Penn-America Insurance Company v. Sanchez – 6/17/2008

June 24, 2008

Arizona Court of Appeals Division One Holds Genuine Issue of Material Fact Exists as to Whether an Insurer Who Unequivocally Defended an Insured For Ten Months, Without a Reservation of Rights, and Who Issued a Reservation of Rights After the Close of Discovery, Waived Its Right to Deny Coverage.

Plaintiffs in the underlying litigation brought suit for wrongful death arising out of an automobile accident involving an independent owner-operator of a truck transporting goods between phoenix and Tucson on behalf of Inside Arizona Delivery Leasing, Inc. (“Inside Arizona”).  Plaintiffs alleged Inside Arizona was vicariously or jointly liable under a number of theories.  InsideArizona notified its insurance agent, which in turn tendered the defense to Penn-America, Inside Arizona’s commercial general liability (“CGL”) carrier.  Notwithstanding exclusions in the Penn-America policy for liability arising out of “ownership, maintenance, use or entrustment to others” of an automobile, Penn-America initially defended Inside Arizona without a reservation of rights.

Ten months into the litigation, following the close of discovery and a written demand for settlement by Plaintiffs, Penn-America tendered the defense to Inside Arizona’s automobile insurance company, NAICC.  NAICC did not immediately commit to provide coverage, nor did it deny coverage.  Rather, NAICC expressed concern regarding any prejudice it might have suffered from the late tender of the defense by Penn-America.  Ultimately, Inside Arizona entered into a Morris agreement with the Plaintiffs, stipulating to a substantial judgment and assigning any rights it had against Penn-America to Plaintiffs in exchange for a covenant not to execute.  NAICC also reached an independent settlement with Plaintiffs.

Penn-America then filed a declaratory judgment action seeking a judicial determination as to its coverage obligations.  Following lengthy motion practice and discovery, the parties filed cross-motions for summary judgment.  Penn-America argued that its CGL policy excluded coverage of the underlying automobile accident claim.  Plaintiffs/Counter-Claimants argued that Penn-America was estopped from asserting any coverage defenses because its reservation of rights was untimely.  After oral argument, the trial court granted summary judgment in favor of Penn-America, and Plaintiffs/Counter-Claimants timely appealed.

The Court of Appeals reversed the trial court’s granting of summary judgment and remanded the case for further proceedings.   The Court first set forth the factors to be considered in determining whether an insurer’s failure to timely issue a reservation of rights results in a loss of the insurer’s coverage defenses—unreasonable delay, and prejudice to the insured.  Next, the Court determined that a genuine question of material fact existed as to both of these factors.  With respect to the reasonableness of the delay by Penn-America in reserving its rights and tendering the defense to NAICC, the Court noted that during the ten months preceding Penn-America’s reservation of rights, the parties conducted considerable discovery, and Penn-America learned numerous facts which could have supported the conclusion that NAICC was the proper insurer.  With respect to potential prejudice to the insured, the Court concluded that the record contained sufficient facts to support the conclusion that Penn-America’s unequivocal defense for a period of ten months lulled the insured into a false sense of security, with the result that when discovery closed and Plaintiffs made a demand for settlement, Penn-America’s reservation of rights left the insured in a very vulnerable position.

Finally, the Court rejected Penn-America’s argument that the insured was not actually prejudiced because it had entered into a Morris agreement.  According to Penn-America, as part of the Morris agreement, the Plaintiffs had covenanted not to execute their judgment against the insured, thus insulating the insured from any potential harm.  The Court disagreed, holding that the potential prejudice to the insured must be measured after the issuance of the reservation of rights, but prior to any Morris agreement.  To hold otherwise, would discourage plaintiffs from entering into Morris agreements, and thereby undermine the protection available to insureds from such agreements.

Chief Judge Gemmill authored the opinion; Presiding Judge Irvine and Judge Weisberg concurred.