U.S. MAGISTRATE JUDGE RECOMMENDS FEDERAL COURT DISMISS INSURED’S COVID-19-RELATED BREACH OF CONTRACT AND EXTRA-CONTRACTUAL CLAIMS

April 20, 2021

U.S. Magistrate Judge Susan Hightower recently issued a report and recommendation to the U.S. District Court for the Western District of Texas recommending dismissal of an insured’s breach of contract claim and related extra-contractual claims arising from the insured’s claim for business interruption coverage arising from the COVID-19 pandemic.

In Ilios Production Design, LLC v. The Cincinnati Ins. Co, Inc., et al., No. 1:20-CV-857-LY, 2021 WL 1381148 (W.D. Tex. Apr. 12, 2021), the district court, at the request of the insurer. sought a report and recommendation from the Magistrate Judge regarding the insurers’ motion to dismiss the insured’s claims. The insured, a lighting and production design company, had a policy of insurance that included “business interruption” coverage. When the insured was forced to close due to local and statewide stay-at-home orders issued to help curtail the spread of the virus that causes COVID-19, the insured subsequently made a claim under its policy, asserting that it had suffered “direct physical loss” as a result of the pandemic and the civil authority orders rending its premises temporarily uninhabitable and unusable for business purposes. The insurer denied the claim, stating that the losses were not covered under the policy because the claim did not involve a “direct, physical loss to property . . . caused by a Covered Cause of Loss.”

The insured sued in state court, alleging breach of contract, common law bad faith, and additional extra-contractual claims. After the case was removed to federal court by the insurer, the insurer filed a motion to dismiss based on the insured’s failure to state a claim upon which relief could be granted.

In construing the underlying policy, the Magistrate agreed with the insurer that the policy only covered a “direct physical loss to property” or loss of income related to damage to property, but it did not cover economic loss caused by a virus or efforts to protect the public from that virus. That is, a “direct physical loss” required a “distinct, demonstrable, physical alteration of the property,” under state law, and the insured was focused on “physical loss” while ignoring the policy’s unambiguous requirement that a “direct physical loss” to the insured’s property occur to trigger coverage.

The insured had not pleaded that the virus was ever present at its premises, but even if it had, the Magistrate concluded that the presence of the virus at the insured’s property would not constitute a direct physical loss because the virus did not threaten the structures and could be eliminated from surfaces with routine cleaning and disinfectant.

As to the civil authority provision, the Magistrate emphasized that such provision also required “direct physical loss” to property and required the physical damage to prompt the act of civil authority, not vice-versa. Additionally, the civil authority orders limited the insured’s operations, but the order did not prohibit the insured from accessing its premises.

Finally, the insured argued that the lack of a virus exclusion undercut the insurer’s attempt to deny claims involving viruses. In response, the Magistrate pointed out that such an exclusion is only triggered if there were coverage under the policy, and since the Court had determined there was no coverage under the policy, the presence or absence of a virus exclusion was irrelevant.

As a result, the Magistrate found the policy expressly excluded coverage for the insured’s insurance claim and recommended dismissal of the insured’s claim, as well as the extra-contractual claims, which were premised on the underlying claim.