Although it may seem strange at first, the recent ruling by the California Fourth Appellate District Court in Thee Sombrero, Inc. v. Scottsdale Co., (2018 EL 5292072), holding that an insurer must pay for a claim where there was no actual physical property damage, is not as odd as it may seem to non-insurance coverage lawyers.  The reason?  It all depends on the policy language and the definition of “Property Damage” where there is an “occurrence.”

The underlying facts are noteworthy in that there was no dispute that the plaintiff-claimant, Thee Sombrero, Inc. (Sombrero), lost revenue and the value of its real estate (diminished value) when the security company it hired to provide security guards failed to keep guns out of Sombrero’s nightclub.  A fatal shooting due to that alleged negligence (“an occurrence”) resulted in a lost ability by Sombrero to operate its property as a nightclub.  That specific loss of use totaled almost a million dollars in diminished value of the Sombrero property.  Sombrero sued the security company for the lost value, and the security company defaulted.  Sombrero then pursued the security company’s insurer, Scottsdale, under California Insurance Code section 11580, which allows a prevailing claimant to file a direct action against the insurer for coverage under the applicable insurance policy.

Scottsdale filed a motion for summary judgment not long after the section 11580 action was filed against it, arguing that the loss of the “use permit” for a nightclub was not lost use of tangible property, but merely the loss of an intangible right to use property in a certain way, and really economic loss that is not covered as property damage under the policy. The trial court agreed.  Sombrero appealed and argued in essence that “[t]he loss of the ability to use the property as a nightclub is, by definition, a ‘loss of use’ of ‘tangible property.’” To which the appellate court commented, “It defies common sense to argue otherwise.”  At the same time, however, the appellate court identified contrary authority involving Scottsdale (albeit in Washington State) that was “strikingly similar” to the present case, yet distinguished the prior Scottsdale decision on three grounds:  1) the focus should be on the loss of use of the tangible property that results from the loss of the entitlement, not just the entitlement, 2) the loss is not defined in the policy as requiring a “total loss” and therefore under normal interpretation standards “any significant use” lost would be within the reasonable expectation of the insured for coverage, and 3) acknowledging that a leasehold of a specific type of property is an actual property right, and the loss of such use of a property right is therefore a loss of use of tangible property.   In stating the “correct principal,” the appellate court held that “losses that are exclusively economic, without any accompanying physical damage or loss of use of tangible property, do not constitute property damage.”  Here, because the Scottsdale policy “expressly defined property damage as including” ‘[l]oss of use of tangible property that is not physically injured’,” the appellate court disregarded the distinguishable California cases with differing policy language under consideration.

While this case did not arise out of a construction defect dispute, the points of insurance coverage may be applicable in a future construction defect context where there has been an “occurrence” but no physical injury to the property, only a valuable loss of use of that property.  Of course, it will always depend on the specific language of the insurance policy, which is why it is so important to understand the insurance policies and potential for coverage in any dispute.