By Jeff Birren, Senior Writer
Sports enterprises across the country regularly purchase insurance to cover various contingencies, including physical damage to their facilities. The Los Angeles Lakers bought insurance in 2019 that covered many things, but in summer, 2019, few could anticipate COVID-19 and the losses it would generate. After the NBA shut down in March 2020, the Lakers filed claims with its insurance carrier, Federal Insurance Company, seeking to recoup millions of dollars in losses. Federal denied the claim, and litigation followed. Recently the United States District Court in Los Angeles dismissed some of the Lakers’ claims (L.A. Lakers v. Fed. Ins. Co., CV 21-022881 TJH (MRWx),U.S.D.C., C.D. Cal., (3-17-22)), __ F. Supp. 3d __; 2022 U.S. Dist. LEXIS 51563; 2022 WL 831549.
Background
The Lakers purchased the “all-risk commercial property insurance policy (the “Policy”) from Federal in August 2019” (Id. at 2). The Policy covered Staples Center where they play and their Health Training Center. It was in effect from August 1, 2019, to August 1, 2020. Federal was obligated to reimburse the Lakers for lost business income and expenses incurred “caused by or result(ing) from direct physical loss or damage to the property” or impairment of their operations “directly caused by the prohibition of access to” the property but “’the prohibition of access by a civil authority must be the direct result of direct physical loss or damage to the property away from, but within one mile” of the Covered Properties.
In March 2020 some of the Lakers’ tested positive for COVID-19. On March 11, the NBA suspended its season due to COVID-19. Five days later the Los Angeles Public Health Officer prohibited gatherings of more than 50 people. On March 19, Governor Newsom issued an order “which required Californians to shelter at home.” Violations were a misdemeanor.
As a result of Staples’ closure, the Lakers claimed that “they lost tens of millions of dollars in revenue.” They also alleged that the “presence of Virus particles on fixtures and building systems caused physical alterations to the Covered Properties.” This happened when “Virus particles landed on, and adhered to, surfaces such as fabric seats, elevator buttons, and air ducts, causing a physical and chemical reaction that transformed the surfaces into vectors of viral spread called fomites.”
The Lakers consequently upgraded the Covered Properties by adding “new air filters, touchless light switches, toilets, and sinks; sleeves or coasting for high-touch surfaces; and plexiglass dividers” (Id. at 3). The Lakers alleged that the Covered Properties “were not usable until those upgrades were completed,” and, the five Metro stations fans use to go to Staples, also had physical loss or damage due to COVID-19.
In June 2020 the Los Angeles Heath Officer allowed professional sports teams to reopen their facilities for training and events. Spectators were still banned. The Lakers consulted with the Health Officer and “made extensive and costly changes to procedures and protocols that enabled them to resume training.” In April 2021, spectators were again allowed to attend live events.
The Lakers sued for declaratory judgment, breach of contract, a “Civil Authority” claim, and breach of the covenant of good faith and fair dealing on March 15, 2021. The Lakers are represented by Proskauer Rose’s New York and Los Angeles offices. Federal responded with a motion to dismiss the complaint. It is represented by Daniel Petrocelli at O’Melveny and Myers. In August 2021 the Court granted the motion to dismiss without prejudice, “after concluding that the Lakers’ allegations of direct physical loss or damages at the Covered Properties were mere legal conclusions couched as factual allegations, and therefore, were insufficient to state a claim.” The Lakers filed their First Amended Complaint (“FAC”) on October 6, 2021. It had the same claims but added factual allegations. It also relied on a recent case from the California Court of Appeal. Federal responded with another motion to dismiss.
The Court’s Statement of the Law
Senior Judge Terry Hatter began by stating that a plaintiff “must allege enough facts to allow the Court to draw a reasonable inference that the defendant is liable for the misconduct alleged.” It must “accept all allegations” in the complaint as true “and draw all reasonable inferences in the plaintiff’s favor” but it is “not bound to accept as true a legal conclusion couched as a factual allegation.”
The Lakers were required to “establish the validity of its three insurance claims.” The parties agreed that the Lakers’ claims had to have “a direct physical loss or damage to the property” (Id. at 3-4), and it was the Lakers’ burden to establish that. The policy did not “define direct physical loss or damage” so the Court construed those terms, applying the normal rules of contractual interpretation. The Court’s goal is to give effect to the parties’ mutual intent, while using the contractual terms’ “ordinary and popular meaning.” If the terms are ambiguous, the Court interprets the terms “to protect the insured’s objectively reasonable expectations” (Id. at 4).
A recent California Court of Appeal decision “is squarely on point here.” That opinion used an online dictionary that defined “physical” as “having material existence; perceptible especially through the senses and subject to the laws of nature.” That dictionary defined the term “direct” as “characterized by close logical, casual, or consequential relationship.” It defined “damage” as “the loss or harm resulting from injury to the property.” A plaintiff making such claims “must plead a casual connection between any physical alteration to that property, and any detrimental economic impact between that plaintiff claimed to have suffered.”
Property Damage Claim
The issue was “whether the Virus caused direct physical damage or loss” to the Covered Properties (Id. at 5). The Lakers alleged that the Virus physically “altered surfaces at the Covered Properties by changing their chemical and physical properties” that in turn “required cleaning or replacement” before such properties were safe again. The Lakers seek“coverage for the cost of cleaning or replacing those allegedly damaged surfaces.” Since the Lakers alleged physical alteration and that those alterations caused detrimental economic impact, the Court found that the Lakers had stated a claim for declaratory judgment and breach of contract.
Business Interruption Claim
This claim “depends on whether the Virus caused direct physical damage or loss that, in turn, caused the interruption of its business operations.” If so, the policy required Federal to “pay for the actual business income loss (and extra expenses] you incur due to the actual impairment of your operations… during the period of restoration.” Federal asserted that the policy did not apply because the Virus did not cause “impairment to the property.”
The FAC stated that Staples was originally closed “due to a litany of blanket NBA and government measures.” The Lakers cleaned Staples, but it was closed by government order and despite the cleaning, it “still could not have reopened until the State of California allowed it to reopen on April 15, 2021” (Id. at 6). The Lakers argued that it was the physical alterations from the Virus that brought on those orders, but those orders were not limited to Staples, but “closed everything in the City of Los Angeles save for a few exempt essential and emergency services.”
Furthermore, several of those orders stated that their purpose was “to stem or slow the spread of COVID-19” within Los Angeles. The stated goal was “the preservation public health, not private property.” Consequently, “there is no casual chain connecting the Virus-related physical alteration” at the Covered Properties “to the properties’ closure.” The closure originated with government orders and “not from any alterations to the Covered Properties.” Had the virus never made it to Staples it nevertheless would have been closed due to government order. Thus, the Lakers “did not and cannot, plausibly plead that the interruption of their business operations was due to direct physical damage or loss” at their properties, so the Lakers “did not, and cannot, state a claim for declaratory judgment and breach of contract relate to the Business Interruption Clause” (Id. at 6-7).
Civil Authority Claim
This claim required the Lakers to plead that its business operations were “interrupted because nearby Metro stations experienced direct physical damage and loss” and were consequently closed by a civil authority (Id. at 7). The property had to be within one mile of the Lakers’ Covered Properties. The government orders that closed the relevant Los Angeles Metro stations “were aimed at limiting the viral spread in the community, not at mitigating property damage at a specific facility.” The order stated that “it was prompted by Virus-related property damage, it applied to the entire City of Los Angeles” and therefore would have closed the relevant Metro stations “even if the Virus had never been present there.” The Court “cannot assume that the Stay at Home Order was issued in response to direct physical loss or damage at the Metro stations.” The Lakers “cannot plausibly plead that the interruption of their business operations” was due to physical damage or loss at those stations. Consequently, “the Lakers did not, and cannot, state a claim for declaratory judgment and breach of contract related to the Civil Authority Clause.”
Bad Faith Claim
The implied covenant of good faith and fair dealing “obligates an insurer to, inter alia, make a thorough investigation of the insured’s claim.” The Lakers “alleged that Federal sent a form denial letter instead of thoroughly investigating the tendered claim” (Id. at 8). For the Property Damage claim, the Lakers stated a claim for breach of the covenant. However, with the Business Interruption and Civil Authority claims, “because Federal rightfully denied those claims” it “did not act in bad faith.”
The Court’s Conclusion
The Court granted the motion, “in part, with prejudice, to the extent that the claims are based on the Business Interruption Clause and Civil Authority Clause of the Policy.” It denied the motion “to the extent claims are based on the Property Damage Clause of the Policy” and the related bad faith claim (Id.).
Conclusion
This scenario could be repeated in jurisdictions across the country as professional teams and college athletic departments seek to recoup billions of dollars in losses brought on by COVID-19. Insurers should carefully read the relevant policies before summarily rejecting claims to avoid facing tort claims for breach of the covenant of good faith and fair dealing. Insureds should also read the policies carefully before filing baseless claims that lead to further losses, including the defendant’s court costs.
