Can They Do That? Possible Constitutional Limitations on State Efforts to Require Business-Interruption and Loss-of-Use Carriers to Cover Small Businesses’ Losses from COVID-19

The efforts to contain the COVID-19 outbreak have sent Congress and state legislatures into overdrive to try to contain the economic fallout.  Given the challenging times, a degree of shared sacrifice is to be expected.  But several pending legislative proposals to require business-interruption and loss-of-use carriers to cover small businesses’ losses from COVID-19—and then to require the rest of the insurance industry to pay into a fund to reimburse those carriers—are subject to serious constitutional question.

Proposed Legislation.  Several state legislatures are actively considering legislation that would retroactively change existing business-interruption and loss-of-use insurance policies to remove contracted-for virus exclusions.  So far, that list includes Massachusetts (SD.2888), New Jersey (A3844), New York (A10226), and Ohio (H.B. No. 589).  The proposed legislation in each of those States is nearly identical; legislators in other States will no doubt file copycat legislation in the near future.  The legislation would require insurers that provide what is called “time element” coverage—business-interruption and loss-of-use coverages—to cover business interruptions during a period of a declared state emergency due to the COVID-19 pandemic, retroactive to the dates each State declared a state of emergency, irrespective of the terms limiting coverage in individual insurance contracts.  The benefit would be conferred on “small businesses,” defined as those with 100 or fewer employees in New Jersey, New York, and Ohio, and those with 150 or fewer employees in Massachusetts.

Each bill would provide a mechanism to reimburse insurance companies that are compelled to pay claims that were not covered by the insurance contracts.  The reimbursement mechanism would be funded through special assessments on licensed insurers in the state.  As currently drafted, the New York and Massachusetts bills would assess all licensed insurers, while the New Jersey bill would assess all licensed insurers except life and health insurance companies, and the Ohio bill would assess licensed casualty insurers.  The assessments would be levied in proportion to the net written premiums received by each insurance company in the previous calendar year. 

It remains to be seen how such a reimbursement procedure would work in practice.  But even in the unlikely event that all the costs associated with a State’s retroactive expansion of insureds’ contract rights would be reimbursed by a State, the redistribution scheme would ensure that, at best, the costs for the legislatively mandated change would still be borne entirely by insurance companies.  Given the shortcomings in this approach, insurance companies offering business-interruption insurance should prepare for a spike in claims if these legislative proposals become law.  We discuss in this Legal Update the potential constitutional issues raised by these legislative proposals.  In addition to any state constitutional limitations, three federal constitutional provisions—the Takings Clause, the Contracts Clause, and the Due Process Clause—could serve as potential bases for challenging these laws.

Takings Clause.  The Fifth Amendment’s Takings Clause provides that private property shall not “be taken for public use, without just compensation.”  The purpose behind that provision is to “prevent the government ‘from forcing some people alone to bear public burdens which, in all fairness and justice, should be borne by the public as a whole.’”  Eastern Enters. v. Apfel, 524 U.S. 498, 522 (1998) (plurality op.) (quoting Armstrong v. United States, 364 U.S. 40, 49 (1960)).  The proposed state bills are a paradigmatic example of governments doing just that:  In the face of economic problems brought about by the COVID-19 outbreak, States are contemplating making insurers that provided business-interruption coverage—or, at best, the insurance industry as a whole—bear all of the COVID-related losses suffered by small businesses.

The Takings Clause would provide one avenue for insurers injured by any state legislative effort to transfer the costs of this shutdown to them without adequate compensation.  The existing contracts of insurers that provide business-interruption coverage are property for purposes of the Takings Clause.  See, e.g., United States Trust Co. v. New Jersey, 431 U.S. 1, 19 n.16 (1977) (“Contract rights are a form of property and as such may be taken . . . provided that just compensation is paid.”); Lynch v. United States, 292 U.S. 571, 579 (1934) (“Valid contracts are property, whether the obligor be a private individual, a municipality, a State, or the United States.”).

A takings claim challenging one of the proposed state legislative schemes would be governed by the regulatory takings framework outlined in Penn Central Transportation Co. v. New York City, 438 U.S. 104 (1978).  That test focuses on (1) the economic impact of the regulation on the claimant; (2) the extent to which the regulation has interfered with distinct investment-backed expectations; and (3) the character of the governmental action.  Id. at 124.

State legislation that forces insurance companies that have written business-interruption and loss-of-use coverage to shoulder the costs of additional coverage that the insured and the insurer had not bargained for could very well satisfy the first two elements of the Penn Central test if those insurance companies suffer actual losses as a result of the legislative modification of their insurance contracts.  Caution must be noted on the second prong, as any State would be likely to argue that because insurance is a highly regulated field, the companies necessarily contemplated future legislative changes.  See, e.g., Connolly v. Pension Benefit Guar. Corp., 475 U.S. 211, 227 (1986) (“Those who do business in the regulated field cannot object if the legislative scheme is buttressed by subsequent amendments to achieve the legislative end.”).  In the case of the proposed legislation, however, a strong argument could be made that the legislative remedies sweep beyond the government’s normal regulatory power to change contractual arrangements going forward and instead impose retroactive obligations on insurers.  In Eastern Enterprises v. Apfel, a plurality of the Supreme Court held that a retroactive law depriving a person of a vested property right—there, the passage of a 1992 law requiring a mining company that ceased operations in 1965 to pay millions of dollars into a miners’ pension fund—constituted a taking.  524 U.S. 498, 504 (1998).  The retroactive creation of extra-contractual obligations, the plurality held, “improperly place[d] a severe [and] disproportionate” burden on the mining company.  Id.

The third element of the Penn Central test is trickier, but not insurmountable.  There is substantial latitude for governments acting for a “significant[]” public purpose, such as for reasons implicating “the health, safety, morals, or general welfare” of the public.  Id. at 125.  The Supreme Court has long recognized that the government’s power is at its zenith when it is acting to protect the general public.  See, e.g., Miller v. Schoene, 276 U.S. 272, 279-80 (1928) (“[W]here the public interest is involved preferment of that interest over the property interest of the individual, to the extent even of its destruction, is one of the distinguishing characteristics of every exercise of the police power which affects property.”).

But even in cases of emergency, when there is an overwhelming public need for action, courts have not given governments free rein to place the full burden on particular groups when the cost should be borne by the public as a whole.  For instance, the Court of Federal Claims found a compensable taking when the U.S. Army Corps of Engineers intentionally released water from government reservoirs to control floodwaters during Hurricane Harvey, flooding property owners’ land.  In re Upstream Addicks & Barker (Texas) Flood-Control Reservoirs,146 Fed. Cl. 219, 261-64 (2019).

For insurers that would be forced to pay into a fund to compensate business-interruption insurers, a takings claim would be a bit more complicated.  The property interest would be the money that they are required to pay into the fund.  A state government would likely argue that the revenue raised from insurance carriers is akin to a business tax on the insurance industry and that “[t]axes and user fees . . . are not takings.”  Brown v. Legal Found. of Wash., 538 U.S. 216, 243 n.2 (2003).  But the Supreme Court recently held that, in some circumstances, monetary exactions can constitute a taking of private property even if the same cost could have been imposed via tax.  See Koontz v. St. Johns River Water Mgmt. Dist., 570 U.S. 595, 615 (2013) (noting that the Court has “repeatedly found takings where the government, by confiscating financial obligations, achieved a result that could have been obtained by imposing a tax”).  The proposed legislation does not levy taxes on insurance companies, so much as seize a portion of the premiums collected by insurance companies doing business in the State to “recover the amounts paid” by the State to business-interruption carriers pursuant to the legislation.  E.g., N.Y. A10226, § 3(a).  The key for insurers challenging that scheme will be to establish a “direct link between the government’s demand and a specific” property interest—here, the “net written premiums” on which the State’s special purpose apportionment is based.  Koontz,  570 U.S. at 614 (observing that money can be a protected property interest for a takings claim “when the government commands the relinquishment of funds linked to a specific, identifiable property interest such as a bank account”).

As a result of a recent Supreme Court decision, any insurers that wish to bring a takings claim would not be required first to exhaust the reimbursement claims procedure outlined in the proposed legislation.  Just last year, the Court held that a “property owner has suffered a violation of his Fifth Amendment rights when the government takes his property without just compensation, and therefore may bring his claim in federal court” without first exhausting state administrative remedies.  Knick v. Township of Scott, Pa., 139 S. Ct. 2162, 2168 (2019); see also id. at 2170 (“The Fifth Amendment right to full compensation arises at the time of the taking, regardless of post-taking remedies that may be available to the property owner.”).  As the Court explained, the mere “fact that the State has provided a property owner with a procedure that may subsequently result in just compensation cannot deprive the owner of his Fifth Amendment right to compensation under the Constitution, leaving only the state law right.”  Id. at 2171.  That said, the viability of a takings claim and the potential recovery in the suit will be impacted by any State’s reimbursement process.  If, for instance, the state statute clearly provides a mechanism for reimbursing every penny that business-interruption carriers are forced to pay out under the proposed legislation, the “later payment of compensation may remedy the constitutional violation that occurred at the time of the taking.”  Id. at 2172.  That would mean that the business-interruption and loss-of-use carriers would not have a viable takings claim, but carriers forced to contribute to the reimbursement fund would.

Contract Clause.  Insurance companies that offer business-interruption or loss-of-use coverage could also conceivably bring a claim under the Contract Clause, which prohibits States from passing any law “impairing the Obligation of Contracts.”  U.S. Const. art. I, § 10, cl. 1.

A Contract Clause claim would be governed by a three-part test: (1) whether the state regulation substantially impairs a contractual relationship; (2) whether the State had “a significant and legitimate purpose behind the regulation, such as the remedying of a broad and general social or economic problem”; and (3) whether the law is reasonable and appropriate for its intended purpose.  Energy Reserves Grp., Inc. v. Kan. Power & Light Co., 459 U.S. 400, 411-13 (1983).

The first prong could plausibly be met if the state reimbursement procedures fail adequately to compensate insurers saddled with claims based on new, retroactive business-interruption riders.  It is possible, though, that the reimbursement scheme—which appears to contemplate spreading out the cost of the legislative contractual changes to all insurance providers as opposed to only those offering business-interruption insurance—could mitigate a claim of substantial impairment.  That is because this factor includes consideration of the extent of past government regulation of the industry.  Energy Reserves Grp., 459 U.S. at 411.  As for the second and third factors, although it might well be a significant and legitimate purpose to provide small businesses with temporary economic relief, insurers could argue that there is no reason why States need to do so by imposing those costs entirely on insurers that issued business-interruption coverage or insurance carriers more generally.

Due Process.  Insurance carriers could also allege a deprivation of due process.  To do so, they would first have to establish a constitutionally protected property interest.  E.g., FDIC v. Mallen, 486 U.S. 230, 243 (1988).  There can be no question that money is property for purposes of the Due Process Clause.  See, e.g., Honda Motor Co. v. Oberg, 512 U.S. 415, 432 (1994) (“Punitive damages pose an acute danger of arbitrary deprivation of property.”). 

Insurance carriers would have to show that the deprivation of their property was “arbitrary”—i.e., not rationally related to a legitimate government interest.  E.g., Mallen, 486 U.S. at 243.  Laws analyzed under that level of scrutiny bring with them “a strong presumption of validity.”  FCC v. Beach Comm’ns, Inc., 508 U.S. 307, 314 (1993).  They will be upheld “if there is any reasonably conceivable state of facts that could provide a rational basis” for them.  Heller v. Doe, 509 U.S. 312, 319 (1993); see also Ben. Guar. Corp. v. R.A. Gray & Co., 467 U.S. 717, 731 (1984) (“[T]he enactment of retroactive statutes confined to short and limited periods required by the practicalities of producing national legislation . . . is a customary congressional practice.”).

Despite the high bar, due process claims for the deprivation of property interests occasionally succeed.  See, e.g., BMW of N. Am., Inc. v. Gore, 517 U.S. 559, 568 (1996) (punitive awards that are grossly excessive in relation to the State’s legitimate interests in punishment and deterrence “enter the zone of arbitrariness that violates the Due Process Clause of the Fourteenth Amendment”); Mikeska v. City of Galveston, 451 F.3d 376, 380 (5th Cir. 2006) (holding that even though a municipality had a “legitimate state interest” in protecting public access to public beaches, it did not offer a rational basis for why the means it employed—refusing to reconnect utilities to houses on those beaches—permissibly furthered that interest); Hamby v. Neel, 368 F.3d 549, 564 (6th Cir. 2004) (holding that although limiting public insurance coverage to those eligible is a legitimate state interest, the application process created by the State failed to rationally further that interest in light of “alternative reasonable and practical means” that would have better determined eligibility).  Insurance carriers could plausibly argue that, however legitimate states’ interest in helping small businesses through the economic disruption occasioned by COVID-19 may be, forcing insurers to bear the full brunt of that cost is an irrational means of securing that benefit—indeed, no more rational than forcing insurers alone to pay the cost of constructing field hospitals or purchasing personal protective equipment for first responders.

Legislative and regulatory responses to the economic turmoil occasioned by the COVID-19 outbreak will continue to come at a breakneck pace for the foreseeable future.  The insurance industry is already working collaboratively with governments, policyholders, and other private organizations to respond to the crisis.  So far, no State has enacted a law providing an extra-contractual benefit to small businesses at the cost of insurers that provide “time element” coverage—business interruption and loss-of-use policies.  As these bills are considered in state legislatures, it will be important to examine carefully the details of each bill, including the scope and manner of the special assessment mechanism for reimbursing the business interruption and loss-of-use carriers.  If such laws are enacted in substantially the form currently proposed, however, insurers may want to test their validity in court.  Although States enjoy a surprising amount of leeway to enact legislation effectively mandating the transfer of assets from one group to another, their power is not without limits even in times of an emergency.  Insurers could plausibly challenge these wealth-transferring laws under the Takings Clause, Contract Clause, and Due Process Clause.

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And for any legal questions related to this pandemic, please contact the authors of this article or Mayer Brown’s COVID-19 Core Response Team at FW-SIG-COVID-19-Core-Response-Team@mayerbrown.com.