Arizona Court of Appeals, Division One, holds that the collateral source rule does not prevent an insurer from receiving credit for settlement with a third party.

This complex commercial litigation centered around real property encumbered by mechanic’s liens.  The owners of the property had two creditors who held first-priority security interests in the real property; the creditors’ deeds of trust were insured by an insurance company.  Due to the mechanic’s liens, the owners had difficulty selling the property, and the creditors made a claim to their insurer.  The insurer only accepted the defense under a reservation of rights and refused to settle.  The owners of the property entered into a settlement agreement with the lienholders, creating an entity that purchased the liens.  This entity and the creditors subordinated their interests to the new of the buyer of the property, and the sale was consummated.  The creditors assigned their claims against their insurer to the new entity.  Ultimately, the creditors were paid in the full amount of their loans.

The superior court granted partial summary judgment to the insurers on coverage claims, because the creditors were paid in the full amount of their loans.  The Court of Appeals reversed.  It held that the insurance contracts in question covered the claims, and that the superior court had conflated the concepts of coverage and liability.  Meanwhile, the insurer had waived its liability defenses by failing to appeal from a prior decision that found against it on liability.

In the remaining bad faith insurance claim, the superior court permitted evidence that the creditors had received payments from sources other than the insurer.  The creditors argued that the evidence should have been excluded under the collateral source rule, which generally prohibits evidence of an injured person’s recovery from sources independent of the tortfeasor.  The superior court rejected this argument, and the Court of Appeals agreed, finding that the debtors who had paid the creditors were not a source independent of the contract between the creditors and their insurer.

The superior court denied a punitive damages jury instruction against the insurer.  The Court of Appeals reversed, finding that a reasonable jury could have awarded punitive damages on the bad faith claim because the insurer knew of the mechanic’s liens when it issued the insurance policy, refused to withdraw its reservation of rights despite having no legitimate basis for it, and intentionally refused to settle in order to put itself in a more favorable position.

The superior court denied judgment as a matter of law to the insurers on their argument that damages on bad faith were inappropriate because the creditors’ loans had been fully repaid.  The Court of Appeals affirmed, holding that a payment of damages for bad faith was appropriate because the jury could have found that the money the debtors paid the creditors was to acquire the creditors’ claims against the insurance company and was not a repayment of their loans.

Judge Furuya authored the opinion, which Judges Weinzweig and Perkins joined.

Posted by: Garo Moughalian