In an opinion handed down on January 5, the U.S. Court of Appeals for the Fifth Circuit had held that a restaurant’s commercial property insurance policy does not cover lost revenue from the suspension of dine-in services during the COVID-19 pandemic. The court determined that the loss of business from the pandemic did not involve a direct physical loss of or damage to property under the terms of the policy.

Terry Black’s Barbecue, L.L.C. v. State Automobile Mutual Insurance Company (No. 21-50078; op. issued Jan. 5, 2022) arose when the restaurant, which operates locations in Austin and Dallas, sued its commercial property insurer to recover revenue lost as a result of the Governor’s March 19, 2020 executive order declaring a state of emergency related to COVID-19 and subsequent orders by local governments suspending dine-in services at bars and restaurants. The restaurant filed suit in state court, but the insurer successfully removed the case to the federal district court. Accepting the report and recommendation from a federal magistrate, the district court granted the insurer’s motion for judgment on the pleadings pursuant to FRCP 12(c). The court ruled that the insured’s losses were not covered under the policy’s business income and extra expense coverage provisions because physical loss requires a “distinct, demonstrable, physical alternation of the property.” The court further rejected the insured’s claim that the policy’s restaurant extension endorsement (REE), which covered losses arising from suspension of business operations resulting from an order of a civil authority caused by the actual or alleged exposure of the premises to a contagious or infectious disease. The court reasoned that the REE did not contemplate a global pandemic triggering the suspension of operations of all similarly situated restaurants, not just the insured’s.

On appeal, the Fifth Circuit affirmed. Acknowledging that Texas law applies to the case and that the Texas Supreme Court has not decided the issue in question, the court proceeded to make an “Erie guess” as to the how SCOTX would interpret the policy language (as opposed to certifying the question to SCOTX for a determination of Texas law). An Erie analysis involves seven factors: (1) how SCOTX has ruled in analogous cases; (2) SCOTX’s reasoning and analyses in those decisions; (3) relevant SCOTX dicta; (4) lower state court decisions; (5) the “general rule on the question”; (6) other state court rulings to which Texas courts refer in making substantive law; and (7) treatises, legal commentaries, and other authorities.

The court’s Erie analysis concluded the following:

  1. Texas courts interpret the policy term “physical loss” to mean a tangible alteration or deprivation of the insured’s property. The insured did not allege such tangible alteration, nor did it at any time “lose access to, or the ability to use all physical parts of the premises at all times.” Moreover, “the prohibition of dine-in services did nothing to physically deprive [the insured] of any property at its restaurants.”
  2. The policy only provides coverage for physical loss or damage during the “period of restoration,” which is the time necessary to repair, rebuild, or replace the lost or damages property or to resume operations at a new location. The insured’s property in this case did not require “restoration” within the language of the policy. Additionally, the insured’s loss did not result from physical damage or loss to the insured property, but from a civil authority’s order to suspend certain services provided on the property.
  3. In interpreting physical loss to require tangible alteration or deprivation of the property, the Fifth Circuit joined the Second, Sixth, Seventh, Ninth, Tenth, and Eleventh Circuits, as well as other jurisdictions. The court noted further SCOTX’s insistence on the uniform interpretation of identical policy language across jurisdictions.
  4. With respect to the REE coverage, the court held that the civil authority’s suspension of the insured’s services did not result from the actual or alleged exposure of the insured’s property to a contagious or infectious disease, as required by the property. Instead, the suspension resulted from the efforts of civil authorities to contain and mitigate a global pandemic, which included social distancing measures necessitating the closure of all restaurants for dine-in services (but not for takeout or delivery services). In other words, the policy language requires a causal connection between the insured’s premises’ exposure to a contagious disease and the civil authority’s order suspending services at those premises.

The court further upheld the district court’s denial of the insured’s motion to amend its pleadings to, among other things, allege the presence of COVID-19 on its premises for purposes of the REE provision on the basis that such amendment would not lead to a different result. In so doing, the court effectively foreclosed subsequent litigation attempting to stretch REE coverage to encompass each individual premises on which COVID-19 could be shown to have existed (setting aside whether such a showing can even be made in the context of a community-spread virus).

Although this particular question has not yet reached SCOTX for a definitive reading of Texas law, the Fifth Circuit’s Erieguess is undoubtedly well-founded and correct. If the court had any doubt about that, it would almost certainly have asked SCOTX to weigh in, as it has in other recent close cases. But the economic effects of the pandemic—past, present, and future—are likely to continue to generate litigation that will challenge the court system for the foreseeable future.

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