Control of the Defense: Basic Principles

Introduction

The question of who may control the policyholders defense under what circumstances is very well developed in California law. Nonetheless, the right control of the defense is widely misunderstood by lawyers and judges. The answer to the question requires two separate analyses: 1) what contractual, statutory and common law standards control the insurer-policyholder relationship; and 2) what ethical standards impede dependent counsel[1] from representing both the insurer and the policyholder.[2]

While there are exceptions, the general rules are: 1) A defendant always has the initial right to control the defense. 2) An insurer that says “yes” may control its policyholder’s defense. 3) An insurer that says “no” may not control its policyholder’s defense. 4) An insurer that says “maybe” may or may not control the defense depending on whether its reservation of rights creates a disqualifying conflict of interest.[3]

The Nature of Indemnity

When a policyholder becomes legally liable to the plaintiff,[4] the insurer must indemnify the policyholder by paying the injured plaintiff.[5] The insurer is not entitled to relitigate issues of the policyholder’s liability to the plaintiff, nor the amount of the victim’s injuries, nor any other issues necessarily decided by the judgment against the policyholder.[6] The insurer’s rights to due process of law are generally satisfied by the insurer’s receipt of notice of the suit.[7] Thus, the insurer is bound by a judgment against the policyholder even though the insurer is not an actual party to the lawsuit.[8]

The Nature of an Insurer’s Duty to Defend

A liability insurer’s duty to defend[9] is a creature of contract, statute and case law. Because the insurer is not licensed to practice law,[10] it cannot lawfully discharge its promise to defend by itself. Instead it must hire a competent, ethical attorney to conduct the defense on its behalf. Although insurance companies are financial institutions, the promise to defend is more than a sterile obligation to pay money. “It entails the rendering of a service.”[11] The duty to defend must be discharged “immediately and entirely.”[12] “[T]his duty is nonetheless distinct and separate from the contractual obligation to pay an indemnitee’s defense costs, after the fact.”[13] “If an insurer has an obligation to pay defense costs under a liability policy, as opposed to an indemnity policy, the insurer must pay the costs as they are incurred.”[14]

The Defendant Initially Controls the Defense

As a party to the lawsuit, the defendant/policyholder has the initial right to control the defense.[15] The policyholder may choose to relinquish that control to the insurer, but is not required by statute to do so.[16] This right includes the power to select, direct, hire, and fire the attorney.[17] An attorney is the client’s agent on matters for which the attorney is employed, so that the client may be bound by the attorney’s acts.[18] “The interest of the client in the successful prosecution or defense of the action is superior to that of the attorney, and he has the right to employ such attorney as will in his opinion best subserve his interest.”[19] “[A] client should have both the power and the right at any time to discharge his attorney with or without cause.”[20] A defendant who has liability insurance may choose to notify one’s insurer of a plaintiff’s lawsuit, whereupon the insurer may or may not earn the right to control the policyholder’s defense.

Statutory Control of the Defense

Absent a contractual provision to the contrary, the Civil Code confers upon the policyholder the right to conduct the defense. “In the interpretation of a contract of indemnity, the following rules are to be applied, unless a contrary intention appears.”[21] “The [insurer] is bound, on request of the [policyholder], to defend actions or proceedings brought against [the policyholder] in respect to the matters embraced by the indemnity, but [the policyholder] has the right to conduct such defenses, if he chooses to do so.”[22] A contrary intention may appear from an express waiver[23], the policyholder’s acquiescence,[24] or the language of the policy.[25]

While the policyholder has a statutory “right to conduct” the defense, “[i]f the [insurer] . . . is not allowed to control its defense, judgment against the [policyholder] is only presumptive evidence against the [insurer].”[26] “The settlement, or a judgment rendered upon a stipulation of such a settlement, becomes presumptive evidence only of the liability of the insured and the amount thereof, which presumption is subject to being overcome by proof on the part of the insurer.”[27]

Contractual Right to Control the Defense

Liability insurance is a “contract whereby one undertakes to indemnify another against . . . liability.”[28] The language of an insurance contract may confer upon the insurer certain rights to control the conduct and the cost of defending the policyholder. However, the meaning of[29] the language used in different kinds of policies varies widely.[30]

Various Policy Promises to Defend

A typical CGL policy states: “We will pay on behalf of the insured those sums that the insured becomes legally obligated to pay as damages because of ‘bodily injury’, ‘property damage’ or ‘personal and advertising injury’ to which this insurance applies. We will have the right and duty to defend the insured against any ‘suit’ seeking those damages.” A standard policy does not elaborate on what the bare “right” to defend entails. Nor does a typical policy expressly state who may control the conduct of the defense. Usually D&O policies make no express promise to defend leaving control of the defense with the policyholder. Title policies usually limit the causes of action for which the insurer will pay. A standard homeowners policies states: “We will provide a defense at our expense by counsel of our choice.” (Emphasis added.) A typical professional malpractice policy states: “The Company shall have the right to appoint counsel and to make such . . . defense of a claim as is deemed necessary by the Company.” (Emphasis added.)

Such language may be interpreted to mean that the insurer the contractual right to appoint dependent counsel to conduct the defense. However, such language does not resolve ethical conflicts of interest that may plague dependent counsel. No reported California opinion holds that any of the foregoing provisions constitute a waiver by the policyholder of dependent counsel’s ethical obligations to the policyholder/client. Thus, even where policy language appears to permit the insurer to select a defense lawyer, dependent counsel may not necessarily accept or continue employment to represent both the policyholder and the insurer where their interests conflict. When dependent counsel cannot ethically accept the assignment, control of the defense may not shift to the insurer or its ethically challenged dependent counsel.

Notice Provision

A typical CGL policy has a notice provision, such as: “If a claim is made or ‘suit’ is brought against any insured, you must: . . . Notify us as soon as possible.” Many courts and lawyer speak in terms of “tendering” the defense to the insurer by giving notice. However, a typical policy never uses the word “tender.” No reported California opinion holds that a policyholder offers control of the defense to the insurer by the policyholder’s compliance with the notice requirement of the policy. Thus, the policyholder does not cedes control of the defense to the insurer simply by notifying the insurer of a claim.

No-Voluntary-Payment Provision

Standard liability policies include a no-voluntary-payment provision that typically limit the policyholder’s right to recover from the insurer money spend by the policyholder without the insurer’s consent, including costs of defense. A typical CGL policy states: “No insured will, except at that insured’s own cost, voluntarily make a payment, assume any obligation, or incur any expense . . . without our consent.” Some policies are more strongly worded: “The Assured shall not . . . incur any costs or expenses in connection [with any claim] without the written consent of the Underwriters, who shall be entitled at any time to take over and conduct in the name of the Assured the defense of any claim.”[31] The California Supreme Court has ruled that “provisions . . . requiring [the insurer’s] prior consent to the expenditure of defense costs and permitting [the insurer] to assume the defense of any claim are common in [all] liability insurance policies. Their purpose ‘is to prevent collusion as well as to invest the insurer with the complete control and direction of the defense or compromise of suits or claims.”’[32]

“[W]hen an insurer reserves its rights on a given issue and the outcome of that coverage issue can be controlled by counsel first retained by the insurer for the defense of the claim, a conflict of interest may exist.” Where the policyholder selects independent counsel and the insurer selects dependent counsel both “shall be allowed to participate in all aspects of the litigation [and] . . . cooperate fully in the exchange of information that is consistent with each counsel’s ethical and legal obligation to the insured.”[33] However, Rule 3-310 and Cumis require conflicted dependent counsel to withdraw unless the policyholder gives informed written consent. No reported California opinion clarify whether dependent counsel may purport to represent the policyholder with a disqualifying conflict of interest.

Common Law Standard to Control the Defense

California case law is clear that the right to control the conduct of the defense depends upon: 1) the agreement of the parties, if any; 2) whether a disqualifying conflict of interest exists; and 3) whether the insurer is faithfully performing[34] its duty to defend.[35] An agreement of the parties, express or implied, may supercede the policy language, the statutory standard or the common law standard. Generally, if no disqualifying conflict of interest exists, the insurer may control the defense, while the policyholder may control the defense if a disqualifying conflict is present. Also generally, an insurer in material breach of its duty to defend loses control of the defense and settlement.[36]

The right to control the defense largely depends upon whether the insurer says “Yes”, “No”, or “Maybe”.[37] When an insurer says Yes, agreeing to defend and indemnify its policyholder for a plaintiff’s lawsuit, it may generally control the defense. However, conflicts of interest may arise regarding settlement within policy limits and whether the insurer will pay compensatory damages even if punitive damages are awarded.[38]

When an insurer says No, refusing to defend or indemnify its policyholder,[39] “an insured who is abandoned by its liability insurer is free to make the best [of the situation].”[40] “[O]nce the insurer had wrongfully denied liability and refused to defend, the insured was released from his obligation to leave the management of the claim to the insurer and was justified in proceeding on her own account in whatever manner seemed proper to her under the circumstances.”[41]

When an insurer says Maybe, reserving it rights to defer a decision whether to accept responsibility to defend or indemnify its policyholder, control of the defense generally turns on whether the reservation creates a disqualifying conflict of interest.[42] Although courts have used a variety of nomenclature, a reservation of rights always creates disqualifying conflicts of interest unless all grounds upon which the insurer may disclaim coverage are unrelated to,[43] irrelevant to,[44] extrinsic to, independent of,[45] or have nothing to do with[46] the third party litigation.


[1] The moniker “dependent counsel” acknowledges that “defense counsel and the insurer frequently have a longstanding, if not collegial, relationship” (Gulf Ins. Co. v. Berger, Kahn, Shafton, Moss, Figler, Simon & Gladstone (2000) 79 Cal.App.4th 114, 131), “[a]s a practical matter . . . in reality, the insurer’s attorneys may have closer ties with the insurer and a more compelling interest in protecting the insurer’s position, whether or not it coincides with what is best for the insured” (Purdy v. Pacific Automobile Ins. Co.(1984) 157 Cal.App.3d 59), and “[i]nsurance companies hire relatively few lawyers and concentrate their business. A lawyer who does not look out for the Carrier’s best interest might soon find himself out of work.” (San Diego Navy Fed. Credit Union v. Cumis Ins. Society, Inc. (1984) 162 Cal.App.3d 358, 364 (Cumis).

[2] “We conclude the 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.” (Cumis, supra, 162 Cal.App.3d at 375 (citations omitted).)

[4] “One who indemnifies another against an act to be done by the latter, is liable jointly with the person indemnified, and separately, to every person injured by such act.” (Civ. Code § 2777.)

[5] “Upon an indemnity against liability . . . the person indemnified is entitled to recover upon becoming liable.” (Civ. Code § 2778(1).)

[6] “An insurer that has been notified of an action . . . is bound by a judgment in the action . . . as to all material findings of fact essential to the judgment of liability of the insured.” (Hogan v. Midland National Ins. Co. (1970) 3 Cal.3d 553, 564 (Hogan).)

[7] “[W]hen the insured tenders the suit, the carrier is receiving its chance to be heard.” (Hinton v. Beck (2009) 176 Cal.App.4th 1378, 1385 (Hinton).)

[8] “[T]he judgment in the underlying action is conclusive as to the insurer’s liability [only if] factual matters upon which the issue of coverage turns are expressly or impliedly determined in the prior action.” (Hogan, supra, 3 Cal.3d at 565 (citations omitted).)

[10] “No person shall practice law in California unless the person is an active member of the State Bar.” (Bus.&Prof. Cd. §6125.) “[A]n insurance company does not engage in the practice of law due to the mere employment relationship between the insurer and the attorneys defending its insured against third party claims.” (Gafcon, Inc. v. Ponsor & Associates (2002) 98 Cal.App.4th 1388, 1396-97 (Gafcon).)

[11] Buss v. Superior Court (1997) 16 Cal.4th 35, 46 (Buss)

[12] “To defend meaningfully, the insurer must defend immediately. To defend immediately, it must defend entirely.” (Buss, supra, 16 Cal.4th at 48 (citation omitted).)

[13] Crawford v Weather Shield Mfg., Inc. (2008) 44 Cal. 4th 541, 558.

[14] Save Mart Supermarkets v. Underwriters at Lloyd’s London (ND Cal. 1994) 843 F.Supp. 597, 603 (citations and ellipses omitted.)

[15] “The attorney may be changed at any time [u]pon the consent of both client and attorney [or u]pon the order of the court.” (Cd. Civ. Proc. §284 (ellipses omitted).)

[16] The policyholder “has the right to conduct such defenses, if he chooses to do so.” (Civ. Code § 2778(4).)

[17] “The relation between them is such that the client is justified in seeking to dissolve that relation whenever he ceases to have absolute confidence in either the integrity or the judgment or the capacity of the attorney.” (Fracasse v. Brent (1972) 6 Cal.3d 784, 790 (Fracasse).) Client May Fire Counsel

[18] “An attorney shall have authority: 1. To bind his client; 2. To receive money claimed by his client and to discharge the claim or acknowledge satisfaction of the judgment.”(Cd. Civ. Proc. §283 (ellipses omitted).); Blanton v. Womancare, Inc. (1985) 38 Cal.3d 396, 403.

[19] Fracasse, supra, 6 Cal.3d at 800.

[20] Id. at 790.

[21] Civ. Code § 2778.

[22] Civ. Code § 2778(4).

[23] Civ. Code § 2860(e).

[26] Civ. Code § 2778(6).

[27] Lamb v. Belt Casualty Co. (1935) 3 Cal.App.2d 624, 631-632 (Lamb).

[28] Ins. Code § 22.

[31] Gribaldo, Jacobs, Jones & Associates v. Agrippina Versicherunges A.G. (1970) 3 Cal.3d 434, 449.

[32] Ibid.

[33] Civ. Code § 2860(f).

[34] “[The insurer] lost its right to control the litigation when it refused to defend or indemnify [its policyholder]. [A]n insurer has no direct interest in the lawsuit when it has waived such interest by refusing to defend its insured.” (Hinton, supra, 176 Cal.App.4th at 1385. See also, Eigner v. Worthington (1997) 57 Cal.App.4th 188, 196 (Eigner); Stalberg v. Western Title Ins. Co. (1991) 230 Cal.App.3d 1223, 1233 (Stalberg).)

[35] Defaulting Insurer Forfeits Control of the Defense

[39] “Upon receiving proof of claim, every insurer . . . shall immediately. . . accept [yes] or deny the claim, in whole [no] or in part [maybe].” (Code of Regs. § 2695.7(b) (ellipses omitted, text in parentheses added).)

[40] Pruyn v. Agricultural Ins. Co. (1995) 36 Cal.App.4th 500, 515.

[41] Drinnon v. Oliver (1972) 24 Cal. App.3d 571, 580. See also, Peterson v. Allstate Ins. Co. (1958) 164 Cal. App.2d 517; Ritchie v. Anchor Casualty Co. (1955) 135 Cal. App.2d 245; Kennedy v. American Fidelity & Casualty Co. (1950) 97 Cal. App.2d 315; Lamb, supra, 3 Cal. App.2d 624; Indemnity Ins. Co. of North America v. Forrest (9th Cir.1930) 44 F.2d 465; and cases collected in 49 A.L.R.2d 755; Eigner, supra, 57 Cal.App.4th at 196; Stalberg, supra, 230 Cal.App.3d at 1233 [an insurer that wrongfully refuses to defend the insured forfeits its right to control the defense, including its rights to select defense counsel and litigation strategy].)

[43] See, Montrose Chemical Corp. v. Superior Court (1993) 6 Cal.4th 287, 306: “[C]overage hinges on factual issues that are unrelated to the issues in the third party liability action”.

[44] See Montrose Chemical Corp. v. Superior Court (Canadian Universal Ins. Co.) (1994) 25 Cal.App.4th 902, 909: “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”.

[45] See, Gafcon, supra, 98 Cal.App.4th at 1422. No prejudice “where the coverage issue is ‘independent of, or extrinsic to, the issues in the underlying action’”.

[46] See, Long v. Century Indemnity Co. (2008) 163 Cal.App.4th 1460, 1471: “[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.”

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