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By Jane E. Warring and Kristian N. Smith
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Along with seeking to analogize COVID-19 physical loss or damage to that in the fumes or contaminants context, policyholders are now also attempting to rely on cases discussing the bounds of physical loss or damage in the context of data breaches.

However, where insureds recently tried to draw comparison between the loss of use of their property from a COVID-19 shutdown order and the loss of use of data from a ransomware attack, two recent federal court decisions rejected this approach. The cases are Hamilton Jewelry LLC v. Twin City Fire Insurance Co. Inc.[1] and Cordish Companies Inc. v. Affiliated FM Insurance Co.,[2] decided by the U.S. District Court for the District of Maryland on Sept. 16 and Aug. 31, respectively.

In both Hamilton Jewelry and Cordish Companies, the policyholders relied on National Ink & Stitch LLC v. State Auto Property & Casualty Insurance Co.,[3] a 2020 decision in which the District of Maryland court ruled in favor of an insured screen printing business, permitting it to recover under a commercial property policy for the cost to replace its computer systems after a ransomware attack.

In National Ink, the policy insured "direct physical loss of or damage to Covered Property" and defined covered property to include data and software. The insurer argued that, following the ransomware attack, the computers were still functional and thus not damaged.[4]

 Experts for the insured testified, however, that the ransomware attack had made the computer systems slower, and the computers could contain latent viruses. For these reasons, they contended that all hardware and software needed to be replaced.

 The court discussed numerous coverage cases addressing damage to data and computer systems and ultimately held that the policy did not require that the system be "completely and permanently inoperable" in order for coverage to apply.[5] The court reasoned that the "more persuasive cases are those suggesting that loss of use, loss of reliability, or impaired functionality" satisfy the "physical loss or damage" requirement in the policy.[6]

This type of argument — that loss of use or impaired functionality can constitute physical loss or damage — has obvious appeal for policyholders pursuing their property insurers for lost income while their businesses were closed following COVID-19 shutdown orders. But thus far, policyholders have been unsuccessful in arguing that a computer's loss of functionality is equivalent to the loss of use of a building or facility due to a COVID-19 stay-at-home order.

In Hamilton Jewelry, a local jeweler made a claim for business interruption coverage under a policy insuring income loss during a "suspension ... caused by direct physical loss of or physical damage to property."[7] The jeweler relied on National Ink for the proposition that "direct physical loss" or "direct physical damage" encompasses "the loss of use of property that was not physically destroyed."[8]

But the court concluded that National Ink was distinguishable on two grounds. First, National Ink covered "physical loss or damage" as opposed to "physical loss or physical damage." Second, the policy in National Ink expressly defined "covered property" to include software and stored data. The court granted the insurer's motion for judgment on the pleadings.

In Cordish Companies, the court also ruled in favor of the insurer.[9] There, an operator of commercial properties including casinos argued its COVID-19 income loss constituted business interruption loss "as a direct result of physical loss or damage of the type insured." The policyholder claimed National Ink supported its argument that a virus can constitute physical loss or damage.

Rejecting this argument, the court noted that in National Ink, the ransomware rendered certain software and data "entirely unusable."

Conversely, in Cordish Companies, the insured's properties were not unusable, and nothing was permanently destroyed — the complaint at issue did "not allege that Cordish's properties sustained any alteration or change, much less one that rendered them unusable as a result of the virus."[10]

In fact, the complaint did not allege that the coronavirus was present at any of its properties. And even if it had, there was no evidence the property itself was compromised.

The Hamilton Jewelry and Cordish decisions follow two earlier COVID-19 decisions from the U.S. District Court for the Central District of California, Pez Seafood DTLA LLC v. Travelers Indemnity Co. decided on Jan. 20 and Long Affair Carpet & Rug Inc. v. Liberty Mutual Insurance Co. decided in 2020, that distinguished National Ink as not applicable to COVID-19 insurance claims.[11]

Likewise, in two COVID-19 business interruption decisions, the U.S. District Court for the Middle District of Tennessee was asked to reconcile the U.S. District Court for the Western District of Tennessee's 2006 decision in Southeast Mental Health Center Inc. v. Pacific Insurance Co.[12] with the insureds' claims that the loss of use of their property during the pandemic constitutes physical loss. 

The Middle District of Tennessee cases are 1210 McGavock St. Hospitality LLC v. Admiral Indemnity Co. decided by U.S. District Judge Aleta Trauger in December 2020 and Acme Nashville LLC v. The Cincinnati Casualty Co. decided by U.S. District Judge William Campbell on Sept. 22., 2021.[13]

Although the Southeast decision held that loss of use and functionality of a pharmacy's computer system constituted physical loss or damage, the Middle District of Tennessee court found Southeast did not support the insureds' arguments in the COVID-19 context.

Per Judge Trauger's decision in McGavock, in Southeast "loss of functionality was considered to be physical damage only insofar as it related to a physical object located on the covered premises."[14]

Although the court in Southeast held that the computer was damaged due to the loss of data, it did not extend that holding to the insured's loss of use of the entire facility for the two weeks during the power outage.

Thus far, courts have found reasons to distinguish the cyber case law holding that loss of use of data and computer systems can constitute physical loss or damage in the COVID-19 business interruption context. In the COVID-19 context, the majority of courts have found that loss of use, standing alone, does not constitute physical loss or damage.

The recent cases distinguishing cyber cases fit with this pattern, mainly focusing on the fact that ransomware physically damages and alters an object, i.e., slowing down a computer system or destroying data, while COVID-19 does not have this type of effect. Notably, the National Ink decision also hinged on expert opinions that all hardware and software had to be replaced.

In the same vein, courts deciding COVID-19 cases have relied upon property policies' "period of restoration" provisions, which link recovery for business income losses to the time for repair and replacement of property, to find that, because COVID-19 does not require the repair or replacement of property, it does not cause physical loss or damage.

Overall, while ransomware cases may look more like standalone "loss of use" cases on the surface, the facts of these cases ultimately did involve physical loss or damage to property — albeit to somewhat intangible property such as software.

Ultimately, it appears that, to date, existing cyber case law will not provide policyholders with a viable loss of use argument in COVID-19 cases. Time will tell whether courts may find the COVID-19 case law helpful in analyzing future cyber coverage disputes.

Jane E. Warring is a partner and Kristian N. Smith is a senior associate at Zelle LLP.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] Hamilton Jewelry LLC v. Twin City Fire Insurance Co. Inc., No. 8:20-CV-02248-PWG, 2021 WL 4214837, at *9 (D. Md. Sept. 16, 2021).

[2] Cordish Companies Inc. v. Affiliated FM Insurance Co., No. CV ELH-20-2419, 2021 WL 3883595, at *15–16 (D. Md. Aug. 31, 2021).

[3] National Ink & Stitch LLC v. State Auto Property & Casualty Insurance Co., 435 F. Supp. 3d 679, 680 (D. Md. 2020).

[4] Id. 

[5] Id.

[6] Id. 

[7] 2021 WL 4214837, at *1.

[8] Id. at *9.

[9] 2021 WL 3883595, at *15–16.

[10] Id.

[11] See Pez Seafood DTLA, LLC v. Travelers Indem. Co ., 514 F. Supp. 3d 1197, 1204 (C.D. Cal. 2021) (distinguishing National Ink, along with other cases involving ammonia, gasoline, and toxic gases, from COVID-19 because it involved a "physical intrusion that compromises the physical integrity of property"); Long Affair Carpet & Rug, Inc. v. Liberty Mut. Ins. Co. , 500 F. Supp. 3d 1075, 1079 (C.D. Cal. 2020) (distinguishing National Ink because it was decided under an "Electronic Media and Records (Including Software)" policy provision not at issue in the COVID-19 case).

[12] Southeast Mental Health Center Inc. v. Pacific Insurance Co., 439 F. Supp. 2d 831 (W.D. Tenn. 2006).

[13] See 1210 McGavock St. Hosp. Partners, LLC v. Admiral Indem. Co. , 509 F. Supp. 3d 1032, 1043 (M.D. Tenn. 2020) and Acme Nashville LLC v. The Cincinnati Cas. Co., No. 3:20-CV-00496, 2021 WL 4311211, at *6 (M.D. Tenn. Sept. 22, 2021).

[14] 509 F. Supp. 3d at 1043.