On April 21, 2022, the Supreme Judicial Court (SJC or Court) dashed the hopes of three restaurants to recover from their insurer the business interruption losses they suffered during the COVID-19 pandemic. In Verveine Corp. et al. v. Strathmore Insurance Company, the Court ruled that the standard business property insurance form did not cover COVID-19-related business interruption claims.
The SJC’s decision has national importance because it is the first state supreme court to decide upon the applicability of the term “direct physical loss or damage” to properties owned by businesses that had to shut down or terminate operations during the COVID-19 epidemic. While federal district court and federal appeals courts have ruled in favor of insurers in lawsuits brought by insureds over COVID-19-related business interruption claims, no state high court had ruled on this coverage issue until the SJC rendered its decision. The federal court decisions all depended upon what the state’s highest court where the insurance contract was made would decide. Federal courts deciding state-based contract actions are constrained by the United States Supreme Court rulings to apply state law to statutory and appellate court decisions.
Hundreds of businesses around the country have sued, claiming that their business interruption losses caused by government-imposed lockdowns or operating restrictions because of the COVID-19 pandemic were recoverable under their commercial property insurance policies. Insurance companies have uniformly denied these claims because of no physical loss or damage to the insured properties. The SJC decision validating the insurers’ position marks an important precedent that other state supreme courts will likely follow.
The plaintiff restaurants and their commercial property policies
The three plaintiff restaurants named in the litigation, Coppa, Toro, and Little Donkey are subsidiaries of the Verveine Corporation. The restaurants had a long-standing relationship with the Commercial Insurance Agency (Commercial) to handle their property and casualty insurance. For the policy year in question, Commercial had obtained commercial property policies through the Strathmore Insurance Company, a wholly owned subsidiary of the Greater New York Mutual Insurance Company.
One policy covered both Toro and Coppa, and a separate policy covered Little Donkey. Each policy provided business interruption coverage for lost income resulting from a covered property loss. The coverages under the two policies were otherwise the same, except the Little Donkey policy had an exclusion for “loss or damage caused by or resulting from any virus, bacterium or other microorganisms that induce or is capable of inducing physical distress, illness, or disease.” The policy for Coppa and Toro had no similar exclusion mentioning viruses.
The governor’s emergency order banning in-person dining because of the COVID-19 virus
From January 2020 through early March 2020, exponentially increasing COVID-19 infections across the globe caused the World Health Organization to declare a pandemic on March 11, 2020.
On March 15, 2020, the governor, invoking his emergency civil defense powers, issued a stay-at-home order prohibiting, among other things, in-person dining at all restaurants and bars. The emergency order did provide that a restaurant could remain open for takeout and delivery service provided it complied with social distancing.
Toro and Coppa complied with the in-person dining prohibition but suffered a major decline in their sales from the limitation of only providing takeout and delivery services. Little Donkey suspended operation. In June 2020, the stay-at-home orders were modified to allow limited in-person dining at reduced capacities, and the restaurants were able to resume their operations but with significant reductions in their revenues based upon the capacity limits specified in the modified order.
The restaurants, based on their lost business income from the effect of the COVID-19 emergency order, filed business interruption claims under their commercial property policies with Strathmore. Strathmore summarily denied the claims, citing the lack of any “physical loss or damage to” the insured properties from the COVID-19 emergency orders. Strathmore also advised Little Donkey that it was denying its claim based upon its policy having a virus exclusion.
The restaurants’ lawsuit dismissed by Superior Court, but their appeal taken up directly by the SJC
In June 2020. the restaurants filed a lawsuit against Strathmore suing for a (1) declaratory judgment, (2) breach of contract, and (3) unfair and deceptive claim practices. Little Donkey also brought a negligence claim against its insurance agency, Commercial, for failing to procure a policy without a virus exclusion.
On a motion to dismiss, the Superior Court found that under the undisputed and unambiguous terms of the policy, there was no “direct physical loss or damage” resulting from the COVID-19 virus triggering any coverage for any of the restaurants. The Superior Court also granted Commercial’s motion to dismiss the negligence claim based upon the fact that the existence of the virus exclusion on the Little Donkey policy was immaterial because there was no policy coverage regardless of the exclusion.
When the restaurants appealed to the Appeals Court, the Supreme Judicial Court, on its own volition, ordered a direct appellate review, bypassing the Appeals Court, based on the significance of the issue involved for restaurants and other businesses affected by the governor’s emergency order and for the insurance industry.
De novo review by the SJC of the Superior Court dismissal of the restaurant’s coverage claims
On appeal, the Supreme Judicial Court addressed Strathmore’s motions to dismiss “de novo.” Under the appellate de novo standard for motions to dismiss, the SJC reviewed anew the restaurants’ complaint claiming the Strathmore insurance policies stated coverage without consideration of the Superior Court’s decision.
The Court’s analysis of whether Strathmore policies provided coverage began with the observation that the appeal posed a question of contractual interpretation and, therefore, the Court would analyze the policies based on:
- The fair meaning of the language used, as applied to the subject matter.
- Every word in the insurance contract serving a purpose and being given meaning and effect whenever practicable.
- Unambiguous words of the policy being construed in their usual and ordinary sense.
- The meaning of wording that is at all unclear or in doubt being ascertained by “what an objectively reasonable insured reading the relevant policy language would expect to be covered; and
- Any ambiguities in the language of the insurance contract being interpreted against the insurer who used them in favor of the insured.
The insuring agreements at issue requiring ‘direct physical loss or damage’
The building and personal property coverage form in both policies at issue before the Court stated that:
[Strathmore] will pay for direct physical loss or damage to “Covered Property at the [insured] premises…Caused by or resulting from any “Covered Cause of Loss.”
Under the policies’ definitions, the “Covered Property” included the “building or structure” identified in the policies’ declarations. The “Covered Cause of Loss” in each policy was defined as “Risks of Direct Physical Loss” without further specification making the policy, in effect, an “all-risk” policy. However, the Court observed that “in the context of the restaurants’ property coverage forms, ‘direct physical loss of or damage to Covered Property’ characterized what effects the covered causes must have on the property to trigger coverage, not the causes themselves.”
The business income and extra expense coverage for both policies stated:
“[Strathmore] 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 of or damage to property at [the insured premises] …The loss or damage must be caused by or result from a Covered Cause of Loss”
In interpreting these policies’ requirement of direct physical loss or damage to property for coverage, the Court noted that Massachusetts has previously ruled on the meaning of “direct physical loss or damage to” property.
The Court concluded that, based on Massachusetts law, “direct physical loss of or damage to” property requires some “distinct, demonstrable, physical alteration of the property.”
To the Court, the term “period of restoration” as used in the policies bolstered this physical alteration requirement in dealing with the meaning of the business interruption coverage. This coverage, under the policies, would end on “(1) the date when the property at the described premises should be repaired, rebuilt or replaced with reasonable speed and similar quality; or (2) the date when the business is resumed at a new permanent location.
The provisions the Court underlined clearly implied to it that there would not be a covered business interruption loss unless the insured property had to be repaired, rebuilt, or replaced or the business had to be permanently moved to a new location because of the damage to the insured location.
A rapidly dissipating airborne substance is not ‘loss or damage to property
In attempting to argue to the Court that there had been direct physical loss or damage to the insured locations, the restaurants argued that the “presence” of the virus on surfaces and in the air at their restaurants constituted covered loss or damage to their properties. However, the Court did not accept the argument as valid. Assuming, for argument sake, that, the restaurants had the virus present on surfaces, and in the air, the Court ruled such a “presence” still did not trigger coverage under the policies because:
“[The] presence of a harmful airborne substance that will quickly dissipate on its own, or surface-level contamination that can be removed by simple cleaning, does not physically alter or affect property.”
Instead, the Court held that such direct physical loss or damage to property only occurred if there were “saturation, ingraining, or infiltration of a substance into the materials of a building or persistent pollution of premises requiring active remediation efforts.” The coronavirus did not satisfy this condition because of its “evanescent” [meaning “soon passing out of existence; quickly fading or disappearing”] nature.
Also, the Court pointed out that the virus, even if present on the insured premises, would not cause any direct physical effect on the insured properties. The loss of business in the restaurants was not caused by a direct physical effect on the insured properties by the COVID-19 virus. During the in-person dining ban, the restaurants could and did carry on takeout operations without hindrance.
The absence of a policy virus exclusion does not imply coverage for virus-caused damages.
The plaintiffs also argued that the addition of the virus exclusion to the Little Donkey created a negative implication that the other policy not containing such an exclusion should cover claims arising from viral causes. The court, however, rejected this principle as a matter of law, stating that the absence of an express exclusion does not operate to create coverage and that when a claim is clearly outside the terms of an insuring agreement, a specific exclusion is not legally necessary.
The negligence claim against the insurance agent dismissed
On the negligence claim against Little Donkey’s insurance agent, Commercial, the Court agreed with the Superior Court that the addition of the virus exclusion to Little Donkey’s policy presented no basis for recovery. The insuring agreement in the Little Donkey policy barred coverage. Therefore, the virus exclusion had no effect in this instance.
The Supreme Judicial Court decision was predictable
The decision of the SJC is the final word in Massachusetts on whether commercial property policies provide any business interruption coverage. Since the SJC’s interpretation of the insurance policy in question decided a matter of state contract law, there is no federal question and no further appeal possible.
While restaurants and some other businesses have made great efforts to find coverage, the SJC’s decision to find no coverage presents no surprise.
On March 17, 2020, Agency Checklists published an article, “Business Interruption Coverage & The Coronavirus Pandemic.” The article, written by this author two days after the governor’s order barring in-person dining, opined:
The overriding coverage issue concerning business interruption losses resulting from the consequences of the Covid-19 pandemic is the ‘direct physical loss’ provision found in the business interruption coverages. A business closure or material loss of income caused by employee sickness, customers refusing to patronize the business location, or for restaurants and pubs, an order to cease on-premises services does not constitute a direct physical loss to the insured property.
Insurance Coverage Legal Expert/Co-Founder & Publisher of Agency Checklists
Over the course of my legal career, I have argued a number of cases in the Massachusetts Supreme Judicial Court as well as helped agents, insurance companies, and lawmakers alike with the complexities and idiosyncrasies of insurance law in the Commonwealth.
Connect with me directly, by calling me at 617-598-3801 or by sending an email using the button below.