In Newman Myers Kreines Gross Harris, P.C. v. Great Northern Insurance Company, No. 13-Civ-2177, 2014 WL 1642906 (S.D.N.Y. Apr. 24, 2014), the United States District Court for the Southern District of New York, applying New York law, granted summary judgment to a commercial property insurer in connection with a business interruption claim. The court held that the policyholder’s alleged business interruption losses resulting from a power outage during Superstorm Sandy were not covered losses. Id. at *1, 8. In its analysis, the court characterized the “decisive question” for resolution as “whether the insured premises experienced ‘direct physical loss or damage.’” Id. at *4.
The policyholder’s utility provider had preemptively shut off power to the policyholder’s building in anticipation of flooding as the storm approached the region, reasoning that if the power remained on and a flood occurred at the power distribution center, the damage to its equipment would be more severe and delay the time for restoring power to affected areas. Id. at *1. The policyholder’s employees were told that “the Building was closed due to a loss of power.” Id. Notably, however, the building “did not sustain any structural damage as a result of Hurricane Sandy.” Id. at *5.
When its insurer subsequently denied the claim for business interruption losses and extra expenses arising out of the five-day power outage, the policyholder sued for breach of contract. Id. at *1. At issue was the meaning of the policy’s provision “for loss of business income and extra expenses occasioned by ‘direct physical loss or damage.’” Id. at *2 (citation omitted). The policyholder argued, relying on decisions from other jurisdictions, that “the phrase ‘direct physical loss or damage,’ construed in line with the reasonable expectations of the insured, does not require actual structural damage to the covered premises. Instead, . . . there need only have been ‘an initial satisfactory state that was changed by some external event into an unsatisfactory state.’” Id. at *5 (citation omitted). See id. (discussing various cases finding coverage for, respectively, “damages allegedly caused by defective drywall that released sulfuric gas into the premises,” an “unpleasant odor rendering property unusable,” “contamination of well water,” and a “rockfall [that] did not cause structural damage . . . [but] revealed [a threat] of future rockfalls [that] made living in [the policyholders’] homes untenable”).
The district court rejected the policyholder’s reliance on such decisions, explaining that “each involved the closure of a building due to either a physical change for the worse in the premises or a newly discovered risk to . . . its physical integrity. Those characteristics are not presented by Con Ed’s preemptive decision to shut off power to several utility service networks in order to safeguard its own system and equipment.” Id. at *6 (citations omitted). The district court found “[m]ore apposite” a New York appellate court decision denying business interruption coverage to a theater company that had been forced to cancel 35 performances of a musical after the “theater was rendered inaccessible to the public . . . by a municipal order closing the street for safety reasons . . . following a construction accident at another building in the area.” Id. (citing Roundabout Theater Company v. Continental Casualty Company, 302 A.2d 1 (N.Y. App. Div. 2002)).
The district court concluded that, as in Roundabout Theater, “[t]he critical policy language . . . unambiguously requires some form of actual, physical damage to the insured premises to trigger loss of business income and extra expense coverage.” Id. at *7. It reasoned that “[t]he words ‘direct’ and ‘physical’ . . . ordinarily connote actual, demonstrable harm of some form to the premises itself, rather than forced closure of the premises for reasons exogenous to the premises themselves, or the adverse business consequences that flow from such closure.” Id. Moreover, “construing ‘direct physical loss or damage’ to require actual, physical damage to the insured premises [would] give effect to all provisions of the Policy.” Id.; see id. (explaining that “‘the time required to,’ inter alia, ‘repair or replace property,’” was expressly included within the definition of the time period during which losses would be covered, and “[t]he words ‘repair’ and ‘replace’ contemplate physical damage to the insured premises as opposed to loss of use of it”). Thus, the policyholder had “not met its burden of showing that the Policy covers its losses,” and summary judgment for the insurer was warranted. Id. at *8.
The district court also decided to address, “in the interest of completeness, and in the event an appeal is taken,” the insurer’s “alternative argument . . . that, even if there were ‘direct physical loss or damage’ to a covered premises . . . the Policy expressly excludes coverage for loss or damage caused by flooding.” Id. It concluded that the utility provider’s action was a “precautionary measure, to maintain the integrity of the utility network in the event of future flooding. Thus, the power outage . . . was not directly caused by flood, as that term is commonly understood.” Id. at *9. Reasoning that exclusions are to be construed narrowly and that ambiguities in an insurance policy must be construed against the insurer, the court concluded that the insurer would not be able to prove the losses were excluded by the flood provisions. Id. Accordingly, the insurer’s grant of summary judgment was predicated solely on the absence of “direct physical loss or damage” rather than on the flood exclusion.
The Newman Myers decision is notable because of the potential breadth of its application. The meaning of “direct physical loss or damage” is relevant not only to other Superstorm Sandy business interruption claims and to such claims arising out of future storms, but may also be relied upon in disputes arising from claims under property policies for losses arising out of cybersecurity breaches.