(COVID-19 Business Interruption Claim As Alleged in Complaint Satisfied the Direct Physical Loss or Damage Requirement in Commercial Property Policy, But Contamination Exclusion Barred Coverage of Claim)

(January 2024) - In San Jose Sharks, LLC v. Superior Court, 98 Cal.App.5th 158 (December 21, 2023), the California Sixth District Court of Appeal found that the San Jose Sharks, LLC's ("Sharks") claim for business interruption losses due to the shutdown of its hockey arena operations caused by COVID-19 as alleged in its complaint satisfied the direct physical loss or damage requirement in a commercial property policy issued by Factory Mutual Insurance Company ("Factory Mutual"). However, the "contamination" exclusion in the Factory Mutual policy excluded coverage of the claim.

As such, the Court of Appeal denied the Sharks' petition for writ of mandate seeking to reverse the trial court's decision to strike its business interruption claims. The trial court found that coverage was still afforded under the Factory Mutual policy for interruptions caused by communicable disease. Based on the trial court's decision, the Sharks filed a petition for writ of mandate requiring the trial court to reverse its order striking that portion of the claim related to business interruption losses.

While affirming the trial court's ultimate decision, the Court of Appeal found that the Sharks' complaint alleged a potential claim for "direct physical loss or damage to property." The Court of Appeal reasoned as follows:

Here, there is presently no dispute that "'physical loss or damage' requires a 'distinct, demonstrable, physical alteration of the property,'" more than "'mere loss of use of physical property to generate business income, without any other physical impact on the property ... .'" At that level of generality, plaintiffs' allegations pass muster. At minimum, plaintiffs alleged droplets bearing the virus demonstrably and measurably contaminated the surfaces of the insured properties. To the extent plaintiffs further alleged that the virus altered their property's molecular structure, Factory Mutual does not contest that we must assume the truth of that allegation. (See Marina Pacific, supra, 81 Cal.App.5th at p. 108 [crediting allegations to the effect that the virus "bonds to surfaces through physiochemical reactions involving cells and surface proteins, which transform the physical condition of the property"].)

Factory Mutual contends that even if the virus were to alter the surface molecular structure of insured property so as to render the property unsafe, that alteration does not constitute physical loss or damage. In Factory Mutual's reasoning: (1) the ordinary and popular usage of "physical loss or damage" does not include "activity at the molecular level that is imperceptible to any of the [unaided] human senses [even if] 'scientifically measurable'"; (2) the communicable disease coverage extension is triggered without a showing of physical loss or damage, indicating an understanding that communicable diseases do not cause physical loss or damage; and (3) cases concerning other noxious substances have required that the substance make the property "physically uninhabitable." Our understanding of the policy before us does not require plaintiffs to clear the hurdles Factory Mutual would have us raise.

Coverage extends to "all risks of physical loss or damage" not expressly excluded. (Italics added.) The parties agreed to an exclusion for "contamination" caused by a virus, unless the contamination directly results from "other physical damage" that is not excluded. (Italics added.) If the parties did not contemplate that viral contamination could constitute a form of physical loss or damage, there would have been no need to specify that contamination resulting from "other" (covered) physical damage was not excluded from coverage. Moreover, given this exclusion it is unsurprising that the communicable disease coverage extension does not require physical loss or damage as a trigger.

Factory Mutual contends that if plaintiffs may plead a claim for physical loss or damage that is not perceptible by the unaided human senses, plaintiffs may be permitted to state a claim "without pleading any facts specific to a location or property item." This contention mixes two distinct issues: the means by which the physical loss or damage is ascertained is distinct from the specificity with which plaintiffs must identify the damaged property in their pleadings.

Here, plaintiffs allege that their insured property was damaged by a viral contaminant. Further, plaintiffs allege that they discarded and replaced items as part of their reopening process. Nothing in the policies suggests that the term "all risks of physical loss or damage" excludes risks that, while altering property in a distinct, demonstrable, and physical way, damage property in a way that is imperceptible to the unaided human senses. Nor do the policies suggest that physical loss or damage is covered only when the property is rendered "physically uninhabitable," as opposed to rendered unsuitable for its intended purpose. (See generally Inns-by-the-Sea v. California Mutual Ins. Co. (2021) 71 Cal.App.5th 688, 701–704 [286 Cal. Rptr. 3d 576] (Inns) [distinguishing cases where noxious substances rendered property unsuitable for its intended purpose where analysis turned on whether it was the presence of the virus on the premises or government orders caused unsuitability].)

Notwithstanding its determination that the Sharks' complaint alleged facts supporting a claim for direct physical loss or damage to property, the Court of Appeal denied the Sharks' petition because the "contamination" exclusion in the Factory Mutual policy applied to exclude coverage of the Sharks' business interruption claim. The Court of Appeal reasoned as follows:

Because plaintiffs alleged that it was a virus that caused the disputed physical damage to their property, their allegations implicate the policies' contamination exclusion. Plaintiffs concede that the exclusion precludes recovery for the diminution of property value as a result of contamination and costs due to the contamination, but they contend that it does not exclude claims for lost earnings. Factory Mutual contends that the exclusion encompasses any losses from viral contamination including business interruption otherwise covered under the policy's "Time Element" provision. Reading the policy as a whole, we conclude that the policy is not reasonably susceptible to plaintiffs' interpretation. Rather, the policy unambiguously excludes physical loss or damage in the form of viral contamination from the scope of coverage.

Although, as we have recognized, the policies cover "all risks of physical loss or damage" except as excluded, the policies expressly exclude three categories "unless directly resulting from other physical damage not excluded." (Capitalization omitted.) In relevant part, the three enumerated exclusions are: "1) contamination, and any cost due to contamination ... [;] 2) shrinkage[;] and (3) changes in color, flavor, texture or finish."8 (Boldface omitted.) Reading the list together and in context, it is clear that the three exclusions are risks of physical loss or damage that are excluded from the all-risks coverage.

"[C]ontamination" is "any condition of property due to the actual or suspected presence of ... virus ... ." (Boldface omitted.) There is no dispute that the risk of physical loss or damage on which plaintiffs rely constitutes contamination within the meaning of the policy; plaintiffs dispute only whether earnings lost due to such damage are excluded.

We reject plaintiffs' contention that the exclusion of "contamination, and any cost due to contamination" makes the policy ambiguous.(See generally Schmier v. City of Berkeley (2022) 76 Cal.App.5th 549, 558 [291 Cal. Rptr. 3d 431] ["'"[W]here an ambiguous contract is the basis of an action, it is proper, if not essential, for a plaintiff to allege its own construction of the agreement. So long as the pleading does not place a clearly erroneous construction upon the provisions of the contract, in passing upon the sufficiency of the complaint, we must accept as correct plaintiff's allegations as to the meaning of the agreement"'"].) Plaintiffs begin from a reasonable premise—if excluding "contamination" were by itself sufficient to remove contamination from the scope of coverage for "all risks of physical loss or damage" then "and any cost due to contamination" would be surplusage. Even so, taking the policies as a whole, plaintiffs' construction of the provision—that "contamination, and any cost due to contamination" excludes only (1) the diminution of property value due to contamination; and (2) any cost due to contamination—is untenable. Nothing in the structure of the relevant section or the definition of "contamination" supports the inference that "contamination" refers to a type of loss, as opposed to a type of "risk"—that the property's condition will be altered by viral contamination—from which diverse losses may flow. Plaintiffs' construction would require us to disregard the structure of the contract—its coverage of "all risks of physical loss or damage, except as hereinafter excluded" and subsequent exclusion of several risks, including contamination—and to tailor the definition of "contamination" to fit plaintiffs' coverage claim in lopsided hindsight bereft of textual support. This we are unable to do. HN10[ ] CA(10)[ ] (10) Where there is only one reasonable interpretation of contractual language, the contract is unambiguous such that the parties' dispute may be resolved at the pleading stage. (See George v. Automobile Club of Southern California (2011) 201 Cal.App.4th 1112, 1128 [135 Cal. Rptr. 3d 480] [proper to sustain general demurrer without leave to amend where insurance contract is not reasonably susceptible to the meaning alleged in the complaint].)

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