JRK Property Holdings, Inc. v. Colony Insurance Company

(Judgment on the Pleadings in Favor of Insurers Reversed Based on Possible Physical Loss Caused by COVID-19 and Rejection of Application of Pollution Exclusion to Bar Coverage of Underlying Claim)

(January 2024) - In JRK Property Holdings, Inc. v. Colony Insurance Company, et al., 96 Cal.App.5th 1 (October 2, 2023), Pet. for Rev. Granted (Supreme Court Calif. December 20, 2023), in a partially published decision, the California Second District Court of Appeal reversed the trial court’s entry of an order dismissing JRK Property Holdings, Inc.’s (“JRK”) complaint for breach of contract and declaratory relief against multiple excess insurers after they had denied coverage of business interruption claims resulting from restricted operations due to COVID-19 pandemic and associated government shutdown orders.

In the unpublished portion of its decision, the Court of Appeal found that the complaint alleged sufficient facts supporting JRK’s contention that its properties had sustained “direct physical loss” as required by primary policies to which the defendant excess insurers followed form. In addition, in the published portion of its decision, the Court of Appeal found that the pollution exclusion in the policies did not apply to bar coverage of the claims as such exclusion only applied to environmental losses.

As respects the unpublished portion of the decision addressing direct physical loss, the Court of Appeal reasoned as follows:

We agree with JRK that the complaint adequately alleges loss resulting from physical alteration of the insured property to support its causes of action for breach of contract and declaratory relief.

. . .

The allegations in JRK's complaint fall squarely within the type of allegations we found sufficient to allege coverage in Marina Pacific and Shusha. In Marina Pacific, the insureds alleged that "COVID-19 . . . not only lives on surfaces but also bonds to surfaces through physiochemical reactions involving cells and surface proteins, which transform the physical condition of the property." (Marina Pacific, supra, 81 Cal.App.5th at p. 108; see Shusha, supra, 87 Cal.App.5th at p. 264 [noting allegations "the virus `can remain on smooth surfaces for at least 28 days,' and it `adheres to, attaches to and alters the surfaces of the property and surfaces' it comes into contact with, creating ‘fomites,' which are `objects, previously safe to touch, that now serve as agents and mechanism for transmission of deadly, infectious viruses and diseases"'], review granted.)

JRK similarly alleged the COVID-19 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 thus compromises the physical integrity of the structures it permeates . . . ." Further, "[g]iven the ubiquity and pervasiveness of the coronavirus, no amount of cleaning or ventilation intervention will prevent an infected and contagious person—even one who is pre-symptomatic or asymptomatic—from entering an indoor space and exhaling millions of viral particles into the air, which: (a) fills the air with aerosolized coronavirus that can be inhaled, sometimes with deadly consequences; and (b) deposits coronavirus particles on the surfaces, physically altering and transforming them into disease-transmitting fomites." (Italics added.) JRK therefore had to take significant measures "far beyond ordinary or routine cleaning or improved ventilation" to "repair the properties from their unsafe, hazardous, and potentially deadly condition."

Finally, the insureds in Marina Pacific alleged that as a direct result of the presence of the virus, "the insureds were required to close or suspend operations in whole or in part at various times and incurred extra expense as they adopted measures to restore and remediate the air and surfaces at the insured properties." (Marina Pacific, supra, 81 Cal.App.5th at pp. 108-109; see Shusha, supra, 87 Cal.App.5th at p. 264 ["La Cava lost business revenues and incurred substantial costs to mitigate the damage by reconfiguring its property and increasing its sanitization procedures."], review granted.) Similarly, JRK alleged "the ubiquitous presence of COVID-19 and the coronavirus, including in infected guests, customers, employees and residents at JRK's insured properties, has interrupted that business model by causing physical loss and/or damage to the insured properties and rendering them unusable for their intended purpose." Further, JRK "incurred substantial costs and financial losses directly responding to documented onsite cases," including costs related to converting "physical leasing offices into virtual leasing systems," closing "various common spaces," and expending "substantial sums of money to disinfect contaminated spaces after documented cases."

. . .

As respects the published portion of the decision, the Court of Appeal reasoned as follows in rejecting the defendant insurers’ contention that the pollution exclusion in their policies barred coverage of the claims:

Insurers contend the Policies' pollution exclusion bars coverage for JRK's losses because it covers the dispersal and migration of pollutants and contaminants, which terms are specifically defined to include a virus. We agree with JRK that the pollution exclusion does not apply here because a reasonable interpretation of the exclusion is that it applies only to traditional sources of environmental pollution, as the Supreme Court held in MacKinnon, supra, 31 Cal.4th at pages 639 to 640.

. . .

Insurers contend the “widespread dispersal and migration” of the COVID-19 virus, as alleged, caused the losses JRK claims, thus falling within the pollution exclusion. But as the MacKinnon court found, terms like dispersal or migration have technical definitions in the context of environmental pollution, and they therefore apply to specific types of dispersal and migration. With respect to the term “dispersal,” for example, when used “in conjunction with ‘pollutant,’ [it] is commonly used to describe the spreading of pollution widely enough to cause its dissipation and dilution.” (MacKinnon, supra, 31 Cal.4th at p. 651; see County of Maui v. Hawaii Wildlife Fund (2020) 590 U.S. ___ [206 L.Ed.2d 640, 140 S.Ct. 1462, 1469] [the Clean Water Act “defines the term ‘discharge of a pollutant’ as ‘“any addition of any pollutant to navigable waters … from any point source”’”]; 33 U.S.C. § 1362(16) [defining “‘discharge’”]; 42 U.S.C. § 9605(c)(2) [“[T]he President shall take into account the potential migration of any hazardous substance or pollutant or contaminant through such surface water to downstream sources of drinking water.”].)

Unlike the dictionary definition, the reasonable interpretation of “dispersal” in the environmental pollution context does not encompass the spread of a virus resulting from people simply breathing and touching surfaces. (See Northwell Health, Inc. v. Illinois Union Ins. Co. (S.D.N.Y., Mar. 29, 2022, No. 20-CV-6893-LTS-OTW) 2022 U.S.Dist. Lexis 57432, p. *13 [“A sick patient's delivery of COVID-19 into one of Northwell's hospitals or other medical facilities ‘by merely breathing, speaking, or touching objects and surfaces,’ … or ‘through some medical procedures,’ … cannot reasonably be characterized as constituting the ‘discharge, dispersal, release, escape, migration, or seepage’ of any ‘waste materials.’”].)

Notwithstanding MacKinnon, Insurers contend the inclusion of “virus” within the definition of “pollutant or contaminant” makes clear the pollution exclusion applies here, citing out-of-state cases declining to limit pollution exclusions to traditional environment pollution where the exclusion defines a pollutant or contaminant to include a “virus.” For example, Insurers rely on Northwell Health, Inc. v. Lexington Ins. Co. (S.D.N.Y. 2021) 550 F.Supp.3d 108, 121 (Northwell), in which the district court applied New York law to a policy provision excluding “‘loss or damage caused by … actual, alleged or threatened release, discharge, escape or dispersal’ of ‘contaminations or pollutants,’ and defin[ing] contamination to include disease-causing microorganisms, bacteria, and viruses.” (Ibid.) Although the court acknowledged New York case law holding the terms “‘discharge’” and “‘dispersal’” used in a pollution exclusion were “terms of art in environmental law,” citing Belt Painting Corp. v. TIG Ins. Co. (2003) 100 N.Y.2d 377, 386–390 [795 N.E.2d 15], the court declined to limit the exclusion to environmental or industrial pollution because the term “contaminants” was defined to include viruses. (Northwell, at p. 121.)

. . .

There is no question that COVID-19 is a virus, just as there was no question the pesticide in MacKinnon could be considered an “irritant” or a “contaminant.” (MacKinnon, supra, 31 Cal.4th at pp. 650–652 [“Virtually any substance can act under the proper circumstances as an ‘irritant or contaminant.’”]; id. at p. 654 [“pesticides may be pollutants under some circumstances”].) Rather, under MacKinnon, the appropriate inquiry in interpreting the pollution exclusion is whether pollution caused by the release, discharge, or dispersal of a virus in the ordinary sense of those terms encompasses the spread of a virus due to the normal human activities of breathing and touching surfaces. (See MacKinnon, supra, 31 Cal.4th at p. 649.) It does not. Just as a reasonable policyholder would not consider the spraying of pesticides in an apartment building the dispersal of pollution under the policy in MacKinnon, a reasonable policyholder would not consider the dispersal of the COVID-19 virus from natural human activity to be pollution.

Our interpretation of the pollution exclusion not to include the spread of the COVID-19 virus does not render the inclusion of the term “virus” in the exclusion meaningless. There are other scenarios in which the dispersal of a virus would fall within the pollution exclusion. For example, if an environmental disaster at a plant causes the release of virus-laden sewage into the surrounding area, the spread of the virus would likely fall within the exclusion as “pollution” caused by the discharge, dispersal, or release of a “pollutant or contaminant.”

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Lastly, in the published portion of the decision, the Court of Appeal also upheld the trial court’s dismissal of the JRK lawsuit against those excess insurers (RSUI and Evanston) which included “pathogen exclusions” in their policies. The Court of Appeal reasoned as follows:

There is no reference in the RSUI or Evanston virus exclusions to pollution. Rather, RSUI's exclusion applied to losses or damage caused by “the discharge, dispersal … or application of any pathogenic or poisonous biological or chemical materials.” And the Evanston exclusion applied to losses or damage caused by the “[p]resence, growth, proliferation, or spread of any ‘organic pathogens,’” defining “organic pathogen” to include a “virus.” Although RSUI's exclusion uses the four traditional discharge terms of art from MacKinnon, it does not follow that use of those terms without any reference to pollution limits the exclusion to environmental pollution. And the Evanston virus exclusion uses neither the pollution nor dispersal language.

Further, Evanston's exclusion explicitly defines an “organic pathogen” to include a “virus.” Although the RSUI exclusion does not define “pathogenic … materials,” the term “pathogenic” is defined as “causing or capable of causing disease.” (Merriam-Webster's Online Dict. (2023) <https://www.merriam-webster.com/dictionary/pathogenic> [as of Oct. 2, 2023], archived at <https://perma.cc/YEZ8-WR8Y>.) Similarly, “pathogen” is defined as “a specific causative agent (such as a bacterium or virus) of disease.” (Merriam-Webster's Online Dict. (2023) <https://www.merriam-webster.com/dictionary/pathogen> [as of Oct. 2, 2023], archived at <https://perma.cc/F793-Y68T>.) COVID-19 aerosols and droplets expelled from humans and capable of creating infectious fomites, as alleged in the complaint, are therefore unambiguously “pathogenic materials” or “pathogens.”

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The Evanston pathogen exclusion, specifically barring coverage for losses from a virus, likewise precludes coverage for COVID-19. (See L&L Logistics and Warehousing Inc. v. Evanston Ins. Co. (E.D.Va. 2021) 533 F.Supp.3d 299, 305 [finding Evanston's pathogen exclusion under California law “quite clearly excludes viruses from the realm of ‘covered causes,’ even where the loss or damage was only indirectly caused by a virus”].)

As to both pathogen exclusions, JRK contends that interpreting them to bar COVID-19 coverage is inconsistent with the Policies‘ communicable disease coverage. However, the communicable disease coverage provision does not apply to the policies JRK negotiated with Evanston and RSUI. The Policies limited coverage for communicable diseases to a $2.5 million sublimit “per occurrence,” but the Evanston and RSUI policies provided excess coverage only for losses per occurrence above $10 million. Likewise, JRK's argument that an ambiguity is created by the lack of a virus exclusion lacks merit because there is no inconsistency—given the pathogen exclusions that applied to viruses, there was no need for a virus exclusion.

The trial court did not err in concluding the RSUI and Evanston pathogen exclusions unambiguously preclude coverage for losses from COVID-19, and the court did not abuse its discretion in denying leave to amend as to these two insurers.