Major Victories for Insurers in Fifth Circuit Regarding COVID-19 Business Interruption Claims

The Fifth Circuit Court of Appeals has joined seven other Circuits in finding no coverage for COVID-19 business interruption claims.[1]  In Terry Black’s Barbecue, L.L.C. v. State Auto. Mut. Ins. Co., 2022 U.S. App. LEXIS 287 (5th Cir. Jan. 5, 2022) and Aggie Invs., L.L.C. v. Continental Cas. Co., 2022 U.S. App. LEXIS 393 (5th Cir. Jan. 6, 2022), the Fifth Circuit considered claims under all-risk policies.  In Terry Black’s Barbecue, the policy included provisions for loss of business income and extra expense.  To trigger such coverages, the policy required that the suspension of operations “must be caused by direct physical loss of or damage to property at the premises.”  The policy’s definition of “period of restoration” was the period of time that begins at the time of loss or damage and ends when the property is “repaired, rebuilt or replaced” or when operations resume at a new location.  Further, the policy contained a restaurant extension endorsement providing civil authority coverage “resulting from the actual or alleged … exposure of the described premises to a contagious or infectious disease.”

The Court recounted the history of the policyholder’s claims.  On March 19, 2020 the Governor of Texas issued an executive order directing people to avoid eating or drinking at restaurants.  In certain counties in Texas, civil authorities prohibited in-person restaurant services.  The policyholder complied with the order, curtailed its usual services, and lost income.  The policyholder filed claims for business interruption and extra expense, as well as under the restaurant extension endorsement.  The insurer denied the policyholder’s claim and the policyholder sued.  The insurer removed and filed a motion for judgment on the pleadings pursuant to Federal Rule of Civil Procedure 12(c).

The district court (Judge Robert Pitman of the Western District of Texas, Austin Division) ruled in favor of the insurer on the business interruption and extra expense claims.  The district court adopted the magistrate’s report and opinion.  In doing so, the district court concluded “physical loss” requires a “distinct, demonstrable, physical alteration of the property.”  The district court also ruled in favor of the insurer on the restaurant extension endorsement claims, adopting the magistrate’s reasoning that there was no coverage because the civil authority orders were issued as a result of the global pandemic, not because of any “actual or alleged exposure of the described premises” to COVID-19.  Because the policyholder did not overcome the required threshold of bringing the claims within coverage, the district court did not reach the application of a virus exclusion. 

In making an Erie guess as to how the Texas Supreme Court would decide the issues, since the policyholder alleged only “loss” rather than “damage,” the Fifth Circuit began by noting that the phrase “direct physical loss of property” is not defined in the policy.  Here the Fifth Circuit inserted a significant footnote.  The policyholder argued that “loss of” property is distinct from “damage to” property because those phrases are separated by the word “or” in the policy.  The Fifth Circuit observed that some courts, including the Fifth Circuit itself in the prior opinion of Trinity Indus., Inc. v. Ins. Co. of N. Am., 916 F.2d 267, 270-71 (5th Cir. 1990) (interpreting “loss or damage” together as a single phrase), have interpreted “loss” or “damage” to have synonymous meanings in the business income/extra expense provision.  The Fifth Circuit in this case departed from Trinity and opined that “loss” and “damage” have two distinct meanings.  However, since the policyholder only sought coverage for “loss” of property, the Fifth Circuit analyzed that language only.  Thus, the Fifth Circuit left open the meaning of “damage” in the context of COVID-19.  Importantly, the Fifth Circuit did not alter its prior ruling from Trinity that “the language ‘physical loss or damage’ strongly implies that there was an initial satisfactory state that was changed by some external event into an unsatisfactory state – for example, the car was undamaged before the collision dented the bumper.”  Indeed, as discussed below, the Fifth Circuit reiterated that ruling.

Analyzing the word “physical,” the Fifth Circuit relied on Texas state court authorities to determine that “physical” means “tangible”:

●          “Physical” means “of, relating to, or involving material things; pertaining to real, tangible objects;”

●          “To give ‘physical’ its plain meaning, a covered injury must be one that is tangible;”

●          “Physical loss or damage” means “there was an initial satisfactory state that was changed by some external event into an unsatisfactory state,” citing Trinity; and

●          “An intangible or incorporeal loss that is unaccompanied by a distinct, demonstrable, physical alteration of the property is not considered a direct physical loss.”

The Fifth Circuit also analyzed the word “loss” and found a severe connotation to the word, with a common theme in definitions of being “ruined” or “destroyed.”  The Fifth Circuit declined to certify questions to the Texas Supreme Court about the meaning of these terms because, although the specific policy language had not been interpreted by a Texas state court, such courts had interpreted similar policy language that “sheds sufficient light here.” 

            Considering the plain meaning of “physical loss,” the Fifth Circuit determined that the policyholder’s claim was not covered by the policy’s business interruption and extra expense provisions.  The Fifth Circuit observed that the policyholder failed to allege any tangible alteration or deprivation of property.  Indeed, “[n]othing physical or tangible happened to [the policyholder’s] restaurants at all.”  The Fifth Circuit found that the policyholder had access and use of all parts of the restaurants at all times and that the prohibition against dine-in services did not deprive the policyholder of any property at its restaurants.  In reaching this conclusion, like many other courts, the Fifth Circuit focused on the fact that the policy provided coverage only during the “period of restoration.”  Since there was no tangible alteration of the property to “repair, rebuild or replace” as required by the policy to trigger coverage, there was no coverage.  The Fifth Circuit also examined the purpose of the policy.  The Fifth Circuit reasoned that a commercial property policy covers the commercial property that is insured and the business income/extra expense provision covers the business interruption that is caused by loss or damage to the commercial property, not an economic loss with no tangible effect on the property or business. 

The Fifth Circuit then placed its decision in the context of the seven other Circuits in ruling against policyholders by deciding that “physical loss of property” requires a tangible alteration or deprivation of property.  Interestingly, the Fifth Circuit chose to quote 10012 Holdings, Inc. v. Sentinel Ins. Co., 2021 U.S. App. LEXIS 38270 (2nd Cir. Dec. 27, 2021) (concluding that “direct physical loss” does not extend to loss of use but requires physical damage) even though the Fifth Circuit held “loss” and “damage” are two separate things.

The Fifth Circuit rejected the policyholder’s arguments that the policy only required that it be deprived of a “physical space” and that loss of “use” of the dining rooms for their intended purposes amounted to a physical loss.  The Fifth Circuit observed that the phrase “physical space” is not present in the policy.  Further, Fifth Circuit observed that the policyholder was never deprived of the physical space and the “limitation on the kind of services permitted to be offered at the restaurants is just not a deprivation of the physical space under any reading under the policy.”  Regarding loss of “use,” the Fifth Circuit opined that loss of “use” was not loss of property.  In any event, the policyholder could “use” its property other than for dine-in purposes.  It did not matter that the “intended” use of the restaurant could not be achieved.  The Fifth Circuit summed up by concluding that the word “intended” was not included in the policy and “physical loss of property” is not synonymous with “loss of use of property for its intended purpose.”

Turning to the restaurant extension endorsement, the Fifth Circuit opined that, because the civil authority orders did not “result from” the policyholder’s exposure to COVID-19, the endorsement did not provide coverage either.  The Fifth Circuit determined the phrase “resulting from” in the endorsement was causation.  In a tactic employed by many policyholders, the policyholder in this case alleged that civil orders were issued “following” guidance from the Centers for Disease Control and Prevention (or, in other cases, state and local authorities or industry groups).  The Fifth Circuit adamantly asserted that the civil authority orders were not caused by the two-location barbecue restaurant’s exposure to COVID-19.  Rather, the Fifth Circuit explained that the orders were caused by a global pandemic “and the need to take measures to contain and prevent the spread of COVID-19.”  The civil authority orders were clearly aimed at avoiding spread of COVID-19, rather than existing exposure to COVID-19.  The Fifth Circuit also rejected an argument based on a “food or drink poisoning of a guest” argument by the policyholder; There was no such poisoning at the premises that caused the civil orders to be issued. 

The policyholder abandoned its extracontractual claims in the district court.  Those claims would have been eliminated anyway because there is no coverage, according to well-established authority such as Progressive Co. Mut. Ins. Co. v. Boyd, 177 S.W.3d 919, 921 (Tex. 2005) (per curiam).

Finally, the Fifth Circuit denied the policyholder leave to amend its pleadings.  Since this case was removed from state court, the policyholder argued it should be allowed to bring its petition up to federal pleading standards and “cure” its factual allegations to allege the presence of COVID-19 in its restaurants.  The Fifth Circuit ultimately observed that no amendment would bring a claim within coverage, that is, any amendment was futile, and emphasized that the policyholder’s own briefs and oral arguments demonstrate that there was no tangible alteration to the restaurants.  Perhaps the Fifth Circuit was also keen to begin to bring order to COVID-19 business interruption litigation in lower courts by denying leave.   

The day after the Fifth Circuit issued its opinion in Terry Black’s Barbecue, the Court issued a short opinion in Aggie Investments that followed suit.  The Fifth Circuit again held that a “direct physical loss of property” required a tangible alteration or deprivation of property.  The Fifth Circuit observed that the policyholder had alleged only loss of revenue due to reduced capacity in its stores, but the policyholder had ownership of, access to, and ability to use its entire property the whole time.  Further, the Fifth Circuit held that the phrase “direct physical loss of property” was not ambiguous and could not properly include loss of use, otherwise such an interpretation would read the word “physical” out of the policy.  Thus, the Fifth Circuit affirmed the district court’s dismissal (Judge Amos Mazzant, Eastern District of Texas, Sherman Division).     

The Fifth Circuit’s opinions in Terry Black’s Barbecue and Aggie Investments are major victories for insurers.  The opinions were long-awaited as decisions by other Circuits piled up.  Significantly, no Circuit has split from the wave of authority in favor of insurers.  Although COVID-19 is less than two years old and it is changing, clearly traditional insurance principles are guiding courts.  Policyholders are not meeting their threshold burdens to bring claims within coverage such that courts need not even reach the virus exclusion found in many policies.           

[1]             See 10012 Holdings, Inc. v. Sentinel Ins. Co., 2021 U.S. App. LEXIS 38270 (2nd Cir. Dec. 27, 2021); Santo’s Italian Café, LLC v. Acuity Ins. Co., 15 F.4th 398 (6th Cir. Sept. 22, 2021); Sandy Point Dental, P.C. v. Cincinnati Ins. Co., 2021 U.S. App. LEXIS 36399 (7th Cir. Dec. 9, 2021); Oral Surgeons, P.C. v. Cincinnati Ins. Co., 2 F.4th 1141 (8th Cir. July 2, 2021); Mudpie, Inc. v. Travelers Ins. Co. of Am., 15 F.4th 885 (9th Cir. Oct. 1, 2021); Goodwill Indus. of Cent. Okla., Inc., v. Phila. Indem. Ins. Co., 2021 U.S. App. LEXIS 37802 (10th Cir. Dec. 21, 2021); Gilreath Family & Cosmetic Dentistry, Inc. v. Cincinnati Ins. Co., 2021 U.S. App. LEXIS 26196 (11th Cir. Aug. 31, 2021).

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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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