Tenants Criminal Acts Damaging Property Eliminates Coverage

Criminal Act Exclusion Enforced

Landlords must be careful who they allow to rent their property. K.V.G. Properties rented real property to criminals who created a marijuana growing facility in the property and, as part of the work to grow the marijuana, did severe damage to the real property.

In K.V.G. Properties, Inc. v. Westfield Insurance Company, No. 17-2421, United States Court Of Appeals For The Sixth Circuit (August 21, 2018) the Sixth Circuit was faced with an insurance-coverage dispute because some of KVG’s commercial tenants got caught growing marijuana in their rental units. Unfortunately for their landlord, the tenants caused substantial damage to the premises before the police caught up with them.

THE POLICY

This case arises out of a standard first-party commercial insurance contract. The policy provides a broad range of coverage, from general physical damage insurance to a “fine arts floater.” The policy is organized under multiple “Forms,” each with their own insuring agreements, terms, and exclusions. The claim in this case arose under the Building and Personal Property Coverage Form (“BPP Policy”). Under this Form, Westfield agreed to pay for “direct physical loss of or damage to Covered Property . . . caused by or resulting from any Covered Cause of Loss.” For the purposes of KVG’s claims, a “Covered Cause of Loss” is any “Risk[] Of Direct Physical Loss.”

This generous insuring agreement is tempered by a litany of exclusions. One such exclusion states that Westfield “will not pay for loss or damage caused by or resulting from” any “[d]ishonest or criminal act by you, any of your partners, members, officers, managers, employees (including leased employees), directors, trustees, authorized representatives or anyone to whom you entrust the property for any purpose.”

FACTS

KVG, a commercial landlord, leased several pieces of real property to a group of commercial tenants. KVG authorized the tenants to use the property for general office or light industrial business. On October 29, 2015, the U.S. Drug Enforcement Agency raided the premises and caught the tenants growing lots of marijuana. KVG speedily evicted the tenants, but the damage had already been done: To accommodate their “business,” the tenants removed walls, cut holes in the roof, altered ductwork, and severely damaged the HVAC systems. The total cost of repair appears to be around $500,000.

KVG subsequently filed a claim with Westfield for insurance coverage. Westfield denied the claim, finding that several exclusions applied. The district court found that the loss was excluded by the policy and granted Westfield’s motion for summary judgment.

ANALYSIS

The Michigan courts engage in a two-step analysis when determining coverage under an insurance policy: (1) whether the general insuring agreements cover the loss and, if so, (2) whether an exclusion negates coverage.

The insuring agreements are written broadly to cover all “Risks of Direct Physical Loss.” Indeed, one would struggle to think of damage not covered by this language, and this is not a case that tests its boundaries. It is abundantly clear that the property suffered physical damage, necessarily caused by some risk (or risks) of direct physical loss. The harder question is whether the risks here are not covered because an exclusion takes them off the table.

Westfield argues that KVG’s tenants conduct was criminal under either state or federal law and that these acts were the main cause of KVG’s loss. Coverage under a policy is lost if any exclusion within the policy applies to an insured’s particular claims.

Under this exception, the core issue is whether the tenants committed a “criminal act” within the meaning of the policy. Cultivating marijuana is a crime under federal law but it is protected by Michigan law under certain conditions.

Exercising the Michigan courts’ common-law power to interpret public initiatives, a federal court 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. However, no reasonable jury could find that KVG’s tenants complied with Michigan law.

Ultimately, the insurer bears the burden of proving facts showing that an exclusion applies. Here, the record contains evidence that KVG itself claimed, in Michigan court, that its tenants violated the law. In its eviction pleadings against each tenant, KVG repeatedly claimed that the “[t]enant illegally grew marijuana” in the unit and stated that the “[i]llegal growing of marijuana” was a “continuing health hazard.” These pleadings were signed by KVG’s lawyer, who sought and obtained immediate possession of the premises under Michigan’s summary eviction statute.

Neither party disputes that federal agents raided the premises as part of a criminal investigation. At the time of the raids, federal officials were operating under guidance from the Deputy Attorney General stating that they should not prioritize individuals whose actions are in clear and unambiguous compliance with existing state laws providing for the medical use of marijuana.

The facts of the raid and arrests of the tenants were sufficient to meet Westfield’s prima facie case of proving a criminal act by the preponderance of the evidence.

The policy says “criminal act,” not “crime” or “criminal conviction.” A fugitive from justice may properly be deemed a criminal by the person he harms, even though the State cannot prove it beyond a reasonable doubt. The Michigan Supreme Court would not read an onerous “conviction requirement” into a standard commercial insurance contract. The Sixth Circuit declined to do so in the complete absence of state authority providing otherwise.

The policy’s insuring agreements cover the damage here. Westfield, however, has proven that the Dishonest or Criminal Acts Exclusion applies. Therefore, the district court did not err in granting Westfield’s motion for summary judgment.

ZALMA OPINION

The criminal acts exclusion, clearly and unambiguously, excluded coverage for losses due to the acts of a person or persons to whom the insured entrusted the property. In this case the insured entrusted the property to its tenants who damaged the property as part of their illegal marijuana growing operation. The lack of coverage was obvious and criminal.


© 2018 – Barry Zalma

This article, and all of the blog posts on this site, digest and summarize cases published by courts of the various states and the United States.  The court decisions have been modified from the actual language of the court decisions, were condensed for ease of reading, and convey the opinions of the author regarding each case.

Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant  specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 50 years in the insurance business. He is available at http://www.zalma.com and zalma@zalma.com.

Mr. Zalma is the first recipient of the first annual Claims Magazine/ACE Legend Award.

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About Barry Zalma

An insurance coverage and claims handling author, consultant and expert witness with more than 48 years of practical and court room experience.
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