Insurance Law

• Publication year: 2023
• Citation: Vol. 2023
• Author: Stephen Raucher

INSURANCE LAW

AUTHORS^*

Stephen Raucher

Michael Sohigian

INTRODUCTION

In 2023, there was a veritable tidal wave of insurance company victories in California courts, with all but two of the cases discussed in this article coming down in favor of the insurance industry. With respect to first party property policies, the courts have continued to narrowly construe the meaning of "direct physical loss." And while policyholders scored a rare victory reaffirming the broad scope of the duty to defend under a third party liability policy, two other cases construed "insured contract" and "no voluntary payment" provisions in ways limiting coverage. Looking ahead, 2024 promises two major decisions from the California Supreme Court on coverage for COVID-19 business interruption claims, and perhaps on whether the contractual one-year statute of limitations in property policies governs Unfair Competition Law claims. Will the pendulum swing back in favor of policyholders? Check back next year.

FIRST PARTY POLICIES

SPECIFIED PERILS HOMEOWNERS POLICY PROVIDES NO COVERAGE FOR LOSS OF EMBRYOS

As discussed below, the question of what constitutes "direct physical loss" under first party property damage policies has bedeviled California courts since the onset of the COVID pandemic. The issue presented itself in a different context in Wong v. Stillwater Ins. Co.,¹ in which the First District Court of Appeal found the insureds failed to show that the partial thawing of stored embryos constituted direct physical loss.

Following in vitro fertilization, the Wongs stored three viable embryos cryogenically with Pacific Fertility Center ("PFC"). Several years later, the Wongs received notice that the storage tank suffered from a mechanical failure, leading to partial thawing of the embryos. The Wongs tendered a claim under their homeowners insurance policy, which provided coverage for "direct physical loss" to personal property "anywhere in the world" arising out of 16 specified perils.² When the carrier, Stillwater Insurance Company ("Stillwater"), denied coverage, the Wongs filed suit, but the trial court granted summary judgment in favor of Stillwater.

On de novo review, the Court of Appeal affirmed the judgment on two separate grounds. First, the Court found that plaintiffs had failed to raise a triable issue of fact as to whether the claimed loss fell within the

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policy's insuring clause. Quoting the seminal case of MRI Healthcare Center of Glendale, Inc. v. State Farm General Ins. Co.,³ the Wong court noted that "for loss to be covered, there must be a 'distinct, demonstrable, physical alteration' of the property"⁴ Yet the Wongs' own IVF doctor conceded that there was "no way to know" whether the embryos had actual physical damage; rather, the doctor testified that as a result of the malfunction, "no responsible physician would use them."⁵ This was fatal to the Wongs' claim.

However, the Court found that coverage was barred on a second, independent basis. Because the policy was for "specified perils" only, the insureds also had the threshold burden of proving the loss was caused by a specifically-enumerated peril.⁶ The Wongs claimed the loss was caused by an "explosion," one of the 16 enumerated perils. In support, they cited to testimony from an expert's deposition in a separate case pending in federal court against PFC However, that expert testified that the storage tank failure resulted from an "implosion," not an "explosion," which the Wong court noted are opposite concepts.⁷ Moreover, the deposition testimony was inadmissible hearsay, and therefore could not be relied upon to oppose summary judgment in any event.⁸

FINAL DETERMINATION OF COVERAGE FOR COVID-19 BUSINESS INTERRUPTION CLAIMS AWAITS TWO CALIFORNIA SUPREME COURT CASES

Coverage for business interruption losses under commercial property insurance policies resulting from the COVID-19 pandemic has predominantly revolved around the question of whether the virus causes physical alteration of the subject property This stems from two cases decided in 2021: the Ninth Circuit's ruling in Mudpie, Inc. v. Travelers Cas. Ins. Co. of Am. that "for loss to be covered, there must be a 'distinct, demonstrable, physical alteration' of the property;"⁹ and the Fourth District Court of Appeal opinion in The Inns By The Sea v. California Mutual Ins. Co., rejecting a policyholder's lost business income COVID-19 claims because they did not result from a "direct physical loss of or damage to property."¹⁰

Since those rulings, most courts in California have rejected the argument that the COVID-19 virus can cause physical damage to property However, starting with Marina Pacific Hotel & Suites, LLC v. Fireman's Fund Ins. Co.,¹¹ a few have been willing to accept the premise as true at the demurrer stage. Given this divergence of opinion, in early 2023, the California Supreme Court agreed to settle the debate over whether the actual or potential presence of the COVI D-19 virus on an insured's premises can constitute "direct physical loss or damage to property" by accepting that certified question from the Ninth Circuit in Another Planet Entertainment, LLC v. Vigilant Ins. Co.¹² Meanwhile, during the pendency of the appeal, the Supreme Court has granted review of several other decisions, whose ultimate outcomes will follow from Another Planet.¹³

However, even if such cases can get past the pleading stage, the decision by Division One of the Fourth Appellate District in Best Rest Motel, Inc. v. Sequoia Ins. Co.¹⁴ provides a preview of the challenges such cases will face on summary judgment Best Rest involved a fairly typical fact pattern, in which the policyholder was a hotel which suffered lost income during the pandemic. Its policy provided coverage for loss of business income "due to the necessary suspension of its operations caused by direct physical loss of or damage to the insured property from a covered cause of loss."¹⁵

The insurer filed a motion for summary judgment, arguing there was no evidence that the virus damaged any property, or alternatively, that there was no nexus between Best Rest's losses and the presence of COVI D-19 at the hotel.¹⁶ While Best Rest submitted an expert declaration opining that COVI D-19 does in fact damage property surfaces by making them infectious,¹⁷ the Best Rest court could still not find causation between the physical presence of the virus and the insured's economic damages. The Best Rest court found that while there was a decline in the insured's hotel business, there

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was no evidence that it was caused by the physical presence of the virus on the hotel premises itself.¹⁸ Rather, the economic losses suffered by the insured were caused by overall conditions of the global pandemic, i.e., the decline in travel and need for hotels.¹⁹ Accordingly, summary judgment for the insurance company was affirmed.²⁰

A second COVID-19 coverage case pending in the California Supreme Court is John's Grill, Inc. v. The Hartford Financial Services Group, Inc.²¹ In John's Grill, the First Appellate District considered a virus coverage endorsement which, unlike most policies found in COVID-19 coverage disputes, included an affirmative grant of coverage for "loss or damage" caused by virus, and a special definition of "loss or damage" that included the cost of structural mitigation work to remove the virus and testing for it once the work was done.²² However, while the virus endorsement provided the potential for coverage for lost business income caused by the pandemic, the Court found it was rendered illusory by a separate clause which specified the causes of loss that would trigger the virus endorsement The trigger clause was found to be "indecipherable when applied to viruses" because "none of the listed causes has anything to do with the biological processes that actually cause a virus."²³ Thus, while the insured had a reasonable expectation of coverage pursuant to the virus endorsement, no such coverage was actually provided.

The Supreme Court will therefore address whether such a limiting condition renders a grant of coverage illusory It will also address whether a conditional grant of coverage for property loss or damage to covered property caused by a virus, including the cost of removal of the virus, is triggered by cleaning surfaces in the covered property that are contaminated by the virus in the absence of physical alteration of the property.

GOVERNMENT ORDERS DO NOT CONSTITUTE A PHYSICAL LOSS

In contrast to cases focused on physical alterations to the subject property, some insureds have attempted to argue that government shutdown orders caused a functional loss of the property In Starlight Cinemas, Inc. v. Massachusetts Bay Ins. Co.,²⁴ the insured movie theater operator alleged that its commercial property policy covered lost business income due to suspension of operations required by government shutdown orders. (It likely framed the issue this way because its policy contained a virus exclusion.) Consistent with prior rulings holding that property must be physically altered in order to trigger coverage, the Second Appellate District, Division Seven, held that "the allegation of temporary loss of use of property resulting from pandemic-related government closure orders—without any physical loss of the property—is not sufficient."²⁵

In so ruling, the Starlight Cinemas court expressly disagreed with Coast Restaurant Group, Inc. v. Amguard Ins. Co.,²⁶ in which the Fourth Appellate District, Division Three, found that business interruption insurance potentially covered a restaurant's losses resulting from government closure orders. According to the Coast court, the restaurant "suffered a covered loss under the policy because the governmental restrictions . . . deprived the appellant of important property rights in the covered property."²⁷ However, coverage was nonetheless barred by two exclusions: for loss or damage caused directly or indirectly by (1) "the enforcement of...