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Loss of Use can be “Property Damage” under Insurance Policies

General liability insurance policies normally cover “property damage.”  Physical injury to, or outright destruction of, property almost always fits within policy coverage.

But what about situations when the property is not physically injured at all, but the owner has lost important use rights associated with the property, such as the loss or alteration of a conditional use permit?

It all depends on the specific language in the insurance policy, as illustrated by a Court of Appeal opinion recently published by California’s Fourth Appellate District — Thee Sombrero, Inc. v. Scottsdale Insurance Company.

Background: insurance policy covers “loss of use;” property loses conditional use permit

Thee Sombrero, Inc. (Sombrero) owned commercial property in Colton, California.

The city issued a conditional use permit (CUP) authorizing the use of the property as a nightclub.  The CUP required city approval for the nightclub’s floor plan, and no modifications to the floor plan were allowed without city approval.

Sombrero’s tenant operated the nightclub.  Under the city-approved floor plan, the club had a single entrance door, equipped with a metal detector.

Crime Enforcement Services (CES) provided security services for the club.  CES obtained a corporate general liability policy from Scottsdale Insurance Company (Scottsdale).  The policy covered CES’s liability for “property damage,” which was defined as either “physical injury” to the property or “loss of use” of property that is not physically injured.

On June 4, 2007, one patron of the nightclub shot and killed another.  Investigation discovered that CES had created a second entrance to the club — a “VIP entrance” — that lacked a metal detector, and that the gun used in the killing got into the club through the VIP entrance.

The city revoked the CUP.  Sombrero eventually obtained a modified CUP allowing the property to be used as a banquet hall instead of a nightclub.

Sombrero sued CES for breach of contract and negligence, and obtained a default judgment in its favor for $923,078 — damages representing the diminution in value suffered by the property due to the lost CUP.

Sombrero then filed a direct action against Scottsdale under Insurance Code section 11580(b)(2) for breach of the insurance policy.

Trial court’s ruling: summary judgment granted for insurer

Scottsdale filed a motion for summary judgment, which the trial court granted.

The trial court held that Sombrero was essentially suing for “economic loss,” which was not the same thing as “lost use.”  Because the policy excluded coverage for mere economic loss, Scottsdale could not be liable, and the court entered judgment in Scottsdale’s favor.

Court of Appeal’s Opinion: insurer is on the hook

The Court of Appeal reversed the trial court’s judgment.

Looking to the language of the insurance policy, the court observed: “The loss of the ability to use the property as a nightclub is, by definition, a ‘loss of use’ of ‘tangible property.’  It defies common sense to argue otherwise.”

Sombrero did not simply lose the CUP, as Scottsdale contended.  The court noted that “the appropriate focus is not on the loss of the entitlement, but rather on the loss of use of tangible property that results from the loss of the entitlement.”  Here, the revocation of the CUP meant that Sombrero could no longer use the property as a nightclub.

The court also rejected Scottsdale’s argument that a “total loss of all uses” would be required to trigger coverage.  The court held “the reasonable expectations of the insured would be that ‘loss of use’ means the loss of any significant use of the premises, not the total loss of all uses.”

The court acknowledged that strictly economic losses like lost profits, loss of goodwill, and investment losses typically are not covered by a comprehensive general liability policy.  Losses that are “exclusively economic, without any accompanying physical damage or loss of use of tangible property, do not constitute property damage.”

But, those same items may be recovered from the insurer if they provide a measure of damages for a covered claim.  Here, diminution in value was an appropriate measure of damages for harm caused by the covered loss of use — the lost CUP.

Finally, the court emphasized that the language of the insurance policy will usually determine the outcome.  Where an insurance policy defines “property damage” more narrowly as “physical injury to or destruction of tangible property, including loss of its use,” the policy would not cover the loss of use of property that has not been physically damaged.

Lesson

“Loss of use” can sometimes be covered as “property damage” under general insurance liability policies.  But it all depends on how the policy language defines “property damage.”

While strictly economic losses are generally not recoverable, economic losses may be recoverable if they provide a measure of damages for property damage that is covered by the insurance policy.

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