Vermont Ruling in Favor of Insured Seeking Business Interruption. Coverage due to Covid is a pyrrhic victory
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IN Huntington Ingalls Industries, Inc. et al. v. Ace American Insurance Company et al, No. 2021-173, 2022 VT 45Supreme Court of Vermont (Sept. 23, 2022) The Supreme Court of Vermont reversed a decision that refused to allow an insured shipbuilder to recover business interruption losses resulting from state orders dealing with Covid-19 and remanded the case to district court to determine whether Covid caused direct physical damage to property.
Insured Huntington Ingalls Industries, Inc. and insurer Huntington Ingalls Industries Risk Management LLC survived the dismissal of the case seeking coverage under a property insurance policy for certain losses incurred by Huntington Ingalls Industries due to the COVID-19 pandemic.
Insured, Huntington Ingalls Industries, Inc., is the largest military shipbuilding company in the United States and provides professional services to government and industry partners. It employs over 42,000 people, the majority of whom work at its shipyards in Virginia and Mississippi.
In March 2020, the insured purchased a property insurance policy (Global Policy) from the insurance company Huntington Ingalls Industries Risk Management LLC, its captive insurance subsidiary and a Vermont corporation. The policy covers the period March 15, 2020 to March 15, 2021. In the same month, the insurer purchased policies from several reinsurers to reinsure all of its obligations to insureds under the global policy. Each reinsurer participated under a certain percentage of the reinsurance program. Reinsurers’ policies incorporate the Global Policy by reference, such as states that their responsibility “shall be coupled simultaneously with that for [insurer] and shall in all respects be subject to the same risks, terms, conditions, prices, interpretations[,] and exclusions” of the underlying policy issued to the insured.
The policy, entitled “Global Property Insurance”, contains relevant provisions that all real and personal property is insured against all risks of direct physical loss or damage to property. In the “business interruption” clause, it includes “[l]us due to the necessary interruption of the business conducted by [insured], regardless of whether it is in whole or in part. . . caused by physical loss or damage insured herein.” Recovery under the interruption provision is limited to the extent that the insured is (a) wholly or partially unable to produce goods or carry on normal business operations or services during [p]period of [r]recovery; (b) unable to recover lost production within a reasonable period of time. . .; or (c) demonstrate a loss or reduction in net profit for the services or production prevented, impaired or interrupted.”
The recovery period begins on the “date of . . . loss or damage” and “[s]hall not exceed the time that would be required in the exercise of due diligence and dispatch to rebuild, repair or replace property that has been destroyed or damaged.” The recovery period also includes “[s]so additional time to restore [insured’s] business to the condition it would have been in if no loss had occurred.” The policy provides that Vermont law governs its construction.
SARS-CoV-2 is a virus that causes the disease COVID-19. In March 2020, civil authorities across the United States began issuing orders requiring some businesses to close and advising people to stay at home to reduce the spread of the virus. Civilian orders generally required the companies to adhere to social distancing, use enhanced sanitation practices on surfaces and follow recommendations from the Centers for Disease Control and Prevention (CDC) and state health departments. But they allowed businesses to operate at a level needed to provide essential services.
The insured kept its yards open but made changes to its operations to comply with CDC guidelines and protect employees.
In September 2020, the insured and the insurer sued the reinsurer seeking a declaratory judgment that they are entitled to coverage under the policy for property damage, business interruption, and other losses suffered as a result of SARS-CoV-2, the pandemic, and civil government orders. The complaint alleges that the pandemic caused “direct physical loss or damage to property” as the virus lingered on surfaces for days and lingered in the air for hours at the shipyards.
DECISION OF THE TRIAL COURT
The district court granted the reinsurance companies’ request for judgment on the pleadings and consequently rejected all the insured’s requests. The inquiry below focused on the meaning of “direct physical loss or damage to property” under the policy.
Interpretation of policy
An insurance policy is interpreted according to its terms and the apparent intentions of the parties as expressed in the insurance language. Terms of an insurance policy are interpreted according to their plain, ordinary and popular meaning, and will enforce unambiguous terms that are written.
When examining whether a policy’s undefined terms have a plain meaning, the Vermont Supreme Court often refers to dictionary definitions.
First, the phrase “direct physical loss” ends with “to property” and this is property insurance, so the analysis is framed with a focus on what happens to the insured property. The centrality of property to this policy requires that something must occur that affects personal or real property for “direct physical loss or damage to property” to occur.
Although all risk policies are generally interpreted in favor of coverage, risk and loss are distinct concepts. The Supreme Court concluded that direct physical injury requires a clear, demonstrable, physical alteration of property. When it combined the definitions of “direct”, “physical” and “harm” above, the simple meaning is obvious. However, a distinct, detectable, physical change need not necessarily be visible; changes at the microscopic level can reach this threshold. The Supreme Court held Ashland Hosp. corp. v. Affiliated FM Ins. Co., no. 11-16-DLB-EBA, 2013 WL 4400516, at *4-5 (ED Ky. Aug. 14, 2013), the USDC for the Eastern District of Kentucky concluded that disk drives altered at the microscopic level due to heat exposure that caused reduced reliability constituted “ direct physical loss or damage to insured property.
The definition is consistent with the policy section on the recovery period, which defines the time for which an interruption claim can be made. The insured may make an interruption claim under the policy for the period commencing with the date of the insurable event and not exceeding the time necessary to “rebuild, repair or replace” the damaged property and such additional time as is necessary to restore it the business was insured to its condition before the loss.
For an intangible to cause a direct physical loss, the cause of the loss must be of such long duration that intervention, rather than just the passage of time, is required to satisfactorily remedy it.
The insurance in this case is unambiguous and must therefore be given its clear meaning. The phrase “direct physical loss or damage to property” includes two distinct components, both of which will trigger coverage unless an exclusion applies: “direct physical injury” and “direct physical loss.”
“Direct physical damage” requires a clear, demonstrable, physical alteration of property. “Direct physical loss” means sustained destruction or deprivation, in whole or in part, with a causal relationship to a physical event or physical condition.
Pure economic harm will not meet either of these standards. Applying the plain meaning of the policy language as interpreted in this case, the insured has the burden of proving that the losses it claims are either “direct physical loss” or “direct physical damage” to property.
Remanding this case and allowing further substantive development in the district court is consistent with the philosophy underlying the filing. Although the science, when fully presented, may not support the conclusion that the presence of a virus on a surface physically alters that surface in a distinct and demonstrable way, it is not the court’s role at this stage of the proceeding to test the facts or evidence.
To be clear, the opinion does not state that what occurred on the insured’s yard is “direct physical loss or damage to property” under the policy. The Supreme Court merely concluded that the insured has alleged enough to survive a motion to dismiss.
The insured’s complaint contains sufficient allegations to survive a motion for judgment on the pleadings under Vermont’s extremely liberal pleading standards.
Justice Carroll dissented
“As a matter of law, human-generated droplets containing SARS-CoV-2 cannot cause ‘direct physical loss or damage to property’ under this policy. No future litigation can change that reality. While I agree with the majority’s conclusion that the disputed policy’s condition is unequivocal, I cannot agree that the insured’s claim survives beyond the application stage.” He therefore distanced himself from this.
News that Vermont handed the first victory to an insured seeking business interruption coverage for losses resulting from Covid 19. The opinion was extremely lengthy and dealt with definitions and interpretations of insurance policies, the gist of the decision being that the insureds alleged sufficient facts to to avoid a motion to dismiss but must now go to the trial court and present evidence and science that the virus caused direct physical damage to the insured’s property. Some courts across the country have found that there was no direct physical loss or damage.
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Barry Zalma, Esq., CFE, now limits his practice to serving as an insurance consultant specializing in insurance coverage, insurance claims management, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He practiced law in California for more than 44 years as an insurance coverage and claims attorney and more than 54 years in the insurance industry. He can be reached at http://www.zalma.com and email@example.com.
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