Wakefern Food Corp. v. Liberty Mutual Fire Ins. Co., a recent case in the appellate division of the Superior Court of  New Jersey,  broadly construed the term “physical damage” in an all-risk insurance policy to include loss of function and loss of use.

Plaintiffs in this case, a group of supermarkets, sued Liberty Mutual for coverage of loss of business and food spoilage as a result of the 3-day blackout in the northeastern United States and eastern Canada in August of 2003. Liberty denied coverage under a first-part, all-risk insurance policy that included an extension coverage for damage due to the loss of electric power.  Liberty contended that the policy only applied where there was physical damage to off-premises electrical plant and equipment and here, the electrical grid failures that resulted in the blackout had no such physical damage, even though they were incapable of producing electricity for several days.  The term “physical damage” was not defined in the policy.

Plaintiffs appealed the trial court’s order denying them summary judgment and granting it for Liberty based on this issue of physical damage to the appellate division.  In reversing the trial court the appellate court concluded that the term “physical damage” in the policy was ambiguous, that the trial court erred in construing it too narrowly and in the favor of the insurer and in a way inconsistent with the reasonable expectations of the insured.  The court further held that there was physical damage here within the terms of the policy, where the electrical grid shut down due to a physical incident and were physically incapable of performing their essential function. 

The court’s finding of ambiguity was based not only on the insured’s presentation of evidence that there was physical damage to equipment contributing to the blackout, but also that the loss of function amounted to physical damage under the policy.  The court noted that neither the insured nor the supermarkets possessed sophisticated knowledge as to the functioning of a power grid.  The average policy holder could not be expected to understand the highly technical definition of physical damage put forth by the insurer and the duty falls on the insurer to make that definition clear.  Also important to the court’s holding was that Plaintiffs played no role in drafting the provision at issue.

The implications of this court’s holding extend farther than the very specific facts of this case.  The court cites to several cases in various jurisdictions and with varying factual bases for the contention that physical loss can include the loss of function or use and that the burden is on the insured to define the term in the policy to exclude such losses if that is so intended.