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


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 where so many others have had that door improperly and prematurely shut by other federal courts recently.

Coronavirus coverage cases require courts to properly apply foundational principles of policy interpretation and undisputed procedural standards to a first-in-a-generation phenomenon.  Unfortunately, many courts have exceeded their limited role in reviewing insurer motions to dismiss COVID-19 business interruption cases by making premature factual and scientific determinations instead of properly accepting well-pled facts in the complaints as true and allowing discovery to proceed.  In far too many cases, the following warning from Purdue University’s amicus brief in the Seventh Circuit review of Circle Block Partners, LLC v. Fireman’s Fund Insurance Company has gone unheeded:

“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.

But in a measured decision, Judge Eagles rejected Zurich carrier American Guarantee and Liability Insurance Company’s motion to dismiss Novant Health, Inc.’s claim to recovery for losses arising from the presence of the Coronavirus in its hospital and outpatient properties.

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 simply cannot meet their burden to show that the continuous reintroduction of a deadly virus could not be covered under a property policy insuring against all direct physical loss of or damage to property.  The hospital and medical facilities in question 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 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 attorneys were among the first to publicize that the disproportionate number of courts applying a more exclusionary test of physical loss or damage to property (which requires a “distinct, demonstrable physical alteration to property” rather than the loss of functional use of property) may have relied uncritically on mischaracterizations contained within a trusted legal treatise, Section 148:46 of Third Edition of Couch on Insurance.  The Couch treatise created this narrow test in the 1990s with 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,” while failing to cite virtually all the cases that, for years, refused to apply its narrow test and continued to apply the majority rule loss of functional use test.  Most decisions dismissing COVID-19 business interruption actions quote the restrictive “physical alteration” test, citing Couch or the cases that are its progeny.  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 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 Zurich EDGE policy form relied on by the carrier, widely known as the Virus Deletion Endorsement, deleted virus from the policy’s Contamination Exclusion policy wide against the carrier’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.

The court turned last to the assertion by American Guarantee that Novant Health’s claim for business interruption was not ripe. Remarkably, the carrier argued that its own failure to render a coverage denial within the policy’s one-year statute of limitations meant that the claim was not ripe for review.  American Guarantee had also refused timely requests to render a coverage determination or to grant an extension of the limitations period. Honoring the insurer’s overtly prejudicial request would mean a suit brought any time before the expiration of the limitations period would be unripe and a suit brought any time after would be barred. The right to seek judicial resolution of coverage disputes cannot be pocket vetoed by an insurer refusing to render a final determination. The court appropriately rejected this argument outright.

This decision exemplifies judicial restraint in avoiding factual determinations at the pleading stage that policyholders should be able to expect.  It is a reminder that uninformed conceptions about the character and effect of the COVID-19 virus are no substitute for the engaged and earnest judicial review of a fully developed factual record and informed advocacy on the merits.


Couch’s “Physical Alteration” Fallacy: Its Origins and Consequences

Zurich Pleads with Court to Ignore Science