Are a tenant’s unauthorized renovations to landlord property covered under a landlord’s property insurance policy? The outcome likely depends on how the issue is framed.
To assist public adjusters and policyholder advocates, this blog is intended to help properly frame the issues to demonstrate why a landlord’s claim for property damage arising from a tenant’s unauthorized renovations should be covered under a commercial owner’s first-party property insurance policy.
Assume that a tenant, without the permission or knowledge of the landlord, modifies and renovates the landlord’s building to cultivate marijuana. Assume that the tenant’s unauthorized renovations include the installation of false walls, and modifications to the property’s plumbing, electrical and HVAC systems.
Further assume that when the landlord (insured) discovers the unauthorized modifications to the property, the landlord timely makes a claim under a first-party property insurance policy for the damage sustained as a result of the tenant’s unauthorized renovations.
Is the landlord’s insurance claim covered? To answer this question, we need to first look at the policy exclusions that insurers are likely to raise to avoid paying the claim.
The Policy Exclusions:
Most first-party property policies contain exclusions for intentional or dishonest acts. A common exclusion found in commercial property insurance policies is the “Entrustment Exclusion”, which states in pertinent as follows:
2. We will not pay for loss or damage caused by
or resulting from any of the following:
h. Dishonest or criminal act by you, any of
your partners, employees, directors, trustees,
authorized representatives or anyone
to whom you entrust the property for any
purpose (ISO Form CP 10 30 10 91)
Based on the above exclusion, we can expect that insurers might try to frame the property damage arising from the unauthorized renovations to the landlord’s property as an excluded “illegal act” (particularly in states where growing and distributing marijuana is illegal) given that courts have found the “entrustment exclusion” to include tenants to whom the landlord’s property has been entrusted (Su v. New Century Ins. Services, Inc., 2013 WL 5775160 (C.D. Cal. 2013)).
In this context, insurers will likely argue that the property damage is related to criminal conduct—cultivation/distributing marijuana—to support a denial of the claim.
Most first-party property policies also contain exclusions for negligent or faulty work that generally reads in pertinent part as follows:
3. We will not pay for loss or damage caused by
or resulting from any of the following. But if
loss or damage by a Covered Cause of Loss
results, we will pay for that resulting loss or
c. Faulty, inadequate or defective:
(1) Planning, zoning, development, surveying,
(2) Design, specifications, workmanship,
repair, construction, renovation, remodeling,
(3) Materials used in repair, construction,
renovation or remodeling; or
of part or all of any property on or off the
described premises. (ISO Form CP 10 30 10 91)
Based on this exclusion, we can expect insurers to avoid coverage by arguing that the damage (unauthorized renovations) was caused by faulty construction and/or faulty renovations performed by the tenant.
After researching these issues, I have determined that a denial of the claim based on either of the two above exclusions would be incorrect for two distinct reasons.
First, the criminal act/entrustment exclusion states that damage caused by dishonest and criminal acts of the insured, or anyone to whom the property is entrusted, is excluded. Under well-known principles of insurance law, exclusions must be interpreted narrowly. (AIU Ins. Co. v. Sup.Ct. (FMC Corp.), 51 Cal.3d 807, 822 (1990) (finding that while coverage clauses are interpreted broadly, exclusionary clauses are interpreted narrowly to protect the insured’s reasonable expectations.).
In our hypothetical example, the damage was not caused by a criminal act of growing or cultivating marijuana. If the growth of marijuana caused mold damage that might be damage caused by a criminal act.
However, the damage in our hypothetical example was caused by the tenant’s unauthorized renovations/modifications to the landlord’s property. Were the modifications themselves dishonest or criminal acts? While modifying the property’s HVAC, plumbing and electrical systems might create non-compliance issues regarding building codes, such conduct is not “criminal” or “dishonest”. Because the exclusion limits coverage only if the damage is “caused by” criminal or dishonest conduct, the exclusion should be found to be inapplicable.
Further, the negligent work exclusion should not apply because the insured landlord did not authorize any work to be done on the property. Courts have found that the exclusion is inapplicable where a tenant performs unauthorized renovations. As an example, the court in Wilson v. Farmers Ins. Exch., 102 Cal. App. 4th 1171, 1176 (2002), explained the inapplicability of the exclusion as follows:
Our interpretation of the scope of the “inadequate renovation” exclusion is consistent with the only other case we have found in this area—Husband v. Lafayette Ins. Co. (La.Ct.App.1994) 635 So.2d 309. In Husband, a tenant made a number of unauthorized alterations to the house he was renting from the plaintiffs. The work the tenant performed was “shoddy and extremely unprofessional.” (Id. at p. 311.) When the tenant vacated the house, the plaintiffs discovered the alterations for the first time. The defendant insurance company denied the plaintiffs’ claim for coverage under their all-risk homeowner’s policy, relying at trial on the “inadequate renovation” exclusion in the policy. In an analysis later approved by the appellate court, the trial court held the tenant’s alterations “were not excluded from coverage because these renovations were not approved by the insured.” (Ibid.) As the trial court explained: “ ‘This court interprets the exclusion contained in the pertinent policy provisions to apply to situations where the insured or someone authorized by the insured contracts for alterations to the property and is dissatisfied with the quality of the performance under that contract. The insurer by this exclusion intended to prevent the expansion of coverage under the policy to insuring the quality of a contractual undertaking by the insured of someone authorized by him. [¶] However, in this case the alterations were undertaken without authorization and in direct conflict with the terms of the lease, and therefore fall outside the exclusion of the policy.’”
Based on the case law discussed above, one should reasonably conclude that: (1) neither of the referenced exclusions applies and (2) unauthorized renovations/modifications performed by tenants without the knowledge of the insured landlord are therefore covered under a first-party property insurance policy.