Direct Physical Loss of or Damage to Property Under California Law

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Decisions are starting coming down with some frequency in the myriad COVID-19 business interruption coverage cases. This blog post will highlight some aspects of a very recent decision by a California federal court that dismissed the policyholder’s complaint. The court, under California law, addressed the direct physical damage condition of the property policy.

In 10E, LLC v. Travelers Indemnity Co. of Connecticut, No. 2:20-cv-04418-SVW-AS (C.D. Calif. Sep. 2, 2020), the court issued an amended order granting the insurance company’s motion to dismiss the complaint. The policyholder, a restaurant, sought coverage under the business income, extra expense and civil authority order provisions of its business property insurance policy.

The policy has the expected language seen in many business interruption provisions: the “suspension must be caused by direct physical loss of or damage to property at the described premises,” the extra expense “would not have incurred if there had been no direct physical loss of or damage to property,” and “[T]he civil authority action must be due to direct physical loss of or damage to property at locations, other than described premises, that are within 100 miles of the described premises, caused by or resulting from a Covered Cause of Loss.”

The policy also had a virus and bacteria exclusion, which applied to all the relevant coverage grants, including civil authority order.

Although the insurance company made three arguments for dismissal, the court did not reach the first two arguments (application of the exclusion and allegations as to the civil authority order), and focused on the third argument; that there is no plausible claim under the business income and extra expense coverage grants because of the lack of direct physical loss of or damage to covered property.

The court correctly pointed out that the policy conditioned coverage on direct physical loss of or damage to property. This is what the court said about direct physical loss or damage:

Physical loss or damage occurs only when property undergoes a “distinct, demonstrable, physical alteration.” MRI Healthcare Ctr. of Glendale, Inc. v. State Farm Gen. Ins. Co., 187 Cal. App. 4th 766, 779 (2010) (citation and quotation marks omitted). “Detrimental economic impact” does not suffice. Id. (citation and quotation marks omitted); see also Doyle v. Fireman’s Fund Ins. Co., 21 Cal. App. 5th 33, 39 (2018) (“[D]iminution in value is not a covered peril, it is a measure of loss” in property insurance).

Importantly, the court noted that “[a]n insured cannot recover by attempting to artfully plead temporary impairment to economically valuable use of property as physical loss or damage.” Accordingly, because the policyholder only plausibly alleged that in-person dining restrictions interfered with the use or value of its property–not that the restrictions caused direct physical loss or damage–the complaint did not state a claim for business income and extra expense coverage. The court noted that labeling the business as “non-essential” did not physically alter the insured’s property.

The court applied this same reasoning to the civil authority order coverage as well. The court rejected the conclusory language of the complaint as vague and without any detail as to how any property was damaged.

While the court granted leave to serve another amended complaint, its analysis of direct physical loss and its application to civil authority order coverage raises a high bar for further pleading. In passing, the court noted its skepticism on how the insured can evade application of the virus exclusion.

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