IN THE

SUPREME COURT OF THE STATE OF ARIZONA

YOLANDA E. QUIHUIS AND ROBERT QUIHUIS, A MARRIED COUPLE,

Plaintiffs,

v.

STATE FARM MUTUAL AUTOMOBILE INSURANCE COMPANY, A FOREIGN 

CORPORATION,

Defendant.

No. CV-14-0093-CQ

Filed October 1, 2014

United States District Court for the District of Arizona

No. 4:10-cv-00376-RCC

Certified Question from the 

United States Court of Appeals for the Ninth Circuit

Quihuis v. State Farm Mut. Auto. Ins. Co., 748 F.3d 911 (9th Cir. 2014)

QUESTION ANSWERED

COUNSEL:

Stanley G. Feldman (argued), Jeffrey A. Imig, Haralson, Miller, Pitt, 

Feldman & McAnally, P.L.C., Tucson, for Yolanda E. Quihuis and Robert 

Quihuis

David M. Bell (argued), Howard L. Andari, David Bell & Associates, PLLC, 

Phoenix, for State Farm Mutual Automobile Insurance Company

VICE CHIEF JUSTICE PELANDER authored the opinion of the Court, in 

which CHIEF JUSTICE BALES, JUSTICE BERCH, JUSTICE BRUTINEL, 

and JUSTICE TIMMER joined.
QUIHUIS V. STATE FARM

Opinion of the Court

2

VICE CHIEF JUSTICE PELANDER, opinion of the Court:

¶1 The United States Court of Appeals for the Ninth Circuit has 

certified the following question for our review:

Whether a default judgment against insured-defendants that 

was entered pursuant to a Damron agreement that stipulated 

facts determinative of both liability and coverage has 

(1) collateral estoppel effect and precludes litigation of that 

issue in a subsequent coverage action against the insurer, as 

held in Associated Aviation Underwriters v. Wood, [209 Ariz. 

137,] 98 P.3d 572 ([] App. 2004), or (2) no preclusive or binding 

effect, as suggested in United Services Automobile Association v. 

Morris, [154 Ariz. 113,] 741 P.2d 246 ([] 1987).

Quihuis v. State Farm Mut. Auto. Ins. Co., 748 F.3d 911, 912 (9th Cir. 2014).

¶2 We hold that the default judgment does not preclude 

litigation of whether coverage exists under the policy. Consistent with 

Morris, Wood, and the Restatement (Second) of Judgments (“Restatement”)

§ 58 (1982), however, we also hold that an insurer in a coverage action may 

not, in the guise of a coverage defense, litigate what are essentially and 

solely liability issues resolved by the default judgment.

I.

¶3 The Ninth Circuit’s certification order states the facts and 

procedural history:

Norma Bojorquez (“Norma”) and Carol Cox (“Carol”) 

were coworkers in Nogales, Arizona. Norma sought a car for 

her daughter, Iliana Bojorquez (“Iliana”), and expressed 

interest in Carol’s 1994 Jeep Cherokee (the “Jeep”). By 

January 9, 2008, Carol and Norma had executed a written 

sales agreement for the Jeep which called for eight monthly 

installments totaling $3,000. Carol gave Norma the only set 

of keys to the Jeep, and Norma drove the car home. Norma 

gave the keys to Iliana so that Iliana could drive the Jeep at 

her pleasure. Carol did not transfer the Jeep’s title certificate 
QUIHUIS V. STATE FARM

Opinion of the Court

3

to Norma because she thought it necessary to retain the title 

certificate as collateral until Norma paid off the Jeep. The 

Coxes never retook possession of the Jeep.

The Coxes maintained insurance coverage on the Jeep 

through a policy with State Farm (the “Policy”). The Policy 

provided liability coverage for bodily injury caused by 

accident[s] resulting from the use of cars owned by the Coxes, 

including the Jeep. The Policy covered the Coxes and 

permissive users of their cars if the use was within the scope 

of their consent. The Policy also imposed a duty to defend on 

State Farm. The Coxes did not cancel the [P]olicy until 

January 29, 2008.

On January 22, 2008, Iliana was driving the Jeep when 

it collided with a car driven by Yolanda Quihuis. In Arizona 

state court, Yolanda Quihuis and her husband, Robert 

Quihuis, sued Iliana for negligence and the Coxes for 

negligent entrustment. The negligent entrustment claim 

relied on the Coxes’ alleged ownership of the Jeep at the time 

of the accident. State Farm refused to defend the Coxes 

because the Jeep’s ownership had transferred to Norma 

before the accident.

On October 29, 2009, the Coxes, the Bojorquezes, [and] 

the Quihuises . . . entered into a Damron agreement entitled 

“Assignment of Rights, Agreement Not to Execute.” In 

pertinent part, they stipulated that the Coxes owned the Jeep 

at the time of the accident, that Iliana was incompetent to 

drive a motor vehicle and her negligence caused the accident, 

and that the Coxes should have known that Iliana was 

incompetent to drive and therefore should not have entrusted 

the Jeep to her.1 The Coxes and Bojorquezes agreed to 

damages in the amount of $275,000. The Coxes assigned their 

 

1 This is not entirely accurate. In the Damron agreement, the Coxes 

stipulated that Iliana was driving “in the scope of [their] consent” a vehicle 

they owned. But the agreement provided that the Quihuises “claim,” not 

that the Coxes stipulate, that the Coxes should have known that Iliana was 

incompetent to drive the vehicle and should not have entrusted it to her.
QUIHUIS V. STATE FARM

Opinion of the Court

4

rights under the Policy to the Quihuises, who agreed not to 

execute upon a judgment against the Coxes or the 

Bojorquezes. The parties also agreed to request a default

judgment to terminate the case. On December 31, 2009, the 

state court entered default judgment in the amount of 

$350,000 — $325,000 for Yolanda’s injuries and $25,000 for 

Robert Quihuis’ loss of consortium.

The Quihuises, standing in the Coxes’ shoes, then 

brought a declaratory judgment action [“DJA”] against State 

Farm in Arizona state court for indemnification and failure to 

defend. State Farm removed the case to the United States 

District Court for the District of Arizona.

In November 2011, the district court granted State 

Farm’s motion for summary judgment. Applying Arizona 

law, the district court held that the default judgment did not 

preclude State Farm from litigating the question of whether 

the Coxes owned the Jeep at the time of the accident . . . . 

Consequently, State Farm could litigate the question of 

coverage, and the court held that the undisputed facts 

established that the Bojorquezes owned the Jeep at the time of 

the accident as a matter of law.

The Quihuises timely appealed, contending there was 

no conflict of interest between the Coxes and State Farm, and 

that Arizona case law establishes that an insurer may not 

litigate an issue determinative of coverage if that issue is also 

determinative of liability and was stipulated to as part of a 

Damron agreement that resulted in entry of a default 

judgment. They also contended that ownership of the Jeep 

was a genuine issue of material fact. 2

 

2 The Ninth Circuit agreed with the district court’s ruling that the 

Coxes did not own the Jeep at the time of the accident. See Quihuis, 748 F.3d 

at 914, 918. We do not address that issue because the only question certified 

is whether State Farm was allowed to litigate the ownership issue at all.
QUIHUIS V. STATE FARM

Opinion of the Court

5

Quihuis, 748 F.3d at 912–14 (footnotes omitted); see A.R.S. § 12-1863(2) 

(requiring certification order to state all facts relevant to certified question); 

Ariz. R. Sup. Ct. 27(a)(3)(B) (same).

II.

¶4 When a liability insurer refuses to defend its insured against 

a third party’s tort claims, as State Farm did here, the insured and the 

claimant may enter into a Damron agreement “under which the insured 

stipulates to a judgment, assigns his rights against the insurer to the 

claimant, and receives in return a covenant from the claimant not to execute 

against the insured.” Parking Concepts, Inc. v. Tenney, 207 Ariz. 19, 20 ¶ 3 

n.1, 83 P.3d 19, 20 n.1 (2004); see Damron v. Sledge, 105 Ariz. 151, 152–53, 460 

P.2d 997, 998–99 (1969). An insured may enter into a similar agreement if 

the insurer defends the third-party action but reserves its right to later 

dispute coverage. Morris, 154 Ariz. at 119, 741 P.2d at 252; see also Ariz. Prop. 

& Cas. Ins. Guar. Fund v. Helme, 153 Ariz. 129, 137–38, 735 P.2d 451, 459–60 

(1987). We refer to this latter type of agreement as a “Morris agreement.” 

See Parking Concepts, 207 Ariz. at 20 ¶ 3 n.1, 83 P.3d at 20 n.1.

¶5 After obtaining a judgment pursuant to a Damron or Morris

agreement, the claimant then seeks payment of the judgment by the insurer 

based on the latter’s indemnity obligation under the policy. 1 Allan D. 

Windt, Insurance Claims and Disputes: Representation of Insurance Companies 

and Insureds § 9.11 (6th ed. 2013) [hereinafter “Windt Treatise”]. The 

insurer, in turn, generally may contest any duty to indemnify by asserting

that its policy did not cover the accident or claim. See Morris, 154 Ariz. at 

119, 741 P.2d at 252 (adopting “[t]he better result” that “permit[s] the 

insurer to raise the coverage defense, and also permit[s] an insured to 

protect himself from the risk of noncoverage or excess judgment” when 

insurer defends under a reservation of rights). Standing in the insured’s 

shoes as assignee, the claimant may also sue the insurer on various claims, 

including breach of the insurance contract and bad faith. See Acosta v. Phx.

Indem. Ins. Co., 214 Ariz. 380, 383 ¶ 13, 153 P.3d 401, 404 (App. 2007) (“When 

an insurer allegedly acts in bad faith in its duty to indemnify or protect its 

insured against liability to third parties, . . . [the bad faith] claim can be 

brought either by the insured or the insured’s assignee.”).

¶6 This case involves (1) a liability insurer’s refusal to defend its 

insured against a third-party tort claim after the insurer determined its 
QUIHUIS V. STATE FARM

Opinion of the Court

6

policy did not cover the accident; (2) a stipulated default judgment against 

the insured under a Damron agreement; and (3) a question of ownership, 

which is both an element of liability for the underlying negligent 

entrustment tort claim against the insured and a requirement of coverage 

under the insurance policy. The certified question turns on what issuepreclusion rules apply under these circumstances.3 As the Ninth Circuit 

observed, no Arizona case squarely resolves the question presented here. 

See Quihuis, 748 F.3d at 914.

¶7 State Farm argues that when the Quihuises served their 

complaint on the Coxes, “no insured-insurer relationship existed between 

State Farm and the Coxes” because the Coxes sold the Jeep before the 

accident. Accordingly, State Farm asserts, the general issue-preclusion rule 

set forth in Restatement § 27 governs. See Chaney Bldg. Co. v. City of Tucson, 

148 Ariz. 571, 573, 716 P.2d 28, 30 (1986) (applying § 27). Issue preclusion 

under that section requires actual litigation of the issue of fact or law in 

question, and thus default judgments generally have no preclusive effect. 

Id.; see also Restatement § 27 cmt. e (“In the case of a judgment entered by . . . 

default, none of the issues is actually litigated.”).

¶8 The Quihuises, in contrast, contend that Restatement § 58, 

which specifically concerns indemnitors that have an independent duty to 

defend, provides the controlling rule. See Restatement § 58; Farmers Ins. Co.

v. Vagnozzi, 138 Ariz. 443, 448, 675 P.2d 703, 708 (1983) (adopting

Restatement § 58). We agree that § 58 applies and therefore analyze issue 

preclusion in this case under that section, applying other relevant principles 

established in case law.

4

 

3 “Issue preclusion” and “collateral estoppel” refer to the same 

principle. Gilbert v. Bd. of Med. Exam’rs of Ariz., 155 Ariz. 169, 174–75, 745 

P.2d 617, 622–23 (App. 1987). We use the modern term “issue preclusion”

in this opinion.

4 State Farm argues that Restatement § 58 does not apply, and hence 

it could litigate the ownership issue in the DJA, because the district court

concluded in that action that the Coxes did not own the Jeep and thus it was 

not covered at the time of the accident. We reject that circular argument 

because it assumes an answer to the certified question — whether the 

district court properly allowed State Farm to litigate the ownership issue. 

We also find unpersuasive State Farm’s argument, based on State Farm’s 
QUIHUIS V. STATE FARM

Opinion of the Court

7

A.

¶9 Restatement § 58 provides:

(1) When an indemnitor has an obligation to indemnify an 

indemnitee (such as an insured) against liability to third 

persons and also to provide the indemnitee with a defense of 

actions involving claims that might be within the scope of the 

indemnity obligation, and an action is brought against the 

indemnitee involving such a claim and the indemnitor is 

given reasonable notice of the action and an opportunity to 

assume its defense, a judgment for the injured person has the 

following effects on the indemnitor in a subsequent action by 

the indemnitee for indemnification:

(a) The indemnitor is estopped from disputing the 

existence and extent of the indemnitee’s liability to the injured 

person; and

(b) The indemnitor is precluded from relitigating

those issues determined in the action against the indemnitee 

as to which there was no conflict of interest between the 

indemnitor and the indemnitee.

(2) A “conflict of interest” for purposes of this Section 

exists when the injured person’s claim against the indemnitee 

is such that it could be sustained on different grounds, one of 

which is within the indemnitor’s obligation to indemnify and 

another of which is not.

¶10 In this case, § 58 applies because (1) the Coxes’ insurance 

policy imposed on State Farm both an indemnity and a defense obligation;

(2) the Quihuises’ complaint involved a claim that “might be within the 

scope of [State Farm’s] indemnity obligation”; (3) the Coxes gave State Farm 

reasonable notice of the Quihuises’ lawsuit, thereby providing State Farm 

with “an opportunity to assume [the Coxes’] defense”; and (4) “a 

 

post-accident, retroactive cancellation of coverage for the Jeep, that § 58 

does not apply because “no indemnity relationship exists.”
QUIHUIS V. STATE FARM

Opinion of the Court

8

judgment” was entered in favor of the Quihuises and against the Coxes. See 

Restatement § 58(1). Thus, we must identify the issues that § 58 precludes

State Farm from litigating in the DJA. Although we “incorporate[d]” 

Restatement § 58 in Vagnozzi, 138 Ariz. at 448, 675 P.2d at 708, we have not 

yet applied it in a case such as this.

B.

1.

¶11 Section 58(1)(a) precludes State Farm from disputing the 

“existence and extent” of the Coxes’ liability to the Quihuises. Although 

§ 58 does not define what “existence and extent” of liability means, Arizona 

case law provides insight.

¶12 In Morris, the insured settled with a third-party claimant and 

stipulated to a judgment after the insurer defended under a reservation of 

rights. 154 Ariz. at 115, 741 P.2d at 248. The claimant then sued the insurer 

for indemnification, and the insurer sought to litigate “all aspects of the 

liability case” in contesting its indemnity obligation. Id. at 120, 741 P.2d at 

253. Rejecting that position, we found that the insurer was precluded from 

litigating “the fact []or amount of liability,” if the insured’s settlement with 

the claimant “was reasonable and prudent.” Id. We concluded, however,

that the insurer could later litigate whether there is coverage under the 

policy, stating that “any stipulation of facts essential to establishing 

coverage would be worthless.” Id. We stressed that coverage must be open 

for later litigation because, otherwise, insureds might be able “to obtain 

coverage that the insured did not purchase” simply by entering into a 

Damron or Morris agreement. Id.

¶13 The Wood case illustrates the boundaries Morris set for 

insurers in contesting coverage. In Wood, after a default judgment was 

entered against the insured pursuant to a Morris agreement, the insurer 

argued that it could “fully litigate all liability and damage issues”

— matters “bearing solely on the insureds’ fault, causation, or the plaintiff’s 

damages” — in the coverage action. Wood, 209 Ariz. at 149 ¶¶ 32, 34, 98 

P.3d at 584. Applying Morris, the court of appeals precluded the insurer 

from litigating, “in the guise of a coverage defense,” the existence and 

extent of the insured’s liability. Id. at 150 ¶ 37, 98 P.3d at 585.
QUIHUIS V. STATE FARM

Opinion of the Court

9

¶14 Wood represents a straightforward application of Restatement

§ 58(1)(a); it precludes an insurer from litigating not only the fact of liability, 

but also those issues that “relat[e] strictly to liability and damages [and not] 

coverage.” Id. at 152 ¶ 47, 98 P.3d at 587; see also Ariz. Prop. & Cas. Ins. Guar. 

Fund v. Martin, 210 Ariz. 478, 481 ¶ 15, 113 P.3d 701, 704 (App. 2005)

(distinguishing Wood because the insurer in that case argued there was no

liability and therefore no coverage, whereas the insurer in Martin sought to 

litigate “legitimate coverage issues in a [DJA] based on specific policy

exclusions”).

¶15 Although the facts of this case fall between the situations 

presented in Morris and Wood, those cases demonstrate that § 58(1)(a) does 

not preclude litigation of pure coverage issues in a DJA. State Farm is not 

seeking to litigate the existence or extent of the Coxes’ liability, see Morris, 

154 Ariz. at 120, 741 P.2d at 253, nor is it arguing that there is no coverage 

because the Coxes are not liable to the Quihuises, see Wood, 209 Ariz. at 150 

¶ 37, 98 P.3d at 585. Rather, the ownership issue here not only bears directly

on liability, but also controls whether there is coverage under the policy, 

and neither § 58(1)(a) nor any Arizona case applying that section precludes

an insurer from litigating this type of coverage issue. In sum, we have 

adopted Restatement § 58 with the limitation recognized in Morris —

insurers generally are not precluded from litigating coverage issues.

2.

¶16 In addition to being precluded from challenging the 

“existence and extent” of the Coxes’ liability under Restatement § 58(1)(a), 

State Farm is precluded under § 58(1)(b) from “relitigating” any issues that 

were “determined in the action” against the Coxes, unless there is a conflict 

of interest as defined in § 58(2). Section 58(1)(b) does not define or explain 

what “determined in the action” means, but the Restatement does provide

two illustrations that assist in interpreting that phrase:

1. A is injured when struck by a car owned by B and 

driven by C. A brings an action against B, contending that C 

operated the car with B’s permission. B is insured by I under 

a policy covering B’s liability for another’s use of his car with 

B’s permission. The policy also imposes on I the duty to 

defend B in actions in which a claim within the indemnity 

obligation might be sustained. I refuses to assume defense of 
QUIHUIS V. STATE FARM

Opinion of the Court

10

the action. A recovers judgment by default against B. I may 

not dispute the existence and extent of B’s liability to A and 

may under applicable law be estopped to deny its liability for 

indemnification of B.

2. Same facts as Illustration 1, except that I assumes 

defense of B. After actual litigation of the issue of permission, 

judgment is for A. I is precluded as to the existence and extent 

of B’s liability to A and, if the term “permission” has the same 

meaning under the policy as under the rule making B 

vicariously liable for C’s act, I is precluded as to whether the 

loss was within the terms of the policy so far as “permission” 

is concerned. Whether I would be estopped to litigate 

whether B’s policy had lapsed for failure to pay the premium 

is a matter of the law of insurance.

Restatement § 58 cmt. a, illus. 1–2. The first illustration corresponds with 

§ 58(1)(a) and contains language that mirrors that subsection. The second 

illustration reflects principles presented in both § 58(1)(a) and (1)(b).

¶17 The contrast between the two illustrations sheds light on how 

§ 58 applies in different contexts. In the first illustration, the only thing the 

insurer clearly “may not dispute” is “the existence and extent of B’s liability 

to A.” Neither that illustration nor § 58(1)(a) precludes the insurer from 

litigating the permission issue in a later coverage action to determine

whether it must indemnify. Rather, the illustration states that “applicable 

law” will determine whether the insurer will “be estopped to deny its 

liability for indemnification.” Restatement § 58 cmt. a, illus. 1. As discussed 

below, ¶¶ 24–37 infra, “applicable law” in Arizona does not preclude an 

insurer from later litigating coverage.

¶18 In contrast, the second illustration states that the insurer will 

generally be precluded from litigating the permission issue in arguing that 

the loss was not covered. The only significant factual difference between 

the first and second illustration is the process by which judgment was 

obtained: the first illustration involves a default judgment, while the 

second involves a judgment on the merits “[a]fter actual litigation.” Only 

in the second situation is the insurer precluded from litigating an issue that 

was “determined in the action” between A and B. Restatement § 58(1)(b). 
QUIHUIS V. STATE FARM

Opinion of the Court

11

Thus, the phrase “determined in the action” in § 58(1)(b) refers to a judicial 

determination of issues actually litigated.

¶19 This understanding of § 58’s illustrations finds support in the 

language used in § 58(1)(b), which states that an insurer is precluded from 

“relitigating” issues, instead of just “litigating” issues. “Relitigation” 

implies that there was some prior litigation on the issue, which means that 

“determined in the action” refers to a judicial determination after some 

prior litigation.

¶20 Restatement § 57 uses similar language and also supports our 

interpretation. Under § 57, an indemnitor without an independent duty to 

defend is only “precluded from relitigating issues determined in the action 

against the indemnitee if . . . the indemnitor defended the action . . . or . . . 

the indemnitee defended the action with due diligence and reasonable 

prudence.” Restatement § 57(1)(b). Section 57 thus prohibits the 

indemnitor from relitigating only those issues determined after prior, 

actual litigation, as long as one of two conditions not applicable in this case

is met. Section 58, on the other hand, does not impose the same conditions. 

Thus, while both sections refer to prior litigation, § 58 applies even if during 

the actual litigation, the insurer did not defend and the insured did not 

defend with due diligence or reasonable prudence. See Restatement

§ 58(1)(b).

¶21 Based on this analysis, we reject the Quihuises’ assertion that 

issue preclusion “arises from the entry of a judgment against insureds 

whether after trial or by default.” Section 58(1)(b) does not preclude State 

Farm from litigating the ownership issue in the DJA. That issue was not 

“determined in the action” because it was not actually litigated and decided 

by the trial court that entered the stipulated default judgment. This is not 

to say that the default judgment has no preclusive effect or is meaningless. 

It precludes State Farm from denying the “existence and extent” of the 

Coxes’ liability — established by the default judgment

— under § 58(1)(a), ¶¶ 11–15 supra, and it prevents State Farm from

avoiding that result simply by crafting a coverage argument that, in 

essence, merely disputes the Coxes’ tort liability. Wood, 209 Ariz. at 150 

¶ 37, 98 P.3d at 585.

¶22 The result does not change simply because the issue that 

determines coverage also happens to be an element of the liability claim 
QUIHUIS V. STATE FARM

Opinion of the Court

12

against the Coxes. In Restatement § 58’s illustrations discussed above, the 

permission issue was just as essential to B’s liability as the ownership issue 

is to the Coxes’ liability for negligent entrustment in this case. Yet it is only 

in the second illustration, which contemplates actual litigation, that the 

insurer is precluded from litigating the permission issue. These 

illustrations therefore support the principle that, even when a coverage 

requirement is also an essential element of the insured’s liability, an insurer 

may later litigate that issue in disputing coverage as long as it was not 

“determined in the action” through actual litigation.

¶23 Because ownership was not actually litigated in the 

underlying tort case, § 58(1)(b) does not preclude State Farm from litigating 

that issue in the DJA, regardless of whether State Farm and the Coxes had

a “conflict of interest” in the underlying case under § 58(2). We note, 

however, that an insurer generally may contest coverage even if the 

allegations in the tort action do not themselves create a conflict of interest 

within the meaning of § 58(2)’s definition. Cf. Vagnozzi, 138 Ariz. at 446, 

448, 675 P.2d at 706, 708 (adopting Restatement § 58 but also observing that 

a “conflict of interest” arises “when investigation by the insurer reveals 

facts which tend to place the claim outside coverage of the policy, yet the 

question of coverage depends on facts to be litigated in the tort suit,” and 

that “the better rule is to suspend the operation of collateral estoppel where 

there is an adversity of interests”). Although the allegations of a plaintiff’s 

complaint generally trigger a liability insurer’s duty to defend, see ¶ 27 infra, 

they should not dictate whether issue preclusion applies. Cf. Navajo Freight 

Lines, Inc. v. Liberty Mut. Ins. Co., 12 Ariz. App. 424, 430, 471 P.2d 309, 315 

(1970) (holding that insurer’s contractual obligation to defend or indemnify 

was not governed by allegations of complaint against alleged omnibus 

insured because the creation of such obligations “cannot be left to the 

imagination of the drafter of a complaint”). Just as a settlement agreement 

“should not be used to obtain coverage that the insured did not purchase,” 

nor should the choice of allegations in a complaint. Morris, 154 Ariz. at 120, 

741 P.2d at 253.

C.

¶24 The Quihuises, however, argue that the Restatement § 58’s

first illustration, ¶ 16 supra, is directly on point and supports their assertion 

that State Farm is precluded from litigating the ownership issue in the DJA. 

That illustration provides that, “under applicable law,” the insurer might 
QUIHUIS V. STATE FARM

Opinion of the Court

13

be precluded from contesting its liability for indemnification. The 

Quihuises contend that under Arizona law, State Farm is precluded from 

litigating the ownership issue because (1) it breached its duty to defend the 

Coxes; and (2) the Quihuises obtained a default judgment, like the injured 

party A in the first illustration.

¶25 The Quihuises’ argument finds some support in the comment 

to § 58, which refers to rules in some jurisdictions that “creat[e] strong 

disincentives against default in performance of the duty [to defend].” 

Restatement § 58 cmt. a. Alluding to the “applicable law” some states have 

adopted, the comment states:

One such rule is that if the indemnitor fails to assume defense 

of an action involving a claim that “might be found to be”

within the indemnity obligation, [the indemnitor] is 

precluded from contesting not only the existence and extent 

of the indemnitee’s liability to the injured person but also the 

obligation to indemnify. . . . The terms of these supportive 

rules are beyond the scope of this Restatement.

Id. Thus, the first illustration’s statement that “applicable law” might 

preclude an insurer from “deny[ing] its liability for indemnification” 

merely refers to the approach some states have taken in this area. The 

question, then, is whether Arizona law precludes an insurer that refuses to 

defend its insured from denying its obligation to indemnify, even though 

§ 58 does not itself call for such preclusion.

1.

¶26 We turn first to the Quihuises’ argument that Arizona law 

precludes State Farm from litigating the ownership issue in the DJA 

because it breached its duty to defend. This case differs from Morris and 

Wood in that State Farm refused to defend the Coxes in the Quihuises’ tort 

action, even under a reservation of rights. The Quihuises contend that

“State Farm’s choice not to defend its insured precludes it from collaterally 
QUIHUIS V. STATE FARM

Opinion of the Court

14

attacking a default judgment against its insured.” They presume that State 

Farm had and breached a duty to defend the Coxes.5

¶27 It is well settled that a liability insurer’s duty to defend is 

separate from, and broader than, the duty to indemnify. See Morris, 154 

Ariz. at 119, 741 P.2d at 252; see also Restatement § 58 cmt. a. A liability 

insurer’s duty to defend generally arises “[i]f the complaint in the action . . .

upon its face alleges facts which come within the coverage of the liability 

policy.” Kepner v. W. Fire Ins. Co., 109 Ariz. 329, 331, 509 P.2d 222, 224 (1973); 

see also Morris, 154 Ariz. at 117, 741 P.2d at 250 (“[T]he insurer must defend 

claims potentially not covered and those that are groundless, false, or 

fraudulent.”).

¶28 Unlike in some states, in Arizona “there is no absolute duty 

to defend,” especially when “the alleged facts [in the complaint] ostensibly 

bring the case within the policy coverage but other facts which are not 

reflected in the complaint plainly take the case outside the policy coverage.” 

Kepner, 109 Ariz. at 331, 509 P.2d at 224. Although Kepner involved a policy 

exclusion rather than a coverage condition, its reasoning is pertinent here. 

The Quihuises’ complaint alleged in conclusory fashion that the Coxes 

owned the Jeep at the time of the accident. State Farm’s post-accident 

investigation, however, revealed facts outside the complaint

— including Carol Cox’s written sales agreement with, and transfer of the 

Jeep’s only set of keys to, Norma Bojorquez two weeks before the accident

— indicating the Coxes’ lack of ownership and therefore lack of coverage 

for the Jeep. (The policy endorsement stated that “Your car does not include 

a vehicle that you no longer own.”)

¶29 Contrary to the reasoning in Kepner, the proposition urged by 

the Quihuises would impose on insurers an absolute duty to defend in cases 

like this in order to avoid being precluded from denying coverage in a DJA, 

even if a policy clearly does not cover the underlying tort claim against the 

insured. For example, in this case, if before the accident the Coxes had 

executed a sales agreement with Bojorquez, received full payment for the 

Jeep, and transferred its title and all of the Jeep’s keys to Bojorguez, one 

could not reasonably argue that the Coxes still owned the vehicle. But 

 

5 Although the Quihuises alleged in the DJA that State Farm breached 

its duty to defend the Coxes, the district court did not expressly address or 

rule on that claim.
QUIHUIS V. STATE FARM

Opinion of the Court

15

under the Quihuises’ argument, the bare allegation of ownership in the 

complaint, State Farm’s refusal to defend the Coxes, and the Quihuises’

acquisition of a default judgment against the Coxes pursuant to a Damron

agreement would preclude State Farm from litigating the ownership issue 

in a later coverage DJA. Such a result defies logic and law. Even had State 

Farm promptly filed a DJA to establish that the Jeep was not owned and 

therefore not covered, that scenario could engender the “’race to the 

courthouse’” that we disapproved of in Vagnozzi, 138 Ariz. at 447, 675 P.2d 

at 707.

¶30 We do not decide if State Farm had a duty to defend the

Coxes. But even if State Farm had and breached that duty, that 

determination would not necessarily control the question of issue 

preclusion. See Windt Treatise § 4.37 (“The vast majority of cases have 

properly held that an insurer’s unjustified refusal to defend does not estop 

it from later denying coverage under its duty to indemnify.”); see also 

Flannery v. Allstate Ins. Co., 49 F. Supp. 2d 1223, 1227–28 (D. Colo. 1999) 

(“The majority of jurisdictions . . . do not preclude an insurer from 

contesting coverage because it breached its duty to defend.”) (collecting 

cases). Although breaching the duty to defend will give rise to “liab[ility] 

for the damages that the insured thereby incurs, . . . [t]he insurer’s breach 

of contract should not . . . be used as a method of obtaining coverage . . . 

that the insured did not purchase.” Windt Treatise § 4.37; cf. Morris, 154 

Ariz. at 120, 741 P.2d at 253.

¶31 Citing Vagnozzi and Wood, in which the insurers defended 

under a reservation of rights, the Quihuises argue that “[w]hen an insurer 

refuses to defend, and no conflict of interest exists [under Restatement § 58], 

it is bound by the facts that are essential to the judgment of liability against 

its insured.” Although dicta in Vagnozzi might support that assertion, 138

Ariz. at 445, 675 P.2d at 705, we find that case of limited help because its 

holding was confined to conflict of interest principles. Id. at 448, 675 P.2d 

at 708 (holding that “where there is a conflict of interest between an insured 

and his insurer, the parties will not be estopped from litigating in a 

subsequent proceeding those issues as to which there was a conflict of 

interest, whether or not the insurer defended in the original tort claim”). 

Nor did Vagnozzi address the meaning or application of Restatement § 58 

in a situation like this.
QUIHUIS V. STATE FARM

Opinion of the Court

16

¶32 Referring to “the interplay and confusion of the doctrine of 

collateral estoppel and the insurer’s duty . . . to defend an insured,” the 

Court in Vagnozzi stated: 

If the insurance company refuses to defend an action under 

circumstances where it has a duty to defend, it is bound under 

the doctrine of collateral estoppel by the facts determined in 

the trial of such action which are essential to the judgment of 

tort liability. A party will not be precluded from litigating 

policy coverage in a subsequent proceeding if the question of 

coverage turns on facts which are nonessential to the 

judgment of tort liability.

138 Ariz. at 445, 675 P.2d at 705 (citations omitted). Those statements do 

not support a finding of issue preclusion here, however, as there was no 

“trial” in which the ownership issue was actually litigated and determined. 

In addition, ownership of the Jeep was essential to the Coxes’ liability for 

negligent entrustment only because the Quihuises chose to specifically 

allege and limit the claim to that element, which fell within the policy’s 

coverage, rather than alleging negligent entrustment more generally or 

including an alternative element (control) that would not have been 

covered. See Acuna v. Kroack, 212 Ariz. 104, 110 ¶ 22, 128 P.3d 221, 227 (App. 

2006) (negligent entrustment claim may be based on defendant’s ownership

or control of a vehicle); Tissicino v. Peterson, 211 Ariz. 416, 419 ¶¶ 8–10, 121 

P.3d 1286, 1289 (App. 2005) (same, citing cases); Restatement (Second) of 

Torts §§ 308, 390 (1965).

¶33 Moreover, applying issue preclusion to deprive an insurer of 

its coverage defense because the insurer allegedly breaches its duty to 

defend “subverts any meaningful distinction between the duty to defend 

and the separate duty to indemnify, and, in many cases, serves no more 

than to punish the insurer for the breach of a contractual duty.” Sentinel 

Ins. Co. v. First Ins. Co. of Haw., 875 P.2d 894, 912 (Haw. 1994). Because “the 

two duties are truly separate and distinct, . . . an insurer’s wrongful failure 

to defend should not result in a loss of an indemnity defense.” Flannery, 49 

F. Supp. 2d at 1228 (internal quotation marks omitted). Thus, we reject the 

Quihuises’ argument that State Farm is precluded from litigating the 

ownership issue in the DJA based solely on its refusal to defend the Coxes

in the tort action.
QUIHUIS V. STATE FARM

Opinion of the Court

17

2.

¶34 We turn next to the Quihuises’ contention that because they 

obtained a default judgment, and thus had more than just a Damron

agreement, State Farm should be precluded from litigating any coverage

issues subsumed in that judgment. Our cases have not made this 

distinction, nor does Restatement § 58. In addition, the Quihuises have not 

shown why the preclusion rules should change depending on whether the 

injured party took the further step of having a judge reduce the Damron

agreement to a stipulated default judgment, without any actual litigation or

court finding on the facts that directly pertain to both liability and coverage. 

Cf. Morris, 154 Ariz. at 120, 741 P.2d at 253 (“‘Plainly, the [stipulated] 

‘judgment’ does not purport to be an adjudication on the merits; it only 

reflects the settlement agreement.’”) (alteration in Morris) (quoting Miller v. 

Shugart, 316 N.W.2d 729, 735 (Minn. 1982)). Our statements in Morris that 

“any stipulation of facts essential to establishing coverage would be 

worthless,” and that “[a]n insured’s settlement agreement should not be 

used to obtain coverage that the insured did not purchase,” are just as 

apropos when a default judgment based on stipulated facts is entered 

pursuant to a Damron agreement. Id.

D.

¶35 The Quihuises also rely on Dairyland Insurance Co. v. Richards, 

108 Ariz. 89, 492 P.2d 1196 (1972), in arguing that State Farm may not 

litigate the ownership issue in the DJA. We are not persuaded. The Court 

in Dairyland held that a default judgment entered in a third-party tort action

against the insured, based on his negligent driving of a vehicle allegedly 

owned by another, precluded the insurer “from later questioning [in a 

garnishment action on coverage] the ownership of the vehicle [the insured] 

was operating.” Id. at 91, 492 P.2d at 1198. Dairyland’s continued authority 

is questionable, having been eroded by later case law.

¶36 First, after Dairyland this Court rejected the notion that an 

insurer has an “absolute duty” to defend its insured when, despite a 

complaint’s factual allegations that would bring a claim within coverage, 

investigation reveals facts outside the complaint that clearly indicate a lack 

of coverage. Kepner, 109 Ariz. at 331, 509 P.2d at 224. At a minimum, Kepner

qualifies any implication in Dairyland regarding the insurer’s failure to 

defend the insured. 108 Ariz. at 90, 492 P.2d at 1197. Second, Dairyland
QUIHUIS V. STATE FARM

Opinion of the Court

18

blurs the distinction between issue and claim preclusion, and the Court’s 

reliance on “res judicata,” id. at 91, 492 P.2d at 1198, to support its 

conclusion conflicts with current Arizona law. See Cheney Bldg. Co., 148 

Ariz. at 573, 716 P.2d at 30 (distinguishing claim preclusion from issue 

preclusion and finding the latter requires actual litigation under 

Restatement § 27). Third, and most importantly, Dairyland did not involve 

a Damron or Morris agreement and preceded Restatement § 58, Vagnozzi, 

and Morris, all of which reconfigured the applicable issue-preclusion 

principles.

¶37 In light of more recent case law and our interpretation and 

application of Restatement § 58 here, Dairyland’s result would likely differ

were that case decided today. Dairyland involved a default judgment 

obtained without actual litigation. 108 Ariz. at 90, 492 P.2d at 1197. At most, 

then, Restatement § 58(1)(a) would have prevented the insurer from 

litigating the existence and extent of the insured’s liability. Section 58(1)(b), 

however, would not have precluded the insurer from litigating the 

ownership issue because that issue was not “determined in the action” 

between the insured and the claimant. For all these reasons, Dairyland is 

overruled.

E.

¶38 In sum, consistent with our prior cases, we hold that when an 

injured party obtains a default judgment against an insured pursuant to a 

Damron or Morris agreement, that judgment will bind the insurer in a 

coverage case as to the existence and extent of the insured’s liability. With 

the limitation recognized in Morris and Wood, however, the judgment will 

not preclude the insurer from litigating its identified basis for contesting 

coverage, irrespective of any fault or damages assessed against the insured. 

More specifically, we conclude on the facts presented here that, having 

determined that coverage on the Jeep ceased to exist before the accident 

(and thus there was no coverage regardless of any fault or liability of the 

insureds), State Farm is not bound by the stipulation between the Coxes 

and the Quihuises as to a fact essential to establishing coverage, despite 

State Farm’s refusal to defend and the entry of a default judgment pursuant 

to the Damron agreement.

¶39 We take this opportunity, however, to emphasize our prior 

admonition that when an insurer refuses to defend, as State Farm did here,
QUIHUIS V. STATE FARM

Opinion of the Court

19

it does so “at its peril,” Kepner, 109 Ariz. at 332, 509 P.2d at 225, and if a 

court later finds coverage, the insurer must pay the damages awarded in 

the default judgment (at least up to the policy limits) unless it can prove 

fraud or collusion. Parking Concepts, Inc., 207 Ariz. at 22 ¶ 15 n.3, 83 P.3d at

22 n.3 (“[I]n cases where the insurer has refused to defend and the parties 

enter into a Damron agreement, the insurer has no right to contest the 

stipulated damages on the basis of reasonableness, but rather may contest 

the settlement only for fraud or collusion.”).

¶40 An insurer that refuses to defend additionally opens itself up 

to the possibility of contract damages if it is found to have breached its duty 

to defend. See Vagnozzi, 138 Ariz. at 448, 675 P.2d at 708; see also Windt 

Treatise § 4.33. And, depending on whether reasonable grounds exist for 

refusing to defend and denying coverage, the insurer could also face bad

faith tort claims. See Rawlings v. Apodaca, 151 Ariz. 149, 153–55, 160, 726 P.2d 

565, 569–71, 576 (1986); Acosta, 214 Ariz. at 383 ¶ 13, 153 P.3d at 404; see also 

Windt Treatise § 9.15. Thus, in cases like this, the prudent practice is for an 

insurer to defend its insured under a reservation of rights and expeditiously 

pursue a determination on coverage. This opinion is based on the unique, 

limited facts presented here and should not be viewed as curtailing a 

liability insurer’s broad duty to defend or permitting insurers to refuse to 

defend whenever coverage is denied or disputed.

III.

¶41 We answer the certified question by holding that State Farm 

is not precluded from litigating, for coverage purposes, who owned the 

Jeep at the time of the accident.