The New York Court of Appeals (New York’s highest court for those expecting it to be the supreme court) has finally weighed in on the COVID-19 question of what direct physical loss or damage means in a property policy providing business interruption coverage. Not surprisingly, New York joins the vast majority of state and federal courts and affirmed the order below dismissing the complaint.
In Consolidated Restaurant Operations, Inc. v. Westport Insurance Corp., No. 7 (N.Y. Ct of App., Feb. 15, 2023), a restaurant group sought coverage under its all-risk commercial property insurance policy losses due to COVID-19. The policy provided coverage for all risks of direct physical loss or damage to insured property and business interruption losses directly resulting from physical loss or damage to the insured property.
The restaurant group’s insurance carrier denied coverage and brought this action for breach of contract. the insurer moved to dismiss the complaint, which was granted by the motion court and affirmed on appeal.
The Court of Appeals, while giving the complaint a liberal construction when reviewing a motion to dismiss, nevertheless affirmed the order dismissing the complaint. According to the court, the restaurant group made two main arguments for reversal. First, that the phrase “direct physical loss or damage” should be interpreted “more broadly to encompass situations where a physical event occurs on insured property and impairs its functionality or renders it, in whole or in part, unusable for its intended purpose.” Second, even if physical alteration is required, the complaint alleged as much. The court rejected both arguments holding “that ‘direct physical
loss or damage’ requires a material alteration or a complete and persistent dispossession
of insured property, which CRO did not allege.”
As to the first argument, the court held “because the words ‘direct’ and ‘physical’ both modify the phrase ‘loss or damage,’ we read the phrase ‘direct physical loss or damage’ to mean ‘direct physical loss’ or ‘direct physical damage.'” The court held further that ‘physical damage’ must be understood to require a material physical alteration to the property—one that is perceptible, even if not visible to the naked eye.”
The court further found that reading “direct physical loss or damage” to mean impaired functionality and either a partial or complete loss of use for a limited time untenable, “because it would collapse coverage for ‘direct physical loss’ into coverage for ‘loss of use.’” “Direct physical loss,” said the court, “requires more than loss of use; it requires an actual, complete dispossession.” The court also found that this reading harmonized the relevant provisions of the policy, including the Time Element coverages.
Interestingly, on the issue of contamination and uninhabitability (cited in cases presented by the restaurant group), the court left an opening for further interpretation of “direct physical loss or damage” in future cases. The court stated that because the restaurant group “has alleged neither persistent contamination nor total uninhabitability of its restaurants, we need not decide today whether such allegations could fairly be equated with actual material dispossession, and thus ‘direct physical loss.’” Keep in mind that a different pleading could result in a different determination, especially on a motion to dismiss.
On the second argument, the court held that even if the complaint was read with a generous construction to allege that various surfaces in the restaurants became vectors for transmission of the coronavirus, the complaint “fails to identify . . . a single item that it had to replace, anything that changed, or that was actually damaged at any of its properties (205 AD3d 76, 86). As the Appellate Division found, “[n]othing stopped working” (id.). And the allegations themselves confirm that the presence of the coronavirus was temporary.” The court also noted that it agreed with the weight of authority nationwide.
Lastly, there were exclusions in the policy but that court did not reach those exclusions. “Because we conclude that [the restaurant group] did not sufficiently allege ‘direct physical loss or damage,’ we do not reach the question of whether the exclusions in the policy apply.” The court concluded “that the business interruption caused by the actual presence of the coronavirus on the premises of [the restaurant group’s] insured property, as alleged in the complaint, is insufficient to trigger” coverage under the insurance policy.
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