Arizona Court of Appeals Division One holds that an agreement between an insured and an entity controlled by the insured does not create a valid Morris agreement.

In some instances an insurer defends its insured against a third-party claim but reserves the right to challenge coverage under the insured’s policy.  In those circumstances, the insured faces some risk of loss.  Consequently, the insured may settle the claim with the third-party claimant without the involvement of the insurer.  The settlement agreement may also assign to the third-party claimant the insured’s rights against the insurer, including potential claims for bad faith.  That agreement is called a Morris agreement, referencing a decision of the Arizona Supreme Court. United Services Automobile Ass’n v. Morris, 154 Ariz. 113 (1987). 

In this case, the Court of Appeals faced a complicated set of facts from the fallout of the failed entity Mortgages, Ltd.  In short, two entities had a title insurance policy on certain real estate.  The property was subject to several loans, deeds of trust, and mechanics’ liens.  After the priority of the mechanics’ liens became an issue, the two insured entities tendered the claims to the insurer, which defended under a reservation of rights. 

The insureds wanted to settle in order to sell the property.  They created a new entity­ (wholly owned by the insureds) that purchased the mechanics’ liens.  Ultimately, a complicated global settlement occurred among the insureds, the new entity, and others, with the idea that the new entity would pursue claims against the insurer.  The insureds notified the insurer of the alleged Morris agreement.

The insurer challenged the agreement.  The Court of Appeals held that the transactions did not create a valid Morris agreement.  The transaction was not an arm’s length agreement because the insureds controlled the entity with which they settled.  The third-party claimants were not parties to the agreement because they had sold the liens to the new entity.  At that point, the settling parties’ interests were aligned, not adverse.  Those facts place the transaction outside the bounds of a valid Morris agreement.

Judge Cattani authored the opinion; Judges Downie and Brown joined.