By Massimo D'Angelo

Law360 (August 20, 2020, 5:52 PM EDT) --

Massimo D’Angelo

As the COVID-19 contagion ravages the globe while a vaccine and effective drugs to combat the virus are still frantically under development, most businesses around the world have been forced to close, resulting in tremendous financial losses.

Although businesses in New York are gradually phasing toward fully reopening, the brick-and-mortar operations such as retailers and restaurants, in particular, continue to amass major lost profits due to the substantial reduction in foot traffic caused by the quarantine, in-person dining closures and social distancing rules.

Should the rate of infections rise, or, if there is a second wave, as many experts currently predict, business losses will further increase precipitously. Therefore, in an effort to deflect against these losses, many businesses are raising force majeure, simultaneously seeking to have the rent due to their landlords abated under the parties' lease and to recover business interruption coverage pursuant to their insurance policies.

This article reviews some of the recent major COVID-19 force majeure legal developments both internationally and domestically, and discusses how the law is shaping in this arena.

Force Majeure

Force majeure orvis major, in Latin, is generally defined as a superior force. A traditional force majeure clause found in a contract excuses both parties from liability or a contractual obligation upon the occurrence of some extraordinary event or a circumstance beyond the control of the parties.

Some nonexhaustive force majeure examples include war, strike, riot, epidemic, criminal conduct, act of god (earthquake, flood, volcanic eruption, hurricane, etc.), or other specified event. Acts of god, which are jurisdiction-specific, refer to a natural event and do not generally extend to cover viruses, bacteria or pandemics.[1]

Under well-settled New York law, force majeure provisions are narrowly construed, meaning that nonperformance will only be excused where the force majeure clause specifically includes the event that actually prevents a party's performance.[2]

Casualty Under Commercial Leases

With regard to commercial leases, most of them contain a force majeure provision, but such provisions also typically end with a catch-all sentence providing that even if a force majeure event occurs, it does not suspend the tenant's monetary obligations to pay all of the rent due to the landlord under the lease.

However, these same commercial leases usually also contain a separate "fire, damage, or other casualty" provision, which explicitly provides that the rent will abate in the event of a casualty, defined as an:

Inevitable accident; an event not to lie foreseen or guarded against. A loss from such an event or cause; as by fire, shipwreck, lightning, etc.

Black's Law Dictionary (2nd ed.1910).

Consequently, courts may find the term "casualty" to be more expansive in its application than force majeure, which is strictly construed, particularly since the pandemic was unforeseen and likely could not have been guarded against. Thus, the microbial matter propagated by COVID-19, which attaches to property, constantly requiring it to be cleaned, disinfected or sanitized, could be found to equate to a casualty abating the rent.

However, this presents a clear conflict between the force majeure provisions stating that despite such a triggering event, the rent still does not abate and the casualty section, which mandates abatement in an unforeseen event such as the present pandemic.

Where there is a battle between a commercial lease's force majeure provision and casualty provision, it will be the courts that will be deciding whether commercial tenants are entitled to abatements because COVID-19 equates to a casualty, thereby superseding the parties' force majeure provision.

Direct Physical Loss Under Insurance Contracts

Insurance contracts are construed in favor of the insured, and where "clear and unambiguous … must be given their plain and ordinary meaning."[3] Many insurance policies contain exclusions for damages caused by virus or bacteria, and absent legislation to the contrary, the policies with these specific exclusions will likely never be required to pay for interruption claims as a result of the COVID-19 pandemic by carriers.

Conversely, even if such explicit exclusions are not found in the parties' policy, insurance carriers worldwide are disclaiming, or, at the very least, reserving their rights to deny business loss claims on the grounds that a direct physical loss is required to be shown as a precondition to trigger coverage. As shown below, courts have already issued several contradictory rulings on this salient issue.

The Billion-Dollar Questions

The two billion-dollar questions that need to be resolved are whether COVID-19 constitutes: (1) a casualty abating the rent under the lease; and (2) a direct physical loss, triggering coverage for business interruption purposes? If the answers to these two queries are in the affirmative, then landlords will be foreclosed from collecting significant rents and insurance carriers will be paying out billions of dollars in claims stemming from business losses.

Since it appears that the legislation settling these critical questions will never be enacted, their resolution will be played out in courts across the country over the course of the next several years until the highest court in each jurisdiction rules on the subject.

Major Legal Developments

On the global stage, the Paris Commercial Court first issued an interim order on May 20 that COVID-19 equated a force majeure event suspending contractual performance pursuant to the parties' contractual force majeure provision.

More recently, on July 28, the Paris Court of Appeals upheld the interim order, holding that the performance by Total Direct Energie, a French international electrical utility company, under its contract with Électricité de France, to purchase nuclear energy at regulated prices, would be suspended because COVID-19 equated to a force majeure event.

In the U.K., the Financial Conduct Authority recently brought a test case in the Commercial Court in London seeking clarification on business interruption coverage due to COVID-19, which the world is closely monitoring.[4]

Domestically, on June 2, the U.S. Bankruptcy Court for the Northern District of Illinois held that the state's executive order suspending dine-in services due to COVID-19 resulted in a force majeure event, partially excusing performance under parties' commercial lease.[5]

Contrarily, on July 2, a Michigan state court in Ingham County held that a restaurateur was not entitled to recover business losses under its policy of insurance because COVID-19 did not constitute a direct physical loss.[6] Specifically, the decision in Gavrilides stated that a "direct physical loss of or damage to the property has to be something with material existence, something that is tangible … something that alters the physical integrity of the property."

The Gavrilides court ruled that the microbial matter that sticks to surfaces within properties could not be covered by the traditional definition of a direct physical loss, such as smashing the façade of a building with a sledge hammer, despite the fact that the property must constantly be cleaned and disinfected.

Similar to Gavrilides, in a recent decision by the U.S. District Court for the Southern District of New York, the court held that "New York law is clear that this kind of business interruption needs some damage to the property to prohibit you from going."[7]

The court cited Roundabout Theatre Co. Inc. v. Continental Casualty Co., in which the New York Supreme Court Appellate Division, First Department, notably held that the policy at issue did not cover losses occasioned by an order of the City of New York closing the street and denying access to the insured's theater due to a construction accident in the area resulting in the insured to cancel 35 musical production performances, as there was no actual direct physical damage to the insured's structure.

It should be noted, however, that the Roundabout Theatre case did not involve any virus or bacteria that physically attached to property, and further stated that there may be coverage for the relevant period of restoration to damaged property where direct physical loss is found to exist.

Conclusion

While the COVID-19 force majeure law continues to take shape, it appears that there will be no legislation enacted by the Legislature to impose some modicum of uniformity with regard to force majeure — namely, whether COVID-19 is defined as a casualty or direct physical loss. Therefore, it will be the courts making these billion-dollar determinations, and as we have already witnessed over the past several months, these decisions will lend themselves to contradictory rulings that largely depend on how the judge sitting on these cases define these crucial terms.

Most importantly, courts must decide whether the viral matter from the disease, which attaches to properties, constitutes a physical element to support a finding of casualty or direct physical loss, that would allow businesses to recover from their enormous business losses at the hands of the pandemic.

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Massimo F. D'Angelo is a partner at Adam Leitman Bailey PC.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] Merritt v. Earle , 29 N.Y. 115 (1864); see also Michaels v. New York Cent. R. Co., 30 N.Y. 564 (1864); see also Read v. Spaulding, 30 N.Y. 630 (1864); Barnet v. New York Cent. & H.R.R. Co., 222 N.Y. 195 (1918).

[2] Kel Kim Corp.v. Cent. Mkts., Inc. , 70 N.Y.2d 900 (1987); see also 407 East 61st Garage, Inc. v. Savoy Fifth Ave. Corp., 23 N.Y.2d 275 (1968); United Equities Company v. First National City Bank, 395 N.Y.S.2d 640 (1977).

[3] United States Fid. & Guar. Co. v. Annunziata , 67 N.Y.2d 229 (1986).

[4] https://www.fca.org.uk/firms/business-interruption-insurance.

[5] In re Hitz Restaurant Group, No. 20-B-05012, 2020 WL 2924523 (Bankr. N.D. Ill. June 2, 2020).

[6] Gavrilides Management Company et al. vs. Michigan Insurance Co. (Ingham County, July 1, 2020).

[7] Life Magazine v. Sentinel Insurance Company Limited, Index No. 20 Civ. 3311 (VEC) (S.D.N.Y. May 14, 2020) (citing Roundabout Theatre Co., Inc. v. Continental Casualty Co. , 302 A.D.2d 1 (N.Y. App. Div. 1st Dep't 2002)).

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