Automax Hyundai South, L.L.C. v. Zurich American Insurance

Citations: 720 F.3d 798; 2013 U.S. App. LEXIS 13076; 2013 WL 3198603Docket: 12-6161

Court: Court of Appeals for the Tenth Circuit; June 26, 2013; Federal Appellate Court

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Automax Hyundai South, a car dealership in Oklahoma, sued Zurich American Insurance Company after Zurich refused to defend Automax in a lawsuit brought by two customers, Tammy and David Moses, regarding a car purchase. The customers won a significant judgment against Automax in state court. The district court ruled that Zurich had no duty to defend or indemnify Automax, but the appellate court disagreed, concluding that Zurich did have a duty to defend due to potential coverage of the claims under the insurance policy. The court emphasized that Zurich’s failure to defend also requires it to allocate between covered and noncovered claims when addressing indemnity. 

Automax's insurance policy, purchased from Universal Underwriters Insurance Company (Zurich's parent), was designed for automotive businesses and provided coverage for incidents arising from garage operations or auto hazards, with specific definitions for "occurrence" and "injury," including mental anguish. The policy included coverage for statutory errors and omissions related to various auto laws and had exclusions for injuries caused by fraudulent acts or intentional harm.

The underlying lawsuit stemmed from issues related to the sale of a Hyundai Elantra to Tammy Moses, who could not secure financing independently, leading her father, David Moses, to co-sign. However, he was the sole legal signatory, and they were misled into believing the car was new, despite it having been previously sold and returned to Automax. Automax argued that its actions complied with Oklahoma regulations. The appellate court reversed the district court's decision and remanded the case.

Tammy and David Moses discovered that their car, purchased from Automax, had prior damage two months after their purchase, following an accident where Tammy noted steering issues beforehand. After the accident, they learned from a Hyundai dealership that the car had extensive underbody damage prior to their ownership. David approached Automax for compensation, claiming that the damage existed before the sale and later attempted to rescind the sale, alleging fraud and nondisclosure of financing terms. Zurich Insurance denied coverage for Automax, stating no negligence was found and that damage occurred after the Moseses took possession. The Moseses filed suit in Oklahoma state court, alleging common law fraud, violations of the Truth-in-Lending Act, and breaches of consumer protection laws, eventually amending their petitions to include negligence claims regarding inflated income for loan approval. Automax disputed the claims, asserting the car was not damaged or classified as “used” under Oklahoma law. Zurich initially provided limited coverage for Automax’s defense but ceased payment before trial. At trial, the jury received instructions on fraud, negligence, and Truth-in-Lending claims, leading to a verdict in favor of the Moseses, who were awarded $300,000 in compensatory and $100,000 in punitive damages. Automax opted to settle the case for $300,000 instead of appealing.

Automax sought indemnification from Zurich for settlement costs following the Moses trial, but Zurich denied the request, arguing that the jury’s finding of intentional conduct excluded coverage under the policy. Subsequently, Automax sued Zurich for breaching their insurance contract and for bad faith due to its refusal to defend and indemnify in the Moses suit. Zurich moved for summary judgment on both claims, which the district court granted, reasoning that Zurich had no obligation to defend Automax since the claims in the Moses lawsuit were based on intentional conduct, specifically the falsification of income information. The court noted that the jury's finding of intentional and malicious actions further supported Zurich's lack of duty to indemnify under the policy’s exclusion for intentional harm.

Automax then challenged the district court's summary judgment ruling on three points: Zurich's duty to defend, duty to indemnify, and lack of bad faith. The court reviewed the summary judgment de novo, applying Oklahoma law, which interprets insurance policies as contracts. Under Oklahoma law, the duty to defend is broader than the duty to indemnify; an insurer must provide a defense if there are facts suggesting potential liability under the policy. For an insurance contract, clear terms govern its interpretation, but ambiguous terms favor the insured. The insurer must investigate the facts underlying the claims once a defense is requested, not merely rely on the allegations in the complaint.

The duty to defend in a lawsuit is based on facts available at the time the defense is requested, rather than the lawsuit's outcome. Automax’s insurance policy with Zurich includes coverage for accidents resulting in injuries that are not intended or expected from a reasonably prudent person's perspective. The Oklahoma Supreme Court has clarified that terms like "accident" in insurance contexts should be interpreted according to common usage. Negligent actions that yield unexpected results are considered accidents, as illustrated by a case where an employee's mistake led to an unintended consequence.

In evaluating whether Automax's actions regarding the sale of a used car constitute an accident, the complaint identifies three potential liabilities: misrepresenting the car as new, selling a car with undisclosed damage, and issues related to financing. Automax argues that the sale with undisclosed damage could be viewed as an accident, particularly if they were unaware of the damage at the time of sale. This aligns with Oklahoma law, which considers a dealer's failure to detect damage as an accident since they do not intend to cause harm to customers.

The Moseses alleged emotional distress resulting from the sale, qualifying as a covered injury under the policy. The main issue is whether Zurich received enough notice to trigger its duty to defend. Zurich was informed of potential negligence shortly after the Moseses discovered the damage, as indicated in a letter from their attorney alleging fraud due to undisclosed prior damage. Automax shared this letter with Zurich, which denied the claim, asserting that their investigation found no negligence and that the vehicle showed no damage during a prior service. However, Zurich's response implies the possibility that damage existed at the time of sale, which could allow a jury to reconcile differing accounts of the facts.

Automax's defense is supported by the court's pretrial order, which states that Automax denies the vehicle was sold or damaged prior to its sale to the Moseses. Additionally, claims for undisclosed damage are deemed to fail under Oklahoma Statute 47 O.S. 1112.1, which imposes liability only for undisclosed material damage known to the dealer. Courts have established that an insurer has a duty to defend its insured even if the allegations imply intentional conduct, as a jury could find the defendant liable for negligence or nonintentional actions. This principle aligns with Oklahoma's legal framework, where the duty to defend is triggered if there is any potential for liability based on the facts, regardless of the allegations in the complaint.

Zurich's assertion that it did not have a duty to defend due to the intentional nature of the alleged conduct neglects the significance of the underlying facts, which suggest possible negligence by Automax in failing to identify preexisting damage. Furthermore, multiple allegations in the Moses lawsuit encompass various types of misconduct, some of which may be covered by the insurance policy. The prevailing rule indicates that once an insurer's duty to defend is activated, it must provide defense for all claims, regardless of whether some are uncovered. Zurich has not demonstrated that Oklahoma law diverges from this majority rule. Consequently, Zurich is obligated to defend all claims and must bear the costs of defense, as breaching this duty results in liability for the entire litigation costs, particularly when costs cannot be divided between covered and uncovered claims. The next step is to determine whether Zurich also has a duty to indemnify Automax for the settlement with the Moseses.

Zurich contends it is not obligated to indemnify Automax for any part of a settlement due to the jury's findings of intentional conduct and malice. Zurich argues that the negligence claim, which was the only claim suggesting potential coverage, was inherently based on intentional actions. Conversely, Automax argues that the jury's verdict is ambiguous and that this ambiguity favors its position. The jury found Automax liable on three theories—negligence, fraud/deceit, and violations of the truth-in-lending act—without specifying how the $300,000 damages award was divided among these theories or clarifying which claims were associated with the findings of intentionality and malice. This lack of clarity suggests that covered conduct may have contributed to the jury's verdict.

Automax asserts that the pretrial order laid out a general negligence claim, which the jury was instructed to consider, including negligence per se. Therefore, the jury's negligence finding could have been based on conduct covered by the insurance policy, such as Automax's failure to identify vehicle damage prior to sale. The determination of whether the jury's findings of intentionality and malice applied to all claims or only some remains unresolved, affecting both liability and punitive damages.

The critical question is who bears the burden of distinguishing between covered and noncovered claims within the verdict. Prior rulings indicate that if both types of claims are present, the insurer must seek a special verdict to clarify the basis for indemnification. If the insurer does not request such a verdict, it risks being liable for the entire judgment if any claim is covered. This principle extends to settlements, meaning that even though Automax settled rather than facing a final judgment, the same allocation principles apply.

Automax contends that Zurich must assume the burden of allocating claims since it abandoned its defense responsibilities prior to trial. Unlike the insurer in Magnum Foods, which managed the defense, Zurich had stopped representing Automax over ten months before trial. Most courts maintain that while the insured typically bears the burden of allocating covered versus non-covered claims, this burden shifts to the insurer when it fails to fulfill its duty to defend. For example, in Liquor Liability, the insurer that improperly refused to defend must allocate judgments between covered and non-covered claims. Similarly, Camden-Clark ruled that the insured's burden only shifts to the insurer if the insurer had an affirmative duty to defend. 

The logic from Magnum Foods holds that an insurer controlling litigation must not jeopardize the insured's rights, including failing to request special verdicts to clarify damages coverage. The Massachusetts Supreme Judicial Court extended this reasoning, asserting that an insurer should bear the burden of allocation regardless of whether it failed to request a special verdict or provide a defense altogether. This principle incentivizes insurers to fulfill their defense obligations; if they fail, they risk being liable for the entire judgment if they cannot allocate a general verdict. Zurich, having wrongfully refused to defend, faces this burden. However, due to a general verdict from the jury and the impossibility of retrying the case, Zurich encounters significant challenges in determining the jury's rationale for its judgment. Consequently, some courts have ruled that insurers in similar situations cannot adequately allocate a general verdict, resulting in them being responsible for the entire judgment.

Evidentiary hearings have been suggested to determine reasonable allocations of settlements using trial transcripts. The court finds that Zurich should have the opportunity to prove its case, especially since Automax's $300,000 settlement was lower than the $400,000 total damages awarded. The possibility of Automax facing punitive damages, which are generally not covered under Oklahoma liability insurance, may have influenced the settlement discussions. If Zurich cannot prove its case, it must cover the entire settlement.

Zurich's situation could appear unjust, given the jury's finding of Automax's intentional and malicious conduct, which is excluded from coverage. However, the Oklahoma Supreme Court outlines three options for insurers disputing defense demands: seeking declaratory relief, defending under reservation of rights, or refusing to act at the risk of breaching their duty to defend. Zurich chose the third option, forfeiting its ability to ensure accurate indemnity cost apportionment. Had it chosen the first or second options, it might have faced lower costs.

Declaratory relief is available in federal and Oklahoma state courts, allowing insurers to clarify their duty to defend under liability policies. Recent legislation in Oklahoma permits declaratory judgments regarding the duty to defend, removing previous restrictions. Automax claims the district court wrongly granted summary judgment to Zurich on its bad faith claim, while Zurich contends that a reasonable dispute over coverage exists, which would undermine the bad faith claim.

An insurer in Oklahoma has an implied duty to act in good faith and deal fairly with the insured, ensuring they receive policy benefits (Gray v. Holman). Tort liability exists in insurance contracts due to breaches of this duty, which can lead to the economic hardships the contract aimed to prevent (Embry v. Innovative Aftermarket Sys. L.P.). This duty includes prompt payment upon proof of loss and the good faith defense of the insured (Christian v. Am. Home Assurance Co.). To establish a bad faith claim, the insured must prove: 1) entitlement to coverage, 2) lack of a reasonable basis for delaying payment, 3) failure to deal fairly and in good faith, and 4) that the violation caused the insured’s injury (Ball v. Wilshire Ins. Co.). The burden of proof lies with the insured (Garnett v. Gov’t Emps. Ins. Co.).

In this case, the district court granted summary judgment to Zurich on the bad faith claim, concluding Automax was not entitled to coverage and that Zurich had a legitimate basis for denying coverage, thus not addressing the other claim elements. However, there are indications that Zurich may have misunderstood its duty to defend, which requires investigating underlying facts upon a request for defense (Turley). If Zurich failed to conduct this investigation, it may not have had a reasonable basis for denying Automax’s claim. Consequently, since Zurich had a duty to defend Automax and may lack a reasonable basis for denying coverage, the summary judgment is reversed and remanded for further proceedings.