Wildfire Insurance Coverage Issues: Physical Damage and Prevailing on Claims for Business Interruption, Lost Profits, and Indirect Losses

By David Tayman

The wildfires which recently raged in and around the Great Smoky Mountains have caused substantial damage to communities and businesses throughout Eastern Tennessee and Western North Carolina.  Wildfires in this area  destroyed hundreds of structures, burned well over a hundred thousand acres, caused substantial casualties, and displaced thousands of people.  These communities are strong and they will recover, but that recovery will take time and resources.  One important source of support for that recovery will be the insurance policies owned by those affected.  While some losses, such as direct fire damage, will likely be covered with little dispute, claims for more complex losses, such as business interruption and the lost profits resulting from delays and disruption caused by the fire and its aftermath are more likely to be the subject of coverage disputes.

These kinds of complex claims are likely to be of particular importance to the region around the Great Smoky Mountains as it seeks to recover from the wildfires.  Tourism is one of the main industries in this area.  Tourism revenues are likely to be heavily impacted both by the delays and shutdowns necessary for tourism-related businesses to rebuild infrastructure and from a decline in the number of people who want to travel to the region.  The wildfires have had an actual and perceived impact on the wilderness environment that has historically drawn so many visitors year after year.

One important consideration for policyholders seeking to recover under their insurance policies is the presence of exclusions from coverage.  While less common in the Appalachian region, wildfires regularly cause damage which results in insurance coverage litigation in other parts of the country.  A recent court decision addressing insurance coverage in the context of wildfire on the West Coast  gives some insight into how these exclusions might be addressed.  In Oregon Shakespeare Festival Assoc. v. Great American Insurance Co., 2016 WL 3267247 (D. Or. 2016), the United States District Court for the District of Oregon recently issued an opinion discussing policy exclusions in the context of wildfire-caused business interruption and property losses.

The plaintiff in that case was the organization in Ashland, Oregon which hosts the annual Oregon Shakespeare Festival.  At issue was property damage and lost business income associated with smoke from a nearby wildfire which took place during the summer of 2013.  The damage was caused not by the fire itself, but by smoke and associated soot and ash which permeated the festival theater.  The Festival also suffered wildfire-related air quality issues which caused the Festival to have to cancel a number of performances.  The property damage did not include any permanent or structural damage to the Festival’s facilities.  For the policyholder to be entitled to business interruption coverage for  losses associated with the cancelled performances, the “suspension” of the Festivals’ “operations” had to be “caused by direct physical loss of or damage to property” at the insured location.  Whether physical damage had occurred was a central question to determining coverage for the business interruption losses.

The Court followed a two step approach to determining whether the Festival was entitled to insurance coverage:  First, the Festival had to show that the loss fell within the scope of the policy’s coverage grant.  Second, assuming the loss was within that scope, the insurer, Great American, had the burden to establish that the loss was excluded by specific language in the policy.  Here the insurer unsuccessfully contested whether the damage was within the scope of the policy based on an argument that the damage was to the “air” in the Festival’s premises and that “air” did not constituted damaged “property.”  The court rejected this argument and found the damage was within the scope of the policy.  Noting that “while air may often be invisible to the naked eye, surely the fact that air has physical properties cannot reasonably be disputed,” the court found that Great American’s argument equated “physical damage” with “structural damage.”  With no support in the policy language for such an interpretation, the court rejected this argument.

After finding for the insured on the issue of whether the damage was within the scope of the policy, the Court next considered three exclusions, for (1) “delay, loss of use, loss of market,” (2) for “smog” or “smoke,” and (3) for “pollutants.”  The Court gave short shrift to the insurer’s argument regarding the “delay, loss of use, loss of market” exclusion and found that if the policy was read to exclude damages resulting from a delay, loss of use, or loss of market caused by a covered casualty it would unreasonably void the entire purpose of the policy, as most, if not all, first party losses involving physical damage also give rise to some type of delay, loss of use, or loss of market.

In addressing the “smog” and “smoke” exclusions, the court focused in on the specific definitions of these terms.  The term “smog” was not defined in the policy itself, so the court looked to the Oxford Dictionary to interpret that term, finding that the presence of both smoke and fog was necessary to form “smog.”  The court concluded that the insurance company had not presented evidence that any fog was present to combine with the smoke from the wildfire.  In addition, the court noted that “smoke” was specifically excluded elsewhere in the policy, it would not read the “smog” exclusion to bar coverage for any loss involving smoke, despite the insurer’s argument that the term “smog” included smoke damage.  Because the policy’s separate “smoke” exclusion was limited by its own terms to “smoke, vapor, or gas from agricultural smudging or industrial operations,” the court found that the smoke exclusion also did not apply.

The court similarly parsed the language of the pollution exclusion to determine that it did not apply.  While the policy identified smoke as a potential “pollutant,” the court found that “[i]f the policy drafters wanted to exclude smoke other than smoke ‘from agricultural smudging or industrial operations,’ they could have done so.”  In addition, for the pollution exclusion to apply, the losses to be excluded had to be incurred as a result of delay or increased time caused by complying with a government or legal requirement to “test for, monitor, clean up, remove, contain, treat, detoxify, or neutralize” the pollutant.  Since there was no such government or legal requirement associated with the smoke from the Oregon wildfires, the Court found that the pollution exclusion did not allow the insurer to escape paying the claim.

The Oregon Shakespeare court also held that established case law favored coverage.  The court analyzed cases considering what is and is not “physical” damage in the insurance context.  The cases included ones which found a pervasive odor, lead contamination of a furnace that was otherwise still usable, and the release of chemical gases to be physical damage, and a case holding that physical damage can occur on a molecular level and be undetectable “from a cursory inspection” of the property.  The court also made the point that the theatre had been made unusable for its intended purpose.  Thus, pervasive structural damage was not necessary to give rise to coverage.  The court showed that, in making the determination of what is or is not physical damage, consideration of the nature and intended use of the property in question and the purpose of the insurance policy are also relevant inquiries.

While the holdings of Oregon Shakespeare are specific to the policy and facts of that case, it does present us with several important things to consider with respect to wildfire-related insurance claims, whether connected to the recent Tennessee and North Carolina fires or otherwise:

  1. The policyholder bears the initial burden of proving that the loss falls within the policy;
  2. If the policyholder meets its burden, the insurer then bears the burden of showing that exclusions apply to bar coverage;
  3. The specific language of the policy is important and will be closely scrutinized and compared to the facts of the situation; and
  4. To determine whether a particular loss constitutes “physical” damage, courts will look to the nature and intended use of the property at issue and the purpose of the insurance policy.

Perhaps the most important takeaway from Oregon Shakespeare and the other cases in which courts consider coverage issues relating to the impact of wildfire is that, given the right insurance policy, strong arguments exist in favor of making insurance companies pay for claims relating to business interruption, lost profits, and disruption caused by the wildfire.