Beware the Insurance Risks Relating to the Marijuana Industry

The commercial sale of marijuana is currently an area for business growth of exponential potential through, for example, the operation of dispensaries and cultivation centers. But marijuana, be it for medical or recreational use, is still classified by the federal government as a Category 1 controlled substance. Therefore its possession and use can be problematic, not only for the individuals and businesses directly involved with dispensaries and cultivation centers, but also with any ancillary individual or business that deal with them (i.e., a reason banks are reluctant to deal with them – they don’t want to be associated with a “criminal enterprise” and any ensuing potential fallout).

Nevertheless, several states now allow for medical marijuana and some even have legalized its recreational use. While marijuana may now be contributing to the welfare and treasuries of those several states, it remains illegal on a nationwide basis. As such, individuals and businesses that deal with a marijuana venture must remain cognizant about the risk they are undertaking. For example, landlords (and banks that hold mortgages to the premises) that rent to medical marijuana stores or lease warehouses to be cultivation centers, may have a significant hurdle to overcome if they have to make a property insurance claim. If the leased premises burn down through no fault of the landlord, the landlord’s insurer could still assert federal law to support a claim declination, a scenario contemplated in a recent federal district court out of Michigan.

In K.V.G. Properties, Inc. v Westfield Insurance Co., 2017 U.S. Dist. LEXIS 185005, a landlord submitted an insurance claim for property damage to its warehouse resulting from a tenant’s undisclosed and unauthorized use of the premises as a marijuana cultivation facility. The tenant, without permission, had removed walls, cut holes in the roof, created excess moisture, and caused other damage to the warehouse as part of his marijuana business. After evicting the tenant, the landlord made an insurance claim for the damage. The insurance company, however, denied the claim and the landlord sued for the withheld payment.

The District Court, citing several bases, granted summary judgment for the insurer. One argument raised by the insurance company concerned the “Illegal/Dishonest Acts Exclusion” found in many commercial property policies. Observed the District Court:

[T]he purpose of the dishonest acts exclusion has been described ‘to exclude from the risk undertaken by the insurer those losses that arise from the misplaced confidence of the insured in those to whom it entrusts its property.’ …. it is clear that the operations violated federal law. See 21 U.S.C. Sec. 812 (classifying marijuana as illegal substance); 21 U.S.C. Sec. 841(a)(1) (imposing  penalties for manufacture and distribution). See also 21 U.S.C. Sec. 856 (penalizing leasing property for purpose of manufacturing, storing distributing, or using a controlled substance) … This suggests that the loss falls under the dishonest/illegal acts exclusion.

Accordingly, the Court agreed with the insurer that the exclusion barred recovery.

Using the K.V.G. Properties case for support, it is therefore foreseeable that, at least while marijuana remains illegal on the federal level, other insurers may rely on Illegal/Dishonest Acts Exclusion to disclaim coverage and obligations they may have to otherwise innocent policyholders. As a result, even enterprises conducting business that is merely adjacent to the marijuana industry still incur substantial risk in their operations.