Starting in March 2020, state and local governments issued orders shutting down large swaths of the US economy in response to the global COVID-19 pandemic. The orders were prophylactic in nature, designed to promote social distancing and mitigate the spread of the COVID-19 virus. These extraordinary government actions imposed economic hardships that continue to be felt by business owners across the country.

Estimated closure losses for small businesses with 100 or fewer employees alone range from $255 billion to $431 billion per month, and just two months of closure losses could exceed the combined total surplus for all US home, auto and business insurers combined.

Most of these losses are purely economic, as a result of the prophylactic government orders and not a physical casualty to property necessary to trigger insurance. Private insurers have resisted efforts to shift to them these massive purely economic losses, which are not insured risks. Early judicial decisions considering this insurance coverage question agreed.¹

Recently, however, the US District Court for the Western District of Missouri issued the first decision, in Studio 417 Inc. et al. v. The Cincinnati Insurance Co.² allowing an insured to survive dismissal for claims seeking to recover business interruption losses arising from the COVID-19 virus under a commercial property policy.

Although a departure from the other cases that have considered the issue, Studio 417 does not significantly change the legal landscape for most insurance claims, and should not change the analysis that other courts have correctly applied in dismissing COVID-19 business interruption claims.

Studio 417 is easily distinguishable from many claims under policies with virus exclusions.

As the Studio 417 court noted, the Cincinnati policies at issue "do not include, and are not subject to any exclusion for losses caused by viruses or communicable diseases."³ That fact alone makes Studio 417 easily distinguishable from many other COVID-19 business interruption coverage cases pending throughout the country seeking coverage under policies with virus exclusions.

Even Studio 417's briefing acknowledged that a virus exclusion might have made a difference in the outcome of the case. As a result, Studio 417 provides no support for shifting to private insurers the cost of virus-related business interruption losses excluded by their policies.

Other courts should not follow Studio 417, which contradicts or departs from existing case law in other jurisdictions.

Studio 417 adopts a view that should not be persuasive to other courts. As the decision itself acknowledges, its holding is contrary to the law in many other jurisdictions, which requires physical tangible alteration for a physical loss.⁴

Studio 417 also represents a departure from the line of cases it cites for the proposition that loss of use unaccompanied by physical alteration can be physical loss to property. Each of those cases found physical loss only where a physical substance had rendered property unusable or uninhabitable by so permeating the insured property that it could not be simply removed.

In Prudential Property & Casualty Insurance Co. v. Lilliard-Roberts,⁵ the US District Court for the District of Oregon found direct physical loss or damage where visible mold had permeated property to the degree that was no longer removable.

In Port Authority of New York and New Jersey v. Affiliated FM Insurance Co.⁶ the US District Court for the District of New Jersey found that the costs of replacing asbestos-containing materials could be covered if asbestos fibers rendered property uninhabitable and unusable.

In General Mills Inc. v. Gold Medal Insurance Co.,⁷ the Court of Appeals of Minnesota found that oat stocks were injured when contaminated with a pesticide requiring them to be discarded.

After carefully reviewing this jurisprudence, the US District Court for the Western District of Texas agreed in Diesel Barbershop LLC v. State Farm Lloyds that it was not applicable to COVID-19 losses. As other courts have recognized, even under that more expansive line of cases, property that can be rendered usable again by ordinary cleaning has not suffered direct physical loss or damage.⁸  

Studio 417 appears to be alone in holding that a substance that dies naturally in days and can be wiped away could potentially cause direct physical loss to property.⁹ As a result, Studio 417 should not be persuasive to other courts, even in those jurisdictions that take a more expansive view of direct physical loss.

Studio 417 was allowed to proceed on a theory that is contrary to the facts for most insureds and, at best, offers prospects for only a minimal recovery.

Even if another court adopted Studio 417's legal analysis, Studio 417 sanctioned, at the initial pleadings stage, a narrow theory of recovery which does not ultimately support coverage for the extensive costs of government-mandated shutdown orders.

Studio 417 allowed the plaintiffs' claims to proceed because it concluded the policyholder
"[p]laintiffs … allege that this physical substance [the COVID-19 virus] is likely on their premises and caused them to cease or suspend operations.¹⁰

For most insureds, however, these allegations are contrary to the facts: The insureds were in business during the pandemic and shut down only in response to government orders and, in many instances, reopened when the government allowed them to do so. As a result, many policyholders have not alleged that the physical presence of the virus on their property caused their business interruption loss, much less caused a physical casualty to property.

Instead, they have affirmatively alleged that government orders interrupted their business and caused their economic losses. Indeed, even in Studio 417, the court's conclusion that the plaintiffs alleged physical presence of COVID-19 virus on their property caused their business interruption is arguably not a fair reading of the complaint, which details government orders closing or restricting the insured businesses and does not allege that the plaintiffs ever definitively identified COVID-19 on their own properties, much less closed for that reason.

Whatever is alleged in the pleadings, at the summary judgment stage, evidence will likely show that business interruption losses were caused by government-mandated efforts to encourage social distancing, not actual COVID-19 contamination on insured properties.

In many instances, discovery will likely show the business shut down or otherwise restricted its operations only after a government's prophylactic order required it to do so, and only to the extent required by the government order, and that no one concluded the business needed to be shut down because of COVID-19 on the property.

Indeed, we expect the evidence will show that businesses were open during the early days of the pandemic, closed when required to do so by shutdown orders and reopened after orders were lifted, but while the pandemic raged on in the US — with some regions becoming COVID-19 hot spots only after businesses reopened.

These facts are, of course, entirely inconsistent with a contention that a business shut down or restricted its operations because of COVID-19 on its property.

Even if evidence shows that the COVID-19 virus caused a direct physical loss or damage to property, and that the COVID-19-virus-caused loss were the reason for a business interruption, as opposed to governments orders, the wide scientific consensus is that COVID-19 degrades naturally within hours or days and can be quickly cleaned with ordinary commercially available disinfectants.

Any losses caused by the physical presence of COVID-19 should be minimal. On summary judgment, it will be difficult to establish that losses continuing long after the virus was remediated or degraded naturally were caused by the presence of the virus, as opposed to the ongoing application of government prophylactic orders.

Accordingly, despite the ruling in Studio 417, insurers should not be required to bear the massive, purely economic losses from prophylactic government-mandated shutdowns, which were not covered in the policies they issued.

1. Diesel Barbershop, LLC v. State Farm Lloyds, No. 5:20-cv-461-DAE (W.D. Tex. Aug. 13, 2020); Social Life Magazine, Inc. v. Sentinel Ins. Co., Ltd., No. 1:20-cv-03311-VEC, ECF No. 24-1 (S.D.N.Y.) (May 14, 2020 transcript); Gavrilides Mgmt. Co. v. Michigan Ins. Co., No. 20-258-CB (Mich. Cir. Ct.) (July 1, 2020 transcript).
2. Studio 417, Inc., et al. v. The Cincinnati Insurance Co. , No. 6:20-cv-03127-SRB, ECF 40 (W.D. Mo. Aug. 12, 2020).
3. Studio 417, August 12, 2020 Order on Motion to Dismiss ("Order"), at 2.
4. Studio 417 Order, at 10.
5. CV-01-1362-ST, 2002 WL 31495830 (D. Or. June 18, 2002).
6. 311 F.3d 226 (3d Cir. 2002).
7. 622 N.W.2d 147, 150 (Minn. Ct. App. 2001).
8. Mama Jo's, Inc. v. Sparta Ins. Co., No. 17-cv-23362-KMM, 2018 WL 3412974 at *9 (S.D. Fla. June 11, 2018), aff'd No. 18-12887, at 23 (11th Cir. Aug. 18, 2020).
9. Order at 13 n. 6; see Studio 417 Compl. para. 51 (alleging Centers for Disease Control and Prevention protocols to clean with disinfectant).
10. Studio 417 Order, at 11.