It seems like ages ago the WHO proclaimed that the COVID-19 virus was officially a pandemic. Since then, countless countries implemented quarantine rules, some more restrictive than others, forcing residents to physically isolate themselves in an effort to slow the spread of the virus. In Ontario, the insurance industry has been proclaimed as an essential industry, and rightly so. However, most insurers are under fire for denying business interruption coverage to businesses that were forced to shut down. What effect does COVID-19 have on business interruption claims?
Property Insurance and the Business Interruption Add-On
It is important to understand that business interruption is typically not a stand-alone policy. It is an add-on to an existing policy (typically a property policy). A property policy is designed to protect a business’ physical assets against loss or damage from a broad range of causes. What triggers the policy will depend on the type of policy: (1) named peril policies will cover loss or damage caused by a specific peril listed in the insurance contract; or, (2) comprehensive policies that cover loss or damage caused by any peril, unless excluded in the insurance contract. If a business interruption add-on is included on a property policy, the policy will cover continuing expenses or lost profits caused by a temporary need to shut down.
Assume, for a moment, that a restaurant has a property insurance policy with a business interruption add-on covering a named peril, physical loss caused by a fire. If the restaurant sustains a fire loss and is forced to shut down for one month for repairs, the business interruption add-on will cover continuing expenses and lost profits caused by the fire. The insurance contract will determine the scope of coverage.
Physical Damage – MDS Inc. v Factory Mutual Insurance Company (FM Global)
Typically, a property policy will be triggered when a business sustains a physical loss, damage, or destruction to property, which is caused by a covered peril (or not excluded in a comprehensive policy). This begs the question: what is a physical damage?
At the beginning of this month, the Ontario Superior Court released a 113-page decision in MDS Inc. v Factory Mutual Insurance Company (FM Global) (“MDS”). Some have already pointed to this decision as a way to find coverage for loss of business income due to COVID-19; however, we would argue that is not necessarily the case.
Atomic Energy of Canada Limited (AECL) conducts research and produces radioisotopes (an element) at the Nuclear Research Universal Reactor at Chalk River, Ontario (NRU). On May 14, 2009, a generalized power shutdown occurred affecting the NRU. As a result, the NRU identified a leak of heavy water containing radioactive Tritium (a radioactive isotope used for cardiac imaging, cancer treatment, and sterilization of medical products) due to the corrosion of a calandria wall (a heating unit used in a radioactive process). The NRU reported the leak to the Canadian Nuclear Safety Commission (CNSC), who issued an order shutting down the NRU until they could inspect the leak, analyze the cause, devise a complex plan for repair, and implement repairs. The closure lasted from May 14, 2009 to August 2010.
The NRU supplied radioisotopes to MDS Inc., the Plaintiff, who in turn processed them for sale for profit worldwide. MDS Inc. had an all-risks policy underwritten by Factory Mutual Insurance Company (FM Global), the Defendant. The policy had a limit of US $700,000,000.00 covering losses from all risks of physical loss or damage except as excluded. As a result of the NRU shut down, MDS Inc. could not obtain the radioisotopes and therefore lost out on profits in the sum of $121,248,000.00. MDS Inc. made a claim to FM Global for the loss of profits pursuant to their all-risks policy.
FM Global denied the claim relying on two exclusions – we will focus on one: the corrosion exclusion.
As noted above, the case is 113 pages long, with complex evidentiary and coverage analysis. For the purpose of this blog, we will review the decision pertaining to the court’s interpretation of property loss.
All-Risk Policies and Coverage
All-risk policies are unique. They are designed to protect an insured against all losses, unless the cause of a loss is specifically excluded in the insurance contract. They are arguably analogous to comprehensive policies discussed above. If the contract explicitly excludes a loss, the policy may offer exceptions to the exclusion that will bring an excluded loss back into coverage.
Law regarding insurance coverage is clear in this respect – if a policy has an exclusion that is ambiguously worded, effect should be given to the clear language of the policy and the reasonable objective expectations of the parties.
The insurance contract in this case was 83 pages long and provided coverage for loss of profits resulting directly from physical loss or damage. Included in this coverage were losses that are incurred when a civil authority prohibited access to property, service interruption loss under certain conditions, and losses incurred for reasonable delays to the start up of business operations.
The insurance contract included a corrosion exclusion that stated that a loss is not covered if it was caused by corrosion – FM Global relied on this exclusion to deny the claimant. FM Global argued that the cause of the shut down was a corroded calandria wall. However, the exclusion also included an exception that if there was physical damage, the loss would be brought back into coverage.
Physical Damage and the Loss of Use
The court did not accept FM Global’s initial argument that the corrosion exclusion applied to this loss and decided that the loss was covered by the policy. However, out of an abundance of caution, the court decided to assess whether the physical damage exception would bring the loss back into coverage, assuming that the exclusion applied. The court had to decide whether the loss of use of property as a consequence of the leak, would be considered “physical damage”.
The court noted that the term “physical damage” is not defined by the policy and there was no definitive court decision defining the term in the context of an all-risk policy. In fact, all court decisions seemed to be split regarding what constituted physical damage.
There are two lines of cases. The first is a narrow interpretation that required actual, tangible, or corporal damage to the property. The second is a broad interpretation that includes not only tangible damage but also the impairment of use or function. With respect to the broader interpretation, the court cited a Nova Scotia small claims court decision. In that case, a restaurant sustained an oil spill under the restaurant that caused overpowering fumes. The fumes forced the restaurant to close, to allow the removal of the contaminated soil. The Nova Scotia court decided that physical damage coverage extended to both the physically damaged contents of the business as well as the loss of use.
The Ontario court applied this reasoning to the present situation. The court recognized that there was no physical damage because of the heavy water leak – the leak did not prevented the NRU from operating, it was merely an indication that an abnormal condition existed. The unexpected leak triggered a mandatory reporting requirement to the CNSC, who in turn shut down the NRU until the source was identified and contained. In other words, the NRU was shut down to avoid the possibility of a nuclear accident and upon the order of the CNSC.
The court decided that the loss of use constituted “physical damage” and caused the disruption of the normal movement of the supply of isotopes leading to the plaintiff’s loss of income.
Application to COVID-19
Some argue that this case stands for the premise that businesses that shut down due to the COVID-19 pandemic are entitled to business interruption coverage. As noted above, this is not necessarily the case. Class actions have already been filed in Quebec and Saskatchewan against insurers for refusing to pay business interruption claims to business that had to shut down due to restrictions on business operation due to COVID-19. However, we do not believe that the finding in MDS is applicable in the current situation and insurers may have a valid reason to deny coverage pursuant to business interruption policies.
Firstly, each insurance contract must be assessed on its own terms. Coverage will vary from one insurer to the next and from one insured to the next. Just because one business is able to secure business interruption coverage stemming from the COVID-19 pandemic, does not mean that the next business will.
Secondly, a specific distinction must be made between this case and the COVID-19 pandemic. In this case, the coverage was assessed in the context of a global all-risk policy, not a comprehensive property policy. Although the court interpreted the term “property damage” broadly, it was done in the context of a loss that stemmed from a physical event that halted production of a product. The all-risk policy held by MDS Inc. specifically contemplated a loss of business income due to the failure of a third-party supplier to produce a product.
Thirdly, this decision was made by a justice using one line of reasoning. Whether the decision was right or wrong is beyond the scope of this blog. Rather, it is important to note that the second line of cases, the more narrow interpretation property damage, may be more applicable in the present situation.
Finally, the Ontario government has forced businesses to close in an effort to contain the COVID-19 virus; however, this is not a property damage. It is unlikely that a court will recognize a loss of use alone, as a distinct property damage.
As noted above, each insurance policy is unique and needs to be assessed thoroughly by the insurer before a coverage determination is made. Keeping in mind that property coverage is a first-party policy, the insurer must make sure to operate in good faith and conduct its due diligence before making a firm coverage decision.
See MDS Inc. v Factory Mutual Insurance Company (FM Global), 2020 ONSC 1924