COVID-19 and “Business Interruption" Insurance Coverage—What you Need to Know

As the COVID-19 crisis unfolds, businesses are looking to insurers to bear the risk of unprecedented financial losses.  

In a previous Torkin Manes article, we canvassed some of the key factors clients are considering in deciding whether to present a claim for “Business Interruption” coverage.  

This type of coverage is typically triggered only when a business experiences a loss of revenue or increased operational expenses resulting from tangible “physical” damage to the business’ insured property. Accordingly, a business whose factory has burned down will have a more straightforward claim for business interruption coverage than a business which cannot operate its factory due to COVID-19.

Despite the traditional understanding of “physical damage”, the unprecedented nature of the economic crisis brought about by COVID-19 could encourage governments or the Courts to take steps to broaden the circumstances in which a business may be entitled to interruption coverage.  

A recent decision of the Ontario Superior Court, MDS Inc. v. Factory Mutual Insurance Company, 2020 ONSC 1924, may influence this outcome, though this is far from certain.  MDS involved very different circumstances from the current COVID-19 pandemic. 

An understanding of the facts of MDS is key to determining its implications.

An Unexpected Shutdown, a Major Loss of Profits

The Plaintiff (“MDS”) was in the business of purchasing and processing radioisotopes created in the Nuclear Research Universal Reactor in Chalk River, Ontario (“the NRU”).  

The Defendant insurer, Factory Mutual Insurance Company (“FM”), had issued a policy of insurance to MDS (“the Policy”), which provided lost revenue coverage resulting from all risks of physical loss or damage to the NRU, except as specifically excluded under the Policy.

In May, 2009, a leak of radioactive water as a result of corrosion was discovered in the NRU, which resulted in a shutdown order by the Canadian Nuclear Safety Commission (“CNSC”).   

This shutdown lasted for an unexpected 15 month period, during which MDS lost over $120,000,000.00 in profits, as its only source of radioisotopes could no longer operate.  

MDS made a claim to the insurer for lost profits in May, 2009.  The insurer denied the claim in August, 2009.  

To support its denial of coverage, the insurer relied primarily on an exclusion in the Policy for “physical damage” to the reactor caused by corrosion.  

The insurer took the position in its denial letter that the operators of the NRU had known for years that corrosion was taking place, and that the leak was therefore not “fortuitous” or accidental.  Rather, it was an event that was certain to happen during the life of the policy period.  

Prior to trial, MDS agreed that if the trial judge found that the leak was caused by “non-fortuitous” corrosion, the corrosion exclusion would apply, and they would not be able to recover under the Policy.  

The Exclusion under the Policy

At trial, the Court focused primarily on determining whether to accept expert evidence that the leak was caused by non-fortuitous corrosion which had been occurring for years.  

This was in contrast to expert evidence which showed that the leak was caused by the presence an aggressive agent, probably chlorine. The trial judge accepted this latter theory. 

Specifically, the Court held that unanticipated and unexpected pitting corrosion precipitated by chlorine caused the NRU’s leak.  

Accordingly, the Court ruled that the corrosion exclusion relied on by the insurer would not apply to exclude coverage.  The fortuitous corrosion that caused the leak in the NRU would be covered under the Policy.

The Exception to the Exclusion—“Resulting Physical Damage”

In the event that an appellate Court would later conclude that the corrosion exclusion in fact applied, the Court considered whether an exception to the exclusion for “resulting physical damage” could bring MDS’ loss of use of the NRU back into coverage.  This would allow the plaintiffs to recover losses despite the application of the corrosion exclusion.

The exception in the Policy read as follows:

C. This Policy excludes the following, but, if physical damage not excluded by this Policy results, then only that resulting damage is insured:

3) deterioration, depletion, rust, corrosion or erosion, wear and tear, inherent vice or latent defect. 

It seems clear in the wording above that the exception requires “physical damage” to result.  Moreover, and notably, the express term “resulting physical damage” was not a term used in the Policy itself.  

On a close review of the wording, it seems that the trial judge only had to determine whether loss of use was contemplated by “damage” that resulted from “physical damage” to the NRU (i.e., the leak). 

The Court, however, framed the question it had to answer in different terms: “should resulting physical damage be defined narrowly to require actual physical damage, or should it be defined broadly to include loss of use?”  

On this reading, the Court concluded that it had to decide whether to accept two competing interpretations of what constitutes “resulting physical damage”:

1. Did there have to be actual tangible damage to qualify as resulting physical damage, as argued by the insurer?  or
2. Did “resulting physical damage” include the loss of use of the nuclear reactor, as argued by the plaintiffs?

The trial judge ultimately held that resulting physical damage under the Policy was not limited to actual physical damage or to an actual nuclear event, but included “loss of use” of the nuclear reactor, as argued by the plaintiffs.

In reaching this conclusion, the Court held that the term “resulting physical damage”, as an exception to an exclusion under an insurance policy, had to be interpreted broadly.

Moreover, a broad interpretation of “resulting physical damage” was consistent with the nature of the insurance policy, which in this case, was an all-risks policy:

…Applying [the Supreme Court of Canada’s] principles of Ledcor to interpret the meaning of resulting physical damage, I conclude that a broad definition of resulting physical damage is appropriate in the factual context of this case to interpret the words in the Policy to include impairment of function or use of tangible properly caused by the unexpected leak of heavy water [in this case]…

Is “Tangible” Property Damage Still Required?

Notably, the Court elected to give meaning to the term “resulting physical damage”, a term not expressly referenced in the Policy. 

The Court’s conclusion was that “resulting physical damage” from something excluded (like non-fortuitous corrosion) can include loss of use to a property which is shut down because of tangible damage, which is not excluded under the Policy.  

Critically, the Court in MDS did not find that coverage for “physical damage” to a property amounts to coverage for loss of use of that property, where there is no tangible damage.  

Accordingly, it is arguable that MDS may not actually alter the landscape for business interruption coverage for the loss of use of insured property--tangible damage to the property is still a prerequisite.

The Implications of MDS for COVID-19

To what extent has the Court’s analysis in MDS encouraged a later finding by another Court that “physical damage” coverage should be interpreted more broadly?  Put another way, to what extent should “physical damage” coverage include loss of use even in situations where the insured property has not sustained tangible damage, but rather was required to cease operating due to Covid-19?  

On a narrow view, MDS involved a coverage claim for a nuclear reactor leak, made to an insurer that underwrote a policy for that specific purpose.   In that sense, MDS is limited to its particular facts and the particular Policy at issue.

On the other hand, the Court in MDS was careful to note the general nature of an “all-risks” policy, which is purchased “to provide peace of mind in case the unforeseen occurs”.    As the Court observed, “the purpose of all-risks property insurance…is to provide broad coverage”.

While the words “resulting physical damage” do not appear in the Policy, the Court’s view that such wording includes “loss of use” may influence a later Court to take the additional step of finding that an all-risks commercial property policy provides coverage resulting from “physical damage” caused by a government-ordered shutdown.  At the same time, however, it is clear that securing business interruption coverage without actual, tangible physical damage under a policy remains an “uphill battle”.  COVID-19 will certainly test the boundaries of the MDS case and its reasoning.  

The lawyers at Torkin Manes can provide advice on any entitlements to insurance coverage that may be available in the current COVID-19 climate. Should you wish to have a claim for business interruption coverage reviewed, our lawyers would be happy to assist you and your business.

For more information about dealing with COVID-19, please visit our COVID-19 Resource Center.