Arizona Court of Appeals Division One Holds That An Insured and Insurer Cannot Join in a Morris Agreement That Avoids the Primary Insurer’s Obligation to Pay Policy Limits and Passes Liability in Excess of Those Limits on to Other Insurers.

In 2000, Plaintiffs brought a construction defect class action suit against developer Hancock.  Hancock answered and filed a third-party complaint naming several Subcontractors.  The Subcontractors tendered their defenses to their respective insurers, who accepted the tenders under a reservation of rights.  Hancock tendered its defense to its insurers (the “Direct Insurers”), as well as the Subcontractors’ insurers (the “Non-Participating Insurers” or “NPIs”), who were obliged under their policies to provide primary coverage to Hancock for claims arising from the Subcontractors’ work.  Under those policies, the Direct Insurers furnished primary coverage to Hancock for its own liability and excess coverage for liability attributed to the Subcontractors.  The NPIs accepted Hancock’s tender under reservations of rights.

In 2004, Plaintiffs, Hancock, and the Direct Insurers entered a settlement agreement into the record under which Hancock agreed to (1) pay Plaintiffs $375,000 – an amount well below the Direct Insurers’ policy limits, (2) assign to Plaintiffs its rights against the Subcontractors and the NPIs, and (3) stipulate to a judgment, the amount of which was later agreed to be $8.475 million.  In exchange, Plaintiffs agreed not to execute the judgment against Hancock or the Direct Insurers.  The Subcontractors and NPIs had no knowledge of the agreement before it was entered.  Plaintiffs later agreed to limit their claims against the Subcontractors to indemnification claims for both the $375,000 paid by Hancock and for Hancock’s costs and attorneys’ fees, and the Subcontractors settled those claims in early November 2005.

In April 2005, the Court approved the class action settlement.  In February 2006, shortly after Plaintiffs moved for determination of the reasonableness of the stipulated judgment, the NPIs intervened.  In June 2008, the NPIs sought summary judgment on the ground that Hancock had not provided them the notice required under United Services Automobile Ass’n v. Morris, 154 Ariz. 113, 741 P.2d 246 (1987), and thus had breached the cooperation clause of the applicable insurance policies.  The NPIs also argued that the agreement was not a Morris agreement.  The trial court granted the NPIs summary judgment, holding that the agreement was a binding Morris agreement, but finding that the NPIs were prejudiced by Hancock’s failure to provide notice and an opportunity to withdraw their reservations of rights.  The court entered judgment in favor of the NPIs, excusing them from having to defend and indemnify and awarding them approximately $388,000 in attorneys’ fees and taxable costs to be paid by Plaintiffs jointly and severally.  Plaintiffs timely appealed.

The ArizonaAppeals Court affirmed in part, vacated in part, and remanded.  The Court first held that the settlement agreement was not a compliant Morris agreement.  Under Morris, an insurer who defends under a reservation of rights may be subject to liability for the amount of a stipulated judgment between the plaintiff and the insured.  This is appropriate because the insured and insurer have interests adverse to one another.  To avoid inflated and unfair judgments, however, Morris requires the insured to provide notice to the insurer, demonstrate that the settlement was free from fraud and collusion, and prove that the settlement amount is reasonable.  If these requirements are not met, plaintiffs may not be able to collect from defendants or their insurers.  Safeway Ins. Co. v. Guerrero, 210 Ariz. 5, 106 P.3d 1020 (2005).

In this case, the Court held that the settlement was not a Morris agreement because the clear intent of the agreement was to favor the Direct Insurers against the NPIs, and because the insured and insurers’ interests were aligned.  Given that the interests implicated in Morris were absent, the Court held that an insurer that reserves its rights may not employ Morris to reduce its liability below policy limits, and that an insured that facilitates such an effort breaches its duty to cooperate with its other insurers.  Put another way “a settlement that mimics Morris in form but does not find support in the legal and economic realities that gave rise to that decision is both unenforceable and offensive to the policy’s cooperation clause.”

The Court next held that even if the agreement was a Morris agreement, Plaintiffs did not provide the necessary notice to the NPIs that they would be bound by the settlement.  Because they were not given notice, they face no liability for the resulting stipulated judgment.

Finally, the Court reversed the award of attorneys’ fees under A.R.S. § 12-341.01(A).  Although the Court rejected Plaintiffs’ argument that attorneys’ fees could never be awarded against class action plaintiffs, it ruled that special considerations apply in such situations, including that the involvement of class members in the management of the litigation is often more attenuated than in traditional cases, as was the case here.  Moreover, the superior court did not reach the merits of the claims asserted by Plaintiffs.  Accordingly, the Court ruled that the trial court abused its discretion in awarding fees jointly and severally against Plaintiffs.

Judge Swann authored the opinion; Presiding Judge Hall and Judge Weisberg concurred.