Erik Tomberg and Spencer Hoisington | Wilson Elser
On December 13, 2024, the North Carolina Supreme Court issued a ruling in a business interruption coverage case that strayed from the national trend of courts finding in favor of insurance carriers following government-ordered business closures during the COVID-19 pandemic. Specifically, in North State Deli, LLC, et al. v. The Cincinnati Ins. Co., the court concluded that loss of physical use of property – such as a restaurant – can constitute “direct physical loss” under property policies, paving the path to coverage for policyholders who are unable to access or otherwise use insured spaces. While the height of the pandemic may have passed, perhaps even more notable is the court’s striking emphasis on the “reasonable expectations of the policyholder” as the “lodestar” for insurance contract interpretation where terms are disputed, potentially tipping the scales in favor of policyholders – particularly where those terms are not expressly defined in the policy.
North State Deli v. The Cincinnati Ins. Co
In North State Deli, LLC, et al. v. The Cincinnati Ins. Co., No. 225PA21-2, 3 (N.C. Dec. 13, 2024), the plaintiffs were a collection of North Carolina restaurants that were forced to curtail or suspend business operations after then-Governor Roy Cooper and local municipalities issued orders imposing broad limitations on the use and operation of such establishments during the COVID-19 pandemic. The restaurants filed an action against their shared commercial property insurer, Cincinnati Insurance Company, seeking a declaratory judgment that gubernatorial, county, and municipal orders constitute covered perils that caused “direct physical loss” to their properties. The restaurants carried similar “all-risk” commercial property policies that protected the building and personal property, as well as business income, from any “direct physical loss” to property. Notably, the policies did not contain a virus or viral contamination exclusion.
After the trial court agreed with the restaurants, a unanimous panel at the North Carolina Court of Appeals reversed the order. However, on further appeal, the North Carolina Supreme Court ultimately reversed the Court of Appeals and agreed with the trial court, determining that the restaurants had successfully stated a claim for coverage due to “direct physical loss” to their insured spaces. The policies in question did not define “direct physical loss,” which proved fatal to Cincinnati’s position
The North Carolina Supreme Court focused on the “contextual and common-sense expectation that insurance should protect from threats to property that make it unusable for the purpose for which it is insured.” Property “loss,” the court reasoned, “surely occurs when it is no longer usable for its insured purpose, as a policyholder would reasonably expect.” (emphasis added). Therefore, based on the “reasonable expectations” doctrine and the lack of clearly defined terms in the policy, the court concluded that “when the restaurants lost physical use of their properties as restaurants due to the pandemic orders, they experienced a direct physical loss.”
Cato Corporation v. Zurich Am. Ins. Co.,
In the companion case of Cato Corporation v. Zurich Am. Ins. Co., No. 353PA23 (N.C. Dec. 13, 2024), decided the same day, the North Carolina Supreme Court addressed a similar claim for coverage brought by a clothing retailer that alleged COVID-19 transformed and destroyed its property. In stark contrast to the policy in North State Deli, the Cato policy expressly excluded viral contamination as a covered cause of loss – which proved to be dispositive, as the court enforced the exclusion and affirmed the lower courts’ rulings that dismissed the insured’s declaratory judgment action. The Cato court implied it would have come to a different conclusion if the Zurich policy had not contained a detailed viral contamination exclusion, as “[the] parts of Cato’s policy that grant coverage are functionally the same as the parts of North State Deli’s policy that grant coverage.” Thus, Cato is an example of how a well-defined exclusion carved out coverage for a claim that was otherwise subject to essentially the same policy language as North State Deli.
TAKEAWAYS
All that said, any executive orders and local regulations concerning COVID-19 are long expired, so what are the takeaways?
- In the short term, insurance carriers should check their pending claims in North Carolina to confirm whether they are impacted by the state’s new interpretation of “direct physical loss,” and confirm whether they have up-to-date provisions reflecting the changing landscape since the advent of the pandemic. Prudent carriers writing in North Carolina also should examine their current policies – particularly “all-risk” or “openperils” policies – to check for language similar to that contained in the Cincinnati and Zurich policies, and take action to address future claims.
- Carriers that have sought to streamline their policies with fewer definitions should pay particularly close attention to the North State Deli court’s admonishment that “[it] is the insurance company’s responsibility to define essential policy terms….” (emphasis added). “Otherwise,” the court observed, “insurance companies are licensed to pitch consumers on an expansive, ‘all-risk’ policy, while hiding behind a narrower definition imposed by judicial fiat when it comes time to pay out. Such a setup contradicts our court’s holdings that the lodestar for insurance contract interpretation is the reasonable expectation of the policyholder and that ambiguities should be resolved in the insured’s favor.”
- These sentiments should serve as a fair warning to carriers that if policy terms are left undefined, North Carolina courts are likely to lean toward an interpretation that the terms are ambiguous and therefore should favor the “reasonable expectations” of the policyholder, regardless of the carrier’s rationale for employing the terms. Accordingly, carriers should consider reviewing their policy forms and reevaluating whether undefined terms they previously left to the dictionary to define should be clarified or expressly defined, even where they have been interpreted in a largely consistent manner across most jurisdictions.
- Arguably, the North Carolina Supreme Court’s decision is at odds with its prior ruling in Accardi v. Hartford Underwriters Insurance Co., 373 N.C. 292, 295, 838 S.E.2d 454, 457 (2020), where it held that “[ambiguity] is not established by the mere fact that the insured asserts an understanding of the policy that differs from that of the insurance company.” One reading of North State Deli is that the court looked to the insured’s expectations of coverage first as a means of establishing ambiguity, instead of the other way around. Either way, as Cato demonstrates, carriers are likely to be in a more favorable position when policy terms are clearly defined and articulated.
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