Physical Alteration of Insured Property is not Required for Coverage Under a Communicable Disease Coverage Extension Where “Direct Physical Loss or Damage” Under the Terms of the Insurance Policy Includes Costs Incurred by an Insured to Disinfect, Mitigate or Monitor the Effects of a Communicable Disease at an Insured Property
In Amy’s Kitchen, Inc. v. Fireman’s Fund Insurance Company (No. A163767), filed October 4, 2022, the Court of Appeal of the State of California, First Appellate District held physical alteration of insured property was not required for coverage under a communicable disease coverage extension or a loss avoidance or mitigation coverage extension where “direct physical loss or damage” under the terms of the property insurance policy includes necessary costs incurred by an insured to disinfect, mitigate or monitor the effects of a communicable disease.
Amy’s Kitchen manufactures organic and vegetarian meals at facilities in California, Oregon and Idaho. Amy’s Kitchen purchased a comprehensive property insurance policy from Fireman’s Fund, which includes coverage extensions for communicable disease and for loss avoidance and mitigation. The communicable disease coverage extension provides that Fireman’s Fund “will pay for direct physical loss or damage to Property Insured caused by or resulting from a covered communicable disease event at a location including the following necessary costs incurred to…[m]itigate, contain, remediate, treat, clean, detoxify, disinfect, neutralize, cleanup, remove, dispose of, test for, monitor, and assess the effects [of] the communicable disease.”
The Fireman’s Fund policy defines “communicable disease event” as one in which “a public health authority has ordered that a location be evacuated, decontaminated, or disinfected due to the outbreak of a communicable disease at such location.”
The loss avoidance or mitigation coverage extension states that Fireman’s Fund will pay “necessary expense you incur to protect, avoid, or significantly mitigate potential covered loss of damage that is actually and imminently threatening Property Insured.”
According to Amy’s Kitchen, it incurred costs to mitigate, contain, clean, disinfect, monitor and test for the effects of the coronavirus at insured locations, and to avoid or mitigate potential coronavirus-related losses threatening those locations. The costs included the purchase of temperature screening equipment to test for COVID-19, protective shields to prevent transmission on assembly lines, masks, goggles, cleaning supplies and “hero pay.”
Amy’s Kitchen submitted a claim to Fireman’s Fund, which the insurer denied on the basis there was no direct physical damage to the covered property.
In response to Fireman’s Fund’s denial of Amy’s Kitchen’s claim, Amy’s Kitchen filed a lawsuit against Fireman’s Fund, alleging causes of action for breach of contract, declaratory relief and bad faith.
Fireman’s Fund filed a demurrer in response to Amy’s Kitchen’s complaint. The trial court sustained Fireman’s Fund’s demurrer without leave to amend on the basis Amy’s Kitchen failed to allege “direct physical loss or damage to the Property Insured,” as required by the communicable disease coverage extension. The trial court reasoned that any potential loss or damage Amy’s Kitchen had incurred costs to avoid could not be a “potential covered loss or damage” because no potential COVID-related harm could amount to “direct physical loss or damage.” Amy’s Kitchen filed an appeal in response to the trial court’s decision.
The appellate court found the trial court erred by holding the phrase “direct physical loss or damage,” as used in the communicable disease coverage extension, must be construed as it has been in other contexts to require a “distinct, demonstrable, physical alteration of the property” or a “physical change in the condition of the property” (quoting MRI Healthcare Center of Glendale, Inc. v. State Farm General Ins. Co., 187 Cal.App.4th 776, 779-780 (2010)).
The appellate court pointed out the definitions section of the Fireman’s Fund policy does not define “direct physical loss or damage” or any of its component parts. Rather, the communicable disease coverage extension specifies three categories of costs that, if incurred as a result of a covered communicable disease event, are covered:
(a) Tear out and replace any part of the Property Insured in order to gain access to the communicable disease;
(b) Repair or rebuild Property Insured which has been damaged or destroyed by the communicable disease; or
(c) Mitigate, contain, remediate, treat, clean, detoxify, disinfect, neutralize, cleanup, remove, dispose of, test for, monitor, and assess the effects [of] the communicable disease.
On appeal, Fireman’s Fund argued that “direct physical loss or damage” does not include necessary costs incurred to mitigate, clean, disinfect, or test for the communicable disease unless the communicable disease event physically altered the property.
In response to Fireman’s Fund’s argument, the appellate court pointed out the term “physical alteration” does not appear in the text of the Fireman’s Fund policy. The appellate court also noted Fireman’s Fund derives the necessity for physical alteration of the property from other cases construing the phrase “direct physical loss or damage” in very different policy provisions, including cases involving business-income, extra-expense, and/or civil-authority provisions covering lost income. The appellate court explained that none of those decisions focused on the reasonable interpretation of a communicable disease coverage extension in which coverage is triggered by a communicable disease event causing costs to be incurred to “[m]itigate, contain, remediate, treat, clean, detoxify, disinfect, neutralize, cleanup, remove, dispose of, test for, monitor, and assess the effects [of] the communicable disease.”
The appellate court noted that under California law an insurance policy must be construed in light of how a reasonable layperson would read its language. E.M.M.I., Inc. v. Zurich American Ins. Co., 32 Cal.4th 465, 471 (2004). Here, the appellate court found a reasonable layperson reading the phrase “direct physical loss or damage,” as it appears in the communicable disease coverage extension, would assume the phrase includes costs incurred for each of the three purposes specified in subparagraphs (a), (b) and (c) of the provision.
The appellate court further found that treating physical alteration as an additional condition of coverage, as Fireman’s Fund argued, would render subparagraph (c) redundant and meaningless. The appellate court explained that subparagraphs (a) and (b) address the situation in which the presence of a communicable disease leads to physical alteration of the insured’s property, where property must be torn out, repaired or replaced. If subparagraph (c) were construed to apply only if there is a physical alteration of the property, the provision would have no possible application not covered by subparagraphs (a) and (b).
The appellate court also highlighted a case cited by Fireman’s Fund for the proposition “the presence of the virus itself . . . [does] not constitute direct physical loss of or damage to property” as “contaminated surfaces can be disinfected and cleaned.” O’Brien Sales & Mktg., Inc. v. Transportation Ins. Co., 512 F.Supp.3d 1019, 1024 (N.D. Cal. 2021). According to the appellate court, if that view is correct, the only possible explanation for including subparagraph (c) would be to expand the coverage to include the cost of mitigation and disinfection, which otherwise would not be covered. Thus, the appellate court found “the only plausible interpretation of subparagraph (c) of the communicable disease extension in this policy is that the need to clean or disinfect infected or potentially infected covered property constitutes ‘direct physical loss or damage’ of that property within the meaning of the policy.” The appellate court held the trial court erred in holding otherwise. The appellate court also held the trial court incorrectly rejected Amy’s Kitchen’s claim under the loss avoidance or mitigation coverage extension on the same basis.
The appellate court also found the trial court properly sustained Fireman’s Fund’s demurrer on the ground Amy’s Kitchen failed to allege facts that the direct physical loss or damage was caused by or resulted from a “communicable disease event,” but also concluded the trial court erred by denying Amy’s Kitchen leave to amend its complaint in that regard.
Based on the foregoing, the appellate court reversed the trial court’s judgment of dismissal and remanded the case with directions to issue an order sustaining Fireman’s Fund’s demurrer with leave to amend.
This document is intended to provide you with information about insurance law related developments and trends. The contents of this document are not intended to provide specific legal advice. If you have questions about the contents of this alert, please contact the author. This communication may be considered advertising in some jurisdictions.