On a certified question from the Ninth Circuit the court holds that a default judgment entered pursuant to a Damron agreement “does not preclude litigation of whether coverage exists under the policy.”

Cox, the holder of a State Farm auto policy, sold the car, though she hung on to the title pending full payment and hadn’t cancelled the policy. The new owner’s daughter caused an accident w/ Quihuis, who sued her and Cox (presumably meaning that mom had no insurance). Cox did a Damron admitting, inter alia, ownership of the car at the time of the accident. Pursuant to the agreement, judgment was entered and assigned to Quihuis, who sued State Farm. The case was removed; the District Court gave State Farm summary judgment, finding that Cox hadn’t owned the car. Quihuis appealed, resulting in the certified question.

The argument that a Damron agreement can affect coverage is one that various lawyers have been making for a long time. As applied in this case, the idea is that since ownership was a liability issue (on a negligent-entrustment allegation) it is conclusively established by the judgment and cannot be questioned even if it also determines coverage. For this proposition some, including Quihuis’ lawyers, have cited a Division Two opinion, AAU v. Wood (2004). AAU is of Biblical length and breadth so it is appropriate, and perhaps necessary, that Justice Pelander, who wrote it, is now called on to understand apply it.

He begins by deciding that Restatement (Second) of Judgments 58, which has to do with indemnitors and indemnitees, controls. “Section 58(1)(a) precludes State Farm from disputing the ‘existence and extent’ of the Coxes’ liability to the Quihuises.” He then looks to case law to decide what “existence and extent” means.

Morris said that under a Morris agreement the insurer could litigate coverage. Wood, Justice Pelander tells us, was “a straightforward application of 58(1)(a)”; it prohibited re-litigation of liability and also of “issues” that “relate” “strictly” to liability and damages. Add these together and they mean that 58(1)(a) “does not prevent relitigation of pure coverage issues.”

58(1)(b) precludes relitigation of any issues “determined in the [underlying] action” unless there was a conflict of interest between indemnitor and indemnitee. Justice Pelander looks to the illustrations to conclude that this applies only to issues actually litigated.

Quihuis argued that she had a judgment, not just an agreement. But “Our cases have not made a distinction [between them], nor does section 58.”

Quihuis also argued that Morris and Wood shouldn’t apply because State Farm refused to defend Cox, even under a reservation. But, citing Kepner, in Arizona there is no absolute duty to defend, especially when facts not in the Complaint take the claim outside the coverage. Even if State Farm had breached a duty to defend, which the opinion does not decide, it would still be entitled to litigate coverage. The opinion ends, however, with language warning insurers that the prudent thing is to defend under a reservation.

Quihuis’ was an interesting case on which to bring this issue since her Damron was a dodgy one, creating coverage by having someone admit to things that a court found weren’t true. There had been some speculation that the court would have to overrule AAU to prevent this fraud. Justice Pelander’s position, though, has always been that AAU was a perfectly simple (we would normally add “straightforward” but he has taken the word out of our mouth) holding consistent with everything else in the law. A more skeptical mind could conclude that he sees the case as an outlier – needed at the time for reasons that don’t entirely bear scrutiny – that can, at least on this point, now be reined in.

(link to opinion)