[author: Nathan D. Meyer]

The Arizona Court of Appeals recently upheld as valid and enforceable a Damron Agreement in which an insured and its excess insurer assigned their rights against a primary insurer.  In so holding, the Court of Appeals made the significant declaration that an insurer who refuses to defend is bound for purposes of coverage by any issues determined in a stipulated judgment that underlies a Damron Agreement.

The case, Colorado Cas. Ins. Co. v. Safety Control Co., Inc., 228 Ariz. 517, 520, 269 P.3d 693, 696 (App. 2012), arose from a car accident at a road improvement project.  Subcontractors on the project were contractually obligated to provide primary insurance for the project's general contractor.  The general contractor also purchased excess insurance that covered liability arising from the subcontractors' work.  Plaintiff sued ADOT and the general contractor.  The general contractor tendered its defense to the pertinent subcontractor.  Both the subcontractor and the primary insurer denied the tender, so the general contractor's excess insurer provided a defense.  The Plaintiff, ADOT, general contractor and excess insurer entered a Damron Agreement.  The general contractor stipulated to entry of a $750,000 judgment and assigned all of its rights against the subcontractor and the primary insurer to the Plaintiff.  The Plaintiff received $75,000 from the excess insurer, received $20,000 from ADOT and agreed not to execute the stipulated judgment against either the general contractor or excess insurer.

The Court of Appeals began its analysis by reciting the basics of the duty to defend and Damron Agreements in Arizona.  "An insurance contract imposes on the insurer the duty to defend the insured against claims potentially covered by the policy and the duty to indemnify the insured for covered claims.  The insured, in turn, must cooperate with the insurer and aid in his defense...  [W]hen an insurer breaches the contract of insurance by failing to defend; the duty of cooperation does not prevent the insured from entering into a settlement with the claimant and assigning his rights under the policy to the claimant.  As long as the stipulated judgment is not fraudulent or collusive, an insurer that has failed to defend is bound by the judgment with respect to all matters which were litigated or could have been litigated in that action."[1]

Colorado Casualty rejected the argument that the Damron Agreement was collusive and invalid simply because the excess insurer provided a defense to the general contractor and the general contractor "was not compelled to settle to avoid the sharp thrust of personal liability.[2] The Court of Appeals distinguished Leflet v. Redwood Fire & Casualty Insurance Co.,[3] another recent case, for two reasons.  Leflet did not address a primary insurer's refusal to defend an arguably covered claim.[4] Also, Leflet invalidated a Morris Agreement because it favored a primary insurer over an excess insurer and therefore attempted to shift liability away from "where it should be in the first instance-with the primary insurer rather than the excess insurer."[5] The Court of Appeals concluded this issue by noting, "an insurer that refuses to defend a claim must know that a judgment may be entered against the insured and that it will be liable if the claim is within its policy" and a primary insurer "may not escape the consequences of its decision to decline to defend [an insured] simply because [another insurer] did not make the same decision."[6]

The Court of Appeals rejected the argument that the primary insurer was liable for the full amount of the stipulated judgment, as a matter of law, simply because the Damron Agreement was neither fraudulent nor collusive. Thus, Colorado Casualty confirmed the principle that, "an agreement under Damron or Morris does not create coverage that the insured did not purchase."[7] Instead, a primary insurer is "liable only if the judgment constituted liability falling within its policy."[8]

Colorado Casualty, most importantly, declared the primary insurer was "bound for purposes of coverage by any issues determined by the stipulated judgment."[9] In making this declaration, the Court of Appeals relied on Associated Aviation Underwriter v. Wood[10] for the principle that an insurer is bound by "legal and factual issues that underlie" a stipulated judgment entered as part of a Morris Agreement.[11] Colorado Casualty also observed that, "[u]nder general principles of indemnity law, if an indemnitor has received 'reasonable notice of the action' but declines an opportunity to assume or participate in the defense, absent a conflict of interest it is 'estopped from disputing the existence and extent of the indemnitee's liability' if the 'indemnitee defended the action with due diligence and reasonable prudence.'"[12] In Colorado Casualty, however, the stipulated judgment had no such preclusive effect on coverage because it incorporated the parties' settlement agreement, which explicitly stated neither ADOT nor the general contractor admitted liability.

The Court of Appeals' declaration that a stipulated judgment may bind an insurer "for purposes of coverage" is significant.  It may cause plaintiffs and insureds to include stipulated facts in the stipulated judgments which underlie both Damron and Morris Agreements in an effort to make an ultimate judicial determination of coverage more likely.

Colorado Casualty's declaration, however, is at odds with the Supreme Court's recognition in Morris that, "[t]o relieve himself of personal exposure, the insured may be persuaded to enter into almost any type of agreement or stipulation by which the claimant hopes to bind the insurer by judgment and findings of fact."[13] The Court of Appeals' citation to Wood as standing for the principle that an "insurer is bound by legal and factual issues that underlie stipulated judgment entered pursuant to Morris" is an oversimplification easily susceptible to misuse.  Wood merely prohibits an insurer from litigating liability issues disguised as coverage issues.[14] In Wood, an insurer improperly argued it was entitled to a declaration of no coverage because the plaintiff could not prove an "insured event" of "actionable fault" falling within "the basic insuring provision of its policies."[15] Indeed, in Arizona Property and Cas. Ins. Guar. Fund v. Martin,[16] the Court of Appeals quickly distinguished Wood and allowed an insurer to litigate whether a plaintiff was in the course of her employment to determine if course of employment and workers' compensation exclusions applied in a declaratory judgment action to enforce a Morris Agreement.

Accordingly, after Colorado Casualty, insurers should be vigilant for Damron and Morris Agreements which include stipulated facts that attempt to prevent an insurer from litigating coverage defenses in subsequent actions to enforce the underlying stipulated judgments.

About the Author: Nathan D. Meyer is a Partner at the Phoenix law firm of Jaburg Wilk.  One of his specialties is insurance coverage and bad faith.  Nate advises and represents his insurance clients in coverage, bad faith, contribution and liability matters.  He can be reached at 602.248.1032 or ndm@jaburgwilk.com

This article is not intended to provide legal advice and only relates to Arizona law. It does not consider the scope of laws in states other than Arizona. Always consult an attorney for legal advice for your particular situation.

[1] Colorado Casualty, 228 Ariz. at 522, 269 P.3d at 698 (citations omitted).

[2] Id. at 523, 269 P.3d at 699

[3] 226 Ariz. 297, 247 P.3d 180 (App.2011).

[4] Colorado Casualty, 228 Ariz. at 523, 247 P.3d at 699.

[5] Id.

[6] Id.

[7] Id. (citing United Services Auto. Assoc. v. Morris, 154 Ariz. 113, 120, 741 P.2d 246, 253 (1987)).

[8] Colorado Casualty, 228 Ariz. at 523, 247 P.3d at 699.

[9] Id. (citing Associated Aviation Underwriters v. Wood, 209 Ariz. 137, 150, 98 P.3d 572, 585 (App.2004)).

[10] 209 Ariz. 137, 150, 98 P.3d 572, 585 (App.2004).

[11] Colorado Casualty, 228 Ariz. at 523, 247 P.3d at 699 (citing Wood, 209 Ariz. at 150, 98 P.3d at 585 (insured bound by "legal and factual issues that underlie" stipulated judgment).

[12] Colorado Casualty, 228 Ariz. at 523, 269 P.3d at 699 (citing Rest. (Second) of Judgments § 57(1) (1982)).

[13]Morris, 154 Ariz. at 119-120, 741 P.2d at 253-253.

[14] See Wood, 209 Ariz. at 150, 98 P.3d at 585.

[15] Id.

[16] 210 Ariz. 478, 480, 113 P.3d 701, 703 (App. 2005).