While driving the rented vehicle, Mr. Bovre was involved in an accident that injured Robert and Lorraine McGill. The McGills sued Mr. Bovre and made a settlement offer, which included an amount representing SLI coverage.

KnightBrook denied Mr. Bovre's demand for SLI coverage, asserting that he had not purchased it.

Mr. Bovre ultimately entered into a settlement agreement with the McGills under which they were paid the combined policy limits of $530,000 from the state-mandated insurance and Mr. Bovre's own insurance policy. He also assigned to the McGills his claims against KnightBrook and Payless for their alleged failure to provide SLI insurance (breach of contract, negligence, and insurance bad faith), and agreed to an $8 million adverse judgment in exchange for the McGills' covenant not to execute on the judgment against his personal assets.

The McGills then sued Payless and KnightBrook, seeking to recover the $8 million judgment. The McGills and KnightBrook entered into a settlement in which the McGills' (previously the Bovres') claims against Payless were further assigned to KnightBrook, which paid the McGills the $970,000 SLI policy limit and promised them a percentage of any recovery from Payless.

KnightBrook subsequently sued Payless, asserting its assigned claims, along with an equitable indemnification claim for the $970,000 it had paid the McGills, arguing that the Payless employee at the rental counter had been at fault for not memorializing Mr. Bovre's denial of SLI coverage.

The U.S. District Court for the District of Arizona dismissed the contract claims, holding that they were extinguished by accord and satisfaction when KnightBrook settled with the McGills.

Relying on the Restatement (First) of Restitution § 78 (Am. Law Inst. 1937) (the "First Restatement"), the district court also ruled that KnightBrook was entitled to equitable indemnification from Payless for the $970,000 SLI policy limits it had paid to settle the McGills' claims. In awarding KnightBrook equitable indemnification from Payless, the district court relied on Section 78 as a "refinement" of the rule stated in Section 76 of the First Restatement to hold that, although KnightBrook did not have to prove that it or Payless actually was liable to the McGills, it was "sufficient if [KnightBrook] were subject to a 'supposed obligation' which [Payless] had a greater responsibility to discharge, [KnightBrook] became subject to the obligation because of the fault of [Payless], and, in choosing to make the settlement payment, [KnightBrook] acted in the 'justifiable belief' that [it] would be liable in the McGills' lawsuit."

Payless appealed to the U.S. Court of Appeals for the Ninth Circuit, which concluded that the outcome of the case rested on answers to two questions it certified to the Arizona Supreme Court:

1. Whether Arizona equitable indemnity law incorporates the Restatement (First) of Restitution § 78 (Am. Law Inst. 1937), and, if so,

2. Whether § 78 requires that the indemnity plaintiff and indemnity defendant's liability be coextensive as to the underlying plaintiff.

The First Restatment Section 76 of the First Restatement provides:

A person who, in whole or in part, has discharged a duty which is owed by him but which as between himself and another should have been discharged by the other, is entitled to indemnity from the other, unless the payor is barred by the wrongful nature of his conduct.

Section 78 of the First Restatement provides:

A person who with another became subject to an obligation or supposed obligation upon which, as between the two, the other had a prior duty of performance, and who has made payment thereon although the other had a defense thereto,

(a) is not entitled to restitution if he became subject to the obligation without the consent or fault of the other;

(b) is entitled to restitution if he became subject to the obligation with the consent of or because of the fault of the other and, if in making payment, he acted . . . .

(ii) in the justifiable belief that such a duty existed[.]

The Arizona Supreme Court's Decision

The Arizona Supreme Court held that Arizona's equitable indemnity law did not incorporate Section 78 because it conflicted with Arizona's general equitable indemnity principles. The court then declined to answer the second certified question as moot.

In its decision, the court explained that Arizona's equitable indemnity law sought to avoid unjust enrichment by allowing recovery only when an indemnity plaintiff subject to derivative or imputed liability discharged an "actual obligation" that a culpable indemnity defendant owed to a third party. In Arizona, the court added, there was no "duty of indemnity" unless the payment discharged the primary obligor "from an existing duty."

According to the court, Section 78 expanded the scope of equitable indemnity in a manner "inconsistent" with Section 76 of the First Restatement and Arizona's equitable indemnity law because Section 78 did "not require an actual legal obligation or a discharge of the indemnity defendant's liability." Rather, the court found, Section 78 created a new cause of action based on the relationship between the indemnitor and the indemnitee, expanding equitable indemnity to cover "supposed obligation[s]" that may be based on the payor's "justifiable belief" that the payor owed a duty to the third party. The court concluded that it was:

unwilling to impose liability based on the "justifiable belief" that a duty exists, and we are troubled that [Section] 78 could preclude an indemnitor from raising viable defenses to the underlying claim, as Payless contends happened here.

The case is Knightbrook Ins. Co. v. Payless Car Rental System, Inc., No. CV-17-0156-CQ (Ariz. Feb. 8, 2018). Attorneys involved include: Alison R. Christian, Gena L. Sluga (argued), Douglas L. Christian, Stephen M. Dichter, Christian Dichter & Sluga, PC, Phoenix, Attorneys for KnightBrook Insurance Company and Knight Management Insurance Services LLC. William J. Maledon, Thomas L. Hudson, Osborn Maledon, P.A., Phoenix; William F. Greaney (argued), Philip J. Levitz, Covington & Burling LLP, Washington, D.C.; and Arron Nesbitt, Wilson Elser, Denver, CO, Attorneys for Payless Car Rental System Incorporated and PCR Venture of Phoenix, LLC.