The Coronavirus Crisis
On top of its human toll, the coronavirus pandemic has had massive economic effects. Stay-at-home orders, which remain in place in much of the United States, have resulted in massive layoffs, spiraling claims for unemployment compensation, and unprecedented federal aid.
Many businesses affected by the pandemic have turned to their insurers seeking “business interruption” coverage. As its name suggests, this coverage typically reimburses the policyholder for costs incurred when the business is unable to open. Insurers have denied policyholders’ pandemic-related claims, contending that they only have to cover business interruption that results from a “physical injury” and that the damage that results from infestation with the coronavirus or a governmental shutdown order does not constitute “physical injury.” Insurers have also cited the exclusions in many of their policies that purport to bar coverage for virus-related injuries.
Legislative Responses to the Crisis
One response to the insurance industry’s position has been introduction of legislation voiding virus exclusions and/or defining physical injury to include coronavirus. New Jersey, Massachusetts, Ohio, New York, Pennsylvania, and South Carolina are all considering such legislation. The proposed bills generally provide that, notwithstanding any other law or policy language to the contrary, every insurance policy that insures against loss or damage to property which includes the loss of use and occupancy and business interruption shall be construed to include coverage for business interruption resulting from COVID-19. The bills typically provide mechanisms for insurers to seek reimbursement from a state established and managed fund for losses paid related to COVID-19.
Insurance Industry Responses to the Proposed Legislation
Predictably, the insurance industry has objected to this legislation. For example, in a recent interview, Evan Greenberg, CEO of Chubb, said in an interview on CNBC state governments can’t force insurance companies to cover incidents not included in the policy. “You can’t just retroactively change a contract. That is plainly unconstitutional,” Greenberg told “Mad Money” host Jim Cramer. See https://www.cnbc.com/2020/04/16/chubb-ceo-making-insurers-cover-pandemic-losses-is-unconstitutional.html.
Law firms that defend insurers have similarly argued that “This proposed legislation …., is unfair and is likely unconstitutional, as it appears to run afoul of the Contracts Clause of the Constitution.” See https://www.saul.com/publications/alerts/state-business-interruption-coverage-bills-likely-contain-constitutional-infirmities. That Clause prohibits States from “pass[ing] any . . . Law impairing the Obligation of Contracts . . . .” U. S. Const., Art. I, Sec. 10. The insurer lawyers contend that “the proposed legislation would substantially impair insurance policies, as [it] would operate to rewrite policies to cause them to cover a risk they do not currently cover.…” See https://www.saul.com/publications/alerts/state-business-interruption-coverage-bills-likely-contain-constitutional-infirmities. While acknowledging that the Supreme Court has upheld state laws that impair contracts, so long as they are reasonably tailored to fulfill a legitimate interest, insurer counsel contend that such laws are still unconstitutional. Counsel claim that the proposed laws do not fulfill a legitimate interest because they “arguably benefit only a narrow class of businesses; the public at-large is only an indirect beneficiary.” Id. And counsel assert that the proposed laws are not “appropriate and reasonable” because they “attempt to shift the responsibility of providing financial assistance to small businesses from the government to certain insurance companies. . . .” Id.
Why the Insurance Industry Is Wrong about the Contracts Clause
This analysis is simply mistaken. The case law interpreting the Contracts Clause demonstrates that legislation designed to provide relief to policyholders is constitutional.
As discussed below, under the cases, courts have established a balancing test that weighs the extent to which the challenged legislation contravenes contractual expectations against the purpose of the legislation and the means used to achieve that purpose. Under that test, the proposed legislation is constitutional.
The range of state legislative actions that can affect contractual relationships is broad. For instance, a state statute may render a contract wholly illegal. See Stone v. Mississippi, 101 U.S. 814, 819 (1879) (upholding state statute outlawing lottery against claim that it violated contract rights of lottery company). Or a statute may directly change the term of a contract. E.g., United States Trust Co. v. New Jersey, 431 U.S. 1, 3 (1977) (state law abrogated covenant in contract with holders of state bonds); Home Bldg. & Loan Ass’n v. Blaisdell, 290 U.S. 398, 416 (1934) (state law modified foreclosure provisions in mortgages). Even a law that has nothing to do with either the express terms of the contract or its subject matter can affect the parties’ allocation of risk, such as a law that changes the statute of limitations for contract actions. See J. Ely, Jr., Whatever Happened to the Contract Clause?, 4 Charleston L. Rev. 371, 377 & n.48 (2010) (discussing Contracts Clause cases involving statutes of limitations).
Yet, as the Supreme Court has made clear, “it is not every modification of a contractual promise that impairs the obligation of contract under federal law.” City of El Paso v. Simmons, 379 U.S. 497, 506–07 (1965). Even though the language of the Contracts Clause is “facially absolute,” Energy Reserves Group v. Kansas Power & Light Co., 459 U.S. 400, 410 (1983), “the prohibition against impairing the obligation of contracts is not to be read literally,” Keystone Bituminous Coal Ass’n v. DeBenedictis, 480 U.S. at 502. Rather, “[t]he States must possess broad power to adopt general regulatory measures without being concerned the private contracts will be impaired, or even destroyed, as a result.” United States Trust Co. v. New Jersey, 431 U.S. at 22. In other words, the ban on impairment of contracts “must be accommodated to the inherent police power of the State ‘to safeguard the vital interests of its people.’’’ Energy Reserves Group, 459 U.S. at 410, quoting Home Bldg. & Loan Ass’n v. Blaisdell, 290 U.S. at 434.
Though not specifically referenced in the Constitution, the “police power” gives state legislatures broad leeway to pass laws to protect the public health, safety, and welfare. The classic case is Stone v. Mississippi, 101 U.S. 814 (1879). There, a state statute outlawing lotteries was challenged by a company that had previously obtained a charter from the state to run a lottery. Rejecting the challenge, the Court held that the state’s power to shield the public from the evils of gambling trumped the contract rights of the lottery company. Id. at 819. Over time, the definition of the police power expanded to include a wide variety of laws designed to protect the public. See, e.g., Home Building & Loan Association v. Blaisdell, 290 U.S. 398, 444 (1934) (Great Depression “furnished a proper occasion for the exercise of the reserved power of the State to protect the vital interests of the community” by providing for mortgage relief for financially strapped homeowners); Manigault v. Springs, 199 U.S. 473, 480 (1905) (even if contract for sale of alcohol was permissible when made, state could later prohibit such sales without violating Contracts Clause).
As we’ll discuss in the next part of this post, since the New Deal, the Supreme Court has generally applied these principles to uphold state legislation against challenges brought under the Contracts Clause. We’ll also discuss how these basic principles have been applied by lower courts in insurance coverage cases and why we think the proposed legislation passes muster under the Constitution.