Just What Is Tangible Property?

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Two days ago, an interesting decision came out of a California Appeals Court. Intriguing enough to us, maybe not to many others, that we put aside this week’s intended blog posting and scribbled this one instead. Though we fear the subject may only appeal to insurance wonks, we’re predicting that the court’s reasoning may leach into non-insurance areas as well.

In a decision that can be seen by clicking: HERE, the California Court of Appeal tells us that a leasehold is “tangible property.” Though the court doesn’t need our blessing, and that’s for sure, Ruminations thinks the court got it right. Before reading this decision, we would have said that “tangible” meant you could touch it.

There’s a little story that will give the context for the court’s decision. By reason of a conditional use permit, a property could be used (and was being) as a nightclub. A third-party security provider failed to screen certain “VIP” patrons for guns while screening others. One unscreened patron shot and killed another. One of the fallouts was that the conditional use permit was canceled and a new one was issued. The new permit eliminated a nightclub as a permitted use and now allowed use of the property as a catering hall. The property owner sued the security company alleging that the security company’s failure reduced the value of the property by a little more than $900,000 and got a judgment in that amount. Then, to collect on the judgment, it sued the security company’s liability insurance carrier. As readers might have guessed, the carrier responded that there was no coverage under the policy. Its specific defense was that loss of the right to use the property for the more valuable use, that of a nightclub, was neither bodily injury nor property damage; thus the security company’s policy did not cover such a claim.

Clearly, the property owner was not claiming bodily injury. The court did not identify the policy form, but it quoted the relevant property damage coverage provision. Clearly, the policy in question was the most common version, the Commercial General Liability form promulgated by the Insurance Services Organization, Inc. (ISO). It covers property damage caused by the insured and here is how it defines “property damage”:

“Property damage” means:

a.  Physical injury to tangible property, including all resulting loss of use of that property. All such loss of use shall be deemed to occur at the time of the physical injury that caused it; or

b.  Loss of use of tangible property that is not physically injured. All such loss of use shall be deemed to occur at the time of the “occurrence” that caused it.

Take note that property damage for a “loss of use” does not require physical damage. Earlier policy forms and possible non-ISO forms used a different formulation. Those other formulations often required physical injury before there would be coverage for a loss of use.

Though a lower court did not find the property owner’s loss of the right to use its property as a nightclub to be the loss of use of tangible property, the appellate court had a distinctly different idea. In fact, the appellate court began its discussion with the following:

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.

The common sense is that before the security company’s negligence resulted in the property’s right to be used as a nightclub, the property could be used as a nightclub. It wasn’t just that the permit was lost; it was that the use as a nightclub was lost. That’s an important distinction because of prior case law in other states. For example, in a Washington case, a very similar security failure resulted in a restaurant’s loss of a liquor license. There, the court focused on the loss of the license itself, finding that such a license was not tangible property, instead holding that “[a] liquor license is merely representative of a privilege granted by the state and, as such, is intangible property.” In that case it appears that the tenant couldn’t or didn’t plead that it had lost its right to occupy or use its premises; seemingly it could still operate its restaurant, sans liquor. In addition, Ruminations doesn’t know the facts well enough to know if such a claim would have been supportable or if the tenant could have used the space for any other use.

The insurance carrier argued that “a right to occupy premises is not a tangible property interest.” Here is some of what the California court wrote in response:

A building is tangible. Dirt is tangible. Hence, a lessee in possession has a tangible property interest in the leased premises.

[B]efore [a] tenant takes possession, [the] tenant’s right to possess premises is not tangible property; it is a contractual right that does not mature into a property right until possession actually occurs [BUT a] tenant has [a] tangible property interest in leased premises after tenant actually [takes] possession of the property.

In a folksy way, the court gave an overriding explanation, albeit one focusing on “insurance” law principles. Here it is:

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.

Careful readers will have already noted that the court’s analysis (and our description as well) centers on a tenant’s right and the actual claimed loss before the court was that of the property’s owner. That would make the court’s words: “dicta.” [Here’s how one web-source legal dictionary defines dicta – “Dicta are judicial opinions expressed by the judges on points that do not necessarily arise in the case. Dicta are regarded as of little authority, on account of the manner in which they are delivered; it frequently happening that they are given without much reflection, at the bar, without previous examination.”] In this case, the dicta were given with a great deal of reflection. The court’s analysis covered a great deal of prior case law and carefully considered the insurance company’s arguments against a finding of “tangible property.” Thus, it shouldn’t be dismissed.

When a court includes “dicta” in its decision, it is uncommon for the court to label it as such. Here, the court very well knew what it was doing and knew it had no need to explore the question as to whether a tenant’s leasehold interest was tangible property but affirmatively chose to do so. It could have just skipped all of its analysis and begun its holding with what it wrote two-thirds of the way through its opinion:

Most important, though, our view on this point is dictum, because our case is distinguishable. Here, Sombrero is the owner of the property, not a lessee. As such, it plainly has an interest in tangible property.

We think the ruling in this case can be important, but we haven’t yet thought through all of its implications. One is clear because it was addressed in the court’s decision. That concerns the measure of damages. Here, like with any other kind of damage to property, the measure is the cost of repair or the diminution in value of the property. Loss of the right to operate a nightclub was irreparable; therefore, the appropriate measure of damage was the drop in market value for the property were it to be sold. [Importantly, while the court recognized this measure of damages to be an unrecoverable “economic loss” had it been the owner’s only loss, the fact that the loss of use of tangible property was also involved made a recovery possible.]

Another implication is clear. Where a tenant causes a loss of use for a property without actually causing physical damage, it might be able to shift the loss to its insurer. Another situation could be where a tenant loses the right to operate its business because of a change in law, it could recover something from somebody by virtue of the loss of its right to “use tangible property.” That wouldn’t be under a commercial property insurance policy because the standard form defined covered property in a way that ignores “tangible property.”

Here’s a request we’re making. Reader’s, let us know the ways you think this understanding of a leasehold interest as “tangible property” can be used either as a sword or a shield. Let us know if you think this understanding can be employed in a lease. What else? Let us know. If it works out, we’ll revisit this topic down the road.

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Comments

  1. Things that adversely affect the value of a property:
    1. The taking of (lawful) parking spaces through eminent domain or other actions.
    2. The removal of billboards or monument-type signage.
    3. Modification of curb cuts affecting ingress/egress.

  2. Steve – just trying to clarify your comment – are you suggesting that because the liability insurance policy in this case expressly states that “loss of use of [tangible] property” constitute insured “property damage”, then losses through eminent domain takings or police actions (there is a difference) are thereby likewise claimable?

    • Those could be the implications but for eminent domain awards payable based on loss of “real property.” The California court’s analysis didn’t distinguish between real and personal (tangible) property. As to eminent domain, leasehold interests are treated as real property interests, but the ubiquitous (or nearly ubiquitous) single award rule lumps the leasehold interest within the award for loss of real property. That leaves it for the landlord and tenant to privately negotiate any allocation. Search through Ruminations for a posting on that subject.

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