United States: Endeavor Operating Co. LLC v. HDI Global Insurance Company

(Business Interruption Claims Based on Shut-Down of Entertainment Venues Due to COVID-19 Do Not Satisfy Direct Physical Loss or Damage to Property Requirement in Commercial Property Policies)

(January 2024) - In Endeavor Operating Company, LLC v. HDI Global Ins. Co., 96 Cal.App.5th 420 (September 21, 2023), Pet. for Review Granted (Calif. Supreme Court December 13, 2023), the California Second District Court of Appeal affirmed the trial court's judgment dismissing Endeavor Operating Company, LLC's (Endeavor) complaint seeking coverage for business interruption losses caused by the shutdown of entertainment venues owned by Endeavor due to COVID-19. In affirming the trial court's entry of judgment, the Court of Appeal found that the policy required "direct physical loss or damage to property" in order to trigger business interruption coverage under such policy. Further, such requirement applied to coverage extensions related to civil authority orders requiring the shutdown of businesses and ingress/egress clauses.

The Court of Appeal rejected Endeavor's arguments that presence of the COVID-19 virus on property was sufficient to satisfy the requirement for "direct physical loss or damage to property." The Court of Appeal reasoned as follows:

Having concluded that the policy requires that there be a "direct physical loss or damage to property" (either Endeavor's or a third party's within a specified distance of Endeavor's premises), we must now ask whether Endeavor has—or can—adequately plead that requisite "direct physical loss or damage to property" by alleging that SARS-CoV-2 viral particles were deposited onto or adsorbed to the surfaces of its (unspecified) properties. We conclude that the answer is, as a matter of law, "no."

The California courts are in accord that the phrase "direct physical loss or damage to property" means a "'distinct, demonstrable, physical alteration'" of the insured property. (Simon Marketing, supra, 149 Cal.App.4th at p. 623; MRI Healthcare, supra, 187 Cal.App.4th at pp. 778–779; Starlight, supra, 91 Cal.App.5th at p. 33; Santa Ynez, supra, 90 Cal.App.5th at p. 1069; Best Rest Motel, Inc. v. Sequoia Ins. Co. (2023) 88 Cal.App.5th 696, 703 [304 Cal. Rptr. 3d 756]; see generally John's Grill, supra, 86 Cal.App.5th at pp. 1209–1210 [summarizing cases].)16 This is the default definition to be applied where a policy does not provide a different definition of "direct physical loss or damage." The policy here provides no different definition, and Endeavor does not allege the existence of any extrinsic evidence supporting a mutual intent to deviate from the default definition.

However, the courts are split on whether the presence of the SARS-CoV-2 virus on insured property satisfies the default definition. One line of cases holds, as a matter of law, that this definition is not met by the ephemeral presence of the virus on the surface of property. (United Talent, supra, 77 Cal.App.5th at pp. 834, 838.) A competing line of cases holds that the definition can be met on demurrer because a policy holder can allege that the ephemeral presence of the virus on the surface of property constitutes a "physical alteration" of that property and because we are obligated to accept that allegation as true, no matter how "improbable" it is. (Marina Pacific, supra, 81 Cal.App.5th at pp. 104–105, 108–112; Shusha, supra, 87 Cal.App.5th at pp. 262–263.)

We agree with the first line of cases, and do so for two reasons.

First, we agree with United Talent that the ephemeral presence of a virus on the surface of property does not "alter" or "'cause a physical change in the condition of the property'" because "'it may be wiped off surfaces using ordinary cleaning materials, and it disintegrates on its own in a matter of days'" or weeks. (United Talent, supra, 77 Cal.App.5th at pp. 834, 835, quoting Sandy Point Dental, P.C. v. Cincinnati Ins. Co. (7th Cir. 2021) 20 F.4th 327, 335; accord, Inns-by-the-Sea, supra, 71 Cal.App.5th at p. 703, fn. 17 [collecting cases holding that "'contamination [of property] which is short-lived or does not prevent the use of the structure does not qualify as direct physical loss'"].) If, as some courts adopting this definition have held, dust and debris from nearby road construction that lands on the surface of insured property does not satisfy this definition because it is easily cleaned, neither does the SARS-CoV-2 virus, which is similarly easy to clean according to Endeavor's own allegations in the complaint. (Accord, Mama Jo's, Inc. v. Sparta Ins. Co. (11th Cir. 2020) 823 Fed. Appx. 868, 879.) This is why the presence of SARS-CoV-2 is unlike the presence of other substances—such as unpleasant odors, dangerous chemical contamination, or asbestos—that permeate the property and require substantial effort to remove. (United Talent, at p. 834; Western Fire Ins. Co. v. First Presbyterian Church (1968) 165 Colo. 34 [437 P.2d 52, 55–56] [gasoline saturating walls and floors of building, causing strong odors and increased flammability; direct physical loss or damage]; Mellin v. Northern Security Ins. Co. (2015) 167 N.H. 544 [115 A.3d 799, 803–804] [pervasive odor of cat urine that is difficult to remove; direct physical loss or damage]; Essex Ins. Co. v. BloomSouth Flooring Corp. (1st Cir. 2009) 562 F.3d 399, 401, 404–406 [same, as to "locker room" smell]; Farmers Ins. Co. v. Trutanich (1993) 123 Ore.App. 6 [858 P.2d 1332, 1335] [same, as to odor from a methamphetamine operation]; Yale University v. CIGNA Ins. Co. (D.Conn. 2002) 224 F.Supp.2d 402, 412–414 [asbestos and lead contamination necessitating removal; direct physical loss or damage]; Port Authority v. Affiliated FM Ins. Co. (3d Cir. 2002) 311 F.3d 226, 235–236 [no pervasive contamination by asbestos necessitating removal; no direct physical loss or damage].)

Second, we respectfully disagree with Marina Pacific and Shusha that the general principle requiring factual allegations to be accepted as true at the demurrer stage obligates us to ignore that those allegations do not, as a matter of law, meet the applicable definition triggering coverage. We agree with Marina Pacific and Shusha that, at the demurrer stage, we must accept as a scientific fact how the SARS-CoV-2 virus interacts with surfaces. (T.H. v. Novartis Pharmaceuticals Corp. (2017) 4 Cal.5th 145, 156 [226 Cal. Rptr. 3d 336, 407 P.3d 18].) However, the trial court's judgment for the insurers is nevertheless correct here because we are concluding that the type of viral interaction with surfaces alleged by Endeavor (and accepted as true)18 does not, as a matter of law, satisfy the default definition of "direct physical harm or loss to property." (E.g., Childhelp, Inc. v. City of Los Angeles (2023) 91 Cal.App.5th 224, 236 [308 Cal. Rptr. 3d 193] ["'[A] trial court may properly sustain a general demurrer to a declaratory relief action without leave to amend when ... the controversy presented can be determined as a matter of law'"]; accord, Inns-by-the-Sea, supra, 71 Cal.App.5th at p. 714 ["Additional allegations about the science behind the pandemic would not change th[e] analysis"].) And to the extent Endeavor's allegation is read as an allegation that the presence of SARS-CoV-2 particles on surfaces satisfies the definition of "direct physical loss or damage to property," it is akin to an allegation that Endeavor's loss is covered by the policy; as such, it is a conclusion of law that we may disregard on review of a demurrer. (County of Santa Clara v. Superior Court (2023) 14 Cal.5th 1034, 1041 [310 Cal. Rptr. 3d 130, 531 P.3d 951].)

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