The California District Court of Appeal for the Fourth Appellate District recently overturned a lower court ruling and held that the reduction in permitted uses under a Conditional Use Permit qualifies as the loss of use of tangible property and therefore “property damage” under a general liability insurance policy.

Thee Sombrero Inc. (Sombrero) obtained a conditional use permit to operate a nightclub in Colton, California.  One of the conditions of the permit was the city had to approve the floor plan for the property and that it could not be modified without city approval.  The nightclub hired CES, which provided security guard services at the club.  One night, a nightclub patron shot and killed another patron at the nightclub.  After the shooting, Sombrero learned that CES had converted a storage area into a “VIP” entrance to the club that had no metal detector, which is how the gun used in the shooting got into the club.  As a result of the shooting, the city revoked the club’s permit although they allowed it to operate the property as a less-lucrative banquet hall under a modified use permit.

Sombrero sued CES alleging its failure to frisk the shooter (which entered the club through the unapproved VIP entrance) was the cause of its nightclub permit’s revocation, which lowered the property’s value from $2.8 million to $1.8 million, a difference in value of $923,078.  CES failed to answer Sombrero’s complaint whereby a default judgment was entered against it.  The case proceeded as an Insurance Code section 11580 action by Sombrero against CES’ insurance carrier, Scottsdale Insurance Co.

Scottsdale argued that the carrier’s liability was for “property damage” caused by an “occurrence” and that property damage was defined in the policy, in part, as the loss “of use of tangible property that is not physically injured.”  Scottsdale brought and was granted summary judgment on the basis that the loss in value (caused by the loss of permit to operate as a nightclub) was not a loss of the use of tangible property, but merely a loss of its intangible right to use the property in a certain way (i.e., as a nightclub).  Scottsdale argued the diminution in value was a purely economic loss not covered by the property damage coverage afforded under the General Liability policy.

The Court of Appeals disagreed and overturned the trial court’s ruling, reasoning that “the loss of the ability to use the property as a nightclub is, by definition, a ‘loss of use’ of ‘tangible property.’” Unlike prior cases in which courts held there was no coverage where only economic damages were alleged, the court here emphasized that the complaint alleged that the loss of the permit right resulted in the loss of use of the property as a nightclub, which in turn reduced the economic value of the business.

If followed by courts in other appellate districts, this decision could lead to a significant expansion of the scope of the definition of “property damage” under Commercial General Liability policies if the policy has the same or similar language as in the Scottsdale policy. It’s expected Scottsdale will appeal the decision.

Thee Sombrero, Inc. v. Scottsdale Insurance Company, (E067505, 10/25/18)