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INSIGHT: Covid-19 State Legislation Could Shake Up Insurance Contracts

May 12, 2020, 8:00 AM

Many business owners are now looking to insurance providers for coverage of Covid-19 related losses, but many insures are asserting that policies for business interruption typically require some sort of physical damage to occur to the insured property.

As a result, a wave of insurance claims across the country are turning into lawsuits—the crux of most of these disputes being whether property damage is required or met.

New Jersey Takes the Lead

Meanwhile, many states are proposing legislation that would remove the property-damage dispute altogether. New Jersey, New York, Ohio, and other states have introduced bills that would require insurers of policies that insure against damage to property and resulting business income losses to cover losses resulting from Covid-19.

New Jersey was the first state to propose legislation that would compel insurers to cover small business owners’ claims for Covid-19 related business interruption losses. The bill, A-3844, would only require insurers to indemnify policyholders employing less than 100 employees and would require business interruption policies to be construed to cover losses arising from Covid-19.

It also attempts to set up a fund in the state Department of Banking and Insurance for insurers to be reimbursed from—the fund being made up of an assessment on insurers.

After A-3844 was introduced, the bill faced significant backlash and was put on hold. But even though A-3844 has not made it past its state’s legislative hurdles, the New Jersey bill has evoked other states to propose similar legislation. At least five other states including Ohio, New York, Massachusetts, Pennsylvania, and Louisiana are considering almost identical language to A-3844.

Contracts Clause Challenges

These bills stand to substantially alter the policies initially agreed to by insurers and throw a wrench into any risk-calculation performed in crafting such policies. If passed, insurers may look to the contracts clause in the Constitution to challenge these laws’ validity.

While far from a sure thing, this doctrine could provide a reasonable defense against the application of the bills listed above. And though some members of the bar believe such defenses are sure to fail, these potential cases may create the perfect storm for courts to revisit their contracts clause jurisprudence.

The contracts clause states: “No State shall…pass any law… impairing the Obligation of Contract.” Scholars say the clause was formed to prevent states from creating laws to help debtors at lenders’ expense. The clause was meant to curtail debtor-relief legislation during periods of economic downturn and encourage a healthy credit market by assuring lenders that debt obligations were not subject the political pressures in economic downturns.

The clause was frequently used during the 19th century to combat laws that interfered with rights under existing agreements. But this changed in 1934, when the Supreme Court issued its decision in Home Building & Loan Association v. Blaisdell. In Blaisdell, the state of Minnesota passed a moratorium that prevented mortgagors from foreclosing on mortgages for a two-year period in response to the Great Depression.

Even though this type of law was likely the exact thing the founders attempted to prohibit through the contracts clause, the Supreme Court upheld the law—highlighting the emergency nature of the law and the fact that mortgagor’s interest were not seriously undermined.

Since then, the court has yet to overturn legislation that changed an existing private contract—except once. In Allied Structural Steel Co. v. Spannaus, the Supreme Court heard a case involving another Minnesota law. The law at issue was the Private Pension Benefits Protection Act, requiring employers to pay a “pension funding charge” if they closed an office in Minnesota or ended a pension plan. The plaintiff closed an office and was charged a fee—it sued.

The court struck down the law, reasoning that the law imposed “a sudden, totally unanticipated, and substantial retroactive obligation upon the company to its employees, [and] was not enacted to deal with a situation remotely approaching the broad and desperate economic conditions of the early 1930s.”

It also stressed the reliance on existing laws the company had in calculating its pension funding, much like insurers do their premiums. The court quoted an earlier decision to highlight that “[t]he amounts set aside are determined by a painstaking assessment of the insurer’s likely liability. Risks that the insurer foresees will be included in the calculation of liability, and the rates or contributions charged will reflect that calculation. The occurrence of major unforeseen contingencies, however, jeopardizes the insurer’s solvency and, ultimately, the insureds’ benefits. Drastic changes in the legal rules governing pension and insurance funds, like other unforeseen events, can have this effect.”

Scholars struggle to determine whether Allied Structural Steel is an anomaly in contracts clause jurisprudence or whether it may one day be used to revitalize the clause’s potency. The bills discussed above addressing Covid-19 business losses may very well create the grounds to make this determination.

On the one hand, these bills respond to a very real economic crisis at play, much like the Blaisdell case which altered mortgage contracts during the Great Depression. Moreover, insurers now play in a highly regulated environment where reliance on existing laws may be ill placed.

But on the other hand, such legislation would not merely shift back payments on a mortgage for two years, it would force insurers to pay out on policies they may have never expected to pay and pose a very real threat to the liquidity of the insurance market—perhaps even to the detriment of the purpose of the legislation at issue.

These bills responding to Covid-19 continue to gain traction in state legislatures as the economic impact of the disease continues to unfold. It is likely that at least one of these bills will become law. If so, courts should expect to see significant resistance from the insurance industry—and perhaps even a shakeup of contracts clause jurisprudence.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Barclay Nicholson is a partner in Norton Rose Fulbright’s Houston office.

Peyton L. Craig is an associate with Norton Rose in Houston.

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