For a landlord, it’s a bad day when your tenant gets busted for operating a meth lab, and the local authorities condemn your house because it’s contaminated with the byproducts of his business.  It’s even worse when you learn there is no coverage for the cost of cleaning up the contamination.

Neighborhood Investments, LLC, leased a house in Louisville, Kentucky, to a Mr. Kenneth McCormick. As neighborhood investments go, this was not a winner.  Mr. McCormick was arrested for operating a methamphetamine laboratory at the leased location.  Worse yet for the landlord, the methamphetamine production had contaminated the house and rendered it uninhabitable.  Authorities prohibited re-leasing the house to any other tenant until the premises were decontaminated.

Neighborhood Investments made a claim for the decontamination costs under its property insurance policy, which was issued by Kentucky Farm Bureau Mutual Insurance Company (“KFB”).  KFB denied the claim, and Neighborhood Investments sued.

Better Call Saul

Unsurprisingly in a land gone mad over “Breaking Bad,” this is not the first coverage case involving an illegal meth lab.  In several earlier cases, insurers sought to deny coverage by relying on the “contaminant” language found in the “latent defect” exclusion.

That argument met with only limited success.  Courts have been reluctant to read the “contaminant” language so broadly as to include the odors, particulate and chemical residue associated with meth lab contamination.  In Largent v. State Farm Fire & Cas. Co.,842 P.2d 445, 446 (Or. App. Ct. 1992), the court declined to apply the latent defect exclusion, finding that it “does not apply to underlying covered events that may have the incidental result of producing residual contamination.”  In Graff v. Allstate Ins. Co., 54 P.3d 1266, 1268 (Wash. App. Ct. 2002), the court held that the byproducts of illegal meth labs are not a “contaminant” under the language of the latent defect exclusion.

In State Farm Fire and Cas. Co. v. Groff,  No. CIV–10–171–SPS, 2011 WL 3937317, *3 (E.D. Okla. Sept. 7, 2011), the court held that the contamination exclusion in the plaintiff’s policy applied to claims based on “the presence of methamphetamine fumes or residue thereof on walls and other surfaces,” but that it might not apply to corrosion that was allegedly caused by those fumes, and it definitely did not apply to “holes in doors and walls and broken windows,” even if they were caused by an unruly drug kingpin.

Cooking Meth is a Criminal Act

Courts have been more receptive to denials of coverage based on the criminal acts exclusion in liability policies. E.g. Tualatin Valley Housing Partners v. Truck Ins. Exchange, 144 P.3d 991, 993-94 (Or. App. Ct. 2006).  That was the approach taken by KFB in Neighborhood Investments, LLC v. Kentucky Farm Bureau Mut. Ins. Co., No. 2013-CA-000375-MR (Ky. App. Ct. March 28, 2014).  Neighborhood Investment’s policy contained an exclusion that barred coverage for loss caused by any “[d]ishonest or criminal act by you. . .  or anyone to whom you entrust the property.”  KFB argued that Neighborhood Investments had “entrusted” its house to the felonious tenant.  The trial court agreed and granted summary judgment to the insurer.

On appeal, the landlord argued that the term “entrust” was not defined in the policy, that it was not synonymous with “lease,” and that, at best, the policy was ambiguous on the issue of what it means to “entrust” a property to someone else.

The appeals court, however, was armed with a passel of dictionaries, and it affirmed.  It cited Merriam-Webster’s Collegiate Dictionary, which defines “entrust” as meaning, “to confer a trust on” or “to commit to another with confidence.”   It cited Black’s Law Dictionary, which says “entrust” means “[t]o give (a person) the responsibility for something, usu. after establishing a confidential relationship.”  And it cited a 40-year-old Texas case, Imperial Ins. Co. v. Ellington, 498 S.W.2d 368 (Tex. Civ. App. 1973), which had made the following observations:

The word ‘entrusted,’ as used in the exclusionary provision, conveys the idea of the delivery or surrender of possession of property by one to anotherwith a certain confidence regarding the other’s care, use or disposal of the property. …

‘Entrustment’ clearly suggests the existence of a consensual bailment situation where the person delivering the property expects the person to whom possession is delivered to use the property for the purpose intended by the owner and stated by the recipient.

Under the terms of the lease, the court found, Neighborhood Investments had acknowledged that “it expected McCormick would not use the house for any kind of criminal enterprise, much less any kind of criminal enterprise that would render the house uninhabitable.”  Thus, the landlord had “entrusted” the house to McCormick within the plain meaning of the term, and the criminal acts exclusion applied.

What Will the Sequel Bring?

Heisenberg might say it’s uncertain whether the criminal acts exclusion would apply to damage caused by a meth lab—if, like Jesse Pinkman, the tenant/operator has managed to avoid arrest and conviction.  The courts do not appear to have addressed this question yet, but in other contexts, “[a] conviction is not required for a ‘criminal act’ exclusion in an insurance policy to apply.”  Cincinnati Ins. Co. v. Roccanova, 2012 WL 381752 (E.D. Ky. Feb. 6, 2012).  The insurer would simply need to establish the criminal act by a preponderance of the evidence, and the chemical deposits on the walls of the premises would doubtless supply a big clue.  Moreover, a contrary rule would arguably discourage landlords from reporting drug dealing tenants to the authorities.  That would be taking trust too far.