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In response to the wave of litigation over COVID-19-related business income claims, an overwhelming majority of courts considering the relevant policy language — approximately 80% — have found no coverage as a matter of law under the applicable insurance policy.[1]
But in Elegant Massage LLC v. State Farm Mutual Automobile Insurance Co.,[2] the U.S. District Court for the Eastern District of Virginia went its own way; ignoring well-established principles of contract interpretation, the court found the term "direct physical loss" ambiguous and the virus exclusion inapplicable.
In the coming months, we expect other courts applying Virginia law will treat this decision as an outlier and reject its misguided analysis.
The Facts
On March 23, to prevent the spread of COVID-19, Virginia's governor ordered closure of spas and massage parlors, among other businesses deemed nonessential. On May 15, he eased restrictions subject to certain limitations, e.g., 50% occupancy.
Light Stream Spa, a provider of therapeutic massages located in Virginia Beach, Virginia, closed voluntarily on March 16, in advance of the governor's mandate. The spa submitted a claim to State Farm for lost income and extra expenses the same day.
On March 26, State Farm denied the claim:
[B]ecause [the Spa] voluntarily closed their business on March 16, 2020, there was no civil order to close the business, there was no known damage to the business space or property resulting from COVID-19, and the Loss of Income Coverage excludes coverage for loss caused by virus.[3]
In response, the spa filed a class action complaint asserting claims for breach of contract and declaratory relief. Notably, the spa did not allege presence of the virus at its property and it characterized the governor's order as the sole cause of its income losses.[4] In other words, the spa alleged only a loss of use of its property entirely unrelated to whether the virus was actually ever present on the property.
State Farm moved to dismiss.
The court granted the motion in part,[5] and denied it in part. In the court's view, the spa's alleged "inability to use the premises because of uncontrollable forces" was sufficient to constitute an "accidental direct physical loss to Covered Property," and State Farm "failed to show that any of the Policy's Exclusions clearly apply" — including the virus exclusion.[6]
Direct Physical Loss
The first key issue for the court was "what constitutes a 'direct physical loss' in the context of the Policy and Plaintiff's circumstances." Specifically, the court focused on the meaning of the phrase as used in three policy provisions:
Covered Cause of Loss
"Covered Cause of Loss" was defined as an "accidental direct physical loss to covered property unless the loss is (1) Excluded in SECTION 1-EXCLUSIONS; or (2) Limited in the Property Subject to Limitations Provisions."
Business Income
According to the court:
The policy provides for the loss of business income sustained as a result of the "suspension" of "operations." The suspension "must be caused by accidental direct physical loss to property at the described premises." The Policy states that it will only pay for "Loss of Income" that [the policyholder] sustains during the "period of restoration"[7] that occurs after the date of accidental direct physical loss.
Extra Expense
The policy covered:
Extra expenses incurred during the "period of restoration" that [the policyholder] would not have incurred if there had been no accidental direct physical loss to property at the described premises. The loss must be caused by a Covered Cause of Loss.
Finding no policy definition, the court immediately began an analysis of whether the phrase "direct physical loss" was ambiguous — and never looked beyond those three words again. This was a critical error. Virginia's Supreme Court has emphasized that:
A judicial interpretation should conform to the plain meaning that reasonable insurers and insureds likely would have attributed to the words. … The search for this plain meaning does not myopically focus on a word here or a phrase there. Instead, it looks at a word in the context of a sentence, a sentence in the context of a paragraph, and a paragraph in the context of the entire agreement. The plain meaning of a word depends not merely on semantics and syntax but also on the holistic context of the word within the instrument.[8]
The court found three potential meanings for "direct physical loss" in Virginia case law: structural damage; distinct and demonstrable physical alteration; and "incidents that make the covered property uninhabitable, inaccessible, and dangerous to use … because of, for example, intangible and invisible noxious gases or toxic air particles."[9]
The court looked to Travco Insurance Co. v. Ward as the source for the court's second and third definitions.[10] In Travco, the toxic gases released by the drywall were actually present at the property.
However, the spa took pains to allege the virus was not present at its property, obviously in large part to avoid application of the virus exclusion — an incongruent position the court accepted.[11] Thus, the spa alleged nothing more than a loss of use at its own property, which did not fit within any of the court's three definitions of "direct physical loss."[12]
By focusing on only three words of the policy, the court lost sight...
