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Law360 (May 7, 2021, 7:26 PM EDT) —
A California hotel hit Zurich American Insurance Co. and Zurich North America with a proposed class action in Illinois federal court on Friday, alleging that the insurer wrongfully denied coverage for business losses it incurred during statewide COVID-19 shutdown orders.

The shutdown rules from state and local officials are in and of themselves a covered loss within the meaning of its all-risk policy with Zurich, and the hotel and proposed class members with similar policies suffered “direct physical loss of or damage to” their businesses because of those government orders, Hotel Constance Pasadena said in its complaint.

“Physical loss of, or damage to, property may be reasonably interpreted to occur when a covered cause of loss threatens or renders property unusable or unsuitable for its intended purpose or unsafe for ordinary human occupancy and/or continued use,” the hotel said.

In response to guidance from the U.S. Centers for Disease Control and Prevention, California Gov. Gavin Newsom and others, lodging establishments like Hotel Constance Pasadena were effectively shuttered to prevent gatherings of 10 or more people in lobbies, restaurants, bars and other common areas, according to the complaint.

“The closure of all non-life-sustaining businesses and prohibition of gatherings evidences an awareness on the part of both state and local governments that COVID-19 spreads easily and causes loss of or damage to property,” the hotel said. “This is particularly true in places where in-person business is conducted or large gatherings are inevitable, as the contact and interaction necessarily incident to such businesses causes a heightened risk of the property becoming contaminated.”

And even if the shutdown rules don’t constitute a covered cause of loss under the policy, the virus and the public health emergency of the pandemic itself should, as it caused direct physical loss or damage when the property covered under the Zurich policy was rendered “unusable for its intended purpose.”

And while Zurich contends that a virus exclusion in the policy — for losses caused by “any virus, bacterium or other micro-organism that induces or is capable of inducing physical distress, illness or disease” — precludes coverage for the hotel’s claim, Hotel Constance Pasadena said that doesn’t apply if the court agrees that the governmental orders themselves amount to direct physical losses.

The hotel also argued that two insurance industry trade groups, Insurance Services Office, Inc. and the American Association of Insurance Services, made false representations when representing hundreds of insurers seeking approval from state regulators for the virus exclusion in 2006.

The ISO and AAIS told regulators that coverage for “disease-causing agents” had never been in effect, but that was not true, as various courts had held that property insurance policies covered claims involving disease-causing agents, and on numerous occasions had concluded that any condition making it impossible to use property for its intended use constituted “physical loss of or damage to” such property, according to the complaint.

“The foregoing assertions by the insurance industry (including defendants), made to obtain regulatory approval of virus exclusion provisions, were in fact misrepresentations and for this reason, among other public policy concerns, insurers should now be estopped from enforcing the virus exclusion to avoid coverage of claims related to the COVID-19 pandemic,” Hotel Constance Pasadena said.

The hotel, which seeks a declaratory judgment and is suing Zurich for breach of contract, seeks to represent a class of all U.S. policyholders who purchased commercial property insurance from Zurich but have been denied coverage for their lost business income after being ordered by a governmental entity to shut down or otherwise limit their business operations, or that have sustained losses due to an action by civil authority in the wake of the pandemic.

“Defendants’ denial of lost business income claims has left plaintiff and the class without vital coverage acquired to ensure the survival of their businesses during this temporary suspension of operations,” the hotel said.

The hotel and putative class is represented by Gary F. Lynch and Kelly K. Iverson of Carlson Lynch LLP.

Counsel information for Zurich could not be immediately