April 10, 2020

Coverage for COVID-related business losses? Decision supports that this may be a physical loss or damage to property.

The COVID-19 public health emergency is bringing the economy to its knees, as businesses are grinding to a halt. Whether a business has been forced to close completely by the presence of COVID-19 onsite or by government order, or its operations have been severely restricted by the practices of physical distancing and self-isolation, the resulting business interruption losses are profound.

Businesses have turned to “all risk” property insurance policies for potential relief, with limited success and growing litigation. A class action was filed this month in Saskatchewan against multiple insurers for breach of contract in refusing to pay business interruption claims from the COVID-19 crisis. Coverage for business interruption losses will ultimately be determined by specific policy language, although some U.S. states are also considering the passage of legislation to require insurers to provide coverage for claims for business interruption arising out of COVID-19.

While considerable uncertainty surrounds these issues, a central question for many of these claims will be whether the presence or suspected presence of the virus on a property, or even the widespread practices of social distancing and self-isolation which interfere with use of a property, will constitute “physical loss or damage” to that property. All Risk policies typically extend to all risks of direct physical loss or damage to the premises caused by a peril not otherwise excluded.

The jurisprudence on this issue is unsettled. Some courts have held that coverage for “physical” loss to property does not extend to loss of use while others have held that it does.

The recent decision of MDS Inc v Factory Mutual Insurance Company (FM Global), 2020 ONSC 1924, supports the argument that an inability to access and use one’s place of business, as we are currently experiencing in the pandemic, constitutes physical loss to that property under “all risk” property insurance policies.

The case concerned an All Risks Policy issued by Factory Mutual to MDS, a manufacturer of diagnostic medical equipment. The Policy protected property against all risks of physical loss or damage except as excluded. It provided additional “Time Element” coverage which included a loss of profits to MDS flowing from physical damage to a supplier “directly resulting from physical loss or damage” and other specified situations like a civil authority prohibiting access to property or service interruptions.

At issue in the case was the claim for lost profits arising from a lengthy shutdown of a nuclear reactor in Chalk River, Ontario arising from a leak of heavy water and subsequent discovery of corrosion in the reactor walls. This shutdown caused a disruption in the supply of radioisotopes to MDS. Radioisotopes were processed by MDS for sale and use in cardiac imaging and cancer treatment equipment.

MDS submitted a claim under the Policy for lost profits sustained while its supplier’s property was unusable. Factory Mutual denied coverage on the basis of an exclusion for damage caused by corrosion, which was the cause of the water leak. The court held that this exclusion covered only anticipated and predictable corrosion, which did not apply to the fortuitous corrosion in this case.

Of note, the corrosion exclusion did not extend to “physical damage” resulting from corrosion. And here, Factory Mutual denied coverage as the loss of use of the reactor was not resulting “physical” damage. It is the court’s analysis of this resulting physical damage exception which is relevant to business interruption claims arising from COVID.

The insurer argued that the exception required that actual tangible damage was caused to the reactor. MDS maintained that resulting physical damage included loss of use of the reactor as a consequence of the leak. The term “physical damage” was undefined in the Policy, but Justice Wilson held that when read in light of the Policy as a whole, it was evidently intended to include loss of use and provide coverage for disruptions in the supply of radioisotopes due to loss of use of the reactor. 

MDS had purchased an extension of coverage to address interruption of the business of a supplier affecting its profits. The court held that this extension superseded a general exclusion for business interruption or loss of use to property under the policy.

As a result, Justice Wilson held that resulting physical damage should be interpreted broadly to capture not only “corporal, tangible damage”, but also “impairment of use or function.” There was no dispositive jurisprudence on the meaning of resulting damage for the case, as the factual circumstances and policy language at issue in prior cases differed. However, the court referenced one lower court decision finding that coverage under an All Risk policy for losses suffered by a pizza restaurant that was forced to close its premises as a result of fumes arising from a vandalized nearby oil line.

Justice Wilson also considered another case out of Colorado where an insured’s property was rendered uninhabitable by the infiltration of gasoline vapours from an adjacent property. There was also a government order of uninhabitability in effect. The court held that this loss of use amounted to covered physical loss. Justice Wilson analogized these facts to the MDS case, since the reactor’s shutdown was ordered by the Canadian Nuclear Safety Commission until its safety protocol was satisfied.

Justice Wilson held that this broad interpretation of an exception to an exclusion was consistent with the principles of Ledcor Construction Ltd and the purpose of an All Risk policy, which here was to provide MDS with peace of mind that it would be compensated for a loss of profits if a fortuitous event interrupted the supply of radioisotopes. Common sense dictated that resulting “physical damage” had to be interpreted broadly to include loss of use to the reactor while the leak in it was being investigated and repaired.

MDS reflects an important consideration of the question whether physical damage requires actual tangible damage or may include a loss of use of property in an All Risk policy. And it will be relevant to the growing claims and litigation around business interruption losses suffered in the COVID-19 pandemic. While it appears that legislation or executive orders may determine that litigation in at least some jurisdictions, an appeal of this decision seems highly likely given the unsettled jurisprudence. Thus we certainly have not seen the final word on whether “physical damage” includes the loss of use of property.