Criminal Acts Causing Property Damage Not Covered by Homeowner Policy

In the context of first party property coverage, criminal act exclusions typically have three requirements that must be met before the exclusion is applicable: (1) there must be a policy-defined loss; (2) the loss must be caused by a dishonest or criminal act; and (3) the dishonest or criminal act must be committed by a person or entity that the homeowner “entrust[ed] with the property for any purpose.” See, e.g., Neighborhood Investments, LLC v. Kentucky Farm Bureau Mut. Ins. Co., 2014 WL 1260480 (Ky. App. March 28, 2014). Homeowner policies do not usually define the word “in trust,” however.

In Neighborhood Investments, LLC v. Kentucky Farm Bureau Mut. Ins. Co., 2014 WL 1260480, the Kentucky Court of Appeals, on first impression, held that a landlord had “entrusted” the rental house to the tenant for purposes of the policy’s criminal act exclusion and, therefore, the exclusion barred coverage for the damage caused by the tenant who had manufactured methamphetamine on the property.

During the term of the lease, the tenant, McCormick, was arrested for manufacturing methamphetamine in the rental house. Civil authorities determined that the byproducts of McCormick’s methamphetamine production had contaminated the house and rendered it uninhabitable. The authorities prohibited the landlord from re-leasing the house to any other tenant until the premises had been decontaminated.

The landlord/insured sought coverage under the homeowners policy issued by Kentucky Farm Bureau Mutual Insurance Co. (Farm Bureau) seeking coverage for the substantial decontamination expenses. Farm Bureau declined coverage on the basis of the criminal act exclusion. The Farm Bureau policy excluded coverage “for loss or damage caused directly or indirectly by … dishonest or criminal act[s] by … anyone to whom you entrust the property for any purpose . …” Id. at *1-*2.

The landlord/insured did not contest the validity of the criminal act exclusion. Both the landlord/insured and Farm Bureau agreed that the policy would define the contamination caused by McCormick’s methamphetamine production as a “loss” for purposes of coverage, and that McCormick’s methamphetamine production constituted a “criminal act.” The only issue that remained was whether McCormick qualified as “anyone” whom the landlord/insured “entrust[ed]” with “the property for any purpose.”

The landlord/insured argued that a lease was a contract for the possession and profits of the tenancy and that a person who occupied the property was in possession of the property under a lease as a tenant. The word “lease” was a legal term of art which was not synonymous with the word “entrust.” The Kentucky Court of Appeals disagreed.

The Court found that the landlord/insured’s argument overlooked the concept that words used in contracts are not given legal or technical meaning when they are not defined by the contract itself, but are given the meaning, usage and understanding of the average person. The Court then reviewed various dictionary definitions, see, e.g., MERRIAM-WEBSTER’S COLLEGIATE DICTIONARY (11th ed. 2005, pg. 417) and BLACK’S LAW DICTIONARY (7th ed. 1999, pg. 554), as well as how several courts from varying other jurisdictions had interpreted the word “entrust” in the context of a criminal acts exclusion. See, e.g., Imperial Ins. Co. v. Ellington, 498 S.W.2d 368, 372 (Tex. Civ. App. 1973). Based on this review, the Kentucky Court concluded that the word “entrusted” conveyed the idea of the delivery or surrender of possession of property by one to another with a certain confidence regarding the other’s care, use or disposal of the property.

According to the Court, the landlord/insured certainly had delivered and surrendered possession of the house to McCormick. The landlord/insured expected McCormick would not use the house for any kind of criminal enterprise, much less a criminal enterprise that would render the house uninhabitable. Therefore, the Court concluded that, within the common and ordinary meaning of the word, the landlord/insured had “entrusted” its house to McCormick. The Court’s conclusion was bolstered by the Seventh Circuit Court of Appeals decision in Vision Financial Group, Inc. v. Midwest Family Mut. Ins. Co., 355 F.3d 640, 643 (7th Cir. 2004) which examined exactly the same criminal acts exclusion and determined that the word “entrusted” clearly encompassed a lessee-lessor relationship.

The Kentucky Court found that the criminal act exclusion was applicable and that Farm Bureau was not required to provide coverage for the substantial decontamination expenses.