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.