Arizona Supreme Court rejects First Restatement of Restitution § 78 and holds that an indemnity plaintiff is entitled to equitable indemnity only when it discharged an actual obligation owed by an indemnity defendant to a third party.

Payless Car Rental rented a vehicle to a driver and offered him supplemental liability insurance provided by KnightBrook.  Although the driver did not pay for the insurance, he later maintained that he was entitled to coverage because he did not initial the space in the rental contract to decline coverage.

While driving the rented vehicle, the driver caused an accident, injuring others.  The injured sued the driver.  The driver settled with the injured and assigned to them any claims he had against Payless and KnightBrook.  The injured then sued Payless and KnightBrook.  KnightBrook settled with the injured, paying them the policy limit, and the injured assigned their claims against Payless to KnightBrook.  KnightBrook then sued Payless in federal court, asserting its assigned claims and seeking equitable indemnification for the money it had paid the injured.

Relying on the First Restatement of Restitution § 78, the federal district court ruled that KnightBrook was entitled to equitable indemnification.  Payless appealed to the Ninth Circuit, which certified to the Arizona Supreme Court the question of whether Arizona equitable indemnity law incorporates § 78.

The Arizona Supreme Court held that § 78 is not incorporated into Arizona law because it conflicts with Arizona’s general equitable indemnity principles and is not a sound rule.  In Arizona, recovery is allowed only when an indemnity plaintiff discharges an actual obligation that the indemnity defendant owed to a third party, whereas § 78 allows recovery for payments on obligations that do not exist so long as the indemnity plaintiff had a “justifiable belief” that an obligation existed.  The Court refused to impose liability based on a “supposed obligation,” noting that a troubling consequence of § 78 is that it could preclude an indemnitor from raising viable defenses to the underlying claim.

Justice Lopez authored the opinion for the unanimous Court.