Insurance companies complain that our courts are too hard on them. Once in a while, though, something like this comes along.

Monterey, a home-builder, sued one of its subs, BBP Concrete. Federated insured BBP. Federated denied coverage but defended BBP under a reservation of rights. Eventually, Monterey and BBP decided to resolve disputes they had against each other by agreeing that nobody would pay anything to anybody.

Federated then moved to intervene to pursue a subrogation claim against Monterey, arguing that it should recover the costs and fees it had spent defending BBP because Monterey’s claim was, according to Federated, groundless. The trial court denied intervention, figuring that Federated could bring the subro claim as a separate action; the Court of Appeals reversed and remanded with instructions that require the trial court to allow the intervention.

The court held, first, that the settlement between BBP and Monterey did not bind Federated, even though a subrogee stands in the shoes of the subrogor and even though the Monterey-BBP settlement specifically released the defense costs. The court cited cases from other jurisdictions for the proposition that once the tortfeasor is informed of the subrogation rights, they cannot be released by the insured. This is a novelty to Arizona law; whether the cases cited actually stand for that proposition on these facts is an exercise we leave for the reader.

Next, the court decided what Federated really wanted — even though it had never thought to ask for it — was a reasonableness hearing under USAA v. Morris, 154 Ariz. 113, and that Morris required that it get one.  (Morris allows the insured to settle a claim without the insurer’s approval when the insurer reserves its rights.) This is true even though the settlement did not result in any additional liability to Federated. At the hearing the burden will be on Monterey to prove, under the court’s new subrogation law, that it did not have notice of the subro claim (which it clearly did according to the facts recited by the court) and/or that, under Morris, the settlement was reasonable. If it fails to prove these things, Federated can proceed with its claim (which will presumably requre proving that Monterey’s claim was meritless).

This of course gives the insurer the best of both worlds. It can deny coverage yet still prevent or manipulate settlement by using the threat of subrogation for defense costs. And this is done under the cover of a case — Morris — that was supposed to prevent it from doing just this sort of thing.