How is the Phrase “Direct Physical Loss” or “Direct Physical Damage” Typically Treated in the All-Risk and Business Interruption context?
The concept of a “direct physical loss or damage” is integral to all-risk property coverage and, typically, business interruption coverage. Yet, few courts have defined which events trigger “physical loss or damage.” See Robert Kelly, Todd Rossi, David T. Brown & Stefan R. Dandelles, Recent Developments in Insurance Coverage Litigation, 46 Tort Trial & Ins. Prac. L.J. 435 (2011). When a property’s structure is damaged by wind, water, or fire, the physical change created by this event clearly presents “physical damage.” See Scott G. Johnson, What Constitutes Physical Loss or Damage in a Property Insurance Policy?, 54 Tort Trial & Ins. Prac. L.J. 1, 96 (2019). Some courts interpret “physical loss or damage” to require a “physical alteration of the insured property and that mere loss of use is not physical loss or damage.” See Ward Gen. Ins. Servs., Inc. v. Emp’rs Fire Ins. Co., 7 Cal. Rptr. 3d 844, 851 (Ct. App. 2003) (Loss of electronically stored data was not a “direct physical loss of or damage to” covered property.) Meanwhile, other courts find that “loss of use” or “loss of function” also constitutes “physical loss or damage.”
The following paragraphs provide a brief analysis of how each jurisdiction in which our firm works defines “direct physical loss” with particular attention given to all-risk policies in the first party property and casualty context.
Arizona’s courts are largely silent on “direct physical loss.” Inferentially, Arizona’s insistence upon the explicit terms and language in insurance contracts seems to dominate interpretation. See e.g. Estate of Tovrea v. Nolan, 173 Ariz. 568, 573, 845 P.2d 494, 499 (Ct. App. 1992) (The statement of one exception implicitly denies the existence of other unstated exceptions.); Goldberger v. State Farm Fire & Cas. Co., 247 Ariz. 261, 448 P.3d 302, 307 (Ct. App. 2019) (Policy coverage for “accidental direct physical loss” applies to all real and personal property unless a contrary enumerated provision states otherwise.)
California provides a clear and concise definition of “direct physical loss.” A direct physical loss occurs when a “change in insured property [that was originally] in a satisfactory state,” is damaged by an accident or other fortuitous event which causes the property to become “unsatisfactory for future use absent repairs.” MRI Healthcare Ctr. of Glendale, Inc. v. State Farm Gen. Ins. Co., 187 Cal. App. 4th 766, 779, 115 Cal. Rptr. 3d 27, 37–38 (2010). Further, “the word “direct” used in conjunction with the word “physical” indicates the change in the insured property must occur by the action of the fortuitous event triggering coverage…” In the eyes of California’s courts, “direct” means “[w]ithout intervening persons, conditions, or agencies.” Id. Finally, for a loss to be covered, there must be a “distinct, demonstrable, physical alteration” of the property in question. Id.
In sum, California tends to handle “direct physical loss” similarly to how it deals with other first-party coverage issues: the courts “limit” the Plaintiff’s ability to recover by narrowing the scope of coverage to the explicit terms of the insurance contract document.
Colorado emphasizes that “Courts will enforce an insurance policy as written unless the relevant policy language is ambiguous” and that “an unambiguous limitation or exclusion must be enforced as written.” Morley v. United Servs. Auto. Ass’n, 2019 COA 169, ¶ 18. Colorado has a well-developed framework explaining “direct physical loss.” See e.g. W. Fire Ins. Co. v. First Presbyterian Church, 165 Colo. 34, 437 P.2d 52 (1968); Morley v. United Servs. Auto. Ass’n, 2019 COA 169, ¶ 18. Focusing on “direct physical loss” provisions in “all risk” coverage policy, the Colorado Supreme Court found that a “loss of use” provision “cannot be viewed in splendid isolation, but must be viewed in its proper context” to conclude that there is a “direct physical loss.” Id. at 55—56. Viewing First Presbyterian and Morley together, it can be fairly concluded that Colorado’s courts will first attempt to apply the plain terms of the insurance contract and then—if there is ambiguity—apply a “totality of the circumstances” approach to interpret the document.
Florida’s courts give “the undefined words of an insurance contract their ordinary meaning, just as…with any other type of contract.” Homeowners Choice Prop. & Cas. v. Maspons, 211 So. 3d 1067, 1069 (Fla. Dist. Ct. App. 2017); State Farm Fire & Cas. Co. v. Castillo, 829 So.2d 242, 244 (Fla. Dist. Ct. App. 2002). Following this principle, Florida provides an actual definition of the term “direct physical loss.” In the absence of contrary language, a “loss” is the diminution of value of something, while the terms “direct” and “physical” impose the requirement that the damage be “actual.” Maspons at 1069. Thus, the requirement that property undergo a “diminution of value” to successfully claim a “direct physical loss” provides guidance in determining trigger of coverage for business interruption coverage.
Texas is less “predictable” than many other states when interpreting “direct physical loss.” At times, Texas Courts favor Plaintiffs speculative insurance claims. See e.g. Lambrecht & Assocs., Inc. v. State Farm Lloyds, 119 S.W.3d 16, 27 (Tex. App. 2003) (Employee’s acts that sabotaged company data records constituted a “direct physical loss” in “all-risks” policy). However, at other times, Courts side with insurance defendants. See e.g. Texas Windstorm Ins. Ass’n v. Dickinson Indep. Sch. Dist., 561 S.W.3d 263, 276 (Tex. App. 2018) (Court upheld hurricane water damage claim denial due to lack of a “direct physical loss” under all-risks policy that specifically excluded damage not caused by “wind and hail.”); JAW The Pointe, L.L.C. v. Lexington Ins. Co., 460 S.W.3d 597 (Tex. 2015) (All-risk policy’s anti-concurrent causation clause defeated “direct physical loss” claim following hurricane after municipal authorities condemned property under zoning ordinance).
Due to the frequency of severe hurricanes striking Mississippi, the state has an extensive body of case law interpreting “direct physical losses” in all-risks policies. Each of the four major cases interpreting “direct physical losses” tend to favor insurers as Mississippi’s courts tend to adhere strictly to the terms set forth in insurance contracts. See E.g. Hoover v. United Servs. Auto. Ass’n, 125 So. 3d 636, 640 (Miss. 2013) (Affirming lower court’s ruling that flooding caused by storm surge during hurricane was exempted from coverage in policy that exempted flooding but included coverage for wind damage.); Corban v. United Servs. Auto. Ass’n, 20 So. 3d 601 (Miss. 2009) (Reversal and remand instructing jury to determine whether wind—and not water—caused a “direct physical loss” during hurricane storm surge.); Robichaux v. Nationwide Mut. Fire Ins. Co., 81 So. 3d 1030 (Miss. 2011) (Substantively, the facts and ruling were the same as in Corban.); United States Fid. & Guar. Co. of Mississippi v. Martin, 998 So. 2d 956, 965 (Miss. 2008) (While appellate decision “favored” the plaintiff, the Court only “sided” with the Plaintiff after strictly adhering to the to the policy’s terms and remanding the case to the trial court to answer question of fact per the policy’s language.).
Nevada’s scant body of case law fails to inform insurers on how the state will respond to a “direct physical loss” provision in an all-risks policy. To wit, only two major cases have concerned the handling of direct physical losses. See e.g. Fourth St. Place v. Travelers Indem. Co., 127 Nev. 957, 968, 270 P.3d 1235, 1242 (2011) (Upholding insurer’s denial of claim in all-risks policy for “direct physical loss” due to policy’s exclusion for “faulty workmanship” and applied the exclusion toward not only a flawed process but also the subsequent damage stemming from this flawed process); Fed. Ins. Co. v. Coast Converters, 130 Nev. 960, 968, 339 P.3d 1281, 1286 (2014).
New Mexico’s courts have not addressed “direct physical loss.” Thus, no strong precedent guides a working definition of this term. See e.g. Battishill v. Farmers All. Ins. Co., 2006-NMSC-004, ¶ 21, 139 N.M. 24, 29, 127 P.3d 1111, 1116 (“When an all-risks section is clear and unambiguous, it should be applied as written.”). This keeps with New Mexico court’s pattern of avoiding ruling on insurance law topics when possible. See e.g. Winters v. Charter Oak Fire Ins. Co., 4 F. Supp. 2d 1288, 1294 (D.N.M. 1998) (“New Mexico courts have not considered nor adopted the doctrine of “efficient proximate cause.”)
South Carolina’s Courts offer little guidance on the interpretation of “direct physical loss.” While most jurisdictions tend to cling to strict interpretation of an insurance policy’s textual language, South Carolina’s definition of “direct physical loss” is unclear. See e.g. Ocean Winds Council of Co-Owners, Inc. v. Auto-Owner Ins. Co., 350 S.C. 268, 271, 565 S.E.2d 306, 308 (2002) (Holding that the plain language of an all-risks policy requiring “actual collapse” of a building to trigger a covered event for “risks of direct physical loss involving collapse” was “too narrow” an interpretation and sided with insureds.); But see also S.C. Farm Bureau Mut. Ins. Co. v. Durham, 380 S.C. 506, 671 S.E.2d 610 (2009) (Ruling in favor of insurer that there was no covered event for water damage due to anti-concurrent causation clause.)
Utah’s courts do not succinctly define the term: “direct physical loss.” Like most states, Utah has a longstanding commitment to “the principle that ‘insurance policies should be construed liberally in favor of the insured and their beneficiaries so as to promote and not defeat the purposes of insurance.’” United States Fid. & Guar. Co. v. Sandt, 854 P.2d 519, 521 (Ut. 1993); Richards v. Standard Accident Ins. Co., 200 P. 1017, 1020 (Ut. 1921). Further, Utah makes efficient proximate cause its default rule but does allow parties to “freely choose to contract out of it.” Alf v. State Farm Fire and Cas. Co., 850 P.2d 1272, 1277 (Ut. 1993).
Despite these overarching principles, Utah’s court consistently favor the interests of insurers. For example, in an all-risks policy, the Court of Appeals refused to read “direct contact with water” through an “opening in the roof” to include coverage when a new home’s roof was “in a state of partial completion.” Poulsen v. Farmers Ins. Exch., 2016 UT App 170, ¶ 9, 382 P.3d 1058, 1062. In another case, the Supreme Court of Utah narrowly read “direct physical loss” to exclude coverage per the terms of an all-risks policy that denied coverage for “wear and tear” when a dilapidated oil-storage tank ruptured. S.W. Energy Corp. v. Cont’l Ins. Co., 1999 UT 23, ¶ 2, 974 P.2d 1239, 1240. Inferentially, these cases suggest that Utah’s courts are willing to strictly enforce a policy’s terms as drafted.