Auto-Owners Insurance Company v. McNally

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WO
IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF ARIZONA
Auto-Owners Insurance Company,
Plaintiff,
v.
Marisa McNally, et al.,
Defendants.
No. CV-24-00114-PHX-SHD
ORDER
On August 20, 2024, Plaintiff/Counterdefendant Auto-Owners Insurance Company
(“Auto-Owners”) filed a Motion to Dismiss Counterclaim. (Doc. 24.) On October 24,
2024, Auto-Owners also filed an Application for Entry of Default Against Defendant
Marisa McNally, (Doc. 37), and after the Court ordered a response, (Doc. 39), Griffen Roy
and Corina Farcasanu1 filed a Motion to Set Aside Application for Entry of Default, (Doc.
40). The Court will now grant in part the motion to dismiss, deny the application for
entry of default, and deny the motion to set aside application for entry of default as moot.
I. FACTUAL AND PROCEDURAL BACKGROUND2
On February 27, 2022, McNally, after consuming alcohol, was involved in an
1 As discussed in greater detail below, Roy and Farcasanu have appeared as the
defendants/counterclaimants in this action in place of McNally based on their allegation
McNally assigned her claims, rights and defenses against Auto-Owners to them. (Doc. 20
at 2.) Accordingly, they will be referred to as “Assignees” in this Order.
2 The facts set forth below are those alleged in the First Amended Complaint (Doc.
12) and are not disputed by Assignees in their Answer and Counterclaim (Doc. 20).
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automobile accident with Assignees. (Doc. 12 ¶¶ 13–14.) At the time of the accident, the
vehicle McNally was driving was insured under a policy issued to McNally by
“Progressive.” (Id. ¶ 16.) Separately, McNally’s parents and/or their trust maintained three
policies, issued by Auto-Owners, that were in effect at the time of the accident: (1) an
automobile policy (the “Automobile Policy”); (2) a condominium policy (the “Condo
Policy”); and (3) an umbrella policy (the “Umbrella Policy”), for which the Automobile
Policy and Condo Policy were the underlying policies. (Id. ¶¶ 6–8; Doc. 20 at ¶ 6.) The
Umbrella Policy provides certain liability coverage in excess of the Automobile and Condo
Policies, up to $4,000,000 per occurrence. (Doc. 12 at ¶ 7.) McNally is not a named
insured on any of the Auto-Owners policies, but she resided in the condo covered by the
Condo Policy. (Id. ¶¶ 9, 17.) The Umbrella Policy provides coverage to a “relative who
resides in [the named insureds’] household”. (Doc. 20 at ¶ 19; see also Doc. 12 at ¶ 26.)
In 2023, Assignees sued McNally for injuries they suffered in the car accident.
(Doc. 12 at ¶¶ 19–21.) McNally tendered the defense of the lawsuits to Auto-Owners,
which disclaimed coverage under the Automobile Policy and Condo Policy, and reserved
its rights with respect to the Umbrella Policy, agreeing to appoint counsel to monitor the
defense of the lawsuits as a potential excess carrier. (Id. ¶¶ 22–25.) Auto-Owners
explained its reservation of rights in a July 11, 2023 letter as follows: “To the extent
McNally was not residing in the household of the named insureds – i.e., the Trust and
Krainz and McNally, its Trustees – she is not considered an insured under the umbrella
policy and is, therefore, not entitled to coverage.” (Doc. 24-2 at 6.)
On January 17, 2024, Auto-Owners sued McNally seeking a declaration of its rights
and obligations under the Umbrella Policy, (Doc. 1), and later filed a First Amended
Complaint in which it sought “a judicial determination that Auto-Owners has no obligation
to provide coverage to McNally with regard to any claims arising out of the Accident,”
(Doc. 12 at 7). On July 25, 2024—five days before the deadline for McNally to respond
to the First Amended Complaint—she sent a letter to Auto-Owners in which she
(a) explained in detail why she believed she was covered by the Umbrella Policy as a
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relative residing in her parents’ household, (b) disclosed that Assignees had expressed an
interest in acquiring her rights and claims against Auto-Owners in exchange for their
agreement not to pursue her personal assets, and (c) offered Auto-Owners the opportunity
to withdraw its reservation of rights, dismiss this lawsuit, and extend coverage to her by to
avoid her assigning her rights to Assignees. (Doc. 24-3 at 2–4.) Auto-Owners did extend
coverage to McNally and on July 30, 2024, McNally and Assignees executed an Agreement
to Assign All Claims, Rights and Defenses to Insurance Claims and Benefits (the
“Assignment Agreement”). (Doc. 24-4.)3
That same day, Assignees—standing in the name and position of Marissa
McNally—answered the First Amended Complaint and asserted counterclaims against
Auto-Owners for breach of contract, bad faith, and punitive damages. (Doc. 20 at 2
(“Defendants/Counterclaimants Roy and Farcasanu are the assignees of Marisa McNally
with respect to any claims and defenses she may have against Plaintiff Counter-defendant
Auto-Owners arising out of the failure of Auto-Owners to provide Marisa McNally
unreserved coverage under the Umbrella Policy.”).) Auto-Owners moved to dismiss the
counterclaims under Rule 12(b)(6). (Doc. 24.) That motion is fully briefed. (Docs. 30,
35.)
Additionally, on October 24, 2024, Auto-Owners applied for entry of default against
McNally because she did not personally respond to the First Amended Complaint. (Docs.
37–38.) The Court ordered Assignees and/or McNally to respond to the default application,
(Doc. 39), and Assignees effectively did so by filing a Motion to Set Aside Application for
Entry of Default, (Docs. 40–42). The default application and motion to set aside are fully
briefed. (Docs. 43, 44.)
3 Although neither the July 25 letter nor the Assignment Agreement were attached to
the Answer and Counterclaim, (Doc. 20), they are referenced in that document and
therefore may be considered on this motion to dismiss. See, e.g., United States v. Ritchie,
342 F.3d 903, 907–08 (9th Cir. 2003) (courts may consider documents incorporated by
reference in the complaint, including if the plaintiff refers to the document extensively or
the document forms the basis of the claim).
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II. DISCUSSION
A. Auto-Owners’ Motion to Dismiss Counterclaims
Auto-Owners seeks dismissal of Assignees’ counterclaims on two grounds: (1) that
Assignees lack standing to assert the counterclaims because the Assignment Agreement is
invalid, and therefore they cannot assert rights originally held by McNally as the putative
insured; and (2) even if the Assignment Agreement was valid, each of the counterclaims
fails to state a claim upon which relief can be granted. Each argument is addressed in turn.
1. Assignees’ Standing
a. Applicable Law
“Assignees of a claim . . . have long been permitted to bring suit.” Sprint
Commc’ns Co., L.P. v. APCC Servs., Inc., 554 U.S. 269, 275 (2008) (holding that
assignees of claims have Article III standing); see also Misic v. Bldg. Serv. Emps. Health
& Welfare Tr., 789 F.2d 1374, 1378 n.4 (9th Cir. 1986) (noting the “familiar principle
that the assignee stands in the shoes of the assignor, and, if the assignment is valid, has
standing to assert whatever rights the assignor possessed”). Under Arizona law, when an
insurer denies coverage to its insured, an insured defendant may enter into an agreement
in the underlying action in which the insured “admits to liability and assigns to a plaintiff
his or her rights against the liability insurer . . . in exchange for a promise . . . not to
execute the judgment against the insured.” Safeway Ins. Co v. Guerrero, 106 P.3d 1020,
1022 n.1 (Ariz. 2005). These agreements generally take two forms: (1) Damron
agreements, which arise in the context of an “insurer’s refusal to defend the insured,” and
(2) Morris agreements, which “can be prompted by a number of circumstances,”
including when an insurer has reserved its rights, anticipatorily breached its duty to
indemnify, or failed to settle in bad faith. Id. (citing Damron v. Sledge, 460 P.2d 451
(Ariz. 1969) and United Servs. Auto. Ass’n v. Morris, 741 P.2d 246 (Ariz. 1987)).
“Morris agreements are designed to reconcile the ‘conflicting interests’ of an
insured and a liability insurer in certain difficult situations.” Id. at 1024. “While an insurer
with a good faith policy defense has a right to dispute coverage, the insured is thereby
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placed in a precarious position” such that they may “protect themselves from the sharp
thrust of personal liability” by entering into such agreements without violating the
cooperation clause of an insurance contract. Id. (citations and quotation marks omitted).
In such situations, however, the “insureds (or their assignees) [must] show that any Morris
agreement is free of fraud or collusion . . . and reasonable in amount,” id. (citations and
quotation marks omitted), and must provide “notice to the insurer,” Morris, 741 P.3d at
252. Moreover, if the insurer ultimately demonstrates that the claim is not covered by the
pertinent policy, it has no liability under the Morris agreement. Guerrero, 106 P.3d at
1024.
b. Validity of the Assignment Agreement under Arizona Law
Auto-Owners first asks the Court to deem the Assignment Agreement invalid
because Auto-Owners is an excess carrier that did not breach any duty to defend, arguing
that Morris-type agreements are available only in situations where the insurer breached a
duty to defend. (Doc. 24 at 8–11.) In making this argument, Auto-Owners incorrectly
conflates Damron agreements and Morris agreements. While Damron agreements arise
following “an insurer’s refusal to defend the insured,” Morris agreements arise in “a
number of circumstances” including those involving a “reservation of rights by [an]
insurer” or an “alleged anticipatory breach of [the] insurer’s duty to indemnify.” Guerrero,
106 P.3d at 1022 n.1. The Assignment Agreement here is a Morris-type agreement. Auto-
Owners reserved its rights as to its indemnification obligation under the Umbrella Policy
and later filed this action seeking a declaration that it owed no coverage to McNally, putting
her in the precarious position of facing personal liability for any judgment exceeding her
primary policy coverage limits. After being placed in that situation, McNally “admit[ed]
to liability and assign[ed] to [Assignees] . . . her rights against [Auto-Owners] . . . in
exchange for a promise . . . not to execute the judgment against” her. Id. Auto-Owners
cites no caselaw supporting its position that a Morris agreement executed under these
circumstances is invalid under Arizona law.
Moreover, its reliance on Geurden v. Quantum Transportation LP, 298 F. Supp. 3d
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1222 (D. Ariz. 2018), is misplaced. In that case, the court found that an agreement executed
under similar circumstances was, in fact, a Morris agreement. See id. at 1226. The insureds
in Geurden stipulated to a judgment after a primary insurer demanded that the excess
carrier tender its policy limits and the excess carrier responded by denying that it had any
“duty to defend and/or indemnify” as the “insurance policy was excess to policies of other
insurers that were . . . providing a defense.” Id. at 1224. When the parties in the underlying
litigation asked the court to enter the stipulated judgment, the court inquired as to whether
it needed to conduct a reasonableness hearing before entering the judgment, explaining that
courts do “not conduct a reasonableness inquiry” for Damron agreements, but “must
inquire into Morris agreements for their reasonableness.” Id. at 1225.
After briefing by the parties and the excess carrier, which had intervened, the court
ruled that a reasonableness hearing was required. Although the parties to the stipulated
judgment characterized it as “a ‘Damron Agreement,’” id. at 1224–25, the court concluded
that it could not have been a Damron agreement because the excess carrier had no duty to
defend at the time of the stipulation and thus could not have breached any duty to defend,
id. at 1226–27 (finding that alleged anticipatory breach of duty to defend by the excess
carrier could not give rise to a Damron agreement). Instead, the Court determined that the
circumstances gave rise to a Morris agreement entitling the excess carrier to a
reasonableness hearing. Id. at 1227. Thus, Geurden belies Auto-Owners’ argument that
there can be “no valid assignment of claims by an insured against an excess carrier.” (Doc.
25 at 8.)
Auto-Owners next argues that the Assignment Agreement is invalid because
McNally failed to provide “proper notice.” (Doc. 24 at 11–12.) While an insurer is entitled
to notice of an impending Morris agreement, see, e.g., Morris, 741 P.3d at 252, Auto-
Owners received such notice on July 25, 2024, when McNally informed Auto-Owners
about the impending agreement and offered it the opportunity to waive its reservation of
rights and accept coverage:
The underlying Plaintiffs Roy and Farcasanu have expressed an
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interest in acquiring an assignment of the rights and claims of my client
against Auto-Owners in exchange for a promise by Roy and Farcasanu not
to pursue the personal assets of my client and agreement to the amount of
damages sustained by Roy and Farcasanu. This letter is an offer to forego
such an assignment and agreement if Auto-Owners withdraws its
reservation of rights, dismisses the Declaratory Action, and agrees to
coverage under the Umbrella Policy for Marisa McNally with respect to
the February 27, 2022 collision.
(Doc. 24-3 at 3–4 (emphasis in original).) Auto-Owners does not dispute that it received
the July 25 letter and instead argues that the notice was inadequate because Auto-Owners
“was given two days” to agree to coverage, was not provided with a draft of the Assignment
Agreement, was not informed of the amount of the proposed stipulated judgment, and was
not given the opportunity to defend. But Auto-Owners does not cite any caselaw in support
of its argument that it was entitled to additional time to accept coverage or additional
information about the impending Morris agreement. Nor does it suggest that it ever asked
McNally for additional time or additional information to consider her offer. Under these
circumstances—and at this early stage of the case—the Assignment Agreement will not be
deemed invalid and the counterclaims will not be dismissed for lack of standing. Cf. Lujan
v. Defs. of Wildlife, 504 U.S. 555, 561 (1992) (standing “must be supported . . . with the
same manner and degree of evidence required at the successive stages of the litigation,”
which, at the pleading stage, requires only “general allegations [that] embrace those
specific facts . . . necessary to support the claim.”).
2. Failure to State a Claim
a. Rule 12(b)(6) Standard
Dismissal of a claim for failure to state a claim under Federal Rule of Civil
Procedure 12(b)(6) “may be based on either a ‘lack of a cognizable legal theory’ or ‘the
absence of sufficient facts alleged under a cognizable legal theory.’” Johnson v. Riverside
Healthcare Sys., LP, 534 F.3d 1116, 1121–22 (9th Cir. 2008) (quoting Balistreri v. Pacifica
Police Dep’t, 901 F.2d 696, 699 (9th Cir. 1990)). In determining whether a claim satisfies
this standard, the claimant’s allegations are taken as true, and the pleadings are construed
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in the light most favorable to the nonmovant. Outdoor Media Group, Inc. v. City of
Beaumont, 506 F.3d 895, 900 (9th Cir. 2007). A pleading must contain “a short and plain
statement of the claim showing that the pleader is entitled to relief.” Fed. R. Civ. P. 8(a)(2).
To survive a motion to dismiss, a complaint must state a claim that is “plausible on its
face.” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009); see Bell Atlantic Corp. v. Twombly,
550 U.S. 544, 570 (2007). “A claim has facial plausibility when the plaintiff pleads factual
content that allows the court to draw the reasonable inference that the defendant is liable
for the misconduct alleged.” Iqbal, 556 U.S. at 678. A court need not accept as true
“conclusory statements” or “legal conclusions.” Id.
b. Breach of Contract Counterclaim
The elements of a breach of contract claim are “the existence of the contract, its
breach and resulting damages.” Graham v. Asbury, 540 P.2d 656, 657 (Ariz. 1975). Here,
Auto-Owners asserts that Assignees’ breach of contract counterclaim must be dismissed
because Assignees have not, and cannot, allege a breach of any contractual given that “no
duty has arisen or was otherwise imposed upon Auto-Owners as an excess carrier under
the circumstances.” (Doc. 24 at 12–13.) It further argues that because it breached no
contractual obligation, it has not caused any damages. (Id. at 13.)
Although Assignees generally allege that Auto-Owners owed McNally coverage as
“a relative resident in the insured household” and breached the insurance contract, (Doc.
20 at 6 ¶¶ 4-7), they do not allege which specific contractual obligation Auto-Owners
breached, when that obligation arose, or how they have been damaged by the alleged
breach. (Doc. 20 at ¶¶ 3-7.) These omissions are problematic in this case because “Arizona
courts . . . hold that ‘until a primary insurer offers its policy limit, the excess insurer does
not have a duty to evaluate a settlement offer, to participate in the defense, or to act at all.’”
Geurden, 298 F. Supp. 3d at 1227 (quoting Twin City Fire Ins. Co. v. Burke, 63 P.3d 282,
287 (2003)). Assignees have not alleged facts sufficient to state a plausible breach of
contract claim and instead rely on conclusory allegations. Accordingly, their breach of
contract will be dismissed for failure to state a claim.
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Because Assignees could theoretically amend their counterclaims to allege facts
sufficient to state a breach of contract claim against Auto-Owners, they will be granted
leave to amend. See Cook, Perkiss & Liehe, Inc. v. N. Cal. Collection Serv. Inc., 911 F.2d
242, 247 (9th Cir. 1990) (“[A] district court should grant leave to amend even if no request
to amend the pleading was made, unless it determines that the pleading could not possibly
be cured by the allegation of other facts.”); Fed. R. Civ. P. 15(a)(2) (leave to amend should
be freely given “when justice so requires”).
c. Bad Faith Counterclaim and Punitive Damages
“Arizona law implies a covenant of good faith and fair dealing in every contract.”
Wells Fargo Bank, N.A. v. Ariz. Laborers, Teamsters & Cement Masons Local No. 395
Pension Tr. Fund, 38 P.3d 12, 28 (Ariz. 2002). In the insurance context, “there is a legal
duty implied in an insurance contract that the insurance company must act in good faith in
dealing with its insured on a claim, and violation of that duty of good faith is a tort.” Deese
v. State Farm Mut. Auto. Ins. Co., 838 P.3d 1265, 1267 (Ariz. 1992) (quotation marks
omitted). Third party bad faith claims involve allegations that “the insurer acted in bad
faith in its duty to indemnify or protect the insured from third-party claims.” Satamian v.
Great Divide Ins. Co., 545 P.3d 918, 928 (Ariz. 2024).
Auto-Owners argues that Assignees’ have failed to state a claim for bad faith and
that their associated punitive damages claim must also be dismissed. (Doc. 24 at 13–14.)
With respect to the bad faith counterclaim, Auto-Owners makes two arguments in support
of dismissal: (1) that Assignees improperly allege the same conduct by Auto-Owners upon
which they based their breach of contract claim, and (2) that Auto-Owners’ filing of this
declaratory judgment action cannot by itself support a bad faith claim. (Id.) In making
these arguments, however, Auto-Owners ignores the actual allegations in the counterclaim,
which include that Auto-Owners failed to investigate and act reasonably in evaluating the
coverage claim by withholding information from McNally, failed to consider her interests
while serving its own interests to her detriment, and imposed “needless adversarial hoops.”
(Doc. 20 at ¶¶ 11–19). Auto-Owners’ failure to substantively engage with the allegations
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set forth in the counterclaim require rejection of its argument. Furthermore, because the
bad faith claim will not be dismissed, there is no basis to dismiss Assignees’ associated
claim for punitive damages.
B. Application for Entry of Default and Motion to Set Aside
A party seeking default must show by affidavit or otherwise that “the party against
whom a judgment . . . is sought has failed to plead or otherwise defend.” Fed. R. Civ. P.
55(a). Here, Auto-Owners does not dispute that the Assignees answered and are defending
this declaratory judgment action, and instead argue it is entitled to default because McNally
did not personally respond to the First Amended Complaint. (Docs 37–38, 43.) In its
application for entry of default, supporting declaration, and response to the motion to
vacate application for entry of default, however, Auto-Owners fails to cite a single rule,
statute or case supporting its argument that a party that has assigned its rights under an
insurance policy must personally appear to defend itself in a declaratory judgment action
filed by the insurer. (Id.) Auto-Owners’ argument is inconsistent with one of the core
elements of a Morris agreement, which is the assignment of the insured’s rights under the
insurance contract to the injured party. Given that the Assignment Agreement will not be
deemed invalid at this early stage of the case, Auto-Owners has failed to satisfy is burden
under Rule 55(a) and the court will not enter default against Assignees. Because the Court
declines to enter default, it will deny as moot Assignees’ motion to set aside the application
for entry of default.
Accordingly,
IT IS ORDERED that Auto-Owners’ motion to dismiss counterclaim (Doc. 24) is
granted in part and denied in part, as follows:
(1) Count One for breach of contract is dismissed with leave to amend.
(2) Counts Two and Three for bad faith and punitive damages may proceed.
IT IS FURTHER ORDERED that Assignees may have 14 days to file a First
Amended Counterclaim. Consistent with LRCiv 15.1, Assignees shall file, concurrently
with any amended counterclaim, a notice of filing the amended pleading that attaches a
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copy of the amended pleading indicating in what ways it differs from the original
counterclaim.
IT IS FURTHER ORDERED denying Auto-Owners’ application for entry of
default (Doc. 37).
IT IS FURTHER ORDERED denying as moot Assignees’ motion to set aside
application for entry of default (Doc. 40).
Dated this 6th day of November, 2025.
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