Commercial property insurance policies typically insure against loss of business income resulting from “Covered Causes of Loss,” and in the standard ISO-based policy those causes of loss comprise “direct physical loss,” with the term “loss” being defined in the policy as “accidental physical loss or accidental physical damage.” “Direct physical loss” is thus an essential element of an insured’s initial burden of proof in order to establish that its claim falls within the insuring agreement provided under its property insurance policy.

Government-ordered closures of business are probably not the first thing most people think of when they hear the terms “accidental physical loss or accidental physical damage” or “direct physical loss,” but there has been a flood of litigation across the country in the last two years over whether such closures of businesses implicate business-interruption (BI) insurance under property insurance policies. The great majority of the decisions have gone in favor of insurers and against insureds, though the grounds for courts holding that BI insurance is not implicated have varied considerably. So, too, have the grounds on which the minority of decisions finding in favor of insureds have rested, though perhaps the most common thread among those decisions has been a finding of ambiguity in the contract language requiring interpretation of that language in favor of insurance coverage. Virginia’s decisions thus far have, generally, tracked the broader national trends in these respects.

An insured bears the initial burden to show that his claim falls within the insuring agreement provided in his insurance contract, or insurance “policy.” Only once the insured has met his threshold burden does the burden shift to the insurer to show the applicability of one or more exclusions to the insurance granted in the insuring agreement. In commercial property insurance policies, the insuring agreement generally grants insurance benefits if the insured has sustained a direct physical loss.

The terms “direct” and “physical” typically are not defined in insurance policies, and courts in Virginia and most states therefore interpret them according to their “ordinary and accepted meaning,” usually determined by reference to a standard dictionary. Simple enough, right?

In the recent flood of COVID-related BI claims, courts have reached a variety of results in interpreting and applying the phrase “direct physical loss” in trying to determine whether losses of business income due to the pandemic are insured. The trend in many, and perhaps most, of the decisions on BI claims has been to interpret “direct physical loss” to require that the insured business’ property has been physically altered or damaged. See, e.g., Diesel Barbershop, LLC v. State Farm Lloyds, No. 5:20cv461, 2020 U.S. Dist. LEXIS 147276, *15-*16 (W.D. Tex. Aug. 13, 2020); Rose’s 1, LLC v. Erie Ins. Exch., No. 2020 CA 002424 B, 2020 D.C. Super. LEXIS 10, *11-*13 (D. C. Super. Ct. Aug. 6, 2020).

Courts in Virginia have not been uniform in their interpretation of “direct physical loss,” particularly when Virginia law has been applied rather than the law of another state. One decision from last year in which a court in Virginia, applying Virginia law, addressed the question of “direct physical loss” held that term to be ambiguous, thereby requiring that it be interpreted against the insurer and in favor of insurance coverage. Elegant Massage, LLC, v. State Farm Mut. Auto. Ins. Co., No. 2:20cv265, 2020 U.S. Dist. LEXIS 231935 (E.D. Va. Dec. 8, 2020). Elegant Massage was filed by an insured massage parlor to recover for loss of business income it sustained due to Governor Northam’s order that businesses deemed non-essential be shut down to prevent the transmission of the COVID virus. Judge Jackson issued a decision denying State Farm’s motion to dismiss the insured’s complaint. He held that “‘direct physical loss’ has been subject to a spectrum of interpretations in Virginia . . . ranging from direct tangible destruction of property to impacts from intangible noxious gasses or toxic air particles that make the property uninhabitable or dangerous to use.” 2020 U.S. Dist. LEXIS 231935, *19. Based on that perceived “spectrum of interpretation,” the Court held that the phrase was not susceptible to just one reasonable interpretation, and on that basis held that the phrase was ambiguous. 2020 U.S. Dist. LEXIS 231935, *27.

Having decided that the language was ambiguous, the Court held that “it is plausible that a fortuitous ‘direct physical loss’ could mean that the [insured] property is uninhabitable, inaccessible, or dangerous to use because of intangible, or non-structural sources.” Id.

Elegant Massage thus generally falls into line with decisions from courts elsewhere which have considered the standard definitions of “direct” and “physical,” and based upon them have held that the term “direct physical loss” standing “alone does not require a ‘physical alteration of the [insured] property’ or ‘a physical change in the condition of the property.’” Mudpie, Inc. v. Travelers Cas. Ins. Co., No. 20cv3213, 2020 U.S. Dist. LEXIS 168385, *10 (N.D. Cal. Sept. 14, 2020); see North State Deli, LLC v. The Cincinnati Ins. Co., No. 20CVS02569, slip. op. at 6 (N.C. Super. Ct. Oct. 9, 2020). Elegant Massage has been considered an outlier by a number of courts that have considered the issue of direct, physical loss, including other district courts within the Fourth Circuit. See, e.g., Bluegrass, LLC v. State Auto Mut. Ins. Co., No. 2:20cv414, 2021 U.S. Dist. LEXIS 3088, *14 (S.D. W.Va. Jan. 5, 2021) (mildly criticizing Elegant Massage and referring to it as “a notable outlier”).

Yet even if “direct physical loss” is deemed ambiguous when interpreted in a vacuum, many courts have read the phrase in the context of the entire policy to hold that the language can only be interpreted to require physical alteration or damage to the property insured. See, e.g., Mudpie, 2020 U.S. Dist. LEXIS 168385, *10. Notably, in another relatively recent case, a different court in the Eastern District of Virginia has suggested, without deciding, that under Virginia law the phrase “direct physical loss” can only be reasonably construed to refer to physical damage or alteration of tangible property. See Barroso, Inc. v. Twin City Fire Ins. Co., No. 1:20cv632 (E.D. Va. Nov. 10, 2020), hrg. tr. (Dkt. 41 at 10.) Unfortunately, in Barroso Judge Brinkema did not issue a written opinion, and her thoughts on “direct physical loss” are not really unpacked in the summary-judgment hearing transcript. We’ll come back to Barroso in a bit.

At least one court in Virginia, applying the substantive law of another state, has held that “direct physical loss” does, indeed, require physical damage or alteration to the insured property. In Skillets, Inc. v. Colony Ins. Co., Judge Hudson applied Florida law in a lawsuit filed by an insured restaurant chain, Skillets, seeking to recover loss of business income that it, too, sustained following the Florida governor’s order for non-essential businesses to cease in-house dining. The Court held that “Skillets did not suffer a direct physical loss as a result of COVID-19 or the closure orders, and its business losses incurred as a result of these events are therefore not covered” by its insurance policy with Colony. No. 3:20cv678, 2021 U.S. Dist. LEXIS 45452, *11 (E.D. Va. Mar. 10, 2021).

In reaching its decision, the Court stated that it would “follow the rising tide of courts applying Florida law – as well as that of other states – in holding that ‘there is simply no coverage [for loss of business due to COVID-19] under policies if [the policies] require ‘direct physical loss or damage’ to property.’” Id. While Skillets argued that it had sufficiently plead “direct physical loss” because it alleged that the COVID virus was present in its restaurants, Judge Hudson noted that under Florida law putative “alterations [to property] removable by cleaning do not constitute direct physical loss,” id., *12, and also that Skillets’ “argument [was] not persuasive because Skillets’ alleged claims and damages [were] inseparable from the closure orders.” Id., *14. See Royal Palm Optical, Inc. v. State Farm Mut. Auto Ins. Co., No. 20-80749, 2021 U.S. Dist. LEXIS 62754, *14 (S.D. Fla. Mar. 30, 2021) (“an item or structure that merely needs to be cleaned has not suffered a ‘loss’ which is both ‘direct’ and ‘physical’”).

Among the decisions on which Skillets relied, and which Judge Hudson expressly rejected, was Elegant Massage. Judge Hudson noted that Elegant Massage was not binding on his decision because it applied Virginia law and Judge Hudson was tasked with applying Florida law. Id., *17. Judge Hudson nevertheless referred to Elegant Massage as “well-reasoned.” Id. Other courts within the Fourth Circuit have also held that BI claims based on the COVID-19 shutdown generally are not the result of direct physical loss and, therefore, are not subject to BI insurance benefits. See, e.g., Bel Air Auto Auction, Inc. v. Great Northern Ins. Co., No. RDB-20-2892, 2021 U.S. Dist. LEXIS 72154, *30-*33 (D. Md. Apr. 14, 2021) (Md. law).

After the question of whether a COVID-19 BI claim falls within an insurance policy’s insuring agreement – i.e., whether the claim is based on “direct physical loss” – the next most common issue litigated in these cases is likely the operation of a “virus exclusion” in those insurance policies that include such exclusions. As with the question of “direct physical loss,” most courts around the country to have considered “virus exclusions” in connection with COVID BI claims have held them to be unambiguous and to clearly operate to bar such claims.

Judge Brinkema’s decision in Barroso, decided under Virginia law, followed that majority trend in holding that the virus exclusion in the subject insurance policy barred the claim. Barroso was filed when the insurer, Twin City, denied the insured restaurant owner’s claim for BI benefits resulting from loss of revenue following Governor Northam’s shut-down of in-person dining at the beginning of the pandemic. The insured, Barroso, argued that even though it had not alleged that the COVID virus was ever present inside its restaurant, it was nevertheless entitled to recover BI benefits because its insurance policy provided such benefits for losses resulting from government-ordered shutdowns.

Assuming, without deciding, that Barroso had met its threshold burden to show that insurance under its property insurance policy was otherwise implicated – i.e., that the claim resulted from a direct, physical loss – the Court nevertheless held that the contract’s virus exclusion was clear and unambiguous, and that it clearly operated to bar Barroso’s claim. Barroso, No. 1:20cv632 (E.D. Va. Nov. 10, 2020), hrg. tr. (Dkt. 41 at 16.) The exclusion provided that Twin City “will not pay for loss or damage caused directly or indirectly by any of the following . . . [p]resence, growth, proliferation, spread or any activity of . . . [a] virus.” Barroso, No. 1:20cv632, Def. Memo. ISO Mot. Summ. J. (Aug. 31, 2020, Dkt. 23 at 14 of 37. The exclusion further provided that it applied “regardless of any other cause or event that contributes concurrently or in any sequence to the loss.” Id. Judge Brinkema rejected Barroso’s argument that the proximate cause of the claimed loss was the Governor’s shut-down order and not the COVID virus: “[U]nder the specific language of this insurance policy and in particular the very . . . clear exclusion for injuries that are the result, either directly or indirectly, of a virus . . . [the insured] is not covered by this insurance policy.” Barroso, No. 1:20cv632 (E.D. Va. Nov. 10, 2020), hrg. tr. (Dkt. 41 at 16.)

Barroso stands in strong contrast to the decision in Elegant Massage, which not only held that the phrase “direct physical loss” was ambiguous, but also held that “the expansive anti-concurrent causation clause is not a recognized or settled doctrine in” Virginia, and the Court therefore opted not to enforce that language. See 2020 U.S. Dist. LEXIS 231935, *32. Importantly, the exclusion at issue in Elegant Massage was materially identical to the exclusion on which Barroso’s decision was based.

By rejecting the anti-concurrent causation clause, Elegant Massage also accepted the same argument that Judge Brinkema rejected in Barroso concerning proximate cause for the claimed loss of business income – viz., that the loss resulted not from the presence of the COVID virus inside the insured’s premises but, rather, from the Governor’s order shutting down inside dining. Id., *33. In Elegant Massage, Judge Jackson supported his conclusion that the virus exclusion did not bar the insured’s claim by interpreting the exclusion to require the insurer to show that the virus had grown, proliferated, spread, or was at least present inside the insured’s premises. See id., *34-*35. Elegant Massage thus held that “in applying the Virus Exclusion there must be a direct connection between the exclusion and the claimed loss and not . . . a tenuous connection anywhere in the chain of causation. That is, although the Virus Exclusion does require that the virus be the cause of the policyholder’s loss, the connection must be the immediate cause in the chain.” Id., *35-*36.

Elegant Massage and Barroso appear to represent diametrically opposed views of both the virus exclusion’s scope and the enforceability of the exclusion’s anti-concurrent causation clause. Barroso, unfortunately, did not result in a written opinion from Judge Brinkema (either published or unpublished), and the Court’s reasoning therefore needs to be parsed out of the transcript of the summary judgment hearing. The absence of a written opinion in Barroso thus weakens its value as legal precedent.

In October, 2021, however, the Eastern District of Virginia was again called upon to determine whether a BI claim resulting from the COVID pandemic implicated the commercial property insurance under which an insured sought to recoup its loss of income from the pandemic shutdown. In Adorn Barber & Beauty, LLC v. Twin City Fire Insurance Company, the insured, Adorn, was forced to close its business when Governor Ralph Northam declared a State of Emergency due to the pandemic. The closure caused Adorn to sustain over $150,000 in loss of income, forcing Adorn to dismiss part-time employees and to reduce the salaries of its full-time employees. See Adorn Barber & Beauty, LLC v. Twin City Fire Ins. Co., No. 3:20cv418, 2021 U.S. Dist. LEXIS 200344, *2-*3 (E.D. Va. Oct. 18, 2021). Adorn submitted a claim for loss of business income to Twin City, asserting that its losses were caused by contamination of its business facility by the COVID virus and also by Virginia’s emergency shutdown orders. See id., *3. When Twin City denied the claim, Adorn filed suit against Twin City in federal court.

The insurance policy that Twin City had issued to Adorn included a “Limited Fungi, Bacteria or Virus Coverage” endorsement, by which Twin City excluded insurance for “loss or damage caused directly or indirectly by the presence, growth, proliferation, spread or any activity of . . . bacteria or virus.” Id., *6 (int’l punct. omit’d). The policy further provided that the “exclusion applies whether or not the loss event results in widespread damage or affects a substantial area.” Id., *7.

Without addressing whether Adorn’s claim resulted from direct, physical loss, Judge Payne held that the policy’s virus exclusion clearly applied to the claim, and dismissed the lawsuit. He relied substantially on another decision he had authored in April, 2021, in L & L Logistics & Warehousing, Inc. v. Evanston Ins. Co., No. 3:20cv324, 2021 U.S. Dist. LEXIS 71797 (E.D. Va. Apr. 13, 2021), where the Court had addressed the same virus exclusion at issue in Adorn (as well as in Barroso and in Elegant Massage) under California law. In L & L, Judge Payne had held that the subject virus-exclusion was clear and unambiguous and clearly barred the insured’s claim. As the Court had put it in L & L, “the Virus Exclusion prohibits any claim caused by a virus – full stop.” Id., *11. Noting in Adorn that “[e]ssentially the same virus exclusion language is present in [Adorn’s] . . . case,” Judge Payne held that the insurance policy “exclude[d] coverage for Adorn’s claims as a matter of law.” Adorn Barber & Beauty, 2021 U.S. Dist. LEXIS 200344, *11. The court cited numerous other decisions from throughout the Fourth Circuit and beyond that have reached the same conclusion, and held that “extensive and well-reasoned authority” supported the conclusion that “Adorn’s claims for coverage for its business and expense losses [was] excluded by the plain language of the Virus Exclusion provision of the Policy.” Id., *12.

Judge Payne also rejected Adorn’s arguments that the virus exclusion was ambiguous, that denying insurance coverage for the BI claim would have been contrary to the parties’ reasonable expectations, and that the doctrine of “regulatory estoppel” should be applied to prevent Twin City from denying the claim, as well as Adorn’s argument that Elegant Massage dictated that the court rule in Adorn’s favor. Judge Payne distinguished Elegant Massage, however, holding that Elegant Massage had been driven by the court’s analysis of whether the claim at issue in that case had been based upon a direct, physical loss, and not on the virus exclusion in the policy at issue there. See id., *18-*19. Judge Payne did not mention or discuss Judge Jackson’s reasoning in Elegant Massage that “in applying the Virus Exclusion there must be a direct connection between the exclusion and the claimed loss and not . . . a tenuous connection anywhere in the chain of causation. That is, although the Virus Exclusion does require that the virus be the cause of the policyholder’s loss, the connection must be the immediate cause in the chain.” 2020 U.S. Dist. LEXIS 231935, *35-*36. Instead, Adorn Barber & Beauty tacitly rejected the reasoning of Elegant Massage.

Even after nearly two years from the start of the COVID lockdown, COVID BI claims continue to percolate through the federal and state courts in Virginia, Maryland, and other courts throughout the Mid-Atlantic region and the rest of the country. Over time, there appears to be developing a general consensus that such claims do not result from a direct, physical loss to insured property, and even assuming that they do, the virus exclusions included in most commercial property policies have generally been construed to bar COVID BI claims. It does not appear that an appeal to the Fourth Circuit has been sought in Adorn Barber & Beauty, and, thus, there are not yet any appellate decisions in Virginia dealing with these questions.

If you have questions regarding situations such as these and how courts are treating the questions of “direct physical loss” and the applicability of virus exclusions in a specific state or federal circuit, feel free to contact Kevin Streit (kstreit@setlifflaw.com) at (804) 377-1270 or Steve Setliff (ssetliff@setlifflaw.com) at (804) 377-1261.