In what may be Rhode Island’s first ruling in a business interruption insurance coverage dispute prompted by COVID-19 shutdowns, a Providence adult entertainment venue has had mixed success in surviving a defendant insurer’s motion to dismiss.

Superior Court Judge Brian P. Stern recently ruled that plaintiff Atwells Realty, which operates Club Desire, did not successfully plead the damages necessary to support a claim under its insurance policy’s business income provision.

“In the instant case, Atwells did not allege any physical damage to or physical loss of the premises, whether tangible or intangible — such as an alteration or transformation to its premises caused by some event, i.e., COVID-19 — that rendered the premises incapable of performing its essential function,” Stern wrote.

However, the judge concluded that the nightclub could move forward with a claim under the civil authority clause of the policy it holds with the defendant, Scottsdale Insurance Co.

Stern found that Atwells had pleaded the two requirements the insurance contract specifies for civil authority coverage: damage to any property within one mile of the club, and prohibited access to its premises as a result of that third party’s physical loss.

“To state a claim, all that is required under the Rhode Island standard are facts sufficient to provide fair and accurate notice as determined by the four corners of the complaint and as applied to the policy,” Stern wrote. “Atwells’ allegations for civil authority coverage meet this standard.”

Moreover, the judge found that Scottsdale did not meet its burden of showing the policy’s virus exclusion bars such coverage.

The 30-page decision is Atwells Realty Corp. v. Scottsdale Insurance Company.

State pleading standard

Nicholas J. Hemond, who practices in Providence, represents plaintiff Atwells in the dispute. Local counsel for defendant Scottsdale Insurance is Stephen Adams, also of Providence. Neither attorney responded to requests seeking comment on the decision.

But Stacey P. Nakasian, who is not involved with the case, said she found it interesting that Stern repeatedly acknowledged that the pleading standard is different depending on whether one is in federal or state court, and that in Rhode Island, the standard is not as stringent as the federal plausibility standard.

“[The judge] was careful to take a deep dive, probably aware he’s leading the pack with these types of claims.”

— Stacey P. Nakasian, Providence

That may be one reason — as reflected in statistics reported by the University of Pennsylvania Law School in its “Covid Coverage Litigation Tracker” — that such lawsuits filed to this point are about twice as likely to be dismissed in federal court, she added.

“The judge is very clear in emphasizing that Rhode Island is a ‘notice pleading’ state and that some of these issues will have to be decided on a fully developed record. All he has at the dismissal stage is the complaint,” the Providence attorney pointed out.

Nakasian said insurance coverage disputes necessitate “getting into the weeds” of a policy’s specific provisions, since the contracts are construed against the carriers and complex questions often arise as to what the terms mean — for example, the virus exclusion in the case at hand.

“After taking a hard look at the language of the policy, Judge Stern came out and said the insured had pleaded enough to keep the door open as to civil authority coverage, and that the carrier had not shown the exclusion would apply under the circumstances,” Nakasian continued. “He was careful to take a deep dive, probably aware he’s leading the pack with these types of claims.”

On that front, Nakasian said while she did not know the volume of COVID-19 business interruption claims in the judicial pipeline at this juncture, she surmised some have likely resolved without litigation.

“We’re not seeing a tsunami yet, and we’re certainly talking to our clients about how to purchase insurance going forward. Everyone is aware of these issues now,” she said.

Business interruption claim

Plaintiff Atwells Realty has operated the Desire nightclub since 2003. As part of its business, the company holds liquor, food sales and adult entertainment licenses.

In 2019, Atwells bought an insurance policy with defendant Scottsdale Insurance. It includes coverage for business income caused by “direct physical loss of or damage to insured property” and for actions taken by a civil authority prohibiting access to the property.

The contract also contains a “virus exclusion,” specifying that Scottsdale “will not pay for loss or damage caused by or resulting from any virus, bacterium or other micro-organism that induces or is capable of inducing physical distress, illness or disease.”

As the coronavirus pandemic began to take hold in March 2020, Providence Mayor Jorge O. Elorza issued an order suspending all entertainment and adult entertainment licenses in the city. A few days later, Gov. Gina M. Raimondo suspended all dine-in service in restaurants, lounges and nightclubs in the state.

As a result of those executive orders, Atwells was prohibited from having patrons at Desire and business operations were accordingly suspended, even though the company said there was no evidence to suggest that anyone associated with the club had contracted COVID-19 or that the premises was contaminated.

In April 2020, Atwells filed a claim with Scottsdale under the business income and civil authority clauses of its policy, alleging that it had “suffered a direct physical loss of its premises for use for its intended purpose” causing “an extreme and total loss” of revenues.

The insurer denied the claim.

As for the contract’s business income provision, Scottsdale reasoned that Atwells’ losses did not involve “direct physical damage” to its property. It similarly demurred on civil authority coverage, noting that the terms require a prohibition of access to the property made in response to “dangerous physical conditions” within one mile of the insured’s premises. Scottsdale also relied on the policy’s virus exclusion clause.

Atwells brought the present breach of contract action, and Scottsdale moved to dismiss for failure to state a claim.

Prima facie case

With the burden on Atwells to make a prima facie case that coverage for its losses exists under the policy, and in light of the contract’s terms and the facts alleged, the motion was granted in part and denied in part.

Stern first concluded that Atwells had failed to put forward sufficient allegations of a “direct physical loss of or damage to property” as required for business income coverage.

He declined to adopt the plaintiff’s reading of the phrase as ambiguous, which could have supported a broader interpretation to include more than tangible, structural injuries.

“Although the policy leaves ‘direct physical loss of or damage to property’ undefined, when this coverage is viewed in its entirety, the loss of income must be (1) due to the necessary suspension of operations, and (2) incurred during [a] ‘period of restoration,’” Stern wrote. “[I]t is clear that the loss of business income must have occurred during this ‘period of restoration,’ that is, while the premises is being repaired, built, or replaced.”

In the judge’s view, because Atwells did not allege that its operations were suspended in order for it to somehow repair its property, such as a restoration effort to rid the premises of COVID-19, it did not plead facts sufficient for business income coverage.

But the outcome was different as to civil authority coverage, with Stern finding that the plaintiff made out an adequate case in pleading that COVID-19 is a physical substance that survives on surfaces and caused damage to other properties within one mile of its nightclub, and further maintaining that executive orders shut down its nightclub business as a result of the virus being spread throughout the state, including those within a one-mile radius.

“[T]he court is not prepared to rule out, at the pleading stage, that COVID-19 in the air and on surfaces could be considered a physical alteration of a premises that only causes harm to persons on the premises while not altering the physical structure,” Stern explained. “This is a factual issue better left for discovery.”

Finally, Stern said that Scottsdale had not met its burden of showing that the virus exclusion bars civil authority coverage.

Although the exclusion precludes coverage if the loss or damage is caused by or results from a virus, the judge was “not convinced by Scottsdale’s argument that the virus exclusion precludes civil authority coverage when Atwells did not allege that its ‘loss or damage [was] caused by or result[ed] from a virus,’ as contemplated by the exclusion, but rather was caused by the executive orders that suspended operations due to a pandemic and presence of COVID-19 through the state.”