Judicial Council of California Issues Opinion in JRK Property Holdings Vs. Colony Insurance Case

SACRAMENTO, California, Oct. 3 -- The Judicial Council of California issued the following opinion (No. B321806) on Oct. 2, 2023:

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In the Court of Appeal of the State of California, Second Appellate District, Division Seven

JRK PROPERTY HOLDINGS, INC., Plaintiff and Appellant, v. COLONY INSURANCE COMPANY et al., Defendants and Respondents.

APPEAL from an order of dismissal of the Superior Court of Los Angeles County, Daniel S. Murphy, Judge. Affirmed in part, reversed in part, and remanded.

Spertus, Landes & Umhofer, Kevin J. Minnick; Cohen Ziffer Frenchman & McKenna, Robin Cohen, Meredith Elkins and Orrie A. Levy, for Plaintiff and Appellant.

Clyde & Co. US, Susan Koehler Sullivan, Douglas J. Collodel and Brett C. Safford for Defendants and Respondents Endurance American Specialty Insurance Company and Maxum Indemnity Company.

Duane Morris, Max H. Stern, Jessica E. La Londe and Holden Benon for Defendants and Respondents Ironshore Specialty Insurance Company, Ategrity Specialty Insurance Company, RSUI Indemnity Company and Certain Underwriters at Lloyd's, London Subscribing to Policy No. (UMR) B0180PG1903066, and Certain Underwriters at Lloyd's, London Subscribing to Policy No. (UMR) B0180PG1902622.

Cummins & White, Larry M. Arnold, Margaret R. Miglietta, Noura K. Rizzuto; Stewart Smith and William F. Stewart for Defendant and Respondent Colony Insurance Company.

Kennedys CMK and Susan Frances Dent for Defendant and Respondent Crum & Forster Specialty Insurance Company.

Phelps Dunbar, Jay R. Sever; Selman Leichenger, Edson, Hsu, Newman & Moore and Meka Moore for Defendant and Respondent Scottsdale Insurance Company.

Dickinson Wright and Bennett Evan Cooper for Defendant and Respondent Evanston Insurance Company.

Akerman and Michael R. Weiss for Defendants and Respondents Homeland Insurance Company of New York and Hallmark Specialty Insurance Company.

Faegre Drinker Biddle & Reath, Kristopher S. Davis; Rinker Danzig Scherer Hyland & Perretti, Brian E. O'Donnell and Maura C. Smith for Defendant and Respondent Mitsui Sumitomo Insurance Company of America.

JRK Property Holdings, Inc. appeals from the order of dismissal with prejudice entered after the trial court granted without leave to amend the motion for judgment on the pleadings filed by primary insurer Ironshore Specialty Insurance Company (Ironshore) and excess insurers RSUI Indemnity Company (RSUI), Evanston Insurance Company (Evanston), and others (collectively, Insurers)./1 JRK sued Insurers for breach of contract and declaratory judgment after Insurers denied coverage for JRK's lost business income that resulted from its restricted operations and diminished rental revenue due to the COVID-19/2 pandemic and associated government orders.

On appeal, we again address whether the alleged presence of the COVID-19 virus on an insured's properties constitutes "direct physical loss or damage" to the insured properties, providing coverage under the insurance policies at issue. In the unpublished portion of the opinion, we conclude JRK adequately alleged for purposes of Insurers' motion for judgment on the pleadings that contamination from the COVID-19 virus physically altered the premises of its properties.

In the published part of this opinion, we address Insurers' argument in the alternative that coverage was barred by a pollution exclusion that applied to pollution caused by, among other things, the release, discharge, or dispersal of pollutants or contaminants, where the terms "pollutants or contaminants" are defined to include a contaminant that can cause or threaten harm to human health or damage to property, including a "bacteria, virus, or hazardous substances" listed under specified environmental laws. The Supreme Court in MacKinnon v. Truck Ins. Exchange (2003) 31 Cal.4th 635, 639-640 (MacKinnon) held that the historical background of the pollution exclusion shows its inclusion in insurance policies was intended to address only traditional sources of environmental pollution. We reject Insurers' argument that inclusion of the term "virus" in the definition of a contaminant transforms an exclusion that applies to "pollution" (and typically environmental pollution) into one that encompasses the spread of a virus due to the normal human activities of breathing and touching surfaces.

JRK also challenges the trial court's holding with respect to RSUI and Evanston that their policies' pathogen exclusions bar coverage. We conclude in the published portion of the opinion that the RSUI pathogen exclusion applies because it bars coverage for "losses or damage" caused by the discharge or dispersal of a "pathogenic" material. Clearly the COVID-19 virus is a pathogen. Although the exclusion uses the traditional discharge terms of art addressed in MacKinnon, the exclusion contains no reference to pollution. And the Evanston pathogen exclusion specifically bars loss or damage caused by the spread of an organic pathogen, defined to include a virus.

We reverse as to all Insurers except Evanston and RSUI.

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FACTUAL AND PROCEDURAL BACKGROUND

A. JRK's Business and Insurance Policies

As alleged in the complaint, JRK was a real estate investment firm with investments in approximately 100 hotel and residential properties across 22 states at the time the COVID-19 pandemic took hold. JRK had $250 million in business interruption property insurance coverage it purchased "in a layered program" from Insurers, with each insurer providing a specified share of the total coverage. The insurance policies (Policies) provided substantially identical coverage incorporating or following a "master property policy" (with limited exceptions discussed below). The Policies were in effect from June 1, 2019 to June 1, 2020.

The Policies provided business interruption coverage for "loss resulting from necessary interruption of business conducted by the Insured and caused by direct physical loss, damage, or destruction by any of the perils covered herein." However, the Policies included a pollution exclusion for "[p]ollution caused directly or indirectly by the release, discharge, dispersal, seepage, migration, or escape of pollutants or contaminants."/3 "Pollutants or contaminants" were defined as any "solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals and waste, which after its release can cause or threaten damage to human health or human welfare or causes or threatens damage, deterioration, loss of value, marketability or loss of use to property insured hereunder, including, but not limited to, bacteria, virus, or hazardous substances as listed in the Federal Water, Pollution Control Act, Clean Air Act, Resource Conservation and Recovery Act of 1976, and Toxic Substances Control Act or as designated by the U.S. Environmental Protection Agency."

Two of the Policies included insurer-specific exclusions precluding coverage for pathogenic materials or pathogens (pathogen exclusions). The RSUI policy excluded "loss or damage caused directly or indirectly by the discharge, dispersal, seepage, migration, release, escape or application of any pathogenic or poisonous biological or chemical materials." The RSUI exclusion did not define the term "pathogenic."

The Evanston policy excluded loss or damage directly or indirectly caused by the "[p]resence, growth, proliferation, spread or any activity of 'organic pathogens.'" It defined an "organic pathogen" to include "[a]ny organic irritant or contaminant, including, but not limited to, 'fungus', . . . bacteria, virus, or other microorganisms of any type" and "[a]ny disease-causing agent as classified by the Environmental Protection Agency." The Evanston pathogen exclusion applied regardless of whether there was direct physical loss or damage to covered property or loss of use, occupancy or functionality or decreased valuation of covered property, or loss of business income. Further, the pathogen exclusion replaced any policy exclusion for "'fungus', wet rot, dry rot and bacteria."

B. The Complaint

JRK filed this action on May 27, 2021 alleging causes of action for breach of contract and declaratory relief premised on Insurers' refusal to cover JRK's losses and reservation of rights, in which Insurers stated they did not have sufficient information to provide coverage.

As alleged, the outbreak of the COVID-19 pandemic in early 2020 had an acute impact on JRK's business. Because the virus could spread by airborne droplets and smaller aerosols that linger in the air, creating "fomites" on surfaces "physically affected by the coronavirus," the highly contagious virus caused loss and damage to JRK's large residential properties, hotels, and commercial establishments. Specifically, "[t]he virus hangs in the air and attaches to property for extended periods of time. Studies have shown that fomites--physical surfaces that promote infection--can become infectious on a whole range of surfaces, including stainless steel, wood, paper, plastic, glass, ceramic, cardboard, and cloth, many of which are used throughout JRK's properties." The virus could survive for days on surfaces, compromising the "physical integrity of the structures it permeates" and posing an "imminent risk of physical damage to all other structures." Thus, "[b]etween contagious surfaces and invisible particles suspended in the air, the coronavirus turned JRK's properties into a gauntlet of deadly particles." Moreover, because the virus was resilient, simple cleaning was not sufficient to sterilize the properties, and no amount of cleaning could remove the aerosolized virus particles, which had the potential to generate new infectious fomites.

In response to the outbreak of COVID-19, state and local governments imposed "sweeping restrictions on residents' daily lives and property to protect them." Each of the states in which JRK owned property imposed some form of lockdown order restricting travel, directing residents to remain at home, and closing non-essential businesses. These orders had "widereaching impacts, including reduced travel and loss of jobs, resulting in tenants failing to pay market rents."

Residents at JRK's properties tested positive for COVID-19 as early as mid-March 2020; in total, its properties had at least 178 confirmed cases, including tenants and employees. At least 60 of JRK's residential properties had at least one confirmed positive test from a resident, and JRK alleged it was "statistically certain" the virus was present at all of its properties at some point since the pandemic began. In addition, JRK's residential properties were "uniquely vulnerable to the physical loss or damage the virus causes, as its apartment properties face[d] increased exposure when tenants [were] ordered to 'stay home,' yet the public areas such as lobbies and elevators [were] required to be open for safety and building use."

Accordingly, the pandemic caused JRK to suffer significant financial losses, including substantial costs incurred to respond to on-site cases. The lockdown orders also "devastated JRK's business" by prohibiting residential evictions, deferring rental payments, and closing popular tourist destinations, bars, restaurants, and venues that provided the draw for travelers to stay at JRK's hotels.

JRK provided prompt notice of its claim to Insurers in March 2020. Insurers responded through their adjuster on July 6, 2020 with a reservation of rights indicating they lacked sufficient information to determine "'whether or not there may be coverage under the Policies'" but failing to request any specific information.

JRK provided a second notice on August 17, 2020 to its higher-level excess carriers. On October 5, 2020 the adjuster responded with a "supplemental reservation of rights letter that was materially similar to the July 6 [l]etter." On March 29, 2021, after JRK provided requested information, Insurers again reserved their rights and "effectively denied coverage."

C. Insurers' Motion for Judgment on the Pleadings

On January 21, 2022 Insurers filed a motion for judgment on the pleadings, arguing JRK failed to allege facts showing a distinct "'physical alteration'" to its covered property as required to establish "'direct physical loss or damage'" under California law, making only conclusory assertions. Further, temporary loss of use did not constitute "'direct physical loss or damage.'" Insurers argued Inns-by-the-Sea v. California Mutual Ins. Co. (2021) 71 Cal.App.5th 688 (Inns-by-the-Sea) and the federal appellate courts were unanimous in rejecting insurance coverage for economic losses arising from the COVID-19 pandemic. Insurers also argued specific exclusions precluded coverage, including the pollution exclusion in all of the policies, and the pathogen exclusions in two of the policies. Finally, Insurers urged the trial court to deny leave to amend because no amount of "artful pleading" could remedy the legal deficiencies in the complaint.

In its opposition JRK argued it sufficiently alleged "'direct physical loss or damage'" by pleading the actual presence of COVID-19 on the insured properties, which altered the air and surfaces of the properties and rendered the properties functionally useless. JRK distinguished Inns-by-the-Sea on the basis the alleged loss there resulted from the government orders, not physical loss or damage from the virus. JRK asserted the pollution exclusion did not apply because it was limited to traditional environmental pollution, and the pathogen exclusions likewise did not apply. JRK requested leave to amend if its allegations were inadequate.

After a hearing, on April 18, 2022 the trial court granted the motion without leave to amend as to primary insurer Ironshore and the excess insurers. In granting the motion, the court concluded JRK suspended its operations as a result of the government orders, not the presence of the virus on its properties. The court also found the pollution and pathogen exclusions barred coverage. The court denied the motion with respect to the primary insurers other than Ironshore (not parties on appeal), finding a triable issue of fact as to whether a communicable disease provision applicable only to those insurers barred coverage./4 The communicable disease provision did not apply to the excess insurers because the provision was subject to a $2.5 million cap, and the excess insurers' policies attached above that level.

On May 10, 2022 the court entered an order of dismissal in favor of Insurers and awarded costs in an amount to be determined. JRK timely appealed.

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Footnotes:

* Pursuant to California Rules of Court, rules 8.1100 and 8.1110, this opinion is certified for publication with the exception of part D of the Discussion.

1/ Insurers also include excess insurers Certain Underwriters at Lloyd's, London subscribing to Policy No. (UMR) B0180PG1903066, Certain Underwriters at Lloyd's, London subscribing to Policy No. (UMR) B0180PG1902622, Ategrity Specialty Insurance Company, Colony Insurance Company, Crum & Forster Specialty Insurance Company, Endurance American Specialty Insurance Company, Hallmark Specialty Insurance Company, Homeland Insurance Company of New York, Maxum Indemnity Company, Mitsui Sumitomo Insurance Company of America, and Scottsdale Insurance Company. The motion was also brought on behalf of other primary insurers, but the trial court denied the motion as to those insurers because their policies provided coverage for interruption by communicable disease. Those insurers are not parties to this appeal.

2/ For ease of reference, we refer to the SARS-CoV-2 virus, its variants, and the coronavirus disease caused by them as COVID19.

3/ We have omitted capitalization and boldface when quoting from the insurance policies.

4/ The communicable disease provision provided coverage for "the actual loss sustained and extra expense incurred by the insured during the period of liability if access to a location owned, leased or rented by the insured is limited, restricted or prohibited as a result of [Sect.] a) [a]n order of an authorized governmental agency regulating the actual not suspected presence of communicable disease; or [Sect.] b) [a] decision of an officer of the insured as a result of the actual not suspected presence of communicable disease." The Ironshore policy included a provision stating coverage for [c]ommunicable [d]isease is [e]xcluded."

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Original text here: https://www.courts.ca.gov/opinions/documents/B321806.PDF