Loss of Income Caused by a Government Mandate to Suspend Business Operations Due to the COVID-19 Virus is not Covered by a Standard Property Insurance Policy Because the Physical Presence of the Virus on Insured Property Does not Constitute Physical Loss of or Damage to the Property

In Apple Annie, LLC v. Oregon Mut. Ins. Co. (No. A163300, filed September 2, 2022 and certified for publication), the Court of Appeal of the State of California, First Appellate District held that an insured’s loss of business income, caused by a government mandate to suspend business operations due to the COVID-19 virus, is not covered by a commercial property insurance policy because the physical presence of the virus on insured property does not constitute physical loss of or damage to the insured property.

The appellate court explained that although the COVID-19 virus that gave rise to the government mandate has a physical presence, and thus Apple Annie may have suffered economic loss from the physical presence of the COVID-19 virus, Apple Annie did not suffer direct physical loss of or damage to its property, which is required for coverage under the commercial property insurance policy.

Apple Annie operates restaurants in Marin, San Francisco and Santa Barbara Counties. Oregon Mutual Insurance Company issued Apple Annie a comprehensive commercial general liability and property insurance policy, under which Oregon Mutual promised to “pay for direct physical loss of or damage to Covered Property at the [insured] premises,” and to “pay for the actual loss of Business Income [Apple Annie] sustains due to the necessary suspension of [its] ‘operations’ during the ‘period of restorations.'” Additionally, under the Oregon Policy, “[t]he suspension must be caused by direct physical loss of or damage to property at the described premises,” and “[t]he loss or damage must be caused by or result from a Covered Cause of Loss.” The Oregon Mutual Policy does not define the phrase “direct physical loss of or damage to.”

According to Apple Annie, in March 2020, the Marin and San Francisco Departments of Public Health and the Governor of California issued “Shelter in Place Orders” that forced Apple Annie to suspend business operations at its locations, which resulted in a loss of business income. Oregon Mutual denied Apple Annie’s claim for business income loss. In response, Apple Annie filed a lawsuit against Oregon Mutual for breach of contract. The trial court granted Oregon Mutual’s motion for judgment on the pleadings and entered judgment in its favor. Apple Annie appealed the trial court’s ruling.

In affirming the trial court’s ruling, the appellate court considered and adopted the reasonings and holdings of several other courts, including the Fourth District Court of Appeal in its recent decision in Inns-by-the-Sea v. California Mutual Ins. Co., 71 Cal.App.5th 688 (2021). The Inns court found no possibility of coverage under a commercial property insurance policy for a business’ pandemic-related loss of income. The court explained the COVID-19 virus did not itself cause direct physical damage to the insured property:

“The presence of COVID-19 on Plaintiff’s property did not cause damage to the property necessitating rehabilitation or restoration efforts similar to those required to abate asbestos or remove poisonous fumes which permeate property. Instead, all that is required for Plaintiff to return to full working order is for the [government orders and restrictions to be lifted]. This case…concerns an invisible virus that is present throughout the world…It is that general presence, and not a specific physical harm to covered properties, that caused governments at all levels to consider restrictions. The question, therefore, is one of widespread economic loss due to restrictions on human activities, not the consequence of a direct physical loss or damage to insured premises.”

The appellate court also highlighted the Inns court’s adoption of the Couch on Insurance Treatise for the general principle that in the context of first party property insurance, the mere loss of use of physical property to generate business income, without any physical impact on the property, does not give rise to coverage for direct physical loss.

In reaching its decision, the appellate court also considered and rejected Apple Annie’s arguments in favor of coverage. For instance, Apple Annie argued that because the phrase “physical loss of or damage to” is disjunctive, “loss of” and “damage to” must each be given a separate meaning. However, the appellate court noted with approval the Second District Court of Appeal’s rejection of that identical argument in Musso & Frank Grill Co. Inc. v. Mitsui Sumitomo Ins. USA Inc., 77 Cal.App.5th 753 (2022), wherein the Second District characterized the argument as a strained attempt to create an ambiguity that could be construed against an insurer. The appellate court also explained the terms “loss” and “damage” are often used in overlapping and redundant ways, and “even if there were any distinction between loss and damage, it would become relevant only after detriment has been caused by a ‘direct physical’ cause, which is not alleged here.”

The appellate court also rejected Apple Annie’s argument that the phrase “direct physical loss of or damage to” is ambiguous and subject to a reasonable construction that supports coverage. In doing so, the court dismissed Apple Annie’s arguments that: (1) no physical alteration is necessary to show the policyholder has suffered a “physical loss of” insured property when the government issues orders that prohibit the policyholder from using the insured property for its intended purpose; and (2) “physical loss of” includes the loss of use of the insured property, even if that loss is temporary.

Additionally, Apple Annie argued that “property damage” is defined by the Oregon Policy to include “loss of use of tangible property that is not physically injured.” However, the appellate court recognized the definition was included in the liability section of the policy and noted “the cause of loss in the context of property insurance is wholly different from that in a liability policy,” and a liability insurer “agrees to cover the insured for a ‘broader spectrum of risks’ than in property insurance.”

Based on the foregoing, the appellate court affirmed the trial court’s ruling on Oregon Mutual’s motion for judgment on the pleadings.