The Sixth Circuit’s recent decision in K.V.G. Properties, Inc. v. Westfield Insurance Co.underscores that an insured’s admissions in non-insurance litigation may later be used as a basis for insurers and courts to deny claims for coverage. In K.V.G. Properties, the court affirmed summary judgment in favor of an insurer in a case in which the insured sought coverage for property damage caused by tenants who surreptitiously converted the insured’s warehouse into an unauthorized marijuana cultivation operation. The Sixth Circuit concluded that the damage was a covered direct physical loss but held that a Dishonest or Criminal Acts Exclusion barred coverage. To support a finding that the insured’s tenants had committed a criminal act, the court held that the policyholder’s pleadings in its eviction cases against the tenants (which asserted that the tenants had committed illegal acts) were binding admissions in the insured’s subsequent case over its claim for insurance coverage. The Sixth Circuit concluded that these admissions made the case so one-sided that it required granting summary judgment in favor of the insurer.
In K.V.G. Properties Inc. v. Westfield Insurance Co., the insured claimed that its building and personal property policy covered its loss from unauthorized alterations made to its Michigan warehouse by tenants who surreptitiously began cultivating marijuana. The Sixth Circuit agreed that the damage caused to the warehouse by the tenants’ tearing down walls, cutting holes in the roof and modifying the electrical, water and HVAC systems were covered risks of direct physical loss. However, the policy excluded coverage for “loss or damage caused by or resulting from” a “[d]ishonest or criminal act by ... anyone to whom” the insured “entrust[ed] the property for any purpose.” The court held that this exclusion barred coverage for the insured’s entire loss.
The insurer had introduced evidence that the U.S. Drug Enforcement Agency had raided the premises. The court concluded this had some tendency to show the tenants violated the federal Controlled Substances Act and the Michigan Medical Marihuana Act. The insurer also introduced evidence that the insured had represented to a state court that the tenants should be evicted because they acted illegally in growing marijuana. The court held that, taken together, this was sufficient proof that the tenants committed a criminal act, even if they were never convicted of a crime beyond a reasonable doubt. The insured failed to rebut the insurer’s prima facie case that the exclusion applied because it introduced no evidence that the tenants complied with the law. The Sixth Circuit therefore held that the insured’s entire loss was excluded by the tenants’ criminal acts.
To explain the facts in more detail, the insured was a commercial landlord that leased several units in a Michigan warehouse to a group of four individuals and a corporation for operation as a general office or to conduct light industrial business. The leases did not authorize the tenants to make alterations to the structure or its electrical, water or HVAC systems. The insured apparently did not visit the property for over four years and knew nothing of the tenants’ activities on premises.
Meanwhile, the tenants began operating a large-scale marijuana cultivation operation, in violation of the CSA (which forbids growing marijuana in almost all circumstances) and without complying with the MMMA (which permits growing marijuana in certain circumstances). To facilitate their enterprise, the tenants surreptitiously removed walls, cut holes in the roof, modified the electrical system and plumbing and added HVAC ductwork and gas lines, causing significant damage to the property.
The DEA raided the premises as part of a criminal investigation into the tenants’ possible violations of the CSA. Federal guidance then, in effect, directed the DEA to prioritize using federal resources to pursue marijuana cultivators and distributors who were not following state law. The DEA’s raid thus suggested the tenants were operating in violation of the MMMA, as well.
The insured asserted that it learned of the tenants’ activities after the raid and thereafter filed eviction actions against the tenants. In its court filings, the insured repeatedly claimed that the tenants illegally grew marijuana on the premises and that doing so qualified the tenants for eviction. The insured succeeded in evicting the tenants based on these representations.
The insured next filed a claim with its insurer for the damage resulting from the tenants’ alterations to the property. The insurer conceded the loss occurred at some point during the policy period and that at least some of the damage resulted from a direct physical loss. The insurer denied the claim, however, based on several exclusions, including the dishonest or criminal acts exclusion.
The insured filed suit in Michigan state court seeking a declaration of coverage. The insurer removed the case to federal court and moved for summary judgment. The district court agreed, concluding that the exclusion applied because the tenants had committed a criminal act, or at least acted dishonestly, in their representations to the insured about their intended use of the property. The district court accordingly granted summary judgment in favor of the insurer.
The Sixth Circuit affirmed. The court first concluded that all of the tenants’ damage to the property qualified as covered direct physical losses. “It is abundantly clear,” the Sixth Circuit wrote, “that the property suffered physical damage, necessarily caused by some risk (or risks) of direct physical loss.” The court provided little explanation for its conclusion, stating only that “[t]he physical damage to the building is covered ... because of its very nature ... .”
The Sixth Circuit then concluded, however, that the insurer was entitled to summary judgment because the insured’s loss was excluded from coverage by the dishonest or criminal acts exclusion. This exclusion included two elements: (1) a dishonest or criminal act and (2) committed by “anyone to whom” the insured “entrust[ed] the property for any purpose.” The insured did not argue on appeal that the second element was relevant, therefore the Sixth Circuit only addressed the first. The court held that the tenants had committed a criminal act.
Specifically, the court held the insurer could prove that the tenants committed a criminal act that caused the insured’s loss by a preponderance of the evidence, even though the tenants were never convicted of a crime beyond a reasonable doubt. The court explained: “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 Sixth Circuit’s holding that this exclusion does not incorporate a “conviction requirement,” thus significantly lowers the burden on insurers attempting to prove a criminal acts exclusion applies.
Turning to the insurer’s proof that the tenants had committed a criminal act that caused the insured’s loss, the court determined three facts were relevant to this question:
- Because the DEA was prioritizing enforcement of the CSA against those noncompliant with state marijuana laws, its decision to raid the property had some tendency to suggest that the tenants violated the MMMA;
- The insured repeatedly represented in eviction proceedings against the tenants that they had acted illegally in growing marijuana, which was the impetus for the tenants’ alterations of the property for which the insured sought coverage; and
- No evidence suggested that the tenants had been in full compliance with the MMMA.
The Sixth Circuit held that, particularly when taken together, these facts were sufficient to show by a preponderance that the tenants committed a criminal act. As to the insured’s admissions, the court wrote that the insured’s “repeated claim[s]” in “its eviction pleadings against each tenant” that they “illegally grew marijuana” were “evidence” that the tenants committed criminal acts. The court explained: “Pleadings are binding legal documents that can be admitted as evidence against that party in subsequent proceedings.” The Sixth Circuit’s decision in P.V.G. Properties is a reminder to insureds to exercise caution when litigating against those responsible for their losses not to make admissions that insurers and courts may later use as a basis to exclude coverage.
The insured in P.V.G. Properties was unable to rebut this key evidence with any evidence that the tenants had complied with the MMMA. The court suggested that if the tenants had done so, it might have rendered the exclusion inapplicable because the policy was governed by Michigan law. But the court would not answer that question absent evidence of compliance. Therefore, the Sixth Circuit affirmed summary judgment for the insurer that the exclusion applied, and the insured’s loss was not covered under the policy.
The Sixth Circuit’s decision sets a relatively low burden of proof for an insurer to establish that a criminal acts exclusion applies to an otherwise-covered loss. P.V.G. Properties thus also highlights that commercial property owners should take reasonable steps to monitor their tenants’ activities, as the insured in that case had failed to do. Most importantly, P.V.G. Properties underscores that all insureds should take care to avoid admissions that may be used against them in subsequent litigation over coverage for their losses.
This article was first published in Law360.