Insurance Law Hawaii

Is There Direct Physical Loss Under Property Policy with Presence of COVID-19?

    Most property policies provide coverage for property damage only when there is "direct physical loss" to covered property. Early indications are that COVID-19 remains on surfaces. The duration can last from a few hours to three weeks, depending on the type of surface material. If an employee is infected and the store or restaurant must closed because the virus may rest on surfaces within the building, is there direct physical loss, even though the building structure itself is unharmed?

    To answer this question, cases from jurisdictions outside Hawaii may provide guidance. In a case from Louisiana, the homeowner had to move out of her home when excessive levels of organic lead were discovered in the kitchen, living room, master bedroom, and attic. Widder v. La. Citizens Prop. Ins. Corp., 82 So. 3d 294 (La. Ct. App. 2011). The insurer denied coverage because there was no direct physical loss. The trial court agreed; since the home was still intact, no direct physical loss had occurred, so there was no coverage under the policy. The appellate court reversed. It compared the presence of inorganic lead in the home to cases that found a direct physical loss from the existence of Chinese drywall, from which gaseous fumes were released, rendering the home unusable or uninhabitable. Physical damage was not necessary.

    What if smoke from a nearby wildfire fills an outdoor theater, forcing cancellation of performances and loss of business income? This was the situation in Oregon Shakespeare Festival Ass'n v. Great Am. Inc. Co., 2016 U.S. DIst. LEXIS 74450 (D. Ore. Jun 7, 2016). Wildfires in the area caused smoke, soot, and ash to accumulate on the surface of seats and concrete ground of the open-air theater. The air quality was poor, but no federal, state or local agency ordered cancellation of the performances. Further, the theater did not suffer any permanent or structural damage to its property. The insurer denied coverage, contending that the loss or damage must be structural to the building itself. After all, the smoke in the air at the theater did not require any repairs to the structure of the property. The court disagreed. The theater sustain "physical loss or damage to property" when the wildfire smoke infiltrated the theater and rendered it unusable for its intended purpose. The decision in  Oregon Shakespeare Festival was eventually vacated by a joint stipulation of the parties. Oregon Shakespeare Festival Ass'n v. Great Am. Ins.Co., 2017 U.S. Dist. LEXIS 33208 (D. Ore. March 6, 2017), but the reasoning is still sound. 

    The Oregon Shakespeare Festival case cited several cases to support its view.  A pervasive odor in a home caused by a subtenant's illegal methamphetamine operation was considered a "direct physical loss." The court concluded that odor was "physical" because it damaged the house. Farmers Ins. Co. of Oregon v. Trutanich, 858 P.2d 1332 (Ore. Ct. App. 1993).

    An accidental release of ammonia into a packaging facility caused the facility to shutdown for one week while the ammonia dissipated. The court noted that while structural alteration provided the most obvious sign of physical damage, property can sustain physical loss or damage without experiencing structural alteration. The release of ammonia into the building, rendering the building unfit for occupancy, constituted "physical loss or damage."  Gregory Packaging, Inc. v. Travelers Prop. Cas. Co. of Am., 2014 U.S. Dist. LEXIS 165232 (D. N.J. Nov. 25, 2014). 

    Where gasoline vapors penetrated the foundation of the insured church and accumulated, rendering the building uninhabitable, the property was held to have suffered a "direct, physical loss." Western Fire Ins. Co. v. First Presbyterian Church, 437 P. 2d 52 (Colo. 1968). Carbon monoxide levels in an apartment building sufficient to render the building uninhabitable was a "direct, physical loss." Matzner v. Seaco Ins. Co., 1998 Mass. Super. LEXIS 407 (Mass. Super. 1998).

    Finally, contamination due to microscopic asbestos fibers was found to be contamination causing the physical loss or damage required to trigger coverage under a property policy.  United Stat Fidelity & Guar. Co. v. Wilkin insulation Co., 144 Ill. 2d 64 1991). 

    Based upon these cases, a building in which the virus is located may well present "direct physical loss" under a property policy. Of course, exclusions will also have to be considered to determine whether coverage exists. 

No Duty to Defend Breach of Contract Claim Which Does Not Constitute Property Damage

    The court determined there was no duty to defend because the underlying complaint alleged the contractor's breach of contract, but no property damage. Southern-Owners Ins. Co. v. Mac Contractors of Florida, 2020 U.S Dist. LEXIS 14611 (M.D. Fla. Jan. 29, 2020).

    KJIMS Construction contracted with the homeowners to construct their residence on a cost-plus basis. KJIMS did not perform substantial completion of the home, and either abandoned construction or was terminated from further performance by the homeowners. The homeowners served KJIMS with a Notice of Claim pursuant to Florida law, identifying 86 distinct defects that were caused by KJIMS and/or its subcontractors which KJIMS failed to correct.

    The homeowners filed suit against KJIMS, alleging breach of the cost-plus contract involving the repair and replacement of improper and/or defective materials, improper installation, and the use of materials that did not comport with building codes or plan specifications. The homeowners also alleged that they all incurred damages in having to complete the scope of work under the contract in amounts over and above the anticipated contract amount.

    Southern-Owners initially defended, but after an amended complaint was filed by the homeowners, Southern-Owners withdrew the defense. KJIMS retained its own counsel and eventually settled with the homeowners for $70,000. 

    Southern-Owners sued KJIMS for a declaratory judgment to establish it had no duty to defend or indemnify under the policy. The court noted that a claim for the cost of repairing or removing defective work was not a claim for property damage, while a claim for the costs of repairing damage caused by the defective work was a claim for "property damage." 

    Here, the underlying complaint asserted a claim for the costs of repairing or completing defective work, and not damages caused by the defects. Therefore, the court found that KJIMS had not proven that the underlying complaint brought the suit within the CGL policy's definition of "property damage." Therefore, Southern-Owners had no duty to defend or indemnify KJIMS. 

 

First Suit Filed for Losses Caused by COVID-19

    Last week, the first lawsuit was filed seeking insurance coverage for business-interruption due to losses caused by COVID-19. The case, Cajun Conti, LLC, et al. v. Certain Underwriters at Lloyd's of London, ,et al., was filed in Louisiana. A New Orleans restaurant, Oceana Grill," seeks a declaratory judgment that its "all risks" policy issued by Lloyd's covers losses resulting from the closure of its restaurant due to the Governor's order restricting public gatherings and the Mayor of New Orleans' order closing restaurants. 

    The lawsuit contends that "contamination of the insured premises by the coronavirus would be a direct physical loss needing remediation to clean the surfaces of the establishment." The lawsuit further alleges the policy contains no exclusions for a "viral pandemic." The suit seeks a declaration that "the policy provides coverage to plaintiffs for any future civil authority shutdowns of restaurants in the New Orleans area due to physical loss from coronavirus contamination and that the policy provides business income coverage in the event that the coronavirus has contaminated the insured premises." The obvious dispute will be whether the coronavirus  constitutes a "direct physical loss or damage" as required by the policy.

    Assuming there is "direct physical loss," the policy provides coverage for loss where "future civil authority shutdowns of restaurants in the New Orleans are due to physical loss from coronavirus contamination." Further, the policy provides "business income coverage in the event that the coronavirus has contaminated the insured premises."

    This is the first of what promises to be many lawsuits filed by businesses for losses caused by COVID-19. 

 

Umbrella Carrier Must Drop Down to Fill Gap in Coverage

    The umbrella insurer was required to drop down when the primary carrier's policy only covered the additional insured when it was vicariously liable for the named insured's operations. Am. States Ins. Co. v. Ins. Co. of the State of Pa., 2020 U.S. App. LEXIS 585 (9th Cir. Jan. 7, 2020).

    Sierra Pacific Industries and Howell's Forest Harvesting were sued for damages caused by the Moonlight Fires. Howell was insured by American States. Sierra was an additional insured under the American States policy, but only to the extent that Sierra was vicariously liable for Howell's operations. Sierra was insured under an excess and umbrella policy issued by Insurance Company of the State of Pennsylvania (ICSOP). 

    Because American's policy did not extend to Sierra's potential non-vicarious liability for the property damage caused by the fire, there was a gap in the scope of American's defense obligation in the underlying suits. The district court noted that when claims were covered by an umbrella policy but not by the underlying primary policy, the umbrella insurer dropped down to provide primary coverage.

    Further, because American and ICSOP shared the same level of obligation on the same risk for the same insured, and American undertook its defense duty while ICSOP did not, the district court correctly held American was entitled to equitable contribution of defense costs from ICSOP. 

    In addition to providing excess coverage, the ICSOP policy included an umbrella clause providing that ICSOP would cover "the total of all damages" resulting from property damage "covered by the [ICSOP] policy but not covered by an underlying policy." The ICSOP policy also created both excess and umbrella defense obligations. Its umbrella defense obligation provided that ICSOP had a "duty to defend any claim or suit seeking damages covered by" the ICSOP policy "but not covered by any underlying insurance."  Since the American policy provided for a duty to defend only with respect to Sierra's vicarious liability, the district court correctly determined that the ICSOP had a duty to drop down and defend the underlying suits in a co-primary capacity with American.

   In apportioning defense costs, the district court determined that the most equitable approach was to split costs equally between American and ICSOP. This was not an abuse of discretion. 

    Finally, the district court should have awarded prejudgment interest to American. The case was remanded with an instruction to award prejudgment interest to American. 

    

New York Instructs Property Carriers to Advise Insureds on Business Interruption Coverage

    The New York Department of Financial Services (DFS) took the unusual step last week of instructing all property/casualty insurers to provide information on commercial property insurance and details on business interruption coverage in light of the COVID-19 outbreak. The notice is here. 

    The notice recognizes that policyholders have urgent questions about the business interruption coverage under their policies. Insurers must explain to policyholders the benefits under their policies and the protections provided in connection with COVID-19. 

    The explanation to policyholders is to include the following relevant information.

What type of commercial property insurance or otherwise related insurance policy does
the insured hold?

Does the insured's policy provide "business interruption" coverage? If so, provide the
"covered perils" under such policy. Please also indicate whether the policy contains a
requirement for "physical damage or loss" and explain whether contamination related
to a pandemic may constitute "physical damage or loss." Please describe what type of
damage or loss is sufficient for coverage under the policy.

Does the insured's policy provide "civil authority" coverage? If so, please describe
what type of damage or loss is sufficient for coverage under the policy. Please also
describe any relevant limitations under the policy. Please explain whether a civil
authority prohibiting or impairing the policyholder's access to its covered property in
connection with COVID-19 is sufficient for coverage under the policy.Does the insured's policy provide "contingent business interruption" coverage? If so,
please describe what type of damage or loss is sufficient for coverage under the policy.
Please provide the "covered perils" under such policy. Please also indicate whether the
policy contains a requirement for "physical damage or loss" and explain whether
contamination related to a pandemic may constitute "physical damage or loss."

Does the insured's policy provide "supply chain" coverage? If so, is such coverage
limited to named products or services from a named supplier or company? Please also
indicate whether the policy contains a requirement for "physical damage or loss" and
explain whether contamination related to a pandemic may constitute "physical damage
or loss."

For each instance of coverage described above, please provide the applicable waiting
period under the insured's policy. Please also indicate whether the amount of time
coverage remains in effect once becomes active for a given incident.

    We are unaware of any similar order being issued by the Hawaii Division of Insurance, but policyholder likely have concerns similar to those in New York.

Claims of Contamination by Lead Paint Must be Defended

    In an unpublished decision, the Illinois Appellate Court determined that claims against the insured painting contractor had to be defended by the CGL carrier. Owners Ins. Co. v. Precision Painting & Decorating Corp., 2019 Ill. App. Unpub. LEXIS 2425 (Ill. App. Ct. Dec. 31, 2019).

    The homeowners hired Precision to paint the exterior of their home. Portions of the home were pointed with lead-based paint. Prior to the work, there were no visible paint chips or dust on the interior or exterior of the property. 

    The contract required that all preparation work be done according to EPA regulations for lead-based paint. The regulations required  Precision to take special care to contain lead dust while working on the home. The underlying complaint alleged that Precision failed to abide by the safety requirements. Precision did not clean up lead-based paint dust and debris on and around the home at the end of the work day.

    Testing after completion of the scrapping job showed interior dust in 16 of 20 samples exceeded the limits for lead in dust set by the Illinois Department of Public Health. Even the land around the home showed lead in the soil that exceeded the Department of Health limits. Consequently, the homeowners were required to pay for contamination clean-up. 

    The homeowners sued Precision, who tendered the defense to Owners. Owners then filed a complaint for declaratory judgment seeking a declaration that it had no duty to defend because no property damage caused by an occurred was alleged in the underlying complaint. Precision counter-claimed for breach of contract. The parties filed cross-motions for judgment on the pleadings.

    The circuit court granted Owners' motion, finding no duty to defend. There was no "occurrence" because the contract specifically contemplated that there would be lead in the paint and provided for various EPA-required precautions that Precision would take. Precision's failure to properly contain the lead, resulting in the contamination, was thus not an "accident." 

    The appellate court noted that instead of focusing on the foreseeability of the event (the release of lead-based particles), or even generally the damages (lead contamination), the case law instructed the focus be on what, specifically, was damaged, and whether the remediation of that damage fit within the general purpose of a CGL policy. When the underlying lawsuit alleged damages beyond repair and replacement, and beyond damage to other parties of the same project over which the contractor was responsible, those additional damages were deemed to be the result of an "accident." 

    There was no question that the allegations here constituted an "accident" and thus an "occurrence." Precision was hired to work on the exterior of the home. The "work product" - the scope of Precision's project - was the exterior of the house. The underlying complaint alleged that Precision's negligence caused damage well beyond that. In great detail, the homeowners alleged that the lead dust infiltrated the interior of their home, as well as the surrounding land. The homeowners were not claiming that the exterior walls were painted defectively and must be repaired or repainted; they alleged other parties of their property - the interior and surround land- were damaged. Therefore, the underlying complaint alleged damages caused by an "occurrence." Owners was not entitled to judgment on the pleadings on this ground. 

    The case law also held that damage to property that extended beyond the work product of the contractor was "property damage." The underlying complaint alleged damage beyond the exterior of the home, to which Precision's work product was limited. The underlying complaint alleged damage to the interior of the home and its surrounding land These allegations constituted "property damage" under the policy. 

    Therefore, Owners had a duty to defend.

    

Insurance Coverage and COVID-19

    Individuals and businesses are asking what insurance coverage might be available for harm caused by COVID-19 and the coronavirus. Here is a short survey addressing possible coverage under various policies.

    Property Insurance - Typically, damage to tangible property by "covered causes of loss" is covered by a commercial property or homeowner's policy. The policy frequently requires a "direct physical loss." Loss caused by fire or hurricane are examples of covered perils. Tangible property that becomes unusable may be covered.Some courts have found that contamination rendering property uninhabitable constitutes a "physical loss." Arguably, these terms do not rule out the possibility of damage caused by the presence of microscopic organisms or require that loss or damage be visible.  Issues an insured may face, however, include the cause of the loss, whether an exclusion for viral contamination applies, or whether a building was unusable or voluntarily closed.  

    Business Interruption - Commercial property policies may include business interruption coverage for loss of income due to suspension of business operations. The closing of a business must be due to a covered cause of loss. Actions by government or law enforcement forcing the closure of a business may be a covered cause of loss. Restricting access to a business where transmission of an infectious disease is suspected may lead to coverage for income losses. Business interruption claims can be complex and often require the assistance of experts such as accountants. 

    Contingent business interruption coverage applies if a supplier or customer has to suspend operations, thereby impacting the business of the insured. 

    Directors and Officers - If a corporation faces a securities lawsuit due to its failure to disclose the impact of coronavirus on its business, a directors and officers policy may be implicated. With the recent stock market plunge, investors are likely to investigate whether proper precautions were taken to reduce losses in the stock market and elsewhere. 

    Workers Compensation - Employees contracting the coronavirus at the workplace or in the course and scope of their employment may seek coverage under workers compensation. Further, employees traveling from the workplace to an infected area or those stationed in an infected area may seek coverage under workers compensation if they become infected.

    Liability Coverage - Liability policies typically cover bodily injury or property damage caused by an occurrence, or accident. Liability policies protect businesses against third-party claims for bodily injury resulting from exposure to dangerous conditions. Guests of hotels, restaurants, malls, sporting events, or an office who allege they contracted the coronavirus could sue the owners and/or operators of such facilities. Such suits could be based upon the owners and/or operations' failure to exercise reasonable care in guarding against the danger or failing to warn customers. Liability policies may exclude communicable diseases. 

    The availability of coverage under various policies will heavily depend upon the facts surrounding an incident and the policy language. As always, give notice to the carrier as soon as possible after a loss and document the loss as completely as possible

    Be safe and check your coverage.

 

Coverage Established for Ransomware Attack

    The court found direct physical loss was established, allowing coverage for a ransomware attack on the insured's computer server and networked computers. Nat'l Ink & Stitch, LLC v. State Auto Prop. & Cas. Ins. Co., 2020 U.S. Dist. LEXIS 11411 (D. Md. Jan. 23, 2020).

    The insured stored art, logos, and designs for its business on its computer server. An ransomware attack prevented the insured from accessing all of the art files and other data contained on the server, and all of its software. The attacker demanded payment of a bitcoin to release access to the software and data. The insured retained a security company to replace and reinstall its software and to install protective software on its computer system. Although the computers still functioned, installation of protective software slowed the system and resulted in a loss of efficiency. The art files could not be accessed, and the insured had to recreate them. 

    The insured submitted its claim to State Auto. The policy provided State Auto:

will pay for the direct physical loss of or damage to Covered Property at the premises described in the Declarations caused by or resulting from any Covered Cause of Loss. 

The Businessowners Special Form Computer Coverage endorsement defined "Covered Property" to include "Electronic Media and Records (Including Software)." "Electronic Media and Records" included,

(a) Electronic data processing, recording or storage media such as films, tapes, discs, drums or cells;

(b) Data stored on such media.

    State Auto denied coverage for the cost of replacing the insured's computer system. State Auto concluded there was no "direct physical loss of or damage to" the computer system to justify the replacement cost for the entire system under the policy.

    State Auto contended that because the insured only lost data, an intangible asset, and could still use its computer system to operate its business, it did not experience "direct physical loss" as covered by the policy. The insured argued that the policy's language contemplated computer data and software to be property subject to "direct physical loss," and that its computer system itself sustained damage, in the form of impaired functioning. 

    The court held that the insured could recover based on either (1) the loss of data and software in its computer system, or (2) the loss of functionality to the computer system itself. The policy expressly listed "data" as an example of Covered Property under its definition of "Electronic Media and Records (Including Software)." Therefore, the plain language of the policy contemplated that data and software were covered and could experience "direct physical loss or damage." 

    The insured also demonstrated damage to the computer system itself, despite its residual ability to function. State Auto equated "physical loss or damage" to the computer system to require an utter inability to function. The policy language and relevant case law imposed no such prerequisite. Loss of use, loss of reliability or impaired functionality demonstrated the required damage to a computer system, consistent with the "physical loss or damage to" language in the policy. Not only did the insured lose its data and software, but was left with a slower system, making it unable to access a significant portion of software and stored data. Because the plain language of the policy provided coverage for such losses and damage, summary judgment was granted in favor of the insured.

"Your Work" Exclusion Bars Coverage

    Although the appellate court agreed there was property damage caused by an occurrence, the "your work" exclusion barred the insured contractor's claim. King's Cove Marina, LLC v. Lambert Commercial Construction. LLC, 2019 Minn. App. LEXIS 389 (Minn. Ct. App. Dec. 16, 2019).

    King's Cover Marina sought to expand and remodel its main building. The marina hired Lambert to perform the remodeling project. Lambert hired Roehl Construction, Inc. as a subcontractor to install new concrete footings on the main level of the building and to provide concrete for the second-level mezzanine floor.

    After completion, the marina sued Lambert for breach of contract and negligence. The marina alleged that the concrete floors on the first and second levels were not constructed in accordance with industry standards or with project plans and specifications, resulting in excessive movement and cracking of the new concrete floors. Lambert tendered its defense to its insurer, United Fire & Casualty Company. United Fire defended under a reservation of rights and later sued Lambert for declaratory judgment. 

    While the declaratory judgment action was pending, Lambert and the marina settled the underlying lawsuit. Lambert confessed judgment in the marina's favor in the amount of $2 million. Judgment was entered against Lambert. The marina filed a supplemental complaint for garnishment against Untied Fire. United Fire answered, asserting that the settlement was unreasonable because it failed to allocate between covered and non-covered damages. The trial court determined on summary judgment there was coverage for the claims and damages asserted by the marina against Lambert. United Fire appealed.

    The appellate court agreed with the trial court's determination that there was property damage caused by an occurrence. However, Exclusion (l) applied to bar coverage. The provision excluded coverage for:

"Property damage" to "your work" arising out off it or any part of it and included in the "products-completed operations hazard."

This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.

The products-completed operations hazard included "all 'bodily injury' and 'property damage' occurring away from premises you own or rent and arising out of 'your product' or 'your work.''"

    Here, any costs associated with repairing or replacing Lambert's faulty work were barred by Exclusion l. The marina's claimed damages arose at least in part out of Lambert's work and any damages associated with repairing such work were excluded from coverage by Exclusion l. 

    The exception for subcontractors under Exclusion l was not applicable because the settlement agreement between the marina and Lambert was limited to roofing and siding performed by Lambert and excluded the concrete work performed by Roehl. Thus, the subcontractor exception to Exclusion l did not apply to the claims at issue in the settlement agreement. 

    The settlement agreement was also unreasonable as a matter of law because it did not allocate between covered and non-covered damages. The trial court failed to distinguish between repair-and-replacement damages caused by work Lambert was hired to perform - to which Exclusion l applied - and damages to adjacent structures that were not caused by, though arising from, Lambert's construction work. 

Procedural Bad Faith Presentation

  Our panel addressed Procedural Bad Faith this morning at the ABA’s Insurance Coverage Litigation Committee’s annual seminar this morning in Tucson, AZ.