In Thee Sombrero, Inc. v. Scottsdale Ins. Co., 28 Cal.App.5th 729 (October 25, 2018), the California Fourth District Court of Appeal reversed the trial court's entry of summary judgment in favor of Scottsdale Insurance Company ("Scottsdale") addressing whether indemnity coverage was afforded under the Scottsdale policy for the diminution in value of property as a result of the named insured, Crime Enforcement Services' ("CES"), negligent conduct related to a shooting on such property. The parties' dispute related to Thee Sombrero's ("Sombrero") lessee's operation of a nightclub on the property.

The City of Colton ("City") issued a Conditional Use Permit ("CUP") authorizing the use of the property as a nightclub. In 2007, Sombrero leased the property to new tenants who operated it as a nightclub called El Sombrero. In connection with the new tenancy, the City inspected the property; it approved a floor plan and it found that the property was in compliance with the floor plan. As part of the floor plan, the club had a single entrance door equipped with a metal detector.

CES provided security services at El Sombrero. Scottsdale provided coverage to CES under a corporate general liability policy. The policy afforded coverage for "property damage" caused by an "occurrence." "Property damage" was defined as either "(a) physical injury to tangible property, including all resulting loss of use of that property or (b) loss of use of tangible property that is not physically injured."

On June 4, 2007, one patron of El Sombrero shot and killed another. After the shooting, Sombrero learned that CES had converted a storage area into a "VIP entrance" to the club. The VIP entrance had no metal detector. The owner of CES admitted that the gun used in the shooting came into the club through the VIP entrance.

As a result of Sombrero's negligence, the City revoked the CUP and replaced it with a modified CUP which provided that the property could be operated only as a banquet hall. According to Sombrero, the change in the use of the property resulted in a diminution of value of $923,078.00. After securing a default judgment against CES, Sombrero filed a direct action against Scottsdale seeking indemnity coverage for such judgment pursuant to Insurance Code §11580(b)(2). In response, Scottsdale filed a motion for summary judgment arguing that the judgment secured by Sombrero for diminution in value of the property constituted economic loss, rather than "property damage" as defined in the Scottsdale policy. The trial court agreed and entered summary judgment in favor of Scottsdale.

In reversing the trial court's entry of summary judgment, the Court of Appeal reasoned as follows:

First, the appropriate focus is not on the loss of the entitlement, but rather on the loss of use of tangible property that results from the loss of the entitlement. We agree that in IPA, the liquor license was not tangible property. Nevertheless, the loss of the liquor license meant that Northwest Visions could no longer use its premises for the remunerative purpose of selling diners alcohol along with their food. Here, identically, the revocation of the CUP meant that Sombrero could no longer use the property as a nightclub.

Second, the reasonable expectations of the insured would be that "loss of use" means the loss of any significant use of the premises, not the total loss of all uses.

. . .

California law is in accord. In Hendrickson v. Zurich American Ins. Co. (1999) 72 Cal.App.4th 1084 [85 Cal. Rptr. 2d 622] (Hendrickson), a group of growers sued Crown Nursery, alleging that it sold them strawberry plants that had been damaged by an herbicide. (Id. at pp. 1086–1087.) Zurich insured Crown Nursery, but Zurich refused to defend (id. at p. 1087), arguing that the growers had not alleged any property damage. (Id. at p. 1089.) The appellate court disagreed: "Here, the growers' complaint may reasonably be construed as alleging that as a result of [Crown Nursery's] negligent delivery of defective plants, the growers suffered a loss of strawberry production, and thereby a loss of the use of their land. The policies in this case expressly state that '[l]oss of use of tangible property that is not physically injured constitutes 'property damage.' Thus, we conclude that the growers' action presents a potential for coverage which requires a defense." (Id. at p. 1091.) Hendrickson therefore supports our view that a loss of a particular use of tangible property can be property damage.

Scottsdale argues that Hendrickson involved a physical injury rather than a loss of use; it asserts, "[T]he court found the insured's contaminated strawberries could have potentially ruined tangible property, namely, the claimants' strawberry crop." Not so. As quoted above, the court specifically concluded that "the growers suffered ... a loss of the use of their land." (See Hendrickson v. Zurich American Ins. Co., supra, 72 Cal.App.4th at p. 1091, italics added).

In dictum, the court also reasoned that the right to occupy the property granted by the lease between Sombrero and the nightclub owner constituted a tangible property interest rather than an intangible property interest. The court stated as follows in connection with its observation:

In any event, the issue is not whether, as a technical legal matter, a leasehold is tangible property. Rather, it is whether an insured, reading his or her policy, would understand "tangible property" to include real property that he or she leases. If your leased apartment was rendered uninhabitable by some noxious stench, you would conclude that you had lost the use of tangible property; and if a lawyer said no, actually you had merely lost the use of your intangible lease, you would goggle in disbelief.

The Court of Appeal relied heavily on the argument that a reasonable insured would expect the Scottsdale policy to afford coverage for loss of use of tangible property measured by diminution in value. The Court of Appeal reasoned that economic loss constitutes a measure of such loss of use. The Court noted that economic loss, exclusively, without any accompanying physical injury or loss of use of tangible property would not qualify as "property damage" as defined in Scottsdale's policy. Here, Sombrero lost the use of the property as a nightclub. Hence, the court reasoned that the diminution in value of the property based on a nightclub use, as opposed to a banquet hall, constituted a measure of the loss of use of tangible property sustained by Sombrero.

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