Pueblo v. Cna, 1 CA-CV 07-0215.

• Decision Date: 13 March 2008
• Docket Number: No. 1 CA-CV 07-0215.,1 CA-CV 07-0215.
• Citation: 218 Ariz. 13,178 P.3d 485
• Parties: PUEBLO SANTA FE TOWNHOMES OWNERS' ASSOCIATION, Inc., an Arizona non-profit corporation, Plaintiff/Appellee, v. TRANSCONTINENTAL INSURANCE COMPANY and Transportation Insurance Company, Defendants/Appellants.
• Court: Arizona Court of Appeals

178 P.3d 485

218 Ariz. 13, PUEBLO SANTA FE TOWNHOMES OWNERS' ASSOCIATION, Inc., an Arizona non-profit corporation, Plaintiff/Appellee, v. TRANSCONTINENTAL INSURANCE COMPANY and Transportation Insurance Company, Defendants/Appellants.

No. 1 CA-CV 07-0215.

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

March 13, 2008.

Meagher & Geer, P.L.L.P. By Thomas H. Crouch, Scottsdale, and Nixon, Peabody, LLP By Walter T. Johnson, San Francisco, Attorneys for Defendants/Appellants.

Mann, Berens & Wisner, LLP By Jay M. Mann, Scott F. Frerichs, Phoenix, Attorneys for Plaintiff/Appellee.

OPINION

JOHNSEN, Judge.

¶ 1 This is an appeal of a judgment entered after a subcontractor and a homeowners association entered into a Morris agreement¹ assigning the subcontractor's rights under an insurance policy issued by Transcontinental Insurance Company ("CNA"). The superior court found that because CNA delayed for 18 months before informing the subcontractor that it reserved its right to deny indemnity coverage, thereby prejudicing the subcontractor, CNA was estopped from asserting coverage defenses against the homeowners association. The court also approved a stipulated judgment of $1.1 million plus attorney's fees as reasonable and ordered CNA to pay prejudgment interest from the date of the agreement.

¶ 2 We conclude the superior court correctly held CNA estopped from denying coverage but that the court erred in granting prejudgment interest from the date of the Morris agreement because the stipulated amount was not liquidated until the court approved the settlement. Accordingly, we affirm the judgment as modified.

FACTUAL AND PROCEDURAL HISTORY

¶ 3 This appeal arises out of construction defect claims by Pueblo Santa Fe Townhomes Owners' Association, Inc. ("Pueblo") against a general contractor and two construction managers. The alleged defects included numerous large cracks in the homes' exterior stucco that allegedly created avenues for water to enter the interior. Subcontractor Palo Verde Plastering ("PVP") performed the stucco work on 34 of the buildings.

¶ 4 Pueblo filed its complaint on June 17, 1998. After Pueblo served a "Doe Amendment to Complaint" that identified PVP and other subcontractors as defendants, PVP submitted a notice of claim to CNA on August 5, 1999.² Shortly thereafter, CNA retained a Phoenix law firm to represent PVP.

¶ 5 CNA insured PVP under a commercial general liability policy that contained a "your work" exclusion that disclaimed coverage for damage to "[w]ork or operations performed by you or on your behalf . . . and [m]aterials, parts or equipment furnished in connection with such work or operation." According to CNA, the effect of this exclusion was that the policy would cover "resulting damages" for which PVP might be held liable — meaning, for example, water damage to the interior of the homes caused by cracks in the stucco PVP had applied — but would not cover the cost to repair or replace the stucco itself. The "your work" exclusion was significant in this case because from early on, Pueblo had identified stucco repair/replacement as a major component of its alleged damages. According to a report prepared for Pueblo in October 1999, for example, cracks would require stucco repair or replacement at a cost of some $2.3 million.

¶ 6 Evidence at trial showed that whenever a subcontractor insured by CNA submitted a notice of claim in a construction-defects case, CNA's practice was to issue an immediate reservation of rights letter to the insured. For a reason that was never explained, however, CNA failed to do so in this case. It was not until February 2001, 18 months after PVP submitted its claim, that the CNA claims handler noticed the file contained no reservation of rights letter. She issued the letter on February 19; due to a mix-up with PVP's address, however, the letter was not received until March 1, 2001.

¶ 7 In the meantime, by agreement of the parties, the superior court had set a deadline in October 2000 for the completion of any destructive testing to be performed on the homes within the Pueblo development. The court also ordered that any expert who failed to appear at the scheduled testing would not be permitted to conduct any additional testing outside of the established schedule.

¶ 8 Destructive testing often is performed in construction-defect cases to determine the extent of damage and evidence of the existence or cause(s) of particular defects. Where stucco cracks are abundant, for example, parties may hire consultants to cut through the stucco and the wall beneath to determine whether water has permeated the interior of the building through the cracks. Destructive testing also may disclose the cause of the defects — where stucco has cracked, for example, destructive testing may reveal foundation movement or unstable framing or other structural problems that may have caused the cracks.

¶ 9 The lawyers that CNA retained to represent PVP did not inform PVP of the court-ordered deadline for destructive testing, and no one participated in or attended the testing on PVP's behalf.³ Several other parties, lawyers and expert witnesses attended the testing. Based on the test results, Pueblo disclosed an expert witness report that faulted the chemical content of the stucco PVP used on the townhomes. That report became the basis of Pueblo's claim against PVP based on the stucco cracks.

¶ 10 Before PVP received CNA's letter reserving the right to deny coverage for the costs of repair or replacement of the stucco, Gloria and Frank Morgan, who own PVP, had not been actively monitoring the litigation. Within a couple of weeks after receiving the letter, they began searching for additional legal assistance. PVP eventually retained separate counsel to monitor the lawsuit, although the original counsel hired by CNA remained PVP's counsel of record.

¶ 11 It was not until May 31, 2001, seven months after the destructive-testing deadline, that the law firm that CNA had retained for PVP hired an expert witness for PVP. The expert, Michael Keith, met on June 15, 2001, with the Morgans and the associate from the retained law firm. Gloria Morgan testified that she was "chomping at the bit" when she heard an expert had been hired because she was eager to meet with somebody to discuss their defense. There is no indication in the record that PVP was aware at the time that the deadline for conducting destructive testing of the townhomes had already expired. Gloria Morgan testified that she did not learn until nearly a year later that additional destructive testing would not be allowed.

¶ 12 As 2001 drew to a close, it was becoming more and more clear that a judgment against PVP might be very significant. In late November, Pueblo served a revised "Cost to Repair Estimate" that stated that the direct cost to repair the stucco was just under $1.5 million and the total cost when combined with a pro-rata share of the overhead and related expenses was greater than $2.1 million. An internal consultant reported to CNA that although the portion of possible damages against PVP that CNA believed to be covered under its insurance policy likely would be no more than $20,000, PVP faced uninsured exposure of between $600,000 and $800,000 to repair the stucco and up to $1.5 million to replace it. Gloria Morgan testified that the partner of the law firm CNA retained to represent PVP contacted her and her husband in late December 2001 to "urgently" invite them to a meeting at which the company's potential exposure was discussed. They left the December 26 meeting feeling "pretty shaken" because of the lawyer's questions about whether their personal assets were protected from exposure to liability.

¶ 13 In April 2002, PVP assigned one of its employees, Rick Skeens, to study the facts relating to Pueblo's claims. Skeens, who had a college background in chemistry, was critical of the calculations and logic underlying Pueblo's report criticizing the chemical content of the stucco. He worked with Keith and with a structural engineering expert witness that CNA had retained to develop PVP's defense. Meanwhile, however, other defendants in the case were negotiating settlements with Pueblo that preserved their indemnity claims against PVP. The original defendants reached a settlement with Pueblo during mediation in March 2002, and as part of that settlement assigned to Pueblo their indemnity claims against PVP.

¶ 14 In April 2002, CNA filed a declaratory relief action against PVP and Pueblo, seeking a judgment declaring that it had no duty to indemnify PVP for damages other than those that "resulted" from PVP's work. PVP later filed a counterclaim alleging bad faith liability and seeking indemnity under the policy.

¶ 15 PVP and Pueblo participated in a mediation in June 2002, but the mediation was not successful. It was apparent from that session that PVP would be, in Gloria Morgan's words, "the last man standing" among the defendants. According to a report retained counsel prepared for CNA as an October 2002 trial date approached, "[i]t is unlikely that [PVP] will not ultimately have to pay something." Although PVP's counsel's "best estimate" was that PVP would be found liable for between $50,000 and $100,000 in damages, Pueblo was seeking more than $2 million against PVP and another subcontractor responsible for the stucco work. Just prior to trial, PVP finally entered into a Morris agreement with Pueblo in which PVP stipulated to a $1,100,000 judgment. PVP assigned Pueblo all of its claims against CNA, but reserved its right to sue for bad-faith damages along with attorney's fees and costs associated with that claim.⁴

¶ 16 Following the Morris agreement, the superior court consolidated the CNA/PVP declaratory judgment action with the action brought by Pueblo against CNA pursuant to the settlement. The issue in the six-day coverage trial to the court was whether CNA would be estopped from denying...