Fid. Nat'l Title Ins. Co. v. Osborn III Partners LLC

• Citation: 250 Ariz. 615,483 P.3d 237
• Decision Date: 09 March 2021
• Docket Number: No. 1 CA-CV 18-0040,1 CA-CV 18-0040
• Parties: FIDELITY NATIONAL TITLE INSURANCE COMPANY, Intervenor/Appellant/Cross Appellee, v. OSBORN III PARTNERS LLC, et al., Defendants/Appellees/Cross-Appellants.
• Court: Arizona Court of Appeals

250 Ariz. 615

483 P.3d 237

FIDELITY NATIONAL TITLE INSURANCE COMPANY, Intervenor/Appellant/Cross Appellee,

v.OSBORN III PARTNERS LLC, et al., Defendants/Appellees/Cross-Appellants.

No. 1 CA-CV 18-0040

Court of Appeals of Arizona, Division 1.

FILED March 9, 2021

Jones Skelton & Hochuli, PLC, Phoenix By Robert R. Berk, Charles M. Callahan, Lori L. Voepel

Loeb & Loeb, LLP, New York, NY By David M. Satnick, Helen Gavaris Co-Counsel for Intervenor/Appellant/Cross-Appellee

Perkins Coie, LLP, Phoenix By Richard M. Lorenzen, Alexis E. Danneman Counsel for Defendants/Appellees/Cross-Appellants

Judge Kent E. Cattani delivered the opinion of the Court, in which Presiding Judge Maria Elena Cruz and Judge Paul J. McMurdie joined.

CATTANI, Judge:

¶1 In this case, we address the applicability of United Services Automobile Ass'n v. Morris , 154 Ariz. 113, 741 P.2d 246 (1987), in the context of title insurance. Under Morris , which arose in the context of liability insurance, when an insurer agrees to defend its insured against a third-party claim but reserves the right to challenge coverage, the insured may independently settle with the third-party claimant without violating the insured's duty of cooperation under the insurance contract. Id. at 119, 741 P.2d at 252. We hold that Morris applies to title insurance. We further hold that a common provision in title insurance policies that denies coverage for liens or other defects "created, suffered, assumed or agreed to by the insured claimant" (here, Exclusion 3(a)) applies to mechanics’ liens that arise because of insufficient funds when a lender cuts off funding for a construction project. Accordingly, and for reasons that follow, we affirm the superior court's Morris rulings, but we reverse its ultimate coverage determination as well as the resulting judgment in favor of the insureds. Because our resolution affects the prevailing party calculus for purposes of an award of attorney's fees, we vacate the award in favor of the insureds and remand for further proceedings on the parties’ attorney's fee requests and entry of judgment consistent with this opinion.

FACTS AND PROCEDURAL BACKGROUND

¶2 In 2006, Mortgages Ltd. loaned developer Osborn III Partners $8.5 million, secured by a deed of trust, to fund construction of the Ten Lofts condominium complex in Scottsdale. In a second loan agreement, Mortgages Ltd. committed to loan the developer $41.4 million, again secured by a deed of trust on the property. The developer used a portion of the second loan to satisfy the first loan and obtain a release of the first deed of trust. Mortgages Ltd. procured a title insurance policy (the "Policy") from the predecessor to Fidelity National Insurance Company ("Fidelity") to insure the priority of its security interest, including over later-recorded mechanics’ liens.

¶3 The developer hired Summit Builders ("Summit") as general contractor for the project.

Before construction was completed, Mortgages Ltd. failed to disburse about $1.1 million of the $41.4 million it had agreed to provide, and the developer stopped paying Summit. Summit and its subcontractors later recorded mechanics’ liens against the Ten Lofts property seeking payment for completed but unpaid work.

¶4 Meanwhile, Mortgages Ltd. suffered financial problems that led to an involuntary bankruptcy proceeding in 2008. As part of the reorganization, the bankruptcy court transferred Mortgages Ltd.’s interest in the Ten Lofts project to a newly created company, Osborn III Loan LLC, and several individual fractional interest holders (collectively, the "Successors"). The court also created ML Manager to manage this and other elements of the overall restructuring of Mortgages Ltd.

¶5 In December 2008, Summit and several subcontractors filed a lien foreclosure action in superior court asserting that their mechanics’ liens had priority over the deed of trust on the Ten Lofts property recorded by Mortgages Ltd. and now held by the Successors. Fidelity accepted the defense but did so under a reservation of rights.

¶6 While the state-court action was ongoing, ML Manager noticed and held a trustee's sale of the Ten Lofts property, at which ML Manager acquired the property with an $8 million credit bid. ML Manager then sought permission from the bankruptcy court to sell the Ten Lofts property to a third party, free and clear of all liens. Summit objected, arguing that the trustee's sale had not extinguished its mechanics’ lien. The bankruptcy court ultimately approved the sale but ordered that over $3.4 million of the proceeds (enough to cover all the lien claims) be held in escrow until the resolution of the lien litigation. The order to that effect included language that "[n]othing in [the sale o]rder ... shall waive, release or impact the coverage or liability of the title insurance policy for the payment of the alleged mechanics’ liens."

¶7 ML Manager and Summit then agreed to settle the lien priority litigation through what they characterized as a Morris agreement. The agreement provided that Summit would receive $1.75 million of the escrowed sale proceeds, assign all its mechanics’ lien claims to ML Manager, and indemnify ML Manager against any other lien claims. Contesting the validity of this agreement, Fidelity filed a limited objection to ML Manager's request for approval of the settlement in bankruptcy court. The bankruptcy court approved the split of the escrowed sale proceeds but made no finding regarding the agreement's validity under Morris .

¶8 Meanwhile, in state court, Fidelity intervened in the lien priority case to challenge the settlement agreement's validity and filed a separate complaint contesting coverage; the Successors counterclaimed for breach of contract and bad faith. The superior court consolidated the cases.

¶9 The parties moved for summary judgment on various issues, with a stipulation that if Morris applied to title insurance, the settlement was reasonable, not fraudulent or collusive, and made with appropriate notice to Fidelity. The superior court ruled that: (1) Morris applies to title insurance, (2) the agreement here fell within Morris even though it lacked certain terms (i.e., a stipulated judgment, covenant not to execute, and assignment of insurance claims) that generally appear in typical Morris agreements, (3) the sale of the Ten Lofts property to a third party did not terminate coverage for the Successors’ claim (which related to a lien that arose before the sale), (4) the Successors stood in Mortgages Ltd.’s shoes for coverage issues (meaning Fidelity could assert against the Successors any defense it would have had against Mortgages Ltd.), and (5) Mortgages Ltd. had not "created" the lien (which would implicate Exclusion 3(a)) by failing to fully fund the loan because Mortgages Ltd. had the right under the loan agreement to stop funding when it did.

¶10 Fidelity successfully moved for reconsideration of the Exclusion 3(a) ruling based on an issue of fact as to whether Mortgages Ltd. had acted within its rights under its loan contract. After a bench trial, the superior court found the developer's prior default under the loan agreement gave Mortgages Ltd. a contractual right to withhold the final $1.1 million, and thus held that Exclusion 3(a) did not apply and the Successors’ claim was covered under the Policy.

¶11 Fidelity then moved for summary judgment on the Successors’ bad-faith claim. The superior court granted the motion, concluding as a matter of law that the coverage issue was fairly debatable, so Fidelity's conduct did not constitute bad faith.

¶12 The court entered judgment in favor of the Successors for $1,750,000 (the amount paid to settle with Summit), plus attorney's fees and costs. Fidelity timely appealed, and the Successors timely cross-appealed. We have jurisdiction under A.R.S. § 12-2101(A)(1).

DISCUSSION

¶13 The parties’ appeal and cross-appeal challenge the superior court's various rulings in interconnected ways. Fidelity's primary contention is that Morris does not apply to title insurance and, alternatively, that if it does, the form of the Successors’ settlement agreement did not comply with Morris . Fidelity further challenges the court's coverage determinations, positing both that coverage terminated under Condition 2(b) of the Policy upon the property's conveyance to a third-party buyer and that coverage was excluded under Exclusion 3(a) of the Policy because Mortgages Ltd. "created" the defect by cutting off loan funds, which led to Summit's mechanics’ lien.

¶14 For their part, the Successors counter all of Fidelity's arguments contesting the court's rulings. Additionally, they challenge the superior court's conclusion that they stand in Mortgages Ltd.’s shoes for purposes of Exclusion 3(a), asserting instead that the exclusion can be applied only against the individual insured that created the defect (here, Mortgages Ltd. itself). The Successors further argue that the court wrongly granted summary judgment in favor of Fidelity on their bad-faith claim, asserting that Fidelity's position on the applicability of Exclusion 3(a) was not fairly debatable.

¶15 As described in more detail below, we conclude that the principles of Morris apply in the context of title insurance. We also hold that a settlement agreement's form need not mirror the elements of the settlement in Morris itself (stipulated judgment with a covenant not to execute accompanied by an assignment of insurance claims), and that the agreement here fell within Morris ’s parameters. We affirm the superior court's rulings in this regard.

¶16 Regarding coverage, the superior court correctly concluded that the Ten Lofts property sale did not terminate coverage for the Successors’ claim, and the court properly determined that the Successors were subject to exclusions to the same extent Mortgages Ltd. would have been. We reverse the ultimate coverage decision, however, because we conclude that even though Mortgages Ltd. had a...