Third-Party Bad Faith
In a third party claim, a liability insurer generally has three duties—the duty to defend, the duty to indemnify, and the duty to give equal consideration to settlement offers. Arizona Property & Cas. Ins. Guaranty Fund v. Helme, 153 Ariz. 129, 735 P.2d 451 (1987). When the liability insurer refuses to defend the insured against a third party’s tort claim, the insured may enter into a Damron agreement, pursuant to which the insured stipulates to the entry of judgment and assigns his rights against his liability insurer to the third party, in exchange for a covenant not to execute. Damron v. Sledge, 105 Ariz. 151, 460 P.2d 997 (1969); Parking Concepts, Inc. v. Tenney, 207 Ariz. 19, 83 P.3d 19 (2004). The insured may enter into a similar agreement when the liability insurer defends under a reservation of rights to deny coverage, called a Morris agreement. In both cases, the liability insurer may contest liability for the resulting judgment by proving the insurance policy does not cover the claim. United States Auto. Ass’n v. Morris, 154 Ariz. 113, 741 P.2d 246 (1987).
Whether and to what extent the judgment estops the liability insurer from re-litigating facts and issues relating to coverage is the subject of much litigation. A recent Arizona Supreme Court opinion settles this dispute. Quihuis v. State Farm Mut. Auto. Ins. Co., 235 Ariz. 536, 334 P.3d 719 (2014). In Quihuis, the Arizona Supreme Court considered a certified question from the Ninth Circuit Court of Appeals:
The Quihuis coverage dispute centered over permissive use of the insured vehicle. Norma Bojorquez (“Norma”) purchased a car from her co-worker Carol Cox (“Carol”) and agreed to make eight $3,000 monthly payments. The parties signed a written agreement documenting the purchase and loan terms on January 9, 2008. Carol did not transfer title to Norma believing that she needed to retain the title to keep the vehicle as collateral until the loan was paid. Norma then gave the car to her daughter Iliana Bojorquez to use (“Iliana”).
Carol maintained liability insurance on the vehicle through State Farm. The policy covered Carol and any permissive users if their use was within the scope of her consent.
On January 22, 2008, while the State Farm policy was still in force, Iliana was driving the vehicle when she was involved in an accident with Yolanda Quihuis (“Yolanda”). Yolanda sued Iliana for negligence and Carol for negligent entrustment, based on an allegation that Carol owned the vehicle at the time of the accident. State Farm refused to defend Carol on the grounds ownership of the vehicle had transferred to Norma at the time of the accident.
Carol, Norma, and Yolanda later entered into an agreement stipulating: 1) Carol owned the vehicle at the time of the accident; 2) Iliana was incompetent to drive a motor vehicle and her negligence caused the accident; and 3) Carol should have known that Iliana was incompetent and should not have entrusted the vehicle to her. The parties stipulated to damages in the amount of $275,000, Carol assigned her rights against State Farm to Yolanda, and Yolanda agreed not to execute on the judgment. The state court subsequently entered a default judgment in the amount of $325,000 for Yolanda’s injuries and $25,000 for her husband’s loss of consortium.
Yolanda then brought a declaratory judgment action on the assigned claims against State Farm for indemnification and failure to defend. The district court granted State Farm’s motion for summary judgment and held the default judgment did not preclude State Farm from litigating whether Carol owned the vehicle at the time of the accident. Yolanda appealed that decision to the Ninth Circuit Court of Appeals.
The Court recognized the fact issue—ownership of the vehicle at the time of the accident—applied to both the issues of liability and coverage. The Court adopted Restatement (Second) of Judgments § 58 (1982) and held that 1) the default judgment does not preclude State Farm from litigating whether coverage exists under the policy; and 2) an insurer in a coverage action may not litigate solely liability issues resolved by the default judgment under the guise of coverage. However, where there is a conflict between the insured and the insurer on a fact issue relating both to liability and coverage, the insurer is not precluded from litigating that fact issue in a subsequent coverage action. Here, the Court held State Farm was not precluded from litigating the ownership of the vehicle in the coverage action. Id. at 545, 334 P.3d at 728.
Yolanda also argued that State Farm was precluded from litigating the ownership issue because it breached its duty to defend. The Court rejected that argument, finding that the insurer does not give up its right to contest coverage even where it has breached the duty to defend. Id. at 545-46, 334 P.3d at 728-29.
The Court also touched on another issue that has been the subject of much litigation—whether the insurer must pay the full amount of the judgment if it is later determined that there is coverage for the claim. The Court stated if a court later finds coverage, the insurer must pay the judgment up to the policy limits unless it can prove fraud or collusion. Id. at 547, 334 P.3d at 730. The Court also noted if there are no reasonable grounds for refusing to defend and denying coverage, an insurer may be liable for the tort of bad faith. Id.
In a special action, the Arizona Court of Appeals clarified the circumstances under which an insurer waives the attorney-client privilege in defending itself against a bad faith claim. Everest Indemnify Ins. Co. v. Rea, 236 Ariz. 503, 342 P.3d 417 (App. 2015). The real party in interest, Rudolfo Brothers Plastering, alleged that Everest acted in bad faith by entering into a settlement agreement that exhausted coverage under the liability insurance policy, allegedly to the detriment of Rudolfo, an insured under that same policy. Everest contended its decision was reasonable and in good faith based on its subjective beliefs about the relative merits of various available options to resolve the litigation. Everest communicated with counsel during its decision-making process. Rudolfo contended Everest waived the attorney-client privilege by asserting a subject good faith defense to the bad faith claim.
The Arizona Supreme Court previously held an insurer impliedly waives the attorney-client privilege when it affirmatively asserts that it acted in good faith because it relied on the advice of counsel regarding its evaluation and interpretation of the law. State Farm Mut. Auto. Ins. Co. v. Lee, 199 Ariz. 52, 13 P.3d 1169 (2000). Rudolfo relied heavily on a subsequent Arizona Court of Appeals decision which held an insurer waives the attorney-client privilege by defending itself based on the subjective reasonableness of its conduct after conferring with counsel. Mendoza v. McDonald’s Corp., 222 Ariz. 139, 213 P.3d 288 (App. 2009).
The Court of Appeals in Rea found Mendoza was inconsistent with Lee. Rea held “the assertion of a subjective good faith defense coupled with consultation with counsel did not, without more, waive the attorney-client privilege.” Rea, 236 Ariz. at 505, 312 P.3d at 419. The Court found that to waive the attorney-client privilege, the insurer must assert a defense in this case, that depends on the advice of or consultation with counsel. Id.
Although Everest consulted with lawyers, the Court concluded Everest’s decision to settle the case was not necessarily the product of legal advice and Everest had not asserted it was. Id. at 506, 312 P.3d at 420. The Court held Everest did not impliedly waive the attorney-client privilege. Id.
Arizona’s bad faith law continues to evolve. Staying abreast of case law developments and partnering with legal counsel will position insurers to make informed decisions regarding coverage.
ABOUT THE AUTHOR: Lynn Allen is a partner at Tyson & Mendes, LLP. She specializes in general liability defense, insurance coverage, and bad faith litigation. Contact Lynn at 602.386.5660 or firstname.lastname@example.org.
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