Fifth Circuit Affirms that Business Interruption Coverage Requires Direct Physical Loss; COVID-Related Losses Do Not Qualify

In a win for Wiley’s client, the United States Court of Appeals for the Fifth Circuit, applying Louisiana law, affirmed the grant of an insurer’s motion to dismiss with prejudice. Hotel Mgmt. of New Orleans, LLC v. General Star Indem. Co., 2023 WL 3270904 (5th Cir. May 5, 2023) (per curiam). The Fifth Circuit found that an insured hotel’s economic losses related to the COVID-19 pandemic could not trigger coverage under a commercial property insurance policy. Specifically, the court held the policy insured against the risk of “direct physical loss of or damage to” property, which required some tangible alteration of the property.

The insured owned and operated hotels in New Orleans. The insured suffered financial losses due to the COVID-19 pandemic and sought coverage under its commercial property insurance policy, which included Business Income and Extra Expense Coverage (colloquially referred to as “business interruption coverage”). However, the insured did not allege that its property was tangibly altered by the virus or that any physical repairs to its property were needed because of the virus. Coverage litigation ensued, and the insurer moved to dismiss on the basis that economic losses were not “direct physical loss of or damage to” property, which is required to trigger coverage under the policy. The United States District Court for the Eastern District of Louisiana granted the insurer’s motion, and the insured appealed.

The Fifth Circuit affirmed. At the time the appeal was being briefed, the Louisiana Supreme Court had not specifically weighed in on the issue. The Fifth Circuit made an “Erie guess” in Q Clothier New Orleans, L.L.C. v. Twin City Fire Insurance Co., 29 F.4th 252 (5th Cir. 2022), predicting that, under Louisiana law, only “tangible alterations of, injuries to, and deprivations of property” could qualify as a “direct physical loss.” After Q Clothier was decided, the Louisiana Supreme Court confirmed that the Fifth Circuit’s Erie guess was correct. See Cajun Conti LLC v. Certain Underwriters at Lloyd’s, London, 2023 WL 2549132 (La. Mar. 17, 2023).

The Fifth Circuit’s opinion thus focused on whether the policy actually required “direct physical loss.” The Court rejected the insured’s argument that the policy did not require a showing of “direct physical loss.” The Court noted that the policy’s business interruption coverage applied to losses resulting from “any of the perils covered herein,” which was defined as “all risks of direct physical loss of or damage to property.” As a result, the policy required direct physical loss, which the insured could not establish under Louisiana law.