Late May marked the fourth anniversary of the American Law Institute’s vote to approve the organization’s Restatement of the Law, Liability Insurance.

In general, throughout its long and contentious drafting process, there were numerous concerns raised by insurers, and their counsel, that the ALI was seeking to adopt positions in the RLLI that would lead to all manner of detrimental outcomes for insurers in coverage disputes.  A review of the several dozen decisions, that have had something to say about the RLLI, reveals that that has not come to pass.  

[I have a one-hour webinar that undertakes an examination of the first four years of the RLLI and the impact that it has had on the coverage landscape.  I’ve done it for lots of insurers.  If you are interested, drop me a note.  See above article re: webinars.]

Late last month, the Arizona District Court cited to the ALI’s Insurance Restatement in finding against the insurer in Clarendon America Ins. Co. v. R.E.P. Custom Builders, Inc., No. 20-8078 (D. Ariz. May 24, 2022).  While Clarendon goes in the category of an insurer ALI loss, the opinion makes clear that the outcome was going to be the same, even without the court’s added cite to the ALI Restatement.  But the decision is worth a look, as the Restatement provision at issue is one of the more unusual ones.

REP grows out of a construction defect coverage suit.  In 2006, the Whiles hired REP as their general contractor for the construction of a house in Cornville, Arizona.  REP contracted with McBride Excavating to grade the land and construct the building pad.  The Whiles began noticing issues with their house in 2009.  In 2016, the Whiles filed suit against REP, alleging that “movement, cracking, separation and/or rotation of the flooring and/or concrete and/or retaining wall elements” resulted in “substantial vertical offsets (i.e., trip hazards)” and rendered the house “unsafe to its occupants and/or visitors.”

REP’s insurer, Praetorian, undertook REP’s defense, under a reservation of rights, hiring the firm of Springel & Fink to serve as counsel.  REP’s expert placed all of the blame for the problems on settlement of the fill used to construct the building pad.  So Springel & Fink filed a third-party complaint against McBride Excavating for its faulty work.  However, the complaint was dismissed as untimely under Arizona’s statute of repose. 

In May 2020, REP and the Whiles agreed to a stipulated judgment in the amount of $406,000 and change.  REP assigned to the Whiles insurance-related claims against REP’s insurers, for not paying the stipulated judgment.

Praetorian and Clarendon, another REP insurer, filed an action seeking a declaration that their policies do not provide coverage. They generally asserted subsidence of land exclusions and the court held that no coverage was owed.

Despite the court concluding that no coverage was owed, there was also the issue of a bad faith claim against Praetorian.  It was argued that Praeterian, by delaying its authorization of litigation against McBride, the at-fault subcontractor, until after Arizona’s statue of repose had expired, REP was unable to secure indemnity or contribution.  

The details of this alleged delayed authorization are not spelled out.  In any event, Praetorian argued that it could not be liable for defense counsel Springel & Fink’s alleged legal malpractice. 

Looking at Lloyd v. State Farm, a 1992 Arizona appeals court decision for guidance, the REP court discerned the following rule: “when an insurer assumes a duty to defend an insured, the insurer may breach that duty if it inhibits the timely filing of pleadings in the insured’s defense.”

As for whether Praetorian did, in fact, delay authorizing a third-party complaint against McBride, a genuine dispute existed, leaving this aspect of the bad faith claim to the jury.

Of note, the court pointed out that the rule from Lloyd v. State Farm – an insurer may breach the duty to defend if it inhibits the timely filing of pleadings in the insured’s defense – comports with the ALI Insurance Restatement, § 12(2), which provides for liability of the insurer “when the insurer directs the conduct of the counsel with respect to the negligent act or omission in a manner that overrides the duty to counsel to exercise independent professional judgment.” 

[Section 12(1) provides that if the insurer “fails to take reasonable care” in selecting defense counsel, “the insurer is subject to liability for the harm caused by any subsequent negligent act or omission of the selected counsel that is within the scope of the risk that made the selection of counsel unreasonable.”]

What’s interesting about the decision citing to the ALI Restatement’s § 12 is that the scenarios provided in that section, for assigning liability to an insurer, for alleged legal malpractice of its retained defense counsel, are quite narrow.  Yet, here, the case allegedly managed to fall within the standard.

In any event, it is clear that the court, in Clarendon America Ins. Co. v. R.E.P. Custom Builders, given its decision to follow Lloyd, was going to reach the same decision even without citing the ALI Restatement’s take on the issue.  But the decision demonstrates what has been a common use of the Restatement – providing additional, even if unneeded, support for a court’s decision.