Three Sombrero v Scottsdale Insurance Company – Case Study

CASE STUDY PREPARED FROM ORIGINAL PUBLISHED
OPINION
ERNEST A. LONG
Alternative Dispute Resolution
Resolution Arts Building
2630 J Street, Sacramento, CA 95816
ph: (916) 442-6739 $ fx: (916) 442-4107
elong@ernestalongadr.com $ www.ernestalongadr.com
Three Sombrero v Scottsdale Insurance Company 10/25/18
Insurance Coverage; (Ins. Code, § 11580, subd. (b)(2)) ; Loss of Use;
Diminution in Value as Measure of Damages
Thee Sombrero, Inc. (Sombrero) owned a piece of commercial
property in the city of Colton. A conditional use permit (CUP) had been
issued authorizing the use of the property as a nightclub. One of the
conditions of the CUP was that the city had to approve the floor plan for
the property, and thereafter, the floor plan could not be modified without
city approval.
In 2007, Sombrero leased the property to new tenants who operated it
as a nightclub called El Sombrero. In connection with the new tenancy, the
city inspected the property; it approved a floor plan, and it found that the
property was in compliance with the floor plan. As part of the floor plan,
the club had a single entrance door, equipped with a metal detector.
2
Crime Enforcement Services (CES) provided security guard services
at El Sombrero. It had a corporate general liability policy issued by
Scottsdale. The policy covered CES’s liability for “property damage”
caused by an “occurrence.” “Property damage” was defined as either (a)
“physical injury to tangible property, including all resulting loss of use
of that property,” or (b) “loss of use of tangible property that is not
physically injured.” “Occurrence,” for present purposes, was defined as
“an accident.”
On June 4, 2007, one patron of El Sombrero shot and killed another.
After the shooting, Sombrero learned that CES had converted a storage
area into a “VIP entrance” to the club. The VIP entrance had no metal
detector. The owner of CES admitted that the gun used in the shooting got
into the club through the VIP entrance.
As a result of the shooting, the city of Colton revoked the conditional
use permit. Sombrero managed to negotiate a modified CUP, which
allowed it to operate the property as a banquet hall rather than as a
nightclub.
3
On May 26, 2009, Sombrero sued the security company, CES, for
breach of contract and for negligence. The complaint alleged that CES
failed to frisk the shooter and that this failure caused the revocation of the
CUP. The revocation of the CUP, in turn, “lowered the resale and rental
value of the Property” and caused “lost income.” As damages, the
complaint sought “the reduction in fair market value of the Property” as
well as “lost income.”
On May 24, 2012, Sombrero obtained a default judgment against CES
for $923,078. Henry Aguila, the president of Sombrero, submitted a
declaration in support of the default judgment in which he stated:
“The 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 . . . .
The 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.”
4
Sombrero then filed this direct action (Ins. Code, § 11580, subd. (b)(2))
against Scottsdale Insurance Company (Scottsdale), the security company
CES’s liability insurer.
Scottsdale filed a motion for summary judgment. It 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 property damage does not include economic loss.
In its opposition, Sombrero 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, it is covered as property damage.
On October 11, 2016, after hearing argument, the trial court granted
the motion. It explained: “The underlying judgment against CES was set
in the amount of $923,078 based on lost value after the permit was revoked.
This amount is what Sombrero is seeking to recover from Scottsdale in this
case and is described by Sombrero as economic loss. Lost value is
economic loss, but economic loss is not lost use of tangible property.
Accordingly, the coverage in Scottsdale’s policy for property damage does
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not extend to Sombrero’s economic losses caused by Scottsdale’s insureds.”
On November 7, 2016, the trial court entered judgment accordingly.
On appeal, Sombrero contends that “the loss of use of the property
by the revocation of the CUP constitutes . . . ‘loss of use of tangible
property that is not physically injured.’”
The Fourth District Court of Appeal began its opinion by noting that:
“Liability insurance obligates the insurer to indemnify the insured against
third party claims covered by the policy by settling the claim or paying any
judgment against the insured. Where judgment is obtained against an
insured in an action based on bodily injury, death, or property damage,
the plaintiff (now a judgment creditor) may bring an action against the
insurer on the policy, subject to the policy’s terms and limitations, to
recover on the judgment. In short, the ‘“judgment creditor may proceed
directly against any liability insurance covering the defendant, and
obtain satisfaction of the judgment up to the amount of the policy
limits.”’ Among the elements that must be proven is that ‘“the policy
covers the relief awarded in the judgment. . . . ”’ ” (Howard v. American
Nat. Fire Ins. Co. (2010) 187 Cal.App.4th 498, 512–513.)
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“An insurer’s duty of indemnification requires a determination of
actual coverage under the policy. In contrast, ‘“a liability insurer owes a
duty to defend its insured when the claim creates any potential for
indemnity.’” ‘The insurer must defend in some lawsuits where liability
under the policy ultimately fails to materialize; this is one reason why it is
often said that the duty to defend is broader than the duty to indemnify.’ ”
(Advanced Network, Inc. v. Peerless Ins. Co. (2010) 190 Cal.App.4th 1054,
1060–1061.)
Sombrero persistently argues that Scottsdale had to show that there
was no potential for coverage. However, as it acknowledges, this standard
applies to the duty to defend, not the duty to indemnify. “‘While an
insurer has a duty to defend suits which potentially seek covered damages,
it has a duty to indemnify only where a judgment has been entered on a
theory which is actually (not potentially) covered by the policy.’”
(Palmer v. Truck Ins. Exchange (1999) 21 Cal.4th 1109, 1120.) Thus, Scottsdale
only had to show that there was no actual coverage.
This does not mean that cases dealing with a duty to defend are
irrelevant. If 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.
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Contrariwise, if a case holds that there is a duty to defend, because there is
a potential that the facts might turn out to be similar to the facts here, it
follows that there is a duty to indemnify on these facts.
According to the allegations of Sombrero’s complaint against CES,
CES’s negligence caused the revocation of the CUP, which caused
Sombrero to lose the ability to use the property as a nightclub. 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.
Nevertheless, there is some contrary authority. Scottsdale relies on a
case with strikingly similar facts, Scottsdale Ins. Co. v. International Protective
Agency, Inc. (2001) 105 Wash.App. 244. There, Scottsdale insured a security
services company, IPA. One of IPA’s clients was a restaurant owned by
Northwest Visions. Northwest Visions sued IPA, alleging, among other
things, that IPA negligently allowed a minor to enter the restaurant and, as
a result, Northwest Visions lost its liquor license. Scottsdale refused to
defend, on the ground that Northwest Visions was not claiming property
damage. Northwest Visions obtained a default judgment against IPA.
Scottsdale then filed an action for a declaratory judgment regarding its
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duty to defend. The trial court denied Scottsdale’s motion for summary
judgment.
The appellate court reversed. It held that Northwest Visions’
“complaint does not allege loss of use of tangible property. . . . A liquor
license is merely representative of a privilege granted by the state and, as
such, is intangible property. . . . The complaint alleges that Northwest
Visions lost its liquor license thereby destroying its business. There is no
allegation or evidence in the record that Northwest Visions lost its use of or
right to occupy the premises. Even if it had, a right to occupy premises is
not a tangible property interest. . . . Scottsdale correctly argues that there
was no property damage within the meaning of the policy because the
complaint does not allege that Northwest Visions . . . lost the use of the
premises or building for ‘any purpose, as owner or lessee, other than one
that involves the sale of liquor.’ ” (Scottsdale Ins. Co. v. International
Protective Agency, Inc., at pp. 249–250)
IPA is helpful, because it outlines the arguments that can be made
against the common-sense position, but the Justices find it is ultimately
unpersuasive, for three reasons.
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First, 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. The Court agrees that in IPA, the liquor license was not
tangible property. Nevertheless, the loss of the liquor license meant that
Northwest Visions could no longer use its premises for the remunerative
purpose of selling diners alcohol along with their food. Here, identically,
the revocation of the CUP meant that Sombrero could no longer use the
property as a nightclub.
Second, 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. (Liberty Mut. Ins. Co. v. Wheelwright Trucking Co.,
Inc. (Ala. 2002) 851 So.2d 466, 494–495) California law is in accord. In
Hendrickson v. Zurich American Ins. Co. of Illinois (1999) 72 Cal.App.4th 1084,
a group of growers sued Crown Nursery, alleging that it sold them
strawberry plants that had been damaged by an herbicide. Zurich insured
Crown Nursery, but Zurich refused to defend, arguing that the growers
had not alleged any property damage. The appellate court disagreed:
“Here, the growers’ complaint may reasonably be construed as alleging
that as a result of Crown Nursery’s negligent delivery of defective plants,
the growers suffered a loss of strawberry production, and thereby a loss of
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the use of their land. The policies in this case expressly state that ‘loss of
use of tangible property that is not physically injured’ constitutes ‘property
damage.’ Thus, the DCA concludes that the growers’ action presents a
potential for coverage which requires a defense.” Hendrickson therefore
supports the Court’s view that a loss of a particular use of tangible
property can be property damage.
Scottsdale argues that Hendrickson involved a physical injury rather
than a loss of use; it asserts, “The court found the insured’s contaminated
strawberries could have potentially ruined tangible property, namely, the
claimants’ strawberry crop.” Not so. As quoted above, the court
specifically concluded that “the growers suffered . . . a loss of the use of their
land.” (Hendrickson v. Zurich American Ins. Co. of Illinois, at p. 1091)
Third, the Justices question IPA’s statement that “a right to occupy
premises is not a tangible property interest.” (Scottsdale Ins. Co. v.
International Protective Agency, Inc., at p. 250) At least under California law,
“a lease is . . . a conveyance of an estate in real property . . . . ” (Avalon
Pacific-Santa Ana, L.P. v. HD Supply Repair & Remodel, LLC (2011) 192
Cal.App.4th 1183, 1190.) A building is tangible. Dirt is tangible. Hence, a
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lessee in possession has a tangible property interest in the leased
premises.
In any event, the issue is not whether, as a technical legal matter, a
leasehold is tangible property. Rather, it is whether an insured, reading his
or her policy, would understand “tangible property” to include real
property that he or she leases. If your leased apartment was rendered
uninhabitable by some noxious stench, you would conclude that you had
lost the use of tangible property; and if a lawyer said no, actually you had
merely lost the use of your intangible lease, you would goggle in disbelief.
Most important, though, this discussion point is dictum, because the
case on appeal is distinguishable. Here, Sombrero is the owner of the
property, not a lessee. As such, it plainly has an interest in tangible
property.
The trial court did not actually rely on Scottsdale’s argument (based
on IPA) that Sombrero lost only an intangible right to use property in a
certain way. Instead, it ruled that Sombrero suffered an economic loss, and
that this is not property damage. Scottsdale therefore argues that a “mere
economic loss” is not a loss of use of tangible property.
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“Strictly economic losses like lost profits, loss of goodwill, loss of the
anticipated benefit of a bargain, and loss of an investment, do not
constitute damage or injury to tangible property covered by a
comprehensive general liability policy.” (Giddings v. Industrial Indemnity
Co. (1980) 112 Cal.App.3d 213, 219.) However, as Giddings added, “A
complaint seeking to recover damages of this nature from an insured
does fall within the scope of the insurance coverage . . . where these
intangible economic losses provide ‘a measure of damages to physical
property which is within the policy’s coverage.’ ” “In the liability policy
context, diminution in market value is accepted as a proper method of
measurement of any property damages which may have been sustained. ”
(Pruyn v. Agricultural Ins. Co. (1995) 36 Cal.App.4th 500, 510; accord, MidContinent Cas. Co. v. Circle S Feed Store, LLC (10th Cir. 2014) 754 F.3d 1175,
1184; Lucker Mfg. v. Home Ins. Co. (3d Cir. 1994) 23 F.3d 808, 818, fn. 12.)
In Hendrickson, the insurer argued that the growers’ claims for lost
strawberry production “do not allege a loss of use of property, but claim
only economic losses associated with the property, which does not
constitute property damage.” (Hendrickson v. Zurich American Ins. Co. of
Illinois, at p. 1090.) The appellate court disagreed: “The alleged loss of
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profits or diminution in property value are not solely economic losses, but
damages because of property damage, and therefore constituted
alternative measures of any property damage allegedly sustained.”
The correct principle, then, is not that economic losses, by definition,
do not constitute property damage. Like the court in Auto-Owners
Insurance Company v. Southeastern Car Wash Systems (E.D. Tenn. 2016) 184
F.Supp.3d 625, the Justices “find it difficult to conceive of loss-of-use
damages as anything other than economic losses.” 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.
Here, for the reasons already stated, Sombrero did suffer a loss of use
of tangible property. Moreover, the diminution in value of the property
was a proper measure of the damages from that loss of use. Thus, the
mere fact that Sombrero was seeking to recover damages calculated on the
basis of diminution in value falls short of showing that it was not seeking
to hold CES liable for a loss of use of tangible property.
14
At oral argument, Scottsdale asserted for the first time that Kazi v.
State Farm Fire & Cas. Co. (2001) 24 Cal.4th 871 is on point. There, the
Tollaksons sued the Kazis, claiming that they had an implied easement
over the Kazis’ land and that the Kazis had interfered with their easement.
Moreover, they claimed that, absent the easement, their own land “was not
buildable.” They alleged that the interference with the easement had
diminished the value of their own land by $400,000.
The Kazis had three separate insurance policies that covered liability
for property damage. One defined property damage as “‘physical injury to
or destruction of tangible property, including loss of its use.’” (Kazi v. State
Farm Fire and Cas. Co., at p. 876.) Another defined it as “‘ . . . damage to or
loss of use of tangible property.” The third defined it as “‘physical damage
to or destruction of tangible property, including loss of use of this
property.’” The insurers failed to defend.
The Supreme Court held that there was no potential coverage, and
hence no duty to defend, for two reasons. First, an easement is not tangible
property. (Kazi v. State Farm Fire and Cas. Co., at pp. 880-885.) Second, the
Tollaksons had not claimed that there was any physical damage to their
own land.
15
Kazi is not controlling here because there is a crucial difference
between the policy language in Kazi and the policy language in this case.
Kazi relied extensively (see Kazi v. State Farm Fire and Cas. Co., at pp. 874-
875, 878-884, 887) on the earlier case of Gunderson v. Fire Ins. Exchange
(1995) 37 Cal.App.4th 1106. Gunderson had held, among other things, that
when a policy defines property damage as “physical injury to or
destruction of tangible property, including loss of its use,” it does not cover
the loss of use of property that has not been physically damaged. Thus, in
Kazi, the Supreme Court rejected any coverage for loss of use of the
Tollakson’s own land on the sole ground that it had not been physically
injured.
Here, however, the policy expressly defined property damage as
including “loss of use of tangible property that is not physically injured.”
Thus, unlike in Kazi, the mere fact that Sombrero’s property was not
physically damaged is not dispositive of the question of whether there was
coverage for loss of use of that property.
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
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loss of use of tangible property. Sombrero’s loss of the ability to use the
property as a nightclub constituted property damage, which was defined
in the policy as including a loss of use of tangible property.
The judgment is reversed. Sombrero is awarded costs on appeal
against Scottsdale.