On September 23, 2022, the Vermont Supreme Court issued an opinion reversing the dismissal of insurance claims seeking coverage for damage the insured argued was caused by the SARS-CoV-2 virus.
Huntington Ingalls Indus., Inc. et al. v. Ace American Ins. Co. et al., No. 2021-173, 2022 VT 45. The decision goes against the majority of cases in other state and federal courts finding that insureds have failed to adequately allege that the SARS-CoV-2 virus can cause direct physical damage or loss that is covered by property insurance policies. But does the decision really mean all that much? In some ways, yes. And in other ways, maybe.
The insured in the case, Huntington Ingalls Industries, is the largest military shipbuilder in the U.S., with more than 42,000 employees. Huntington purchased an “all risk” property insurance policy in March 2020 from its captive insurance subsidiary, Vermont-based Huntington Ingalls Industries Risk Management LLC, which in turn purchased policies from multiple reinsurers to cover its obligations. The policy at issue covered all real and personal property “against all risks of direct physical loss or damage to property.” The policy also contained a business interruption clause covering “[l]oss due to the necessary interruption of business conducted by [Huntington], whether total or partial . . . caused by physical loss or damage insured herein.” Notably, the policy did not include the standard-form virus exclusion that has been available in the insurance industry since 2006.
Not long after Huntington obtained the policy, the first COVID-19 case arose among Huntington’s shipyard employees. By September 2020, more than 1,000 employees had been infected, and by April 2021, more than 6,000 infections had occurred. During the course of these infections, Huntington and its captive sought coverage from the reinsurers under the reinsurance policies for property damage, business interruption, and other losses suffered as a result of the virus, the pandemic, and civil authority orders. Coverage was denied.
Following the denial of coverage, Huntington and its captive (collectively, “plaintiffs”) filed suit in the Vermont Superior Court seeking a declaratory judgment that they were entitled to coverage under the policy. The suit alleged that Huntington suffered “direct physical loss or damage to property” when the virus lingered in the air for several hours at the shipyard and when infected droplets fell onto and adhered to surfaces for several days, transforming them into “fomites.” The suit further alleged losses in the form of disruption of operations, schedule impacts, increased expenses to continue operating, lost profits, and other losses.
The Superior Court concluded that plaintiffs had not alleged sufficient facts to support a viable claim for coverage, and therefore entered judgment on the pleadings in favor of the reinsurers. The basis for the decision was that Huntington did not suffer loss of property (i.e., because the shipyard continued to operate despite the presence of the virus) but rather suffered uncovered income losses. The decision was bolstered by a majority approach emerging in federal and state courts that, as a matter of law, the presence of the virus on property does not constitute “direct physical loss or damage to property.”
The Decision on Appeal
Plaintiffs appealed the dismissal to the Vermont Supreme Court. On appeal, the Supreme Court recognized that the key issues to decide were the interpretation of the phrase “direct physical loss or damage to property” and whether the facts as alleged by plaintiffs were sufficient – at the pleadings stage of the case – to state a claim for physical loss or damage. By a 3-to-2 vote of the Justices, the Court found that plaintiffs had sufficiently alleged a claim that, if ultimately proven before a trier of fact, would demonstrate coverage under the policy.
The majority first examined the phrase “direct physical loss or damage to property,” noting that the Court was not bound by the out-of-state decisions that have interpreted the phrase to foreclose COVID-based property damage claims. After a lengthy discussion, the majority stated as follows:
“Direct physical damage” requires a distinct, demonstrable, physical change to property. “Direct physical loss” means persistent destruction or deprivation, in whole or in part, with a causal nexus to a physical event or condition. Purely economic harm will not meet either of these standards.
On the way to reaching this interpretation, the majority explained that “a distinct, demonstrable, physical alteration need not necessarily be visible; alterations at the microscopic level may meet this threshold,” and that “[i]f a distinct, demonstrable change to property occurred that caused an interruption in business operations, that change will likely need some type of physical remediation or repair to address that alteration.”
Then, in applying this interpretation to plaintiffs’ allegations, the Court began by observing the “extremely liberal” and “exceedingly low” pleading standard that applies in Vermont’s state courts – namely that a pleading may be dismissed only where it is “beyond doubt that there exist no facts or circumstances that would entitle [plaintiffs] to relief.” Against this standard, the majority found that plaintiffs sufficiently alleged “direct physical damage” by their claim that “the virus physically altered property in [Huntington’s] shipyards when it adhered to surfaces.” The majority also pointed to the allegation that “as a result of such physical alternations to its property, [Huntington] has had to take steps to remedy the situation by physically altering its property,” which steps were “beyond mere cleaning.” Under these circumstances, the majority 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.” Finally, the majority concluded its analysis with a caveat:
Although the science when fully presented may not support the conclusion that presence of a virus on a surface physically alters that surface in a distinct and demonstrable way, it is not the Court’s role at this stage in the proceedings to test the facts or evidence . . . .
To be clear, this opinion does not state that what occurred in insured’s shipyards is “direct physical loss or damage to property” under the policy. We merely conclude that insured has alleged enough to survive a Rule 12(c) motion under our extremely liberal pleading standards.
The remaining two Justices who heard the appeal dissented, arguing that as a matter of law “direct physical loss or damage to property” does not occur when human-generated droplets of a virus come to rest on surfaces. This is consistent with the majority of cases to date, which ultimately rest on the notion that COVID harms people, not property. The dissent contended that in order for an event to physically damage property under the terms of the policy, the event must “alter the property’s tangible characteristics” and “require the property to be repaired, rebuilt, or replaced.” While the dissent accepted as true that plaintiffs had sufficiently alleged that infected droplets became contagious fomites at the shipyard, this did not “alter the appearance, shape, color, structure, or other material dimension of the property.” In other words, “fomite does not physically change property,” and simply wiping away fomites from a surface does not constitute a “repair” to the property. The dissent further argued that the others measures Huntington took were to protect people rather than to repair property. And in response to the majority’s position that plaintiffs had pled a novel claim that could be further developed, the dissent characterized the claim as a metaphysical one that should be rejected.
The Vermont Supreme Court’s decision in Huntington Ingalls Indus., Inc. et al. v. Ace American Ins. Co. et al. is not the first in the U.S. to conclude that COVID business interruption lawsuits should not be dismissed without the development of further evidence, but it is the first such decision by a state’s highest court. But what does the decision really mean? First, at a high level the decision is a clear reminder that the liberal pleading standard remains alive and well in Vermont, notwithstanding the much tougher “plausibility” standard adopted in the federal courts back in 2007 and since adopted by a number of states. Second, the decision paves the way for similar COVID-related claims, especially in Vermont, to advance into the discovery, expert witness, and summary judgment phases, where litigation costs can ramp up quickly and significantly. What remains to be seen – as the majority acknowledges in the opinion – is whether insureds are able to prove that the SARS-CoV-2 virus actually causes “direct physical loss or damage to property,” thereby triggering coverage. For now we will just need to wait and see.