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Determine Whether Property Damage Occurred
A first party property policy does not insure property: it insures a person, partnership, corporation or other entity against the risk of loss of the property. Before an insured can make a claim for indemnity under a policy of first party property insurance the insured must prove that there was damage to property the risk of loss of which was insured by the policy. The obligation imposed on the insured by the policy is often relatively easy to fulfill.
For example, in the case of a fire the charred building need only be shown to the insurer. Other situations may not be as easy to prove. Is a building overhanging a newly created cliff damaged? Has a church that is permeated with a gasoline odor sustained property damage? Was missing property stolen? Has a building showing signs it may collapse, subject to an insured peril called “collapse?”
Often, an insurer needs the wisdom of Solomon to reach a correct and fair result. The first party property adjuster is charged with the duty of helping the insured establish the existence or nonexistence of property damage due to a risk of loss insured against and not excluded and work to keep all of the promises made by the insurance policy.
When a first party property policy insures against the risk of physical loss to certain real or personal property, whether the policy is a named peril, all risk, special risk, or direct risk of physical loss policy, the insured must first prove there is damage to the property. An insured may also make claim for loss of use of the property that is the subject of the insurance.
The Insured can retain the property and sustain a constructive loss of use by denial of access or danger of imminent destruction. In Hughes v. Potomac Insurance Co., 199 Cal. App. 2d 239 (1962), the court found coverage after the land next to the house slid away causing the undamaged house to overhang a cliff. The California Court of Appeal found that damage to a structure existed if it was not a safe place for people to live even though all the walls stood and the roof kept out the rain.
While a loss of use may, in some cases, entail a physical loss, “loss of use” and “physical loss or damage” are not synonymous. Indeed, interpretation of physical loss as requiring only loss of use stretches “physical” beyond its ordinary meaning and may, in some cases “render the word ‘physical’ meaningless.” In Source Food Tech., Inc. v. U.S. Fidelity and Guar. Co., 465 F.3d 834, 835 (8th Cir.2006) the court found no coverage under a policy covering “direct physical loss to property” when property was meat which was not allowed to cross the border into the United States and was thus treated as unusable but in fact suffered no spoilage or contamination.
The Covid 19 Pandemic caused serious litigation on the issue of what is physical loss or damage and how a limitation in a policy of insurance defeats attempts to obtain coverage for loss of use of property and interruption of business caused by orders of state authorities.
Oral Surgeons, P.C., sued its insurers for loss of earnings. Oral Surgeons offers oral and maxillofacial surgery services at its four offices in the Des Moines, Iowa, area. Oral Surgeons stopped performing non-emergency procedures in late March 2020, after the governor of Iowa declared a state of emergency and imposed restrictions on dental practices because of the COVID-19 pandemic. Oral Surgeons resumed procedures in May 2020 as the restrictions were lifted, adhering to guidance from the Iowa Dental Board. The insurer refused to pay Oral Surgeons sued.
In Oral Surgeons, P.C. v. The Cincinnati Insurance Company, The Restaurant Law Center Amicus on Behalf of Appellant(s), American Property Casualty Insurance Association; National Association of Mutual Insurance Companies Amici, No. 20-3211, United States Court of Appeals for the Eighth Circuit (July 2, 2021) the Eighth Circuit was asked by Oral Surgeons and some Amici to find the loss of use of its offices was physical loss and Oral Surgeons were entitled to business interruption benefits.
Oral Surgeons submitted a claim to The Cincinnati Insurance Company (Cincinnati) for losses it suffered as a result of the suspension of non-emergency procedures. The policy insured Oral Surgeons against lost business income and certain extra expense sustained due to the suspension of operations “caused by direct ‘loss’ to property.” The policy defined “loss” as “accidental physical loss or accidental physical damage.”
Cincinnati responded that the policy did not afford coverage because there was no direct physical loss or physical damage to Oral Surgeons’ property. Oral Surgeons sued. The district court granted Cincinnati’s motion to dismiss, concluding that Oral Surgeons was not entitled to declaratory judgment.
Oral Surgeons’ appeal alleged that the COVID-19 pandemic and the related government-imposed restrictions on performing non-emergency dental procedures constituted a “direct ‘loss’ to property” because Oral Surgeons was unable to fully use its offices. Oral Surgeons argued that the policy’s disjunctive definition of “loss” as “physical loss” or “physical damage” created an ambiguity that must be construed against Cincinnati. To give the terms separate meanings, Oral Surgeons suggests defining physical loss to include “lost operations or inability to use the business” and defining physical damage as a physical alteration to property.
An appellate court must construe the policy to give effect to the intent of the parties. Intent is determined by the language of the policy itself, unless there is ambiguity. Ambiguity exists only when policy language is subject to two reasonable interpretations. Generally speaking, the plain meaning of the insurance contract prevails.
The Cincinnati policy clearly required direct “physical loss” or “physical damage” to trigger business interruption and extra expense coverage. Accordingly, there must be some physicality to the loss or damage of property. Oral Surgeons needed to prove, therefore, that a physical alteration, physical contamination, or physical destruction of its property brought about a loss.
The common usage of “physical” in the context of a loss therefore means the loss of something material or perceptible on some level. The policy cannot reasonably be interpreted to cover mere loss of use when the insured’s property has suffered no physical loss or damage. The Eighth Circuit refused to find “loss of use” and “physical loss or damage” synonymous. Rather, they are opposites.
The unambiguous requirement that the loss or damage be physical in nature accords with the policy’s coverage of lost business income and incurred extra expense from the date of the physical damage to the insured’s property until the insured restores the damaged property to use. The “period of restoration” begins at the time of “loss” and ends on the earlier of:
The date when the property at the “premises” should be repaired, rebuilt or replaced with reasonable speed and similar quality; or
The date when business is resumed at a new permanent location.
Property that has suffered physical loss or physical damage requires restoration. That the policy provides coverage until property “should be repaired, rebuilt or replaced” or until business resumes elsewhere assumes physical alteration of the property, not mere loss of use. When the only reason the property was not used was an order of a governmental agency is not a physical loss, or physical damage. In fact, the property where Oral Surgeons practiced was unchanged during the entire time they could not perform Oral Surgery.
The complaint pleaded generally that Oral Surgeons suspended non-emergency procedures due to the COVID-19 pandemic and the related government-imposed restrictions. The complaint thus alleged no facts to show that it had suspended activities due to direct “accidental physical loss or accidental physical damage, regardless of the precise definitions of the terms “loss” or “damage.”
Since the policy clearly did not provide coverage for Oral Surgeon ’s partial loss of use of its offices, absent a showing of direct physical loss or physical damage. Where no ambiguity exists, an appellate court will not write a new policy to impose liability on the insurer.
There is no question that the orders closing businesses due to fear of spreading Covid-19 caused damage – a loss of business income – to Oral Surgeons and all other businesses who were forced to close down by order of the state or some entity. That order did not damage the property that was the subject of the insurance and there was no need to restore it since once the order was pulled the business of Oral Surgeons was able to begin immediately. No insurance policy insures against every possible loss. The loss claimed by Oral Surgeons was one for which no insurance benefits were available.
When a residence contains walls that were constructed using sheets of Chinese drywall that, over time, released sulfuric gas into the Residence it was found to have incurred property damage even though the walls remained intact. (Travco Ins. Co. v. Ward, 715 F.Supp.2d 699 (E.D. Va. 2010))
Other cases have likewise accepted the view that “damage” includes loss of function or value including a loss of power to the insured’s premises. (Dundee Mut. Ins. Co. v. Marifjeren, 1998 ND 222, 587 N.W.2d 191, Gen. Mills, Inc. v. Gold Medal Ins. Co., 622 N.W.2d 147, (Minn.Ct.App.2001); Pepsico, Inc. v. Winterthur Int’l Am. Ins. Co., 24 A.D.3d 743, 806 N.Y.S.2d 709 (2005); Wakefern Food Corp v. Liberty Mutual, 406 N.J. Super. 406 N.J. Super. 524, 968 A.2d 724 (App. Div. 2009)).
In ordinary use and widely accepted definitions, physical damage to property means “a distinct, demonstrable, and physical alteration” of its structure. 10 Couch on Insurance § 148:46 (3d ed. 1998). Physical damage to a building as an entity by sources unnoticeable to the naked eye must meet a higher threshold. The Colorado Supreme Court in Western Fire Ins. Co. v. First Presbyterian Church, 165 Colo. 34, [968 A.2d 738] 437 P.2d 52 (1968), concluded that coverage was triggered when authorities ordered a building closed after gasoline fumes seeped into a building’s structure and made its use unsafe. Although neither the building nor its elements were demonstrably altered, its function was eliminated. [Wakefern Food v. Liberty Mut. Ins., 968 A.2d 724, 406 N.J. Super. 524 (N.J. Super., 2009)]
Policy Language
Standard polices do not define the phrase “physical loss or damage.” In contrast, commercial general liability (CGL) policies define “property damage” as “physical injury to or destruction of tangible property which occurs during the policy period.”
The meanings are different and a court, a lawyer or an adjuster should not use a case interpreting a CGL to help in understanding a first party property policy.
An example of the failure to show damage to tangible property is a decision of the California Court of Appeal in Simon Marketing v. Gulf Insurance Co., 149 Cal.App.4th 616, 57 Cal.Rptr.3d 49 (2007). Unknown to Simon Marketing, a company that created promotional games for McDonald’s Corp., their security director, Jerome Jacobson, stole $21 million in kickbacks in a scheme where he channeled winning game tickets to a network of accomplices and co-conspirators. As a result, Simon lost its $100 million business, and was involved in a series of consumer lawsuits and multi-million dollar settlements spanning across the nation and into Canada. Simon claimed that its insurance policies with both Gulf Insurance Co. and Federal Insurance Co. covered the losses it sustained by Jacobson’s fraudulent conduct. The court, however, disagreed.
While a person may insure against the risk of loss of “just about any type of property” recovery under a property insurance contract is limited to physical property loss or damage, not intangible losses or detrimental economic impact. Neither Simon’s lost business nor its settlement costs and payments amount to the requisite physical property loss. Simon’s loss of income was specifically excluded under both policies. Simon’s argument that it “held” McDonald’s game pieces as a bailee or trustee and was “legally liable” for them, created a covered loss. This reasoning failed because it was McDonald’s, not Simon, that sustained the loss when it paid for the stolen prizes. The Court of Appeal explained:
The fact is that not every dishonest act of an employee is an insured loss under a contract of property insurance. There must be loss of, or damage to, insured property…
Unless the risk of loss is specifically insured, a first party property policy will only cover damage to tangible property and the insured must prove, to recover under the policy that its loss was by an insured peril to covered tangible property.
In addition, the plain meaning of the first party property policies aptly define property damage and it is clear that loss of profits, damage to commercial reputation, and loss of goodwill are not tangible property damage as defined by such policies.[1]
The threshold requirement for recovery under a contract of property insurance is that the insured property has sustained physical loss or damage. The requirement that the loss be “physical,” given the ordinary definition of that term is widely held to exclude alleged losses that are intangible or incorporeal, and, thereby, to preclude any claim against the property insurer where the insured merely suffers a detrimental economic impact unaccompanied by a distinct, demonstrable, physical alteration of the property. [Doyle v. Fireman’s Fund Ins. Co., 229 Cal.Rptr.3d 840, 21 Cal.App.5th 33 (Cal. App., 2018)]
On a rare occasion, a court will fall prey to a need to be poetic. It happened in California when the Court of Appeal started off its insurance coverage opinion with: “O thou invisible spirit of wine, if thou hast no name to be known by, let us call thee devil!” (Shakespeare, Othello, act II, scene 3.)
The court waxed poetic after being presented with a most unfortunate tale of a villainous wine dealer who sold millions of dollars’ worth of counterfeit wine to an unsuspecting wine collector. When the wine collector discovered the fraud, he filed an insurance claim based on his “Valuable Possessions” property insurance policy. The insurance company denied the claim. The wine collector sued for breach of contract. The trial court ruled in favor of the insurance company, sustaining its demurrer and the Court of Appeal reviewed the decision in David v. Fireman’s Fund Insurance Company, supra.
David Doyle is a collector of rare, vintage wine. His “world-class” wine collection is housed in a wine storage facility in Laguna Beach. Starting in 2007, Doyle insured his wine collection against loss or damage by purchasing a “Valuable Possessions” policy from Fireman’s Fund Insurance Company (Fireman’s Fund), with a blanket policy limit of $19 million. Doyle went on to purchase eight annual renewal policies.
During the eight years that Doyle was insured under the policy, he purchased close to $18 million of purportedly rare, vintage wine from Rudy Kurniawan. But a law enforcement investigation revealed that for many years Kurniawan had apparently been filling empty wine bottles with his own wine blend and had been affixing counterfeit labels to the bottles. In 2013, Kurniawan was convicted of fraud and was sent to prison for 10 years.
The Fireman’s Fund insurance policy at issue in this case is a preprinted “Scheduled Valuable Possessions Policy,” which covers various items of valuable personal property such as jewelry, furs, and fine art. The policy also covers: “‘Collectibles’, meaning wine, sports cards, dolls, model trains, and other private collections of rare, unique or novel items of personal interest including memorabilia.”
The “Perils Insured Against” provision of the policy provides: “We insure for direct and accidental loss or damage to covered property caused by an ‘occurrence.’” The policy defines an “‘occurrence’” as “a loss to covered property which occurs during the policy period . . . and is caused by one or more perils we insure against.” The policy does not define the term “loss.”
The requirement that the loss be “physical,” given the ordinary definition of that term is widely held to exclude alleged losses that are intangible or incorporeal, and, thereby, to preclude any claim against the property insurer where the insured merely suffers a detrimental economic impact unaccompanied by a distinct, demonstrable, physical alteration of the property.
Doyle has not pleaded a breach of contract claim that can be proven at trial because nothing happened to the covered property (i.e., the wine that Doyle purchased and insured) still exists in his cellars in intact bottles.
Fireman’s Fund only insured against the risk of physical loss to the wine. It was not insuring against any losses to Doyle’s finances or to his unrealized expectations as to the value of the wine he had purchased.
When Doyle purchased the wine from Kurniawan it was counterfeit. The wine remained counterfeit (and essentially worthless) throughout the entire coverage period of the policy. Perhaps Doyle has a valid claim against Kurniawan for fraud. Doyle cannot reasonably expect his Fireman’s Fund “Valuable Possessions” property insurance policy to reimburse him for his multiple purchases of wine from Kurniawan, which was essentially valueless at the time of purchase.
The Court of Appeal concluded that Doyle failed to establish that any type of financial loss, including fraud, comes within the scope of the property insurance policy he purchased. That the policy does not specifically list fraud as an exclusion is irrelevant.
Finally, the court offered to Doyle a small piece of wisdom from the Bard of Avon: “The robbed that smiles steals something from the thief.” (Shakespeare, Othello, act I, scene 3.)
The judgment was affirmed because the court’s fault, as Shakespere’s “Timon of Athens” said “Every man has his fault, and honesty is his”. An honest man may never recover for the fraud perpetrated upon him from a property insurance policy.
Property insurance does not insure property, as every lawyer should know, it only insures against certain risks of loss to specifically identified property. Since the property, the risk of loss of which was insured, was not damaged by any stated risk of loss, there could be no coverage. When the fraudster was convicted the value of the wine diminished but the wine was not damaged.
Since property insurance does not insure property but the interests of the insured named in the policy no one not insured may recover. The naming of an item of property in an insurance policy does not give rise to an interest in the policy to the property owner who is not otherwise covered. [Goldstein v. Scott, 108 Ill.App.3d 867, 872-873, 64 Ill.Dec. 374, 378, 439 N.E.2d 1039, 1043 (1982).]
Burden of Proof
It is the obligation of the insured to prove that property has been physically damaged. The loss of marketability is not a peril insured under a property policy; only physical damage to tangible property is insured.
In Lundstrom v. United Servs. Auto. Ass’n-CIC, 192 S.W.3d 78 (Tex. App. 2006), a case involving a leaking water pipe, the US Court of Appeal affirmed the District Court for the Eastern District of Pennsylvania and found that a leaking water pipe can bring about a loss of personal property.[2] One of the insured’s employees noticed that the ground was saturated with water and that the water meter was spinning rapidly. This led to the conclusion that the water from the underground pipe was escaping after passing through the water meter. Confirmation of this conclusion came in the form of a water bill for $39,523.45. The insureds contended that the all risk policy should cover this expense, but the insurer disagreed and argued that this was a pecuniary loss as distinguished from a physical loss of property.
The court disagreed and found coverage, stating that the insurer’s position “ignored the common sense meaning of the phrase ‘physical loss.’” The water became the property of the insured once it passed through the water meter, and therefore the subsequent escape of water was a physical loss of the insured’s personal property—the water.
In an action by an insured on an insurance contract, the burden of proof is on the insured to establish every fact essential to his cause of action and also to establish that his claim is within policy coverage. … Accordingly, the Court finds that the burden of proof is on the plaintiff to prove that any damage under Coverage B, for the contents or personal property, was caused by a named peril, by a preponderance of the evidence.[3]
The applicability of an exception to an exclusion is a question of coverage, on which the insured has the burden of proof after the insurer carries the burden to establish the applicability of the exclusion.[4]
The insured bears the burden showing that there is coverage, however, the insurer bears the burden of proving the applicability of any exclusions in the policy that permits the insurer to deny coverage. [Guar. Nat’l Ins. Co. v. Vic Mfg. Co., 143 F.3d 192, 193 (5th Cir. 1998).]
The insured’s initial burden is to prove coverage. The burden then shifts to the insurer to prove the application of an exclusion to deny coverage. If it meets that burden, the burden shifts back to the insured to prove an exception to an exclusion. Insureds attempt to invoke the ensuing loss exception.
The adjuster faced with a “close call” should consider leaning toward a covered loss whenever a doubt exists. The test this author suggests is to ask: can the property be used for the purpose for which it was designed and built in the same manner it was used before the event claimed to cause a loss? If the answer is “no” there is property damage.
Exclusions
Mysterious Disappearance
Typical of a mysterious disappearance is the situation found in Johnson v. General Accident, Fire & Life Assurance Corporation 454 S.W.2d 837 (1970), where the plaintiff took her daughter to school and then went shopping between 8:00 and 9:00 am. During that time, a diamond wristwatch she had been wearing disappeared. The Texas Court of Civil Appeals found that the loss was a “disappearance under circumstances which excite, and at the same time, baffle, wonder or curiosity.”