Leflet v. Fire

• Court: Arizona Court of Appeals
• Writing for the Court: SWANN, Judge.
• Citation: Leflet v. Fire, 226 Ariz. 297, 247 P.3d 180, 600 Ariz. Adv. Rep. 6 (Ariz. App. 2011)
• Decision Date: 20 January 2011
• Docket Number: No. 1 CA–CV 09–0663.,1 CA–CV 09–0663.
• Parties: Charles LEFLET; Carlos Bustamonte; and Cynthia Sampley, on behalf of themselves and all others similarly situated, Plaintiffs/Appellants,v.REDWOOD FIRE AND CASUALTY INSURANCE COMPANY; West American Insurance Company; The Ohio Casualty Insurance Company; American Fire & Casualty Insurance Company; Auto–Owners Insurance Company; Transportation Insurance Company and Transcontinental Insurance Company, Defendants/Appellees.

226 Ariz. 297

247 P.3d 180

600 Ariz. Adv. Rep. 6

Charles LEFLET; Carlos Bustamonte; and Cynthia Sampley, on behalf of themselves and all others similarly situated, Plaintiffs/Appellants,

v.REDWOOD FIRE AND CASUALTY INSURANCE COMPANY; West American Insurance Company; The Ohio Casualty Insurance Company; American Fire & Casualty Insurance Company; Auto–Owners Insurance Company; Transportation Insurance Company and Transcontinental Insurance Company, Defendants/Appellees.

No. 1 CA–CV 09–0663.

Court of Appeals of Arizona, Division 1, Department E.

Jan. 20, 2011.

Duke Gerstel Shearer, LLP by Andrew F. Lloyd and Alan R. Johnston (Admitted Pro Hac Vice), San Diego, CA, Attorneys for Plaintiffs/Appellants.Meagher & Geer, P.L.L.P. by Thomas H. Crouch, Kurt M. Zitzer and John C. Hendricks, Scottsdale, Attorneys for Defendants/Appellees Transportation Insurance Company and Transcontinental Insurance Company.Graif Barrett & Matura, P.C. by Kevin Barrett and Jay R. Graif, Phoenix, Attorneys for Defendant/Appellee Auto–Owners Insurance Company and Redwood Fire and Casualty Insurance Company.The Cavanagh Law Firm, P.A. by Scott A. Salmon, Cassandra V. Meyer, and Taylor C. Young, Phoenix, Attorneys for Defendants/Appellees West American Insurance Company, Ohio Casualty Insurance Company, and American Fire & Casualty Insurance Company.SWANN, Judge.

¶ 1 In this construction defect class action, the Plaintiff homeowners entered into a settlement agreement with the Defendant developer, Hancock Communities, LLC, and HC Builders, Inc., (collectively, “Hancock”) and two of Hancock's insurers: Commercial Underwriters Insurance Company (“CUIC”) and Clarendon America Insurance Company (“Clarendon”) (collectively, the “Direct Insurers”). Invoking United Services Automobile Ass'n v. Morris, 154 Ariz. 113, 121, 741 P.2d 246, 254 (1987), the developer and its insurers stipulated to an $8.475 million judgment against them and assigned to Plaintiffs their claims against various subcontractors and their insurers (“Non–Participating Insurers” or “NPIs”). The NPIs challenged the agreement and the trial court granted them summary judgment, ruling that the settlement agreement amounted to a breach of Hancock's contractual duty of cooperation with the NPIs.

¶ 2 We are presented with an issue of first impression: whether an insured and an insurer can join in a Morris agreement that avoids the primary insurer's obligation to pay policy limits and passes liability in excess of those limits on to other insurers. We hold that such agreements are invalid, and therefore affirm the trial court's grant of summary judgment in favor of the NPIs. For reasons discussed below, we vacate the award of attorney's fees against the homeowners.

FACTS AND PROCEDURAL HISTORY ¹

¶ 3 Hancock built and marketed homes in “Trailwood,” a residential development of over 400 single-family homes, between 1997 and 2000. In May 2000, Plaintiffs sued Hancock for breach of contract and breach of implied warranties to recover for construction defects found in the homes. Plaintiffs sought class-action status and the class was certified on December 20, 2001.

¶ 4 Hancock filed an Answer and Third–Party Complaint. The Amended Third–Party Complaint named as third-party defendants several subcontractors involved in building Trailwood, and asserted claims for breach of contract, breach of warranty, negligence and indemnity.²

¶ 5 Hancock and the Subcontractors each tendered their defenses to their respective insurers, all but one of which accepted the tenders under a reservation of rights.³ In addition to its own Direct Insurers, Hancock also tendered its defense to the Subcontractors' insurers (the NPIs in the settlement and appellees here), who were obliged under their policies to provide primary coverage to Hancock for claims arising from the scope of the Subcontractors' work. Under the terms of the policies, the Direct Insurers furnished primary coverage to Hancock for its own liability and excess coverage for liability attributed to the Subcontractors. The Subcontractors' insurers accepted Hancock's tender under reservations of rights. Hancock's Direct Insurers remained liable for any claims that did not fall within the scope of the coverage provided by the NPIs.

¶ 6 After substantial discovery, the court ordered the parties to mediation. The mediation did not produce a settlement—Plaintiffs demanded $5 million, and the defending parties collectively offered only $807,000. During mediation, Hancock's counsel began discussing a Morris agreement in an attempt to convince the NPIs to contribute more to a settlement offer. In parallel negotiations, the insurers were unable to agree on how they would share the costs of Hancock's defense.

¶ 7. On October 7, 2004, Plaintiffs' counsel and counsel for Hancock appeared in court and entered a settlement agreement into the record. Under the agreement, Hancock agreed to pay Plaintiffs $375,000, to assign to the Plaintiffs its rights against the Subcontractors and their insurers in “a Damron/Morris type agreement,” and to stipulate to a judgment in favor of Plaintiffs for an amount to be determined later. In exchange, Plaintiffs agreed not to execute the judgment against Hancock or the Direct Insurers who were participating in the agreement. The rights Hancock and the Direct Insurers were to assign included their contribution rights from the NPIs for Hancock's unpaid attorney's fees and expenses, Hancock's rights to pursue bad faith claims against the NPIs, rights against the NPIs to which Hancock had tendered its defense, and any “contractual or otherwise recognized by law indemnification rights” they had against the Subcontractors, the NPIs, or any other insurer of the Subcontractors.

¶ 8 The court accepted the agreement as binding between the parties pursuant to Ariz. R. Civ. P. (“Rule”) 80(d). The Subcontractors and NPIs had no knowledge of the agreement before it was entered into the record. The amount that Hancock and the Direct Insurers agreed to pay in exchange for the agreement not to execute against them was well below their policy limits—CUIC's policy limit alone was $1,000,000 “per occurrence.”

¶ 9 On January 14, 2005, the parties to the agreement presented the final written version to the court. In it, Hancock and the Direct Insurers stipulated to a judgment in favor of Plaintiffs for $8.475 million. Plaintiffs agreed to limit their claims against the Subcontractors to indemnification claims for both the $375,000 paid by Hancock and for Hancock's costs and attorney's fees incurred defending the action. The Court approved the class action settlement in April 2005. The Subcontractors settled those claims with Plaintiffs in early November 2005.

¶ 10 In February 2006, shortly after Plaintiffs moved for a determination of the reasonableness of the stipulated judgment, the NPIs intervened. In June 2008, the NPIs sought summary judgment on the ground that Hancock had not provided the notice required under Morris and had therefore breached the cooperation clause of the applicable insurance policies. The NPIs also argued that the agreement did not qualify as a Morris agreement.

¶ 11 On August 15, 2008, the court granted summary judgment in favor of the NPIs, holding that the October 7, 2004 agreement entered on the record was a binding Morris agreement, but finding that the NPIs were prejudiced by Hancock's failure to provide the NPIs with notice and an opportunity to withdraw their reservations of rights. The court therefore concluded that the agreement was a breach of the cooperation clause. The court entered judgment in favor of the NPIs, excusing them from having to defend and indemnify, and awarding them $388,541.35 in attorney's fees and taxable costs to be paid “jointly and severally” by the Plaintiff homeowners. Plaintiffs timely appeal.

DISCUSSION

¶ 12 The trial court granted summary judgment on the ground that Hancock was in breach of contract for failure to provide proper notice of the impending Morris agreement. We agree that Plaintiffs, Hancock and the Direct Insurers did not provide the NPIs the notice required under Morris. However, we may also “affirm a trial court on any basis supported by the record,” Solimeno v. Yonan, 224 Ariz. 74, 82, 227 P.3d 481, 489 (App.2010) (citing State v. Robinson, 153 Ariz. 191, 199, 735 P.2d 801, 809 (1987)), and there is an independent and more fundamental basis on which to do so: the agreement falls outside the bounds of Morris. ⁴

I. THE SETTLEMENT AGREEMENT IS NOT A COMPLIANT MORRIS AGREEMENT AND PROVIDES NO BASIS FOR CLAIMS AGAINST THE NPIs.

¶ 13 In Morris, our supreme court held that an insurer who defends under a reservation of rights may be subject to liability for the amount of a stipulated judgment between the plaintiff and its insured. Reasoning that the insured has a cognizable interest adverse to that of the insurer in avoiding “the sharp thrust of personal liability,” the court held that the insured may enter into a settlement with a claimant without breaching the cooperation clause of the policy. Morris, 154 Ariz. at 118–19, 741 P.2d at 251–52. By simultaneously assigning its right to sue the insurer for bad faith, the insured can potentially bind the insurer to a stipulated judgment in excess of policy limits, and extract from the claimant a covenant not to execute.

¶ 14 The court recognized the dangers of this settlement mechanism—the insured has little incentive to minimize the amount of the judgment, and the ability of the insured to subject an insurer to tort damages in excess of the policy limits creates the opportunity for collusive settlements that bear little relation to the merits of the underlying case. To avoid such evils, Morris requires the insured to provide notice to the insurer, demonstrate that the settlement was free from fraud and collusion, and prove that the settlement amount is reasonable. 154 Ariz. at 119–20, 741 P.2d at 252–53.

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