“[W]hen coverage is disputed, the interests of the insured and the insurer are always divergent.” By reserving its rights to later deny coverage for the outcome of a liability dispute, an insurer creates a coverage dispute that exists simultaneous with the liability dispute being litigated by a plaintiff. Although both disputes involve the same participants, the interests of each differ between the two disputes. Often the result is that adversaries in one dispute may become allies in the other dispute. Such divergence of interests sometimes put participants to hard choices. If forced to choose, most policyholders conclude that it is more important to win the coverage dispute against the insurer than it is to win the liability dispute with the plaintiff for one simple reason: the insurer must pay for the former and may not have to pay for the latter. As a result, the policyholder may “attempt to obtain a ruling that such liability emanated from . . . conduct within his insurance coverage.”
Notwithstanding the fact that for a defendant should be reluctant to confess liability to a plaintiff, there may be as many as seven distinct incentives for a policyholder to actually confess covered liability to a plaintiff. Confessing covered liability may make sense if: 1) is true; 2) may achieve prompt closure; 3) may “pop” the policy limit; 4) may impede the insurer’s claim against the policyholder to recover reimbursement of the costs of defense; 5) may undermine the insurer’s claim against the policyholder to recover reimbursement of the costs of settlement; 6) may permit the plaintiff to cooperate with the plaintiff; and/or 7) may create a valuable asset with which the policyholder may resolve the liability dispute by assignment.
ASSURED COVERAGE PRODUCES HARMONY
Under the American adversarial system of justice, a liability dispute between plaintiff and defendant is a binary contest of one against the other through advocates for a distinct point of view. When a liability insurer concedes full coverage, the traditional tripartite relationship among the policyholder (as witness) insurer (as financier), its lawyer (as advocate) coalesce as a defense team that operates in idyllic harmony, dedicated to a single goal of defeating or minimizing the plaintiff’s claim. Quite simply, the insurer, the policyholder and their common lawyer gang up on the plaintiff. The defense team is like the Three Musketeers: “All for one and one for all.” With no money at risk in the liability dispute, the policyholder can afford to indulge in pride over profit.
A DENIAL OF COVERAGE MAY RESHUFFLES ALLEGIANCES
But when a liability insurer denies coverage, the binary liability dispute between plaintiff and defendant may be supplemented by a second, simultaneous coverage dispute that may shatter this idyllic harmony of the defense team – fractured by conflicts of interest. In its place, a web of conflicts among the plaintiff, the plaintiff’s lawyer, the policyholder, independent counsel, the insurer, its dependent counsel, and its coverage counsel may develop. The “All for one and one for all” spirit of the Three Musketeers may become a free-for-all.
1. Harmony Dissolves When an Insurer Reserves Rights
California courts have uniformly recognized that the tripartite relationship is harmonious only “absent a conflict of interest.” When conflicts of interest exist, “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.”
2. Policyholder May Cleave From Insurer and Dependent Counsel
“The tranquility of this coalition is disturbed where disagreement arises between the members. Dissatisfaction flowering into litigation may disrupt the harmony of the arrangement. The situation has changed. Partners have become adversaries. The closely knit fabric is torn and shredded.” The policyholder “may face the possibility of substantial loss which can be forestalled only by action of the carrier. Thus [the policyholder] 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.” Under the Cumis Rule, the existence of a disqualifying conflicts of interest may compel dependent counsel to withdraw and the insurer to pay for independent counsel.
3. Plaintiff and Policyholder May Unite
Significantly, the policyholder and the injured plaintiff often share a common goal to compel the insurer to fund a settlement or a judgment, and the defense. While the defendant continues to desire to defeat the plaintiff’s claims of liability and damages in the liability dispute, the policyholder may simultaneously desire to work with the plaintiff in the coverage dispute to support their shared need for coverage. Thus, enemies may become cautious allies. Raw self interest of both the policyholder and the plaintiff may be served if the policyholder truthfully confesses covered liability for which the insurer alone must pay the plaintiff. Both litigants may favor profit over pride to seek prompt closure of both the liability dispute and the coverage dispute at little or no expenditure of time, money, or stress. Through cooperation the policyholder and the plaintiff may resist the insurer’s goal that by denying coverage the plaintiff may take less while the policyholder may pay more. Public policy encourages “insurers to defend and settle cases for which insurance coverage is uncertain. In so doing, it transfers from the injured party to the insurer the risk that the insured may not be financially able to pay the injured party’s damages.” These adversaries may easily unite to oppose a common enemy – the insurer. Such cooperation is permissible under California law. The policyholder and the plaintiff may develop favorable, admissible evidence during the pendency of the liability dispute for use against the insurer and dependent counsel in a coverage dispute.
INCENTIVES FOR THE POLICYHOLDER TO SUPPORT COVERED LIABILITY
The very best reason for a policyholder to confess covered liability because it is the truth. It is improper for a policyholder “to combine with the insurer to present a sham defense” and it is equally improper for dependent counsel to urge a policyholder to participate in resisting a valid claim. Dependent counsel may not “manipulate its own client through the process of coaching [and] encouraging” the policyholder to deny all wrongdoing.
Litigation is stressful and a distraction from more fruitful pursuits. Usually both the plaintiff and the policyholder simply want it to be over so that they can get on with their lives. Only lawyers profit by the vigorous combat of litigation. Only the insurer profits by delay. “The law favors settlements.” A statute requires insurers to attempt “in good faith to effectuate prompt, fair, and equitable settlements of claims in which liability has become reasonably clear.” Thus, when; 1) a policyholder truthfully accepts covered liability; and 2) a plaintiff agrees to accept an equitable sum; then 3) the liability dispute becomes ripe for resolution.
3. Not Enough Coverage
Sometimes defendants find that the harm they have caused to a plaintiff is greater than the policy limit they have purchased. Liability insurance is not commercially available to buy after the fact of injury. But higher liability insurance limits are available almost for free. “[T]he implied obligation of good faith and fair dealing requires the insurer to settle in an appropriate case although the express terms of the policy do not impose such a duty. ¶ [A]n insurer, who wrongfully refuses to accept a reasonable settlement within the policy limits is liable for the entire judgment against the insured even if it exceeds the policy limits.” “The reasonableness of a settlement offer is to be evaluated by considering whether, in light of the victim’s injuries and the probable liability of the policyholder, the ultimate judgment is likely to exceed the amount of the settlement offer.”
Thus, when a plaintiff offers to settle within policy limits, one of the factors employed to determine whether the offer is reasonable is the likelihood that policyholder will be found liable. It may be a disservice for a policyholder to deny liability during (and prior to) settlement negotiations because reasonable doubt about liability may excuse the insurer’s duty to settle.
4. Buss Defense Cost Reimbursement Claim
“[M]ay the insurer seek reimbursement from the insured for defense costs? Yes, as to claims that are not even potentially covered.” In a “mixed action, in which some of the claims are at least potentially covered and the others are not,” “may the insurer seek reimbursement from the insured for defense costs? ¶ The answer is as follows.” “As to the claims that are not even potentially covered, the insurer may indeed seek reimbursement for defense costs.” “[F]or what specific defense costs may the insurer obtain reimbursement from the insured? ¶ The answer is: Defense costs that can be allocated solely to the claims that are not even potentially covered.”
Two incentives flow naturally from this body of law. First, the policyholder’s exposure to pay the insurer reimbursement for the costs of defense is in direct proportion to the policyholder’s exposure to: 1) “claims that are not even potentially covered”; and 2) claims that are at least potentially covered. Thus logically, it is in the interests of the policyholder to embrace potentially covered liability to the plaintiff. Second, the witness who is likely to be best equipped to give testimony regarding the required allocation of defense costs to claims that are or are not potentially covered is the defense lawyer who did the defense work. Logically, it is in the interests of the policyholder to embrace independent counsel who is loyal only to the policyholder and eschew dependent counsel who is beholden to the insurer.
5. Blue Ridge Defense Cost Reimbursement Claim
“[A]n insurer may be reimbursed for a reasonable settlement payment made over the objection of its insureds” and “[i]f . . . the insurer subsequently establishes the noncoverage of its policy, it would be free to seek reimbursement of the settlement payment from its insured.” A “rule allowing unilateral reservation of the right to seek reimbursement of settlement payments for noncovered claims advances significant public policy considerations.” “[T]he insurer only has a duty to indemnify the insured for covered claims, and no duty to pay for noncovered claims because the insured did not pay premiums for such coverage.” While the Supreme Court has not yet addressed exactly how to allocate costs of settlement, if at all, it appears that the “right to seek reimbursement [would be allocated only] for any noncovered claim.”
Again, two incentives flow naturally from the insurer’s right to recover settlement costs. First, the policyholder must pay the insurer only for noncovered claims but not for covered claims. Thus it is logical for the policyholder to embrace covered liability to the plaintiff. Second, dependent counsel is not likely to well serve the policyholder as a witness asked to allocate settlement value between covered and noncovered claims. Instead, it is in the interests of the policyholder to embrace independent counsel as a preferred witness.
6. Settle and Sue
While an defending insurer may control settlement, a wrongfully abandoned policyholder may enter into a reasonable, non-collusive settlement with a plaintiff and recover the amount of the settlement from the defaulting insurer. An insurer that agrees to defend but fails to faithfully discharge its duty also risks losing control of settlement. Litigants who settle on terms that include an independent adjudication of liability and damages are entitled to conclusive presumptions in a coverage action against the defaulting insurer, while a settlement without an adjudication is entitled only to rebuttable presumptions.
7. Assignment and Covenant Not to Execute
Many liability lawsuits are resolved by settlement in which an impecunious defendant assigns to the plaintiff the only valuable asset the policyholder owns – rights against a defaulting insurer. Often such settlements necessarily give the policyholder and the plaintiff a stake in the outcome of the coverage dispute. When covered liability is clear, the plaintiff may recover for the policyholder’s covered liability while the policyholder may recover for costs incurred in conducting the defense of the liability dispute.
 San Diego Navy Fed. Credit Union v. Cumis Ins. Society, Inc. (1984) 162 Cal.App.3d 358, 375 (Cumis).
 Gray v. Zurich Insurance Co. (1966) 65 Cal.2d 263, 279 (Gray).
 See, Article: Assignment of Policyholder’s Claims to a Plaintiff.
 See, Article: Three Way Relationship – Harmony or Dissonance.
 See, Practice Pointer: Prize: Price or Pride.
 See, Article: Compendium of Conflicts of Interest.
 Gafcon, Inc. v. Ponsor & Associates (2002) 98 Cal.App.4th 1388, 1406; see also: State Farm Mutual Automobile Ins. Co. v. Federal Ins. Co. (1999) 72 Cal.App.4th 1422, 1429 (“In the absence of a conflict of interest”); National Union Fire Ins. Co. v. Stites Prof. Law Corp. (1991) 235 Cal.App.3d 1718, 1727 (“So long as the interests of the insurer and the insured coincide”); James 3 Corp. v. Truck Ins. Exchange (2001) 91 Cal.App.4th 1093, fn. 3 (“there is not a conflict of interest.”) American Mut. Liab. Ins. Co. v. Superior Court (Nork)(1974) 38 Cal.App.3d 579, 592-93 (“The tranquility of this coalition is disturbed where disagreement arises [to] disrupt the harmony of the arrangement” (ellipses omitted); Cumis, supra, 162 Cal.App.3d at 364 (Upon “a reservation of rights . . . there may be little commonality of interest”); Kroll & Tract v. Paris & Paris (1999) 72 Cal.App.4th 1537, 1543 (“The possibility that the interests may become adverse is exactly the reason Cumis counsel exists.” (ellipsis omitted); Assurance Co. of America v. Haven (1995) 32 Cal.App.4th 78, 87 (“it is quite difficult for an attorney beholden to the insurer to represent the insured where the insurer is reserving its rights regarding coverage.”)
 Cumis, supra, 162 Cal.App.3d at 375.
 Nork, supra, 38 Cal.App.3d at 592-93 (ellipses omitted.)
 Merritt v. Reserve Ins. Co. (1973) 34 Cal.App.3d 858, 870.
 See, Article: Cumis Rule.
 See, Article: Disqualifying Conflicts of Interest.
 “Disregarding [their] common interests, the remaining interests of the two diverge to such an extent as to create an actual, ethical conflict of interest warranting payment for the insureds’ independent counsel.” (Cumis, supra, 162 Cal.App.3d at 375 (ellipsis omitted).)
 Blue Ridge Ins. Co. v. Jacobsen (2001) 25 Cal.4th 489, 503.
 See, Articles: See, Article: Cooperation: A Limited Defense, Compendium of Cases: Cooperation, Collusion: A Limited Defense, Compendium of Cases: Collusion, Elusive Definition of Collusion and see, Practice Pointers: Cooperation: A Strategic Choice, Line Dividing Cooperation from Collusion.
 See, Practice Pointer: Develop Admissible Evidence.
 See, Article: Perjury.
 Valladao v. Fireman’s Fund Indem. Co. (1939) 13 Cal.2d 322, 329.
 Betts v. Allstate Ins. Co. (1984) 154 Cal.App.3d 688, 709.
Potter v. Pacific Coast Lumber Co. (1951) 37 Cal.2d 592, 602.
 Ins. Code §790(h)(5).
 Comunale v. Traders & Gen. Ins. Co. (1958) 50 Cal.2d 654, 659-61 (ellipses omitted).)
 Isaacson v. California Ins. Guar. Ass’n (1988) 44 Cal.3d 775, 793; CACI Jury Instruction 2334: “A settlement demand is reasonable if in light of the claimed injuries or loss and (name of plaintiff’s) probable liability, the judgment in the lawsuit was likely to exceed the amount of the settlement demand.”
 Buss v. Superior Court (1997) 16 Cal.4th 35, 39.
 Id. at 47.
 Id. at 49.
 Id. at 50.
 Id. at 52 (emphasis added).
 “Cumis counsel is independent and represents only the insured.” (Assurance Co. of America v. Haven (1995) 32 Cal.App.4th 78, 88.)
 See, Article: Dependent Counsel Is Beholden to the Insurer.
 Blue Ridge Ins. Co. v. Jacobsen (2001) 25 Cal.4th 489, 492-93 (Blue Ridge).
 Johansen v. California State Auto. Assn. Inter-Ins. Bureau (1975) 15 Cal.3d 9, 19; see also Blue Ridge, supra, 25 Cal.4th at 499.
 Blue Ridge, supra, 25 Cal.4th at 502-03.
 Id. at 503.
 See, Article: Control of Settlement.
 See, Article: Favorable Evidentiary Presumptions from Settlement.
 See, Article: Assignment of Policyholder’s Claims to a Plaintiff.
 See, Model Contract: Assignment In Exchange for Covenant Not to Execute.