Last week, the North Carolina Supreme Court issued its long-awaited ruling in North State Deli, LLC v. The Cincinnati Insurance Company, siding with a group of North Carolina restaurants that sought business interruption insurance for losses they sustained because of the COVID-19 pandemic.  Specifically, the court held that those restaurants sustained “direct physical loss” to property, as that phrase is used in their commercial property policies, when COVID-19 government orders restricted the restaurants’ use of and access to their property, resulting in the suspension of their operations and the loss of income.  In reaching this holding, the Supreme Court of North Carolina joined the Supreme Court of Vermont as the only other state supreme court to have ruled in favor of policyholders on the question of COVID-19 business interruption insurance coverage. 

The insurance industry may criticize these opinions and attempt to paint them as outliers, but the North Carolina Supreme Court’s reasoning rests on well-established principles of insurance policy interpretation that reflect the law in virtually all jurisdictions in the United States.  In the wake of the pandemic, many courts ignored these fundamental rules of construction, as well as prior pro-policyholder precedent interpreting the phrase “physical loss” broadly, when issuing decisions dismissing COVID-19 business interruption lawsuits.  Fortunately, the North Carolina Supreme Court chose to apply the law and prior precedent, rather than judicial “group think.”  While it is premature to predict whether other state supreme courts will follow suit, North State Deli underscores how the faithful adherence to bedrock insurance policy interpretation principles can prevent courts from imposing limitations on coverage that the parties to an insurance contract never expressed.

By way of background, the plaintiffs in North State Deli are bars and restaurants in North Carolina that were forced to suspend business operations because of COVID-19-related orders by government authorities.[1]  They were all insured by the defendants under materially similar commercial property insurance policies that protect the businesses’ building, personal property, and business income from any “direct physical loss” to property.[2]  Moreover, none of the policies in question contained virus exclusions,[3] which became relatively common in commercial property policies after the SARS-outbreak of the early part of this century.  The key dispute in North State Deli was whether a “direct physical loss,” as defined in the policies, includes losses arising from pandemic era government orders that restricted use of the plaintiffs’ properties.  The trial court sided with the restaurants, finding on a motion for partial summary judgment that restrictions are “direct physical loss” to property.  The Court of Appeals then reversed that order, interpreting the policies to exclude such losses.[4]

On appeal, the plaintiffs argued that the orders did immediately result in material deprivation of property.  The orders targeted individual conduct on the property, the functions of the property, and how policyholders could physically access, occupy, and use the insured space.[5]  The defendants countered that “direct physical loss” cannot simply mean “loss of physical use” but instead must imply some type of physical issue with the property.  They cited a federal district court decision, which had reasoned that “loss of a car” does not mean the same thing as “loss of use of a car.”[6]  The North Carolina Supreme Court rejected this argument, pointing to an earlier New Hampshire decision that concluded “that ‘physical loss to property’ could include loss resulting from persistent cat urine odor which rendered a property ‘temporarily or permanently unusable or uninhabitable’.”[7]  The court reasoned that “[t]his overlap between property ‘use’ and ‘loss’ follows from a contextual and common-sense expectation that insurance should protect from threats to property that make it unusable for the purposes for which it is insured.”[8]  Thus, as the North Carolina Supreme Court put it: “Property ‘loss’ surely occurs when it is no longer usable for its insured purpose, as a policyholder would reasonably expect.  Thus, when the restaurants lost physical use of their properties as restaurants due to the pandemic orders, they experienced a direct physical loss.”[9]

Further, the North Carolina Supreme Court noted that the all-risk policies in question define coverage in large part by what they exclude from coverage, and observed that the restaurants’ policies contain no exclusions for viruses in general, even though evidence from the National Association of Insurance Commissioners suggests that 82.83% of business insurance policies contain such exclusions.[10]  Accordingly, the court reasoned that “[k]nowledge of the risks of viruses, together with knowledge that other policies exclude virus risks while this one does not, underscores that a policyholder would reasonably understand the absence of such an exclusion as an affirmative grant of coverage.”[11]  Thus, for these reasons and others, the North Carolina Supreme Court reversed the Court of Appeals, noting that because both parties had reasonable interpretations of the policies, North Carolina’s “background principles” compelled the Court  to resolve the ambiguity in favor of the insured policyholders.[12]  

North State Deli is a noteworthy opinion for numerous reasons.  Perhaps most importantly, it reaffirms that core pro-policyholder principles of insurance policy interpretation will be applied by courts applying North Carolina law.  The court emphatically reaffirmed that in North Carolina, “the lodestar for insurance contract interpretation is the reasonable expectation of the policyholder and that ambiguities should be resolved in the insured’s favor.”[13]  Provisions granting coverage must be read expansively, while provisions excluding coverage must be read narrowly.[14]  Moreover, ambiguous terms that are reasonably susceptible to the meaning proposed by either party must be construed “against the insurance company and in favor of the policyholder.”[15]  Critical to the Court’s holding was the finding was that the core phrase “direct physical loss” was not defined in the policies, and therefore must be read according to the reasonable expectations of the policyholder.[16]  As the court explained, the insurer “could have provided a narrower definition of the phrase ‘direct physical loss,’” but it did not, instead opting only to restate a circular non-definition: “‘Loss means accidental physical loss or accidental physical damage.”[17]

In following these well-worn rules of construction, which are similar to those found in virtually all jurisdictions in the United States, the court did not shrink away from the possibility that North Carolina’s principles of insurance contract construction may, in some cases, cause coverage to “expand[] beyond what the [insurance] company says it contemplated,” but it cautioned that in those cases “‘the fault lies in [the insurer’s] own selection of the words by which it chose to be bound.’”[18]  Moreover, in concluding remarks that could be viewed as veiled criticism of the way many courts weighed in on the alleged “kind” of physical loss or damage that must be sustained before business interruption coverage is triggered, the Court stated as follows:

It is the insurance company’s responsibility to define essential policy terms and the North Carolina courts’ responsibility to enforce those terms consistent with the parties’ reasonable expectations.  Otherwise, insurance companies are licensed to pitch consumers on an expansive, “all-risk” policy, while hiding behind a narrower definition imposed by judicial fiat when it comes time to pay out.[19]

Indeed, the Supreme Court of North Carolina made clear that it believed other courts had misapplied the law in prior COVID-19 decisions, stating: “we decline to do what other courts have done and affirmatively define the ‘slippery’ term Cincinnati chose to use in this manifestly ambiguous situation.”[20]  Thus, in North Carolina at least, insurance companies should not count on the courts to rescue them from the consequences of drafting ambiguous policy language.  Moreover, some North Carolina policyholders with pending COVID-19 business interruption claims may ultimately recover under their policies, nearly five years after the onset of the pandemic.

Outside North Carolina, policyholders with pending claims in states where state supreme courts have already found that COVID-19 business interruption related losses are not covered may not benefit from the North State Deli decision.  However, the decision does suggest that policyholders pursuing COVID-19 business interruption claims in other states should continue to stay the course.  This is especially true for policyholders with claims pending in federal courts.  Although statistics on the rates of COVID-19 business interruption dismissals in federal court vary, many federal courts dismissed cases at the pleadings stage before state law concerning COVID-19 business interruption had a chance to develop.  While in some cases those dismissals may have been warranted based on the specific policy language or factual allegations at issue, it is a fundamental principle of federal jurisprudence that federal courts sitting in diversity jurisdiction must apply state substantive law.[21]  And, to date, only a handful of state supreme courts have decided whether COVID-19 related business interruption losses arise from “physical loss or damage.”[22]  More decisions like North State Deli could begin to turn the tide and help policyholders finally recover some of the devastating losses they suffered when shutting down their businesses during the early days of the pandemic.  

[1] N. State Deli, LLC. Cincinnati Ins. Co., No. 225PA21-2, 2024 WL 5100978, at *1 (N.C. Dec. 13, 2024).

[2] Id. at *2–3.

[3] Id. at *8.

[4] Id. at *4, *9.

[5] Id. at *6.

[6] Id.

[7] Id. at *16 (quoting Mellin v. N. Sec. Ins. Co., 115 A.3d 799, 805 (N.H. 2015)).

[8] Id. at *16.

[9] Id.

[10] Id. at *8.

[11] Id. at *20.

[12] Id. at *8.

[13] Id. at *9.

[14] Id. at *5.

[15] Id. at *5.

[16] Id. at *21.

[17] Id. at *21.

[18] Id. at *7 (quoting Jamestown Mut. Ins. Co. v. Nationwide Mut. Ins. Co., 266 N.C. 430, 437, 146 S.E.2d 410 (1966)).

[19] Id. at *23 (citation omitted).

[20] Id. at *22.

[21] See generally Erie R.R. Co. v. Tompkins, 304 U.S. 64 (1938).

[22]See University of Pennsylvania, University of Connecticut Insurance Law Center, Covid Coverage Litigation Tracker, https://cclt.law.upenn.edu/.