| Alaska Supreme Court Opinions made Available byTouch N' Go Systems and Bright Solutions |
|
|
|
| Alaska Supreme Court Opinions made Available byTouch N' Go Systems and Bright Solutions |
|
|
|
|
You can search the entire site. or go to the recent opinions, or the chronological or subject indices. Baxter Senior Living, LLC v. Zurich American Insurance Company (9/27/2024) sp-7724
Notice: This opinion is subject to correction before publication in the PACIFIC REPORTER.
Readers are requested to bring errors to the attention of the Clerk of the Appellate Courts,
303 K Street, Anchorage, Alaska 99501, phone (907) 264-0608, fax (907) 264-0878, email
corrections@akcourts.gov.
THE SUPREME COURT OF THE STATE OF ALASKA
BAXTER SENIOR LIVING, LLC, )
) Supreme Court No. S-18541
Plaintiff, )
) U.S. District Court No.
v. ) 3:22-CV-00044-SLG
)
ZURICH AMERICAN INSURANCE ) O P I N I O N
CO., )
) No. 7724 - September 27, 2024
Defendant. )
)
Certified Question from the United States District Court for
the District of Alaska, Sharon L. Gleason, District Judge.
Appearances: William M. Banskton, John R. Crone, and
Suzanne A. Adler, Bankston Gronning Brecht P.C.,
Anchorage, for Plaintiff. David M. Schoeggl, Michael B.
Baylous, and Erika A. O'Sullivan, Lane Powell LLC,
Anchorage, Patrick F. Hofer, Clyde & Co. US LLP,
Washington, D.C. Jared K. Clapper, Clyde & Co. US LLP,
Chicago, Illinois, for Defendant. Laura A. Foggan, Crowell
& Moring LLP, Washington, D.C. and Eva R. Gardner,
Ashburn & Mason, P.C., Anchorage, for Amicus Curiae
American Property Casualty Insurance Association.
Before: Maassen, Chief Justice, and Carney, Borghesan,
Henderson, and Pate, Justices.
CARNEY, Justice.
----------------------- Page 2-----------------------
INTRODUCTION
We accepted two certified questions from the United States District Court
for the District of Alaska. The District Court asked: (1) Can the presence of the
COVID-19 virus at an insured property constitute "direct physical loss of or damage
to" the property for the purposes of an insurance policy; and (2) can operational
restrictions imposed on an insured property by COVID-19 pandemic-related
governmental orders constitute "direct physical loss of or damage to" the property for
the purposes of a commercial insurance policy? Our answer to both questions is "no."
FACTS AND PROCEEDINGS
A. Facts
Baxter Senior Living, LLC opened an assisted living facility in Anchorage
in 2019. It obtained an insurance policy from Zurich American Insurance Company
with coverage from September 2019 to September 2020. Among the coverages the
policy provided were the following:
[(1) Property Coverage for Microorganisms, which states:]
We will pay the following when 'microorganisms'[1] are the
result of a 'covered cause of loss', other than fire or
lightning:
a. Direct physical loss of or damage to Covered Property
caused by 'microorganisms', including the cost of removal
of the 'microorganisms';
b. The reasonable cost to tear out and replace any part of
the covered building or other property needed to gain access
to the 'microorganisms'; and
c. The reasonable cost of testing performed after
removal, repair, replacement, or restoration of the damaged
property is completed, provided there is a reason to believe
that the 'microorganisms' are still present.
1 "Microorganism" is defined in the policy as "any type or form of organism
of microscopic or ultramicroscopic size including, but not limited to, 'fungus', wet or
dry rot, virus, algae, or bacteria, or any by-product."
-2- 7724
----------------------- Page 3-----------------------
. . .
[(2) Business Income Coverage, which states:] We will pay
for the actual loss of 'business income' you sustain due to
the necessary 'suspension'[2] of your 'operations'[3] during
the 'period of restoration'.[4] The 'suspension' must be
caused by direct physical loss of or damage to property at a
'premises' at which a Limit of Insurance is shown on the
Declarations for Business Income. The loss or damage must
be directly caused by a 'covered cause of loss'.
. . .
[(3) Civil Authority Coverage for Business Income, which
states:] We will pay for the actual loss of 'business income'
you sustain for up to the number of days shown on your
Declarations for Civil Authority[5] resulting from the
necessary 'suspension', or delay in the start, of your
'operations' if the 'suspension' or delay is caused by order
of civil authority that prohibits access to the 'premises' or
'reported unscheduled premises'. That order must result
2 "Suspension" is defined in the policy as "[t]he slowdown or cessation of
. . . business activities," or "[t]hat a part or all of the covered location is rendered
untenantable."
3 The policy defines "operations" as "business activities occurring at the
covered location prior to the physical loss or damage," and that "the covered location
is tenantable prior to the physical loss or damage."
4 Under the policy a "period of restoration" is "the period of time that begins
when . . . [t]he direct physical loss or damage that causes 'suspension' of your
'operations' occurs" and ends on "[t]he date when the location where the loss or damage
occurred could have been physically capable of resuming the level of 'operations'
which existed prior to the loss or damage, if the location had been restored to the
physical size, construction, configuration, location, and material specifications which
would satisfy the minimum requirements necessary to obtain all required building
permits, occupancy permits, operating licenses, or similar documents."
The policy excludes from the definition "any increased period required
due to the enforcement of any ordinance or law that requires any insured or others to
test for, monitor, clean up, remove, contain, treat, detoxify or neutralize, or in any way
respond to, or assess the effects of . . . 'microorganisms'."
5 The policy provided Baxter with up to 30 days of coverage.
-3- 7724
----------------------- Page 4-----------------------
from a civil authority's response to direct physical loss of or
damage to property located within one mile of the 'premises'
or 'reported unscheduled premises' which sustains a
'business income' loss. The loss or damage must be directly
caused by a 'covered cause of loss'.
. . .
[(4) Microorganisms Coverage for Business Income, which
states:] We will pay for the actual loss of 'business income'
you sustain due to the:
a. Necessary 'suspension' of your 'operations' from
direct physical loss of or damage to Covered Property caused
by 'microorganisms' when the 'microorganisms' are the
result of a 'covered cause of loss'; or
b. Prolonged 'period of restoration' due to the
remediation of 'microorganisms' from a covered loss.
. . .
[(5) Extra Expense Coverage, which states:] We will pay for
the actual and necessary 'extra expense'[6] you incur due to
direct physical loss of or damage to property at a 'premises'
at which a Limit of Insurance is shown for Extra Expense on
the Declarations. The loss or damage must be directly
caused by a 'covered cause of loss'.
. . .
[(6) Civil Authority Coverage for Extra Expense, which
states:] We will pay for the actual and necessary 'extra
expense' you incur for up to the number of days shown on
the Declarations for Civil Authority when an order of civil
authority prohibits access to the 'premises' or 'reported
unscheduled premises'. That order must result from a civil
authority's response to direct physical loss or damage to
6 The policy defines "extra expense" as "operating expenses you incur
during the 'period of restoration' that would not have been necessary to incur if there
had been no direct physical loss or damage to the property, provided such expenses are
incurred . . . [i]n an attempt to avoid a 'suspension' of or to continue those 'operations'
which have been affected by the direct physical loss or damage to the property[] or . . .
[i]n an attempt to minimize the 'period of restoration'."
-4- 7724
----------------------- Page 5-----------------------
property located within one mile from the 'premises' or
'reported unscheduled premises' where the 'extra expense'
was incurred. The loss or damage must be directly caused
by a 'covered cause of loss '.
. . .
[(7) Communicable Disease Suspension of Operations
Coverage for Business Income, which states:] [T]he
coverage provided at a 'premises' or 'reported unscheduled
premises' will also cover the actual loss of 'business income'
you sustain due to an order of an authorized public health
official or governmental authority that prevents access to
that 'premises' or 'reported unscheduled premises', or a
portion of that 'premises' or 'reported unscheduled
premises', because of the discovery or suspicion of a
communicable disease or threat of the spread of a
communicable disease at that 'premises' or 'reported
unscheduled premises'.
Sometime in March 2020, in response to the emerging COVID-19
pandemic, the Alaska Department of Health and Social Services (DHSS) sent Centers
for Disease Control (CDC) recommendations to owners and operators of assisted living
facilities, including Baxter, aimed at protecting "individuals who are at risk for severe
illness, . . . includ[ing] the residents of all assisted living homes." Abiding by the
recommendations would restrict usual operations at the facilities and require the
7
purchase of additional supplies.
Baxter began limiting access to the facility in March; it refused tours of
the facility, reduced residents' access to friends and family, suspended new admissions
7 These recommendations included: (1) social distancing; (2) altering
residents' schedules to reduce mixing; (3) daily temperature checks and symptom
screening of staff and visitors; (4) requiring staff to wear masks and wash hands before
entering and after leaving residents' rooms; (5) limiting outside programs;
(6) considering suspension of new admissions; (7) implementing short-term closures
for cleaning and contact tracing; (8) implementing longer-term closures or quarantines;
(9) suspending visitor access with alternative means of communication for family
members; and (10) allowing only limited end-of-life family visits.
-5- 7724
----------------------- Page 6-----------------------
and visits to the facility, and instituted strict distancing and hygiene protocols for all
residents and staff. Baxter sought, but had difficulty obtaining, personal protective
equipment due to shortages. And it incurred additional costs for equipment and other
safety measures. Despite these efforts, Baxter staff and residents experienced 44
positive COVID-19 cases by November 2020.
In July 2020 Zurich provided Baxter a Notice of Conditioned Renewal,
which stated that the insurance provision governing the suspension of operations
resulting from a government response to a threat of the spread of communicable disease
would be removed effective September 2020. Coverage for loss of business income
under the Communicable Disease Suspension of Operations provision would therefore
no longer be available.
In August DHSS issued "COVID-19 Recommended Guidance for
Congregate Residential Settings," encouraging operators of residential care facilities
like Baxter to "implement measures to ensure overall safety and well-being of all of
[their] residents" and consider a number of factors in their evaluations. The document
also provided residential care facilities with a three-phased plan to assist in evaluating
these factors. If a facility adopted the guidance, the document warned that "the actions
contained in that document [would] become mandatory as your facilities requirements."
Thus if a facility "fails to meet all the phase criteria and continues to progress to a less
8
stringent phase, the facility may be subject to enforcement action(s)."
In September, prior to the removal of coverage for loss of business income
under the Communicable Disease Suspension of Operations provision, Baxter filed a
claim with Zurich for loss of business income under that provision. Zurich denied the
claim.
8 See 42 C.F.R. §§ 488.402, 488.406, 488.408 (2023) (authorizing Centers
for Medicare and Medicaid Services (CMS) and states to impose remedies under
42 C.F.R. § 488.406 for noncompliance found by CMS or state survey agencies).
-6- 7724
----------------------- Page 7-----------------------
B. Proceedings
In February 2022 Baxter filed a complaint alleging seven claims for
breach of contract. Six of the seven claims involved coverage for "direct physical loss
of or damage to" covered property or extra expenses resulting from "direct physical loss
of or damage to" such property.9 Baxter alleged that the pandemic generally, the
presence of the COVID-19 virus at its facility, and DHSS directives and orders relating
to the pandemic caused loss of use of its property resulting in its operating at less than
full capacity, loss of income, and extra expenses. Baxter also asserted claims for breach
of the implied covenant of good faith and fair dealing and tortious insurance bad faith
based on Zurich's denial of coverage.
Baxter alleged that "direct physical loss of or damage to" property
includes "loss of use of its property" due to the presence of COVID-19 and the various
state directives and orders relating to the pandemic. Baxter sought damages for
Zurich's alleged breaches of the insurance policy by failing to provide coverage for
"loss of use" of property as well as loss of business income and extra expenses due to
its loss of use of property.
In March Zurich removed the case to federal court and moved to dismiss
it. Zurich argued most of Baxter's claims failed because Baxter did not plausibly allege
"direct physical loss of or damage to" property. Zurich argued that "[n]either the mere
presence of the COVID-19 virus . . . nor any generalized threat from its presence
constitutes the 'direct physical loss of or damage to' " property under the policy. Zurich
9 Baxter brought claims of breach of contract of the following coverages:
(1) Property Coverage for Microorganisms, (2) Business Income Coverage, (3) Civil
Authority Coverage for Business Income, (4) Microorganisms Coverage for Business
Income, (5) Extra Expense Coverage, (6) Civil Authority Coverage for Extra Expense,
and (7) Communicable Disease Suspension of Operations Coverage for Business
Income. All these coverages, apart from the Communicable Disease Suspension of
Operations Coverage for Business Income, require "direct physical loss of or damage
to property."
-7- 7724
----------------------- Page 8-----------------------
also argued that Baxter "elected to 'lockdown' its [f]acility." And Zurich separately
argued that the Microorganisms Exclusion in the policy precluded coverage because
COVID-19 was a "microorganism." The Microorganisms Exclusion provides:
We will not pay for loss or damage consisting of, directly or
indirectly caused by, contributed to, or aggravated by the
presence, growth, proliferation, spread, or any activity of
"microorganisms", unless resulting from fire or lightning.
Such loss or damage is excluded regardless of any other
cause or event, including a "mistake", "malfunction", or
weather condition, that contributes concurrently or in any
sequence to the loss, even if such other cause or event would
otherwise be covered.
But if a result of one of these excluded causes of loss is a
"specified cause of loss", other than fire or lightning, we will
pay that portion of the loss or damage which was solely
caused by that "specified cause of loss".
We will also not pay for loss, cost, or expense arising out of
any request, demand, order, or statutory or regulatory
requirement that requires any insured or others to test for,
monitor, clean up, remove, treat, detoxify, or neutralize, or
in any way respond to, or assess the effects of
"microorganisms".
In its motion to dismiss Zurich argued that the provision insuring losses
from microorganisms only applied when microorganisms were the result of a covered
cause of loss, not when they were the cause of the loss itself, as Baxter claimed. Zurich
also argued that the Communicable Disease Suspension of Operations provision did not
apply because no public health official or governmental authority prevented access to
Baxter's premises. Finally, Zurich argued that it did not breach the implied covenant
of good faith and fair dealing and did not engage in tortious insurance bad faith because
its denial of coverage was based on a reasonable policy interpretation.
Baxter opposed the motion to dismiss. It argued that "direct physical loss
of or damage to" property does not require "physical damage." Baxter also argued its
claims under the provision covering losses from communicable diseases and implied
-8- 7724
----------------------- Page 9-----------------------
covenant of good faith and fair dealing, and its bad faith claim did not implicate the
meaning of the phrase "physical loss of or damage to" property. Baxter finally argued
that the Microorganisms Exclusions did not exclude coverage under many of the
provisions it relied upon. Zurich replied, maintaining that "physical loss of or damage
to" property required tangible physical damage to property.
In September 2022 the United States District Court for the District of
Alaska certified two questions of law to this court under Alaska Appellate Rule 407:
(1) Under Alaska law, can the presence of the COVID-19 virus at an
insured property constitute "direct physical loss of or damage to" the
property for the purposes of a commercial insurance policy?
(2) Under Alaska law, can operating restrictions imposed on an insured
property by COVID-19 pandemic-related governmental orders constitute
"direct physical loss of or damage to" the property for the purposes of a
10
commercial insurance policy?
We accepted the questions and allowed amicus briefing from the
American Property Casualty Insurance Association (APCIA), the primary national
trade association for home, auto, and business insurers.
STANDARD OF REVIEW
Under Appellate Rule 407(a), we may answer certified questions that
"may be determinative of the cause then pending in the certifying court and as to which
it appears to the certifying court there is no controlling precedent in [our] decisions."
"We exercise our independent judgment when answering a certified question of law
10 The district court denied Zurich's motion for reconsideration of the order
certifying questions.
-9- 7724
----------------------- Page 10-----------------------
and 'select the rule of law that is most persuasive in light of precedent, reason, and
policy. ' "11
DISCUSSION
More than two thousand COVID-19 business interruption cases have been
filed in American courts since the beginning of the pandemic.12 Virtually all of them
have been decided against Baxter's position. A vast majority of federal court decisions
have dismissed COVID-19 business interruption claims with prejudice; so too have a
majority of state courts ruling on the merits on motions to dismiss.13 And nearly all
state supreme courts confronted with the question have concluded that the phrase
"direct physical loss of or damage to property" does not encompass COVID-19
14
pandemic-related operating restrictions or the presence of the COVID-19 virus.
11 Buntin v. Schlumberger Tech. Corp., 487 P.3d 595, 598 (Alaska 2021)
(quoting Kallstrom v. United States, 43 P.3d 162, 165 (Alaska 2002)).
12 See COVID COVERAGE LITIGATION TRACKER, https://cclt.law.upenn.edu/
(last visited Sept. 9, 2024) (recording over 2,390 COVID-19 business interruption cases
based on "physical loss or damage" language).
13 See Trial Court Rulings on the Merits in Business Interruption Cases,
COVID COVERAGE LITIGATION TRACKER, https://cclt.law.upenn.edu/judicial-rulings/
(last visited Sept. 9, 2024) (noting nearly 86% of merits rulings on motions to dismiss
in federal court and over 69% of such rulings in state court have been full dismissals
with prejudice).
14 See, e.g., Conn. Dermatology Grp., PC v. Twin City Fire Ins. Co., 288
A.3d 187, 199 (Conn. 2023) (concluding record lacks indication of physical
transformation of properties as a result of COVID-19 pandemic but instead that "the
COVID-19 pandemic caused a transformation in governmental and societal
expectations and behavior that had a seriously negative impact on the plaintiffs'
businesses"); Wakonda Club v. Selective Ins. Co. of Am., 973 N.W.2d 545, 552-55
(Iowa 2022) (concluding possibility of COVID-19 virus being present on insured's
facilities was insufficient to trigger coverage because "mere loss of use of property,
without more," was not "direct physical loss of property"); Cajun Conti LLC v. Certain
Underwriters at Lloyd's, London, 359 So. 3d 922, 926-29 (La. 2023) (concluding
COVID-19 did not cause "direct physical loss of or damage to" insured restaurant's
-10- 7724
----------------------- Page 11-----------------------
property); Tapestry, Inc. v. Factory Mut. Ins. Co., 286 A.3d 1044, 1060 (Md. 2022)
(rejecting insured's argument that "Coronavirus rested on and adhered to surfaces of
property at its stores" was direct physical loss or damage because insured "does not
allege that any aspect of its property was either lost or structurally altered by its contact
with Coronavirus particles"); Verveine Corp. v. Strathmore Ins. Co., 184 N.E.3d 1266,
1275-77 (Mass. 2022) (concluding COVID-19 governmental orders or presence of
COVID-19 virus on property was not "direct physical loss of or damage to" property);
Starr Surplus Lines Ins. Co. v. Eighth Jud. Dist. Ct. Cnty. Clark, 535 P.3d 254, 263-67
(Nev. 2023) (concluding presence of COVID-19 on property did not amount to "direct
physical loss or damage" under insurance policy); AC Ocean Walk, LLC v. Am.
Guarantee & Liab. Ins. Co., 307 A.3d 1174, 1185-89 (N.J. 2024) (concluding COVID-
19 pandemic, presence of COVID-19 particles on properties, and governmental
directives compelling limitations of insured's casino and entertainment operations was
not "direct physical loss of or damage to" property because insured was merely "not
permitted to use its property as it would otherwise have done"); Consol. Rest.
Operations, Inc. v. Westport Ins. Corp., 235 N.E.3d 332, 336-42 (N.Y. 2024)
(concluding presence of COVID-19 particles or loss of use due to COVID-19-related
government shutdown orders was not "direct physical loss or damage" because there
was no physical alteration of property); Neuro-Commc'n Servs., Inc. v. Cincinnati Ins.
Co., 219 N.E.3d 907, 915-16 (Ohio 2022) (concluding general presence of COVID-19
in community, presence of COVID-19 on surfaces at premises, and presence of persons
infected with COVID-19 on premises, was not "direct physical loss or damage" to
property); Cherokee Nation v. Lexington Ins. Co., 521 P.3d 1261, 1264-65, 1268-70
(Okla. 2022) (concluding business interruption losses from temporary closure to
prevent COVID-19-related harm was not "direct physical loss or damage to" property);
Sullivan Mgmt., LLC v. Fireman's Fund Ins. Co., 879 S.E.2d 742, 745-46 (S.C. 2022)
(concluding presence of COVID-19 virus particles does not constitute "physical loss of
or damage to" property); Hill & Stout, PLLC v. Mut. of Enumclaw Ins. Co. , 515 P.3d
525, 532-34 (Wash. 2022) (concluding COVID-19 business interruption claim for loss
or intended use and loss of business income was not physical loss of property but "more
akin to an abstract or intangible loss"); Colectivo Coffee Roasters, Inc. v. Soc'y Ins.,
974 N.W.2d 442, 447-48 (Wis. 2022) (concluding presence of COVID-19 did not
constitute physical loss of or damage to property because it does not "alter the
appearance, shape, color, structure, or other material dimension of the property")
(internal quotation marks omitted).
-11- 7724
----------------------- Page 12-----------------------
Vermont is the lone state that has allowed claims for COVID-19 business interruption
losses to survive a motion to dismiss.15 But it did so by stretching the "physical
alteration" requirement for "direct physical damage" to property to include "alterations
at the microscopic level," given Vermont's "extremely liberal" notice-pleading
16
standards.
We see no reason to differ from the overwhelming majority. Even with
our insured-friendly approach to interpreting insurance contracts, we conclude that
neither the presence of the COVID-19 virus at an insured property nor operating
restrictions imposed on an insured property by COVID-19 pandemic-related
governmental orders is "direct physical loss of or damage to" property.17 "Direct
physical loss of or damage to" property requires a tangible or material alteration of
property.
A. Alaska's Approach To Insurance Policy Interpretation.
Alaska law treats insurance policies as "sui generis."18 Insurance policies
are "not controlled directly by usual contractual principles," but are treated instead as
"contracts of adhesion[19] due to the inequality in bargaining power."20 Alaska law
15 Huntington Ingalls Indus. v. Ace Am. Ins. Co., 287 A.3d 515, 536-37 (Vt.
2022).
16 Id. at 527-28, 533.
17 See Downing v. Country Life Ins. Co., 473 P.3d 699, 704 (Alaska 2020)
("We interpret ambiguous insurance policies in favor of the purported insured."
(quoting Dugan v. Atlanta Cas. Cos., 113 P.3d 652, 655 (Alaska 2005))).
18 Long v. Holland Am. Line Westours, Inc. , 26 P.3d 430, 444 (Alaska 2001)
(Eastaugh, J., dissenting).
19 Contracts of adhesion are "standard form printed contracts prepared by
one party and submitted to the other on a 'take it or leave it' basis." Stordahl v. Gov't
Emps. Ins. Co., 564 P.2d 63, 65 n.4 (Alaska 1977) (quoting Standard Oil Co. of Cal. v.
Perkins, 347 F.2d 379, 383 n.5 (9th Cir. 1965)).
20 Weaver Bros. v. Chappel, 684 P.2d 123, 125 (Alaska 1984).
-12- 7724
----------------------- Page 13-----------------------
recognizes that policyholders "are offered a contract on a 'take-it-or-leave-it' basis;
premiums are not negotiated but rather are set so as to ensure that the insurer can profit
from the relationship."21 "Because we treat insurance policies as contracts of adhesion,
we construe such policies so as to provide that coverage which a layperson would have
reasonably expected from a lay interpretation of the policy terms."22 Thus "the
policyholder's 'objectively reasonable expectations' govern, even if 'painstaking study
23
of the policy provisions would have negated those expectations.' "
When interpreting an insurance policy, we look to: "(1) the language of
the disputed provisions in the policy, (2) other provisions in the policy, (3) extrinsic
evidence, and (4) case law interpreting similar provisions."24 While we "interpret
ambiguous insurance policies in favor of the purported insured," it is well established
that "the mere fact that two parties to an insurance contract have differing subjective
interpretations of that contract does not make it ambiguous."25 Ambiguity exists "only
26
when the contract, taken as a whole, is reasonably subject to differing interpretations."
21 Best v. Fairbanks N. Star Borough, 493 P.3d 868, 873 (Alaska 2021)
(citing Stordahl, 564 P.2d at 65 n.4).
22 Downing , 473 P.3d at 704 (internal quotation marks omitted) (quoting
U.S. Fire Ins. Co. v. Colver, 600 P.2d 1, 3 (Alaska 1979)).
23 Id. (quoting Allstate Ins. Co. v. Teel , 100 P.3d 2, 4 (Alaska 2004)).
24 Id. (quoting State Farm Mut. Auto. Ins. Co. v. Houle, 269 P.3d 654, 657-
58 (Alaska 2011)). We do not consider extrinsic evidence in this case because there
was none.
25 Id. (quoting Dugan v. Atlanta Cas. Cos. , 113 P.3d 652, 655 (Alaska
2005)).
26 Id. (emphasis and internal quotations omitted) (quoting Dugan , 113 P.3d
at 655).
-13- 7724
----------------------- Page 14-----------------------
B. The Language "Direct Physical Loss Of Or Damage To" Excludes
Coverage For The Presence Of COVID-19 On Property Or COVID-
19 Pandemic-Related Operating Restrictions Imposed On Property.
1. "Direct physical loss" and "direct physical damage" have
different meanings.
We have never previously defined the phrase "direct physical loss of or
damage to" property as it appears in insurance policies. The closest we have come to
doing so was in Whispering Creek Condominium Owner Ass'n v. Alaska National
Insurance Co. , where we interpreted the phrase, "risk of direct physical loss involving
27
collapse."
The policy at issue in Whispering Creek insured "against risk of direct
physical loss involving collapse . . . caused only by . . . hidden decay."28 The
Whispering Creek Condominium Owners Association sued the insurer for costs to
repair its condominiums whose "ceilings . . . showed signs of possible collapse" due to
rot.29 We agreed with the association because the complex was "in imminent danger
of collapse," and held that the collapse provision covered an imminent danger of
30
collapse.
Baxter argues that the phrase "direct physical loss of or damage to" is
"disjunctive" and therefore that "direct physical loss of" must mean something different
than "damage to" property. Zurich does not take a position on whether the two phrases
"direct physical loss" or "direct physical damage" are disjunctive. APCIA agrees with
Baxter that the phrase can be disjunctive, but argues that "physical loss" cannot mean a
loss of use of property "unaccompanied by any tangible, physical alteration of
property."
27 774 P.2d 176, 178 (Alaska 1989).
28 Id.
29 Id. at 177.
30 Id. at 180.
-14- 7724
----------------------- Page 15-----------------------
The phrase "direct physical loss of or damage to" uses distinct and
separate words in "loss" and "damage." Black's Law Dictionary defines "loss" and
"damage" differently: loss is "an undesirable outcome of a risk; the disappearance or
diminution of value, [usually] in an unexpected or relatively unpredictable way" or "the
failure to maintain possession of something,"31 while damage is a "loss or injury to
person or property[,] esp [ecially] physical harm that is done to something or to part of
someone's body."32 Moreover, because one of the two words would be rendered
meaningless if identical meanings were given to both, the phrases "loss of" and
"damage to" must have different meanings. We also observe that while courts across
the country, including several state supreme courts, disagree how exactly to define "loss
33
of" and "damage to," they generally agree that the phrases have distinct meanings.
31 Loss , BLACK 'S LAW DICTIONARY (12th ed. 2024).
32 Damage, BLACK 'S LAW DICTIONARY (12th ed. 2024).
33 See, e.g., Wakonda Club v. Selective Ins. Co. of Am., 973 N.W.2d 545,
553 (Iowa 2022) (recognizing that "physical loss of" property is distinct from "damage
to" property even though "a distinct definition of 'loss' must be 'physical' under the
Policy language" (quoting Lisette Enters., Ltd. v. Regent Ins. Co., 537 F. Supp. 3d 1038,
1045 (S.D. Iowa 2021))); Verveine Corp. v. Strathmore Ins. Co., 184 N.E.3d 1266,
1274-75 nn.12-13 (Mass. 2022) (noting that physical loss can occur without physical
damage in cases of theft or disappearance); Starr Surplus Lines Ins. Co. v. Eighth Jud.
Dist. Ct. Cnty. Clark, 535 P.3d 254, 261 (Nev. 2023) (noting that insurance policies in
question established "two bases for coverage: 'direct physical loss' as well as 'direct
physical damage' "); Consol. Rest. Operations, Inc. v. Westport Ins. Corp., 235 N.E.3d
332, 337-38 (N.Y. 2024) (holding that "physical damage" required "material physical
alteration" to property while "direct physical loss" required "an actual, complete
dispossession"); Sullivan Mgmt., LLC v. Fireman's Fund Ins. Co., 879 S.E.2d 742, 745
(S.C. 2022) ("Loss connotes destruction, meaning it is broader than the term
damage. . . . [A] property that has suffered physical loss has been damaged, but the
converse is not necessarily true because a property can suffer damage without enduring
destruction or loss."); Hill & Stout, PLLC v. Mut. of Enumclaw Ins. Co. , 515 P.3d 525,
532 (Wash. 2022) (holding "physical loss" can mean property "physically destroyed"
or "deprived of in that the property is no longer physically in . . . possession").
-15- 7724
----------------------- Page 16-----------------------
We therefore agree with Baxter and courts across the country in concluding that "direct
physical loss" and "direct physical damage" have different meanings.
2. "Direct physical loss" requires some physical alteration to or
deprivation of property.
Baxter argues that loss of use is the inability to use property for its
intended purpose and so "direct physical loss" must include loss of use of property due
to COVID-19's presence or due to operating restrictions imposed on an insured
property by pandemic-related governmental orders. Baxter relies on Whispering Creek
to bolster its claim that Alaska law supports its interpretation of the phrase "direct
physical loss." Zurich responds that "direct physical loss" requires an alteration of
property and argues that diminished use of property because of pandemic-related health
orders or the presence of COVID-19 cannot constitute direct physical loss. APCIA
asserts that allowing coverage for "loss of use" cases would render the word "physical"
meaningless.
In Whispering Creek we did not focus the phrase "direct physical loss"
but instead on the word "collapse." The parties disagreed as to whether the
condominiums' condition constituted a collapse and the case law we cited focused on
the meaning of "collapse," not "direct physical loss."34 Whispering Creek, therefore,
does not provide Baxter with the support it asserts.
While loss may by itself encompass the loss of use, the modifying
adjectives "direct" and "physical" narrow its meaning. Black's Law Dictionary defines
"direct" as "[f]ree from extraneous influence; immediate";35 it defines "physical" as
34 774 P.2d at 178-79.
35 Direct, BLACK 'S LAW DICTIONARY (12th ed. 2024); accord Direct, THE
AMERICAN HERITAGE DICTIONARY OF THE ENGLISH LANGUAGE (5th ed. 2016)
("Having no intervening persons, conditions, or agencies; immediate . . . .").
-16- 7724
----------------------- Page 17-----------------------
"[o]f, relating to, or involving material things; pertaining to real, tangible objects."36
"Direct physical loss" therefore must exclude losses that: (1) are not the immediate or
closely connected outcome of some "covered cause of loss"; or (2) are intangible or
37
incorporeal.
A mere loss of use without any physical alteration is a classic example of
an intangible loss: the loss cannot be perceived by the senses.38 And, as APCIA
suggests, allowing coverage for loss of use of property may result in triggering coverage
for any regulation that limits a business's operations to any extent, running contrary to
39
the requirement that the loss be "physical."
We therefore conclude that "direct physical loss" must require some
physical alteration of property or a deprivation of possession; mere loss of use is
insufficient.40 But since neither the presence of the COVID-19 virus at an insured
36 Physical, BLACK 'S LAW DICTIONARY ( 12th ed. 2024); accord Physical,
THE AMERICAN HERITAGE DICTIONARY OF THE ENGLISH LANGUAGE (5th ed. 2016)
("Of or relating to material things . . . ." ).
37 See 10A JORDAN R. PLITT ET AL., COUCH ON INSURANCE § 148:46 (3d ed.
2023) ("The requirement that the loss be 'physical ' . . . is widely held to exclude alleged
losses that are intangible or incorporeal and, thereby, to preclude any claim against the
property insurer when the insured merely suffers a detrimental economic impact
unaccompanied by a distinct, demonstrable, physical alteration of the property.").
38 See Intangible, BLACK 'S LAW DICTIONARY ( 12th ed. 2024) (defining
intangible as "[n]ot capable of being touched; impalpable; incorporeal").
39 See, e.g., Plan Check Downtown III, LLC v. AmGuard Ins. Co., 485
F. Supp. 3d 1225, 1231-32 (C.D. Cal. 2020) (considering hypotheticals where city
changes maximum occupancy codes in restaurants to lower caps or where city amends
ordinance to expand duration when restaurants in residential zones must cease
operations at night and concluding "loss of use" coverage would be "a sweeping
expansion of insurance coverage without any manageable bounds").
40 The classic example of a loss involving deprivation of possession is theft.
E.g., Verveine Corp. v. Strathmore Ins. Co., 184 N.E.3d 1266, 1274-75 nn.12-13 (Mass.
2022).
-17- 7724
----------------------- Page 18-----------------------
property nor operating restrictions imposed on an insured property by COVID-19
pandemic-related governmental orders physically altered the property or deprived
Baxter of possession, they did not cause "direct physical loss" to the property.
3. "Direct physical damage" also requires physical alteration to
property.
Baxter acknowledges that "damage to" property requires "physical or
tangible harm or injury to covered property" but argues that the presence of the COVID-
19 virus caused "physical or tangible harm or injury to covered property." Zurich,
joined by APCIA, rejects Baxter's construction of physical damage, arguing that Baxter
at best only alleges "temporarily diminished use of property."
The Vermont Supreme Court adopted an approach akin to Baxter's
argument in Huntington Ingalls Industries, Inc. v. Ace American Insurance Co.41 In
Huntington, the court considered an appeal from a grant of judgment on the pleadings
in favor of reinsurers on a military shipbuilding company's claims against the
reinsurers.42 The policy at issue insured against "all real and personal property and
against all risks of direct physical loss or damage to property."43 The shipbuilding
company sought coverage under the policy for losses it suffered as a result of COVID-
19, including losses arising from "disruption in orderly construction and repair of
vessels, schedule impacts in the construction and repair of vessels, expenses . . .
incurred to continue as near to normal operations as practicable, loss of profit . . . , and
other time-element losses."44 The Vermont Supreme Court reversed the grant of
41 287 A.3d 515 (Vt. 2022).
42 Id. at 519-21.
43 Id. at 520 (alterations and internal quotations omitted).
44 Id. at 522.
-18- 7724
----------------------- Page 19-----------------------
judgment on the pleadings because the shipbuilding company's allegations were
"sufficient . . . to survive . . . Vermont's extremely liberal pleading standards."45
The court first interpreted "direct physical damage."46 It noted that the
phrase had "three components": (1) "immediate or proximate causation"; (2) "material
force or effect"; and (3) "injury to property."47 It concluded that "direct physical
damage" required "a distinct, demonstrable, physical change to property" and held that
48
these could be "alterations at the microscopic level."
The court next explained that the case's procedural posture was "integral"
49
to its decision, because Vermont has "extremely liberal" notice-pleading standards.
It noted that under Vermont law, "[a] complaint need only be a bare bones statement
that merely provides the defendant with notice of the claims against it."50 As a result it
51
noted that judgments on the pleadings "are disfavored and should be rarely granted."
The court concluded that allegations that COVID-19 "can adhere to
surfaces," transform surfaces into "fomite[s],"52 and therefore "cause[] detrimental
physical effects that alter [] and impair[] the functioning of the tangible, material
45 Id. at 537.
46 Id. at 527.
47 Id.
48 Id. at 527-28. The Supreme Court of Vermont separately concluded that
"direct physical loss" requires: (1) "deprivation or destruction of property"; (2) "in
whole or in part"; (3) that is "causally linked to a physical event"; and (4) is "persistent."
Id. at 529-32.
49 Id. at 533.
50 Id. (internal quotation marks omitted).
51 Id. (internal quotation marks omitted).
52 A fomite is "an inanimate object or substance that is capable of
transmitting infectious organisms from one individual to another." Fomite, THE
AMERICAN HERITAGE DICTIONARY OF THE ENGLISH LANGUAGE (5th ed. 2016).
-19- 7724
----------------------- Page 20-----------------------
dimensions of the property" was sufficient to constitute "direct physical damage."53 It
emphasized that the insured's allegations that it had to take steps to remedy the situation
"by physically altering its property in certain ways, including sanitization procedures,
installation of physical barriers and devices, and redesign of physical spaces,"
"bolster[ed] the argument that a distinct, demonstrable physical alteration occurred and
54
is something that is in need of repair to restore business operations."
The Vermont court "decline[d] to conclude that an event which allegedly
causes a physical alteration to property renders property such that it cannot be used as
intended, and requires physical remediation efforts targeted at the physical alteration
cannot be 'direct physical damage' at th[e] pre-discovery stage."55 It instead was
"inclined to allow experts and evidence to come in to evaluate the validity of insured's
novel legal argument before dismissing th[e] case."56 It emphasized that remanding the
case to allow for further factual development was "consistent with the philosophy
underlying notice pleading," which aims "not to keep litigants out of court but rather to
keep them in so that the merits of the claim may be sorted out during a flexible pretrial
process and, as appropriate, through the crucible of trial."57 And it noted that this
concern was "paramount for cases involving novel legal theories" like the one before
58
it.
While we agree with the Vermont Supreme Court that the phrase "direct
physical damage" requires a physical alteration of property, we depart from its
53 Huntington, 287 A.3d at 533-34 (internal quotation marks omitted).
54 Id. at 534 (internal quotation marks omitted).
55 Id. at 534 n.14.
56 Id. at 535.
57 Id. (internal quotations omitted) (quoting Bell Atl. Corp. v. Twombly, 550
U.S. 544, 575 (2007) (Stevens, J., dissenting)).
58 Id.
-20- 7724
----------------------- Page 21-----------------------
conclusion that COVID-19's presence on property constitutes a physical alteration of
property. The difficulty with Baxter's argument and the Vermont court's theory is that
COVID-19 merely attaches to property; it does not "give rise to the necessary
transformative element of something like fire, water, or smoke."59 Otherwise, as the
Nevada Supreme Court noted, "the alleged presence of a physical force would render
every sneeze, cough, or even exhale a qualifying harm."60 And as the Supreme Judicial
Court of Massachusetts noted in Verveine Corp. v. Strathmore Insurance Co.,
"[e]vanescent presence of a harmful airborne substance that will quickly dissipate on
its own, or surface-level contamination that can be removed by simple cleaning, does
61
not physically alter or affect property."
An analogy between the COVID-19 virus and water illustrates this point.
COVID-19 is to property what water is to a plastic sheet: water does nothing to a plastic
sheet but at most, it stays on it or attaches to it. But water transforms, alters, or changes
the state of dry paper into a wet "mush" or makes it much easier to tear. COVID-19
merely stays on or attaches to property, as water does to plastic. The virus does to
people what water does to paper: it transforms, alters, or changes their well-being, but
its effect on people is not at issue here.
We conclude that "direct physical damage" requires physical alteration of
property. But because COVID-19 does not physically alter property and merely
attaches to it, the presence of COVID-19 on property does not constitute "direct
physical damage."
59 Starr Surplus Lines Ins. Co. v. Eighth Jud. Dist. Ct. Cnty. Clark, 535 P.3d
254, 264 (Nev. 2023) (internal quotations omitted) (quoting Port Auth. N.Y. & N.J. v.
Affiliated FM Ins. Co. , 311 F.3d 226, 236 (3d Cir. 2002)).
60 Id. (internal quotations and alterations omitted).
61 184 N.E.3d 1266, 1276 (Mass. 2022).
-21- 7724
----------------------- Page 22-----------------------
C. Other Provisions Of The Policy Support Excluding The Presence Of
COVID-19 And COVID-19 Pandemic-Related Operating
Restrictions From Coverage.
Baxter argues that other provisions of the policy support its interpretation
of the phrase "direct physical loss of or damage to" property. It argues that the phrase
includes coverage for loss of use of property due to COVID-19 pandemic-related
governmental orders or physical or tangible harm to property caused by the presence of
the COVID-19 virus on the property.
Baxter first argues that the Property Coverage for Microorganisms
supports its argument, asserting that the coverage insures against "direct physical loss
of or damage to Covered Property caused by 'microorganisms,' " and that the word
"microorganisms" is defined to include "viruses" like COVID-19. As a result, it claims,
"direct physical loss of or damage to" property specifically envisions the presence of a
virus constituting "direct physical loss or damage to" covered property.
Baxter next turns to the policy's Business Income Coverage, which
provides coverage for "actual loss of 'business income' [an insured] sustain[s] due to
the necessary 'suspension' of [its] 'operations' during the 'period of restoration.' " It
points to the definition of the word 'suspension,' which refers to either a "slowdown or
cessation of [an insured's] business activities" or "[t]hat a part or all of the covered
location that is rendered untenantable." Baxter notes that the definition of the "period
of restoration" is defined specifically to begin when "[t]he direct physical loss or
damage that causes 'suspension' of [an insured's] 'operations' occurs" and to end when
"the location where the loss occurred could have been physically capable of resuming
the level of 'operations' which existed prior to the loss." And it excludes "any increased
period required due to the enforcement of any ordinance or law that requires any insured
or others to test for, monitor, clean up, remove, contain, treat, detoxify or neutralize, or
in any way respond to, or assess the effects of . . . 'microorganisms.' " Based on these
-22- 7724
----------------------- Page 23-----------------------
definitions, Baxter argues that the policy "expressly envisions a situation where the
covered cause of loss was due to . . . viruses."
Baxter next relies on the Civil Authority Coverage for Business Income,
which provides coverage for actual loss of business income from the "necessary
'suspension' . . . of [an insured's] 'operations' if the 'suspension' or delay is caused by
order of civil authority that prohibits access to the 'premises '." And because
"suspension" includes a "slowdown or cessation of [an insured's] business activities"
or "part or all of the covered location that is rendered untenantable," Baxter argues that
the policy encompasses damages caused by a complete or partial inability to use all of
its property due to pandemic-related governmental orders.
Baxter finally argues that the Microorganisms Coverage for Business
Income, which provides coverage for "actual loss of 'business income' [an insured]
sustain[s] due to the . . . [n]ecessary suspension of [its] operations from direct physical
loss of or damage to Covered Property caused by 'microorganisms'," favors its
interpretation of "direct physical loss of or damage to."
But Baxter misunderstands or misrepresents policy language in its
arguments. First, both the Property Coverage for Microorganisms and Microorganisms
Coverage for Business Income provisions require that the microorganisms causing
"direct physical loss of or damage to" property be "the result of a 'covered cause of
loss'," rather than being the covered cause of loss.62 The language of the
Microorganisms Exclusion explicitly excludes from coverage "loss or damage
consisting of, directly or indirectly caused by, contributed to, or aggravated by the
presence, growth, proliferation, spread, or any activity of 'microorganisms', unless
resulting from fire or lightning." Thus microorganisms like the COVID-19 virus are
62 Emphasis added.
-23- 7724
----------------------- Page 24-----------------------
excluded from being or causing a covered cause of loss under the Microorganisms
Exclusion.
The Business Income Coverage, which provides coverage for loss of
business income as a result of the "suspension" of operations for the "period of
restoration," requires that the "suspension" be caused by "direct physical loss or
damage." But because the Microorganisms Exclusion excludes the COVID-19 virus
from being a covered cause of loss, the "suspension" of operations due to the virus is
excluded from coverage.
The "period of restoration" provision further confirms that "direct
physical loss of or damage to" property requires a physical alteration of property. As
Zurich notes, the "period of restoration" extends coverages only until the "location had
been restored to the physical size, construction, configuration, location, and material
specifications" needed to obtain required permits or similar documents or until
63
"removal, repair, replacement, or restoration of the damaged property is completed."
Restoring a location to its original size, construction or configuration, or until "removal,
repair, replacement, or restoration" is completed, implies that some physical alteration
or destruction of the property must take place for "direct physical loss of or damage to"
property to have occurred. The presence of COVID-19 virus particles requires no such
removal, repair, replacement, or restoration; it either "quickly dissipate[s] on its own,"
64
or "can be removed by simple cleaning."
Baxter also selectively quotes the Microorganisms Coverage for Business
Income provisions, which provide for coverage only "when the 'microorganisms' are
63 See, e.g., Verveine Corp. , 184 N.E.3d at 1273-75 (relying on "period of
restoration" provisions to "bolster[]" interpretation that "direct physical loss of or
damage to" requires "some 'distinct, demonstrable, physical alteration of the
property' " (quoting 10A JORDAN R. PLITT ET AL., COUCH ON INSURANCE § 148:46
(rev. ed. 20 16))).
64 Id. at 1276.
-24- 7724
----------------------- Page 25-----------------------
the result of a 'covered cause of loss,' "65 not when they are the cause of loss. These
provisions support the conclusion that the presence of COVID-19 virus particles on
property does not constitute "direct physical loss of or damage to" property.
Baxter's argument under the Civil Authority Coverage for Business
Income provision also fails because that provision requires an "order of civil authority
that prohibits access to the premises." But Baxter does not allege that DHSS notices
and guidance prohibited access to its premises.
None of the provisions of the policy on which Baxter relies support its
arguments. Instead, they make clear that the presence of the COVID-19 virus and
pandemic-related operating restrictions imposed on property are excluded from
coverage under the policy.
D. Case Law Across The Country Supports Excluding The Presence Of
COVID-19 Or Pandemic-Related Operating Restrictions From
Coverage.
Baxter argues that Alaska's continued adherence to the doctrine of
reasonable expectations renders it unique, requiring insurance contracts to be treated
differently in Alaska.66 It observes that we have never applied our law regarding
reasonable expectations to the phrase "direct physical loss of or damage to" and urges
us to not to "apply some level of analysis that presents a higher bar to coverage than the
law as applied in Alaska."67 Zurich responds by reiterating that courts overwhelmingly
65 Emphasis added.
66 See, e.g., Susan Randall, Freedom of Contract in Insurance, 14 CONN.
INS . L.J. 107, 112 (2008) ("Today only two jurisdictions - Alaska and Hawai'i -
accept the doctrine as it was originally formulated, by permitting policyholders'
expectations to trump clear policy language.").
67 Baxter asserts that the cases it cites that support its position on "direct
physical loss of or damage to" property should be given more weight because they apply
a higher bar to coverage than Alaska law. See, e.g., Seifert v. IMT Ins. Co., 542
F. Supp. 3d 874, 880 (D. Minn. 2021) (concluding under Minnesota law, "direct
-25- 7724
----------------------- Page 26-----------------------
have rejected Baxter's construction of the term "direct physical loss of or damage to."
APCIA agrees, arguing that "nationwide authority and common sense dictate that loss
68
of use is neither direct physical loss of nor direct physical damage to property."
As we noted earlier, courts have decided over two thousand COVID-19
business interruption cases and all but one have rejected Baxter's argument.69 The
language "direct physical loss of or damage to" property appears to exclude coverage
for the presence of COVID-19 and operating restrictions imposed on the property by
pandemic-related governmental orders; other policy provisions bolster this
interpretation; and case law across the country overwhelmingly interprets "direct
physical loss of or damage to" property to exclude coverage. We therefore conclude
that the phrase "direct physical loss of or damage to" property does not encompass
either the presence of the COVID-19 virus at an insured property or operating
restrictions imposed on an insured property by pandemic-related governmental orders.
CONCLUSION
Neither the presence of the COVID-19 virus at an insured property nor
operating restrictions imposed on an insured property by pandemic-related
physical loss" can occur "without structural damage or tangible injury to property," but
merely "an impairment of function and value" to property) (internal quotation marks
omitted); Derek Scott Williams PLLC v. Cincinnati Ins. Co., 522 F. Supp. 3d 457, 463
(N.D. Ill. 2021) (finding insured dental practice stated viable COVID-19 business
interruption claims for coverage under property insurance policy because "physical loss
is broad enough to cover . . . a deprivation of the use of its business premises") (internal
quotation marks omitted); Urogynecology Specialist of Fla. LLC v. Sentinel Ins. Co.,
489 F. Supp. 3d 1297, 1302-03 (M.D. Fla. 2020) (denying insurer's motion to dismiss
because virus exclusion did not unambiguously exclude coverage for COVID-19
business interruption losses); Huntington Ingalls Indus. v. Ace Am. Ins. Co., 287 A.3d
515, 524-533 (Vt. 2022).
68 Capitalization and emphasis omitted.
69 See supra notes 13-15 and accompanying text.
-26- 7724
----------------------- Page 27-----------------------
governmental orders constitutes "direct physical loss of or damage to" the property for
the purposes of a commercial insurance policy.
-27- 7724
 |
| Case Law Statutes, Regs & Rules Constitutions Miscellaneous |
|
