Arizona Court of Appeals Division One Holds That A Superior Court’s Determination, Later Reversed on Appeal, That There Is No Coverage Under An Insurance Policy Does Not Establish That The Coverage Question Was “Fairly Debatable.” In Addition, When An Insurer Seeks A Declaratory Judgment Regarding Coverage, The Insurer Is Not Absolved of Its Obligation To Reasonably Investigate and Fairly Handle The Insured’s Claim.

The Lennar companies developed residential real estate in the 1990s.  After homeowners moved in to the homes, Lennar began receiving complaints about construction defects.  Eventually, several homeowners filed a lawsuit; others threatened litigation, causing Lennar to tender claims under its liability policies issued by Transamerica Insurance Company and others.  In 2000, some of the insurers filed an action for declaratory judgment, asking the court to declare that there was no coverage, and no duty to defend Lennar.  Lennar cross claimed, alleging breach of contract and bad faith denial of coverage.  The superior court granted summary judgment in favor of the insurers and dismissed Lennar’s claims, finding that the construction defects were not an “occurrence” under the insurance policies.  The Court of Appeals reversed.

On remand, the insurers moved for summary judgment a second time, arguing that Lennar’s bad-faith claim could not survive because the superior court’s initial ruling that there was no coverage – though later reversed – proved that the insurers had a reasonable basis to deny coverage.  The superior court agreed and Lennar appealed.

The Court of Appeals again reversed summary judgment.  The duty of good faith and fair dealing obligates insurers “to play fairly with its insured” and to give the insured’s interests “equal consideration.”  Among other things, this means that the insurer has to fairly investigate and evaluate claims, and it must promptly pay a legitimate claim.  When there is a dispute over coverage, bad faith exists if the insurer “intentionally denies, fails to process or pay a claim without a reasonable basis.”  Zilisch v. State Farm Mut. Auto Ins. Co., 196 Ariz. 234, 237, 995 P.2d 276, 279 (2000).  An insurer may challenge coverage of a claim if it is “fairly debatable.”

The insurers argued that the superior court’s first determination that there was no coverage demonstrated, as a matter of law, that the coverage question was “fairly debatable” and thus the insurers acted in good faith when they denied the claim.  The Court rejected this argument, explaining that, although earlier cases had cited similar circumstances as evidence of reasonableness, those statements were dicta and did not hold that “the prior (erroneous) ruling meant that the claim was fairly debatable as a matter of law.” 

Furthermore, the Court held that issues of material fact precluded summary judgment.  To prove its bad-faith claim, Lennar has to show both that the insurers lacked a reasonable basis to deny the claim, and that they knew they lacked a reasonable basis.  As to the first question, because the insurance policy language at issue is subject to differing interpretations, whether the insurers acted reasonably based on their interpretation was a jury question.  Moreover, whether the insurers knew there was not a reasonable basis – that is, believed the issue was “fairly debatable” – is also a question of fact for the jury.  In this case, there was evidence that the insurers knew parties like Lennar intended for the policies to cover construction defect claims.  Such evidence would be considered on remand.

Finally, the Court held that questions of fact precluded summary judgment on Lennar’s claim that the insurers breached their duty to reasonably investigate and fairly handle their claim.  Substantial evidence showed that over a number of years the insurers denied coverage and did not assist in Lennar’s defense.  The insurers argued that they were not obligated to investigate or handle Lennar’s claims so long as the coverage question was unresolved.  They also argued that their efforts to obtain a declaratory judgment on the coverage issue satisfied their duties of good faith.  The Court rejected this assertion, noting that when an insurer objects to coverage it “may not disregard its normal claims-handling responsibilities” while the coverage question is unresolved.

Judge Johnsen authored the opinion; Judges Kessler and Weisberg concurred.