United States: Knightbrook Insurance Company v. Payless Car Rental Systems

In KnightBrook Insurance Company v. Payless Car Rental Systems, 855 F.3d 1072 (May 5, 2017), the United States Court of Appeals for the Ninth Circuit certified the following questions to the Supreme Court of Arizona: "(1) whether Arizona equitable indemnity law incorporates § 78 of the Restatement [(First) of Restitution]; and, if so, (2) whether equitable indemnity under § 78 requires that the indemnity plaintiff's liability to the underlying plaintiff have been coextensive with the indemnity defendant's liability to the underlying plaintiff."

KnightBrook Insurance Company and Knight Management Insurance Services, LLC ("KnightBrook") sued PCR Venture of Phoenix, LLC, a franchisee of Payless Car Rental System, Inc. ("Payless") regarding a master policy KnightBrook issued to Payless that allowed Payless to sell supplemental liability insurance ("SLI") to individuals who rented cars from Payless. Michael Bovre rented a vehicle from Payless but did not purchase or pay for the available SLI coverage. However, Bovre later argued he was entitled to coverage for an accident he was involved in – a collision with two motorcycles wherein those drivers (the McGills) were seriously injured – "because the Payless desk agent: (1) failed to notice that Bovre did not initial the line on the contract that expressly declined SLI; and (2) told Bovre that 'liability coverage' was included in the rental contract." "Bovre's rental did include insurance coverage under a $30,000 state-mandated policy [and] Bovre received coverage under the $30,000 state-mandated policy and $500,000 of coverage from his personal liability policy from Travelers Insurance Company."

The injured drivers sued Bovre. "KnightBrook denied Bovre's request for SLI coverage, explaining in a letter that 'you did not purchase the optional Supplemental Liability Insurance (SLI) coverage at the time of the rental.' KnightBrook did not defend Bovre under a reservation of rights or file a declaratory judgment action over the coverage dispute."  

Bovre settled with the McGills, and the settlement included a Damron agreement (Damron v. Sledge, 105 Ariz. 151 (Ariz. 1969):

[T]he parties stipulated to an $8 million judgment in exchange for: (1) the McGills' covenant not to execute upon the judgment against Bovre's personal assets; and (2) Bovre's assignment to the McGills of Bovre's claims against KnightBrook. Bovre also paid the McGills $530,000, the combined limits of the state-mandated and Travelers policies.

The McGills then sued KnightBrook and Payless, pursuing the assigned claims as well as recovery of the $8 million stipulated judgment. The McGills made a $970,000 settlement demand. KnightBrook requested Payless contribute 50% to satisfy the demand; Payless declined. KnightBrook, alone, then settled with the McGills. Under the terms of the settlement:

(1) [T]he McGills would dismiss all of their claims against KnightBrook in exchange for $970,000; and (2) the McGills would assign to KnightBrook all of their claims against Payless in exchange for 15% of the first $250,000 and 10% of any amount in excess of $250,000 that KnightBrook recovered from Payless. Payless was not notified of the terms of the final settlement agreement until after it had been signed.

KnightBrook then took over as the plaintiff against Payless. Its amended complaint asserted the contract and negligence claims that Bovre had assigned to the McGills and that the McGills had in turn assigned to KnightBrook, as well as KnightBrook's own claims against Payless for equitable indemnification and breach of fiduciary duty. Payless filed a counterclaim against KnightBrook for insurance bad faith. The district court dismissed the contract claims on summary judgment, reasoning that they were extinguished through an accord and satisfaction when KnightBrook paid the McGills $970,000. The remaining claims proceeded to a bench trial. After the trial, the district court ruled: (1) that KnightBrook's negligence and breach of fiduciary duty claims were barred by the statute of limitations; (2) that KnightBrook was entitled to equitable indemnification for the entire settlement payment of $970,000; and (3) that Payless had failed to prove its insurance bad faith claim.

Payless filed this appeal challenging the district court's ruling in favor of KnightBrook on KnightBrook's equitable indemnification claim and Payless's insurance bad faith claim. The questions of law certified in this Order concern only the equitable indemnification claim.

The Court noted that the outcome of this appeal turns on resolution of the two certified questions: "(1) whether Arizona equitable indemnity law incorporates § 78 of the Restatement; and (2) whether equitable indemnity liability under § 78 requires that the indemnity plaintiff's liability to the underlying plaintiff have been coextensive with the indemnity defendant's liability to the underlying plaintiff."

Pertinent to this appeal, Section 78 provides:

A person who with another became subject to an obligation or supposed obligation upon which, as between the two, the other had a prior duty of performance, and who has made payment thereon although the other had a defense thereto,

  1. is not entitled to restitution if he became subject to the obligation without the consent or fault of the other;
  2. is entitled to restitution if he became subject to the obligation with the consent of or because of the fault of the other and, if in making payment, he acted

    . . .

    1. in the justifiable belief that such duty existed . . . .

The district court relied on this provision in reaching its determination:

The district court cited § 78 for the proposition that for purposes of its equitable indemnification claim against Payless, "it is sufficient if [KnightBrook] w[as] subject to a 'supposed obligation' which [Payless] had a greater responsibility to discharge, [KnightBrook] became subject to the obligation because of the fault of [Payless], and, in choosing to make the settlement payment, [KnightBrook] acted in the 'justifiable belief' that [it] would be liable in the McGills' lawsuit." The district court awarded equitable indemnification—without finding that either KnightBrook or Payless would have been found liable in the underlying lawsuit—on the ground that "[t]he requirements of § 78 of the Restatement are satisfied."

At the time the district court issued its opinion, § 78 had never been cited in a published decision of an Arizona court. After the district court issued its decision, however, the Arizona Court of Appeals applied § 78 in Hatch Development, LLC v. Solomon, 240 Ariz. 171, 377 P.3d 368 (Ariz. Ct. App. 2016), in holding that "a duty to indemnify may arise in at least two alternative circumstances: First, when the party seeking indemnity has 'extinguished an obligation owed by the party from whom it seeks indemnification,' or second, when the indemnity defendant is 'at fault.'" Id. at 372. The district court's decision is the only authority cited in Hatch for the proposition that Arizona equitable indemnity law incorporates § 78 of the Restatement.

The Court then addressed the next issue of coextensive liability:

The district court recognized that KnightBrook and Payless did not face coextensive obligations in the McGills' suit. KnightBrook paid the McGills $970,000 to settle a case in which the McGills "sought to recover [from KnightBrook] the $8 million established in the consent judgment against Bovre." The suit asserted negligence, breach of contract, and insurance bad faith claims. But only KnightBrook, and not Payless, was potentially liable for the insurance bad faith claim and the $8 million Damron judgment. [Citation.] Accordingly, as the district court correctly observed, although the McGills could have recovered $8 million from KnightBrook, they could have recovered from Payless only $1 million (the maximum available amount of SLI coverage) plus any compensable damages for Bovre's "emotional suffering, time, effort, and inconvenience." Because KnightBrook's settlement payment to the McGills enabled it to avoid substantial liability that Payless did not face, KnightBrook's and Payless's liability to the McGills was not coextensive.

Whether this matters under Arizona law is unclear. In Herstam v. Deloitte & Touche, LLP, 186 Ariz. 110, 919 P.2d 1381 (Ariz. Ct. App. 1996), the court observed that "indemnity allows one who has discharged a common liability to seek reimbursement in full from another," but it did not define "common liability" or otherwise address whether coextensive liability is a necessary prerequisite for equitable indemnity. Id. at 1388. Although other state courts have held that an indemnitee and indemnitor's respective obligations to the underlying plaintiff must be identical for equitable indemnity liability to attach [citations], no Arizona court has resolved this issue. [Citation.]

The evolution of Arizona's equitable indemnity doctrine is better entrusted to the Supreme Court of Arizona than to us. We therefore certify the foregoing questions of law to the Supreme Court of Arizona.

Due to the Court's certification of the two questions to the Supreme Court of Arizona, the Court determined "the submission of this appeal is withdrawn, and all further proceedings in this case before our court are stayed pending final action by the Supreme Court of Arizona, save for any petition for rehearing regarding this order." 

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