2.2.1 Refusal To Defend

• Jurisdiction: Arizona

The duty of a liability insurance carrier to defend actions brought against its insured is an obligation separate from the duty to ultimately pay a successful suit against the insured.^[7] Standard insurance policies obligate the carrier to defend claims that may have no basis at all as long as the allegations of the complaint bring the claim within the coverage of the policy:^[8]

* * * The duty to defend does not depend upon the insurer's liability to pay, since the insurer's duty to defend stems from its own contractual obligation to the insured while its ultimate liability to pay on behalf of the insured depends upon the law of negligence, and since the usual policy provisions requiring the insurer to defend cannot be construed to impose such a duty only in the case of successful suits against the insured. Accordingly, the insured may be obligated to defend although not held liable to pay. In other words, the insurer may be obligated to defend so-called "groundless" suits-namely, suits the allegations of which bring them within the coverage of the policy, but which are decided in favor of the insured. ***^[9]

A carrier may also be obligated to indemnify the insured against an adverse verdict while having no duty to defend.^[10]

Because the standard defense clauses in insurance policies obligate the carrier to defend groundless, false, or fraudulent suits, the carrier's duty to defend is broader, generally, than its duty to indemnify.^[11]

The carrier's obligation to defend its insured does not arise until the carrier receives the complaint.^[12] If the complaint, on its face, alleges facts or legal theories of recovery that come within the coverage of the policy, the carrier will be obligated to assume defense of the action.^[13]

Where the alleged facts ostensibly bring the claim within the policy coverage, but other facts not reflected in the complaint plainly take the claim outside the policy coverage, there is no absolute duty to defend.^[14] The true facts outside the complaint may justify a carrier's refusal to defend.^[15] This proposition represents an exception to the general rule that the complaint controls the carrier's duty to defend.^[16]

The supreme court in Kepner v. Western Fire Insurance Co.,^[17] listed three reasons justifying the above exception. First, under modern practice, the complaint serves a notice function and is drafted before the facts crystalize through formal discovery proceedings.

[U]nder modern practices, such as the Federal Rules of Civil Procedure, followed in Arizona, the complaint serves a notice function and is framed before discovery proceedings crystalize the facts of the case. The trial focuses on the facts as they exist rather than on facts which might exist under the theory of recovery in the complaint. Accordingly, the duty to defend should focus upon the facts rather than upon the allegations of the complaint which may or may not control the ultimate determination of liability.^[18]

Second, in many cases, proof of the alleged facts may not be decisive as to the carrier's obligation to pay the resulting judgment.^[19] For example, proof of negligence proximately causing injury to the claimant may justify a judgment in the claimant's favor, but the fact that the carrier's policy excludes coverage is irrelevant to the underlying tort action and would not be shown at the trial on the tort claim.^[20]

The allegations in a pleading are not, in all circumstances and situations, the decisive factor in determining whether there exists a duty on the part of the insurance company to defend. This is especially true when the duty to defend depends upon a factual issue which will not be resolved by the trial of the third party's suit against the insured, the duty to defend may depend upon the actual facts and not upon the allegations in the pleading.^[21]

Third, if the carrier has reason to believe that the policy does not cover the insured, the interests of the insured and the carrier may diverge.^[22] However, the court in Kepner does not explain how this conflict of interest may impact upon the carrier's duty to defend.

The insured must give the carrier notice of amended pleadings that would give rise to the carrier's duty to defend the claim.^[23]

An insurance carrier is apparently obligated by Arizona law to defend the insured as to all allegations of the complaint, not merely those that appear to be within the policy's coverage. This rule was adopted by the court of appeals in Western Casualty & Surety Co. v. International Spas of Arizona, Inc.,^[24] where the court stated:

While the Arizona courts have not addressed this issue directly, the apparent majority rule is that if any claim alleged in the complaint is within the policy's coverage, the insurer has a duty to defend the entire suit, because it is impossible to determine the basis upon which the plaintiff will recover (if any) until the action is completed. [Citations omitted.] In addition, we believe that the policy language quoted above clearly creates a duty to defend the entire suit, even though some of the allegations in the complaint are groundless as far as the insurer is concerned. We express no opinion, however, as to the insurer's duty to continue the defense if the litigation should reach a point at which it is impossible for [the claimant] to recover on any claim covered by the policy.^[25]

An insurance carrier may withdraw from a defense of the insured if the insured is not prejudiced thereby, even though the carrier has not undertaken the defense with a specific reservation of rights.^[26] The insured must be left with adequate opportunity to defend the case or the court might not permit the withdrawal.^[27]

The duty to defend is owed to the named insured and omnibus insureds; the duty does not extend to individuals who use the insured automobile without permission.^[28]

An excess carrier's duty to defend, as a matter of law, does not arise until after the primary carrier's coverage has been exhausted.^[29]

Arizona courts recognize that an insurer's duty to defend is determined by the policy language.^[30] An insurer may limit its coverage liability and its corresponding duty to defend by imposing conditions and restrictions upon its contractual obligation not inconsistent with public policy.^[31] In Arizona, "the insurer is under an obligation to defend only if it would be held bound to indemnify the insured in case the injured person prevailed upon the allegations of his complaint."^[32] The general rule in Arizona on an insurance company's duty to defend is as follows: "If on its face the complaint in the action brought against the insured alleges facts which come within the coverage of the liability policy, the insurer is obligated to assume the defense of the action, but if the alleged facts fail to bring the case within the policy coverage, the insurer is free of such obligation."^[33]

To establish the insurance company's duty to defend, the insured must show that "(1) the causes of action are encompassed within the coverage and (2) the policy's exceptions do not apply or do not operate as a matter of law."^[34] Thus, an insurance company has no duty to defend if the underlying factual basis of the complaint, even if true, would not trigger coverage. As aptly discussed by the Arizona Court of Appeals:

But a distinction must be drawn between groundless suits, and actions which, even if successful, would not be within policy coverage: Since the insurer's duty to defend ordinarily is correlative with its duty to pay a judgment which might be obtained against the insured, it is apparent that the insurer has the duty of defending only those actions that are within the terms of the policy, and where there has been no breach of the policy.^[35]

The insurance company also has no duty to defend if the underlying factual basis of the complaint, even if true, would place the cause of action within an exclusion.^[36]

In Crackel v. Allstate Ins. Co.,^[37] the Arizona Court of Appeals found that an insurance company can commit an abuse of process while merely defending its insured in an underlying action. In Crackel, Allstate Insurance Company had adopted written policies governing minor-impact, soft-tissue (MIST) claims. Allstate's policy directed its adjusters and attorneys to handle MIST claims in such a way that it would not be financially feasible for claimants to pursue litigation. Allstate had instructed its representatives to "do-whatever-it-takes to remove any need for claimants to retain an attorney to assist in settling claims, including making 'settlement offers in a range that will make [a] claim economically unacceptable to an attorney.'" In another Allstate manual affecting the claims handling process, Allstate management told personnel to take a "proactive stance on MIST cases" and to "force the attorney and the claimant to think about the obstacles they must overcome to reach a realistic settlement or a walk-away settlement." According to these policies, an increase in Allstate's trial activity would constitute one such "obstacle." The MIST policy further stated that one of its goals was "to send a message to attorneys of our proactive stance on MIST cases."

The Crackel court began its analysis by observing that a near failure to settle or a refusal to make a settlement offer does not constitute abuse of process and litigants have an absolute right to refuse to settle a claim. However, notwithstanding the fact that Allstate conceded that its policyholder/insured was 100% negligent for causing the accident and the fact that Allstate's own medical examiner who performed IMEs on the plaintiffs concluded that the medical expenses of the plaintiffs in seeking precautionary care after the collision could not be faulted, Allstate continued to assert at arbitration that the case was worth "zero" and that the plaintiffs deserved "nothing." Allstate appealed the arbitration award that Allstate's own adjuster conceded was "not -...