New Jersey’s greatest contribution to American rock ’n’ roll, Bruce Springsteen, was nearly relegated to obscurity by a marijuana bust involving his bandmates. Rock legend has it that one of The Boss’ early bands, the Castilles, was forced to break up when some of its members were caught with cannabis in Freehold in 1967. While it would have been unthinkable back then, New Jersey is now on the precipice of marijuana legalization. Gov. Phil Murphy’s campaign platform included a commitment to legalizing recreational use, and three cannabis-related bills have passed through New Jersey Senate and Assembly committees and await the legislature’s final vote, which could happen this month. Legalization would transform New Jersey’s economy, and may also be a litmus test for nearby New York. Looking ahead, business owners, entrepreneurs and investors who are contemplating entry into the cannabis space, when and if legalization occurs, would do well to educate themselves about the potential insurability of various exposures facing the industry.
Coverage Issues and Challenges
Cannabis businesses face many of the same risks as other businesses: for example, a customer could get injured on premises, an employee might sue for wrongful termination, a pipe may burst and damage inventory, or a hurricane could cause wind or water damage to a building. However, due to several factors—including (1) inconsistencies in the regulatory landscape (state and federal; between states; and sometimes between counties or towns within a state), (2) insurers’ general cautiousness due to lack of underwriting and claims experience, and (3) the lack of court-tested standard policy language—the cannabis industry faces some unique coverage challenges.
One area of particular concern is product liability coverage. Similar to other businesses in the consumer goods stream of commerce, any business that “touches the plant” may find itself subject to product liability allegations involving inadequate labeling and/or product defects. In New Jersey, as in other jurisdictions, 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” general liability and product 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.
- 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 and/or CBD.
- 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, “seed to sale” product tracking, and even tax compliance.
In New Jersey, the situation is potentially complicated even further 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 resulting loss of business income. Here, too, however, cannabis insurance underwriters may seek to apply coverage limitations. For example, a commercial property policy designed for a grow operation may insure greenhouse, irrigation, computer and other equipment—but may contain exclusions applicable to standing crops and “mother stock” (i.e., plants from which clippings are cut to create clones). Federal crop insurance is not currently available for cannabis growers but may soon be for a subset of farmers who grow industrial hemp from which CBD is extracted. Policies may also exclude theft of cash, crop or harvested plants, a perennial problem in the industry that may require coverage under a specialized type of crime policy.
Growers have also faced environmental liabilities in many jurisdictions arising from issues such as pesticide and fertilizer run-off, the diversion and/or intensive use of water sources, and airborne fungi resulting from the cultivation and drying process. Neighboring property owners have brought lawsuits, and environmental regulatory agencies have initiated enforcement actions in several states so far. While commercial property and casualty policies typically exclude pollution-related liabilities, specialized coverage forms may be available.
Admitted vs. Non-admitted Carriers
In addition to questions pertaining to what is covered, important issues also surround who is offering the coverage. Insurers are heavily regulated by state insurance departments such as the New Jersey Department of Banking & Insurance. Typically, a carrier must be licensed to do business in the state and must file with the Department for approval to market and sell particular insurance products. Insurers who obtain such approval are known as “admitted” carriers, and they are generally subject to more stringent consumer protection regulations than “non-admitted” carriers. Among other things, regulations applicable to admitted carriers typically provide for approval of rates and policy forms; additional recourse for improper claims handling; and a guarantee fund or other mechanism in case the insurer becomes insolvent. Non-admitted carriers, sometimes known as “excess and surplus lines” carriers, may be permitted to issue policies in the state, but are not be 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, review and process filings from insurers seeking to become admitted. Such has been the case in California, where recreational marijuana has been legal for almost 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 legalization at the federal level. Non-admitted, regional carriers have jumped into the gap, offering (among other things) policy packages that purport to cover legal cannabis from seed to sale, but may not have received regulatory scrutiny.
Prospective policyholders considering purchasing any cannabis-related insurance (whether from an admitted or non-admitted insurer) must conduct extra diligence, given that policy language may be non-standard and/or untested in court and the carrier may have limited cannabis claims experience. Policyholders should also be wary of unfavorable policy terms that are sometimes preferred by foreign insurers, such as choice of law provisions calling for the application of foreign law, and the waiver of certain remedies such as attorneys’ fees and punitive damages for bad faith. Additionally, proposed policy wording (including exclusions) is often subject to negotiation. Subject to this diligence, a carrier with solid financial ratings who is trying to gain traction in this relatively new market could be a good choice.
Take-Aways for Prospective Policyholders
An insurance policy is only as good as the scope of coverage that it offers. Under no circumstances should a prospective policyholder purchase a product simply because it is marketed as “cannabis insurance.” As with any other business investment, due diligence must be conducted. The following are some issues that merit scrutiny:
- Do the proposed type(s) of insurance coverage actually fit your business’ needs?
- Does the nature of your business potentially trigger exclusions that could swallow coverage for certain types of loss?
- For post-legalization New Jerseyans, could the legal landscape and/or political climate in the Garden State have coverage implications?
- Who is underwriting the proposed insurance, to what regulations are they subject, what is their financial strength, and is there any reason to believe that they might be pre-disposed to deny claims?
Brokers can be a helpful resource for exploring market issues, and competent coverage counsel can advise on legal ones. At the risk of mixing New Jersey rock icons, without this due diligence, you—like Bon Jovi—may only be “livin’ on a prayer.”