Hepler Broom, LLC

“Direct Physical Loss” Required to Trigger Coverage for Covid-19 Claims

July 6, 2021

During the Covid-19 pandemic of 2020 and 2021, governors throughout the United States ordered many businesses deemed non-essential to close their doors. As a result, many of these businesses sought relief from their insurance providers by making claims under Building and Personal Property and Business Income coverage forms. Nationwide, policyholders and insurance companies have litigated the issue following an overwhelming number of claims and coverage denials. A 2020 case out of the U.S. District Court for the Northern District of Illinois [Sandy Point Dental, PC v. Cincinnati Ins. Co., No. 20 CV 2160, 2020 WL 5630465, at *2 (N.D. Ill. Sept. 21, 2020), reconsideration denied, No. 20 CV 2160, 2021 WL 83758 (N.D. Ill. Jan. 10, 2021)] provides insurers insights into (1) how courts interpret policy language when policyholders face lengthy business interruptions caused by an unforeseen pandemic, and (2) what language ultimately triggers or excludes coverage under a particular policy.

Background of the Case

On March 20, 2020, Illinois Governor J.B. Pritzker issued an executive order instructing all “non-essential businesses” to close in order to slow the spread of COVID-19 (“Orders,” collectively with Pritzker’s other executive orders). The Orders left Plaintiff, Sandy Point Dental, PC’s (“Sandy Point”) office unable to perform routine dental work, effectively forcing it to shut down, which resulted in a substantial loss of revenue.

After being denied coverage under its insurance policy (“Policy”) with The Cincinnati Insurance Company (“Cincinnati”), Sandy Point filed a three-count complaint against the insurer seeking: (1) a declaration that there was coverage under the policy for losses due to the governmental closure orders, (2) damages and attorneys’ fees (under 215 ILCS 5/155), and (3) a claim for breach of contract for failing to provide coverage. Cincinnati moved to dismiss under Fed. R. Civ. P. 12(b)(6) for failure to state a claim.

The crux of the dispute between the parties was whether the closure of the dental office due to the Orders constituted a “direct physical loss” under the terms of the Policy, specifically, in the Building and Personal Property Coverage Form and the Business Income Coverage Form.

The Business Income Coverage states, in relevant part:

We will pay for the actual loss of “Business Income” … you sustain due to the necessary “suspension” of your “operation” during the “period of restoration”. The “suspension” must be caused by direct physical “loss” to property at “premises” cause[d] by or resulting from any Covered Cause of Loss.

[…]

We will pay for the actual loss of Business Income you sustain due to the necessary “suspension” of your “operations” during the “period of restoration”. The “suspension” must be caused by direct physical “loss” to property at “premises” which is described in the Declarations and for which a “Business Income” Limit of Insurance is shown in the Declaration. The “loss” must be caused by or result from a Covered Cause of Loss.

The Policy defined a Covered Cause of Loss as “RISKS OF DIRECT PHYSICAL LOSS,” unless expressly excluded by the Policy. Additionally, the Policy provided Civil Authority coverage. To trigger such coverage, orders of civil authority must “prohibit access to the ‘premises’ due to direct physical ‘loss’ to the property, other than at the ‘premises’, caused by or resulting from a Covered Cause of Loss.”

In the complaint, Plaintiff did not allege that there was any “demonstrable, physical alteration to the property” at its dental office. In its response to the motion to dismiss, Plaintiff argued that the Policy does not require a tangible, material loss to the physical structure; rather, it allowed a partial loss to the properties from loss of use. Further, Plaintiff argued that the absence of a pandemic exclusion within the Policy, despite the plethora of other exclusions, made it more likely than not that such an exclusion was purposefully omitted, and therefore its loss was covered.

District Court’s Analysis and Ruling

The Court granted Plaintiff’s Motion to Dismiss. In discussing the merits of the motion, the court opined that the critical policy language— “direct physical loss”—unambiguously requires some form of actual physical damage to the insured premises to trigger coverage. The words “direct” and “physical,” which modify the word “loss,” ordinarily connote actual, demonstrable harm of some form to the premises itself. As demonstrated in its pleading, Sandy Point failed to attribute such loss to being unable to access the physical office or due to the presence of the virus on its physical surfaces. Because the “coronavirus does not physically alter the appearance, shape, color, structure, or other material dimension of the property,” Sandy Point failed to plead a direct physical loss—a prerequisite for coverage.

 Next, the court pointed out that the civil authority coverage applied only if a civil authority order prohibited access to the premises due to direct physical loss to property, other than plaintiff’s premises, caused by or resulting from any Covered Cause of Loss. Because Sandy Point did not allege that the coronavirus caused direct physical loss to other property, civil authority coverage did not apply. The court also noted that none of the Orders prohibited all access to the dental office because it was deemed an essential business for any emergency and non-elective work. Thus, its claim for civil authority coverage failed.

Finally, the court addressed Sandy Point’s conclusory statement that Cincinnati’s denial was vexatious and unreasonable. The court concluded that the fact that Cincinnati did not conduct an investigation was an insufficient reason for sanctions, especially given that the complaint itself showed a bona fide dispute existed regarding coverage. Thus, the court dismissed the Section 5/155 claim.

Resolution of Plaintiff’s Subsequent Motions

Thereafter, Sandy Point filed a motion for leave to file a Second Amended Complaint and a motion to reconsider the September 21, 2020, opinion regarding the court’s first finding that there was no physical damage triggering insurance coverage. Sandy Point argued reconsideration was appropriate because there was a change in the law, citing a recent case [Blue Springs Dental Care, LLC v. Owner Ins. Co., 2020 WL 5637963 (W.D. Mo. Sep. 21, 2020)] in which the court found that the COVID-19 virus physically attached itself to the premises, causing physical damage or loss to the property, triggering insurance coverage.

The court was unpersuaded, and on January 10, 2021, it denied the motion, stating that the policy language in Blue Springs was identical to Studio 417, Inc., et al. v. the Cincinnati Ins. Co., 2020 WL 4692385 (W.D. Mo. Aug. 12, 2020). The Blue Springs and Studio 417 opinions were issued by the same judge, who focused on distinguishable policy language – namely that the insurer “will pay for direct physical loss of or damage to Covered Property.” The court expressly distinguished the policy language and reasoning of Studio 417 in its earlier opinion, finding that Studio 417’s policy language was much more expansive than the policy language in the instant case (providing for “direct physical ‘loss’ to property”). Therefore the Blue Springs case did not present new law. Moreover, the court further bolstered its initial holding by citing several Illinois state and federal court decisions[1] that had also concluded that COVID-19 and its associated closure orders did not cause physical damage or physical loss to insured property.

Sandy Point’s proposed Second Amended Complaint did not contain allegations that COVID-19 was ever present in the facility, and it made no allegations of tangible physical damage. Accordingly, the court found that the Second Amended Complaint did not cure the defect of the original pleading and denied its leave to amend.

The Takeaway

The decisions in Sandy Point, Blue Spring, and Studio 417 demonstrate the importance of drafting unambiguous provisions in insurance policies. Given the widespread repercussions of the COVID-19 pandemic, insurers and policyholders were left scrambling to address these new claims. The court’s decision in Sandy Point is in line with those of other Illinois state and federal courts on the issue. This decision provides guidance on evaluating risks associated with denying these types of claims. However, it is important for insurers to analyze both the specific facts associated with each claim and the language of the policy. Given that in the instant case, coverage hinged on a policy’s use of a conjugate (“or”) or preposition (“to”), it might be time to re-read that policy language.

If you have questions about or need assistance in navigating this changing area of the law, please contact an attorney on HeplerBroom’s Insurance Law team.

[1] See for example, It’s Nice Inc. v. State Farm Fire and Cas., Co., Case No. 2020 L 000517 (18th Judicial Circuit (DuPage County) Sep. 29, 2020) (favorably citing Sandy Point and relying on that reasoning to conclude that COVID-19 does not cause physical damage triggering insurance coverage, and dismissing the case); Bradley Hotel Corp. v. Aspen Specialty Ins. Co., 2020 WL 7889047, at *3-4 (N.D. Ill. Dec. 22, 2020) (same); T & E Chi. LLC v. Cincinnati Ins. Co., 2020 WL 6801845, a *4 (N.D. Ill. Nov. 19, 2020) (same); Uncork and Create LLC v. Cincinnati Ins. Co., 2020 WL 6436948, at *4-5 (S.D. W. Va. Nov. 2, 2020) (same); Raymond H Nahmad DDS PA v. Hartford Cas. Ins. Co., 2020 WL 6392841, at *5 (S.D. Fl. Nov. 2, 2020) (same).

COVID-19 Updates

HeplerBroom is pleased to announce that its physical offices have reopened. While the health and safety of our clients, employees, and families, remain our top priority, HeplerBroom attorneys and staff are returning to our offices on full-time or modified schedules. Our offices are open to visitors and clients with scheduled appointments, with appropriate screening of visitors and social-distancing protocols. HeplerBroom will continue to follow CDC recommendations for cleaning and sanitizing.

We are very proud of the dedicated efforts of our attorneys and staff to provide great service and work product to our clients during the pandemic. This would not have been possible without the incredible support provided by the HeplerBroom IT Department and other essential personnel who supported our personnel and clients from the office locations while the rest of our teams worked remotely.

If you have questions about visiting our offices, please do not hesitate to contact us. We look forward to seeing you in person again in the near future.