Insurance Recovery Law

High Times in the Insurance Industry: Colorado Federal Court Considers Coverage for Medical Marijuana Business

Why it matters: With legalized marijuana businesses booming, a new decision from a Colorado federal court offers insight into insurance coverage issues for the industry. The Green Earth Wellness Center operates a retail medical marijuana business and growing facility in Colorado, where the state has legalized certain use of the drug. The company purchased a commercial property and general liability policy from Atain Specialty Insurance Company and submitted two claims: one for damage to the center's property after a break-in and a separate one after a wildfire in the area caused damage to marijuana plants at the facility. Although the fire did not directly impact the insured's business, the smoke and ash overwhelmed the ventilation system and caused damage to the marijuana "mother plants" and "clones." Most importantly for the policyholder, the court rejected the insurer's position that an exclusion for "contraband" applied because of the nature of the insured's business. Instead, the court said the exclusion was rendered ambiguous "by the difference between the federal government's de jure and de facto public policies regarding state-regulated medical marijuana," not to mention the fact Atain was well aware of Green Earth's business when it issued the policy. However, the judge did find that an exclusion for "growing crops" applied to part of the claim.

Detailed discussion: The Green Earth Wellness Center operates a retail medical marijuana business and an adjacent growing facility in Colorado Springs, Colorado. In 2012, the company obtained a commercial property insurance policy for its business from Atain Specialty Insurance Company.

In June 2012, a wildfire started in a nearby canyon and advanced toward the city. The fire did not directly affect Green Earth's business, but the smoke and ash from the fire overwhelmed the company's ventilation system, intruding into the growing operation and causing damage to Green Earth's plants. The policyholder submitted a claim for $200,000 to Atain.

The insurer denied the claim.

Separately, thieves broke into the Green Earth facility through a vent on the roof and stole some of the insured's marijuana plants. Green Earth made a second claim on the policy for damage to the roof and ventilation system, but the insurer again denied the claim, arguing that the damage amounted to only about $2,400, less than the policy's $2,500 deductible.

Green Earth filed suit asserting breach of contract for failure to pay under the policy, a statutory claim for bad faith under Colorado law, and a claim for unreasonable delay in payment. Both parties filed motions for summary judgment, and U.S. District Court Judge Marcia S. Krieger reached a split decision on the issues before her.

Most importantly, the court rejected Atain's contention that an exclusion in the policy for "Contraband, or property in the course of illegal transportation or trade" applied to preclude coverage for Green Earth's claims. With the policy lacking a definition of the term "contraband," Judge Krieger relied upon a dictionary definition of "goods or merchandise whose importation, exportation, or possession is forbidden."

Despite accepting Atain's observation that possession of marijuana for distribution purposes continues to constitute a federal crime, the court pointed out the "erratic" expression of federal policy. "The Court will not attempt to explain nor summarize the conflicting signals that the federal government has given regarding marijuana regulation and enforcement since 2009," the judge wrote. "It is sufficient to recognize that as early as 2009, and again mere weeks before Atain formally denied Green Earth's claim from the Waldo Canyon fire, federal authorities had made public statements that reflected an ambivalence towards enforcement of the Controlled Substances Act in circumstances where a person or entity's possession and distribution of marijuana was consistent with well-regulated state law."

Therefore, the policy's Contraband exclusion "is rendered ambiguous by the difference between the federal government's de jure and de facto policies regarding state-regulated medical marijuana," the court said.

Further, it was undisputed that Atain knew Green Earth was operating a medical marijuana business, Judge Krieger noted. "It is also undisputed that Atain knew—or very well should have known—that federal law nominally prohibited such a business," the court said. "Notwithstanding that knowledge, Atain nevertheless elected to issue a policy to Green Earth, and that policy unambiguously extended coverage for Green Earth's inventory of saleable marijuana. Nothing in the record ever indicates that Atain sought to disclaim coverage for Green Earth's inventory, much less that Atain ever informed Green Earth of its position that such inventory was not insurable. In such circumstances, the Court finds that the record suggests that the parties shared a mutual intention that the Policy would insure Green Earth's marijuana inventory and that the 'Contraband' exclusion would not apply to it."

Atain's related contention that public policy prevented the insurer from paying on the claims was met with a similar rebuke from the court. "The Court assumes that Atain obtained legal opinions and assurances on these points from its own counsel before ever embarking on the business of insuring medical marijuana operations," Judge Krieger wrote, adding in a footnote that the insurer's concerns "ring particularly hollow" since it already issued the policy.

Were the court to find that Atain's promises were void as against public policy, the court added, it "would be inclined to permit Green Earth to amend its pleadings to replace any claims sounding in breach of contract with a claim that Green Earth's payment of premiums for an illusory promise of insurance operated to unjustly enrich Atain," with a likely award of expectation damages.

Judge Krieger was not persuaded by precedent from a Hawaii federal court in Tracy v. USAA Casualty Ins., where a judge ruled in 2012 that an insurance policy providing coverage to a medical marijuana business was unenforceable due to public policy. Noting "several additional years evidencing a continued erosion of any clear and consistent federal public policy in this area," the court declined to follow the decision.

Atain tried other exclusions to block coverage.

Green Earth's business featured plants in several categories, ranging from "mother plants" (maintained solely for the purpose of producing a constant supply of clones but not cultivated to produce usable marijuana) to "clones" (plants that produce a root and grow to maturity). Once mature clones produce flowers and buds, those materials are removed by the grower, dried, and sold.

Green Earth's claim related to the Canyon fire sought damages for $200,000 with regard to mother plants and clones and $40,000 in damage to buds and flowers that had already been harvested. The policyholder contended that all of the plants were considered "stock" under the Atain policy.

Atain disagreed, as the policy defined "stock" as "raw materials and in-process or finished goods." Green Earth found a dictionary definition of "raw materials" that included wheat as "raw material for the flour mill." While noting that producers of agricultural products do not typically refer to their growing plants in common vernacular as "raw materials," Judge Krieger found "at least a colorable argument" that the term could include Green Earth's growing plants.

However, an exclusion for "growing crops" applied to the mother plants and clones, the court determined. The policyholder tried to distinguish its plants, raised indoors in containers, from "crops" grown in outdoor soil. But the court "sees nothing in the plain meaning of the word 'crop' that would seem to differentiate between 'crops' growing naturally in the solid earth and 'crops' of plants growing in pots or otherwise in artificial conditions such as an indoor greenhouse."

In addition, documents about the negotiations between the parties suggested that they "consistently understood" that the policy would not cover Green Earth's marijuana plants, "and thus, construing 'growing crops' to be ambiguous would inexplicably deviate from the parties' prior course of dealing," the court said.

Although the policyholder tried to argue that it had a reasonable expectation that plants would be included, the court pointed out that Atain never sought information about the number, types, and values of the plants Green Earth argued it was going to insure. "The fact that Atain never sought details about Green Earth's grow operation further refutes any contention that Green Earth's expectations that the Policy would cover its growing plants was a reasonable one," the court said, particularly as the application did ask questions about other issues, such as security for the business.

While coverage for the $200,000 claim for mother plants and clones was eliminated by the court, the issue of damages for the harvested marijuana buds and flowers should be decided at trial, Judge Krieger said, as well as Green Earth's contentions that Atain breached the contract, engaged in bad faith, and unreasonably delayed payment.

As for the theft claim, an affidavit stating that Green Earth owned the ventilation system that was damaged and had security footage showing the thieves entering through a hole they created in the system was sufficient to move the claim forward. The court did grant summary judgment to the insurer on breach of contract with regard to the claim, noting that a disagreement about the valuation of a claim was insufficient to form the basis of a breach of contract without evidence that the insurer's position was objectively unreasonable.

"It is not sufficient for an insured to simply tender a different valuation of a claim; indeed, were the court to hold that a mere disagreement between parties as to the valuation of a claim created a triable bad faith claim, essentially every insurance dispute would proceed to trial on such a claim, as disputes between the insurer and insured over the proper valuation of the loss are routine," Judge Krieger concluded.

To read the opinion and order in The Green Earth Wellness Center v. Atain Specialty Insurance Co., click here.

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Fourth Circuit Refuses to Rescind Policy for Innocent Co-Insureds

Why it matters: What happens when innocent co-insureds seek coverage for a lawsuit based on fraudulent misrepresentations made by another co-insured? In the Fourth Circuit Court of Appeals, the federal appellate panel found that innocent doctors at Agape Senior Primary Care remained entitled to coverage under a medical malpractice policy where an individual lied about his medical credentials and held himself out as a doctor. Before learning about the fraud, the company and its physicians—including the imposter—submitted renewal applications to the insurer. After the fraud was revealed, multiple lawsuits were filed against Agape, some naming the other doctors, and they turned to Evanston Insurance Company under a professional liability policy. The insurer denied the tender and filed a declaratory judgment action to rescind the entire policy. But the panel affirmed a district court's decision to invalidate coverage for the fake doctor only and leave it in place for the other insureds. The co-insureds were innocent and had no knowledge of the fraud, the court said, and public policy would not be served by rescission as applied to them. And as the drafter of the policy, the insurer could have added language for instances of fraudulent misrepresentations by one applicant—but failed to do so, the panel added.

Detailed discussion: A case of identity theft resulted in an insurance dispute involving a medical practice in South Carolina. In early 2012, Agape Senior Primary Care hired a man holding himself out to be Dr. Arthur Kennedy, a physician certified by the state board. The company employs physicians and other medical professionals who are sent to nursing homes and assisted living facilities branded with the Agape name.

Neither Agape nor any of its employees knew that Kennedy was actually a man named Ernest Osei Addo, a former friend of Dr. Kennedy who had stolen his identity and obtained a South Carolina driver's license with his own photo. The real Dr. Kennedy was out of the country at the time.

About six months after the fraud began, the truth was revealed when the police arrested Addo and notified the company of his true identity. Following his conviction for aggravated identity theft, Addo was sentenced to two years of imprisonment by a federal court judge.

Prior to Addo's conviction, Evanston Insurance Company issued a professional liability policy to physicians and other medical professionals at Agape, which also provided coverage for Agape. During Addo's time at Agape, the insurer sent renewal forms with individual applications for each physician. Addo filled out an application representing himself as Dr. Kennedy, board-certified in family medicine. The insurer renewed the policy and added Kennedy with an endorsement, charging an additional $4,000 premium for his coverage.

Three lawsuits were filed against Agape relating to Addo's fraud, and other entities gave notice of their intent to file suit. Although Evanston provided a defense for the lawsuits, the insurer filed a separate declaratory action against Agape seeking to rescind the policy.

A federal district court agreed that the policy was void as to Addo because of his fraudulent misrepresentations, but reached the opposite conclusion for the other insureds. In an unpublished opinion, a panel of the Fourth Circuit Court of Appeals affirmed, relying upon both state law and principles of equity.

"South Carolina law disfavors rescission against the insured," the court said. "In particular, under South Carolina law, three factors tip the equity scales in favor of Agape: (1) as the insurer and drafter, Evanston could have included forfeiture language in the policy; (2) neither Agape nor any of its employees had any knowledge of Addo's fraud, rendering them 'innocent' under South Carolina law; and (3) the public interest would not be served through rescission."

As the drafter of the policy, Evanston had the option to include express language supporting rescission for the intentional misrepresentation of any applicant and decided not to do so, the panel wrote. Case law emphasizes that "the existence of such provisions, when they are present, [operate] to limit coverage," the court said, and Evanston "could easily have included" such a provision.

Secondly, the extension of the innocent co-insured doctrine under South Carolina law made sense in this case because state law examines the liabilities of the parties for the fraudulent act, not their obligations. As the Fourth Circuit explained, "[T]he insured usually must exhibit some fault in order to support vitiation of an insurance policy."

Public policy considerations only served to reinforce the other two points, the court said.

"Equity cannot demand that the actions of one corrupt applicant, who conned Agape and Evanston alike, deprive the innocent insureds of the benefit of their contract," the panel wrote. "Agape and its employees separately applied for medical malpractice insurance in good faith, and they would be left without such insurance through no fault of their own. Evanston accepted individual premiums as to each insured and seemingly spread the risk accordingly. Further, and perhaps most important in an equitable determination, rescission would leave the public essentially unprotected on matters of medical malpractice brought against every other Agape employee."

To read the per curiam opinion in Evanston Insurance Co. v. Agape Senior Primary Care, click here.

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Distinguishing Claims Made Policies, New Jersey Supreme Court Says Insurer Not Required to Show Prejudice for Late Notice

Why it matters: In a recent loss for policyholders, the New Jersey Supreme Court has declared that an insurer is not required to demonstrate prejudice to deny coverage for late notice under a claims made policy, even if the claim was made during the policy period. Financing company First Independent purchased a Directors and Officers policy from National Union Fire Insurance Company that required the insured to provide notice of any claims "as soon as practicable" and no later than 30 days after the claim had been made as a condition precedent of coverage. The insurer relied upon this language when denying coverage for a lawsuit filed by Templo Fuente De Vida Corporation over problems with financing for a real estate transaction, arguing that First Independent waited six months to provide notice. The parties in the underlying litigation settled and First Independent assigned its rights against the insurer to Templo Fuente, which sued. But a trial court judge granted summary judgment to the insurer and an appellate panel and the state's highest court affirmed. Unlike an "occurrence" policy, the claims made policy at issue did not require proof of prejudice to the insurer, the court held, as the policyholders "are particularly knowledgeable insureds" who "are much better able to deal with the insurers on an equal footing" and can be expected to understand the terms and conditions of their policy, including the notice requirements.

Detailed discussion: Must an insurance company demonstrate it was prejudiced by an insured's failure to comply with the notice provision in a Directors and Officers "claims made" policy? The New Jersey Supreme Court recently answered in the negative.

The dispute began when Templo Fuente De Vida Corporation engaged a mortgage company to find funding sources for the purchase of property to relocate its church and daycare centers. Templo Fuente made a down payment and entered into a purchase agreement to buy a property, conditioned upon mortgage financing.

Over the course of several months, the financing company—today known as First Independent Financial Group—gave Templo Fuente a series of funding commitments. But on the final closing date, none of the financial sources were able to fund the loan to purchase the property. Templo Fuente sued First Independent to recover its losses.

First Independent purchased a Directors and Officers policy from National Union Fire Insurance Company for the time period of January 1, 2006 through January 1, 2007. The "claims made" policy required that, as a condition precedent to coverage, the insured must "give written notice to the Insurer of any Claim made against an Insured as soon as practicable and either: (1) anytime during the Policy Period or during the Discovery Period (if applicable); or (2) within 30 days after the end of the Policy Period or the Discovery Period (if applicable), as long as such Claim is reported no later than 30 days after the date such Claim was first made against an Insured."

The insurer denied coverage to First Independent based on this provision. The policyholder waited more than six months after being served with the first amended complaint—even retaining counsel and filing an answer—to provide notice to National Union, which was certainly not "as soon as practicable," the insurer said.

Templo Fuente and the insured settled, with a portion of First Independent's liability satisfied by the assignment of its rights against the insurer, and Templo Fuente sued. A trial court judge granted National Union's motion for summary judgment and dismissed the complaint with prejudice. The intermediate appellate panel affirmed and, in a unanimous opinion, so did the New Jersey Supreme Court.

The court emphasized the differences between the "claims made" policy at issue and "occurrence" policies to hold that National Union was not required to demonstrate prejudice to deny a claim for late notice.

"Occurrence" policies were created to offer coverage for harms caused by collision, fire, and other similar acts, with liability triggered by an easily identifiable event, the court explained. Occurrence policies insuring against professional negligence trended out of favor due to the difficulties for underwriters facing an unlimited tail extending beyond the policy period, and insurance companies began to shift to "claims made" policies for professionals.

Because of the different risks, the reporting requirements for the policies differ, with "claims made" policies typically having an additional provision requiring that insurers be notified promptly and within the policy period. Such requirements maximize the insurer's opportunity to investigate and control or participate in negotiations with the third party, the court said.

In New Jersey, the courts have long taken the position that public interest requires an insurer to show prejudice to forfeit coverage for an insured's breach of the notice provision in an occurrence policy. Part of the reasoning is that such policies are generally adhesion contracts with a "stark imbalance" between insurance companies and insureds in terms of their respective understanding of the terms and conditions of the policy, the state's highest court wrote.

However, those same policy concerns do not apply with equal force to claims made policies, the court said, as demonstrated in a 1985 decision in Zuckerman v. National Union Fire Insurance Company concluding that an insurer was not required to demonstrate prejudice in such cases.

With this background, the New Jersey Supreme Court had no problem siding with the insurer as a matter of contract interpretation. "By the terms of the policy, National Union agreed to provide First Independent coverage for acts or omissions taking place at any time so long as the claim was made and reported to National Union both within the policy period and 'as soon as practicable,'" the court wrote.

Despite Templo Fuente's argument that whether a claim was reported "as soon as practicable" was a fact-sensitive issue, the court noted that Templo Fuente did not argue that the notice provision was ambiguous, and conceded during oral argument that First Independent did not notify the insurer "as soon as practicable." The insured also did not explain why the delay occurred. Thus, because no factual dispute existed that notice was not timely, the court held that the six-month delay did not satisfy the policy's notice requirement. However, the court refused to draw a "bright line" for timely compliance with an "as soon as practicable" notice provision.

Turning to the issue of prejudice, the court reiterated the differences between occurrence and claims made policies, particularly the characteristics of the parties involved. "[I]n the vast majority of 'occurrence' policies, the policyholders are 'unsophisticated consumer[s] unaware of all of the policy's requirements,'" the New Jersey Supreme Court said. Courts therefore take special consideration that such policyholders are unlikely to be conversant with the fine print of their policies and "[w]e have historically approached 'claims made' and 'occurrence' policies differently due in large part to the differences between the policyholders themselves."

But First Independent was not an unsophisticated consumer, the court said. "First Independent is not an individual and this policy is not a simple personal liability insurance policy," the court wrote. "To the contrary, the insured was an incorporated business entity that engaged in complex financial transactions," and used a broker to procure the policy on its behalf.

"Those equitable concerns based on the nature of the parties do not control in our analysis of the 'as soon as practicable' notice requirement of the Directors and Officers 'claims made' policy here, where the policyholders 'are particularly knowledgeable insureds, purchasing their insurance requirements through sophisticated broker[s].' In this arena, insurers are 'dealing with a more sophisticated clientele, [who] are much better able to deal with the insurers on an equal footing[.]'"

In the case at hand, a "sweeping statement" about "the strictness of enforcing the 'as soon as practicable' notice requirement in 'claims made' policies generally" was unnecessary, the court said. "We need only enforce the plain and unambiguous terms of a negotiated Directors and Officers insurance contract entered into between sophisticated business entities."

First Independent "violated a condition precedent of timely notice to National Union, and thus breached the policy's express condition of notice of a claim in order for coverage to attach," the unanimous court wrote. "[W]e conclude that the notice requirement within the contract of insurance sold by National Union to First Independent sufficiently conformed to the objectively reasonable expectations of the insured and, hence, did not violate the public policy of New Jersey."

A different conclusion may have been reached in other jurisdictions, the court added, "but our jurisprudence has never afforded a sophisticated insured the right to deviate from the clear terms of a 'claims made' policy."

To read the opinion in Templo Fuente De Vida Corp. v. National Union Fire Insurance Co., click here.

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Insurer Must Provide Defense for Farms Accused of Spraying Pesticide on Neighbor

Why it matters: Rejecting an insurer's arguments that multiple exclusions operated to preclude coverage, a Florida federal court judge ruled that two farms are entitled to a defense for a lawsuit accusing them of spraying pesticide on a neighboring farm. Florida Crystals Corporation and Sugar Farms Co-Op were hit with a lawsuit by Date Palm Wholesalers alleging that their pesticide contractor accidentally sprayed its nurseries, causing damage to the date palm farm's crops. National Union Fire Insurance Company argued that exclusions for an expected or intended injury as well as one for damage to property over which the insured exercises control blocked coverage for the farms. But the court ruled that the alleged spraying error constituted an "accident" under the policy and application of the control provision was unclear. Uncertain if spraying pesticide from the air constituted the exercise of control, the court said it could not apply the exclusion. Having found that the crop dusting was an "occurrence" under the policy, the court ruled the insureds were entitled to judgment and reimbursement for attorneys' fees and costs spent on the underlying litigation.

Detailed discussion: Date Palm Wholesalers, Inc. operates a commercial nursery in Palm Beach County, Florida. Nearby, Florida Crystals Corporation and Sugar Farms Co-Op own and maintain sugar cane growing and processing operations. The sugar cane farmers contract with Roma Air Corp., a company specializing in the aerial application of pesticides.

According to a complaint filed in Florida state court by Date Palm, the sugar cane farms directed Roma to spray a powerful herbicide on a large area of land that included not only the sugar cane operations but Date Palm's nursery as well, damaging many of the palm trees.

When the farms tendered Date Palm's suit to National Union Fire Insurance Company, the insurer filed its own lawsuit, seeking a declaration that the policy at issue imposed no duty to defend or indemnify Florida Crystals and Sugar Farms. U.S. District Court Judge James I. Cohn denied National Union's motion for summary judgment, but National Union renewed the motion.

Proceeding to render judgment on the substance of the pleadings, the court said the insurer could only avoid a duty to defend if all of the allegations in the Date Palm complaint fell within one or more policy exclusions. Because "some allegations in the Date Palm Complaint remain outside of the exclusions identified by [the insurer], thereby triggering [the] duty to defend," the court denied the motion and entered partial judgment on behalf of the insureds.

Judge Cohn first addressed the Expected or Intended Injury Exclusion, which excluded "Property Damage expected or intended from the standpoint of the Insured." The harm to the Date Palm nursery arose from the carelessness of the sugar cane farms in using herbicides, the court said, which came within the policy's meaning of an "accident," or "injuries or damage neither expected nor intended from the standpoint of the insured." Allegations of accidental harm therefore did not fall within the exclusion, the court said.

National Union also pointed to an exclusion for Property Damage to Property Over Which the Insured Exercises Control. Did Roma's alleged spraying of herbicide on Date Palm's plants from the air represent the exercise of control over the property? The question was "arguable," Judge Cohn found, and "'[w]here, as here, the applicability of an exclusion is uncertain, the insurer is not relieved of its duty to defend.'"

Finally, the insurer argued that the Services Performed by or on Behalf of the Insured Exclusion removed the allegations in the Date Palm complaint from the scope of policy coverage. However, an endorsement extending coverage to include the aerial application of chemicals "of benefit to or of direct use in the business of" the insureds appeared to reinstate such coverage.

This explicit addition of coverage for the aerial application of chemicals in the course of the sugar cane farms' business conflicted with the exclusion of claims for damage resulting from services performed on their behalf, the court said. Where an endorsement conflicts with the body of an insurance policy, the endorsement controls and the exclusion did not relieve National Union of a duty to defend.

"Because at least some of the allegations in the Date Palm Complaint fall within the scope of Policy coverage and are not otherwise excluded, the Court finds that [the insurer] has a duty to defend [the sugar cane farms] in the Date Palm Action," Judge Cohn wrote. Accordingly, the sugar cane farms were entitled to judgment on the pleadings on the duty to defend issue and entitled to be reimbursed by National Union for the reasonable attorneys' fees and costs incurred in their defense of the Date Palm action.

The order was not a total victory for the insureds, however, as the court said the duty to indemnify remains unresolved, leaving an award for attorneys' fees and costs incurred in defense of the declaratory action premature. The judge denied the motion for those attorneys' fees and costs without prejudice, allowing the sugar farms to renew their request later in the litigation.

To read the order in National Union Fire Insurance Company v. Florida Crystals Corp., click here.

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