As a general matter, a first-party property insurance policy provides coverage for direct physical loss or damage to covered property. An all-risk policy, one of the most common types of first-party property insurance policies, provides coverage for all risks of “direct physical loss or damage.” In most policies, however, this phrase is not defined.
The threshold requirement that the loss be “physical” is “widely held to exclude alleged losses that are intangible or incorporeal, and, thereby, to preclude any claim against the property insurer when the insured merely suffers a detrimental economic impact unaccompanied by a distinct, demonstrable, physical alteration of the property.” 10A Couch on Insurance § 148:46 (West 3d ed. 1998) (footnotes omitted); see, e.g., Harry’s Cadillac-Pontiac-GMC Truck Co. v. Motors Ins. Corp., 126 N.C. App. 698, 702, 486 S.E.2d 249, 252 (N.C. Ct. App. 1997) (concluding that the insured’s inability to access its premises during a snowstorm does not equate to direct physical loss or damage for purposes of triggering coverage under a first-party property policy). As observed by the Third Circuit, “[i]n ordinary parlance and widely accepted definition, physical damage to property means a ‘distinct, demonstrable, and physical alteration’ of its structure.” See Port Auth. of N.Y. & N.J. v. Affiliated FM Ins. Co., 311 F.3d 226, 235 (3d Cir. 2002) (citation omitted).
Over time, courts have been chipping away at the requirement that an insured prove that it sustained a “distinct, demonstrable, and physical alteration” of its property’s structure in order to recover under a property insurance policy. Some courts have found that a “loss of use” or a “loss of access,” even if only temporary, may satisfy the physical loss or damage requirement. For instance, in Western Fire Insurance Co. v. First Presbyterian Church, 437 P.2d 52 (Colo. 1968), the Colorado Supreme Court held that the physical loss or damage requirement was satisfied where a church was closed by the local fire department due to the presence of gasoline vapors. The court observed:
[I]n the instant case, the so-called “loss of use,” occasioned by the action of the Littleton Fire Department, cannot be viewed in splendid isolation, but must be viewed in proper context. When thus considered, this particular “loss of use” was simply the consequential result of the fact that because of the accumulation of gasoline around and under the church building the premises became so infiltrated and saturated as to be uninhabitable, making further use of the building highly dangerous.
Id. at 38-39.
In Wakefern Food Corp. v. Liberty Mut. Fire Ins. Co., 406 N.J. Super. 524, 968 A.2d 724 (App. Div.), certif. denied, 200 N.J. 209, 976 A.2d 385 (2009), the New Jersey Appellate Division went a step further, holding that a “loss of use” of electrical power following a blackout was sufficient to trigger coverage. In Wakefern, there was some evidence of physical loss or damage to the electrical grid. Indeed, as noted by the court:
There is . . . undisputed evidence that the grid is an interconnected system and that, at least in some areas, the power could not be turned back on until assorted individual pieces of damaged equipment were replaced.
Id. at 540. However, going further than was necessary, the court decided not to base its decision on the physical damage to certain portions of the electrical grid.
In reaching its determination, the court held that the term “physical damage” was ambiguous, and because it was ambiguous, the court construed the term against the insurer. According to the court:
in concluding that the term “physical damage” is ambiguous, we consider the context, including the identity of the parties. These were not two electric utilities contracting about the technical aspects of the grid. Rather, the parties are an insurance company, in the business of covering risks, and a group of supermarkets that paid for what they believed was protection against a very serious risk – the loss of electric power to refrigerate their food. The average policy holder in plaintiffs’ position would not be expected to understand the arcane functioning of the power grid, or the narrowly-parsed definition of “physical damage” which the insurer urges us to adopt. In this context, we conclude that if [the insurer] intended that its policy would provide no coverage for an electrical blackout, it was obligated to define its policy exclusion more clearly.
Id. at 540-41 (internal citations omitted). The court noted that “we do not rest our decision on [the evidence of physical damage]. Rather, we look at the larger loss of function of the system as a whole.” Id. at 540.
In Gregory Packaging, Inc. v. Travelers Property Casualty Co. of America, Civ. No. 2:12-cv-04418 (WHW)(CLW), 2014 WL 6675934 (D.N.J. Nov. 25, 2014), a federal court in New Jersey revisited the physical loss or damage requirement. In that case, the insured was in the process of building a new juice packaging facility in Georgia. An ammonia leak occurred during the testing of the refrigeration equipment. As a result of the leak the facility was evacuated and several local governmental agencies were called to the facility. There was some evidence that an evacuation was ordered in a one-mile radius around the facility, and that the local fire department would not allow anyone to enter the building for some period of time. A remediation company subsequently was hired to dissipate the ammonia from the scene.
However, there did not appear to be any physical alteration to the insured’s property. Rather, the facility simply could not be used until the ammonia dissipated.
The insured, Gregory Packaging, Inc., sought coverage from its insurer, Travelers Property Casualty Company of America, claiming that the leak “resulted in the loss of property and an interruption of business.” Id. at *2. Travelers denied coverage, claiming there was no coverage absent evidence of “a physical change or alteration to insured property requiring its repair or replacement.” Id. After commencing an action against Travelers, Gregory Packaging moved for summary judgment, seeking a ruling that the presence of ammonia inside its facility was sufficient to trigger coverage.
The court ruled in favor of Gregory Packaging, concluding that the presence of the ammonia rendered the facility unfit for occupancy. The court explained that “[w]hile structural alteration provides the most obvious sign of physical damage, both New Jersey courts and the Third Circuit have also found that property can sustain physical loss or damage without experiencing structural alteration.” Id. at *5. The court went on to note “that property can be physically damaged, without undergoing structural alteration, when it loses its essential functionality.” Id. The court relied, in part, on the holdings in Western Fire, Port Authority, and Wakefern in reaching its decision.
The court pointed out that Travelers acknowledged “that an unsafe amount of ammonia was released into the building, that it remained present in the building for some amount of time, and that it was remediated.” 2014 WL 6675934, at *2. In addition, there was “no genuine dispute that the ammonia release . . . rendered Gregory Packaging’s facility physically unfit for normal human occupancy and continued use until the ammonia was sufficiently dissipated.” Id. at *3.
Nonetheless, the only “damage” that resulted from the ammonia leak was that “the ammonia release physically transformed the air within Gregory Packaging’s facility so that it contained an unsafe amount of ammonia or that the heightened ammonia levels rendered the facility unfit for occupancy until the ammonia could be dissipated.” Id. at *6. One could read the decision to mean that any time the air within a facility is “physically transformed,” such that the facility is unfit for human occupancy, the physical loss or damage requirement has been satisfied.
The problem is that air itself generally is not considered insured property. The structure and the property therein, including the fixtures, fittings, and equipment, are generally covered under an insurance policy. It does not appear, however, that any of that property sustained any type of damage in the Gregory Packaging case. In the Western Fire case, gasoline had actually accumulated in the soil around the insured’s building, infiltrating and saturating the foundation and making the structure uninhabitable. Thus, there was actual physical damage to the insured’s property in that case. In an attempt to “find” coverage, the Gregory Packaging court reached even further than the Western Fire court, continuing to erode the physical loss or damage requirement.
It is important to note that the court was not asked to decide whether the release was caused by a peril covered under the policy. Id. at *1 n.1. The court specifically noted that in order to recover, Gregory Packaging “must still prove that the damage was caused by or resulted from a ‘Covered Cause of Loss’ and was not excluded under the policy’s terms.” Id. at *8. Nor was the court asked to decide the period during which the facility was “physically unfit for normal human occupancy.” See id. at *2. Thus, whether the loss was actually covered was not decided by the court.
Nonetheless, the decision is significant in that it is another example of a court finding that the physical loss or damage requirement has been satisfied in the absence of evidence of a distinct, demonstrable, and physical alteration of insured property. Under the court’s holding, a loss of “essential functionality,” even if only temporary, constitutes physical damage.
© William D. Wilson and NJInsuranceBlog.com, 2014. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to William D. Wilson or NJInsuranceBlog.com with appropriate and specific direction to the original content.
