Virtually all of the litigation in COVID-19 coverage cases has been focused on the question of whether “direct physical loss” has occurred, and the overwhelming majority of state and federal courts have answered this question in the negative. However, even where courts have found COVID-19 coverage claims constitute “direct physical loss,” there are other coverage issues that must be addressed.
The most common claim by policyholders in COVID-19 coverage cases is for “Business Income” coverage under property insurance policies based on losses alleged due to various governmental orders issued in response to the COVID-19 pandemic. In most cases, however, the plaintiffs only plead losses of “income,” “revenue,” or “profits,” but do not actually identify what the claimed losses are.
The various property policies at issue contain definitions of “Business Income,” which in general are based on lost profits and incurred expenses during a “period of restoration.” Under this definition, if a policyholder has no lost profits or expenses there is nothing for the insurer to pay on the claim, even if coverage is found to exist.
This becomes an especially pertinent issue if the policyholder has received disbursements from government relief programs enacted in response to the pandemic. These programs include tax-free grants and forgivable loans authorized in 2020 and 2021.
As a result, in cases where “direct physical loss” has been found, insurers should be seeking information from policyholders to determine whether or not the policyholder has actually sustained a loss of “Business Income.” Where policyholders have received financial assistance from COVID-19 relief programs, such claimed losses could be greatly reduced or even eliminated.
Necessity of Damages in Insurance Coverage Cases
Although insurance coverage lawsuits can be filed under a variety of legal theories, such lawsuits are fundamentally claims for breach of contract. While there may be specific and sometimes completely different legal rules governing insurance policy interpretation in various jurisdictions, all jurisdictions agree that insurance policies are a type of contract. At the most basic level, a plaintiff in a breach of contrt action must prove three things: (1) a valid contract exists; (2) the defendant has breached the contract; and (3) the plaintiff was damaged as a result of the defendant’s breach.
In COVID-19 coverage cases, policyholders allege in general that: (1) they have a valid insurance policy issued by an insurer; (2) the insurer has breached the policy by refusing to provide “Business Income” coverage; and (3) the policyholder has been damages because they suffered “Business Income” losses which the insurer has refused to pay.
Thus far, virtually all COVID-19 coverage litigation has been focused on the second issue (whether or not “Business Income” coverage exists). The first issue (whether or not a valid policy exists) is essentially a non-issue, but the third issue (damages) has not been explored in any depth.
In cases where courts have found no “direct physical loss,” the question of damages becomes moot because the policyholder cannot establish a breach of contract. However, even in cases where courts have found “direct physical loss” has occurred, and therefore a potential breach of contract is established, a policyholder must still establish damages to obtain any recovery from the insurer.
The PPP and RRF
Two of the relief programs enacted by Congress in response to the COVID-19 pandemic were the Paycheck Protection Program (“PPP”) and the Restaurant Revitalization Fund (“RRF”). The PPP was created by the Coronavirus Aid, Relief, and Economic Security Act, and eventually received over $900 billion in funding. The RRF was created by the American Rescue Plan Act of 2021, and was funded with $28.6 billion. Both the PPP and RRF were administered by the Small Business Administration (“SBA”). Databases listing recipients of PPP and RRF disbursements can be downloaded from the SBA’s website. Disbursements from the PPP are 1% interest rate loans to cover eligible expenses including payroll costs and benefits, mortgage interest, rent, utilities, worker protection costs related to COVID-19, uninsured property damage costs caused by looting or vandalism during 2020, and certain supplier costs and expenses for operations. However, so long as PPP disbursements are used to pay eligible expenses, the loan is not required to be repaid.
The RRF provides grants for restaurants sustaining financial losses due to the COVID-19 pandemic. The SBA’s website states that the RRF “will provide restaurants with funding equal to their pandemic-related revenue loss up to $10 million per business and no more than $5 million per physical location.” The website also states that the RRF distribution amounts will be calculated as follows: “2019 gross receipts minus 2020 gross receipts minus PPP loan amounts.” PPP and RRF disbursements have been designated as tax-exempt income. As are result, even though PPP and RRF disbursements are considered income for tax purposes, that income is not subject to taxation.
PPP and RRF Disbursements Offset and Potentially Eliminate Claimed “Business Income” Losses
A sample property policy definition of “Business Income” is: Net Income (Net Profit or Loss before income taxes) that would have been earned or incurred if no physical loss or damage had occurred, but not including any Net Income that would likely have been earned as a result of an increase in the volume of business due to favorable business conditions caused by the impact of the Covered Cause of Loss on customers or on other businesses; and Continuing necessary operating expenses incurred.
Although the language of “Business Income” definition can differ between policies, there are two essential components of “Business Income”: (1) lost profits and (2) incurred expenses. With respect to the PPP disbursements, a policyholder’s expenses under the definition of “Business Income” will be reduced or could be eliminated entirely. RRF disbursements, on the other hand, could actually place a policyholder in a better position than if the insurer had paid the claim. The policy language quoted above requires a determination of “Net Income” (revenue minus expenses), while an RRF disbursement is based solely on revenue. As a result, a policyholder receiving PPP and RRF disbursements might have received more money than it could have possibly received under its insurance policy.
Because insurance coverage lawsuits are fundamentally actions for breach of contract, policyholders are required to attempt to mitigate any claimed damages. Additionally, most (if not all) jurisdictions have public policy prohibitions against windfalls or double recoveries. Consistent with these principles, insurers should not only ask the question of how much policyholders have received in governmental relief funds, but should also ask if policyholders were eligible for such funds but did not apply for them.
Evaluating these issues will require financial information from policyholders. In cases where COVID-19 coverage claims have been allowed to proceed, insurers should seek discovery regarding PPP, RRF, and any other state or federal disbursements received by policyholders, which can be grounds for further dispositive motions even if a court has found coverage exists. Insurers in these cases should also strongly consider retaining CPA as experts to not only assist in evaluating financial information received in discovery, but also to inform insurers as to what information to request in discovery.
The purpose of property insurance is to reimburse policyholders for losses sustained as a result of covered causes of loss. Even if those losses are covered, however, if a policyholder has already been reimbursed for those same losses through a government relief program with tax-free income, there is nothing for the insurer to pay. Accordingly, in cases where COVID-19 coverage claims are allowed to proceed, insurers should obtain information regarding policyholders’ financial operations as well as the availability and receipt of government sponsored relief funds.
Dave Rubin is senior counsel at Kroger, Gardis & Regas, LLP, where he practices in the areas of insurance coverage, appellate law, and commercial litigation. This article was published by the International Risk Management Institute, Inc. (IRMI) as part of its Insurance Law Essentials Deep Dives publication.
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