If you are involved in a civil tort lawsuit where a liability insurance company has or may issue a reservation of rights to later deny coverage to its policyholder and pay the injured plaintiff and the insurer has or may appoint lawyers to defend the policyholder who are loyal to the insurer, but not the policyholder, you’ve come to the right place.
DutytoDefend.com is about civil tort litigation, liability insurance, a reservation of rights, conflicts of interest, procedural due process, the struggles between the policyholder and the insurer for control of the policyholder’s defense and control of settlement, and actively protecting one’s own interests in the adversary system of justice. Raising substantial issues of trust, confidence, loyalty, disclosure and secrecy, not one but three related skirmishes often emerge in potentially covered civil litigation: 1) a liability dispute by the plaintiff against the defendant/policyholder and allies; 2) a coverage contest by an insurer against the policyholder, the plaintiff, and allies; and 3) an ethical imbroglio by dependent counsel against the policyholder, the insurer, and allies. As with any legal dispute, resolution of these tussles lies in all of the participants taking the initiative to gather admissible evidence and apply relevant law.
The phrase “duty to defend” describes a liability insurance company’s obligation to pay for a lawyer to control the defense of a policyholder who has been sued by an injured plaintiff – an obligation that the insurer cannot lawfully discharge by itself because it is not licensed to practice law. As a financial institution like a bank, all the insurer can do is pay a lawyer to represent the policyholder. The lawyer in turn must comply with the rules of ethics.
For example, in addition to providing objective memoranda of law, this website argues that all defendants with potential liability coverage should immediately send a Coverage Questionnaire and an Ethical Compliance Questionnaire to compel full disclosure of coverage positions and potential conflicts of interest.
In resolving these three skirmishes, the lawyer who is regularly selected and directed by a liability insurer, here identified as dependent counsel (the counterpart to independent counsel), is vulnerable to ethical attack as the only participant that owes many fiduciary duties, but has few if any rights. “Canons of Ethics impose upon lawyers hired by the insurer an obligation to explain to the insured and the insurer the full implications of joint representation in situations where the insurer has reserved its rights to deny coverage. If the insured does not give an informed consent to continued representation, counsel must cease to represent both. Moreover, in the absence of such consent, where there are divergent interests of the insured and the insurer brought about by the insurer’s reservation of rights based on possible noncoverage under the insurance policy, the insurer must pay the reasonable cost for hiring independent counsel by the insured. The insurer may not compel the insured to surrender control of the litigation.” Like pulling the Joker from the bottom floor of three tiers, challenging the ethics of dependent counsel can bring down an entire house of cards.
Many people incorrectly believe that the law of the duty to defend is arcane. While there are many surprising rules of law and several unresolved issues of law, the law in California is very well developed and is slowly emerging in other jurisdictions. Like eating a large chocolate chip cookies that is to big to stuff in one’s mouth, it can be easily digested by breaking it up into smaller pieces and chewing on them slowly one at a time.
The essential simplicity of the law of the duty to defend emerges with a decision tree that follows as many as ten big decisions insurers may make and another ten responsive decisions policyholder may make. Should the insurer: 1) Accept full coverage; 2) Deny all coverage; 3) Reserve rights; 4) Hire dependent counsel; 5) Agree to a conflict of interest justifies independent counsel; 6) Pay independent counsel properly; 7) Accept a settlement offer; 8) Sue for declaratory relief; 9) Seek reimbursement of defense costs; and 10) Seek reimbursement of settlement costs?
Should the policyholder: 1) Cooperate properly with the plaintiff; 2) Develop evidence of the insurer’s decisions; 3) Challenge dependent counsel’s ethics; 4) Develop evidence of ethical violations; 5) Accept representation by dependent counsel; 6) Seek a judicial determination of the nature of conflicts of interest; 7) Hire independent counsel; 8) Settle with the plaintiff; 9) Sue the insurer and/or dependent counsel, and if so when; and 10) Resist the insurer’s reimbursement claims?
Civil Tort Litigation
Civil tort litigation asks two questions known as issues of liability and damage: 1) does the defendant’s conduct create legal liability to the plaintiff; and 2) if so, how much are the plaintiff’s damages caused by such wrongful conduct. “There is in this State but one form of civil actions for the enforcement or protection of private rights and the redress or prevention of private wrongs.” “In such action the party complaining is known as the plaintiff, and the adverse party as the defendant.” Broadly speaking, only torts are covered by liability insurance. The word “tortious denotes conduct of such a character as to subject the actor to liability.” “[D]uty denote[s] the fact that the actor is required to conduct himself in a particular manner at the risk that if he does not do so he becomes subject to liability to another to whom the duty is owed for any injury sustained of which the actor’s conduct is the legal cause.”
Most plaintiffs and policyholder correctly believe that civil litigation is too stressful, too risky, too complicated, costs too much, and takes too long. Not surprisingly, insurers benefit by delay since they can earn 10.4% on investments – or 64 cents on every dollar during the 5 years it often takes to close a civil lawsuit. Of course, the lawyers can bill more of their time as cases drag out.
Liability Insurance and Procedural Due Process
At its core, a liability insurance policy promises that if a judgment is entered against a policyholder, the insurer will pay it. “Insurance is a contract whereby one undertakes to indemnify another against liability.” “Liability insurance includes: [i]nsurance against loss resulting from liability for injury suffered or for damage to property, or property interests.” A policyholder is entitled to recover [from a liability insurer] upon becoming liable” to an injured plaintiff by entry of judgment.” “An indemnity against liability embraces the costs of defense incurred in good faith, and in the exercise of a reasonable discretion.” The policyholder “has the right to conduct such defenses, if he chooses to do so.” If, after request, the [insurer] neglects to defend the [policyholder], a recovery against the [policyholder in a liability dispute] suffered by him in good faith, is conclusive in his favor against the [insurer]. “If the [insurer] is not allowed to control its defense, judgment against the [policyholder] is only presumptive evidence against the [insurer].” “A judgment against the [policyholder] shall be conclusive upon the [insurer, unless the policyholder] had a good defense upon the merits, which by want of ordinary care he failed to establish in the action.”
As a contract of indemnity, a liability insurance policy uniquely agrees that although the insurer is not a party to a lawsuit against its policyholder not a judgment debtor under the terms of a judgment, it agrees contractually to be bound by the judgment. In agreeing to be bound, the insurer forfeits a measure of its constitutional right to procedural due process of law. The issues of liability and damages that are determined in a plaintiff’s liability dispute against the policyholder bind the insurer. Of course, the insurer is free invoke other limitations of coverage, but it remains bound to the established facts that the policyholder is liable to the plaintiff and the plaintiff has suffered damage in a sum certain. The duty to indemnify is discharged only at the end of the plaintiff’s liability dispute and technically takes no longer than the time required to write a check. Thus, a lot of the action in a coverage contest occurs while the duty to defend is being discharged.
It is a surprise to many of the uninitiated that most standard liability policies make absolutely no promise to settle, even though as many as 96% of some kinds of cases are resolved without trial or judgment.
A claim against a liability insurer must start by giving notice. “If the [insurer] has not reasonable notice judgment against the [policyholder] is only presumptive evidence against the [insurer].” But notice may technically constitute three separate claims: 1) the plaintiff’s third party claim to the insurer for payment of damages; 2) the policyholder’s first party claim to the insurer for indemnification of the plaintiff’s liability claim; and 3) the policyholder’s first party claim to the insurer for a defense of the liability dispute. Each claim deserves separate consideration.
Reservation of Rights
A reservation of rights is a conditional denial of the plaintiff’s third party claim for damages and the policyholder’s first party claim for a indemnification and a conditional acceptance of the policyholder’s first party claim for a defense of the liability dispute. Typically, a reservation of rights letter states that the insurer will defend the policyholder but does not concede indemnity coverage and does not waive any ground upon which the insurer may later learn that it is entitled to deny all coverage.
California law has expanded the permissible scope of a reservation of rights to include two rights not mentioned in any standard policy. Many neophytes find these laws shocking: 1) a liability insurer may agree to pay for its policyholder’s defense while reserving its rights to get back all of its costs of defense from its policyholder and independent counsel; and 2) an insurer may fund a settlement over the objection of its policyholder while reserving its rights to get back all of its costs of settlement from the policyholder.
Insurance regulations require liability insurers to make a coverage decision “immediately”. “Upon receiving proof of claim, every insurer shall immediately, but in no event more than forty (40) calendar days later, accept or deny the claim, in whole or in part. Where an insurer denies a claim, in whole or in part, it shall do so in writing and shall provide to the [policyholder] a statement listing all bases for such denial and the factual and legal bases for each reason given for such denial which is then within the insurer’s knowledge. Where an insurer’s denial is based on a specific policy provision, the written denial shall include reference thereto and provide an explanation of the application of the provision to the claim.” A reservation of rights constitutes a conditional acceptance of the policyholder’s claim for a defense and a conditional denial of the claims to pay the plaintiff’s damages.
A reservation of rights always creates potential conflicts of interest and uncertainty. “[When coverage is disputed, the interests of the insured and the insurer are always divergent.” A reservation of rights always produces uncertainty in that it defers coverage decisions until after the liability dispute is resolved while admissible evidence, collateral estoppel, res judicata, law of the case, and judicial admissions may impact the coverage issues upon which the insurer may later deny coverage. A reservation of rights can taste sweet but cause indigestion in that it does not come right out and deny all coverage. Instead, it just defers until a later time a final decision whether to deny coverage – so maybe the insurer will pay or maybe it will not. Courts sometimes allow insurers to reserve their rights at almost any time, creating further uncertainty.
Insurers tend to reserve their rights to later deny coverage “in a ‘mixed’ action, in which some of the claims are at least potentially covered and the others are not. [W]e justify the insurer’s duty to defend the entire ‘mixed’ action prophylactically, as an obligation imposed by law in support of the policy. To defend meaningfully, the insurer must defend immediately. To defend immediately, it must defend entirely. It cannot parse the claims, dividing those that are at least potentially covered from those that are not. To do so would be time consuming. It might also be futile: The ‘plasticity of modern pleading’ allows the transformation of claims that are at least potentially covered into claims that are not, and vice versa.” Insurers often reserve their rights to later deny coverage in business litigation, construction defect, employment, and malpractice cases, as well as cases in which exclusions or other limitations on coverage may or may not apply.
Conflicts of Interest
“Conflict of interest occurs when a person charged with looking after the interest of A and B is faced with an option whereby if he makes one choice it will of necessity hurt A and help B, and if he makes the other choice he will of necessity help A and hurt B.” “Conflicts [of interest] come in all shapes and sizes [including when] there is a conflict between the interest of the insurer and the insured which in turn creates a conflict for counsel hired by the insurer to represent the insured.”
Conflict Analysis Required
“The potential for conflict requires a careful analysis of the parties’ respective interests.” “There is no talismanic rule that allows a facile determination of whether a disqualifying conflict of interest exists. Instead, [t]he potential for conflict requires a careful analysis of the parties’ respective interests to determine whether they can be reconciled or whether an actual conflict of interest precludes insurer-appointed defense counsel from presenting a quality defense for the insured.” “[T]he professional obligations of counsel who represents a liability insurer as well as its insured — needs clarification.”
“Customarily, the carrier has selected and employed counsel who defend the suit on behalf of the assured and has reserved to itself the right to investigate, negotiate, and settle the suit against the assured. The assured is not in a position to exercise effective control over the lawsuit or to further his own interests by independent action, even when those interests appear in serious jeopardy. The assured may face the possibility of substantial loss which can be forestalled only by action of the carrier. Thus, the assured may find himself and his goods in the position of a passenger on a voyage to an unknown destination on a vessel under the exclusive management of the crew.”
“Any lawyer who attempts to represent two adverse masters places himself in a precarious, perilous position. [Rules of ethics] are distilled principles of ancient, time-honored, and judicially-enforced conduct on the part of lawyers in representing clients. Without them our system of justice would be doomed. It hardly needs to be added that no insurance policy can validly diminish a lawyer’s duty to his insured client. In sum, the ethical dilemma thus imposed upon the carrier-employed defense attorney would tax Socrates”
“Where there is a conflict between insurer and insured, appointed counsel may tend to favor the interests of the insurer primarily because of the prospect of future employment. Even the most optimistic view of human nature requires us to realize that an attorney employed by an insurance company will slant his efforts, perhaps unconsciously, in the interest of his real client – the one who is paying his fee and from whom he hopes to receive future business – the insurance company. [T]he attorney’s economic interests weigh heavily in favor of the insurer, which, after all, may retain his services in other cases; yet the rules of professional responsibility tip the scales toward the insured. Although [some] courts seem to trust the insurer and attorney to act in the best interests of the insured, the more common view is that the longstanding ties that defense counsel has with the insurer will inevitably influence his conduct of the case. The attorney, wishing to maintain the insurer’s business, does not want to aggravate the company. Insurance counsel’s relationship with the insurer is contractual, usually ongoing, supported by strong financial interests, and often strengthened by sincere friendships.). In recognition of this, most courts hold that in conflict situations the insured has the right to independent counsel to conduct its defense and the insurance company has the obligation to pay the reasonable value of the defense conducted by independent counsel.”
Two Classes of Conflicts
Two classes of conflicts of interest deserve separate analysis, even though they are often related: 1) insurer conflicts; and 2) attorney conflicts. Insurer conflicts of interest generally arise out of the terms of the insurance policy contract in which the policyholder and the insurer have a complex matrix of rights and duties to one another. Generally, insurers tend to win in cases that evaluate the rights and obligations of the insurer and the policyholder under the terms of a liability policy. In these cases, the courts tend to enforce a standard that the policyholder has the burden of establishing that conflicts of interest “must be significant, not merely theoretical, actual, not merely potential.” But policyholders tend to win in cases that evaluate whether dependent counsel has complied with the Canons of Ethics. In these cases, the courts tend to enforce a standard that the lawyer must take the initiative to clear conflicts pursuant to the Rules of Professional Conduct, Rule 3-310(C) that “[a lawyer] shall not, without the informed written consent of each client: (1) [a]ccept representation of more than one client in a matter in which the interests of the clients potentially conflict.” “[A] distinction between ‘potential’ and ‘actual’ conflicts of interest is invalid and unworkable.”
Like cancer, conflicts of interest may be relatively benign or malignant.
Benign Conflicts of Interest
“[N]ot every conflict of interest triggers an obligation on the part of the insurer to provide the insured with independent counsel at the insurer’s expense.” “But not every reservation of rights entitles an insured to select Cumis counsel.” “[A] conflict of interest does not arise every time the insurer proposes to provide a defense under a reservation of rights. There must also be evidence that the outcome of [the] coverage issue can be controlled by counsel first retained by the insurer for the defense of the [underlying] claim.” California courts have developed a fairly extensive laundry list of potential conflicts of interest that have been found to not require an insurer to pay for Cumis counsel.
Disqualifying Conflicts of Interest
For an insurer, “[a] disqualifying conflict exists if [i]nsurance counsel had incentive to attach liability to [the insured].” For dependent counsel, a “[c]onflict of interest between jointly represented clients occurs whenever their common lawyer’s representation of the one is rendered less effective by reason of his representation of the other.” The distinction between reservations of rights which do and do not create disqualifying conflicts of interest is whether any ground upon which the insurer reserves the right to disclaim coverage is related to any disputed issue of fact or law in the third party litigation. While judicial expressions of the concept of a disqualifying conflict of interest are consistent, the nomenclature used is not. Thus, the courts have stated that unless the coverage issues raised by an insurer’s reservation of rights are limited by waiver, factual and legal disputes which are unrelated to, irrelevant to, extrinsic to, independent of, or have nothing to do with or do not overlap the third party litigation, the insurer’s coverage dispute cannot be allowed to prejudice the policyholder’s defense.
Control of the Defense
Some insurers tend to seize control of their policyholders defense for many reasons, including the ability to manage expenses and to influence the resolution of factual disputes and issues of law that may support a denial of coverage. On the other hand, policyholders should seek to keep control of their own defense so as to influence factual and legal issues that may support coverage and where the insurer has “denied all liability under the policy, its sole economic motive for prosecuting a vigorous defense had been eliminated. In actions in which the insurer lacks an economic motive for a vigorous defense of the insured, the insurer may not compel the insured to surrender control of the litigation.”
Determining who has the right to control the policyholder’s defense is a little like watching a tennis match with the ball sailing back and forth from one side of the court to the other. Absent a policy provision to the contrary, the policyholder “has the right to conduct such defenses, if he chooses to do so.” (Advantage, policyholder.) But as a practical matter, most insurance policies do successfully grant to the insurer the “right” to defend, and some expressly grant to the insurer the right to appoint defense counsel. (Advantage insurer.) “It hardly needs to be added that no insurance policy can validly diminish a lawyer’s duty to his insured client.” So unless “the reservation of rights is based on coverage disputes that have nothing to do with the issues being litigated in the underlying action”, the policyholder need not accept representation by dependent counsel who has failed to comply with Rule 3-310. (Advantage policyholder.)
Consequences of Wrongful Seizure of Control of the Defense
“Bad faith liability may attach when an insurer fails to notify its insured of a conflict of interest.” An insurer whose reservation of rights creates a disqualifying conflict of interest exposes its dependent counsel to the risk of accepting the assignment without complying with Rule 3-310, who then may face discipline and civil liability. “Thus a lawyer who, while purporting to continue to represent an insured and who devotes himself to the interests of the insurer without notification or disclosure to the insured, breaches his obligations to the insured and is guilty of negligence. [Dependent counsel has a] wider-reaching lawyer’s obligation to exercise due care to protect a client’s best interests in all ethical ways and at all stages”
A policyholder who actively challenges a reserving insurer’s decision to wrongfully seize control of the defense and who challenges the ethics of dependent counsel may exercise significant power over both the insurer and dependent counsel by simply withholding consent and authority to representation by dependent counsel.
 117 memoranda of law; 75 defined terms.
 For emphasis, the editor will occasionally make bold statements of law or that events “always” or “never” occur, which correctly state the rule within the Chinese Gong, but readers are cautioned that there are “always” exceptions to the rule.
 San Diego Navy Fed. Credit Union v. Cumis Ins. Society, Inc. (1984) 162 Cal.App.3d 358, 375 (Cumis) (citations omitted).
 See, Case studies.
 “[N]o decision or authority we have studied furnishes a completely satisfactory answer.” (Hartford Acc. & Indem. Co. v. Foster 528 So.2d 255, 269, 274 (Miss. 1988) (Foster).)
 See, Top Ten Unsettled Issues of Law
 Civ. Code § 307.
 Civ. Code § 308.
 1 Restatement of Torts 2d § 6 (ellipses omitted).
 1 Restatement of Torts 2d § 4 (ellipses omitted).
 See, http://www.stockpickssystem.com/historical-rate-of-return/
 See, http://www.moneychimp.com/calculator/compound_interest_calculator.htm
 “A lawyer’s time and advice are his stock in trade” (attributed to Abraham Lincoln).
 Of course, limitations apply.
 Ins. Code § 22 (ellipsis omitted).
 Ins. Code § 108 (ellipses omitted).
 Civ. Code § 2778(1) (ellipses omitted).
 Id. subsection (3) (ellipses omitted).
 Id. subsection (4) (ellipses omitted).
 Id. subsection (5) (ellipses omitted).
 Id. subsection (6) (ellipses omitted).
 Id. subsection (7) (ellipses omitted).
 Ultimately, “the courts [must] provide to the insurer some measure of procedural due process in order to protect against the consequences of a fraudulent or collusive settlement.” (Pruyn v. Agricultural Ins. Co. (1995) 36 Cal.App.4th 500, 530.)
 See, California Judicial Council statistics for property damage claims.
 Civ. Code § 2778(6) (ellipses omitted).
 Buss v. Superior Court (1997) 16 Cal.4th 35 (Buss).
 Hartford Cas. Ins. Co. v. J.R. Marketing (2015) 61 Cal.4th 988.
 Blue Ridge Ins. Co. v. Jacobsen (2001) 25 Cal.4th 489.
 Cal. Code Regs. § 2695.7(b)(1) (emphasis added, ellipses omitted).
 Cumis, supra, 162 Cal.App.3d at 375.
 Buss, supra, 16 Cal.4th at 47-49 (citations and ellipses omitted).
 Foster, supra, 528 So.2d at 268.
 Manfredi & Levine v. Superior Court (Barles) (1998) 66 Cal.App.4th 1128, 1134-35 (citations, quotation marks, and ellipses omitted).
 Dynamic Concepts, Inc. v. Truck Ins. Exchange (1998) 61 Cal.App.4th 999, 1007.
 Gulf Ins. Co. v. Berger, Kahn, Shafton, Moss, Figler, Simon & Gladstone (2000) 79 Cal.App.4th 114, 131 (Berger, Kahn) (citations, quotation marks, and ellipsis omitted).
 Industrial Indem. Co. v. Great American Ins. Co. (1977) 73 Cal.App.3d 529, 531.
 Merritt v. Reserve Ins. Co. (1973) 34 Cal.App.3d 858, 870.
 Foster, supra, 528 So.2d at 269, 274.
 CHI of Alaska, Inc. v. Employers Reinsurance Corp., 844 P.2d 1113, 1116-17 (Alaska 1993).
 Dynamic Concepts, supra, 61 Cal.App.4th at 1007.
 Cumis, supra, 162 Cal.App.3d at 371, fn.7 (ellipsis omitted).
 James 3 Corp. v. Truck Ins. Exchange (2001) 91 Cal.App.4th 1093, 1101.
 Dynamic Concepts, supra, 61 Cal.App.4th at 1006.
 Gafcon, Inc. v. Ponsor & Associates (2002) 98 Cal.App.4th 1388, 1421 (Gafcon) (quotation marks omitted).
 Berger, Kahn, supra 79 Cal.App.4th at 131 (ellipsis omitted).
 Spindle v. Chubb/Pacific Indemnity Group (1979) 89 Cal.App.3d 706, 713.
 “[C]overage hinges on factual issues that are unrelated to the issues in the third party liability action,” (Montrose Chemical Corp. v. Superior Court (1993) 6 Cal.4th 287, 305 (Montrose I).)
 “Accordingly, the question before us is whether the coverage questions are logically unrelated (that is, irrelevant) to the issues of consequence in the (third party litigation which might) prejudice [the insured] in the underlying actions”. (Montrose Chemical Corp. v. Superior Court (Canadian Universal Ins. Co.) (1994) 25 Cal.App.4th 902, 909 (Montrose II).)
 No prejudice “where the coverage issue is ‘independent of, or extrinsic to, the issues in the underlying action.’” (Gafcon, supra, 98 Cal.App.4th at 1422.)
 “[W]hen the reservation of rights is based on coverage disputes that have nothing to do with the issues being litigated in the underlying action . . . there is no conflict of interest.” (Long v. Century Indemnity Co. (2008) 163 Cal.App.4th 1460, 1470 (Long).)
 See, United Enterprises, Inc. v. Superior Court (2010) 183 Cal. App. 4th 1004, 1010, (“[B]ecause factual issues to be resolved in the declaratory relief action overlap factual issues to be resolved in the underlying actions, the court was required to issue the stay.”)
 Montrose II, supra, 25 Cal.App.4th at 909.
 Tomerlin v. Canadian Indemnity Co. (1964) 61 Cal.2d 638, 647-48 (ellipses omitted).
 Civ. Code § 2778(4) (ellipses omitted).
 Foster, supra, 528 So.2d at 269, 274.
 Long, supra, 163 Cal.App.4th at 1470.
 Evanston Ins. Co. v Preferred Properties, LLC (ED Cal. 2008)
 Betts v. Allstate Ins. Co. (1984) 154 Cal.App.3d 688, 716.
 A [lawyer] shall not accept compensation for representing a [policyholder] from [an insurer] unless [t]he [lawyer] obtains the client’s informed written consent.” (Rule 3-310(F) (ellipses omitted).)
 “[W]ithout authority appearing as attorney for a party to an action or proceeding constitutes a cause for disbarment or suspension.” (Bus.&Prof. Cd. § 6104.)