How to Avoid an Insurance Carrier's Post Hoc Veto Power

In Monterey Homes Arizona, Inc., homeowners brought a lawsuit against Monterey, a homebuilder. Monterey denied that it was liable and filed a third-party complaint against several of its trade subcontractors, including BBP, alleging contractual and common-law indemnity and various breach claims.  BBP submitted the defense of Monterey's third-party claim to its insurer, Federated Mutual Insurance Company (Federated). Federated defended BBP under a reservation of rights and, in doing so, incurred defense costs, which included attorney fees. (In Arizona, an insurer may notify its insured that it is defending under a reservation of its rights to contest coverage and its ultimate liability for judgment.  Damron v. Sledge, 105 Ariz. 151, 460 P.2d 997 (Ariz. 1969).) The parties ultimately participated in mediation where each party participated in settlement discussions. A Morris agreement was executed by Monterey and BBP. The mediation session in which the agreement was entered into was attended by representatives of Monterey, BBP and Federated-Monterey and BBP.  Monterey Homes Arizona, Inc., 221 Ariz. at 353, 212 P.3d at 45.  Each party agreed to release all claims it had against the other and to "no indemnity or defense payments." Although Federated was present and participated in the mediation, it did not sign the mediation agreement and did not consent to BBP's doing so.

Thereafter, notwithstanding the execution of a settlement agreement at mediation, Federated moved to intervene to assert a subrogation claim against Monterey to recover the defense costs it had incurred on BBP's behalf. The superior court denied the motion. The court of appeals, however, concluded that Federated was entitled to intervene to contest the reasonableness of the settlement, and it also stated that it was unclear whether Federated was given appropriate notice of the settlement before it was executed. It reasoned that the safeguards, appropriate notice and reasonableness, apply when an insured that was defended by an insurance carrier under a reservation of rights enters into a settlement that releases the subrogation rights of the insurer.

Accordingly, it is important for parties considering mediation to keep in mind that mediation is an informal process. It is a facilitated negotiation in which a mediator aids the parties to negotiate. In mediation, a mediator does not decide the case; the parties themselves decide how to resolve their dispute, if at all. G. Nicholas Herman & Jean M. Cary, Legal Counseling, Negotiating, and Mediating: A Practical Approach 300 (2009). Thus, any agreement that is reached in mediation must meet the same standards as one made outside of mediation.

The Role of the Insurance Carrier at Mediation after Monterey Homes
In light of Monterey Homes Arizona, Inc., there are a few things that claimants and insureds should consider when deciding whether their dispute is suitable for mediation. Mediation might be less favorable than it would be if the insured were not being defended under a reservation of rights. This is so because despite their efforts to conclusively resolve the dispute between them, the insurer may impede a negotiated settlement from being achieved at that time. The Arizona court has not made clear what constitutes adequate notice, but apparently notice obtained throughout discussions during mediation is insufficient. The court has made clear, however, that the insured must receive notice sufficient to allow it to remove its reservation of rights. (The insurer is not bound by a Morris agreement unless it was put on notice of the agreement and was provided an opportunity to defend unconditionally. Monterey Homes Arizona, Inc., 212 P.3d at 50 citing Parking Concepts v. Tenney, 207 Ariz. 19, 22, 83 P.3d 19, 22 (Ariz. 2004).) The burden is on the claimant to prove that such notice has been satisfied. Thus, parties may find it prudent to write a short memo or outline of their deal at the end of the mediation that the insured can thereafter take under consideration. On a later date, the agreement can be converted into a formal, signed contract. Still, any agreement, despite adequate notice, "must be reasonable and prudent under the circumstances, that is, what a reasonably prudent person in the insured's position would have settled for on the merits of the claimant's case." Monterey Homes Ariz., Inc. v. Federated Mut. Ins. Co., 221 Ariz. 351, 358, 212 P.3d 43, 59 (Ariz. Ct. App. 2009) citing USAA v. Morris, 154 Ariz. at 113,120–21, 741 P.2d at 246, 253–54 (Ariz. 1987).

If parties are willing to formalize a mediated agreement after mediation has occurred, mediation in this context retains its benefits. For instance, in Monterey Homes, the settlement between the claimant and the insured would have been a "win-win" but for the impediment created by the insurer, which may arise only occasionally, and arguably could have been eliminated, in part, if notice was effectuated as described above. Moreover, despite a reluctant insurer, mediation remains a vehicle for preserving or improving continuing relationships. This arguably was important to Monterey Homes and BBP from a business standpoint. Of course, mediation often saves parties time and money. At the very least, parties are able to gain an independent case evaluation that can be a helpful reference point to determine whether to settle or to continue litigating. Harold I. Abramson, Mediation Representation: Advocating in a Problem-Solving Process 117 (2004).

In sum, parties should be aware that, while mediation retains most of its benefits, when an insurer defends its insured under a reservation of rights, parties should be cautious about finalizing an agreement during mediation.

General Rules of Mediation
Because an insurer in Arizona is subject to the tenets of good faith and fair dealing, one may wonder whether it acts in bad faith in espousing that it had failed to receive adequate notice of an agreement, when, in fact, that very agreement had been crafted in the mediation in which it participated. After all, if an insurer has acted in bad faith when determining whether to accept a settlement offer, it becomes liable to the insured. Hartford Accident  & Indem. Co. v. Aetna Cas. & Sur. Co., 792 P.2d 749 (Ariz. 1990) citing Farmer's Ins. Exch. v. Henderson, 82 Ariz. at 335, 338, 313 P.2d at 404, 406 (Ariz. 1957). For reasons set out below, a court is unlikely to find that an insurer has breached its duties of good faith and fair dealing in contesting notice of a Morris agreement developed in mediation in which the insurer participated.

First, case law does not provide much assistance regarding an attorney's ethical rules in this context, and in Monterey Homes, the issue was not even raised. Carrie Menkel-Meadow, "Ethics, Morality and Professional Responsibility in Negotiation" in Dispute Resolution Ethics: A Comprehensive Guide 119–154 (Phyllis Bernard & Bryant Garth eds., 2002). The court has made clear that negligence by an insurer by itself is not sufficient to impose bad faith liability. Hartford Accident & Indem. Co. v. Aetna Cas. & Sur. Co., 792 P.2d 749 (Ariz. 1990), citing Farmer's Ins. Exchange 82 Ariz. at 338, 313 P.2d at 406. Attorneys have been sanctioned, however, when "a negotiator deliberately refused to answer, recklessly gave incomplete or incorrect responses, or allowed some incorrect fact or information to stand; attorneys have also been sanctioned for listening to other parties' disclosures but not disclosing information, or failing to send the client with settlement authority to appropriate meetings."

Additionally, zealous advocacy is required in mediation. Lawrence Fox, "Mediation Values and Lawyer Ethics: For the Ethical Lawyer the Latter Trumps the Former," in Dispute Resolution Ethics: A Comprehensive Guide 119–154 (Phyllis Bernard and Bryant Garth eds., 2002), citing G. Heilmeman Brewing Co. v. Joseph Oat Corp., 871 F. 2d 648 (7th Cir. 1989). "Neither client nor lawyer has a duty to the mediation process which outweighs the obligation to act in the best interest of the client, even if that means the mediation is fated to fail. If that objective necessitates the attorney to display sincere concern for the position of the other side; or requires the attorney to concede some point or appear reasonable or act gracious, that may be perfectly acceptable behavior, if its singular purpose is to advance the interests of the client." Id. That is, the attorney's responsibility is to his client rather than to the mediation process. Even more, when mediation fails, it does not mean that a lawyer has participated in bad faith. After all, the decision to settle or reach an agreement does not belong to the lawyer; settlement authority resides with the client. Ariz. Rules of Prof'l Conduct R. 1.2.

Consequently, because parties to mediation are not required to reach a settlement agreement, a court is unlikely to find that an insurer has acted in bad faith by participating in mediation—in which an agreement is reached between a claimant and its insured—that the insurer later contests. In fact, if the attorney for the insurer contravenes the insurer's advice and goes along with the process, he has failed to distinguish to what or to whom his obligation is owed. Again, it is not owed to the process; rather, it is owed to the client, the insurer.

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