Attorney on Law

COVID-19 and the Failure of Business Interruption Insurance

The problem with the virus is it affected people, not places.

Lance Plunkett, J.D., LL.M.

There’s a commercial for a home warranty product where a homeowner’s insurance company representative carefully explains to the insured that while a volcano erupting or a zombie apocalypse would be covered under its policy, the failure of the insured’s home air-conditioning system was not. The insurance representative today would have added that neither is COVID-19 damage covered (zombies, presumably, do not carry the disease being that they are already dead).

One of the least appetizing aspects of the COVID-19 pandemic has been the realization that business interruption insurance coverage is virtually useless for this type of catastrophic event.

Many questions have come into NYSDA about coverage in general liability insurance policies for business interruptions and the loss of income they engender. Unfortunately, in a classic illustration that no insurance policy should ever be read superficially and taken at face value, it turns out that typical business interruption coverage is for physical harm to a business premises—not to harm caused by a virus like COVID-19. Some policies specifically exclude viruses, but it turns out that such exclusions are not even necessary to block coverage. Even without such language, there has to be an element of physical harm to trigger coverage. Who knew that all business interruptions were not created equal? Insurers, of course.

To the alleged rescue came clever lawyers crafting arguments that COVID-19 was a form of physical damage because it could cling to surfaces for substantial periods of time and make surfaces dangerous transmitters of the disease. Surely, the courts would compel insurance coverage in the face of sympathetic plaintiffs and such an excellent argument from their attorneys. Alas, not so, according to the United States District Court for the Southern District of New York in Social Life Magazine Inc. v. Sentinel Insurance Co., which ruled in favor of the insurer on this issue. However, Judge Valerie E. Caproni granted that the policyholder’s attorney deserved “a gold star for creativity,” but the COVID-19 loss was not covered under the policy issued by the Hartford Financial Services Group, Inc.

In the case, the plaintiff’s attorney argued what could be more physically harmful than the death potentially caused by COVID-19. Judge Caproni responded that while this did indeed raise the potential for harm to the plaintiff’s person, it did not result in any harm to the business premises itself that were the subject of the insurance policy coverage. The plaintiff’s attorney has filed an appeal with the United States Court of Appeals for the Second Circuit, possibly hoping for another gold star.

“E” for Effort Next to the alleged rescue was the New York State Legislature with several bills to mandate insurers retroactively cover business interruptions caused by COVID-19, even if the insurance policy had expressly excluded such coverage. O frabjous day! Callooh! Callay! Sponsors flocked to these bills to demonstrate their support for the small business owners devastated by COVID-19, knowing, of course, that the bills would never pass and become law. But it was a good show for the public.

Why were these bills doomed? For several reasons, and not just the intense lobbying opposition of the insurance industry. The foremost reason was that the United States Constitution contains a provision known as the Contracts Clause, which forbids states from passing any laws that impair the obligations of existing contracts. Thus, attempts to rewrite insurance policies to force coverage for something that was never intended to be covered by the policy contract would be unconstitutional as an attempt to alter the obligations of the insurance contract—and the insurance industry had already threatened litigation on that point even if any state did pass such a law. Interestingly, the Contracts Clause applies to states, not to Congress. But in Congress, the insurance industry was lobbying extensively to make sure the Contracts Clause shield was expanded even further.

The second reason these bills were doomed was because in writing these business interruption policies to limit their exposure to physical damage to a premises, the insurance industry had not made actuarial calculations to take into account something like COVID-19 liability. Thus, the entire premium rate setting for such policies, and the allocation of expected costs, were completely divorced from accounting for COVID-19 liability exposure. Insurers argued it was inherently illogical and unfair to suddenly impose such massive liability coverage on them when they had done nothing to plan for that in crafting their policies.

To get around some of these issues, the proposed New York legislative bills established a system where New York State would set up a fund to reimburse insurers for their coverage expenses. There was some hope that this reimbursement idea would evade the Contracts Clause problem with a compensation substitute (it’s not clear that it would have solved that constitutional dilemma) and would definitely cure the insurers’ unanticipated liability expense issue. Of course, with New York pleading poverty and devastating budget cuts still looming, the idea that the state would take on hundreds of millions of dollars in added debt to reimburse insurers was unrealistic and foredoomed. Were these bills even a serious attempt to solve the COVID-19 crisis for small businesses? They were not meant to deceive the public as just phony public relations ploys, but they were so poorly thought through that the legislative vorpal blade went more snicker than snicker-snack.

Go Ahead and File

Many other lawsuits on this entire issue are pending around the country, but New York is not off to an auspicious start for plaintiffs seeking COVID-19 business interruption coverage. However, if you do not file a timely claim, there is no hope of any coverage. Thus, lawyers advise clients to file claims even if it seems hopeless to do so. You cannot benefit from a favorable court ruling, if one ever comes, if you never filed a timely claim.

Some policies contain civil authority clauses that provide coverage for business interruptions resulting from orders of civil government authorities that compel the closure of a business. Ironically, those clauses, too, have always been deemed to relate only to physical damage to premises where the order of a civil government authority acts to close a premises. Nevertheless, some insurers have been more willing to at least entertain the possibility of civil authority coverage for COVID-19. Others have definitely rejected such civil authority claims for the same reasons as in Social Life Magazine Inc. v. Sentinel Insurance Co. That case will surely not bode well for any claims if not reversed on appeal. We can well expect that this case could go all the way to the United States Supreme Court and take years to finally resolve.

Some people have asked, how could insurers be so insensitive and government so unable to address that insensitivity? The unusually catastrophic nature of COVID-19 may supply its own answer. Institutions were not prepared for the scope and damage COVID-19 caused. The sheer magnitude of the calamity in New York State, in particular, may have worked to help insurers. The potential for massive liability exposure for them on something they traditionally never covered inhibited efforts to hold them accountable. They were able to play their own fairness card against what even Judge Caproni admitted were extremely sympathetic plaintiffs who had suffered real harm from COVID-19. But she held she still had to rule in favor of the insurer denying business interruption coverage.

Beware of insurance policies, for business interruption coverage does not always cover business interruptions, the courts have now told us—beware the insurance Jabberwock, with the jaws that bite, the claws that catch—often doing so to its own insureds.

The material contained in this column is informational only and does not constitute legal advice. For specific questions, dentists should contact their own attorney.