In a win for policyholders, a California appellate court has held that the loss of use of property resulting from alleged negligence constitutes property damage under a liability insurance policy.

In Thee Sombrero, Inc. v. Scottsdale Insurance Company, the property owner, Thee Sombrero, operated a venue as a nightclub. After a shooting inside the nightclub caused a patron’s death, the local government revoked Sombrero’s right to use the property as a nightclub and, instead, limited permissible use of the property to a banquet hall. Sombrero sued the security company it had hired to keep guns out of the club, alleging that it was the security company’s negligence that caused the city to revoke Sombrero’s nightclub use permit and that the loss of use of the facility as a nightclub resulted in damages of almost a million dollars based on an assessment of the property’s diminished market value. The security company did not contest the claim, and Sombrero obtained a default judgment.

Armed with a default, Sombrero next sought to hold the security company’s liability insurer, Scottsdale Insurance Company, accountable for the judgment. Sombrero asserted that the loss of its ability to use the venue as a nightclub constituted loss of use of tangible property under the security company’s liability policy with Scottsdale. The insurer responded with a summary judgment motion, arguing that Sombrero suffered only uncovered economic losses, not tangible property damage. Relying on Scottsdale’s economic losses argument, the trial court granted the motion.

On appeal, a unanimous appellate court reversed in favor of Sombrero. In doing so, the court held that Sombrero’s inability to use the property as a nightclub constituted property damage based on the policy’s definition of “Property Damage,” which included “[l]oss of use of tangible property that is not physically injured.” The court also held that a proper measure of damages for a loss of use of undamaged property might be the property’s diminution in market value. Indeed, as the court explained, “[i]n the liability policy context, diminution in market value is accepted as a proper method of measurement of any property damages which may have been sustained.” Thus, the property’s diminution in value properly served as a measure of Sombrero’s property damages.

The Thee Sombrero decision has significant implications in California and other jurisdictions, given the use of similar if not identical language in liability insurance policies nationwide, and has already garnered national press attention. Walter Andrews, head of Hunton Andrews Kurth LLP’s insurance coverage practice, explained in a recent interview by Law360, available here, that the appellate panel properly treated Sombrero’s financial losses as a measure of its damages from its partial loss of use of the venue as a nightclub. As Andrews further explained, “[o]f course, the damages to be calculated from the loss of use of tangible property will result in a numerical calculation,” “That does not make them ‘economic loss’ and does not take them outside the insurance coverage.”