Commercial Property Insurance Coverage for Texas Winter Freeze Losses

For an incredible 10-day period in mid-February, Texas was battered by a brutal winter storm bringing snow, ice, and record-low temperatures. Millions of Texans were without power and water for days. These conditions forced thousands of Texas businesses to close during the storm. Many of these businesses also sustained property damage from pipe bursts and resulting water discharge. The property insurance claims have already started to come in. Some believe the storm will be the largest insurance event in Texas history.

Unlike most states, where power grids are interconnected, Texas has its own intrastate power grid that supplies power to 90% of the state, according to a report in the Texas Tribune. That grid is operated by the Electric Reliability Council of Texas (“ERCOT”).

On Feb. 15, ERCOT initiated rolling outages of the power grid According to ERCOT, it instructed transmission companies to reduce demand on the grid by implementing rolling outages, asserting that the Texas power grid was “seconds and minutes” from a catastrophic failure without such intervention.

A combination of numerous factors — the effects of the winter storm, the rolling outages by ERCOT, and actions taken by individual businesses — have caused significant financial losses to all types of Texas businesses. Some businesses chose to close simply because of the bad weather. Others closed due to damage resulting from pipe bursts. And others were forced to close due to the rolling blackouts. For example, in Austin, an energy provider ordered all industrial and semiconductor manufacturers to idle or shut down,” according to a report in the Austin American-Statesman. This caused Samsung to cease its operations, causing millions of dollars in losses, BizChina.com reported. In 2018, a 30-minute power outage at a Samsung factory cut the global NAND flash memory chip supply by 3%, BizChina said.

Texas businesses will undoubtedly look for ways to recoup or at least minimize their business income losses. Many will first seek to determine if these losses are covered by their property insurance policies.

This article discusses some of the issues expected to arise in considering whether commercial property insurance policies provide coverage for Texas freeze claims.

As always, it should be noted that policy language is critical. While this article identifies some general issues that are likely to arise in connection with the claims that Texas businesses will present, the specific policy language at issue, along with the facts of the individual loss, will determine whether coverage exists. Furthermore, this article assumes that Texas law applies. Texas law may not apply to all losses within the state (i.e., policy contains a choice-of-law provision, if the insured has property in multiple states, or the policy was procured in another state).

Commercial property insurance policies generally require “direct physical loss or damage” to covered property for coverage to exist. Similarly, most property policies providing business income coverage require a causal connection between insured physical loss or damage and the loss of income.

The ISO commercial property business income form, for example, generally states:

We will pay for the actual loss of Business Income you sustain due to the necessary “suspension” of your “operations” during the “period of restoration.” The “suspension” must be caused by direct physical loss of or damage to property at premises which are described in the Declarations and for which a Business Income Limit Of Insurance is shown in the Declarations…

A critical issue that insurers and insureds will face in connection with Texas winter freeze claims is whether and to what extent are claimed business income losses the result of property damage. A Northern District of Texas court applying Texas law recently noted in connection with an insured restaurant’s attempt to obtain coverage for its business losses associated with the COVID-19 pandemic, a “distinct, demonstrable physical alteration” of property is required to implicate coverage. Vandelay Hospitality v. Cincinnati Ins. Co., No. 3:20-CV-12348-D, 2020 WL 5946863 (N.D.Tex. Oct. 7, 2020) (citing Hartford Ins. Co. of Midwest v. Miss. Valley Gas Co., 181 Fed. Appx. 465, 470 (5th Cir. 2006) (per curiam) (holding that a physical loss to property requires a distinct, demonstrable, physical alteration of the property); de Laurentis v. United Servs. Auto. Ass’n, 162 S.W.3d 714, 722-23 (Tex. App.-Houston [14th Dist.] 2005, pet. denied) (holding that physical loss requires “tangible damage” or “tangible loss”).

Accordingly, if a particular property actually sustained property damage as a result of the freezing temperatures, or perhaps resulting from the rolling outages, the repair cost and business income losses associated with that damage may be covered. However, if a business did not experience any physical damage, but was only subject to power outages there may not be business income coverage under standard policy provisions.

Many commercial insurance policies contain an exclusion that precludes coverage for utility service outages that originate away from an insured’s premises. The ISO Causes of Loss – Special Form contains the following exclusion:

e. Utility Services

The failure of power, communication, water or other utility service supplied to the described premises, however caused, if the failure:

(1) Originates away from the described premises; or

(2) Originates at the described premises, but only if such failure involves equipment used to supply the utility service to the described premises from a source away from the described premises.

Based on this exclusion, losses experienced by a business as a result of an electrical outage would not be covered, unless the electrical outage caused another “Cause of Loss.” For example, if an electrical outage causes a pipe break, the exclusion may not apply to the resulting water damage.

Businesses can purchase coverage for service interruption losses. Depending on the provision at issue (and what is purchased by the insured), this coverage can apply to property damage losses, time element losses, or both. However, such provisions generally only provide coverage for service interruptions that are caused by damage to the service provider’s property. In connection with Texas winter freeze claims, such endorsements may provide coverage to the extent an outage was the result of “physical loss or damage” to the service provider’s property. However, if an outage was solely the result of a deliberate decision by the service provider to interrupt service in order to avoid future damage to the grid, those coverage endorsements may not apply. Determining the actual cause of the outage at a particular business location may be a fact-intensive inquiry that could require expert analysis.

To the extent time element service interruption coverage is available to an insured, such coverages are also typically subject to waiting periods ranging between 12 and 72 hours. These waiting periods apply on a per occurrence basis. Thus, each instance of an outage could constitute a separate occurrence under the policy implicating a new waiting period. This issue will need to be determined on a case-by-case basis as there are many differing policy definitions of “occurrence”.

Many commercial property insurance policies include contingent business interruption (“CBI”) coverage. CBI claims arise when either a supplier or a customer of an insured experiences damage to their property that causes them to be unable to either supply goods or services to the insured or receive the insured’s goods or services. Insureds may contend that ERCOT and/or electricity providers are “suppliers” that implicate this coverage. Insureds may also present CBI claims arising from Texas based suppliers and customers who suffered physical damage. These claims could originate wherever an insured has a Texas based supplier or customer. Supply chains can be enormous, as measured by geography covered or the volume of suppliers and customers included in the chain. Policies typically distinguish between losses caused by direct and indirect suppliers and customers. CBI coverage still requires that one of the insured’s suppliers or customers suffered property damage. For the same reasons noted above in connection with service interruption coverage, determining if such damage existed may be a difficult task.

Insureds may assert that ERCOT’s order implicates civil authority coverage for business income losses. However, civil authority coverage generally also requires physical damage to the insured’s property or to property within a defined nearby geographic area. The coverage is for the interruption of the insured’s business when an order of civil authority impairs access to the insured’s property as a result of insured physical damage.

There are three primary reasons why civil authority coverage likely would not apply to losses associated with rolling outages. First, such provisions typically require that access to the insured’s property be prohibited or impaired. In connection with the winter freeze, the rolling outages did not prohibit businesses from accessing their property. Second, civil authority provisions generally require that the order from the civil authority be the result of property damage near the insured property. Here, it is unlikely property damage near an insured’s property resulted in the outage order. Third, most civil authority provisions are reactive and do not provide coverage to prevent damage. Following 9/11, courts rejected claims arising from the Federal Aviation Administration’s closure of airspace. United Air Lines, Inc. v. Ins. Co. of the State of Pa., 439 F.3d 128 (2d Cir. 2006).

One court noted the government’s order to shut down all air traffic was not the direct result of property damage, but rather was “based on the fear of future attacks.” Id. at 134. “The airport was reopened when it was able to comply with more rigorous safety standards; the timetable had nothing to do with repairing, mitigating, or responding to the damage caused by the attack on the Pentagon.” Id at 135. Based on this, the court determined the insured’s loss was not the “direct result” of damage to adjacent premises. See also S. Tex. Med. Clinics, P.A. v. CNA Fin. Corp., No. H-06-4041, 2008 WL 450012 (S.D.Tex. Feb. 15, 2008) (citing United Air Lines and holding that there is no civil authority coverage when an order is “caused by fears of future attacks,” not by the need to “repair, mitigate, or respond” to physical damage).

Similarly, Texas courts presently considering civil authority orders in the context of COVID-19 business interruption claims are generally confirming that such orders must be issued because of direct physical damage and not merely to prevent community spread of the virus. Terry Black’s Barbecue, LLC. v. State Automobile Ins. Co., No. 1:20-CV-665-RP, 2002 WL 7351246 (N.D. Tex., December 14, 2020) (“The civil authority orders did not cause any tangible physical alteration to Plaintiffs’ property. Rather, Plaintiffs were precluded only from fully operating their restaurants temporarily, while the orders were in effect. Plaintiffs do not allege that the restaurants underwent any physical change as a result of the civil authority orders.”).

Texas courts have set forth the following standard regarding losses caused by multiple causes:

The doctrine of concurrent causes limits an insured’s recovery to the amount of damage caused solely by the covered peril. Because an insured can recover only for covered events, the burden of segregating the damage attributable solely to the covered event is a coverage issue for which the insured carries the burden of proof. Wallis v. United Servs. Auto. Ass’n, 2 S.W.3d 300, 303 (Tex. App.—San Antonio 1999, pet. denied); see also, Seahawk Liquidating Tr. v. Certain Underwriters at Lloyds London, 810 F.3d 986, 990, 995 & n.14 (5th Cir. 2016).

Stated otherwise, when covered and non-covered perils combine to cause a loss, recovery under the policy is limited to only those losses caused by the covered peril. Further, under Texas law, it is the insured’s burden to allocate the amount of loss that is attributable to a covered cause of loss versus a non-covered loss. Nat’l Union Fire Ins. of Pittsburgh, Pa. v. Puget Plastics Corp., 735 F. Supp. 2d 650, 669 n.23 (S.D. Tex. 2010) (“The burden of allocation remains with the insured party” and “under Wallis, once testimony of concurrent causes has been offered into the record, the insured has the burden of allocating the damages among the various causes.” (emphasis added)); see also Certain Underwriters at Lloyd’s of London v. Lowen Valley View, L.L.C., 892 F.3d 167, 170 (5th Cir. 2018) (“The summary judgment evidence reveals that several hail storms struck the vicinity of the hotel in the several years preceding [the insured’s] claim.).

In other words, to the extent a covered peril and a non-covered peril contribute to a claim, the insured has the burden of allocating its losses between the two perils and is only entitled to recover losses caused by the covered peril.

The doctrine of concurrent causes could prove to be very important in evaluating coverage for Texas winter freeze claims. Some businesses shut down and incurred losses simply because of the bad weather and later suffered property damage from a pipe break. Other businesses shut down and incurred losses because of rolling outages and later suffered a pipe break. These scenarios, and many others, potentially implicate both covered and non-covered causes of loss.

In these “multiple cause” scenarios, the insured has the burden segregate its losses between those distinct causes. The failure of the insured to segregate its losses can be fatal to its claim. Conversely, the insurance companies have a duty to conduct a reasonable investigation into an insured’s claim and determine the applicable cause, or causes, of the loss. Insurance companies can be penalized for failing to do so (e.g., bad faith, Texas Insurance Code violations, late payment penalties). Accordingly, insurers have a strong interest in investigating these issues for each individual claim before making a coverage determination.

Thousands of Texas businesses were severely impacted by the Texas winter freeze. A combination of extreme weather conditions, rolling outages, and damage from burst water pipes resulted in financial losses to many of these businesses. Claims for actual physical loss or damage resulting from burst water pipes will likely be covered. Coverage for financial losses resulting from service interruptions will require a more detailed analysis, including an evaluation of all contributing causes and applicable policy language. To the extent a business did not sustain property damage and was only affected by an energy provider’s decision to curtail service, commercial property insurance policies are unlikely to respond.

Policyholders and their attorneys will likely advance creative arguments to obtain coverage for such losses. Like any insurance dispute, a determination of coverage for Texas freeze claims should be based on a reasonable investigation of the facts relevant to the specific claim and a careful analysis of the applicable insurance policy.