United States: Should The Cannabis Industry Fear The Sixth Circuit And K.V.G.?

Although any case has the potential to go sideways, the appeal in K.V.G. Properties, Inc. v. Westfield Insurance Company – which involves a policyholder's right to insurance coverage for property damaged by a third party's marijuana growing operation – should not be cause for alarm in the cannabis industry.

As driven home by the opening briefs recently filed by both parties in the U.S. Court of Appeals for the Sixth Circuit, any potential outcome of the appeal (No. 17-2421) is unlikely to negatively affect a legitimate cannabis-related business' right to insurance.

At issue in K.V.G. is whether a commercial landlord is entitled to coverage from its own insurer for damage done to the landlord's property by tenants who, unbeknown to the landlord, were using the property to grow marijuana illegally. Below, the federal district court explained that "there is no evidence" that "the tenants' marijuana operations were legal under" applicable state law.

Denying the landlord's claim for coverage, the insurer relied, in relevant part, on the illegal/dishonest acts exclusion in the landlord's insurance policy. That exclusion states that the insurer "will not pay for loss or damage caused by or resulting from ... Dishonest or criminal act by you, any of your partners, members, officers, managers, employees ... directors, trustees, authorized representatives or anyone to whom your entrust the property for any purpose ...."

On the basis of that exclusion as well as other policy language, the U.S. District Court for the Eastern District of Michigan found that the landlord was not entitled to coverage and granted the insurer summary judgment. The landlord appealed.

Regardless in whose favor the Sixth Circuit ultimately decides this appeal, the outcome is unlikely to jeopardize the ability of legitimate cannabis-related businesses to buy insurance and obtain coverage under, insurance policies.

For the landlord to prevail – as it should – the appellate court almost certainly would have to determine that the illegal/dishonest acts exclusion does not bar coverage. It could – and should – do so by holding that, for that exclusion to apply, it is the policyholder who must have committed the dishonest or illegal act. That would be the most sensible reading of the policy and that particular exclusion. In K.V.G., there does not appear to even be an allegation that the policyholder committed any such impermissible act.

Additionally, as the landlord explained in its opening brief, "[r]ead in context, it is fairly obvious that this exclusion does not contemplate a landlord–tenant relationship." The relevant context includes the continuation of the exclusion, which provides that it applies "[w]hether or not occurring during the hours of employment." Simply put, the exclusion focuses on the acts of the policyholder or its agents and not some third party.

Even if the insurer were to prevail before the Sixth Circuit, however, the outcome of this appeal is still unlikely to have a dramatic effect on insurance coverage for the cannabis industry for a number of reasons:

  • The Sixth Circuit could simply decide that the landlord has not established that it is entitled to coverage under the policy or that an exclusion other than the illegal/dishonest acts exclusion bars coverage. In either event, the court would not have to consider the effects of the illegal/dishonest acts exclusion if applied to the facts before it.
  • If the Sixth Circuit does decide to consider and apply the illegal/dishonest acts exclusion, its decision can be limited to the question of whether the tenants – to whom it would have to find property was entrusted – were engaged in "dishonest" acts, i.e., by, as the insurer states, "misrepresenting the operations they were conducting in their respective suites, by secretly growing marijuana on the premises, by making unauthorized alterations to the suites as well as to the HVAC and electrical equipment and systems, and by causing damage to and neglecting to maintain other equipment." If the court determines that the exclusion applies because the tenants were engaged in "dishonest" acts, the Sixth Circuit, as the insurer acknowledges, would not need to "reach the question of whether growing marijuana is 'illegal'."
  • Although medical marijuana is now legal in Michigan, it does not appear, as the district court observed, that the tenants were licensed under Michigan law to grow marijuana. To date, the parties' appellate briefs do not contain any evidence that the tenants complied with any Michigan marijuana law. Thus, it appears that the tenants' conduct would have been illegal under state law.

Only if the Sixth Circuit were to go further – indeed, further than it needs to – would the court have to address any issues relating to a cannabis-related business that is legal under state law.

In its brief, the insurer at least implicitly argues that even then the exclusion would apply because the conduct would still be criminal: "[I]rrespective of Michigan law, growing marijuana is illegal under federal law." This argument, however, is disingenuous and overly simplistic. It would be bad faith for an insurance company to sell an insurance policy to a cannabis-related business authorized by state law – knowing, for example, that it grew or sold marijuana – and then later deny coverage because the policyholder was in the cannabis industry. That contrived argument has been met with less and less success in the courts. In any event, the Sixth Circuit need not reach this issue.

The landlord is permitted to file a reply brief, which would be due this week. The landlord also has requested oral argument. The insurer argues that "[o]ral argument would be an unnecessary expenditure of the parties' and the Court's time and resources." The Sixth Circuit has not yet decided if and when it will hear oral argument.

This article is presented for informational purposes only and is not intended to constitute legal advice.

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