There is significant consternation amongst observers watching the small business owner lose everything without insurance carriers covering losses relating to forced closures resulting from the COVID-19 pandemic. This stems from the specter of constitutional challenges against any proposed law which would force insurance carriers to cover Coronavirus-related business interruption. Since this tragedy has shifted commerce to the brink of collapse, we are forced to assess whether the U.S. Constitution will ultimately prevent a lifeline. The obvious challenge would be that any law of that kind would be violative of the “contracts clause” of the Constitution. Article I, Clause 10 states (with relevant portions emphasized):
No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility.
As concisely explained by the U.S. Supreme Court, “The Contracts Clause restricts the power of States to disrupt contractual arrangements.” Sveen v. Melin, 138 S.Ct. 1815, 1821 (2018). “That includes, as here, an insurance policy.” Id. Therefore, insurance carriers will doubtlessly argue that any law enacted by a state that invalidates any prior contractual provision, is unconstitutional. Following the SARS outbreak in the early 2000’s wherein they suffered extensive cost exposure, insurance carriers—companies perpetually dedicated to crafting new ways to insulate themselves— began to include a ‘virus and bacteria’ exclusion in most policies which otherwise purport to cover business interruption. Insurers would argue that a government mandate requiring that they cover business interruption would impermissibly override their contract with the insured, abrogating one or more clear exclusions and “impair [an] obligation of [an insurance] contract.” Id. This, they would argue, would be in violation of the Contracts Clause. Notably however, as the Sveen Court makes clear, “not all laws affecting pre-existing contracts violate the [Contracts] Clause.” Id. A two-part test is employed to determine whether it is violated. The first part determines whether “the state law operate[s] as a substantial impairment of a contractual relationship.” Id. at 1821-1822. The second part determines whether it “is drawn in an appropriate and reasonable way to advance a significant and legitimate public purpose.” Id. at 1822. Importantly, this Contracts Clause discussion could be avoided by the Federal Legislature tackling this problem, since the Constitutional provision is limited to state action. Federal action would not be subject to such scrutiny. However, irrespective of Federal or state legislative action, any law requiring insurers to cover Coronavirus-related businesses interruption would save numerous small businesses. That said, the gridlock in Washington prevents states from relying on the Federal Government to do anything to protect its citizens and the economy as a whole. Amidst House and Senate inaction and concomitant political posturing, states are left scrambling to prevent a second Great Depression. A higher likelihood of state action ripens the need for constitutional analysis. Starting with the second factor first, there is no doubt that requiring insurance companies to cover businesses for business interruption would “advance a significant and legitimate public purpose.” Sveen, 138 S.Ct. at 1821. Doubtlessly, saving legions of businesses which have been unable to operate through no fault of their own serves such a purpose. Moreover, with proper care in drafting, we believe that a law can be easily fashioned in “an appropriate and reasonable way” which would pass constitutional muster. Id. That takes us to the first factor, underscoring the need for meticulous drafting—which must prevent such a law from “operating as a substantial impairment of [the] contractual relationship.” Id. While the freedom to contract is strong in the insurance industry, see Slayko v. Sec. Mut. Ins. Co., 98 N.Y.2d 289, 295 (2002), it is subject to regulation without running afoul of the Contracts Clause because “States retain the power to safeguard the vital interests of [their] people.” Am. Econ. Ins. Co. v. State, 30 N.Y.3d 136, 149 (2017). “In determining the extent of the impairment, [Courts] are to consider whether the industry the complaining party has entered has been regulated in the past.” Id. The insurance industry is one of those industries. See Benesowitz v. Metro. Life Ins. Co., 471 F.3d 348, 352 (2d Cir. 2006), certified question answered, 8 N.Y.3d 661 (2007) (“the insurance industry in New York is highly regulated by the state, and states have a strong interest in supervising highly regulated industries”). Prior regulation portends the permissibility of further regulation. Id. Moreover, a law requiring carriers to provide business interruption coverage to those with policies would not impair the contract relationship so much as further its purposes. See Sveen, 138 S.Ct. at 1822. As held by New York’s High Court, “The purpose served by business interruption coverage cannot be clearer—to ensure that [companies] ha[ve] the financial support necessary to sustain its business operation in the event disaster occurred.” Bi-Econ. Mkt., Inc. v. Harleysville Ins. Co. of New York, 10 N.Y.3d 187, 194 (2008). The current pandemic should qualify, as it doubtlessly caused the interruption. Therefore, the goal must be to maximize the chance of keeping as many of those operators in business as possible. Denying coverage in such dire circumstances, in addition to being morally bankrupt, contravenes the policy’s central purpose. Thus, legislation requiring coverage would actually further the purpose of business interruption insurance—mitigating any argument of impairment. The State has the power to take this action and public policy demands it. “The public policy of this state when the legislature acts is what the legislature says that it shall be.” Slayko v. Sec. Mut. Ins. Co., 98 N.Y.2d at 295. If passed, the pending legislation (Bill No. A10226B pending before the New York State Assembly) will declare certain exclusions (e.g. virus and bacteria exclusions) barring business interruption coverage void as against public policy; it would require that “certain perils be covered under business interruption insurance during the coronavirus disease 2019 (COVID-19) pandemic.” Under the above legal construct, such a law should withstand a Contracts Clause challenge. Legislation defines public policy and can restrict the freedom of contract. Id. Moreover, as with Sveen, such a law would be designed to reflect the policyholder’s intent and the purpose of such policies. See 138 S.Ct. at 1822. That should be enough to overcome the limitations imposed by the Contracts Clause. Farber Schneider Ferrari LLP continues to fight for small businesses and fervently hopes the legislature will take affirmative steps to save them, as they are the lifeblood of our economy. We encourage all readers to call or write our firm with any questions or comments.
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