Nancy D. Adams is the Co-Chair of the Insurance Practice at Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. Kaitlyn C. Leonard is an Associate with Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. in its Boston office.
As the world grapples with the effects of the COVID-19 pandemic, both in terms of the public health and safety implications and in terms of the profound impact that the pandemic is having—and will continue to have—on the national and global economies, some state legislators have attempted to find a source of relief for small businesses. However, in adopting such laws, legislatures may cause more harm than good, particularly for the very businesses that they are seeking to assist.
As of April 17, legislators in seven states1 have proposed bills meant to provide policyholders of business interruption insurance policies with coverage for all losses sustained in connection with the outbreak of COVID-19, even though most of those policies do not provide—and, in some instances, exclude—coverage for such losses.
In general, when insurers enter a line of business, they analyze the potential risk being insured and determine the premium amount based on that risk analysis. Policyholders then pay a premium to insurers in return for the insurer’s promise to pay specified damage or loss. Like any other contract, each party bargains for the terms and the price of the insurance policy. Then, if a policyholder suffers a loss covered by the policy, she may make a claim with her insurer.
Relevant here, policyholders are turning to property policies that provide “business interruption” coverage to reimburse them for financial loss that they have sustained due to the COVID-19 pandemic. Broadly, business interruption insurance, also known as business income insurance or time element insurance, applies when the insured has suffered a financial loss resulting from an event that is otherwise covered by the policyholder’s property policy.
Importantly, for business interruption insurance to apply, the suspension in the policyholder’s business must be the result of direct physical damage to the policyholder’s property. In addition, “the loss or damage” to the policyholder’s property must be caused by, or result from, a “Covered Cause of Loss.”2 Under most property policies, the vast majority of “causes of loss” are insured unless excluded or limited by the policy. Many property policies contain exclusions that expressly exclude insurance for losses caused by, or resulting from, any virus or bacterium.3 For these policies, the policyholder would not be afforded property insurance, including business interruption insurance, for loss caused by, or resulting from, these excluded “causes of loss.”
The Proposed Legislation
Beginning with New Jersey, followed closely by Ohio, Massachusetts, New York, and Louisiana, and most recently by Pennsylvania, and South Carolina, seven states currently have pending legislation which proposes to alter the business interruption coverage afforded under the policies. In addition, United States Representative, Mike Thompson (CA-05) has introduced the Business Interruption Insurance Coverage Act of 2020 (HR 6494). In New Jersey (A3844), New York (A10226), Ohio (HB 589), and Pennsylvania (HB 2372), the bills provide a broad pronouncement that all policies are to be construed to provide coverage for business interruption due to the COVID-19 pandemic for the period of time beginning when each state declared a State of Emergency.
The Massachusetts bill, SD 2888, is much more specific in that it seeks to prevent insurers from denying “a claim for the loss of use and occupancy and business interruption on account of (i) COVID-19 being a virus (even if the relevant insurance policy excludes losses resulting from viruses); or (ii) there being no physical damage to the property of the insured.” The Massachusetts bill similarly seeks to provide coverage during the State of Emergency. Similarly, South Carolina bill, S.1188, would explicitly prevent insurers from denying claims based on “(1) COVID-19 being a virus, even if the relevant insurance policy excludes losses resulting from viruses; (2) there being no physical damage to the property of the insured or to any other relevant property; or (3) orders issued by any civil authority, or acts or decisions of a governmental entity.”
In Louisiana, two bills are currently pending. Senate Bill 477 and House Bill 858 both seek to change any policy “insuring against loss or damage to property that includes the loss of use, loss of occupancy, or business interruption” to be construed as to cover any loss in connection with the COVID-19 pandemic. However, like the other states, Senate Bill 477 and House Bill 858 seek to provide coverage during the State of Emergency in Louisiana.
The proposed legislation in the majority of the seven states seeks to assist small businesses. In New Jersey, New York, Ohio and Pennsylvania the application of the bills is limited to businesses with less than 100 full time employees. In Massachusetts and South Carolina, the proposed law would apply to businesses with less than 150 full time employees. In New York, the bill limits coverage to businesses with less than 250 employees. In Louisiana, House Bill 858 contains a limitation for businesses with 100 full time employees or less, while Senate Bill 477 contains no such limitation. However, the federal bill does not provide a limit on the size of businesses who would qualify.
The bills in Ohio, Massachusetts, New York, Pennsylvania, New Jersey, and South Carolina include provisions that would allow insurers to seek reimbursement through a fund established by each state’s insurance regulatory authority. However, while some bills are vague on the source of such funds, others indicate that the funds will be financed by special assessments on all insurance companies. In other words, by merely being an insurer, a company could be required to contribute toward the payment of business interruption claims on a line of coverage that they never wrote.
Although the legislative rewriting of bargained-for policy language is a startling prospect in general, the elimination of the physical damage requirement is particularly troublesome not only because it alters the grant of coverage, but it also effectively eliminates the burden on insureds to prove that there is coverage in the first place. Efforts to rewrite a contract and force insurers to pay for a loss that they did not insure should be disavowed by both legislators and courts.
In addition to the potential implications on businesses, contracts and the insurance industry, the proposed legislation poses constitutional issues under the following provisions of the U.S. Constitution: (1) The Contracts Clause; (2) The Takings Clause; and (3) The Due Process Clauses. First, under the Contracts Clause, “No State shall … [pass any] Law impairing the Obligation of Contracts[.]” In determining whether a law has violated the contracts clause, a court will apply a three-factor test:
- Whether the law substantially impairs a contractual relationship;
- Whether there is a significant and legitimate public purpose for the law; and
- Whether the adjustment of the rights and obligations under the contract is reasonable and appropriate given the public purpose justifying the law.
Energy Reserves Group, Inc. v. Kansas Power & Light Co., 459 US 400, 410-13 (1983).
On the first prong, while the proposed legislation will almost certainly alter the contractual relationships between insurers and insureds substantially, the extent of insurers’ resulting impairment will likely depend on whether and how much insurers will be compensated by the funds established by each state. On prongs two and three, providing aid to small businesses is without question a worthy purpose, but whether or not the rewriting and decimation of insurance policies is the most reasonable and appropriate way to reach that purpose will be a much harder question for states to answer. A court will also likely consider whether the industry is “heavily regulated” and therefore whether members of the industry can reasonably expect future government regulations. Id. at 413.
Second, under the Fifth Amendment’s Takings Clause, private property shall not “be taken for public use, without just compensation.” The purpose of the Takings Clause is “to prevent the government from forcing some people to bear public burdens, which, in all fairness and justice, should be borne by the public as a whole.” Murr v. Wisconsin, 137 S. Ct. 1933, 1943 (2017) (internal citations omitted). As an initial matter, insurers’ contractual rights will likely be considered private property for purposes of the Takings Clause. See, e.g., Omnia Commercial Co. v. United States, 261 U.S. 502, 508 (1923) (finding that a “contract in question was property within the meaning of the Fifth Amendment”). Under Penn Central Transportation Co. v. New York City, 438 U.S. 104 (1978), a court will again apply a three factor test and look to (1) the economic impact of the regulation on the claimant; (2) the extent to which the regulation has interfered with distinct investment-backed expectations; and (3) the character of the governmental action. Id. at 124.
Many of the same considerations will come into play under a Takings Clause analysis as an analysis under the Contracts Clause. Insurers will no doubt suffer an economic impact as a result of the proposed legislation and there is little question that the intended purpose of helping small business is a legitimate government interest. A determination of whether a Takings Clause violation has occurred will likely come down to how proportionate the impact of the legislation is in comparison to its purpose. See Eastern Enterprises v. Apfel, 524 U.S. 498, 504 (1998) (holding, in a plurality of the Supreme Court, that the retroactive creation of extra-contractual obligations, “improperly place[d] a severe [and] disproportionate” burden on the mining company). Id.
Third, the proposed laws may violate the Due Process Clause. Insurers will need to establish that the deprivation of a constitutionally protected property interest was arbitrary and not rationally related to a legitimate government interest. FDIC v. Mallen, 486 U.S. 230, 243 (1988). Although paying uninsured claims as required by the proposed legislation would likely constitute property, the burden on insurers would be higher given that, under this analysis, laws will be given “a strong presumption of validity.” FCC v. Beach Comm’ns, Inc., 508 U.S. 307, 314 (1993). While the Supreme Court has found that, “the enactment of retroactive statutes confined to short and limited periods required by the practicalities of producing national legislation . . . is a customary congressional practice,” Ben. Guar. Corp. v. R.A. Gray & Co., 467 U.S. 717, 731 (1984), it is nonetheless true that the insurers will have a valid due process claim.
Ultimately, businesses will need assistance to survive the pandemic, but there are other means to provide them with the needed relief. For instance, the National Association of Mutual Insurance Companies has called on the government to create a fund like the 9/11 victim compensation fund to aid those who have suffered from the pandemic. House Financial Services Committee Chairwoman Maxine Waters has introduced a bill outlining proposed legislation that would provide a go-forward mechanism for a federal backstop for pandemic risk insurance and would create a reinsurance program similar to the Terrorism Risk Insurance act for pandemics, by capping the total insurance losses that insurance companies would face. In Louisiana, a third bill, Senate Bill 495, has been introduced and proposes a business compensation fund that offers insurers bad-faith litigation immunity for participation in the fund. Whatever the best option may be, like any agreement, insurers should have a say in the outcome.
Beyond requiring payments for risks that were never underwritten and for which premiums were never paid, the proposed legislation will likely have more far reaching effects than the impact on particular policies. More importantly, however, the proposed legislation threatens to undermine the tenets of basic contract law, given that the parties to an agreement will have no certainty that the terms they have bargained for, and agreed upon, may be removed or fundamentally altered by lawmakers.
- New Jersey, New York, Ohio, Massachusetts, Louisiana, Pennsylvania, and South Carolina.
- Business Income (And Extra Expense) Coverage Form, Insurance Services Office, Inc., Form No. CP 00 30 10 12.
- In 2006, in the wake of the SARS outbreak, the Insurance Services Office, Inc. adopted the virus exclusion.