“Direct Physical Loss” Includes COVID-19 Shutdowns: North Carolina Supreme Court Expands Business Income Coverage Under All-Risk Policies

Introduction

In N. State Deli, LLC v. Cincinnati Ins. Co., 385 N.C. __ (Dec. 13, 2024), the North Carolina Supreme Court resolved a high-stakes dispute between a group of bars and restaurants forced to suspend operations by COVID-19 public health orders and their insurer, Cincinnati Insurance Company. The insureds—collectively doing business as Lucky’s Delicatessen, Mothers & Sons Trattoria, Mateo Bar de Tapas, Saint James Seafood, and other establishments—carried “all-risk” commercial property policies with supplemental business income coverage. After Cincinnati denied pandemic-related business-interruption claims, the restaurants sought declaratory relief. The trial court granted summary judgment for the restaurants; the Court of Appeals reversed; the Supreme Court granted discretionary review and ultimately reversed the Court of Appeals, holding that a “direct physical loss” under an open-perils policy reasonably includes deprivation of use and access due to virus-related governmental shutdowns.

Summary of the Judgment

The Supreme Court, in a unanimous opinion by Justice Earls, held:

Under North Carolina’s insurance-contract principles, undefined policy terms are given their ordinary meaning, and ambiguities are construed in favor of the insured.
The phrase “direct physical loss” in an “all-risk” property policy—coupled with a business income endorsement—reasonably encompasses the temporary deprivation of physical use and access to insured premises caused by COVID-19 governmental orders.
Because the policies did not exclude virus-related losses and the insurer did not define “physical loss” more narrowly, the insureds were entitled to coverage for their lost business income.
The Supreme Court reversed the Court of Appeals and remanded for further proceedings consistent with this interpretation.

Analysis

1. Precedents Cited

Morrell v. Hardin Creek, Inc., 371 N.C. 672 (2018): Summary-judgment standard and drawing inferences in favor of the non-movant.
Avis v. Hartford Fire Ins. Co., 283 N.C. 142 (1973): Difference between covered perils (“risks”) and covered losses.
Woods v. Nationwide Mut. Ins. Co., 295 N.C. 500 (1978): Plain-language rule in insurance contracts.
Accardi v. Hartford Underwriters Ins. Co., 373 N.C. 292 (2020): Undefined policy terms get ordinary meaning; ambiguities are construed against the insurer.
Grant v. Emmco Ins. Co., 295 N.C. 39 (1978) & Wachovia Bank & Tr. Co. v. Westchester Fire Ins. Co., 276 N.C. 348 (1970): Reasonable expectations of insured, contra-proferentem rule, and liberal construction of coverage provisions.
C.D. Spangler Constr. Co. v. Indus. Crankshaft & Eng’g Co., 326 N.C. 133 (1990): Words in disjunctive (“loss or damage”) must each be given effect.

2. Legal Reasoning

The Court’s reasoning unfolded in several steps:

Ordinary-Meaning Inquiry: The policy defined “loss” only as “accidental physical loss or accidental physical damage,” without further definition. The Court consulted standard dictionaries:
- Direct: Logical or causal relationship; absence of an intervening agency.
- Physical: Material, tangible, as opposed to imaginary.
- Loss: Deprivation, failure to keep possession, destruction.
Thus, “direct physical loss” may encompass deprivation of use or access to property caused by a covered peril.
Harmonization with “Damage”: The policy separately covers “physical damage.” The Court rejected a rigid dichotomy (loss = total destruction; damage = partial). A reasonable insured could read “loss” broadly—i.e., material dispossession or deprivation—even if temporary.
Period of Restoration: Cincinnati argued that ending coverage upon “repair, rebuilding, or replacement” implies only repairable harms are covered. The Court held that disjunctive end-points mean only the earliest applicable event controls; the time limit does not redefine “physical loss.”
Exclusions and Brokerage Advice: The policy excludes many events (earthquakes, war, ordinances) but not viruses. One restaurant owner had specifically requested virus coverage, and the broker promised it. The absence of a virus exclusion—unlike in 80–plus percent of business policies nationwide—reinforced insureds’ reasonable expectation of coverage.
Contra-Proferentem & Reasonable Expectations: Because “direct physical loss” is susceptible of both broad and narrow readings, the Court applied contra-proferentem to adopt the insureds’ construction.

3. Impact on Future Cases and on Insurance Law

This decision will reverberate across multiple fronts:

Business-Interruption Litigation: Insureds in North Carolina may press pandemic-related shutdown claims under open-perils policies lacking explicit virus or civil-authority exclusions.
Policy Drafting: Insurers must now define “physical loss” and similar terms with precision, or face broad coverage; virus and governmental-order exclusions may become ubiquitous or more detailed.
Industry Practices: Brokers should beware of affirmatively representing coverage for emerging risks (e.g., pandemics) without clear policy language.
Judicial Guidance: The Court reaffirmed background principles—ordinary-meaning, contra-proferentem, reasonable expectations—providing a predictable framework for interpreting ambiguous coverage clauses.

Complex Concepts Simplified

All-Risk/Open-Perils Policy: Covers all causes of loss except those expressly excluded. More comprehensive than “named perils.”
Business Income Coverage: Supplemental insurance that pays for lost profits when an insured peril forces a suspension of operations.
Direct Physical Loss vs. Physical Damage:
- Damage: Tangible injury or alteration to property.
- Loss: Deprivation of use, possession, or value of property—complete or partial.
Contra-Proferentem: Ambiguous contractual language is interpreted against the drafter (insurer) and in favor of the non-drafter (insured).
Period of Restoration: The time during which business-income coverage applies, ending either when repairs are complete, business resumes elsewhere, or after a fixed period.

Conclusion

N. State Deli, LLC v. Cincinnati Ins. Co. clarifies that under North Carolina law, an insured’s “direct physical loss” includes deprivation of use or access to property when a policy does not narrowly define those terms and does not exclude the peril in question. The decision underscores the principles that (1) undefined policy language carries its ordinary meaning; (2) ambiguities are resolved in favor of the insured; and (3) insurers must clearly delineate the scope of coverage they assume. In the broader legal context, this opinion will shape business-interruption coverage disputes for years to come—especially in the wake of public-health emergencies—and will prompt insurers to draft more precise, narrower clauses or explicit exclusions if they wish to limit their exposure.