Super Storm Sandy caused widespread power outages throughout the New York metropolitan area in late October 2012, rendering it impossible for many companies and firms to conduct business. In Newman Myers Kreines Gross Harris, P.C. v. Great Northern Ins. Co., Civil Action No. 13-CV-2177 (S.D.N.Y. Apr. 24, 2014), a law firm with an office in New York, NY purchased a property insurance policy that included coverage for loss of business income and extra expense. The policy provided coverage due to a business interruption “caused by or result[s] from direct physical loss or damage by a covered peril …” to the covered premises. On October 29, 2012, with the storm bearing down on New York City, the area’s electrical power servicer preemptively shut off the power to three utility service networks to preserve its equipment in the event of flooding. The power interruption affected the law firm’s building, essentially closing it for five days. The firm filed a business interruption claim under its property policy, which the insurer denied because the law firm did not suffer a covered loss under the policy, and the law firm subsequently filed suit.
On the parties’ motion and cross-motion for summary judgment, the Southern District of New York held that preventive power outages rendering an office building unusable did not constitute “direct physical loss or damage” to the covered premises and, therefore, did not trigger coverage for loss of business income and extra expense under the property insurance policy. The district court noted that a “direct physical loss or damage” to the covered premises was a condition precedent to coverage under the policy.
The law firm had argued that “direct physical loss or damage” did not require actual structural damage; rather, there only needed to have been a change to the covered premises from an initial satisfactory state into an unsatisfactory state caused by some external event. The firm relied on case law from other jurisdictions, where courts applying other states’ laws found that an external event (such as an invasion of noxious or toxic gases, contamination of well water, and threat of imminent rockfall) rendering the premises unusable and uninhabitable constituted a “direct physical loss or damage” despite not being tangible, structural, or even visible. The district court distinguished those cases because each involved the closure of a building due to either a physical change for the worse, or a newly discovered risk to the physical integrity of the premises. Conversely, the law firm’s building was closed after the decision was made to preemptively shut off power to preserve equipment at the power supply and distribution centers. The district court reasoned that the words “direct” and “physical” modified the phrase “loss or damage” and, therefore, connote a need for actual, demonstrable harm of some form to the premises in order to trigger coverage. The court found that the “forced closure of the premises for reasons exogenous to the premises themselves, or the adverse business consequences that flow from such closure,” did not constitute a “direct physical loss or damage” to the premises. The district court held that the insured law firm failed to meet its burden of showing that the policy covered its losses and, therefore, granted the insurer’s motion for summary judgment and dismissed the case with prejudice.
The court’s holding reminds us that the phrase “direct physical loss or damage” in a property insurance policy should not be read so broadly as to include claims regarding mere loss of use of premises. This case reinforces the requirement that there be a direct physical change for the worse to the premises, or a newly discovered risk to the physical integrity of the premises, in order to trigger loss of business income and extra expense coverage. Without such “direct physical loss or damage” to the covered premises, the insured cannot meet its burden of proof to establish coverage.