While insurers have been successful in dismissing most COVID-19 property damage claims, especially in federal court, many of the coverage issues that arise in federal court actions are resolved based on state law. When a federal court finds that resolution of a dispute is governed by state law and that there is no controlling state law precedent, the court may certify the state law question to that state’s supreme court for resolution.
The Ninth Circuit Court of Appeals, which covers California, recently certified a state law question on insurance coverage to the California Supreme Court for resolution. In French Laundry Partners, LP v. Hartford Fire Insurance Co., No. 21-15927 (9th Cir. Feb. 6, 2023), one of the first COVID-19 cases, a question arose concerning the applicability of the policy’s virus exclusion. The district court dismissed the case finding no coverage based on the policy’s virus exclusion. The policyholder appealed and the Ninth Circuit certified the following question to the California Supreme Court:
Is the virus exclusion in French Laundry’s insurance policy unenforceable because enforcing it would render illusory a limited virus coverage provision allowing for the possibility of coverage for business losses and extra expenses allegedly caused by the presence and impacts of COVID-19 at an insured’s properties, including the loss of business due to a civil authority closure order?
As you can see, the question is not simply whether the virus exclusion precludes coverage but whether the virus exclusion is unenforceable because it makes a coverage grant nonexistent. The argument being made on appeal is that the virus exclusion is unenforceable, which if accepted, would send the case back to the district court for more proceedings.
The virus exclusion provides as follows:
1. We will not pay for loss or damage caused directly or indirectly by any of the following. Such loss or damage is excluded regardless of any other cause or event that contributes concurrently or in any sequence to the loss or damage:
g. “Fungus”, Wet Rot, Dry Rot, Bacteria or Virus
Presence, growth, proliferation, spread or any activity of “fungus,” wet rot, dry rot, bacteria or virus.
But if direct physical loss or direct physical damage to Covered Property by a “Specified Cause of Loss” results, we will pay for the resulting loss or damage caused by that “Specified Cause of Loss”.
This Exclusion does not apply:
(1) When “fungus,” wet rot, dry rot, bacteria or virus results from fire or lightning; or
(2) To the extent that coverage is provided in the Additional Coverage(s) — “Fungus,” Wet Rot, Dry Rot, Bacteria or Virus — Limited Coverage with respect to loss or damage by a cause of loss other than fire or lightning.
Complicating the clear exclusion is the additional coverage that the policyholder purchased, which provides:
15. “FUNGUS”, WET ROT, DRY ROT, BACTERIA AND VIRUS — LIMITED COVERAGE
a. The coverage described below only applies when the “fungus”, wet or dry rot, bacteria or virus is the result of one or more of the following causes that occurs during the policy period and only if all reasonable means were used to save and preserve the property from further damage at the time of and after that occurrence.
(1) A “specified cause of loss” other than fire or lightning;
(2) Equipment Breakdown Accident occurs to Equipment Breakdown Property, if Equipment Breakdown applies to the affected premises; or
(3) Flood, if the Causes of Loss Flood endorsement applies to the affected premises.
b. We will pay for loss or damage by “fungus”, wet rot, dry rot, bacteria and virus. As used in this Limited Coverage, the term loss or damage means:
(1) Direct physical loss or direct physical damage to Covered Property caused by “fungus”, wet rot, dry rot, bacteria or virus, including the cost of removal of the “fungus”, wet rot, dry rot, bacteria or virus;
(2) The cost to tear out and replace any part of the building or other property as needed to gain access to the “fungus”, wet rot, dry rot, bacteria or virus; and
(3) The cost of testing performed after removal, repair, replacement or restoration of the damaged property is completed, provided there is a reason to believe that “fungus”, wet rot, dry rot, bacteria or virus is present.
The district court rejected the argument that the virus exclusion renders coverage under this additional coverage illusory. The court noted that the policy defined specified cause of loss as:
Specified Causes of Loss’ means fire; lightning; explosion; windstorm or hail; smoke; aircraft or vehicles; riot or civil commotion; vandalism; `Sinkhole Collapse’; `Volcanic Action’; falling objects; weight of snow, ice or sleet; water damage, `Sprinkler Leakage’; `Theft’; or `Building Glass’ breakage.
The court pointed to a Nebraska case that found transmission of a virus by a tornado (i.e., windstorm) was covered under a similar provision and, accordingly, the virus exclusion could not be illusory because there was a possibility of coverage.
The Ninth Circuit, however, certified the question in part because an intermediate appellate court decision in California had found the clause illusory.
This is the second case that the Ninth Circuit has certified a question of state law on COVID-19 business interruption coverage to the California Supreme Court. On December 28, 2022, the Ninth Circuit asked the California Supreme Court whether the actual or potential presence of the COVID-19 virus can constitute “direct physical loss or damage to property” for the purposes of coverage under an insurance policy. See Another Planet Ent., LLC v. Vigilant Ins. Co., 56 F. 4th 730 (9th Cir. 2022).
In certifying this question to the California Supreme Court, the Ninth Circuit is hoping that the California Supreme Court will answer these state law coverage questions: “We believe the Supreme Court of California may gain some efficiencies through concurrent consideration of our certification in this case.” Whether the California Supreme Court answers these questions remains to be seen and if it does, its answers may affect how future COVID-19 business interruption cases will be decided.