4th Circuit: COVID-19 closure is not a covered ‘direct physical loss’

By Nick Hurston

The 4th U.S. Circuit Court of Appeals said a federal court erred by certifying a class action lawsuit that claimed executive orders closing Virginia businesses during the COVID-19 pandemic caused “accidental direct physical loss” to insured property.

The 4th Circuit held in another matter that “direct physical loss” under a similar insurance policy required “present or impending material destruction or material harm,” which was not caused by that state’s pandemic lockdown.

Senior U.S. Circuit Judge Barbara Milano Keenan said that the decision mandated dismissal of the instant case.

“Because the executive orders did not cause such harm and did not physically alter the covered property to require repair, rebuilding, replacement or relocation to another property, we hold that the policy’s coverage for loss of income and extra expenses does not apply to [plaintiff’s] claim based solely on the closure mandated by those orders,” she wrote.

U.S. Circuit Chief Judge Albert Diaz joined Keenan in reversing Elegant Massage LLC v. State Farm Mutual Automobile Insurance Company, et al.

U.S. Circuit Judge James Andrew Wynn concurred in the judgment only.

“I worry that the majority’s exercise of jurisdiction opens Pandora’s box by providing the basis on which future panels may justify inquiries into the merits of class actions that neither I nor the members of the majority would think ripe for appellate review,” he noted in a partial dissent.

Voluntary closure

Elegant Massage voluntarily closed its Virginia Beach location one week before then-Gov. Ralph Northam issued executive orders in 2020 to close businesses, including massage parlors, during the pandemic. Later, massage parlors were allowed to reopen with restrictions.

The day it voluntarily closed, Elegant Massage filed a claim for loss of business income and extra expenses under its “all risk” commercial property insurance policy issued by State Farm.

Coverage under the policy included “‘loss of income’ sustained due to the ‘suspension’ of operations during any ‘period of restoration,’ as well as ‘extra expenses’ incurred during the same period.”

The policy said the “period of restoration” begins immediately after an “accidental direct physical loss” due to a covered cause and ends when the business either resumes at a new permanent location or the property is repaired, rebuilt or replaced.

State Farm denied the claim, saying Elegant Massage had closed voluntarily before the executive order, there was no known damage to covered property due to the pandemic, and the policy excluded coverage for loss caused by a virus.

Certified class

Elegant Massage filed a putative class action complaint against State Farm, alleging that the executive orders caused covered losses.

Moving to dismiss, State Farm argued that Elegant Massage hadn’t alleged “accidental direct physical loss” or any loss requiring a “period of restoration” and reiterated its exclusions.

The District Court denied State Farm’s motion to dismiss, holding that the phrase “direct physical loss” could mean that the covered property was “uninhabitable, inaccessible, or dangerous to use because of intangible, or non-structural, sources.”

Although Elegant Massage hadn’t suffered a structural form of direct physical loss or a distinct, demonstrable, or physical alteration to its structure, the District Court said the executive orders could have rendered the property uninhabitable, inaccessible and dangerous due to the infection risk.

Based on that holding, the District Court determined the predominance and commonality requirements under Rule 23(b)3 had been satisfied and granted class certification.

State Farm appealed the class certification and asked the court to exercise pendant appellate jurisdiction to review the District Court’s denial of its motion to dismiss in light of the court’s recent decision in Uncork & Create LLC v. Cincinnati Insurance Co.

Essential resolution

Rule 23(f) provided jurisdiction for review of the class certification by interlocutory appeal, but Keenan said the District Court’s denial of State Farm’s motion to dismiss was a different question — one which pendant appellate jurisdiction answered.

“We exercise this jurisdiction sparingly and do so only if either (1) ‘an issue is “inextricably intertwined” with a question that is the proper subject of an immediate appeal,’ or (2) ‘review of a jurisdictionally insufficient issue is “necessary to ensure meaningful review” of an immediately appealable issue,’” she explained, citing 2013’s Scott v. Fam. Dollar Stores, Inc.

The court recently quoted Scott in Indus. Servs. Grp., Inc. v. Dobson to describe separate rulings as “‘inextricably intertwined’ when ‘the same specific question will underlie both the appealable and the non-appealable order, such that resolution of the question will necessarily resolve the appeals from both orders at once.’”

Keenan contrasted review of a motion to dismiss with a class certification analysis, under which “the court determines whether the Rule 23 requirements have been satisfied without considering whether the proposed class is likely to prevail on the merits.”

“In the present case, however, these two orders, the denial of the motion to dismiss and the class certification order, are ‘so interconnected’ as to require concurrent review,” she pointed out.

Keenan said jurisdiction was satisfied under the second test because the threshold merits question addressed by the District Court’s denial of State Farm’s motion to dismiss was integral to its conclusion that the class members could prove their claims through common evidence.

“And, critically, both the District Court’s denial of State Farm’s motion to dismiss and the resulting assumptions underlying the class certification order conflict with our later-issued precedent squarely addressing the interpretation of nearly identical language in another commercial property insurance policy,” she noted.

Thus, pendant appellate jurisdiction enabled the court to review the denial of State Farm’s motion to dismiss.

Direct physical loss

State Farm claimed the District Court committed legal error by determining that the executive orders caused “accidental direct physical loss” to the covered property. Elegant Massage said Uncork didn’t apply; it addressed a different insurance policy using West Virginia law.

Observing that the principles of West Virginia law applied in Uncork mirrored those applied here under Virginia law, Keenan said the “similarly ‘plain and unambiguous’ policy language” meant that “direct physical loss” required “present or impending material destruction or material harm.”

Here, the executive orders neither caused such harm nor physically altered the covered property to require repair, rebuilding, replacement or relocation to another property.

The court held that State Farm’s coverage didn’t apply to Elegant Massage’s claim based solely on the closure mandated by those orders. Having found the District Court erred when it denied State Farm’s motion to dismiss, Keenan also said there was no basis for class certification.

The court remanded the case to the District Court with instructions to dismiss the entire matter.