By Jeff Sistrunk

Law360 (December 14, 2020, 1:20 PM EST) -- The COVID-19 pandemic dominated the insurance litigation landscape in 2020, with both insurers and policyholders notching early wins in disputes over coverage for losses due to government-mandated closures, while courts also issued key guidance on coverage for environmental claims and shareholder appraisal actions.

Here, Law360 reviews the biggest insurance rulings of the year.

A Deluge of COVID-19 Coverage Rulings

Insurance companies' widespread denials of companies' claims for coverage of business interruption losses tied to COVID-19 stay-at-home orders have generated a tsunami of litigation in state and federal courts. By mid-December, more than 1,500 coverage cases have been filed across the country, involving policyholders ranging in size from mom and pop restaurants to large manufacturers such as Ralph Lauren Corp, according to a database maintained by the University of Pennsylvania.

Courts have already issued just shy of 100 rulings on motions to dismiss or summary judgment, the UPenn data showed. Out of those decisions, two primary trends have emerged.

In the very first decision on an insurer's motion to dismiss, a Michigan state judge ruled in July that restaurant operator Gavrilides Management Co. LLC cannot force Michigan Insurance Co. to cover its pandemic-related losses because it hadn't alleged that its property sustained "direct physical loss or damage," which is a threshold requirement for business interruption coverage in virtually all commercial property policies.

The state judge found that the five-word phrase requires some visible, tangible alteration to property, not a mere loss of use like that claimed by Gavrilides. And even if Gavrilides had alleged a direct physical loss or damage to its property, an exclusion in its policy for virus-related losses would still apply to bar coverage, the judge held. Gavrilides has appealed the dismissal of its suit.

Since the Gavrilides ruling came down, another 70 state and federal courts have dismissed policyholders' complaints, either because the insured failed to allege direct physical loss or damage or because of the presence of a virus exclusion, or both. Nearly three-quarters of those decisions involved policies that contained virus exclusions, according to the UPenn database.

"Overall, what we have seen so far, at the trial court level, is that if you have a virus exclusion in your policy, the odds of getting through the trial court level past a motion to dismiss seem to be very low," said Newmeyer & Dillion LLP partner Alan Packer, who represents policyholders. "We are also seeing insurers winning on the 'direct physical loss or damage' issue more frequently than insureds. They are winning in a lot of courtrooms on the argument that, even if the virus was in your building or was the reason you shut down, you cannot show the virus physically damaged your premises."

However, policyholders received a glimmer of hope in August when a Missouri federal judge handed down a first-of-its-kind ruling allowing a group of hair salons and restaurants to proceed with a proposed class action claiming Cincinnati Insurance Co. wrongfully refused to cover their pandemic-related losses.

In that decision, U.S. District Judge Stephen R. Bough rejected Cincinnati's assertion that its policies' core requirement of direct physical loss or damage can be satisfied only by a tangible, permanent alteration to property, which, according to the insurer, doesn't occur even if COVID-19 is present in a building.

The district judge said Cincinnati's position conflates "loss" and "damage," when in fact the terms have distinct meanings. Since the policies do not define either term, Judge Bough turned to the dictionary definition of loss: the "act of losing possession" or "deprivation." Applying that definition, the judge held that the businesses' complaint sufficiently alleged a direct physical loss because they claimed the presence of COVID-19 on their premises hobbled their operations. He also noted that the policies did not contain virus exclusions.

The logic of Judge Bough's decision, which has been dubbed "Studio 417" after one of the lead plaintiffs in the case, has been applied by a number of other courts that have denied insurers' motions to dismiss. So far, more than 20 cases have survived dismissal bids and proceeded to discovery, according to UPenn.

Reed Smith LLP partner John N. Ellison, who also counsels policyholders, said Judge Bough applied sensible reasoning to the issues before him.

"Not every policyholder will win its case, but it is unreasonable for the insurers to say across the board that no coverage is available in any case," he said. "Many jurisdictions have recognized, before COVID-19, that you can show physical loss or damage from something that did not necessarily change a building's structure. If it is possible to trigger coverage based on the loss of the ability to use the property due to contamination, then that is a potential avenue of recovery for some of these businesses, depending on the specific facts of their cases."

In addition, at least two groups of policyholders have won their cases outright on summary judgment, in state courts in North Carolina and Washington.

In the first of those decisions, a judge in the Tar Heel state in August agreed with a group of restaurant owners — led by North State Deli LLC — that the plain definition of "direct physical loss" includes an "inability to utilize ... something in the real, material or bodily world, resulting from a given cause," and does not need physical alteration to trigger coverage." Because the virus and government shutdown orders deprived the restaurant owners of the normal use of their property, the judge granted them summary judgment and ordered their insurer, Cincinnati Insurance, to pay for their losses. The insurer swiftly appealed.

"The North Street Deli case was a milestone, because it was the first time a court found coverage outright," said Lathrop GPM partner Alexandra Roje, who represents policyholders. "The court's reasoning in that case could prove to be influential."

Hinshaw & Culbertson LLP partner Scott Seaman said that, with droves of cases still pending and many variations in policy language in play, the COVID-19 coverage battles are just heating up.

"Notwithstanding all of the activity, the COVID coverage wars are at their earliest stages," said Seaman, who represents insurers. "The parties are refining theories as a result of some of the early trial court decisions and are gaining some appreciation for which trial courts may present more hospitable venues for their cases. However, until several appellate court rulings are rendered, the course of the overall litigation will remain very much up in the air."

Calif. Justices Set Rule for Excess Cleanup Coverage

In April, the California Supreme Court issued a long-awaited ruling finding that former pesticide maker Montrose Chemical Corp. of California is not obligated to deplete all its lower-level insurance policies before it can tap into valuable excess policies to cover environmental damage claims.

The unanimous Golden State high court reversed a state appeals panel's ruling that terms found in many of Montrose's dozens of excess insurance policies mandate "horizontal exhaustion," whereby the company would have to exhaust all the lower-level policies it bought between 1961 and 1985 before it can obtain coverage from higher-level excess policies in any year.

Instead, the high court sided with Montrose and applied a "vertical exhaustion" method, which will allow the company to select any triggered excess policy to cover its losses, provided the underlying policies in the coverage "tower" for that same year have been depleted. In turn, any excess insurers that are required to pay can seek reimbursement from other carriers whose policies were triggered, in what is known as a "contribution action," the court said.

The key question in the case, according to the justices, was whether Montrose or its insurance companies must shoulder the "administrative burden" of spreading multiyear, or "long-tail," losses among applicable policies. A vertical exhaustion rule places the onus on the insurers.

"There is no obvious unfairness to insurers from a rule that requires them to bear this administrative burden," Justice Leondra R. Kruger wrote for the court.

According to Seaman, the California Supreme Court's decision "may not be correct, but it is not surprising," given the Golden State's previous adoption of other policyholder-friendly allocation rules. Following the Montrose decision, however, there still may be "a limited window for insurers to argue for horizontal exhaustion under California law," depending on the language of their policies, he said.

"The California Supreme Court pointed out that the parties to insurance contracts are free to write their policies differently to establish alternative exhaustion requirements or coverage allocation rules," he said. "The disappointing aspect of the decision is that, although the court discussed 'other insurance' clauses and insurance schedules, it did not adequately address the specific and differing language in the excess policies regarding exhaustion."

Neal Gerber & Eisenberg LLP partner Seth Lamden, who represents policyholders, said the application of vertical exhaustion to claims like Montrose's is "not an unfair approach."

"On the one hand, it ensures that the policyholder is not deprived of the insurance benefits for which it paid. On the other, no insurer should ever be left holding the bag for an amount greater than their share, because they can always bring contribution claims against co-insurers that they believe also owe coverage," he said.

The case is Montrose Chemical Corp. of California v. Superior Court of Los Angeles County, case number S244737, in the Supreme Court of the State of California.

9th Circ. Curbs Excess Insurers' Ability to Challenge Deals

In September, the Ninth Circuit limited excess insurers' ability to second-guess lower-level carriers' payment decisions when it rejected Axis Reinsurance Co.'s argument that it overpaid on Northrop Grumman Corp.'s settlement of a class action suit because the defense giant's other insurers prematurely exhausted their policies.

Ruling on an issue of first impression within the circuit, a three-judge appeals panel rebuffed Axis' "improper erosion" theory and nixed a California federal judge's order allowing Axis to recoup an undisclosed portion of the $9.7 million it shelled out toward Northrop's $16.75 million settlement of an Employee Retirement Income Security Act class action in 2017.

The trial judge, U.S. District Judge Andre Birotte Jr., found in November 2018 that Axis had overpaid under Northrop's second-layer excess policy because Northrop's two lower-level carriers — National Union Fire Insurance Co. of Pittsburgh, Pa., and a CNA Financial Corp. unit — unnecessarily exhausted their coverage by helping to cover the company's separate 2016 settlement of a U.S. Department of Labor investigation into alleged ERISA violations. Judge Birotte agreed with Axis that the DOL deal was not insurable under California law.

But the Ninth Circuit panel said that even if it agreed that National Union and CNA weren't obligated to cover the DOL settlement — an issue it did not reach — Axis still was not legally entitled to question the other insurers' decision to fund the deal. Instead, the panel adopted a general rule that an excess insurer cannot challenge underlying insurers' payment decisions to argue that its own coverage layer has not been reached, with two exceptions that were not applicable to Axis' case.

"We agree with Northrop that the district court's alternative rule — that excess insurers generally may contest the soundness of underlying insurers' payment decisions — 'would undermine the confidence of both insureds and insurers in the dependability of settlements,' eliminating one of the primary incentives for obtaining insurance in the first place," U.S. Circuit Judge Consuelo M. Callahan wrote.

Nicolaides Fink Thorpe Michaelides Sullivan LLP partner Jeffrey N. Labovitch, who represents insurers, said the decision could lead excess insurers to rewrite their policies to specifically allow them to challenge settlement decisions by lower-level insurers.

"The court essentially told the excess carrier in this case that, if it wants to be able to challenge prior settlements, it should include that as a provision in its policies," he said. "It will be interesting down the road to see if excess carriers start doing that."

Labovitch added that the case leaves open the question of whether the improper erosion theory would be viable in a situation in which the excess insurer is contesting lower-level insurers' payments on the same settlement, as opposed to a previous deal.

"Given the unique facts in Axis's case — with two different lawsuits and two different settlements — it remains to be seen whether this is an outlier or whether other parties will cite this case and try to build upon its reasoning in the future," he said.

The case is Axis Reinsurance Co. v. Northrop Grumman Corp., case number 19-55135, in the U.S. Court of Appeals for the Ninth Circuit.

Del. Justices Ax Coverage for Shareholder Appraisal Actions

The Delaware Supreme Court dealt a blow to companies incorporated in the state when it held in October that a stockholder appraisal action challenging Solera Holdings Inc.'s buyout by Vista Equity Partners didn't trigger the coverage for securities-related claims in Solera's excess directors and officers policies.

In its decision, a unanimous Delaware high court said a state judge erred in July 2019 when she ruled that the underlying appraisal action constituted a securities claim, which is defined in Solera's D&O policies as a claim for any "actual or alleged" violation "of any federal, state or local statute, regulation or rule or common law regulating securities."

The justices agreed with Solera's excess D&O insurers — Chubb Ltd. units Federal Insurance Co. and Ace American Insurance Co., along with AIG subsidiary Illinois National Insurance Co. — that an appraisal action does not fit the policies' definition of a securities claim because it is a "neutral proceeding" that serves only to determine the value of the shares held by stockholders who object to a merger. The ruling thwarted Solera's bid for over $39 million in coverage for costs it incurred in connection with the appraisal case.

"Because appraisal actions involve no adjudication of wrongdoing, they do not involve 'violations' of any law or rule, and thus, they do not fall within the definition of a 'securities claim,'" Justice Karen L. Valihura wrote for the court.

Seaman said the ruling marked a "significant victory" for D&O insurers.

"The decision from the Delaware Supreme Court carries significant weight given that so many companies are incorporated under Delaware law and Delaware is the home of many appraisal actions," he said.

The case is In re: Solera Insurance Coverage Appeals, case numbers 413, 2019 and 418, 2019, before the Supreme Court of the State of Delaware.

--Editing by Rebecca Flanagan and Marygrace Murphy.

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