The cannabis business continues to expand throughout the United States with 33 states that allow some use of medical cannabis, 10 states that allow adult use of cannabis and most others that allow for limited medical use of CBD (cannabidiol). In fact, only four states bar the use of all cannabis products. While the federal Controlled Substances Act (CSA) continues to identify cannabis as a Schedule I drug, the Obama and Trump administrations have ushered in an era that provides some assurance to the cannabis industry that personal use of marijuana and operation of state-regulated cannabis businesses will not be the targets of federal prosecution. In turn, the expansion of the legal cannabis industry requires that it be able to manage risk through insurance for property and liability losses.
The current cannabis insurance market overwhelmingly comprises surplus lines carriers. There also are several smaller admitted carriers that operate in California. Several major commercial carriers should enter the market by the end of 2019, both on a surplus and admitted basis. Federal legalization will, of course, greatly accelerate this process. Unlike other business models, however, the application of insurance policy language to cannabis losses is in its infancy. Given questions on coverage, some states such as Oregon require insurers to clarify how policy language will apply. Other states such as California have encouraged the expansion of insurance products for cannabis.
The ultimate arbiter of the scope of insurance coverage for cannabis is the judicial system. The courts interpret policies, providing guidance to insurers and policyholders alike on the scope and limitations of coverage. Such decisions also prove instrumental in allowing both policyholders and insurers to assess risk and to identify needs going forward. While property and liability policies differ in their insuring clauses, conditions, and exclusions, there is overlap on some issues. Insurers also are likely to draft language that addresses risks unique to the industry for future policies that cross insurance product lines. The following cases highlight several issues peculiar to the cannabis world.
Choice of Law / Insurable Interest / Contraband Exclusion
A consistent theme in both contract law and insurance law is that courts will not enforce contracts that have an illegal object. In this respect, one of the threshold issues insurers and policyholders confront is whether insurance coverage disputes will be governed by state law or federal law. If state law applies in a jurisdiction where the insured's cannabis business was operating legally, an insurance contract will likely be enforceable. However, if federal law applies − or the insured is operating outside the bounds of applicable state law, for example by selling medicinal marijuana for recreational use − the insured may be deemed to be engaged in illegal cultivation or distribution, leaving the contract potentially unenforceable.
In Tracy v. USAA Ins. Co., 2012 WL 928186 (D. Haw. Mar. 16, 2012), an insured engaged in growing marijuana at home in accord with state law, and filed a claim when the marijuana plants were stolen. The insurer argued that if the federal court applied its policy language covering theft of plants to provide coverage for theft of the insured's marijuana plants, it would violate public policy since cannabis is illegal under federal law. The insurer sought summary judgment, asserting the insured did not have an insurable interest in the plants since they were federally prohibited. The court agreed:
The rule under Hawai'i law that courts may decline to enforce a contract that is illegal or contrary to public policy applies where the enforcement of the contract would violate federal law. ... The Court therefore assumes, for purposes of the instant motion, that the "Trees, Shrubs and Other Plants" provision of the Policy covered the loss of Plaintiff's medical marijuana plants. Even in light of that assumption, this Court cannot enforce the provision because Plaintiff's possession and cultivation of marijuana, even for State-authorized medical use, clearly violates federal law. To require Defendant to pay insurance proceeds for the replacement of medical marijuana plants would be contrary to federal law and public policy. ... The Court therefore CONCLUDES that, as a matter of law, Defendant's refusal to pay for Plaintiff's claim for the loss of her medical marijuana plants did not constitute a breach [of] the parties' insurance contract.
In Green Earth Wellness Center, LLC v. Atain Specialty Ins. Co., 163 F. Supp. 3d 821 (D. Colo. 2016), the court reached a different result. There, the insured operated a retail medical marijuana business, which Atain Specialty Insurance Company (Atain) insured through a Commercial Property and General Liability insurance policy. The insured made a claim for smoke and ash damage from a wildfire that impacted the ventilation system of the business and caused damage to the marijuana plants. Id. at 823. The insured's policy included a "contraband" exclusion that barred coverage for "contraband, or property in the course of illegal transportation or trade." Id. at 832. The court declined to apply the exclusion to preclude coverage for damage to the marijuana plants and held "the Policy's 'Contraband' exclusion is rendered ambiguous by the difference between the federal government's de jure and de facto public policies regarding state-regulated medical marijuana." Id. at 833.
Moreover, the court reasoned:
[I]t is undisputed that, before entering into the contract of insurance, Atain knew that Green Earth was operating a medical marijuana business. It is also undisputed that Atain knew—or very well should have known—that federal law nominally prohibited such a business. Notwithstanding that knowledge, Atain nevertheless elected to issue a policy to Green Earth. ... The record suggests that the parties shared a mutual intention that the Policy would insure Green Earths' [sic] marijuana inventory and that the 'Contraband' exclusion would not apply to it." Id. at 833-834.
Finally, the Green Earth court expressly rejected the Hawaii court's rationale in Tracy, observing that since Tracy there has been a "continued erosion of any clear and consistent federal public policy," and further noting that Atain had agreed to insure a marijuana business "of its own will, knowingly and intelligently." Id. at 835.
Criminal Acts Exclusion
In K.V.G. Properties, Inc. v. Westfield Ins. Co., 900 F. 3d 818 (2018), K.V.G Properties sought coverage under a first-party property policy for damage to its physical office space arising from its tenants' cannabis-growing operation. Indeed, the tenants not only had been caught growing marijuana but also had removed walls, cut holes in the roof, and altered ductwork to accommodate their business. Although Westfield denied coverage on multiple grounds, the Sixth Circuit focused its analysis on whether the criminal acts exclusion precluded coverage.
The property at issue was located in Michigan where cultivation of cannabis is a federal crime but is protected in certain circumstances under Michigan law. Westfield argued that its tenants' conduct was criminal irrespective of whether federal law or Michigan law applied and that, consequently, the demand for coverage was precluded under the policy's criminal acts exclusion. The United States District Court in Michigan agreed and dismissed K.V.G. Properties' claim. While recognizing K.V.G. Properties could have a "strong federalism argument" had it been in compliance with Michigan law, the Sixth Circuit agreed that the conduct was outside the bounds of Michigan's marijuana law and affirmed the dismissal.
Accident / Increased Risk Exclusion
In Nationwide Mut. Fire Ins. Co. v. McDermott, 603 Fed. Appx. 374 (6th Cir. 2015), an insured suffered a fire loss that Nationwide learned, after making a $160,209.50 payment, was caused by the insured's butane extraction method in the cultivation of marijuana. Nationwide then denied coverage when it learned that the insured had been "operating an illegal marijuana and THC manufacturing facility in the basement," which caused the fire. Id. at 376. The Nationwide policy provided coverage for accidental fire losses but excluded coverage for any loss "occurring while the hazard [was] increased by a means within the control and knowledge of an insured" and further required that the insured "notify [Nationwide] as soon as possible of any change which may affect the premium risk under [the] policy," including "changes ... in the occupancy or use of the residence premises." Id.
The trial court granted summary judgment on two grounds: first, the court found that the loss did not qualify as an "accident" under the policy because it was the result of a butane extraction process; and second, the court found that a Nationwide policy exclusion for losses that occur while an insured has increased the risk of hazard applied since the insured was using the basement as an illegal marijuana lab, which resulted in an increased hazard without having notified the insurer. The Sixth Circuit did not rule on whether the fire was an "accident" but affirmed the trial court's order granting summary judgment on the basis that the insured's change of use of the property, without notice to the insurer, increased the risk of hazard and was excluded by the policy.
In Swish v. Manhattan Fire & Marine Ins. Co., 675 F. 2d 1218 (11th Cir. 1982), the owner of a small aircraft had leased it to a lessee who attempted to use the plane to smuggle marijuana into the United States from the Bahamas. Law enforcement intervened, but damaged the plane while removing various equipment.
The lease on the plane specifically prohibited the lessee from using the aircraft to carry cargo or engage in illegal activity. The insurance policy at issue included an exclusion for "conversion." The insurer denied the owner's claim for property damage coverage on the basis that the plane had been converted for illegal purposes and the exclusion expressly precluded coverage for conversion, including any "loss or damage during or resulting therefrom." Id. at 1219. The court agreed, finding that the claimed loss occurred during an ongoing conversion when the lessee was using the plane in an illegal manner.
Similarly, the court in National Union Fire Ins. Co. of Pa. v. Carib Aviation, 759 F. 2d 873 (11th Cir. 1985) applied the conversion exclusion to preclude coverage where a lessee of an airplane rented it to purportedly fly from Miami to Orlando but instead flew to the Bahamas to transport marijuana. The plane crashed during the flight, and the court held that the plane had been "converted," and coverage was precluded.
"Controlled Substances" Exclusion
Since marijuana is still identified as a Schedule I substance under the CSA, insurers may seek to rely on the "controlled substances" exclusion to bar coverage for liability claims arising out of a marijuana business. A plain reading of the exclusion applies to bar coverage for any loss related to marijuana. However, carriers must be cognizant of the changing impressions when it comes to cannabis and the protections naturally provided to the insureds.
The Insurance Services Office homeowner's form includes the following "controlled substances" exclusion:
"Bodily injury" or "property damage" arising out of the use, sale, manufacture, delivery, transfer or possession by any person of a Controlled Substance as defined by the Federal Food and Drug Law at 21 U.S.C.A. Sections 811 and 812. Controlled Substances include but are not limited to cocaine, LSD, marijuana and all narcotic drugs. However, this exclusion does not apply to the legitimate use of prescription drugs by a person following the lawful orders of a licensed health care professional.
The court in Prudential Prop. & Cas. Ins. Co. v. Brenner, 350 N.J. Super. 316 (2002) was asked to interpret a similarly worded exclusion in a homeowner's policy arising from the involvement of the homeowner's son in the attempted theft of marijuana that left a drug dealer dead. The boy admitted participation in the theft but denied any plan involving murder. The insurer denied coverage based on the controlled substance exclusion. The court agreed with the insurer. While the court acknowledged that the homeowner's son was in the drug dealer's home only to steal marijuana and that the drug dealer's death was connected to an "ill-conceived plan" that went "wildly and sadly awry," the court held that the "language employed unmistakably encompasses more than the completed act of manufacture, use or transfer of a controlled danger substance" and precluded coverage. Id. at 323.
In contrast, the appellate court in Keckler v. Meridian Sec. Ins. Co., 967 N.E. 2d 18 (Ind. Ct. App. 2012) reversed a trial court's application of the controlled substances exclusion in circumstances where a teenager involved in an automobile accident was observed to have "glassy eyes" and had a bag of marijuana in the car. While the trial court applied the exclusion to preclude coverage, the court of appeal reversed, finding that there was no evidence that the teen had used marijuana. The appellate court rejected the insurer's argument that public policy favored application of the exclusion since drug possession laws were violated, reasoning that Indiana does not apply a public policy exception to overcome coverage provided under the relevant policy. The court elaborated that, even if the law endorsed the insurer's public policy argument, it would be an extraordinary result for the court to deny coverage for "bad behavior" that had nothing to do with the accident. Id. at 26.
Reasonable Expectations / Growing Plants
Insurers generally do not extend coverage to growing plants, although there are exceptions. As is pertinent to a broader liability coverage examination, in Green Earth, supra, the insured argued that the policy should cover the loss of its growing plants, because the insured sought to insure its plants through the purchase of business insurance. Id. at 830. The insured relied on the reasonable expectations doctrine to argue that the court should "honor the reasonable expectations of an insured where circumstances attributable to an insurer have deceived a [sic] objectively reasonable insured into believing that it is entitled to coverage for a certain loss." Id. at 831, citing Bailey v. Lincoln Gen. Ins. Co., 255 P.3d 1039, 1053 (Colo. 2011). The court rejected application of the doctrine as it was not sufficient to merely claim an expectation of coverage. Rather, the court determined there must be some showing that the expectations are reasonable. Green Earth, supra, at 831, citing Bailey, supra, at 1054. The court specifically noted that, "the extrinsic evidence in the record indicates that Atain repeatedly, plainly, and conspicuously advised Green Earth that growing plants would not be covered, and there is no evidence that Green Earth ever objected." Green Earth, supra, at 831.
In Huynh v. Safeco Ins. Co., 2012 WL 5893482, at 1 (N.D. Cal. Nov. 23, 2012), a property owner's tenant operated an illegal marijuana grow house that damaged the building. The court held that an "illegal growing of plants" exclusion precluded coverage for the landlord's claim. Although California had legalized marijuana for medical purposes at the time, the tenant's grow house was illegal. Consequently, the court evaluated coverage on the premise that the tenant's operation was illegal under both state and federal law. The conclusion may have been different − and certainly would have prompted more discussion − had recreational marijuana been legal in California as it is today.
It also is worth noting that growing crops presents a risk management issue pertinent to the marijuana business. The federal crop insurance program, which frequently is involved in either the underwriting or reinsurance of crop insurance in the United States, does not cover cannabis. The consequence of this policy is that surplus lines insurers will have difficulty underwriting crop loss since they will not have access to the federal crop insurance program. To the extent surplus lines may be willing to extend crop loss coverage, it is likely to be for smaller exposures, and premium pricing is likely to be increasingly prohibitive as exposures increase. Whether legalization of cannabis at the federal level would open access to the federal crop insurance program remains to be seen, but would be a logical step.
Vandalism Coverage / Mold Exclusio n
In Bowers v. Farmers Ins. Exchange, 991 P. 2d 734 (Wash. App. 2000), an insured property owner sought coverage for damages arising from mold growth that occurred after its tenant converted the property to a marijuana grow house. The court was asked to determine whether coverage under the vandalism coverage applied and whether the mold exclusion precluded coverage. The insurer argued that the tenant's alteration of the home was not vandalism but an intentional act. The court read coverage broadly and rejected this argument, holding that the tenant's disregard for the integrity of the property constituted vandalism. The court further found that the mold growth was secondary to the vandalism. See also, Kochendorfer v. Metropolitan Prop. & Cas. Co., No. 2:11-cv-01162 (W.D. Wash. 2012) (court granted insured property owner motion for summary judgment, finding that damages from marijuana grow operation arose from tenant vandalism, not the marijuana grow operation).
The "Pollution" Exclusion
It is an inevitable fact that some cannabis businesses will be sued for nuisance or pollutant reasons. The production and harvesting of marijuana plants necessarily involve smells and production materials, which may be found to be offensive to neighboring businesses or residences. The nature of the business, coupled with the "drug" component, already causes highly publicized pushback from neighbors trying to avoid such businesses in the same vicinity, which could include pollutant claims such as smoke, dust, chemicals, and pesticides. Carriers will then have the burden of establishing whether a "pollution exclusion" applies. Under standard CGL policies, a pollution exclusion applies for liability arising out of the dispersal of pollutants. The issue will be whether any claims against a cannabis business will include claims of exposure to anything that constitutes a "pollutant" under policy language and applicable law.
In MacKinnon v. Truck Ins. Exch., 31 Cal. 4th 635, 652 (2003), the California Supreme Court held that a pollution exclusion for bodily injury "resulting from the actual, alleged, or threatened discharge, dispersal, release or escape of pollutants" applies only to traditional environmental pollution. The California court followed a Colorado decision in holding that "while a reasonable person of ordinary intelligence might well understand carbon monoxide is a pollutant when it is emitted in an industrial or environmental setting, an ordinary policyholder would not reasonably characterize carbon monoxide emitted from a residential heater which malfunctioned as 'pollution.' It seems far more reasonable that a policyholder would understand it as being limited to irritants and contaminants commonly thought of as pollution and not as applying to every possible irritant or contaminant imaginable." Id. at 652-653, quoting Regional Bank of Colo. v. St. Paul Fire & Marine Ins. Co., 35 F.3d 494, 498 (10th Cir. 1994).
On the other hand, in Deni Assocs. v. State Farm Fire & Cas. Ins. Co., 711 So.2d 1135, 1138-1139 (Fla. 1998), in examining a pollution exclusion for "any personal injury or property damage 'arising out of the actual, alleged or threatened discharge, dispersal, release or escape of' ... any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalines, chemicals and waste," the Florida Supreme Court stated, "we cannot accept the conclusion reached by certain courts that because of its ambiguity the pollution exclusion clause only excludes environmental or industrial pollution."
To date, there is no national published opinion on whether contaminants, smoke, chemicals, or other irritants used in marijuana cultivation or operations qualifies as a pollutant for application of this exclusion. "Whether marijuana smells qualify as pollutants probably depends on their intensity, range, duration, and location. The occasional waft from a dispensary in a commercial district may not be a pollutant, while a wide-ranging, intense stench in a residential neighborhood may be." Gottlieb, Lawrence & Matt Munson, Insurance Issues Raised by the Legalization of Recreational Marijuana; Vol. 46, No. 1, Am. Bar Ass'n: The Brief, p. 34, Fall 2016. There is simply insufficient information about the court's interpretation of cannabis as a pollutant to provide any guidance on how courts will interpret application of this exclusion.
Law Enforcement Raids
An individual or entity in the cannabis business runs the risk of being raided by law enforcement officials and having their plants or inventory seized. As a general rule, an entity cannot insure against losses suffered during a government raid premised on illegal drug activity. However, at least one insurer is offering an insurance product that provides such protection for state raids in circumstances where the insured is in compliance with state law. Presumably, if federal law legalizes marijuana or recognizes the ability of states to legalize and regulate the cultivation and distribution of marijuana, similar coverage for federal raids will follow.
The foregoing discussion is by no means exhaustive of the issues likely to confront the insurability of the cannabis industry. Other policy provisions that currently exist are likely to become subjects for coverage consideration. In this respect, be aware of insurance policy language that excludes coverage for property in the course of illegal transportation or trade, limited coverage or sub-limits for outdoor plants, exclusions for employee dishonesty, and limitations or exclusions in homeowners' policies for losses arising from a home business. These are likely to be issues in the evolution of cannabis insurance coverage law.
Originally published by Insurance Advocate
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