Case Notes

The landlord rented commercial property to a group of tenants to be used for light industrial purposes. Instead, they surreptitiously used the premises for cultivating marijuana plants, doing significant damage in the process when they removed walls, punched holes in roofs, and altered ductwork, among other things. The property was ultimately raided by federal law enforcement agents and the operation was shut down.

In Michigan state court eviction proceedings brought soon thereafter, the landlord argued it was entitled to remove the tenants because they had violated state and federal law by illegally growing marijuana. The tenants were lawfully evicted.

The landlord/insured sought recovery of approximately $500,000 from its insurance agency, Westfield Insurance Co. The insurance policy on the property contained what the parties termed a “Dishonest or Criminal Acts Exclusion.” It stated that Westfield would “not pay for loss or damage caused by or resulting from” any “[d]ishonest or criminal act by you, any of your partners, members, officers, managers, employees (including leased employees), directors, trustees, authorized representatives or anyone to whom you entrust the property for any purpose.” Based on this and other contract terms Westfield refused to pay the $500,000 claim.

The landlord/insured brought suit against Westfield for breach of contract. The case was removed from state to federal court. There the landlord failed to produce evidence to indicate that its tenants had been in compliance with Michigan State law pertaining to lawful medical marijuana cultivation, causing the court to side with the insurer and dismissed the suit.

The Sixth Circuit noted on appeal that the burden is on an insurer to present evidence that circumstances pertaining to an exclusion to an insurance contract exist. Hunt v. Drielick, 496 Mich. 366 (Mich. 2014). In order to take advantage of the “Dishonest or Criminal Acts Exclusion,” Westfield would have to show that the tenant's acts constituted “criminal acts” within the meaning of the policy language. “In the abstract,” stated the court, “this is an interesting question.” Why? Because while federal law unequivocally prohibits the growing of marijuana unless specifically permitted for very limited uses, the voters of Michigan in 2008 passed the Michigan Medical Marihuana Act (MMMA), I.L. No. 1 (2008), Mich. Comp. Laws sections 333.26421-333.26430; it permits the cultivation of marijuana for medical purposes so long as the growers follow state law dictates. If the tenants in this case followed state law, the landlord would, in the Sixth Circuit's opinion, “have a strong federalism argument in favor of coverage,” based on Erie R.R. Co. v. Tompkins, 304 U.S. 64 (1938). That is because under the Erie doctrine, in cases brought before the federal courts based on diversity jurisdiction, the court is charged with acting as a faithful agent of the state court and state legislature. Further, stated the court: “Since the MMMA was passed by ballot initiative, we would exercise even more care, lest we (as unelected judges) tread directly on the will of the People of the State of Michigan, who cannot easily correct any error we commit. Exercising the Michigan courts' common-law power to interpret public initiatives, we would hesitate before reading a Michigan insurance policy to bar coverage for a 'criminal act' when Michigan law confers criminal and civil immunity for the conduct at issue.”

Here, the insurer presented two forms of evidence that the commercial tenants had engaged in criminal acts leading to the complained-of property damage. First, the landlord itself, through its attorney's own court filings in the eviction action, had asserted that the tenants were conducting an illegal operation in the leased premises, and had in fact obtained court-ordered eviction based on this showing. Second, the fact that the federal raid was conducted at all indicated at least some credible probability that the tenants were doing something illegal under Michigan State law because, at the time of the raid, federal enforcement officials were working in accordance with a guidance issued by the Deputy Attorney General, which told them they should not target medical marijuana operations that were conducting business in accordance with state laws authorizing the use, production and distribution of medical marijuana. See, David W. Ogden, Memorandum for Selected U.S. Attorneys (Oct. 19, 2009); see also James M. Cole, Memorandum for U.S. Attorneys (June 29, 2011). The Sixth Circuit found these two proofs formed a valid basis for a prima facie showing that the insured's tenants were engaged in criminal activity and that it was such activity that caused the claimed property damage.

The burden then shifted to the insured to show that its tenants' activities were in fact lawful. This it could not do, despite the property owner's assertion that it was possible that the tenants complied with state law in cultivating their marijuana plants. The court observed that under Lewis v. Philip Morris Inc., 355 F.3d 515 (6th Cir. 2004), avoidance of summary judgment requires more than a “scintilla” of evidence, and “[t]rials exist to resolve concrete factual disputes, not to satiate the endless imagination of trial lawyers. In the absence of any evidence of legality, requires us to concede to Westfield's evidence of illegality.”

The Sixth Circuit also saw no reason to give weight to the insured's alternative argument that tenant criminality under the contract could not be proven absent actual conviction of the tenants. “We doubt the Michigan Supreme Court would read such an onerous 'conviction requirement' into a standard commercial insurance contract,” stated the court, “and we accordingly decline to do so in the complete absence of state authority providing otherwise.”

The court therefore determined that summary judgment in favor of the insurer was the correct outcome, affirming the lower court's ruling.