United Services Automobile Ass'n v. Morris

In United Services Automobile Ass'n v. Morris, 154 Ariz. 113, 741 P.2d 246 (1987) the Arizona Supreme Court held an insured defended under a reservation of rights may enter into a settlement with a claimant without breaching the cooperation clause of the insurance policy. 154 Ariz. at 119, 741 P.2d at 252. In so holding, the court recognized an insurer and an insured have conflicting interests when a defense is offered with a reservation of rights. Id. at 118-19, 741 P.2d at 251-52. An insurer with a good-faith potential coverage defense may properly reserve its rights to assert a coverage defense, and in so doing, will not breach its policy obligations. Id. at 118, 741 P.2d at 251. Nevertheless, when it defends under a reservation of rights, the insurer has not accepted full responsibility to its insured for the insured's liability exposure. Id. As a result, the insured is placed in a "precarious position." Id. The insured may not only face the potential of a judgment in excess of policy limits, but even if a judgment within policy limits is rendered, the insured may not have coverage under the policy if the insurer prevails on the coverage defenses. Id. Morris attempted to reconcile these conflicting interests. Thus, when the insurer defends under a reservation of rights, control of the litigation for settlement shifts to the insured. Id. at 119, 741 P.2d at 252. The Court noted that an insurer's reservation of rights places an insured in a "precarious position." 154 Ariz. at 118, 741 P.2d at 251. The insureds in that case faced "the possibility of a jury verdict greater than their policy limit or, even if within the limit, one that might not be covered." Id. The insureds were thus entitled "to act reasonably to protect themselves from 'the sharp thrust of personal liability.'" Id. Morris thus held that "the indemnitor's reservation of the privilege to deny the duty to pay relinquishes to the indemnitee control of the litigation." 154 Ariz. at 119, 741 P.2d at 252. And an indemnitee may then independently settle with a third-party claimant without breaching the indemnitee's contractual cooperation obligation. Id. The Arizona Supreme Court held that 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 its insured. Reasoning that the insured has a cognizable interest adverse to that of the insurer in avoiding "the sharp thrust of personal liability," the court held that the insured may enter into a settlement with a claimant without breaching the cooperation clause of the policy. Morris, 154 Ariz. at 118-19, 741 P.2d at 251-52. By simultaneously assigning its right to sue the insurer for bad faith, the insured can potentially bind the insurer to a stipulated judgment in excess of policy limits, and extract from the claimant a covenant not to execute. The court recognized the dangers of this settlement mechanism -- the insured has little incentive to minimize the amount of the judgment, and the ability of the insured to subject an insurer to tort damages in excess of the policy limits creates the opportunity for collusive settlements that bear little relation to the merits of the underlying case. To avoid such evils, 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. 154 Ariz. at 119-20, 741 P.2d at 252-53. The overarching goal of Morris is to permit the insured and the insurer to balance their competing interests in an atmosphere of fairness and defined risk -- not to promote the transformation of underlying contract and tort claims into bad faith claims at inflated values. Morris likewise does not penalize insurers for properly reserving the right to contest coverage -- even under a valid Morris agreement, an insurer may defend on the ground that the loss was not covered. 154 Ariz. at 119-20, 741 P.2d at 252-53.