Smoked. Fifth Circuit Affirms Judgment in Favor of Insurer, Dashing Texas Barbecue Restaurant’s Insurance Claim for COVID-19 Losses.

January 6, 2022

Kicking off 2022, the Fifth Circuit dashed any hopes held by a Texas barbecue restaurant in recovering from its commercial property insurer the lost revenue attributable to the government-ordered shutdowns of in-person dining because of the COVID-19 pandemic. Unfortunately for policyholders, and as we predicted, the ruling is not that surprising, given the significant number of cases nationwide in which appellate courts have sided with insurers in similar disputes. The Fifth Circuit case, Terry Black’s Barbecue, L.L.C. v. State Automobile Mutual Insurance Co., [1] provides insurers with potent ammunition in rejecting COVID-19 claims, as the holding addresses one of the most common problems that policyholders have in establishing coverage: the existence of and ability to prove “direct physical loss of or damage to property.”

The insureds, Terry Black’s Barbecue, L.L.C. and Terry Black’s Barbecue Dallas, L.L.C. (collectively, “TBB”), own and operate two barbecue dine-in restaurants in Austin, Texas, and Dallas, Texas. The commercial property insurance policies issued by State Automobile Mutual Insurance Company (“State Auto”) insure those restaurants against “all risks” and include a business income and extra expense coverage (the “BI/EE Coverage”) component. [2] The BI/EE Coverage extends to ‘“the actual loss of Business Income . . . sustain[ed] and Extra Expense . . . incur[red] due to the necessary suspension of [TBB’s] operations during the period of restoration.’” [3] Importantly, however, to trigger coverage, the suspension of operations ‘“must be caused by direct physical loss of or damage to property at the premises.”’ [4] Each policy also has a “restaurant extension endorsement (the REE), which provides coverage for ‘the suspension of [TBB’s] operations at the described premises due to the order of a civil authority . . . resulting from the actual or alleged . . . exposure of the described premises to a contagious or infectious disease.”’ [5]

As everyone is all too familiar, on March 19, 2020, the Governor of Texas issued an executive order in response to the COVID-19 pandemic, directing people to avoid eating or drinking at restaurants. The Governor encouraged restaurants to use drive-thru, pickup, and delivery options as opposed to dine-in services. In Travis County and Dallas County, civil authorities also prohibited in-person restaurant services and limited restaurants to providing take out, delivery, or drive-thru services. To comply with these orders, TBB suspended dine-in services, which allegedly caused it to suffer business income losses. TBB filed a claim with State Auto, seeking coverage for these losses under the BI/EE and REE provisions, but State Auto denied the claim, prompting TBB to file suit. [6] State Auto subsequently moved for a judgment on the pleadings pursuant to Rule 12(c), which the district court granted. [7]

On appeal, the Fifth Circuit found that the district court correctly determined TBB’s losses are not covered by either the BI/EE or the REE provision. [8] The Court recognized that the Supreme Court of Texas has not yet “interpreted the policy language at issue or whether the relevant provisions cover business interruption losses due to civil authority orders suspending nonessential businesses during the COVID-19 pandemic.” [9] Nevertheless, the Court looked to the interpretation of similar provisions under other circumstances for guidance. [10]

With respect to the BI/EE coverage, the Court concluded that TBB’s suspension of dine-in services does not qualify as a direct physical loss of property under the BI/EE provision. Breaking down the provision word-for-word, the Court first evaluated the meaning of “physical,” which it concluded requires there to be a “tangible alteration[] to property” under applicable Texas law. [11] As to “loss,” the Court found that, under Texas law, this ‘“means a state of fact of being lost or destroyed, ruin or destruction.’” [12] The plain meaning of the term “loss,” according to the Court, is also understood as “‘perdition, ruin, destruction’ or ‘the being deprived of, or the failure to keep (a possession, appurtenance, right, quality, faculty, or the like).’” [13] Thus, in evaluating the “plain meaning” of the phrase “physical loss,” the Court concluded that TBB’s claim was not covered because TBB failed to allege any tangible alteration or deprivation of its property. [14] In other words, TBB could point to no physical or tangible destruction of its restaurants. The Court explained that, to the contrary, “TBB had ownership of, access to, and ability to use all physical parts of its restaurants at all times. And importantly, the prohibition on dine-in services did nothing to physically deprive TBB of any property at its restaurants.” [15] In other words, “TBB’s claimed loss is not about its property but about its inability to provide dine-in services. This economic loss, however, did not have any tangible effect on the property or restaurants.” [16]

The Court specifically rejected TBB’s arguments that the BI/EE provision does not require a tangible alteration and instead only requires that it be deprived of a ‘“physical space”’ at the restaurants. [17] According to the Court:

The phrase [“physical space”] appears nowhere in the policy and nonetheless provides no further definition of the phrase at issue here—physical loss of property. Even accepting TBB’s argument, it still has not alleged that it was deprived of a physical space. TBB has always had access to the dining rooms in its restaurants. It was free to use that “physical space” in whatever manner it chose, except dine-in services. This limitation on the kind of services permitted to be offered at the restaurants is just not a deprivation of the physical space under any reading of the provision. [18]

The Court also rejected TBB’s arguments that it lost the use of its dining rooms for their intended purpose amounts to a physical loss of property, noting that the unambiguous terms of the policy require a loss of property , not the loss of use of property. [19] Further, the Court rejected TBB’s arguments that the BI/EE coverage was implicated because TBB lost the use of its restaurants for their “intended” purposes. [20] The Court reasoned:

TBB’s argument reads far more words into the provision than are actually there. A “physical loss of property” cannot mean something as broad as the “loss of use of property for its intended purpose.” None of those words fall within the plain meaning of physical, loss, or property. And that phrase has an entirely different meaning from the language in the BI/EE provision. “Physical loss of property” is not synonymous with “loss of use of property for its intended purpose. ” [21]

The Court concluded the Supreme Court of Texas would interpret the requirement for a “direct physical loss of property” to require a tangible alteration or deprivation of property. Because the civil authority orders prohibiting dine-in services at restaurants did not tangibly alter TBB’s restaurants, and because TBB failed to allege any other tangible alteration or deprivation of its property, the Court concluded that the policy does not provide coverage for TBB’s losses. [22]

Moving to the REE coverage, the Court found that, because the civil authority orders did not “result from” TBB’s exposure to COVID-19, the REE provision does not provide coverage. [23] According to the Court, the REE provision applies when the suspension of business operations is due to a civil authority order that results “from the actual or alleged exposure of the described premises to a contagious or infectious disease.” [24] Because there was no actual or alleged exposure to a contagious disease at the restaurants, the REE coverage was not implicated.

In reaching this holding, the Court rejected TBB’s arguments that coverage applied because it was following guidance from the Centers for Disease Control and Prevention advising individuals to social distance and take other precautions to prevent the spread of COVID-19. According to the Court, “from a common sense understanding of the onset of the pandemic, the civil authority orders were not caused, even tangentially, by TBB’s alleged or actual exposure to a contagious disease.” [25] Rather, the civil authority orders ‘“resulted from”’ the global pandemic and the measures required to contain and prevent the spread of COVID-19. [26] Based on this, the Court concluded that the language in the orders established that the order were enacted to avoid exposure to COVID-19, not because of exposure to COVID-19. [27]

The Court also affirmed the dismissal of TBB’s extra-contractual claims and affirmed the district court’s denial of TBB’s motion for leave to amend its pleading. The Court explained: “We perceive no set of facts in which TBB states a covered claim for its losses due to the suspension of dine-in services during the pandemic. We conclude amendment would be futile and the district court did not err in denying leave to amend.” [28] Put differently, even if TBB re-plead its claim to allege the presence of COVID-19 in its restaurants, the result would not change.

COMMENTARY

As noted, we previously predicted that insureds would have a very difficult time in establishing coverage for COVID-19 related losses because of the requirement in most commercial property policies that there be a direct physical loss of or damage to the insured property. The Fifth Circuit’s opinion is no outlier; rather, the Fifth Circuit joins the Second, Sixth, Seventh, Eighth, Ninth, Tenth, and Eleventh Circuits, as well as a vast majority of federal district and state courts in Texas and other jurisdictions, in concluding that there is no coverage for COVID-19 related losses under the standard commercial property policy. [29] We suspect that, as the cases continue to work through the appellate process, the insureds will not see any better success. We will, of course, keep you updated should there be any change.

To shift gears, as noted in our September blog, the Supreme Court of Texas likely will soon address whether a major exception to the “eight corners” rule applies. Regardless of how the Supreme Court rules, that decision is certain to have a significant effect on the duty-to-defend analysis and, in turn, liability claims in general. For those that may have missed out on the developments in that area of law, read up here, here, here, and here. We will be sure to keep you apprised of the results of that decision.

Stay tuned…

Sincerely,

Lee Shidlofsky
Member

Douglas P. Skelley
Member

Rebecca DiMasi
Member

Blake Crawford
Senior Counsel

[1] Terry Black’s Barbecue, L.L.C. v. State Auto. Mut. Ins. Co. , No. 21-50078, --- F.4th ---, 2022 WL 43170 (5th Cir. Jan. 5, 2022).

[2] Id. at *1.

[3] Id.

[4] Id.

[5] Id.

[6] Id. at *2.

[7] Id.

[8] Id. at *3.

[9] Id. at *2.

[10] Id. at *3.

[11] Id . at *3–4 (citing U.S. Metals, Inc. v. Liberty Mut. Group, Inc. , 490 S.W.3d 20, 24–25 (Tex. 2015) (quoting Black’s Law Dictionary 1331 (10th ed. 2014)). See also N. Am. Shipbuilding, Inc. v. S. Marine & Aviation Underwriting, Inc. , 930 S.W.2d 829, 833–34 (Tex. App.—Houston [1st Dist.] 1996, no writ) (interpreting “physical loss or damage” to mean there is “an initial satisfactory state that was changed by some external event into an unsatisfactory state”); Great Am. Ins. Co. of N.Y. v. Compass Well Servs., LLC , No. 02-19-00373, 2020 WL 7393321, at *14 (Tex. App.—Fort Worth Dec. 17, 2020, pet. filed) (“[A]n intangible or incorporeal loss that is unaccompanied by a distinct, demonstrable, physical alteration of the property is not considered a direct physical loss.”).

[12] Id. at *4 (quoting de Laurentis v. U.S. Servs. Auto. Ass’n, 162 S.W.3d 714, 723 (Tex. App.—Houston [14th Dist.] 2005, pet. denied) (quoting Black’s Law Dictionary 945 (6th ed. 1990)).

[13] Id. (quoting Oxford Eng. Dictionary, Oxford Univ. Press (Dec. 2021)).

[14] Id.

[15] Id.

[16] Id.

[17] Id. at *5.

[18] Id. (emphasis in original).

[19] Id.

[20] Id.

[21] Id.

[22] Id.

[23] Id. at *6.

[24] Id.

[25] Id.

[26] Id.

[27] Id.

[28] Id. at *7.

[29] See Santo’s Italian Café LLC v. Acuity Ins. Co. , 15 F.4th 398, 401 (6th Cir. 2021) (“Whether one sticks with the terms themselves (a ‘direct physical loss of’ property) or a thesaurus-rich paraphrase of them (an ‘immediate’ ‘tangible’ ‘deprivation’ of property), the conclusion is the same.”); Oral Surgeons, P.C. v. Cincinnati Ins. Co. , 2 F.4th 1141, 1144 (8th Cir. 2021) (“[T]here must be some physicality to the loss or damage of property— e.g. , a physical alteration, physical contamination, or physical destruction.”); Mudpie, Inc. v. Travelers Cas. Ins. Co. of Am. , 15 F.4th 885, 892 (9th Cir. 2021) (concluding “California courts would construe the phrase ‘physical loss of or damage to’ as requiring an insured to allege physical alteration of its property”); Sandy Point Dental, P.C. v. Cincinnati Ins. Co. , 20 F.4th 327 (7th Cir. 2021) (“ ‘[D]irect physical loss’ requires a physical alteration to property.”); Goodwill Indus. of Cent. Okla., Inc. v. Phila. Indem. Ins. Co. , ––– F.4th ––––, ––––, No. 21-6045, 2021 WL 6048858, at *3 (10th Cir. Dec. 21, 2021) (“[A] ‘direct physical loss’ requires an immediate and perceptible destruction or deprivation of property.”); 10012 Holdings, Inc. v. Sentinel Ins. Co., Ltd. , ––– F.4th ––––, ––––, 2021 WL 6109961, at *4 (2d Cir. Dec. 27, 2021) (concluding “direct physical loss” does not extend to loss of use but requires physical damage). Gilreath Fam. & Cosm. Dentistry, Inc. v. Cincinnati Ins. Co. , No. 21-11046, 2021 WL 3870697, at *2 (11th Cir. Aug. 31, 2021).