The ongoing COVID-19 pandemic led to unprecedented closures and losses for businesses throughout the United States. Naturally, policyholders have sought recovery for pandemic-related losses under their “all risk” commercial property policies. According to the University of Pennsylvania Carey School of Law Covid Coverage Litigation Tracker, there have been approximately 2,300 of these COVID-19 coverage cases filed to date. Early pre-trial court decisions overwhelmingly favored insurers; however, recent appellate and high court decisions have demonstrated a slight shift in favor of policyholders.

For example, one of the first COVID-19 coverage decisions was issued by a Michigan state court in the summer of 2020:  Gavrilides Management Company LLC et al v. Michigan Insurance Company. The Gavrilides court rejected the policyholder’s arguments that (1) the loss use of property constitutes a “direct physical loss” covered by the policy and (2) the virus exclusion should not apply since the loss use was caused by government orders. This full dismissal was just the start of policyholders’ uphill court battles.  Since Gavrilides, nearly 70% of state court merits hearings have resulted in a full dismissal with prejudice. In federal courts, that number jumps to nearly 87%.

Policyholders have reason to be optimistic

Recently, however, a few state reviewing courts have examined these legal issues and begun ruling in favor of the policyholder. Most notably, in Huntington Ingalls Industries Inc. et al. v. Ace American Insurance Co. et al., case number 2021-173, the Vermont Supreme Court reversed the lower court’s decision granting judgment on the pleadings to the defendant-reinsurer, holding that the phrase “direct physical loss or damage to property” is unambiguous and that “direct physical damage” can occur even at a microscopic level. The court used typical theories of contract analysis – dictionary definitions, canons of construction, and the rule against surplusage – to support its conclusion that “direct physical loss” and “direct physical damage” each have a distinct meaning.

Huntington follows a California Court of Appeal decision, Marina Pac. Hotel & Suites, LLC v. Fireman’s Fund Ins. Co., 81 Cal. App. 5th 96 (2022), in which the court reversed the trial court’s demurrer. The California Court of Appeal held that “the insureds have unquestionably pleaded direct physical loss or damage to covered property within the definition articulated in MRI Healthcare—a distinct, demonstrable, physical alteration of the property.” The plaintiff alleged that COVID-19 “not only lives on surfaces” but also “transform[s] the physical condition of the property.”

While these cases are not common in the COVID coverage litigation, they provide insight for policyholders seeking recovery. First, policyholders should assess their insurance agreements carefully. Regardless of these decisions, contract language prevails – policyholders scored another recent win in Amy’s Kitchen, Inc. v. Fireman’s Fund Ins. Co., 83 Cal. App. 5th 1062 (2022) based on the policy language read in context suggested that phrase “direct physical loss or damage” could not mean just a physical alteration. Second, these cases show that policyholders’ lawsuits will move forward based on well pled facts. Policyholders should well document any modifications made to business operations, in response to COVID-19. Policyholders should also understand the implications of the presence of COVID-19 in their insured locations.