Coverage for Cannabis? How Cannabis’s Legal Limbo Affects Property Insurance Policies

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Coverage for Cannabis? How Cannabis’s Legal Limbo Affects Property Insurance PoliciesA recent federal court of appeals’ decision raises interesting questions for all policyholders, particularly commercial and residential landlords with tenants that grow, possess, and/or distribute cannabis, even where it is legal to do so under state law.

In K.V.G. Properties, Inc. v. Westfield Ins. Co., decided by the United States Court of Appeals for the Sixth Circuit on August 21, 2018, KVG claimed coverage for losses caused by its commercial tenant’s use of KVG’s property for cannabis cultivation. In connection with its cannabis business, the tenant removed walls, cut holes in the roof, altered ductwork and damaged HVAC systems, which ultimately cost around $500,000 to repair. KVG claimed that its loss was covered under its Building and Personal Property Coverage Form (the “BPP Policy”). However, Westfield denied the claim, arguing that the loss was not covered under the BPP Policy due to an exclusion that provided that Westfield would not pay “for loss or damage caused by [any] [d]ishonest or criminal act by [KVG], any of [its] partners, members, officers, managers, employees . . ., directors, trustees, authorized representatives or anyone to whom [KVG] entrust[s] the property for any purpose” (the “Dishonest or Criminal Acts Exclusion”).

Given the litigants’ positions, the court was forced to address the question of whether the cannabis-cultivating tenants committed a “criminal act” within the meaning of the policy. The court began by noting that, while growing cannabis is a crime under federal law, it is protected by Michigan law under certain conditions. The court also noted that “[u]nder different circumstances, KVG might have a strong federalism argument in favor of coverage.” The court went so far as to say it would “hesitate before reading a Michigan insurance policy to bar coverage for a ‘criminal act’ when Michigan law confers criminal and civil immunity for the conduct at issue.” The court ultimately punted on this difficult federalism issue, though, holding instead that the evidence was such that no reasonable jury could find that KVG’s tenant complied with Michigan law. In reaching this conclusion, the court cited KVG’s pleading in a summary eviction proceeding against the tenant where KVG stated that the tenant “illegally grew cannabis.” The court also noted that federal agents, who at the time were subject to U.S. Attorney General Guidance stating that they should not prioritize individuals whose actions are in compliance with existing state laws, raided the premises. This raid, the court reasoned, confirmed that the tenants were not acting in compliance with Michigan law.

This case has multiple interesting implications for insureds. First, policyholders that have extensive and expensive insurance packages (and, consequently, some ability to negotiate policy terms) could attempt to negotiate a more definitive exclusion to obtain more certainty as to whether losses caused by things such as cannabis use and cultivation are covered.

Secondly, policyholders and their counsel should note that the inconsistency between state and federal law as to cannabis’s legality lends itself nicely to an argument that the Dishonest or Criminal Acts Exclusion (and other similar exclusions) is ambiguous in this context. It is a maxim of coverage law that ambiguous provisions in insurance policies should be construed in favor of coverage, and this ambiguity could give policyholders an avenue to pursue traditionally excluded coverage. To this end, this tension between federal law and certain state laws could almost “read out” the Dishonest or Criminal Acts Exclusion for cannabis-related losses under the theory that the legality of cannabis cultivation is always ambiguous in states where medical and/or recreational cannabis cultivation and use are legal. Brokers acting for insureds might bargain for a more specific exclusion that makes it clear the Dishonest or Criminal Acts Exclusion does not apply to cannabis cultivation or use, or policyholder’s brokers might opt for keeping this more ambiguous exclusion rather than being forced to accept an exclusion specifying that coverage is not provided for losses caused by acts that are illegal under state or federal law, in order to leave open the possibility of arguing for coverage based on the exclusion’s ambiguity.

Lastly, insureds and their lawyers should be mindful of the arguments they make in related proceedings. While it was likely in KVG’s best interest to have its tenant—who was causing losses to the rented property—evicted, its argument that the tenant should be evicted for its illegal cannabis operation ultimately worked to prevent KVG from obtaining coverage for its losses. Policyholders should, to the extent possible, litigate any related issues with an eye toward preserving (or at least not foreclosing) coverage for their losses.