Key Takeaways:

• On February 15, the New York State Court of Appeals joined the majority of federal and state courts across the country in rejecting claims that the COVID-19 virus caused physical loss or damage to property to trigger coverage under Commercial Property Liability policies

• The court determined that “physical damage” must be understood to require a material physical alteration to property that is “perceptible, even if not visible to the naked eye”

• The decision will have wide-reaching implications on pending New York COVID-19 business interruption claims in favor of insurers

On January 10, 2024, the New York State Court of Appeals – the state’s highest court – heard oral argument on an insurance coverage dispute for plaintiff Consolidated Restaurant Operations’ (CRO) business interruption claim stemming from COVID-19 pandemic shutdowns. The main issue presented was whether the actual, suspected, or threatened presence of the COVID-19 virus constituted direct physical loss or damage as required by standard Commercial Property Liability policies to trigger coverage. On February 15, 2024, the Court of Appeals issued its decision, joining the majority of Federal and State Courts across the country in rejecting claims that the COVID-19 virus caused physical loss or damage to property to trigger coverage under Commercial Property Liability policies.

In this matter, CRO, which owns and franchises multiple restaurant brands, commenced a declaratory judgment action in the New York County Supreme Court in August 2020 against its insurer, Westport Insurance Co., seeking a determination that Westport owed CRO coverage for business interruption losses it sustained during pandemic-related shutdowns, arguing that the potential presence of the COVID-19 virus at its premises was a physical loss due to the presence of the virus impairing the business functionality. On August 4, 2021, the trial court judge granted Westport’s motion to dismiss CRO’s complaint finding CRO’s alleged losses are not covered under the Westport insurance policy. CRO appealed the decision to the Appellate Division, First Department, which affirmed the trial court’s decision and held “in order for there to be ‘direct’ ‘physical’ damage or loss to property, there must be ‘some physical problem with the covered property,’ not just the mere loss of use.”

On appeal to the Court of Appeals, CRO maintained its complaint should not have been dismissed as it “alleged in detail that it suffered ‘direct physical loss or damage’” under the Westport policy when the COVID-19 virus “permeated and attached to its insured restaurants, thereby tangibly altering the air and surfaces therein, and severely impacting their functionality.” In opposition, Westport argued the phrase “direct physical loss or damage to property” is clear and unambiguous and requires that loss or damage to the insured property be both direct and physical in nature, meaning “a distinct, demonstrable physical damage or destruction of property.”

In its decision, the Court of Appeals held that direct physical loss or damage requires a “material alteration or a complete and persistent dispossession of insured property” which CRO had not alleged. The court stated “physical damage” must be understood to require a material physical alteration to property that is “perceptible, even if not visible to the naked eye.” The court went on to reject CRO’s argument the phrase “direct physical loss” impaired functionality and either a partial or complete loss of use. The court rejected CRO’s argument, stating that to allow CRO’s interpretation to apply would “collapse coverage” for “direct physical loss” into coverage for “loss of use.” Lastly, the court determined CRO’s complaint fails to allege how the presence of the COVID-19 virus may affect the physical integrity of structures or property, i.e., how virus droplets compromise the physical integrity of objects by harming surfaces and structures, as opposed to harming the people who touch them.

The court’s decision ended with the following:

We do not take lightly the severe economic losses incurred by restaurants and other businesses serving the public as a result of the COVID-19 pandemic. But our task is to faithfully interpret the terms of the insurance policy before us, not to “rewrite the language of the polic[y] at issue” to reach a result with “equitable appeal” (internal citation omitted). The coverage provisions relied upon by CRO only cover economic losses to the extent they are caused by “direct physical loss or damage” to insured property. We conclude that the business interruption caused by the actual presence of the coronavirus on the premises of CRO’s insured property, as alleged in the complaint, is insufficient to trigger such coverage.

The Court of Appeals decision will have wide-reaching implications on pending New York COVID-19 business interruption in favor of insurers. It bears noting, courts all over the country have largely sided with insurers, finding the presence of the COVID-19 virus does not trigger insurance policies that require a “direct physical loss or damage” to property. This decision comes only three weeks after the New Jersey Supreme Court decided AC Ocean Walk, LLC v. American Guarantee and Liability Insurance Company, which also held the insured failed to plead facts supporting a conclusion that its business losses were caused by “direct physical loss” or “direct physical damages” and even if the insured pled facts supporting a finding of a covered “loss” or “damage,” the relevant policies’ contamination exclusion bars coverage.