(Article from Insurance Law Alert, January 2025)
For more information, please visit the Insurance Law Alert Resource Center.
Holding
The North Carolina Supreme Court ruled that property policies covered the policyholders’ alleged business losses during the COVID-19 pandemic, finding that a “reasonable policyholder” could expect “direct physical loss” to include government orders that affected the use of physical property, and construing such ambiguity in favor of coverage. North State Deli, LLC v. Cincinnati Ins. Co., 2024 N.C. LEXIS 970 (N.C. Dec. 13, 2024).
Background
Several bars and restaurants in North Carolina sought coverage for business losses incurred during the period of government shut-down and restrictive orders. The commercial all-risk property policies defined “Loss” as “accidental physical loss or accidental physical damage,” but did not define the terms “physical loss,” “physical damage” or “accidental.” The policies did not contain exclusions related to viruses or contamination.
The specific provision under which the policyholders sought coverage was a supplemental Business Income (And Extra Expense) Coverage Form. That provision applied to the loss of business income due to the “suspension” of “operations” during the “period of restoration” caused by “direct ‘loss’ to property.” In turn, the policy defined “period of restoration” to end on the earlier of three dates: (1) the date when the property is “repaired, rebuilt or replaced”; (2) the date when the business is resumed at a new permanent location; or (3) 12 consecutive months after the date of “loss.”
A trial court granted the policyholders’ summary judgment motion, finding that the ordinary meaning of “loss” includes the loss of possession, distinct from physical damage. An intermediate appellate court reversed, ruling that a loss of use of or access to property does not constitute direct physical loss of or damage to property.
Decision
The North Carolina Supreme Court reversed, ruling that a reasonable policyholder could expect “direct physical loss” to include the loss of use of and access to physical property due to government orders. Relying on standard dictionary definitions, the court reasoned that a loss must “result in the material deprivation, dispossession, or destruction of property.” The policyholders argued that the government orders resulted in such material deprivation because they directly affected the functions of and access to the property, including whether and under what conditions business operations could continue. In contrast, Cincinnati contended that a loss of use of property is not a direct physical loss and that business property did not experience any physical change.
The court concluded that both arguments were reasonable. In particular, the court noted the “common-sense expectation that insurance should protect from threats to property that make it unusable for the purpose for which it is insured.” The court also explained that the terms “physical loss” and “physical damage” must have distinct meanings in order to effectuate both terms, and that “physical loss” could reasonably be interpreted more broadly than damage, to include “impairment of use or function, complete or partial.” Deeming this a “manifestly ambiguous situation,” the court resolved the ambiguity in favor of coverage.
Cincinnati also argued that the “period of restoration” provision, which refers to the repair, rebuilding, or replacement of property, indicated an intention to require physical or structural alteration to property. Rejecting this assertion, the court noted that this provision provided two other end date options for the coverage period, implying that the “repair, rebuild or replace” option does not alone define the contours of coverage.
Finally, the court emphasized that the policies contained numerous exclusions, none of which specified viruses, and that at least one restaurant specifically sought coverage for virus-related losses. The court stated: “Knowledge of the risk of viruses, together with knowledge that other policies exclude virus risks while this one does not, underscores that a policyholder would reasonably understand the absence of such an exclusion as an affirmative grant of coverage.”
Comments
The decision runs counter to the overwhelming majority of decisions which have denied coverage for pandemic-related business losses. Notably, many of those decisions expressly rejected the arguments adopted by the North Carolina Supreme Court here. More specifically, virtually all courts have concluded that a loss of use of property does not satisfy the “direct physical loss or damage” requirement and that the “period of restoration” provision supports that conclusion. Further, many courts have expressly rejected policyholder arguments that the absence of virus exclusions in applicable policies constitutes evidence of an intent to cover such losses where the operative provisions do not encompass such coverage.