Archive for the ‘Property Coverage’ Category

Cannonball! CGL Policy Does Not Cover Pool Contractor for Subcontractor’s Negligence

Tuesday, October 7th, 2014

By Jeffrey Dillon, Sedgwick New York

In Standard Contractors, Inc. v. National Trust Ins. Co., Civil Action No.:7:14-cv-66-HL, the U.S. District Court for the Middle District of Georgia recently granted a commercial general liability insurer’s motion to dismiss a contractor’s coverage action on the ground that the policy’s “Contractors Errors and Omissions” coverage applied only to property damage to the contractors’ work arising from the contractor’s own negligence, not that of its subcontractor.

The contractor sought coverage for the costs it incurred to repair damage to a pool facility it was hired to renovate. The contractor alleged that the damage to the pool and surrounding areas arose from the faulty workmanship of its subcontractor, which allegedly deviated from the design plan by failing to include essential parts and installing an improperly sized component.

In relevant part, the subject policy’s Contractors Errors and Omissions coverage applied to “property damage” to the contractor’s work “due to faulty workmanship, material or design….”  However, in order for coverage to apply, the damages must have resulted from the contractor’s negligent act, error or omission while acting in its “business capacity as a contractor or subcontractor.”  The policy specifically exempted from this coverage “[a]ny liability for ‘property damage’ to ‘your work’ if the damaged work or the work of which the damages arises was performed on your behalf by a subcontractor.”

The court ruled that the exemption prohibited the contractor’s claim for coverage, which the court found to arise solely from the negligent work of its subcontractor.  The court rejected the contractor’s argument that an exception to a policy exclusion, which appeared to extend coverage to damages arising out of work performed on the contractor’s behalf by a subcontractor, demonstrated that coverage attached.  The court found that the more specific and limited language of the coverage grant prevailed over the more broadly inclusive language of the exception to the policy exclusion.

 

 

Lost Cargo is Dead Weight: Insurer Avoids Coverage Due to Breach of “Deadweight Warranty” in Marine Policy

Friday, October 3rd, 2014

By Alex J. Potts, Sedgwick Bermuda

In Hua Tyan Development Ltd v Zurich Insurance Co Ltd [2014] HKCFA 72, the Hong Kong Court of Final Appeal dismissed a marine insurance claim on grounds of breach of warranty by an insured.

The parties entered into an insurance contract with respect to a shipment of a cargo of logs from Malaysia to the People’s Republic of China.   The contract contained a clause warranting the vessels’ deadweight capacity to be no less than 10,000 tons (the “Deadweight Warranty”).

In mid-January 2008, the vessel sank and the cargo was lost.  The insurers rejected the insured’s claim in connection with the loss on the basis that the Deadweight Warranty had been breached, as the vessel only had a deadweight capacity of about 8,960 tons.

The court held that insurers are entitled to rely on the Deadweight Warranty, despite the insured’s various arguments based on estoppel, waiver and rectification. The court found no inconsistency in the insurance contract with respect to the identification of the vessel by name and the existence of the Deadweight Warranty.

The judgment provides considerable certainty and clarification to insurers operating in the Hong Kong marine insurance market, to the effect that insurance contracts will be enforced in accordance with their terms. Although a Hong Kong court decision, the judgment should be of interest to London and Bermuda insurers and P&I clubs for a number of reasons:

  1. Hong Kong’s Marine Insurance Ordinance of 1961 largely follows the UK’s Marine Insurance Act 1906, which was in turn a codification of the common law. As in England and Bermuda, breach of a marine insurance warranty discharges an insurer’s liability automatically as of the date of breach.
  2. This is a topical area of law which is the subject of review, and likely statutory reform, in the UK.
  3. The dismissal of the appeal means that the insured’s brokers have been found liable to indemnify the insured with respect to the vessel’s insured value. The precise circumstances giving rise to the broker’s liability were not fully explored in the judgment; however, the case demonstrates the liabilities that brokers face in practice, when cover is successfully denied by insurers.

British Columbia Supreme Court: Property Policy’s Pollution Exclusion Not Subject to Proximate Cause Analysis

Monday, September 29th, 2014

By Timothy Kevane, Sedgwick New York

An insured’s argument to broadly apply an exception to a pollution exclusion was recently rejected by the British Columbia Supreme Court in Whitworth Holdings Ltd. v. AXA Pacific Insurance Co., 2014 CarswellBC 2648, 2014 BCSC 1696 (Sept. 9, 2014).  There, the court was called on to resolve the application of the exclusion to a sequence of events involving excluded pollution and a non-excluded fire peril.

The insured’s commercial building was damaged in a fire.  As a result of the fire, chemicals escaped from one of the tenants’ fertilizer, herbicide and pesticide wholesale operation, causing pollution damage.  The building was insured by an all-risk property insurance policy.  Among other things, the policy excluded coverage for damage or expense arising from the clean-up due to any release of pollutants, but exempted any loss to the property “caused directly by an insured peril … not otherwise excluded elsewhere in the Policy.”  The insurer argued that the exception ensures coverage exists for fire damage, but not for clean-up of pollutants contaminating property not damaged by fire.  In that case, the cause of the damage was the escape of the pollutants, not the fire.

The insured argued that the exception requires a proximate cause analysis.  According to the insured, the “proximate cause” of the pollution damage was an insured peril, the fire.  That is, but for the fire, the pollutants would not have escaped.  In the insured’s view, any other interpretation would render the exception in the exclusion meaningless, as physical loss caused by fire is already covered regardless of the exception.

The court, however, agreed that the language of the exception – particularly the word “direct” – does not call for a proximate cause analysis.  Relying on the British Columbia Court of Appeal’s reasoning that “direct” describes “an event lead[ing] straight or immediately to its consequence,” the court concluded that the fire and the chemical spill were two distinct events, just as the Court of Appeal found two distinct events in a prior case involving damage to pipes by freezing and damage from the discharge of water.  Neither could be described as a semantic or specious distinction. The court thus adopted the insurer’s interpretation, rejecting the notion that it creates any redundancy in the policy.  To illustrate, the court imagined a reversal of the facts, in which an escape of pollutants subsequently caused fire damage.  The exclusion would bar coverage for the fire damage, thus necessitating the exception to reinstate coverage for the covered fire damage.  Accordingly, the court upheld the application of the exclusion to bar coverage for the pollution damage where it was not directly caused by the fire.

Please click here for a description of Sedgwick’s Canada Insurance practice.  The lawyers in the group are watching coverage decisions and news from Canada for publication on the Insurance Law Blog.

Business Interruption Insurance: Clearing up the Confusion

Tuesday, September 16th, 2014

By Alex J. Potts, Sedgwick Bermuda

In Eurokey Recycling Ltd v Giles Insurance Brokers Ltd [2014] EWHC 2989 (Comm), the English Commercial Court has confirmed the nature of an insurance broker’s duties to its clients when obtaining Business Interruption Insurance (BII) cover.

This case arose out of a broker’s negligence claim, brought by a waste recycling company that had suffered significant losses following a fire. The court dismissed the claim on the basis that the broker had satisfied its duty of care, and it was the company’s own acts or omissions that had resulted in it being under-insured.

The court summarized the broker’s obligations as follows:

  • A broker is not expected to calculate the BII sum insured or choose an indemnity period (which are matters for the commercial client).
  • A broker must, however, explain to the client the method of calculating the sum insured, technical policy terms such as “estimated gross profits” and “maximum indemnity period,” and relevant considerations when choosing a maximum indemnity period.
  • A broker will need to take reasonable steps to ascertain the nature of the client’s business and its insurance needs, but not necessarily by way of detailed investigation. The nature and scope of a broker’s obligation to assess a commercial client’s BII needs will depend upon the circumstances, including the client’s sophistication, and the number of times the broker has met the client in the past.
  • Although BII is for commercial clients, the level of client sophistication will vary enormously. It cannot be assumed that a small or medium-sized enterprise (an SME) will have any understanding of the nature of BII cover.
  • If a client who appears to be well informed about his business provides a broker with information, the broker is not expected to verify that information unless he has reason to believe that it is not accurate.
  • Having satisfied these obligations, a broker must exercise reasonable care to adhere to express instructions as to the BII cover to be obtained.

Although the outcome of the case turned on its own facts, the legal principles are important to the way in which insurance brokers conduct themselves when placing BII risk in the London market, and they should be of interest to brokers’ professional indemnity insurers.

The court made two observations of relevance to the London market collectively. The court noted that, notwithstanding the contract certainty initiative in the London market, there were certain aspects of standard BII policy wordings, such as the definition of gross profit and the calculation of indemnity periods, which still remained unclear for clients, brokers, loss adjusters, and even some insurers. The court also noted that the insurance industry, unlike other parts of the financial services industry, did not yet have standard procedures in place for the identification and recording of sophisticated clients.

It remains to be seen whether the same standard of care is imposed on brokers in the Bermuda insurance and reinsurance market, given certain differences in market practice in London and Bermuda, and the sophisticated nature of many Bermuda (re)insureds.

Sandy in the Courts

Tuesday, July 29th, 2014

Estimates of insured losses from Superstorm Sandy have approached $30 billion. Since late 2013, the courts have been handling numerous insurance cases arising out of the storm.  In this article, Sedgwick’s Michael Topp and Kara DiBiasio review how the federal court in New York (Eastern District) is coordinating the many cases filed in connection with homeowners’ claims.  They also summarize the written opinions that have been issued to date concerning coverage issues raised by Sandy under commercial policies.  The article is available for download here.

The Insurance Law Blog has been updating readers on key Sandy decisions, and we expect many more substantive cov­erage decisions from the courts through­out this year. Concurrent causation, “Named Storm,” and business interrup­tion issues are likely to be heavily con­tested, and Sedgwick and the Insurance Law Blog will continue to monitor the Sandy-related opinions impacting both homeowners and commercial insurers.

Not Feeling It: Court Nixes Claim for Feng Shui Fees and Finds No Bad Faith

Tuesday, June 17th, 2014

By Timothy Kevane, Sedgwick New York

In Patel v. American Economy Ins. Co., — F. Supp. 2d. —, 2014 WL 1862211 (N.D. Cal. May 8, 2014), the U.S. District Court for the Northern District of California granted the insurer’s motion for partial summary judgment, finding no coverage for the fees of a feng shui consultant, rejecting business losses outside the specified period, and concluding there was no bad faith.

The insured dental office suffered smoke damage due to a fire in the basement of premises it occupied.  Among other expenses submitted to its property insurer was a bill for $50,000 from its feng shui consultant who provided advice with respect to crystal replacements, energy balance restoration, furniture placement, and the alignment of Qi forces.  The court held that such expenses did not constitute a “direct physical loss” covered by the policy as they did not involve damage to tangible, material objects.  Furthermore, there was no evidence these expenses were incurred to minimize the suspension of the business and to continue operations (as a covered “extra expense”).  The court held that the extra expense provision was not rendered vague simply because it did not specifically exclude feng shui costs from coverage.

The court also rejected the insured’s supplemental claim for lost business income when it had to shutter its business in 2014 due to additional repairs to the building relating to the original fire, which occurred five years earlier.  The insured argued that the policy covered twelve months’ worth of lost income, and because it initially claimed only one month of lost income immediately after the fire, it remained eligible for another eleven months of coverage.  The court rejected this argument as the business income coverage was limited to the defined “period of restoration,” subject to the requirement that lost income must be sustained within twelve consecutive months from the date of loss.  The court found that it made no difference that restoration work may have resumed outside this limiting period.

Lastly, the court rejected the claim that the insurer disregarded in bad faith the insured’s need to relocate in 2014, citing the absence of any underlying contractual obligation to cover the 2014 lost income.

 

Illinois “Blasts” Non-TCPA Causes of Action Out of Coverage

Tuesday, June 10th, 2014

By Stephanie Sauvé, Sedgwick Chicago

In G.M. Sign, Inc. v. State Farm Fire & Cas. Co., 2014 IL App (2d) 130593 (May 2, 2014), the Illinois appellate court enforced a policy’s Violation of Statutes Exclusion endorsement to preclude coverage for a settlement arising out of an underlying blast-fax lawsuit that alleged various causes of action.

The underlying lawsuit was a class action in which G.M. Sign sued Michael Schane (“Schane”) and Academy Engraving Company for sending unsolicited fax advertisements. G.M. Sign asserted three causes of action in its amended complaint:  violation of the federal Telephone Consumer Privacy Act of 1991 (“TCPA”), conversion, and violation of the Illinois Consumer Fraud and Deceptive Business Practices Act.  The latter two counts made no express reference to the TCPA, but each count was based on the sending of unsolicited fax advertisements to G.M. Sign and others.  Schane later entered into a settlement agreement in which he stipulated to the entry of judgment against him for $4.9 million, to be satisfied with insurance proceeds.

Schane tendered the suit to his insurer, State Farm.  His insurance policy contained a Violation of Statutes Exclusion endorsement precluding coverage for property damage or advertising injury “arising directly or indirectly” out of any action or omission that violates or is alleged to violate the TCPA or any other statute that prohibits or limits the sending, transmitting, communicating, or distribution of material or information.  Citing this exclusion, the insurer denied coverage because the amended complaint alleged violations of the TCPA.

Thereafter, G.M. Sign filed a declaratory judgment action against State Farm claiming coverage under Schane’s policy.  On cross-motions for summary judgment, the trial court found that the insurer had a duty to defend and indemnify Schane, but the appellate court reversed.  The appellate court determined that the insurer had no duty to defend in connection with the amended complaint because the exclusion applied to all counts in the amended complaint.  The court reasoned that the proper analysis of the “arising out of” language in the Violation of Statutes exclusion is a “but for” analysis — if the alleged injury would not have occurred “but for” a violation of the TCPA, then the exclusion barred coverage for the alternative causes of action which arose from the same conduct underlying the alleged TCPA violation.

Look here for more Sedgwick articles related to insurance coverage for violations of the TCPA.

District Court Seeks to Streamline Hurricane Sandy Insurance Cases Through Dismissals

Friday, June 6th, 2014

By Jeffrey Dillon, Sedgwick New York

Yesterday, in the In re Hurricane Sandy Cases, Civil Action No.: 1:14-mc-00041-CLP-GRB-RER, a committee of magistrates in the Eastern District of New York recommended that the district judges presiding over more than 150 lawsuits against insurance companies arising from Hurricane Sandy dismiss numerous state law causes of action and damages claims. The magistrates, who have been appointed to manage more than 1,000 civil actions arising from the hurricane, based their recommendation on prior rulings in Sandy-related cases that certain state law claims and types of damages are not cognizable under New York law. On February 21, 2014, the magistrates directed plaintiffs to voluntarily dismiss claims or damages not recognized by New York law, or submit letters to the Court explaining the legal basis for continuing to pursue such claims. Those plaintiffs who did not respond to the Court’s directive are now subject to the committee’s June 5th Report and Recommendation.

The committee’s recommendation is aimed at avoiding “wasteful and unnecessary” motion practice before the District Court in each of the individual Sandy-related cases, and to resolve claims that are not cognizable under New York law. Plaintiffs have 14 days from receipt of the Report and Recommendation to file objections with the Court or they will be deemed to have waived their right of appeal.

Among the state law claims to be dismissed are: (i) fraudulent misrepresentation and inducement – on the ground that plaintiffs have failed to allege the necessary elements of a legal duty owed by the insurer separate from its duty to perform under the policy and entitlement to special damages; (ii) breach of the implied covenant of good faith and fair dealing – on the ground that New York courts do not recognize a separate cause of action for breach of the implied covenant when a breach of contract claim is also pled on the same facts; (iii) bad faith denial of insurance coverage – on the ground that plaintiffs have not alleged conduct actionable as a tort, independent of the underlying insurance contract; and (iv) claims under Section 349 and 350 of New York General Business Law­ – on the ground that plaintiffs have not alleged injury independent of loss caused by an alleged breach of contract.

The committee also recommended the dismissal of demands for punitive damages, because plaintiffs have not identified that the insurers’ conduct was actionable as an independent tort, and any claims for attorney’s fees, which are not recoverable in actions against insurers to settle rights under a policy.

 

Is Defective Construction an “Occurrence”? More States Are Answering Yes

Tuesday, May 27th, 2014

By Aaron F. Mandel and Stevi A. Siber-Sanderowitz, Sedgwick New York

Last year, we examined the different approaches states have adopted to resolve whether defective construction by itself is an “occurrence” within the meaning of liability insurance policies.  See Is Defective Construction Work an “Occurrence”?  The Answer Isn’t So Concrete, Insurance Coverage Law Report (May 2013).  Since then, a number of states either have seen their highest courts depart from precedent by concluding that such claims satisfy the “occurrence” requirement, or have sought to pass legislation requiring liability policies to define “occurrence” to include faulty construction work.  Below is a summary of these developments, as well as a recommendation on how to address this trend.

The trendsetter appears to have been the West Virginia Supreme Court’s decision in Cherrington v. Erie Insurance Property & Casualty Co., 745 S.E.2d 508 (W. Va. 2013).  As previously reported on the Insurance Law Blog, that case involved a lawsuit arising out of defects at a newly constructed residential project.  Only the project itself suffered damage, and the builder’s liability insurer denied coverage on the ground that, among other reasons, allegations of defective construction do not constitute an “occurrence.”  This position aligned with several prior West Virginia Supreme Court decisions.  Ignoring precedent and stare decisis, the Cherrington court overhauled West Virginia law and held that the term “occurrence” in general liability policies includes defective construction.  The court reasoned that, by defining “occurrence” to mean “an accident,” all damages or injuries unintentionally caused by an insured fall within a liability policy’s insuring agreement.  The court supported its conclusion by noting that the “your work” exclusion implied damage to the insured’s work must be within the insuring agreement.  Otherwise, the exclusion would be meaningless.

Taking Cherrington’s lead, the North Dakota Supreme Court in K&L Homes, Inc. v. American Family Mutual Insurance Co., 829 N.W.2d 724 (N.D. 2013), also reversed course and held that defective construction may constitute an “occurrence” provided that the insured did not expect or intend the faulty work and resulting damage.  There, homeowners claimed their homes were damaged because of substantial shifting caused by improper footings and inadequately compacted soil under the homes’ footings and foundations.  After examining the standard general liability form’s drafting history and surveying cases nationwide, the court concluded that defective construction could qualify as an “occurrence” under the builder’s liability policy if the builder did not intend or expect the faulty work and the “property damage” was not anticipated or intentional.  Although the North Dakota Supreme Court previously had held that faulty or defective workmanship standing alone is not an “occurrence,”¹ the K&L Homes court explained its decision by noting that previous case law incorrectly distinguished between defective construction that damages only the insured’s work, and defective construction that damages a third-party’s work or property.  The court found there is nothing in the definition of “occurrence” which supports differentiating between the two types of damage.

Not to be outdone by its sister courts in West Virginia and North Dakota, the Alabama Supreme Court earlier this year reversed a decision less than six months old, and held that defective construction can qualify as an “occurrence” under a liability policy.  Specifically, in Owners Insurance Co. v. Jim Carr Homebuilder, LLC, the Supreme Court of Alabama held that an insured hired to build a house was not entitled to coverage for “property damage” or “bodily injury” (i.e., mental anguish) resulting from the insured’s defective construction.  No. 1120764, 2013 WL 5298575 (Ala. Sept. 20, 2013) (“Jim Carr I”).  On rehearing, the court withdrew its opinion in Jim Carr I and replaced it with a new decision that held defective construction could constitute a covered “occurrence” under a general liability policy if the damage was unintended.  Owners Ins. Co. v. Jim Carr Homebuilder, LLC, No. 1120764 (Ala. March 28, 2014) (“Jim Carr II”).  As the court explained, “the fact that the cost of repairing or replacing faulty workmanship itself is not the intended object of the insurance policy does not necessarily mean that, in an appropriate case, additional damage to a contractor’s work resulting from faulty workmanship might not properly be considered ‘property damage’ ‘caused by’ or ‘arising out of’ an ‘occurrence.’”  Because the policy did not define an “occurrence” in terms of the ownership or character of the property damage, the court concluded there was no basis for distinguishing between damages to the insured’s work and damage to third-party work.

New Jersey decided to take a different tack in addressing the “occurrence” issue.  On November 25, 2013, New Jersey State Assemblyman Gary Schaer introduced Bill No. A4510, which would have required liability policies issued, renewed, or delivered in New Jersey to define “occurrence” to include damages resulting from faulty workmanship.²  According to the bill’s interpretive statement, it required that “occurrence” be defined to address “both accidents and faulty workmanship” in order to remedy New Jersey case law that “varied in their holdings as to whether damage from faulty workmanship is accidental in nature and therefore within the definition of an occurrence.”³  Although the bill recently died in committee, its introduction demonstrates a continuing trend in states seeking to legislate the “occurrence” issue.  Laws addressing the “occurrence” issue are already on the books in Colorado, Arkansas, South Carolina, and Hawaii. See, e.g., Col. Code § 13-20-808; Ark. Code § 23-79-155; S.C. Code § 38-61-70; Haw. Stat. § 431:1-217.

The foregoing cases and proposed legislation demonstrate states’ willingness to compel liability insurers to cover risks they have not traditionally insured.  The foundation for this traditional rule is sound:  an insured can prevent damage to its own work simply by performing its work correctly.  In contrast, the reasoning behind compelling liability insurers to cover damage to an insured’s own work is shaky.  For example, courts concluding that defective construction work is covered under liability policies because there would otherwise be no reason for those policies to include the “business risk” exclusions ignore that construction defect claims often involve damage to an insured’s work and other third-party property.  The exclusions protect the insurer from having to insure uncovered damage (to the insured’s work) while preserving coverage for the covered damage (to the third-party property).  In other words, the “business risk” exclusions actually confirm that liability policies are not intended to cover damage to an insured’s work as opposed to suggesting that damage is covered in the first instance.

Despite the weak reasons courts and legislatures have cited to in compelling liability insurers to cover faulty workmanship,it is doubtful those courts and legislatures will revert back to leaving defective workmanship claims outside the realm of liability policies.  In that case, how should liability insurers respond?

Although case law and statutes declaring that defective construction qualifies as an “occurrence” within the meaning of liability policies generally leaves the policies’ “business risk” exclusions intact, we previously offered three potential responses in our earlier “Occurrence”? article:  (1) including more specific policy exclusions that eliminate coverage for “property damage” to an insured’s own work; (2) charging higher premiums for policies issued to entities engaged in the construction industry and/or issuing policies only in excess of significant self-insured retentions; or (3) refusing to issue policies to parties that perform construction work.  These options have drawbacks:  higher premiums would be passed along to project owners and developers (which would unnecessarily increase construction costs), significant self-insured retentions could limit the pool of insureds capable of performing construction work to only those that could absorb them (thus decreasing competition), and no longer affording liability coverage for construction projects may cause the construction industry to come to a screeching halt.

Absent a statute or declared public policy prohibiting insurers and their insureds from doing so, a fourth option could be that insurers specify in policies that defective construction is not an “occurrence.”  This would be the insurance equivalent of Newton’s third law (for every action, there is an opposite and equal reaction).

Limiting whether and to what extent faulty workmanship qualifies as an “occurrence” under liability policies would provide the greatest benefit to all involved:  not only would that preserve the intent of liability policies to respond only to third-party injuries caused by defective construction (such as a steel beam falling on a car or a crane collapsing onto an adjacent building), it would keep liability policy premiums down by ensuring damages to construction projects caused by faulty workmanship are addressed through traditional channels – namely, sureties.


¹  ACUITY v. Burd & Smith Constr., 721 N.W.2d 33 (N.D. 2006).

²  The proposed bill, however, noted that it was not intended to restrict or limit the “business risk” exclusions commonly found in liability policies.  In the ISO Form, the “business risk” exclusions include Exclusion j. (Damage to Property), Exclusion k. (Damage to Your Product), Exclusion l. (Damage to Your Work), and Exclusion m. (Damage to Impaired Property or Property Not Physically Injured).

³  Specifically, the bill cited to Pennsylvania National Mutual Casualty Insurance Co. v. Parkshore Development Corp., 403 Fed. App’x 770 (3d Cir. 2010) (applying New Jersey law and holding that a subcontractor’s faulty work that resulted in damage to the insured general contractor’s work was not an “occurrence”), and Firemans Insurance Co. of Newark v. National Union Fire Insurance Co., 387 N.J. Super. 434 (N.J. App. Div. 2006) (holding that faulty workmanship was not “property damage” caused by an “occurrence” under a typical general liability policy).

Lights Out for Policyholders Seeking Business Interruption Coverage Due to Loss of Electricity

Monday, May 19th, 2014

By Alex Shilliday, Sedgwick Dallas

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.

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