The holding

The Vermont Supreme Court sought to interpret “direct physical loss or damage to property” in the insurance policy at issue. The court first acknowledged a jurisdictional split on this issue and, even though the federal court decisions weighed in favor of the insurers, the court made clear that fact would not influence the outcome of this state court proceeding. Ultimately, the court found that dictionary definitions, canons of construction, and the rule against surplusage all support the conclusion that “direct physical loss” and “direct physical damage” each have a distinct meaning. Further, the court found that “direct physical damage” requires a distinct, demonstrable, physical change to property and “direct physical loss” means persistent destruction or deprivation, in whole or in part, with a causal nexus to a physical event or condition – which can occur at a microscopic level. Finally, the court stated that the causation requirement commands that no purely economic loss can constitute a direct physical loss, because any loss must link back to the condition of the property in question.

In turn, the court analyzed how Huntington pled “direct physical damage” in order to determine whether the pleading was sufficient to meet the standard the court articulated. Huntington pled that the COVID-19 virus had continuously been in its facilities. The court noted: “[t]his fact is provable because insured had COVID-positive employees, those employees were infected at work, and infected persons spread the virus to surfaces.” In addition, the virus can “adhere” to surfaces, causing “detrimental physical effects” that “alter[] and impair[] the functioning of the tangible, material dimensions” of a property. Huntington claimed that this alteration meant the property cannot function for its intended purpose and its business had to operate at a reduced capacity. The court held that these statements in the complaint adequately alleged that the virus physically altered the property outside a government order. Moreover, Huntington alleged that due to such physical alterations to its property, it had to make changes to the property. This bolstered the argument that a distinct, demonstrable physical alteration occurred and was something that was in need of “repair” to restore business operations. Since these facts adequately alleged “direct physical damage,” the court did not reach whether the complaint alleged facts that would entitle the insured to relief under a theory of “direct physical loss.”

Though the court did not decide that Huntington actually had “direct physical loss,” it was “inclined to allow experts and evidence to come in to evaluate the validity of insured’s novel legal argument before dismissing this case based on a layperson’s understanding of the physical and scientific properties of a novel virus.” Thus, the suit will proceed past the reinsurers’ motion for judgment on the pleadings.

The takeaway

This case marks the first time a state high court ruled in favor of the policyholder in a COVID-19 coverage case, and comes on the heels of recent California appellate cases allowing cases to proceed past the pleading stage and a favorable jury verdict in a Texas state court. In addition to allowing cases to move forward based on well pled facts, this case also supports coverage for businesses that did not completely shut down during the pandemic but had to reduce their operations or make modifications to their operations in order to continue in business. Insurers have argued in some cases that businesses that remained open, but had to modify their operations to address COVID concerns (such as restaurants offering take out or outdoor dining) are not entitled to coverage. Since the Vermont Supreme Court implied that there may need to be some modifications to the property to qualify for coverage and not just the passage of time, policyholders should gather and maintain evidence of whatever measures they took to modify their physical operations in response to COVID-19.

Client Alert 2022-234