Legend has it that New Jersey’s greatest contribution to American rock ‘n’ roll, Bruce Springsteen, was nearly relegated to obscurity by a marijuana bust involving his bandmates. One of The Boss’ early bands, the Castilles, was allegedly forced to break up when some of its members were caught with cannabis in Freehold in 1967. Fifty years later, it seems the Garden State’s marijuana “Glory Days” may be approaching, with legalization (in some form) on the horizon.
Governor Phil Murphy campaigned on a commitment to legalize recreational use, and although cannabis-related legislation has faced recent setbacks, supporters of legalization are renewing their efforts. Legalization, if and when it occurs, will transform New Jersey’s economy. But business owners, entrepreneurs and investors considering entering the cannabis space should not be “Blinded by the Light,” and would do well to educate themselves about the insurability of various types of exposures they may face.
Cannabis businesses will of course face many of the same risks that all businesses face: a customer may suffer an injury while on the premises, an employee may sue for wrongful termination, a pipe may burst and damage inventory, or a hurricane may cause wind or water damage to a building or grow operation. However, due to several factors—inconsistencies between the state/federal regulatory landscape, insurers’ cautiousness due to lack of underwriting and claims experience, and the lack of court-tested standard policy language—the cannabis industry faces unique insurance challenges.
Potentially Insurable Risks
One area of particular concern is product liability coverage. Like other consumer goods businesses, any business that “touches the plant” may find itself subject to product liability allegations involving inadequate labeling or product defects. As an example, in a wrongful death case in Colorado federal court, a dispensary, which had been sued for failing to provide adequate warnings on edible products, in turn brought the edibles manufacturer into the lawsuit (which ultimately settled). An insurance coverage dispute ensued. See Kirk v. Nutritional Elements & Gaia’s Garden, No. 17-cv-1113 (D. Colo. filed May 4, 2017).
In New Jersey, an injured consumer can sue all parties in the chain of distribution, including the manufacturer, distributor and retailer. While this risk is by no means unique to the cannabis industry, several potential insurance coverage issues may be.
First, off-the-shelf “traditional” liability policies often contain exclusions for illegal conduct, which some insurers have sought to apply to cannabis business activity that is legal under state law, but illegal federally. At least one court has rejected this argument in the context of a first-party property damage claim involving a grow operation, see Green Earth Wellness v. Atain Specialty Ins. Co., 163 F. Supp. 3d 821 (D. Colo. 2016), but it remains to be seen whether such an argument will have traction in other jurisdictions and/or other contexts.
Second, even policies that are expressly tailored for use in the cannabis industry may restrict coverage for products with relatively high amounts of psychoactive THC. More generally, such specialized policies are relatively un-standardized and untested in the claims environment and in courts—the result is that “contract certainty” for insurers and insureds may not be achievable as of yet.
Third, policies may purport to condition coverage on affirmative proof of compliance with state and local regulations pertaining to such issues as licensing, dosage-related sales restrictions and testing requirements, and “seed to sale” product tracking. The situation is potentially complicated by the expected influx of “cannabis tourists” from neighboring New York and other places where cannabis will still be illegal—underwriters may seek to impose additional restrictions or requirements relating to coverage for liabilities involving out-of-state actors.
First-party coverages are also essential to protect grow operations, manufacturing facilities and dispensaries from property damage due to fire, water, wind and other perils, as well as loss of business income resulting from such occurrences. Here, too, cannabis insurance underwriters may seek to apply certain coverage limitations. For example, a commercial property policy designed for a grow operation may insure greenhouse, irrigation, computer and other equipment, but may exclude coverage for standing crops and “mother stock” (plants from which clippings are cut to create clones). Importantly, federal crop insurance is not currently available for cannabis growers (but may soon be for farmers who grow industrial hemp from which CBD is extracted). Policies may also exclude theft of cash, crop or harvested plants—a perennial industry problem that may require a specialized type of crime policy.
Growers may also face environmental liabilities arising from pesticide and fertilizer run-off, diversion or intensive use of water sources, and airborne fungi resulting from cultivation and drying, among other things. In some states, these issues have given rise to lawsuits brought by neighboring property owners and enforcement actions initiated by environmental regulatory agencies. While commercial property and casualty policies typically exclude pollution-related liabilities, specialized coverage forms may be available.
Another type of risk that cannabis-related business will increasingly face is cyber risk, including challenges to data privacy. In some ways, this fact illustrates just how far legal cannabis has come as a legitimate enterprise—sensitive customer information is gathered and stored electronically by legal cannabis businesses just as it is by myriad other types of businesses. This information can include confidential medical or other patient information. Just as we have seen elsewhere in the health care industry, inadequate data security protocols and/or criminal activity can result in the release of confidential information and various types of liability. Consumer class action lawsuits and regulatory/governmental investigations often quickly follow on the heels of cyber events. Additionally, first-party costs relating to network/data remediation, forensic investigation, improvement of data security protocols, and business interruption can be significant. So-called “cyber” policies and certain types of errors and omissions policies may cover such losses.
Insurance Regulatory Issues
Important issues also surround who is offering insurance coverage for cannabis risk. Insurers are regulated by state insurance departments like New Jersey’s Department of Banking & Insurance. Typically, a carrier must be licensed to do business in the state and file for approval to sell particular insurance products. Insurers who obtain such approval, “admitted” carriers, are generally subject to more stringent consumer protection regulations than “non-admitted” carriers, including remedies for improper claims handling. Protections against admitted insurer insolvency may also be more robust. Non-admitted carriers, sometimes known as “excess and surplus lines” carriers, may be permitted to issue policies in the state, but are not governed by the same rules.
If and when New Jersey legalizes, the immediately available insurance will likely be from non-admitted carriers, while the Department takes time to solicit and review filings from insurers seeking to become admitted. Such has been the case in California, where recreational marijuana has been legal for over a year but only a handful of carriers have been admitted and their products approved. This issue is compounded by the fact that many of the big-name national carriers appear to still be taking a “wait-and-see” approach to cannabis underwriting, pending federal legalization. Non-admitted regional carriers have thus jumped into the breach.
For any business, an insurance policy is only as good as the coverage it offers. In the immediate aftermath of legalization, however, New Jersey cannabis businesses will have to pay even greater attention to the specifics of their policies and insurers. Without careful due diligence, they may find themselves, like another New Jersey rock icon, “Livin’ on a Prayer.”
Benjamin D. Tievsky is a senior associate with Pillsbury Winthrop Shaw Pittman in New York. He represents policyholders in insurance coverage matters.