient properties. Coronavirus coverage cases require courts to properly apply established principles of policy interpretation and undisputed procedural standards to this first-in-a-generation phenomenon.

Unfortunately, many courts have balked at the opportunity and have misapplied these rules, failing to engage with the ever-evolving understanding of this virus and to acknowledge the palpable and sustained physical harm it produces. The result has been largely unfavorable for policyholders across the country. Unevolved pleadings and parroted judicial analysis have made premature dismissals the norm. But better-reasoned exceptions such as Novant—and the waves of well-pleaded complaints that specifically discuss the scientifically supported physical loss and damage caused by the coronavirus—inspire hope.

The decision is especially notable for policyholders insured under the Zurich EDGE policy form (Zurich’s all-risk commercial property insurance policy form, sold to its largest property risks), but it is equally applicable to many others.

Critically, the court in Novant found that insurers cannot meet their burden to show that the continuous reintroduction of a deadly virus definitively could not be covered under a property policy insuring against all risks of direct physical loss of or damage to property. The court found that the insured hospital and medical facilities underwent a “tangible and physical transformation” in which the air and surfaces were rendered “dangerous transmission vehicles,” a transformation that would necessarily endure “through any occupation of the property.”

The court therefore held that allegations of the virus’s presence on the covered properties were sufficient for purposes of pleading requirements. In doing so, the district court noted that courts have disagreed as to the definition of “physical loss” as used in insuring clauses like the one at issue. The court left the question open, observing that the term has been reasonably read both restrictively to exclude anything but the most obvious structural damage, and inclusively to cover harms “beyond demonstrable, structural alteration, to include loss of the property’s use, functionality, or reliability.”

Pillsbury’s Insurance Recovery & Advisory attorneys have been some of the first to publicize that the disproportionate number of courts applying a more exclusionary test of physical loss or damage to property (which purports to require a “distinct, demonstrable physical alteration to property” rather than the loss of functional use of property) may have been the result of unknowingly relying upon misrepresentations contained within a trusted legal treatise, Section 148:46 of the Third Edition of Couch on Insurance. Our attorneys recently co-authored a forthcoming pathbreaking scholarly article which exposes these misstatements of law. The article explores how the Couch treatise created the narrower test in the 1990s based on scant support in the caselaw, and then gave its readers the false impression that its new test was the majority rule by labeling it as “widely held”—all while failing to cite virtually any of the cases that, for years, rejected narrower formulations and continued to apply the majority rule “loss of functional use” test.

Most decisions dismissing COVID-19 business interruption actions either cite or quote this specious Couch test directly, or cite to the cases that are its progeny. Couch’s misstatements have therefore likely skewed the outcomes of lawsuits to enforce first-party property policies, and cost policyholders tens, if not hundreds, of billions of dollars in unpaid claims. Whatever your view as to the intended meaning of this pivotal language, Judge Eagles in Novant correctly determined that such “questions are better evaluated on a developed factual record,” not dismissed on pleadings alone.

Having found that the insured met its burden, Judge Eagles appropriately shifted her attention to whether the insurer, Zurich, could meet its burden to prove that the claim was excluded by the policy. Particularly, the court weighed the policyholder’s argument—that an endorsement in the EDGE policy, widely known as the Virus Deletion Endorsement, deleted “virus” from the policy’s Contamination Exclusion—against Zurich’s argument that it only did so for locations in the State of Louisiana.  The court held that numerous provisions in the policy indicating that the Virus Deletion Endorsement applied policy-wide created issues of fact that could not be resolved on a motion to dismiss.

Novant is a significant decision for policyholders fighting against the wave of courts trespassing into factual determinations at the pleading stage. It is an important example to courts that personal conceptions about the character and effect of the coronavirus are no substitute for an engaged and earnest judicial review of a fully developed factual record and informed advocacy on the merits.

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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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