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Insurance Law

Going to Pot: How to Lose Fire Insurance Coverage

Members of the public think that the covenant of good faith and fair dealing only applies to the insurer and the insured can do whatever they want and hide important information from the insurer to avoid increased premium or loss of coverage. In Michigan endorsements added to homeowners policies require the insured to report any change in risk on penalty of losing coverage.

In Nationwide Mut. Fire Ins. Co. v. McDermott.. — Fed.Appx. —-, 2015 U.S. App. LEXIS 3012 (C.A.6 (Mich.) 2/24/15), [enhanced version available to subscribers], the insurer paid for a fire loss under a reservation of rights to the insured and mortgagee and then sought recovery of what it paid to Kasey McDermott for a fire loss caused by the intentional acts of a co-insured.


On January 13, 2012, McDermott’s then-husband, Brien Mathews, accidentally started a fire—while manufacturing and smoking marijuana in their basement—that burned down their home.

McDermott’s insurer, Nationwide Mutual Fire Insurance Company, paid McDermott $160,209.50 for the loss. After learning that Mathews’ marijuana lab caused the fire, however, Nationwide challenged its liability through a declaratory action filed in district court. Following discovery, the district court held: (1) that the policy did not cover McDermott’s loss; and (2) that Nationwide was entitled to subrogation for payments made to McDermott following the fire before it learned of the fire’s cause. On appeal, McDermott challenges the denial of her insurance coverage and her liability to Nationwide for payments made.

In 2010, Brien Mathews, McDermott’s then-husband, became a licensed medical marijuana patient and caregiver pursuant to M.C.L. § 333.26421 et seq, [enhanced version available to subscribers]. After obtaining his “registry identification card,” Mathews worked “up to eight hours a day” to operate and expand his marijuana operation, an operation that, at the time of the fire, served four patients, including himself. From 2010 to 2012, Mathews spent upwards of $20,000 on lab equipment, purchasing dirt, fertilizer, and “[t]ons of lighting.” The operation took place almost exclusively in two rooms in the basement of McDermott’s home, though occasionally Mathews stored marijuana in the garage.


After Mathews began growing and distributing marijuana, he learned of a process known as “butane extraction,” which involves drawing liquid butane through chopped marijuana leaves to extract THC and produce “honey oil,” a THC-rich substance users smoke. Honey oil would sell for four to eight times as much as marijuana. Mathews understood that butane extraction was risky, because “butane was highly flammable.” He knew that he “didn’t want to have any source of ignition around the butane.” He also knew “not to smoke” when he was using butane, and to keep it away from “open flame” and “any object that sparks.”

On January 13, 2012—the day of the fire—Mathews was performing butane extractions when a flame he had lit to smoke some of the honey oil ignited butane that had not yet evaporated. The resulting fire consumed the house and most of their possessions.

Although McDermott knew that Mathews had been growing marijuana in the basement, she claims that she did not know about the butane extractions or that butane was flammable.

At the time of the fire in January 2012, McDermott had a Nationwide Homeowner Policy that provided coverage for “accidental direct physical loss to [the] property” described therein. The policy specified which types of losses were not covered, such as those caused by an intentional act of the insured or those “occurring while hazard [was] increased by a means within the control and knowledge of an insured.” Further, by a Michigan Amendatory Endorsement to the policy, Nationwide informed McDermott that she had “a duty to notify [Nationwide] as soon as possible of any change which may affect the premium risk under th[e] policy,” including “changes … in the occupancy or use of the residence premises.”

The district court found that the policy did not cover McDermott’s losses because the fire was not an accident, and, in any event, McDermott was barred from recovery under the Increased Hazard exclusion; and as a result, Nationwide was entitled to subrogation in the amount of $139,841.04 for payments made on McDermott’s behalf.


McDermott challenges the district court’s ruling, arguing that, as an innocent co-insured under Michigan law, she is entitled to recover under the policy despite her then-husband’s conduct, and should not be “required to reimburse Nationwide.”


The appellate court concluded that because McDermott failed to notify Nationwide of the change in use of her basement—notification expressly required by the policy—the district court correctly denied coverage. The “Michigan Amendatory Endorsement” to McDermott’s policy provided that McDermott had a duty to notify Nationwide as soon as possible of any change which may affect the premium risk under the policy, including, but not limited to, changes in the occupancy or use of the residence premises.

McDermott failed to fulfill the notification condition by not informing Nationwide of Mathews’ marijuana growing operation. During their depositions, both McDermott and Mathews admitted that they had not informed Nationwide that in 2010, Mathews set up a marijuana growing operation in their basement, effectively “changing” the use of the basement from an area “simply used for storage and [their] washer and dryer to an area where [Mathews was] manufacturing and processing marijuana.” Because McDermott failed to satisfy the notification condition in her policy and, by so doing, knowingly omitted—in her representations to Nationwide—a “material fact … during the policy period.” As a result she is not entitled to recovery and is obligated to reimburse Nationwide the money it paid to the mortgagee.

The ruling was required because Nationwide was not informed, as required by the policy, that:

1. Mathews had approximately 28 marijuana plants growing in the basement.

2. Two rooms in the basement had been converted into growing rooms—with one housing plants in the “vegetative state” and the other serving as the “flower room”.

3. Mathews had spent upwards of $20,000 on lab equipment, including “[t]ons of lighting” and numerous cans of butane.

4. According to Nationwide’s representative, had McDermott informed Nationwide of Mathews’ marijuana operation, Nationwide would have declined coverage altogether, because such an operation is an increased hazard and “an unacceptable risk.”

It is impossible to hold an insurance company liable for a risk it did not assume. [Auto–Owners Ins. Co. v. Churchman, 489 N.W.2d 431, 434 (Mich.1992), [enhanced version available to subscribers].] Because McDermott is not entitled to recover under the policy, Nationwide is also contractually entitled to subrogation.

The mortgage clause clearly and unambiguously provides, “[i]f [Nationwide] pay[s] the mortgagee for loss and den[ies] payment to you[,] … [Nationwide is] subrogated to all the rights of the mortgagee granted under the mortgage on the property.”


This case proves, without using the words, that the covenant of good faith and fair dealing applies equally to the insured as it does to the insurer. The insured was under a mandatory duty to advise the insurer that they were using a highly flammable substance – butane – in their basement as part of a marijuana growing and processing operation. Had the insurer known the true facts it would never have insured the risk. Since it paid the innocent mortgagee it was entitled to reimbursement from the insured’s including the claimed innocent spouse who failed to advise of the change in risk.

    By Barry Zalma, Attorney and Consultant

Reprinted with Permission from Zalma on Insurance, (c) 2015, Barry Zalma.

Barry Zalma, Esq., CFE, is a California attorney who limits his practice to consultation regarding insurance coverage, insurance claims handling, insurance bad faith and fraud and acting as a mediator or arbitrator on insurance disputes. Mr. Zalma serves as a consultant and expert almost equally for insurers and policyholders. He founded Zalma Insurance Consultants in 2001 and serves as its only consultant. He recently published the e-books, "Zalma on Rescission in California - 2013"; "Random Thoughts on Insurance" containing posts from this blog; "Zalma on Insurance;" "Murder and Insurance Don't Mix;" “Heads I Win, Tails You Lose — 2011,” “Zalma on Diminution in Value Damages,” “Arson for Profit” and “Zalma on California Claims Regulations,” and others that are available at Zalma Books.

Mr. Zalma can be contacted at Barry Zalma or, and you can access his free "Zalma on Insurance Fraud" newsletter at Zalma’s Insurance Fraud Letter.

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