Insurance—Damron & Morris Agreements—Issue Preclusion in Coverage Case

Quihuis v. State Farm Mut. Auto. Ins. Co., 697 Ariz. Adv. Rep. 23 (October 1, 2014) (J. Pelander)

INSURER HAS RIGHT TO LITIGATE COVERAGE DESPITE DAMRON OR MORRIS AGREEMENT BUT MAY NOT RELITIGATE LIABILITY FACTS IN GUISE OF COVERAGE QUESTION

In this case the 9th Circuit certified to the Arizona Supreme Court the question of whether or not facts stipulated to in a default judgment on liability and damages are binding upon an insured in a subsequent coverage action.   Carol Cox, insured by defendant State Farm, sold her Jeep to a coworker who bought it for her daughter. However the purchase involved eight monthly installment payments of $3,000 so Cox gave possession of the car to the coworker but held onto the title as security. The coworker's daughter was sued for negligent driving and the Coxes for negligent entrustment.  State Farm refused to defend Cox claiming the car in question was no longer owned by her. She, the coworker's daughter and the injured plaintiff then entered into a Damron agreement whereby it was stipulated the daughter was not competent to drive, that Cox knew this and that it was negligent of Cox to entrust the vehicle to her and further that Cox was the owner of the car at the time of the accident. The parties further stipulated to damages of $275,000.The parties agreed to allow a default judgment be entered, Cox assigned her rights against State Farm to the plaintiff and plaintiff agreed not to execute the judgment against Cox.  The trial court rendered a $350,000 default judgment. Plaintiffs then brought a declaratory relief action against State Farm alleging it had failed to defend and was liable to pay the judgment. State Farm removed the case to federal court. The federal district court granted the insurer State Farm summary judgment finding that State Farm was not precluded from litigating the coverage question despite the stipulation and default judgment and that Cox was not the owner of the Jeep as a matter of law and therefore State Farm was not obligated to satisfy the judgment.  Plaintiff appealed and the 9th Circuit certified the question.   The Arizona Supreme Court relied upon Restatement §58 in finding that facts necessarily determined in establishing the existence and extent of liability in the underlying action could not be relitigated in the coverage action because:  “(1) the Coxes' insurance policy imposed on State Farm both an indemnity and a defense obligation; (2) the [plaintiffs'] complaint involved a claim that "might be within the scope of [State Farm's] indemnity obligation"; (3) the Coxes gave State Farm reasonable notice of the [plaintiffs'] lawsuit, thereby providing State Farm with "an opportunity to assume [the Coxes'] defense"; and (4) "a judgment" was entered in favor of the [plaintiffs] and against the Coxes.”   However, when there is a “conflict of interest” between the insured and insurer regarding a factual determination bearing upon coverage and liability,  an insurer may later litigate that issue in disputing coverage as long as it was not "determined in the action" through actual litigation. “Just as a settlement agreement ‘should not be used to obtain coverage that the insured did not purchase,' nor should the choice of allegations in a complaint.” This is true even where the insurer has refused to defend the action. In Arizona there is no “absolute” duty to defend and even where the facts alleged in the complaint would create coverage, facts known to exist may support the insurer's denial of coverage and refusal to defend as well as its right to litigate coverage. Because the ownership question was part of a stipulation and not actually litigated and determined by a fact finder, the insurer was entitled to litigate ownership in the coverage action.   Finally, the court found that a failure to defend does nonetheless have potential serious consequences to an insurer including issue preclusion on the extent of liability and amount of damages at least up to policy limits if not beyond where bad faith is proven.