COVID-19 Business Interruption Claims: First California Court of Appeal Decision Holds That Closure Orders Are Not “Direct Physical Loss”

California has been a hotbed of litigation regarding COVID-19 business interruption claims.  The vast majority of the trial courts have held in favor of insurers and against businesses.  Now, the California Court of Appeal has weighed in.  In a published decision, The Inns by the Sea v. California Mutual Insurance Company (November 15, 2021, Case No. D079036), the Fourth Appellate District held that a hotel’s business income loss resulting from the COVID-19 pandemic was not covered.

The plaintiff, The Inns by the Sea (“Inns”), operated four lodging facilities in Northern California.  Inns had a commercial property policy with California Mutual Insurance Company (“California Mutual”).  In March 2020, local authorities issued orders requiring citizens to shelter in place and prohibited travel unless essential due to COVID-19.  Inns closed its lodging facilities in response to the orders.  Inns made a claim to California Mutual for business income loss.  California Mutual denied the claim on the basis that “[l]oss of business due to reasons other than covered physical damage is beyond the scope of the insurance policy.”

The policy provided coverage for “direct physical loss of or damage to Covered Property at the premises . . . caused by or resulting from any Covered Cause of Loss.” It also provided Business Income coverage, which provided in relevant part:  “We 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 [Inns’] premises . . . . The loss or damage must be caused by or result from a Covered Cause of Loss.”  Similarly, the policy provided Civil Authority coverage for “the actual loss of Business Income you sustain and necessary Extra Expense caused by action of civil authority that prohibits access to the described premises due to direct physical loss of or damage to property, other than at the described premises, caused by or resulting from any Covered Cause of Loss.”

Inns contended it was entitled to coverage under the Business Income and Civil Authority sections.  Inns alleged that “the continued and increasing presence of the coronavirus on [Inns’] property and/or around its premises” led to the orders by local authorities, which in turn led to Inns’ suspension of operations.   The Court assumed for the purposes of the opinion that at some point, a person infected with COVID-19 was known to have been present at one or more of Inns’ lodging facilities.  However, the Court found that this was irrelevant to its analysis.  

The Court first looked at the question of whether the suspension of the Inns’ operations was caused by “direct physical . . . damage to” Inns’ property.  The Court found that it did not.   The orders were issued because of the presence of the virus throughout the counties, not because of presence of the virus at the Inns’ premises.  Indeed, Inns alleged that it closed its premises due to the orders, not due to the actual presence of the virus.  The Court explained:

Indeed, the lack of causal connection between the alleged physical presence of the virus on Inns’ premises and the suspension of Inns’ operations can be best understood by considering what would have taken place if Inns had thoroughly sterilized its premises to remove any trace of the virus after the Orders were issued. In that case, Inns would still have continued to incur a suspension of operations because the Orders would still have been in effect and the normal functioning of society still would have been curtailed. As explained in the context of a lawsuit brought by a restaurant to recover for business losses during the pandemic: “[T]he property did not change. The world around it did. And for the property to be useable again, no repair or change can be made to the property—the world must change. Even if a cleaning crew Lysol-ed every inch of the restaurant, it could still not host indoor dining at full capacity. Put simply, Plaintiff seeks to recover from economic losses caused by something physical—not physical losses.”

Accordingly, the Court found that there was no coverage under the Business Income section of the policy.

Additionally, the Court held that there was no Civil Authority coverage as it would only apply if the prohibited access were due to “direct physical loss of or damage to property” at other premises.  However, the Court noted that, “the Orders make clear that they were issued in an attempt to prevent the spread of the COVID-19 virus. The Orders give no indication that they were issued ‘due to direct physical loss of or damage to’ any property. Therefore, the Orders did not give rise to Civil Authority coverage.” While this is the first appellate decision from a California state court (as opposed to the Ninth Circuit), it certainly won’t be the last.   The Inns by the Sea decision is consistent with decisions from around the country, holding that business shut downs due to COVID-19 closure orders do not constitute a direct physical loss, and we anticipate that this trend will continue in California and nationwide.

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About The Property Insurance Law Observer
For more than four decades, Cozen O’Connor has represented all types of property insurers in jurisdictions throughout the United States, and it is dedicated to keeping its clients abreast of developments that impact the insurance industry. The Property Insurance Law Observer will survey court decisions, enacted or proposed legislation, and regulatory activities from all 50 states. We will also include commentary on current issues and developing trends of interest to first-party insurers.
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