United Services Automobile Ass'n v. Morris

Citations: 741 P.2d 246; 154 Ariz. 113; 1987 Ariz. LEXIS 171Docket: CV-86-0569-PR

Court: Arizona Supreme Court; June 16, 1987; Arizona; State Supreme Court

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John I. Morris petitioned the Arizona Supreme Court for a review of a court of appeals decision affirming a summary judgment in favor of United Services Automobile Association (USAA). The appeals court determined that Morris's insureds breached their duty to cooperate with USAA by entering a stipulated settlement, which discharged USAA from its obligation to pay the resulting judgment. The Supreme Court's review focused on two key questions: whether insureds defending under a reservation of rights can enter into a settlement agreement without breaching their duty to cooperate, and if such a settlement would be binding on the insurer.

The factual background involves an incident on January 30, 1982, where Morris broke into Pamela Taylor's home, leading to her brother, Robert Waltz, retrieving a gun and shooting Morris to prevent harm. Morris subsequently filed a tort action against Taylor and Waltz for gross negligence. Taylor had homeowner's insurance coverage with USAA, which included liability coverage but excluded injuries expected or intended by the insured. USAA became involved after being notified of the action and obtained a signed nonwaiver agreement from Taylor but failed to secure one from Waltz.

USAA retained attorney James M. Koontz to defend Taylor and Waltz. A conflict arose when Morris amended his complaint to include allegations of intentional tort, which would not be covered by the homeowner's policy. Koontz informed USAA of ongoing settlement negotiations but was cautioned that any settlement would be considered a material breach of the policy, releasing USAA from indemnity responsibilities. USAA maintained it had not waived its rights under the policy.

The excerpt outlines a legal dispute involving USAA and its insureds, Taylor and Waltz, over a $100,000 judgment resulting from allegations of intentional acts. USAA intended to file a declaratory judgment action regarding its obligation to indemnify Taylor and Waltz, citing an intentional act exclusion in their policy. Subsequently, Taylor and Waltz settled the case for a covenant not to execute against their assets, leading to a stipulated judgment solely collectible from USAA. After this stipulation, the trial court permitted amendments to the complaint to include intentional acts, prompting USAA to assert that it was not liable for the judgment due to the nature of the insureds' actions and their failure to cooperate. 

Morris, representing the insureds, contended that USAA was estopped from denying coverage because Waltz had not signed a nonwaiver agreement. USAA countered that Waltz understood the implications of his sister's nonwaiver agreement and believed it applied to him. The trial court identified contested material facts regarding the intentional act exclusion and ruled that USAA was not obligated to indemnify Taylor and Waltz because they breached their duty to cooperate by settling without USAA's consent. The court of appeals upheld this decision, emphasizing that the cooperation clause was violated when Taylor and Waltz settled against USAA’s objections.

The discussion also highlights USAA's claim that Waltz was not defended under a reservation of rights, which is crucial for determining the implications of his settlement. The trial court found that USAA had not reserved its rights, leading to two consequences: the waiver of the intentional act coverage defense and the prohibition against Waltz settling without USAA's consent due to the cooperation clause. This clause is intended to prevent insureds from compromising claims when the insurer has unconditionally assumed liability.

In Cay Divers, Inc. v. Raven, the court determined that the trial court erred in its finding that USAA did not reserve its rights against Waltz. The appellate court emphasized that trial court findings are upheld unless clearly erroneous or lacking credible evidence. Despite Waltz not signing a nonwaiver agreement, USAA was not obligated to defend him unconditionally. An insurer can reserve rights upon gaining new information regarding coverage or policy defenses. It was deemed illogical for USAA to reserve rights for Taylor but not for Waltz, who was directly involved in the incident.

Both USAA and Waltz recognized that USAA was defending Waltz under a reservation of rights, as indicated in USAA's motions and Waltz's affidavit. Furthermore, USAA formally reserved its rights regarding the intentional act exclusion just before Taylor and Waltz settled with the claimant, Morris. This established that USAA maintained its right to assert exclusions for both insured parties.

The court raised two key issues: 1) Whether two insured parties defended under a reservation of rights can settle without breaching the cooperation clause, and 2) If so, whether such a settlement would be binding on the insurance carrier. The court noted that liability insurance contracts entail specific obligations for both insurers and insureds, including the insurer's duty to defend claims that could potentially be covered by the policy. The cooperation clause mandates that insureds assist in their defense and refrain from settling claims without the insurer's consent unless the insurer has breached its obligations. The case questioned if the insurer could invoke this clause to prevent insureds, defended under a reservation of rights, from settling to protect themselves.

USAA's attempt to invoke the cooperation clause raises significant issues regarding its obligations and the rights of its insureds, Taylor and Waltz. USAA reserved its rights to assert a policy exclusion for intentional acts, which did not constitute a breach of policy obligations, as noted in Vagnozzi and Miller v. Shugart. However, this reservation placed Taylor and Waltz in a difficult position, exposing them to potential jury verdicts that could exceed their $100,000 policy limit or result in non-covered judgments. USAA's interpretation of the cooperation clause effectively restricts its insureds, forcing them to reject reasonable settlements and risk trial outcomes that could be detrimental to their financial well-being.

The court agrees with Morris that the insureds must act reasonably to avoid personal liability, recognizing that entering into a Damron-type agreement would be in their best interest. USAA's stance, arguing that the cooperation clause allows it to compel its insureds to reject settlements, risks placing the insureds in jeopardy while enabling USAA to contest liability and coverage issues in a declaratory judgment action if the trial verdict is unfavorable. 

The majority of courts resolve such conflicts by allowing insureds to reject a defense under a reservation of rights, compelling the insurer to either defend unconditionally or face potential repercussions for refusing to defend. This approach obliges the insurer to choose between relinquishing its coverage defenses or its right to enforce the cooperation clause. If the insurer attempts to reserve coverage questions, it cannot insist on controlling the defense. An insured, by rejecting the conditional defense, can push the insurer into a position where it either defends unconditionally—thus losing any coverage defense—or allows the insured to navigate the situation independently, often leading to settlements motivated by financial necessity.

Agreements between insurers and insureds can result in unpredictable and potentially unfair outcomes. A preferable approach allows insurers to raise coverage defenses while enabling insureds to protect themselves from noncoverage or excess judgments, and simultaneously shields insurers from unreasonable settlements between claimants and insureds. The Minnesota court in Miller established that an insurer cannot maintain exclusive control over the defense while reserving coverage issues. Insurers are prohibited from using cooperation clauses to prevent insureds from taking necessary steps to protect their interests, particularly when coverage is uncertain. Accepting a settlement that alleviates personal liability is justified under these circumstances. Courts have recognized that an insured may benefit the insurer in cases where coverage is ultimately found to be valid.

The law differentiates between an insurer's duty to defend and to pay. An insurer that defends while reserving the right to deny payment cannot control settlement conditions under those circumstances. A cooperation clause only restricts settlements for claims the insurer fully accepts liability for. Thus, insureds under a reservation of rights may enter into Damron agreements without breaching the cooperation clause, provided these agreements are made fairly and transparently. However, allowing insureds to settle poses risks to insurers, as it may lead to agreements that bind insurers to judgments and findings of fact. The ultimate determination remains whether USAA is bound by the settlement reached by Taylor and Waltz or if it can relitigate aspects of the original tort claim, given that the coverage issue remains unresolved.

Morris refrained from requiring Taylor and Waltz to admit negligence in their actions, recognizing that any such stipulation would be ineffective in establishing insurance coverage. Citing case law, it is noted that insurers are not bound by litigated issues involving conflicts of interest, and an insured's settlement agreement cannot be used to obtain coverage that was not originally purchased. Morris accepted the risk that the actions of Taylor and Waltz could be deemed intentional, negating potential recovery. USAA contended that the settlement agreement should not be binding, arguing it would have succeeded in a liability trial and sought to relitigate all aspects of the case. This position undermines the purpose of Damron agreements, as claimants would be discouraged from settling if they could not benefit from the agreement. 

Concerns arise that an insured might settle for excessive amounts or in frivolous cases to avoid inconvenience. The stipulated judgment merely reflects the terms of the settlement without adjudicating the merits. The settlement effectively substitutes the claimant in pursuing the insurer. The precedent established in Miller indicates that neither the fact nor the amount of liability is binding on the insurer unless the settlement is shown to be reasonable and prudent. An indemnitor is only bound by a settlement if provided notice and the opportunity to defend. If an insured settles contrary to the insurer's instructions, it may assume the defense and the indemnitor can contest liability. Ultimately, the indemnitor is liable if the insured proves the settlement was reasonable under the circumstances, without needing to demonstrate they would have lost the case. Evaluating the reasonableness of the settlement involves considering the facts surrounding liability and damage, as well as the risks of trial, allowing the insurer to challenge the settlement's amount.

The trial court incorrectly determined that the settlement agreement between Morris and the insureds constituted a breach of the cooperation clause. The insureds, facing economic jeopardy due to the insurer's coverage defense, were justified in entering a reasonable, non-collusive settlement for their protection. On remand, the insurer retains the right to litigate the coverage defense without being bound by any factual stipulations. Should the insurer prevail on coverage, it bears no liability for the settlement; if it loses, it may not be bound by the settlement amount unless Morris proves the judgment against Taylor and Waltz was fair and reasonable. If he fails to demonstrate the reasonableness of any portion of the judgment, USAA will not be obligated to honor the settlement. The trial court's judgment is reversed, and the court of appeals' decision is vacated, with the case remanded for further proceedings. 

The dissenting opinion emphasizes that the insurer did not breach its contract obligations, as it defended the insureds while preserving its right to contest liability. The precedent set in Damron v. Sledge allows an insured to be relieved from the cooperation clause when the insurer fails to fulfill its duty to defend or indemnify. The dissent argues that the insurer's actions were consistent with prior rulings and that the court's shift in interpretation unfairly favors the insured, suggesting the cooperation clause only restricts settlements when the insurer unconditionally accepts liability under the policy.

Two cases are referenced to support a legal proposition regarding the rights of insured parties when their insurers deny liability. In **Taylor v. Safeco Insurance Co.**, the Florida court ruled that an insured could settle a case without the insurer's consent if the insurer had disclaimed responsibility, illustrating the majority rule that allows insureds to reject defenses under reservation of rights. In **Cay Divers, Inc. v. Raven**, the Third Circuit found that an insured could reasonably settle a claim without insurer consent and still receive indemnification, despite the insurer's denial of coverage. The court noted that some language in Cay Divers was considered dicta, and a cited case, **American Fire Casualty Co. v. Kaplan**, did not substantiate the argument presented. This case highlighted that an insurer’s denial of coverage relieves the insured from adhering to terms intended to protect the insurer. 

The excerpt further discusses the obligation of insurers to act in good faith, as established in **Rawlings v. Apodaca**, which implies that both parties in an insurance contract must refrain from actions that could impair each other's expected benefits. The rationale adopted from **Miller v. Shugart** suggests that the current situation places the insurer in a difficult position, as noted by the trial court's concerns. Additionally, it is acknowledged that the insurer in the current appeal did not breach its policy obligations, raising questions about the insured's responsibility to uphold contract terms.

Insurers face significant risks regarding settlement negotiations. If an insurer does not engage in these discussions, it may be liable for an inflated judgment within policy limits. However, participating in negotiations typically requires the insurer to forfeit its policy defense. The Miller v. Shugart case emphasizes that while a settlement agreement is binding among the parties involved, it does not conclusively bind the insurer. The burden of proof lies with the plaintiff to demonstrate the reasonableness and prudence of the settlement, which must be assessed based on what a reasonable person in the defendant's position would have settled for, considering liability, damages, and trial risks.

Conversely, the Sargent v. Johnson case illustrates the consequences when an insured settles without the insurer's consent. The court ruled that the insured acted in bad faith by discharging the insurer's defense counsel and entering into a settlement that shifted liability entirely to the insurer, thus breaching the contract. This behavior undermined mutual respect in the insurance relationship and severed the insured-insurer bond. The court highlighted that an insurer's obligation to pay a judgment or settlement is contingent upon whether the insured's actions fall within the defined risk of the policy. Consequently, if coverage does not exist, it is neither unusual nor unjust. The insurer is entitled to expect fair dealings from the insured, as the insurance contract is fundamentally a matter of contractual law rather than social welfare.

The insureds have breached their contract terms and entered into a settlement deemed not to reflect a fair resolution of their liability, indicating a lack of good faith in the settlement process. The insurer's attorney advised against disclosing USAA's position on this judgment unless directly asked, emphasizing that the plaintiff's attorney should infer this independently. Taylor and Waltz, who responded to the complaint without legal representation, are cooperating with USAA, which has submitted affidavits signed by them. The policy mandates that the insured must promptly notify the insurer of any incidents, forward relevant legal documents, and assist in settlement and legal proceedings, while prohibiting voluntary payments or obligations without the insurer’s consent. Compliance with these provisions is required for any legal action against the insurer. The document references several cases regarding the understanding of intentional acts, self-defense, and the reasonableness of settlements in relation to potential liability, noting a specific appellate ruling that clarifies the application of these legal principles in Arizona.