Court Finds That Limitation on Conditional Use Permit Results in Covered Property Damage Due to Loss of Use

In Thee Sombrero, Inc. v. Scottsdale Ins. Co. (No. E067505, filed 10/25/18), a California appeals court held that a property owner’s loss of the ability to use his property as a nightclub, based on revocation of a city’s conditional use permit (“CUP”), constituted covered property damage.

In Sombrero, lessees operated a nightclub under the property owner’s conditional use permit from the City of Colton. A company hired to provide security negligently allowed admission to an armed patron, who shot and killed another patron. The City revoked the owner’s permit, and the owner was only able to negotiate the reinstatement of a limited permit, for use as a banquet hall only.

The property owner sued the security company claiming that “negligence” “lower[ed] the resale and rental value of the Property” and caused “lost income.” As damages, the owner sought “the reduction in fair market value of the Property” as well as “lost income.” According to the complaint, “[t]he property went from being valued at $2,769,231 … with its large occupancy and nightclub entitlement, to being valued at $1,846,153 after the modified conditional use permit allowing for private banquet use….” Since “[t]he difference in value is $923,078…. [Sombrero] is seeking negligence damages against [CES] … in the amount of $923,078, which represents the loss in value due to the modification of the conditional use permit.”

The security company defaulted, and the property owner brought a direct action against the security company’s insurer, Scottsdale. The Scottsdale policy covered liability for “property damage” caused by an “occurrence.” “Property damage” was defined as either (a) “[p]hysical injury to tangible property, including all resulting loss of use of that property,” or (b) “[l]oss of use of tangible property that is not physically injured.” “Occurrence,” was defined as “an accident.”

Scottsdale argued that the loss of the CUP was not a loss of use of tangible property but merely the loss of an intangible right to use property in a certain way. It also argued that the damages were for economic loss, not property damage. The owner argued, among other things, that it lost the use of tangible property due to the revocation of the CUP. It also argued that when an economic loss results from the loss of use of tangible property that is covered as property damage.

Although Scottsdale obtained summary judgment, the appeals court reversed. Noting first that establishing coverage for indemnity carries a higher burden of proof than the duty to defend, the court said that duty to defend case law is nonetheless relevant, because “[i]f a case holds that there is no duty to defend on facts similar to those here, it necessarily follows that there is also no duty to indemnify.”

The Sombrero court then stated that “[t]he 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.” The court disagreed with a Washington case cited by Scottsdale for the proposition that loss of a liquor license does not result in loss of use of tangible property, and noted that in Cunningham v. Universal Underwriters (2002) 98 Cal.App.4th 1141, the court based its determination of coverage on whether the tenant was ever in actual possession, pointing out that Sombrero was the owner and, therefore, necessarily had a possessory interest.

As to the economic loss argument, the Sombrero court stated that “[t]he correct principle, then, is not that economic losses, by definition, do not constitute property damage…. Rather, the correct principle is that losses that are exclusively economic, without any accompanying physical damage or loss of use of tangible property, do not constitute property damage.” And having said that, the Sombrero court also stated that diminution in value can be a proper measure of loss of use damages.

The Sombrero court went on to distinguish Kazi v. State Farm Fire & Cas. Co. (2001) 24 Cal.4th 871, which involved an easement, saying that “an easement is not tangible property.” Further, the Sombrero court distinguished the policy language at issue in Kazi, because the policy there did not cover the loss of use of property that was not physically damaged.

Finally, the Sombrero court took issue with Golden Eagle Ins. Corp. v. Cen-Fed, Ltd. (2007) 148 Cal.App.4th 976, where the court found no coverage when a bank sued over a landlord’s failure to maintain that prevented leasing of safety deposit boxes. Finding little ground to distinguish the result, the Sombrero court ultimately said the Cen-Fed claim was “for the diminution in value of its leasehold interest [as] a claim for economic loss, untethered to an interest in tangible property…. here, Sombrero’s claim for the diminution in value of its ownership interest, even though it was a claim for economic loss, was a claim for loss of use of tangible property.” Plus, the Sombrero court pointed out that Cen-Fed had involved a purely contractual theory, with the jury limiting its award to a breach of lease claim and resulting economic damage, but making no award for loss of use of tangible property.

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October 30, 2018