Damron Agreement or Stipulated Judgment Got You in a Bind? Arizona Supreme Court Considers Binding Effect of Fact Stipulations on Insurers in Quihuis v. State Farm
In Quihuis v. State Farm, --- Ariz. ---, 334 P.3d 719 (Ariz. Oct. 1, 2014), the Arizona Supreme Court recently held that a stipulated fact in a Damron Agreement that is both an element of liability and essential to establishing coverage does not bind an insurer in subsequent coverage litigation. In so holding, the Supreme Court clarified that stipulated facts in Damron Agreements regarding liability do bind an insurer in subsequent litigation, but stipulated facts in Damron Agreements regarding coverage do not bind an insurer in subsequent litigation.
The Facts & Procedural Background
The Insured agreed to sell her Jeep to a Friend for the intended use of Friend's Daughter for eight monthly payments. The Insured gave the keys to Friend, Friend gave the keys to Daughter, the Insured retained the title as collateral until all payments could be made, and Daughter was in an accident with Plaintiff. The Insured, however, did not cancel her insurance policy on the Jeep until shortly after the accident.
Plaintiff sued the Insured for negligence and negligent entrustment. Ownership of the Jeep was essential for both liability and coverage. Plaintiff based the negligent entrustment claim on the Insured's alleged ownership of the Jeep at the time of the accident. The Insurer refused to defend the Insured because the Policy covered vehicles owned by the Insured, but the Insurer asserted the Insured transferred ownership of the Jeep to her Friend before the Accident.
The Insured and Plaintiff entered a "Damron Agreement" in which they stipulated to the following facts: the Insured owned the Jeep at the time of the accident, Daughter was incompetent to drive, Daughter's negligence caused the accident, the Insured should have known Daughter was incompetent to drive, and the Insured should not have entrusted the Jeep to Daughter. They also stipulated to damages; the Insured assigned her rights under the policy to Plaintiff; Plaintiff agreed not to execute the judgment against the Insured, Friend or Daughter; and the Insured and Plaintiff agreed to request a default judgment to terminate the case.
Plaintiff filed a declaratory judgment action against the Insurer to collect on the default judgment. The Insurer removed the case to District Court. The District Court granted the Insurer's motion for summary judgment, holding the default judgment did not preclude the Insurer from litigating whether the Insured owned the Jeep at the time of the accident. Plaintiff appealed to the Ninth Circuit and argued Arizona case law prevents an insurer from litigating a stipulated fact regarding coverage in a Damron Agreement if the same fact also concerns liability. The Ninth Circuit then certified the following question to the Arizona Supreme Court:
Whether a default judgment against insured-defendants that was entered pursuant to a Damron [A]greement that stipulated facts determinative of both liability and coverage has (1) collateral estoppel effect and precludes litigation of that issue in a subsequent coverage action against the insurer, as held in Associated Aviation Underwriters v. Wood, or (2) no preclusive or binding effect, as suggested in United Services Automobile Association v. Morris.
The Arizona Supreme Court held that a stipulated fact in a Damron Agreement and default judgment that is both an element of liability and essential to establishing coverage does not preclude an insurer from litigating that fact in subsequent coverage litigation.
The Arizona Supreme Court based its holding on four primary reasons. First, Quihuis determined that § 58 (rather than § 27) of the Restatement (Second) of Judgments applied, in part, because issue preclusion under § 27 "requires actual litigation of the issue of fact or law in question," but stipulated facts in a Damron Agreement are not litigated.
Second, the Arizona Supreme Court noted § 58 precludes an insurer from litigating the "existence and extent" of liability and damages—but not coverage issues—in a subsequent declaratory judgment action. Quihuis noted § 58 is consistent with United Services Automobile Association v. Morris, which held an insurer is precluded from litigating "the fact or amount of liability" if the insured's settlement with the claimant is "reasonable and prudent." Morris, however, also warned that an "insurer could later litigate whether there is coverage under the policy" and "any stipulation of facts essential to establishing coverage would be worthless" because otherwise insureds might be able "to obtain coverage that the insured did not purchase" simply by entering into a Damron or Morris Agreement." The Arizona Supreme Court also noted § 58 is consistent with Associated Aviation Underwriters v. Wood, which held that, after an insured enters a Morris Agreement, an insurer cannot litigate liability and damage issues in a subsequent coverage action "in the guise of a coverage defense." Quihuis suggested Wood was a straightforward application of § 58 becauseWood precluded an insurer from litigating both the "fact of liability" and "issues that related strictly to liability and damages." The Court reasoned that Morris and Wood both demonstrate that § 58(1)(a) does not preclude litigation of pure coverage issues in a subsequent coverage action. Accordingly, in Quihuis, the Damron Agreement did not preclude the Insurer from litigating ownership of the Jeep because it was a fact that "not only bears directly on liability, but also controls whether there is coverage under the policy." Thus, Quihuis announced that Arizona has "adopted Restatement § 58 with the limitation recognized in Morris—insurers generally are not precluded from litigating coverage issues."
Third, although § 58 precludes an insurer from relitigating any "judicial determination of issues actually litigated," fact stipulations in a Damron Agreement are not litigated. In Quihuis, the Insurer was not precluded from litigating ownership of the Jeep because the issue was not heard and decided by the trial court that entered the stipulated default judgment. Importantly, the Arizona Supreme Court noted the "result does not change simply because the issue that determines coverage also happens to be an element of the liability claim against the" insured. Indeed, "even when a coverage requirement is also an essential element of the insured's liability, an insurer may later litigate that issue in disputing coverage as long as it was not 'determined in the action' through actual litigation."
Fourth, under Arizona common law, an insurer's denial or breach of the duty to defend does not preclude it from denying the duty to indemnify. "It is well settled that a liability insurer's duty to defend is separate from, and broader than, the duty to indemnify." "In Arizona, there is no absolute duty to defend, especially when the alleged facts in the complaint ostensibly bring the case within the policy coverage but other facts which are not reflected in the complaint plainly take the case outside the policy coverage." In Quihuis, for example, Plaintiff's complaint made the conclusory allegation that the Insured owned the Jeep, but the Insurer's investigation revealed the Insured did not own the Jeep. The Arizona Supreme Court refused to adopt a rule that would require an insurer to defend claims clearly not covered to preserve the right to subsequently argue the claims were clearly not covered. Indeed, Quihuis stated, "[s]uch a result defies logic and law."
Additionally, even if a court ultimately finds that an Insurer did breach the duty to defend, "that determination would not necessarily control the question of issue preclusion" because an Insurer's "breach of contract should not be used as a method of obtaining coverage that the insured did not purchase." Quihuis reasoned that "applying issue preclusion to deprive an insurer of its coverage defense because the insurer allegedly breached its duty to defend subverts any meaningful distinction between the duty to defend and the separate duty to indemnify, and, in many cases, serves no more than to punish the insurer for the breach of a contractual duty."
Policy Limits as a Cap on Insurer Liability?
The Arizona Supreme Court concluded the Quihuis decision by making the significant suggestion that insurer liability after a Damron Agreement might be capped at an insured's policy limits. The Supreme Court emphasized its "prior admonition that when an insurer refuses to defend it does so at its peril, and if a court later finds coverage, the insurer must pay the damages awarded in the default judgment (at least up to the policy limits) unless it can prove fraud or collusion."
This seemingly innocuous parenthetical should cause all insurers to stop and take notice. This is the first time any Arizona Supreme Court or Court of Appeals opinion has explicitly suggested that an insurer's liability might be capped at an insured's policy limits even if an insurer breached the duty to defend, the insured entered a Damron Agreement, and a court eventually finds coverage. As an example, if an insurer refuses to defend an insured with a $15,000/$30,000 policy, the insured enters a Damron Agreement in which it stipulates to $2.5 million of damages, and a court eventually finds coverage, Quihuis suggests an insurer might be liable for only $15,000.
It is doubtful the Quihuis parenthetical will be intentionally tested by an insurer because the stakes in such a test would be quite high. Nonetheless, if an insurer finds itself in an unfortunate situation where it failed to defend a covered claim, the insured entered a Damron Agreement, and the insured stipulated to an egregious amount of damages, then an insurer may use the statement "at least up to the policy limits" in Quihuis as powerful leverage in efforts to settle for an amount significantly less than the stipulated damages.
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.
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.
 Pronounced like the plural of the fruit: kiwis.
 Quihuis, 334 P.3d at 721.
 In a "Damron Agreement" an "insured stipulates to a judgment, assigns his rights against the insurer to the claimant, and receives in return a covenant from the claimant not to execute against the insured." Quihuis, 334 P.3d at 722 (citing Parking Concepts, Inc. v. Tenney, 207 Ariz. 19, 20, n. 1, 83 P.3d 19, 20 n. 1 (2004); Damron v. Sledge, 105 Ariz. 151, 152–53, 460 P.2d 997, 998–99 (1969)).
 Quihuis, 334 P.3d at 721, 722.
 Id. at 722.
 209 Ariz. 137, 98 P.3d 572.
 154 Ariz. 113, 741 P.2d 246; Quihuis, 334 P.3d at 721.
 Quihuis, 334 P.3d at 729, 730.
 Section 58 states: "(1) When an indemnitor has an obligation to indemnify an indemnitee (such as an insured) against liability to third persons and also to provide the indemnitee with a defense of actions involving claims that might be within the scope of the indemnity obligation, and an action is brought against the indemnitee involving such a claim and the indemnitor is given reasonable notice of the action and an opportunity to assume its defense, a judgment for the injured person has the following effects on the indemnitor in a subsequent action by the indemnitee for indemnification: (a) The indemnitor is estopped from disputing the existence and extent of the indemnitee's liability to the injured person; and (b) The indemnitor is precluded from relitigating those issues determined in the action against the indemnitee as to which there was no conflict of interest between the indemnitor and the indemnitee. (2) A "conflict of interest" for purposes of this Section exists when the injured person's claim against the indemnitee is such that it could be sustained on different grounds, one of which is within the indemnitor's obligation to indemnify and another of which is not."
 Quihuis, 334 P.3d at 723. The Arizona Supreme Court also held that § 58 applied because: (1) the Insured's policy imposed on the Insurer a duty to defend and indemnify; (2) Plaintiff's complaint alleged a claim that "might be within the scope of [the Insurer's] indemnity obligation"; (3) the Insured gave the Insurer reasonable notice of Plaintiff's lawsuit, thereby providing "an opportunity to assume [the Insured's] defense"; and (4) "a judgment" was entered in favor of Plaintiff against the Insured. Id. at 724.
 Quihuis, 334 P.3d at 724 (citing Rest. 2d § 58(1)(a) ("The indemnitor is estopped from disputing the existence and extent of the indemnitee's liability to the injured person.")).
 154 Ariz. 113, 741 P.2d 246. In Morris, an insurer defended an insured under a reservation of rights, the insured stipulated to a judgment, plaintiff agreed not to execute the judgment against the insured, and the insured assigned its rights against the insurer to plaintiff.
 Quihuis, 334 P.3d at 724 (citing Morris, 154 Ariz. at 115, 741 P.2d at 248).
 Quihuis, 334 P.3d at 724 (emphasis added) (citing Morris, 154 Ariz. at 115, 741 P.2d at 248).
 209 Ariz. 137, 98 P.3d 572.
 Quihuis, 334 P.3d at 724 (citing Wood, 209 Ariz. at 149, 98 P.3d at 584).
 Quihuis, 334 P.3d at 724 (citing Wood, 209 Ariz. at 152, 98 P.3d at 587).
 Quihuis, 334 P.3d at 724.
 Id. at 725.
 Id. at 726.
 Id. at 727 (citing Morris, 154 Ariz. at 119, 741 P.2d at 252).
 Quihuis, 334 P.3d at 727 (citing Kepner v. Western Fire Ins. Co., 109 Ariz. 329, 331, 509 P.2d 222, 224 (1973)).
 Quihuis, 334 P.3d at 728.
 Id. (citing Windt Treatise § 4.37 ("The vast majority of cases have properly held that an insurer's unjustified refusal to defend does not estop it from later denying coverage under its duty to indemnify."); Flannery v. Allstate Ins. Co., 49 F.Supp.2d 1223, 1227–28 (D.Colo.1999) ("The majority of jurisdictions ... do not preclude an insurer from contesting coverage because it breached its duty to defend.") (collecting cases).
 Quihuis, 334 P.3d at 728. (citing Sentinel Ins. Co. v. First Ins. Co. of Haw., 875 P.2d 894, 912 (Hawaii 1994).
 Quihuis, 334 P.3d at 730 (emphasis added) (citing Parking Concepts, Inc., 207 Ariz. at 22, n. 3, 83 P.3d at 22 n. 3 ("[I]n cases where the insurer has refused to defend and the parties enter into a Damron agreement, the insurer has no right to contest the stipulated damages on the basis of reasonableness, but rather may contest the settlement only for fraud or collusion.").