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Ten months into the COVID-19 pandemic, the unprecedented disruption of businesses, large and small, continues unabated. With outright closings and social distancing restrictions, the legislative response to the pandemic has led to devastating business interruption losses. Among the first questions asked by struggling business owners is “Shouldn’t this be covered by my business interruption insurance?” The answer from most insurance companies, has been a resounding “No.”

The courts report a flood of litigation between business owners and their insurance carriers on the issue of whether existing business interruption policies cover losses due to government restrictions imposed in response to COVID-19. More than 1,100 such suits have been filed since the pandemic began in March 2020. In the vast majority of these cases, the insurance policy in question requires proof of “direct physical damage” to the business, such as by flood or fire. According to the insurers, losses incurred as a result of COVID-related restrictions do not satisfy this requirement and are not covered losses. 

While the volume of these lawsuits continues to climb, so, too, have the number of business failures and, in many cases, business bankruptcies. When a business files for bankruptcy, all of its assets become part of the bankruptcy “estate.” These assets are then subject to the jurisdiction of the bankruptcy court. Included among the assets of the newly-established bankruptcy estate are the debtor’s contract rights, including its insurance claims. In the case of a business forced into bankruptcy by the coronavirus pandemic, its business interruption claim might be a valuable—perhaps even the most valuable—asset of the bankruptcy estate.

Case in point: the chapter 11 bankruptcy of Century 21 Department Stores. The retail chain filed for bankruptcy in September 2020, claiming it is owed more than $175 million from insurers based on business interruption claims arising from COVID-19 between March and May 2020. If it is successful in its litigation, the insurance proceeds would be available to pay creditor claims in the bankruptcy case. As evidence of how valuable these claims may be, last month the Bankruptcy Court handling the case approved the sale of Century 21’s rights in the litigation against its insurers for $59 million plus a share of any proceeds recovered in the lawsuit. The sale of these rights will enable Century 21 to pay its secured debt in full and make partial distributions to unsecured creditors.

As other businesses are forced into bankruptcy due to COVID restrictions, business interruption claims could play a pivotal role in reorganization efforts. While the clear majority of decided cases favors the insurers, restaurant owners and other small business owners have been chalking up wins in a number of cases. Like others around the country, celebrity chef José Andrés and other restauranteurs in the Washington D.C. area currently are litigating the coverage issue in Maryland and D.C. federal courts. 

Adding fuel to this smoldering issue, last month the U.S. District Court for the Eastern District of Virginia ruled against State Farm in an action brought by Elegant Massage, LLC, a therapeutic massage spa in Virginia Beach. As a result of Executive Orders issued by the Virginia governor mandating social distancing and other operating restrictions during the pandemic, the spa was forced to close from mid-March to mid-May 2020. When it filed a business interruption claim with State Farm, the insurer denied the claim because the shutdown was not the result of “direct physical loss” to the business premises. Interpreting the language of the insurance policy broadly, however, the Court declined to dismiss the lawsuit, finding that while the spa “was not structurally damaged, it is plausible that [it] experienced a direct physical loss when the property was deemed uninhabitable, inaccessible, and dangerous to use by the Executive Orders because of its high risk of spreading COVID-19, an invisible but highly lethal virus.”

If upheld on appeal (and the outcome is far from certain), the district court decision may strengthen the claims of businesses suffering COVID-related losses under business interruption policies. This, in turn, could transform these claims into critical assets for both insureds and their creditors.

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Luis F. Ruiz

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