Does state or federal law control when issues of criminal law influence a coverage dispute between a policyholder and his or her insurer? That is a question recently addressed in our case where a California husband and wife, who cultivate medical marijuana for the husband’s use, suffered a fire loss. Though it is legal for him to grow and use marijuana for medical purposes, pursuant to California's Health and Safety Code §11362.5, §11357, and §11358, it is a crime under federal law.
An extension cord used for marijuana cultivation overheated and caused a fire that damaged the insureds’ home. The insureds filed a claim with their homeowners insurer, Mid-Century Insurance Company, part of the Farmers Insurance Group of Companies. Citing the Section I, "Intentional Acts" exclusion, Mid-Century argued there was no coverage when the insured "directly or indirectly caused the loss or damage while engaged in committing or concealing a felony . . . ."
The policy contained a "What Law Will Apply" provision that stated the policy was "issued in accordance with the laws of the state in which the residence premises is located and covers property or risks principally located in that state. The law of the state where the residence premises is located shall govern any and all claims or disputes in any way related to this policy.” The "Conflict of Terms" provision provided, where the "terms of this policy which conflict with statutes of the statute where issued, the terms are amended to conform to such statutes."
On motion for summary judgment, the policyholders argued California law should apply. Although Mid-Century conceded there was no language in the "Intentional Acts" exclusion that applied to a situation where an act was legal under state law but illegal under federal law, it argued the exclusion intended all state law to include federal law. The policyholders argued this “understanding” was not stated in the policy, so they had no notice that the provision could be triggered by actions perfectly legal under California law. They also argued such an "understanding" could not be harmonized with the "What Law Will Apply" and "Conflict of Terms" provisions. Further, although Section I omitted any reference to federal law, “Section II - Liability Exclusions - Illegal or Controlled Substance,” specifically incorporated both federal and state law in excluding the manufacture of controlled substances. Mid-Century acknowledged it could have added similar language to Section I, but it did not.
The trial court judge found, as a matter of law, federal law did not apply for purposes of the policy provisions. The policy language in the "Intentional Acts" exclusion section was ambiguous in connection with Mid-Century's claim that federal law would trigger the exclusion, even if state law did not. The policy's repeated statements that California law would apply to coverage disputes supported the court's ruling. The court followed well established principles of insurance law that exclusions must clearly inform the insured of limitations, and exclusions are strictly interpreted against the insurer.
Mid-Century argued this case incorporated constitutional issues, but the judge rightfully held it was a matter of contract interpretation.
This is a case of first impression in California, and the litigation is still ongoing. Mid-Century can spend a lot of time and money to appeal the ruling, and, if it does, the policyholders will continue to live in their damaged home, as best they can, until the case is resolved. In the meantime, it will be interesting to see whether Mid-Century and other insurers change the language in their policies to specifically address this situation.