Issues with insuring Marijuana, your business or homeowners policy will not cover the sometimes legal product

This is a summary of an insurance case involving legal marijuana and the conflict it has with all state approved Department of Insurance polices. Summary is from PLRB, great industry resource that anyone that handles claims is aware of and should be familiar with.

After the California wildfires some Insurance Departments are now working to mandate some basic coverage for cannabis producers, processors, and retailers.

PLRB Property Insurance Law Review
Edition Date: March 4, 2015 PLRB Case No.: 9104
Plaintiff: Nationwide Mutual Fire Ins. Co. Defendant: McDermott
State: MI, Michigan Key(s): HO90 HO109 HO119 MI - Innocent Coinsured
Citation: No. 14-1623, 603 Fed.Appx. 374 (6th Cir. (Mich.) 2/24/15) (unpublished) Author: Kathryn K. Jensen, Counsel and Senior Editor
Subject: ~ marijuana lab; butane extraction; fire; honey oil; medical marijuana use; accidental loss; innocent coinsured; increased hazard; duty to notify of change in occupancy and use that affects the risk; insurer's recovery of prior payments made before it discovered the cause of loss; failure to notify insurer of change in use voided the policy

Nationwide Mutual Fire Ins. Co. v. McDermott

No. 14-1623, 603 Fed.Appx. 374 (6th Cir. (Mich.) 2/24/15) (unpublished)
(U.S. Court of Appeals for the 6th Circuit, applying Michigan law)
Affirming No. 12-11863, 2014 WL 1464418 (E.D.Mich. 4/15/14) [reviewed at PLRB, Prop. Ins. L. Rev. 8932 (2014)]
and 2013 WL 3732874 (E.D.Mich. 7/15/13) [reviewed at PLRB, Prop. Ins. L. Rev. 8732 (2013)]

(click here for the text of the 6th Circuit's 2/24/15 opinion)

In Brief

Failure to notify the insurer of a change in use voided the policy when the policyholder failed to report that her husband had set up a marijuana growing operation in the basement of their home. Consequently, there was no coverage for the fire loss that occurred when her husband lit a flame to smoke marijuana and accidentally ignited the butane he was using to produce "honey oil" from marijuana. The policyholder claimed she did not know that her husband was doing anything more than growing marijuana as a registered medical marijuana patient and caregiver. Nevertheless, she admitted she knew he had altered the basement so he could grow and process marijuana. This knowledge was sufficient to trigger her duty to notify the insurer "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." Her failure to disclose this information to the insurer was also was an omission of a "material fact" under the concealment or fraud clause in the policy. The court further decided that the insurer was entitled to recover the payments it made to the policyholder before it discovered the cause of the fire.

Facts

The issues in this case were (1) whether there was coverage for the policyholder for the total loss of her home and its contents due to a fire, which was accidentally set by her husband while he was manufacturing and smoking marijuana in the basement; and (2) whether the insurer was entitled to recover from the policyholder the payments the insurer made before it learned of the cause of the fire. The insurer initially paid the policyholder $160,209 for the loss. Once it discovered that the fire was caused by the husband's marijuana lab, the insurer filed a declaratory judgment action seeking a declaration that it was not liable for the loss and that it was entitled to recovery of the money it had already paid.

The policyholder argued that she was entitled to recover for the loss on the grounds that: (1) the fire was a covered accidental loss because her husband accidentally started the fire when the flame, which he lit to smoke some marijuana, ignited butane that had not yet evaporated from the butane extraction operations he had been performing; and (2) the policyholder was an innocent coinsured because, although she knew her husband grew marijuana in their home as a registered medical marijuana patient and caregiver, she claimed she had no knowledge that he used butane to extract "honey oil" from the marijuana he grew and illegally sold it to others. [Editor's Note: For more detailed information about the butane extraction process and how the fire began in the basement, see PLRB's review of the trial court's opinion at PLRB, Prop. Ins. L. Rev. 8732 (2013)].]

The insurer argued there was no coverage for the loss because it contended that a fire resulting from an illegal marijuana lab, which used highly flammable butane, was not an "accidental" fire covered by the policy. The insurer also argued the loss was excluded under various provisions in the policy, including: (1) the requirement that the policyholder notify the insurer of any change in occupancy or use of the insured premises; (2) the exclusion for "loss occurring while a hazard is increased by a means within the control and knowledge of an insured"; and (3) the intentional acts exclusion, on the basis that the policyholder was not an innocent coinsured. Finally, the insurer argued that the "Michigan wrongful conduct rule" barred coverage because the fire was the result of illegal activities.

Evidence of the policyholder's knowledge of a change in use in the property including the following deposition testimony:

During their depositions, both [the policyholder and her husband] admitted that they had not informed [the insurer] that in 2010, [the husband] set up a marijuana growing operation in their basement, effectively "changing" the use of the basement from an area "simply used for storage and [their] washer and dryer to an area where [the husband was] manufacturing and processing marijuana.

Id. at *3,

Policy Language

The homeowners policy provided coverage for "accidental direct physical loss to property described in Coverages A and B except for losses excluded under Section I - Property Exclusions." 2013 WL 3732874 at *4.

The policy excluded losses caused by: "Increased Hazard, meaning any loss occurring while hazard is increased by a means within the control and knowledge of an insured." Id.

The Intentional Acts exclusion in the policy stated that losses due to the intentional acts of the insured were excluded from coverage "for all insureds, except for innocent co-insureds when the loss is caused by fire." Id. at n. 8.

A Michigan Amendatory Endorsement stated that the policyholder had "a duty to notify [the insurer] as soon as possible of any change which may affect the premium risk under th[e] policy," including "changes ... in the occupancy or use of the residence premises." 2015 WL 756206 at *2.

With regard to concealment, misrepresentation, or fraud, the policy stated that the insurer reserved the right to:

void this policy, deny coverage under this policy, or at [the insurer's] election, assert any other remedy available under applicable law, if [the named insured], or any other insured person seeking coverage under this policy, knowingly or unknowingly concealed, misrepresented or omitted any material fact or engaged in fraudulent conduct at the time the application was made or at any time during the policy period.

Id. The policy further provided that if the insurer voided the policy under this clause, the policyholder would have to reimburse the insurer for any claim payments previously made.

Trial Court Holding

Summary judgment for the insurer, ruling: (1) there was no coverage for the loss because it was not "accidental" and because the Increased Hazard exclusion also precluded coverage (on 7/15/13); and (2) the insurer was entitled to recover the payments it made to the policyholder following the fire before it learned of the fire's cause (on 4/15/14).

Appellate Court Holding

Affirmed, but on the basis that: (1) the policy was void because the policyholder failed to notify the insurer of a change in occupancy and use and therefore "omitted a material fact ... during the policy period"; and (2) the insurer was entitled to recover the payments it previously made to the policyholder before it discovered the cause of the loss.

Appellate Court Rationale

I. FAILURE TO NOTIFY THE INSURER OF A CHANGE IN USE VOIDED THE POLICY

The policyholder's failure to notify the insurer of the change in use of the premises, based on her knowledge that her husband had set up a marijuana growing operation in the basement, was sufficient to void the policy under the provision that required her to give notice "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." Her failure to give the required notice was a breach of a policy condition that resulted in "the suspension or restriction of insurance" as authorized by M.C.L. § 500.2833(1)(f). Consequently, the insurer could deny "coverage for the losses -- losses caused by the change in use -- that occurred approximately two years after [the husband] set up the marijuana growing operation." Id. at *4

A Michigan court decided that a similar notice provision was enforceable in McGrath v. Allstate Ins. Co., 802 N.W.2d 619 (Mich. App. 11/02/10) [reviewed at PLRB, Prop. Ins. L. Rev. 8118 (2010)]. The policy inMcGrath required notice "of any changes in title, use or occupancy of the residence premises." Failure to notify the insurer of the fact that the named insured moved out of the insured home to live with her daughter was a breach of the duty to give notice of a change in occupancy, as well as violation of the residency requirement in the policy.

The policyholder's failure to notify the insurer of change in the use of the premises also amounted to an omission of a "material fact ... during the policy period" in violation of the concealment or fraud clause in the policy. Under the terms of that clause, as well, the omission resulted in voiding the policy.

II. THERE WERE NO MATERIAL FACTS IN DISPUTE WITH REGARD TO WHETHER THERE WAS A CHANGE IN USE

The policyholder argued that a jury, rather than the court, should decide whether there had, in fact, been a change in use of the premises.

The court of appeals acknowledged that the district court did not address the issue but concluded that there was a change in use as a matter of law.

The policyholder made the following argument:

The policy does not envision every "change" be reported to the insurance company. Using [the insurer's] analysis, policyholders would be required to call their insurance company every time they bought a houseplant or had visitors. The insurer would have to be called every morning, when children left for school and when parents left for work and would have to be called again, when the family returned to re-occupy the dwelling and especially if the insured turned on the oven to cook dinner or a teenager smoked a cigarette. And even if the parent did not know the teenager was smoking a cigarette, be it nicotine or marijuana, and accidentally caused a fire, there would be no insurance coverage because the unknowing parent had not reported this "change" to [the insurer].

Id. at *4.

The court of appeals agreed that the policy did not "envision that every change be reported" but pointed out that it did require reporting of changes in use that would affect the premium risk. The facts in the record met that standard and were not at all analogous to the hypotheticals posed by the policyholder. As the court of appeals explained,

To equate setting up a marijuana growing operation -- an operation not likely contemplated by insurance companies at the time of drafting a standard fire insurance policy -- to buying a houseplant or entertaining guests -- both activities an insurance company would reasonably expect a homeowner to do -- mischaracterizes the extent of the change in use at issue. Far from merely adding one houseplant, at the time of the fire, [the husband] had approximately 28 marijuana plants growing in the basement. Two rooms in the basement had been converted into growing rooms -- with one housing plants in the "vegetative state" and the other serving as the "flower room" -- and [the husband] had spent upwards of $20,000 on lab equipment, including "[t]ons of lighting" and numerous cans of butane. Bay County Sheriff Deputy Jeffrey Wolpert, who investigated the fire, testified that he had never seen a marijuana processing facility as elaborate as the one in [the policyholder's] basement. Further, according to [the insurer's] representative, had [the policyholder] informed [the insurer] of [her husband's] marijuana operation, [the insurer] would have declined coverage altogether, because such an operation is an increased hazard and "an unacceptable risk."

Id. The court thus concluded, "because [the policyholder] failed to report the change in use of the premises to [the insurer] -- a change in use that would have had a great impact on the premium risk -- she cannot recover under the policy. To hold otherwise would make [the insurer] liable for a risk it did not assume." Id.

III. THE INSURER WAS ENTITLED TO RECOVER ITS PRIOR PAYMENTS

Because there was no coverage, the insurer was entitled to recover its prior payments through subrogation against the policyholder. The mortgage clause in the policy clearly provided that if the insurer pays the mortgagee and denies payment to the policyholder, the insurer will be "subrogated to all the rights of the mortgagee granted under the mortgage on the property." Id. at *5. At oral argument before the court of appeals, the policyholder conceded that if there was no coverage for the loss, the insurer would be entitled to subrogation.

[Editor's Note: The insurer relied on its subrogation rights under the mortgage clause because the check it sent to the policyholder was made out to both the policyholder and the mortgagee. The policyholder endorsed the check and sent it to the mortgagee to pay off the mortgage. The district court decided that the fact that the check was mailed to the policyholder did not preclude the insurer from asserting its subrogation rights under the mortgage clause. The court of appeals did not address the question of whether the insurer had subrogation rights under the mortgage clause under the facts of this case, presumably because the policyholder conceded the point during oral argument. For further discussion of the mortgage clause issues, see PLRB's review of the district court's opinion, No. 12-11863, 2014 WL 1464418 (E.D.Mich. 4/15/14) [reviewed at PLRB, Prop. Ins. L. Rev. 8932 (2014)].]

Comments

The U.S. Court of Appeals for the Sixth Circuit affirmed the district court's decision but determined that there was no coverage based on different policy provisions. The district court found there was no coverage on the basis that there was no "accidental" loss, and further concluded that even if the loss could be considered accidental, the Increase in Hazard exclusion applied. The court of appeals did not address those issues but instead found that the policyholder breached her contractual duty to notify the insurer of a change in occupancy or use.

By taking this approach, the court of appeals was able to avoid any consideration of innocent coinsured doctrine or of the innocent coinsured exception in the policy's intentional acts exclusion. The district court decided that innocent coinsured doctrine did not apply to the Increased Hazard exclusion and impliedly found that there was a hazard "increased by a means within the control and knowledge of an insured." Arguably there was a dispute of fact as to precisely what the policyholder knew about her husband's marijuana operations. By focusing on the change of use provision, the court of appeals was able to avoid factual issues, such as the extent of the policyholder's knowledge, and to focus on a policy condition, which did not implicate innocent coinsured doctrine because the evidence of the policyholder's breach came largely from her own admissions. The court of appeals also bypassed the question of whether the loss was accidental.

The provision requiring notice of a change of occupancy or use if it affects the insured risk is not found in standard ISO homeowners forms but is sometimes used in non-standard forms. The increased hazard clause is more common, although it, too, is not included in ISO standard forms. The increased hazard clause was removed from ISO commercial property forms in 1985 when they replaced the prior MP (multi-peril) form with the CP 00 10 (Building and Personal Property Form). See PLRB, Commercial Prop. Annotations CP652 - Vacancy (Language History - Changes and Discussion Regarding MP to CP). The increased hazard clause is found in lines 31-32 of the New York Standard Fire Policy (SFP), which establishes the statutory standard for fire insurance policies in some states. See PLRB, Homeowners Annotations, HO90 - Intentional Loss (listing of SFP states) and lines 31-32 under "Conditions Suspending or Restricting Insurance" (text of SFP ). The clause continues to appear in some policies and has been interpreted in case law from the beginning of the 20th century through the present.

Note on Publication Status: The Sixth Circuit issued its decision as an unpublished opinion. Consequently, it is not precedent, but it may be cited as persuasive authority. See Sixth Circuit Rule 32.1. [ Sixth Circuit Rules are available here ].

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We hope this discussion assists you. It is intended to present you with information about case law and other authority applicable to the interpretation of the relevant insurance policy provisions. Every effort has been made to ensure that the information provided is accurate. However, the opinions expressed here are for internal use only. They do not constitute a substitute for legal advice as to the law of a particular jurisdiction as applied in the full factual context of a particular claim.

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