Duty to Defend Under Difficult Fact Situations
When There Is No Loss to Tangible Property, Insured Who Purchased Valueless Property Cannot Collect from Insurer Because he was Defrauded, Loss of Computer Data as Property Damage
This article was adapted from my book, “Zalma on Insurance Claims Part 103 Third Edition” from Amazon.com and Available as a paperback and Available as a Kindle Book.
Duty to Defend When There Is No Loss to Tangible Property
The Covid-19 Pandemic has resulted in multiple cases dealing with the need for actual tangible damage. For example, in a Class Action attempt failed for lack of direct physical damage.
Caribe Restaurant & Nightclub, Inc. (“Caribe”) initiated a class action against Defendant Topa Insurance Company (“Topa”) alleging breach of contract and seeking declaratory judgment for insurance coverage.
The USDC ruled on a Covid 19 business interruption claim in Caribe Restaurant & Nightclub, Inc., Individually and On Behalf of All Others Similarly Situated v. Topa Insurance Company, Case No. 2:20-cv-03570-ODW (MRWx), United States District Court Central District of California (April 9, 2021) as have almost every court in the country.
Caribe owned and operated La Luz Ultralounge (“La Luz”), a restaurant and nightclub located in Bonita, California. Caribe purchased an insurance policy (“Policy”) from Topa.
In March 2020, due to the COVID-19 pandemic, the State of California and County of San Diego ordered “the closure of bars” and “bann[ed] onsite dining.” In May 2020, San Diego County “permitted the resumption of onsite dining” subject to restrictions. Caribe alleged that, as a result of these civil authority orders, it was forced to “suspend or reduce business” at La Luz. Caribe also alleges that COVID-19 “impaired Caribe’s property by making it unusable in the way that it had been used before.”
Caribe alleged that its losses were covered under the Policy and identified four specific provisions: “Business Income”; “Extra Expense”; “Civil Authority”; and “Duties in the Event of Loss” (referred to as the “Sue and Labor” provision). Caribe filed claims for coverage under these provisions, which Topa denied. Accordingly, Caribe sued Topa asserting that denial of coverage was a breach of contract and seeking declaratory judgment.
Topa argued the Policy provisions Caribe cites provide coverage only for “direct physical loss of or damage to” Caribe’s property and Caribe cannot recover under any of these provisions because it fails to allege “any ‘direct physical loss’ of or damage to” the insured premises. Caribe, on the other hand, insists that it has sustained “direct physical loss” of its property because it was “forced to suspend or reduce business at its location due to COVID-19” and the resultant safety orders.
Every Policy provision at issue contains language conditioning recovery on physical loss or damage to the property. Indeed, the Business Income provision states that coverage is contingent on “the necessary ‘suspension’ of [business] ‘operations'” caused by “direct physical loss of or damage to [the insured] property.” Thus, the question before the USDC became whether Caribe had alleged “physical loss or damage” sufficient to trigger coverage under one of these provisions.
Under California law, losses from inability to use property do not amount to direct physical loss of or damage to property within the ordinary and popular meaning of that phrase. Further, only a “distinct, demonstrable, physical alteration” of property will amount to physical loss or damage that may trigger coverage. MRI Healthcare Ctr. Of Glendale, Inc. v. State Farm Gen. Ins. Co., 187 Cal. App. 4th 766, 779 (2010). Detrimental economic impact alone is insufficient. Several courts in this jurisdiction have recently considered cases with facts nearly identical to this one, and these courts have reached a consensus — where an insurance policy conditions recovery on “direct physical loss or damage,” Economic Business Impairments caused by COVID-19 safety orders do not fall within the scope of coverage.
The Policy provisions on which Caribe relied clearly condition recovery on physical loss or damage to the insured premises. Caribe alleges only that COVID-19 restrictions have prevented it from using its property for normal business operations which it claims is direct physical damage. However, Caribe did not sufficiently allege direct physical loss or damage such as would trigger coverage. Therefore, Caribe’s failure to allege direct physical loss or damage forecloses its claim to coverage under the Policy.
Nevertheless, Caribe contends “direct physical loss” should be read to encompass the type of economic business impairments it has suffered. Even if the Policy covered permanent dispossession, which it does not, Caribe has not alleged permanent dispossession, nor could it, as COVID-19 safety orders only temporarily restricted Caribe’s use of its premises.
While the Court was sympathetic that Caribe is suffering economically from the unprecedented COVID-19 pandemic, an economic business impairment does not qualify as a physical loss or damage to the premises.
Because Caribe did not allege direct physical loss or damage, its claims were not covered and its causes of action for breach of contract and declaratory judgment fail. Therefore, the Court granted Topa’s Motion to Dismiss without leave to amend.
As sad as the Covid 19 losses are a court has no right to, nor will it, change the wording of the policy. The damage done to Caribe and those similarly situated was done by the state of California. Failing to obtain insurance benefits perhaps some creative lawyer will find a way to sue the state for its wrongful and allegedly unconstitutional orders depriving Caribe of the right to do business.
The Supreme Court of California, in Kazi v. State Farm Fire & Cas. Co.,[1] found that a CGL insurer only owes a duty to indemnify if there is damage to tangible property. The court stated:
A standard general liability insurer has a duty to defend and indemnify for a loss to tangible property only. The property loss section of these policies provides coverage for physical injury, loss, or destruction of tangible property, and the focus of the property damage coverage is the property itself. (Waller v. Truck Ins. Exchange, Inc., 11 Cal. 4th 1, 17 (1995) (Waller).
For our purposes, it is important to note that the policies are not intended to cover intangible property losses, including loss of an investment, loss of goodwill or loss of intangible property use. (Id. at pp. 17-18; Gunderson, supra, 37 Cal. App. 4th at p. 1109.)
The court found that an easement is intangible, so there was no obligation to defend or indemnify an insured for such intangible losses. The Kazis had purchased land (Parcel A) adjacent to Parcel B, which was purchased by the Tollaksons. Sale documents indicated that the two parcels shared a common driveway 20 feet in width that straddled the boundary line. The Tollaksons assumed the existence of an implied easement. The Kazis subsequently graded an access road on Parcel A near the boundary line. The Tollaksons filed suit, alleging that the Kazis’ access road obstructed the Tollaksons’ implied easement over Parcel A.
There were two policies at issue. One policy defined property damage as “physical injury to or destruction of tangible property, including loss of its use.” The second policy defined property damage as “physical damage to or destruction of tangible property, including loss of use of this property.”
Concluding that the rights involved were all intangible, the court stated:
Thus, the Kazis’ grading a driveway over their own Parcel A and the 10-foot strip they owned that was subject to an easement dispute did not change the nature of the underlying Tollakson action into an action for tangible property loss. Grading over the insureds’ own land that may have been subject to an implied easement did not change the easement’s intangible nature, nor could it ever change the character of the easement right-of-way the Tollaksons claimed. (Gunderson, supra, 37 Cal. App. 4th at p. 1119.) It is the nature of the easement right that was at issue, not the physicalities that may relate to it. (Ibid.)
As Gunderson made clear, a loss of “pure rights in property” is not the physical damage or injury to tangible property required to trigger a duty to defend or indemnify under general liability insurance policies. (Emphasis added.)
In Indiana, damage from an alleged defective service may be recoverable under a negligence theory if the alleged defective service caused personal injury or damage to other property, but contract law governs purely economic loss arising from the failure of the service to perform as expected.[2]
The economic losses included diminution in value of the structure, incidental and consequential losses, lost profits, rental expense, cost of repair and costs of reconstruction.
Both the economic loss doctrine and the integrated system approach should be viewed as part of the rationale for certain property damage exclusions found in the CGL form.
In Mraz v. Canadian Universal Insurance Co.,[3] the Court of Appeal for the Fourth Circuit concluded, with regard to response costs resulting from government orders to clean up hazardous waste, that:
Response costs are not themselves property damages. An examination of CERCLA’s provisions defining response, § 9601 (23)-(25), and authorizing the president to take response action, § 9604, makes it clear that property damage and response are independent; for example, the government may take response action in cases of a substantial threat of a release of hazardous substances before any damage ever occurs.
One cannot equate response costs with “injury to or destruction of tangible property,” this policy’s definition of property damage. Instead, response costs are an economic loss.
Since the court concluded that response costs were not “property damage” to tangible property, the insurer had no duty to defend or indemnify.
Courts will work to find coverage for defense if logically possible. Therefore, construction defects in the house that damaged the house itself constituted “property damage” sufficient to trigger the duty to defend or indemnify under a CGL policy.[4]
A party that has incurred its own response costs to clean up contamination may also be entitled to bring a cost recovery claim under CERCLA Section 107 for those response costs.[5] However, in essence, an insurer that is only obligated to reimburse the insured for cleanup costs does not itself incur response costs.[6] Therefore, if response costs are paid by an insurer it is necessary for an insurer to seek reimbursement of the response costs paid from the U.S. government available to the insurer by statute. “[T]he plain statutory language and overall scheme of CERCLA indicate that an insurer cannot bring a subrogation action under section 107(a) when it has not itself incurred response costs.”[7]
As the Supreme Court has observed, “[g]iven the clear meaning of the text, there is no need ... to consult the purpose of CERCLA at all,” as “‘it is ultimately the provisions of our laws rather than the principal concerns of our legislators by which we are governed.’”[8]
It is a settled rule that the insurer must look to the facts of the complaint and extrinsic evidence, if available, to determine whether there is a potential for coverage under the policy and a corresponding duty to defend. (Waller v. Truck Ins. Exchange, Inc. (1995) 11 Cal.4th 1, 25.)
Further, it is well established that even after a valid, initial denial of defense, later developments may impact the insurer's duty to defend (Marie Y. v. General Star Indemnity Co. (2003) 110 Cal.App.4th 928, 946), and "'a bare "potential" or "possibility" of coverage [is] the trigger of a defense duty.'" (Howard v. American National Fire Ins. Co. (2010) 187 Cal.App.4th 498, 520, citing Montrose Chemical Corp. v. Superior Court (1993) 6 Cal.4th 287, 300.) [Berry v. State Farm Gen. Ins. Co. (Cal. App., 2019)]
In Chubb Custom Insurance Co. v. Space Systems/Loral, Inc.,[9] the Ninth Circuit explained that response costs are deemed “necessary” when an actual and real threat to human health or the environment exists.[10] Because the statute does not define “incur” in the context of response costs, and there is no controlling authority on the term in the CERCLA context, the Ninth Circuit applied the ordinary meaning, which is to acquire or come into, to become liable or subject to as a result of one’s action, to bring upon oneself.