The “Physical Loss” Requirement for Business Interruption Claims Amid the Coronavirus

The massive economic disruption caused by the novel coronavirus pandemic raises questions about insurance coverage for business interruption losses from communicable disease. Does viral contamination constitute the “physical loss” required to trigger this type of coverage? Although courts have not yet provided guidance specific to COVID-19, past rulings suggest that coronavirus contamination may constitute physical loss or damage triggering coverage for business interruption losses.

Business interruption (BI) insurance, also known as business income or time element insurance, generally provides coverage for lost income and continuing expenses while an organization’s operations are shut down or limited following physical damage from a covered cause of loss. A business that has been damaged by fire, for example, may utilize BI insurance to replace its lost income while repairs are made. Contingent business interruption (CBI) insurance covers lost income and continuing expenses following damage to another organization on which the policyholder’s business depends, such as a key supplier or customer. Although BI and CBI insurance exists in other contexts, such as cyber insurance, this coverage is typically obtained in conjunction with a commercial property policy.

To trigger coverage, the policyholder must establish physical loss to property from a covered cause of loss. Standard business income coverage forms generally require that the suspension of the insured’s operations must “be caused by direct physical loss of or damage” to the insured premises.  The location where the damage must occur varies depending on the type of coverage. For business interruption, the physical loss must occur to the policyholder’s property, whereas for contingent business interruption, the loss must occur to the supplier, customer, or other organization for which coverage has been obtained.

Case law suggests that the presence of contaminants may constitute “physical loss,” particularly where the insured’s property is rendered unusable. In Motorists Mutual Ins. Co. v. Hardinger, for example, a 2005 homeowner insurance case, the Third Circuit addressed allegations that the contamination of the insureds’ well by E. coli bacteria had rendered their home uninhabitable. The court found that E. coli bacteria contamination could constitute physical loss if the “functionality of the [ ] property was nearly eliminated or destroyed,” or if “their property was made useless or uninhabitable.”

While the novel coronavirus may present practical challenges in establishing the presence of contaminants, preliminary scientific evidence indicates that COVID-19 is highly contagious and can live on surfaces for days or even weeks.  The mere presence of individuals diagnosed with the coronavirus may be strong circumstantial evidence of contamination of the premises.

Even if contamination constitutes physical loss, communicable disease exclusions, such as ISO’s Exclusion of Loss Due to Virus or Bacteria, may eradicate coverage.

Given the extent of the impact from COVID-19 and the uncertainty of future developments in case law, policyholders should take all necessary steps to preserve the possibility of coverage, including closely monitoring potential impacts, tracking potential economic losses, and putting their carriers on notice of loss.