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Insurance Coverage and Bad Faith

Eleventh Circuit Ruling Interpreting “Direct Physical Loss” is a Win for Insurers and Could Impact Coronavirus Business Interruption Claims

The Takeaway

As coronavirus business interruption claims continue to be filed and make their way through courts across the country, an August 18, 2020 opinion from the Eleventh Circuit Court of Appeals could influence how Florida’s federal trial courts rule on those claims.

In Mama Jo’s Inc. v. Sparta Insurance Company, Case No. 18-12887, the Eleventh Circuit Court of Appeals, interpreting Florida law, ruled that “an item or structure that merely needs to be cleaned has not suffered a ‘loss’ which is both ‘direct’ and ‘physical.’” Accordingly, the court found that the insurer properly denied coverage for an insured’s property damage and business interruption claims.

This ruling is a clear win for insurers that have taken the position that business closures as a result of the coronavirus pandemic are not covered because of the absence of “direct physical loss of or damage to covered property.” Although unpublished, this opinion could have an impact on coronavirus business interruption claims that end up in Florida federal courts, because the Eleventh Circuit interpreted the same “direct physical loss or damage” language at issue in those claims. 

The Claim

This case arose out of a claim for building damage and loss of business income due to nearby roadway construction causing dust and debris to migrate into an insured restaurant.  The insured performed daily cleaning using its normal cleaning methods, which consisted of dust pans, hoses, rags, towels, and blowers.  The restaurant was open every day and maintained the ability to serve the same number of customers while the roadwork was ongoing, but it claimed that customer traffic had significantly decreased.  Accordingly, the insured restaurant submitted a claim to its insurance company for property damage ($16,235.58 to clean and paint the restaurant) and loss of business income ($292,550.84).

The insured had an “all-risk” commercial property policy, which insured the building, and also had a Business Income (and Extra Expense) Coverage Form.  The building coverage form covered “direct physical loss of or damage to Covered Property . . . caused by or resulting from any Covered Cause of Loss.”  The Business Income (and Extra Expense) Coverage Form covered actual loss of business income due to the necessary suspension of operations caused by “direct physical loss of or damage to” covered property.

The insurer denied the restaurant’s property damage and business interruption claims due to the absence of physical damage at the restaurant and because “it [was] also questionable whether a direct physical loss occurred.”

The Ruling

The Eleventh Circuit affirmed the trial court’s rulings that:

(1) the claim for cleaning was not covered because property that must be cleaned, but is not damaged, has not sustained a “direct physical loss;

(2) direct physical loss refers to tangible damage to property, which causes it to become unsatisfactory for future use or requires repairs; and

(3) the business interruption claim was not covered because the insured could not establish that it suffered a necessary suspension of its operations as the result of a “direct physical loss.”

With respect to the property damage/cleaning aspect of the claim, the court reasoned that summary judgment to the insurer was proper because “under Florida law, an item or structure that merely needs to be cleaned has not suffered a ‘loss’ which is both ‘direct’ and ‘physical.’” As support, the court cited to a Sixth Circuit opinion finding that cleaning expenses are “economic losses,” and not tangible, physical losses.

With respect to the business interruption claim, the court concluded that the failure to show evidence of a “direct physical loss” precluded coverage for the claim.

Conclusion

A critical issue in coronavirus business interruption claims is whether economic loss resulting from a business shut down is caused by “direct physical loss of or damage to covered property.”  In this case, the Eleventh Circuit held that the claimed economic loss was not covered because the purported dust and debris inside the restaurant was not direct physical loss or damage to the property. 

This case should be helpful to insurers litigating coronavirus business interruption claims because it stands for the proposition that “direct physical loss” means something more than economic loss.  According to the Eleventh Circuit, direct physical loss “contemplates an actual change in insured property,” and a business interruption claim will not be covered if that threshold requirement is not met.

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