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Clearing up the Smoke: Insurance and Marijuana

Insurance Law360
February 3, 2017

By Christopher T. Troy, Deepa T. Sutherland and Hernán N. Cipriotti
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Following on from our last article concerning issues for (re)insurers arising from an insured’s illegal conduct, this article examines the issues arising out of the burgeoning legalized marijuana industry in the U.S.

The cultivation and use of marijuana for medicinal and/or recreational purposes are now permitted in 29 states and in Washington D.C. However, marijuana is still classified as a Schedule I controlled substance under the federal Controlled Substances Act[1], and the manufacture, possession, distribution and sale of marijuana for any purpose is, therefore, illegal under federal U.S. law.

This conflict between federal and state laws creates questions of legality, barriers to banking services and a resulting cash industry which, notwithstanding these challenges, is growing and consequently demanding insurance solutions. Insurers should therefore be aware of the unique issues in this developing sector.

A “Growing” Industry

The legal marijuana industry is now big business: it had sales totaling $6.7 billion in 2016 and is projected to grow to $20.2 billion by 2021.[2] As legalization has increased (the recent election saw legalization in an additional seven states[3]), so have the types of businesses involved, ranging from home and independent growers and retailers, to dispensaries and laboratories, through to large corporate operations and investors[4] and entrepreneurs. Parallel to the growth of the industry is that of the secondary market around it. For example, companies servicing the producers and retailers provide a wide range of services, including security, transport of product or cash, warehousing, additives, packaging and waste removal. In addition, there is a plethora of businesses even further removed but still connected to the industry, for example landlords of a marijuana-related business, media companies advertising marijuana products, branding agencies, banks and finance companies, professional advisers and even tourism. Added to this is the increased involvement of the authorities, for example in regard to zoning, or permit/license approval.

These secondary entities have insurance coverage requirements and/or policies that may include homeowner’s, property, general liability, product liability, employers’ liability, professional indemnity, agricultural, health, business interruption, cargo, auto, theft and even cyber.

In terms of the marijuana and hemp industry itself, specialty insurers have set up specific programs in states where it has been legalized including general liability, product liability, property, crop, equipment breakdown and cyber liability[5].

Substantial Risk

However, the cultivation and sale of legalized marijuana pose significant risks from an insurance perspective.

There is the increased risk to property of fires and flooding due to the lighting, heat, irrigation and equipment necessary for cultivation (and, in a home, the danger of circuit overloading), as well as mold, water damage and pollution.

There is a substantial risk of theft, either by burglary or employees, given the value and portability of the marijuana product and cash on premises and in transit. The large amounts of cash in warehouses, premises and homes are the result of the legal marijuana industry having to operate almost entirely as a cash business since most banks are reluctant to handle funds from the marijuana business. This reluctance stems from the fact that banks are insured by a federal agency (FDIC), and the product remains a controlled substance under federal law. So, in addition to reputational concerns, the lack of statutory authority and policy uncertainty raises the fear of being implicated in money laundering, seizure of funds and running afoul of regulators[6]. Coupled with the facilities’ locations made public by the states, this creates prime targets for crime.

Uncertainty The disconnect between federal and state rules and regulations also raises the issue of whether marijuana itself can be legally insured.

The use, possession and sale of marijuana remains illegal under federal law. However, the Obama administration passed legislation that “prohibits [the] DOJ from spending money on actions that prevent the Medical Marijuana States' giving practical effect to their state laws that authorize the use, distribution, possession, or cultivation of medical marijuana.”[7] Additionally, at least two deputy attorneys general have issued memoranda addressing the shifting priorities of the U.S. Department of Justice regarding the enforcement of the CSA and expressing varying degrees of deference to states regulating marijuana.[8] Trump’s presidency, however, adds a layer of uncertainty as to federal policy going forward.

Added to this regulatory patchwork are the various municipal bans on marijuana in ‘legal’ states. Further, individual states regulate insurance and the federal government generally does not interfere with the states’ insurance regulatory schemes.

As disputes arise between companies engaged in the legal marijuana industry, the disconnect between state and federal authority has been recognized by recent court opinions in Colorado, Hawaii and California: (1) Green Earth Wellness Ctr. LLC v. Atain Specialty Insurance Co., 163 F. Supp. 3d 821, 831 (D. Colo. 2016); (2) Tracy v. USAA Cas. Insurance Co., (D. Haw. Mar. 16, 2012) and (3) Mann v. Gullickson (N.D. Cal. Nov. 2, 2016).

In Green Earth, a district court addressed a breach of contract claim by Green Earth, a medical marijuana business, against its CGL insurer, Id. Green Earth made two claims under its policy, for (1) damage to plants as a result of a wildfire; and (2) theft of plants. Both claims were denied and the insurer argued that public policy based on the federal prohibition on marijuana required denying coverage.

The court recognized that “the nominal federal prohibition against possession of marijuana conceals a ... nuanced (and perhaps even erratic) expression of federal Policy.”[9] The court refused to declare the policy to be void on public policy grounds citing to a “…continued erosion of any clear and consistent federal public policy in this area…” Further, the court added that an insurer “having entered into the Policy of its own will, knowingly and intelligently, is obligated to comply with its terms or pay damages for having breached it.”

The court, in its conclusion, cited to the legislation and memoranda discussed above. Additionally, Colorado has passed laws stating that a contract is not void or voidable as against public policy if it pertains to legal marijuana activities.[10] The court declined to follow the earlier decision by the District Court of Hawaii in Tracy. In that case, the plaintiff who allegedly grew marijuana for medical use, filed a claim under a homeowner’s policy when some marijuana plants were stolen. The policy included coverage for the loss of “trees, shrubs, and other plants.” The insurer refused to pay citing to the illegality of marijuana under federal law, and the plaintiff sued for breach of contract. The court held that Hawaii law permitted courts to decline enforcement of contracts where doing so would require a party to violate federal law. The court consequently held that “[t]o require Defendant to pay insurance proceeds for the replacement of medical marijuana plants would be contrary to federal law and public policy, as reflected in CSA, Gonzales, and its progeny.”[11]

Lastly, in Mann v. Gullickson (N.D. Cal. Nov. 2, 2016), the U.S. District Court, Northern District of California, also cited to the discrepancies between federal and state laws when addressing the enforceability of contracts where the subject matter concerns marijuana businesses or activities.[12]

These cases both highlight some issues that insurers may face in ‘legal’ marijuana states and reinforce concerns regarding the uncertainty and state-specificity of the outcome of a disputed coverage issue.

While state legislatures attempt to establish certainty in the market, the federal marijuana ban preserves a significant level of unpredictability. Thus, in the event of change at the federal level elevating enforcement of the CSA in the “green states,” insurers could themselves face regulatory audits for engaging in an illegal business. Tracy illustrates how an insurer may find itself unintentionally implicated in a marijuana-related coverage dispute. While an insurer may have a valid defense to coverage under Hawaiian law, it could find itself on the hook for coverage in a state like Colorado in the event it affords coverage for plants without expressly excluding marijuana.

There is little legal precedent to offer insurers comfort from both an underwriting and claims perspective.

Challenge or Opportunity?

This legal uncertainty prompted Lloyd’s — previously one of the largest insurers of the sector — to self-impose in 2015 a ban on writing this type of business (crop, property and liability cover for growers, sellers or distributors of any form of marijuana, as well as cover for banking or other services provided to them). Although Lloyd’s acknowledged the government’s stated policy of non-enforcement of federal law in ‘legal’ marijuana states, it required the federal government’s formal legal recognition of medical and recreational marijuana as a precondition to insurability. Another concern was obstructing federal anti-money laundering laws and the risk of being implicated as a facilitator of illegal activity should there be a future policy change.

Indeed, insurers writing this business must address how they deal with cash businesses and how to navigate the anti-money laundering legislation and other regulations they are subject to, for example, the UK Proceeds of Crime Act 2002. Other challenges include assessing risk in an industry that lacks loss history data and guidance in the case law, whilst presenting significant public and product liability risk and a potential target for class actions.

However, this business also offers potentially profitable opportunities and some big names are now writing it.

Coverage Issues

From small-scale home growers to large commercial operations, the marijuana industry will likely present a variety of novel coverage issues and underwriting concerns.

As Tracy showed, a homeowner’s policy often covers “trees, shrubs and other plants”. However, if an insured homeowner is legally growing marijuana, the home is subject to increased risk of theft, fire and water damage, which may amount to a change in the nature of the risk. Insurers should consider whether express exclusions or sublimits should be included in the policy to address this exposure.

Policies usually exclude cover for criminal acts, thereby precluding from cover the illegal growing of plants, and for “contraband, or property in the course of illegal transportation or trade”. Whether such exclusions would apply in ‘legal’ states is ambiguous and, as the cases discussed above show, can be both fact and state-specific (and also raises the question as to whether an insured growing more plants than is permitted by state law is only covered for the ‘legal’ amount).

It is unlikely that an insurer providing specific cover for a marijuana-related business could invoke such an exclusion following the court’s comments in Green Earth.

Liability policies usually contain exclusions for injury or damage arising out of the use, sale, manufacture, transfer or possession of a controlled substance under federal law. This exclusion would, on its face, apply to marijuana; however, if there is an exception for the legitimate use of prescription drugs, medical marijuana may be held to fall within this exception in a ‘legal’ state. This point may be relevant in other contexts such as homeowner’s and event cancellation / nonappearance policies.

Pollution exclusions would also need to be examined since insureds may face claims for nuisance as a result of odors.

Other issues to consider include the involvement of third parties in the manufacture or sale of the product, quality control, industry standards, security provision, the presence of weapons on premises and zoning restrictions.

As a practical matter, one insurer reports that claims received under industry-specific property policies are largely related to fire from an electrical fault of the growing equipment. The particularities of the industry are dealt with by means of specific policy definitions, conditions (such as requiring a license and a working safety system) and exclusions (for example, mold). The legal ambiguities may be addressed through a variety of exclusions, including law or ordinance, governmental action and seizure or destruction of property, and/or specific endorsements dealing with government acts and criminal activities, expressly stipulating that there is no coverage for any allegations by the federal government of criminal activity, fines for illegal activities or failure to follow any ordinances. Policy wordings are especially important. Insurers who wish to write marijuana-related business should set out clear and specific coverages, exclusions and endorsements, and tight policy definitions. Insurers who, on the other hand, want no involvement with the marijuana industry, could unwittingly find themselves exposed and should therefore check their policy wordings carefully to ensure that express exclusions and limitations are in place. Future The legal marijuana industry as it currently exists is somewhat paradoxical, being both closely scrutinized and inherently uncertain. The recent election resulted in both increased and broader legalization on state levels, and greater unpredictability as to the breadth of criminal prosecutions by federal authorities. Despite the difficulties presented by the marijuana industry, some insurers have identified it as a business opportunity and are developing means and methods for proceeding legally and profitably. While it remains to be seen how this line of business will develop, it appears to be emerging as a significant risk for a variety of insurers’ customers. As such, underwriters will be well-advised to stay current on developments in not only the laws of the “green states” but also the federal laws and federal policies concerning enforcement of criminal statutes on purely intrastate activities.

Christopher L. Troy is a partner in Zelle’s Philadelphia office, Deepa T. Sutherland is a solicitor in Zelle International's London office and Hernán N. Cipriotti is an associate in the London office.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] 21 U.S.C.A. § 801 et seq.

[2] Borchardt, D. (2017). Marijuana Sales Totaled $6.7 Billion in 2016. Forbes.com. Retrieved 16 January 2017, from https://tinyurl.com/jhhuj2f.

[3] California, Nevada, Maine and Massachusetts have legalized the recreational use of marijuana; North Dakota, Arkansas and Florida have passed medical marijuana legislation. See Day, T. (2017). This map shows every state that legalized marijuana on Election Day. Business Insider. Retrieved 16 January 2017, from https://tinyurl.com/hko2nfz.

[4] For example, in 2015 Privateer Holdings raised USD 75 million in funding solely to create a company focusing on the production, distribution and the education of consumers about legal marijuana. See Lawler, R. (2015). Privateer Holdings Closes $75 Million in Funding to Create the P&G of Pot. TechCrunch. Retrieved 17 January 2017, from https://tinyurl.com/zgjbju6.

[5] See Hackers Cripple Leading Marijuana Sales System. (2017). Fortune.com. Retrieved 17 January 2017, from https://tinyurl.com/jdzw3cm.

[6] This is despite the current administration stating that it would not penalise banks who provide banking services to legitimate medical marijuana businesses in ‘legal’ states and the guidance from the Financial Crime Enforcement Network (FinCEN) on how banks can accept money from the marijuana industry and comply with the law. This guidance, however, does not necessarily shelter banks and financial institutions willing to engage in the business of marijuana from DOJ enforcement of anti-money laundering laws and the Bank Secrecy Act of 1970 (BSA).

[7] See United States v. McIntosh, 833 F.3d 1163, 1175 (9th Cir. 2016) (holding that “at a minimum, § 542 prohibits DOJ from spending funds from relevant appropriations acts for the prosecution of individuals who engaged in conduct permitted by the State Medical Marijuana Laws and who fully complied with such laws” and “prohibits the Department of Justice from preventing the implementation of the Medical Marijuana States' laws or sets of rules and only those rules that authorize medical marijuana use.”)

[8] See generally Memorandum from Deputy Attorney General David W. Ogden, Oct. 19, 2009; Memorandum from Deputy Attorney General James M. Cole, June 29, 2011; and Memorandum from Deputy Attorney General James M. Cole, Aug. 29, 2013.

[9] Green Earth Wellness Ctr. LLC, 163 F. Supp. 3d at 832-835.

[10] See Colo. Rev. Stat. § 13-22-601.

[11] Tracy, 2012 WL 928186 at *13.

[12] See Mann, 2016 WL 6473215 at *3-6.

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