California Supreme Court Upholds “Clear and Unambiguous” Limited Fungi, Bacteria or Virus Coverage Endorsement in First Party Property Policy to Bar Coverage for a Pandemic Loss Claim

On August 8, 2024, the California Supreme Court issued its unanimous opinion in John’s Grill, Inc. v. The Hartford Financial Services Group, Inc., Case No. S278481. The Court reversed the Court of Appeal’s decision in John’s Grill, Inc. v. The Hartford Financial Services Group, Inc. (2022) 86 Cal.App.5th 1195, 1224 (John’s Grill), and disapproved of another Court of Appeal decision, Brooklyn Restaurants, Inc. v. Sentinel Ins. Co., Ltd. (2024) 100 Cal.App.th 1036, review granted June 12, 2024, S284887, to the extent that it had followed John’s Grill. 

The Supreme Court concluded that an endorsement in a first party property policy issued by Sentinel Insurance Company, Ltd. that excluded coverage for any virus-related loss or damage except for virus-related loss or damages from specified perils, such as windstorm, water damage, vandalism or explosion, was enforceable. (Op’n., p. 26.) The endorsement therefore did not afford any coverage for the insured restaurant’s financial pandemic-related losses from the Covid-19 virus where the insured admitted the damage was not from one of specified perils. (Op’n., p. 2.)

After reciting a host of cases enforcing clear and explicit and unambiguous policy language, the Supreme Court reversed the Court of Appeal’s finding that the language of the endorsement was ambiguous, finding that a reasonable insured would understand from the explicit plain language of the policy that virus-related damage was not covered unless it was caused by one of the specified perils. (Op’n., pp. 11-14.)

Perhaps, more importantly, the Supreme Court went on to reject the Court of Appeal’s conclusion that the endorsement offered “virtually illusory coverage” in the context of the insured’s restaurant operations. The Court noted that it had never held that unambiguous policy language may be invalidated under a theory of illusory coverage, despite some statements by lower courts. (Op’n., p. 20.) The Court nonetheless agreed with the Court of Appeal’s conclusion that the test for illusory coverage must focus on the “objectively reasonable expectations of coverage.” (Id. at p. 22.) The Court noted that there were several possible scenarios in which there could be transmission of a virus through one of the specified perils, such that the coverage was not wholly illusory, even if it was unlikely to benefit the insured based on its business operations. (Id. at pp. 24-26.) The Court thus concluded that the insured had not satisfied its burden of invoking the illusory coverage doctrine because it had not demonstrated “a reasonable expectation of coverage for its pandemic-related losses” because the “clear and unambiguous policy language defined the factual scenarios in which [the insured] could have coverage.” (Op’n., p. 23.) 

The Court held: “In sum, under the circumstances here, John’s Grill cannot invoke the illusory coverage doctrine to transform the policy’s limited virus-related coverage into unlimited virus-related coverage. The policy’s limitations on coverage were explicit and unambiguous. Absent some extraordinary circumstance, courts must enforce such explicit and unambiguous policy limitations.” (Op’n., p. 26.)

The California Supreme Court therefore enforced the narrow coverage afforded by the endorsement that used clear and explicit language and rejected an expansive interpretation based on arguments that the endorsement was absurdly restrictive and unfair. The decision will restrict the ability of policyholders to invoke the illusory coverage doctrine in the face of unambiguous policy language where the insurer will be able to demonstrate that there are circumstances, however narrow, in which coverage will arise under the policy language.