- 1 Introduction
- 2 Traditional Adversarial Relationships
- 3 Two Forms of Coverage Denial
- 4 Relationships Are Altered by a Coverage Denial
When a defendant’s liability insurer denies coverage to its policyholder, its decision usually influences the ensuing relationships among the participants in the plaintiff’s lawsuit. When the insurer concedes coverage, a traditional adversarial relationships permit the policyholder, the insurer, and its lawyers to form a defense team which unites them to focus only on opposing the plaintiff’s claim. But when the insurer denies coverage, the traditional adversarial relationships may be fundamentally altered. The insurer’s denial of the duty to defend may prompt the plaintiff and the policyholder to cooperate. The insurer’s agreement to defend under a reservation of rights to later deny coverage may undermine all traditional relationships in complex ways.
Traditional Adversarial Relationships
Plaintiff vs. Defendant
The primary traditional participants in civil litigation are the plaintiff and the defendant who are entirely adverse to one another. In our adversarial system of justice, a plaintiff claims to have suffered a genuine loss for which she seeks just compensation from a defendant. The defendant opposes the plaintiff’s claim so as to minimize the risk of losing everything it took a lifetime to build. Plaintiffs and defendants are natural enemies.
Insurance Infuses Money
When the defendant has purchased liability insurance, relationships become somewhat more complex. Coverage serves to protect the defendant/policyholder from personal financial risk. The policyholder has a reasonable expectation of protection for which he has paid premiums year in and year out, usually without receiving anything in return, except peace of mind. The policy of liability insurance also protects the injured plaintiff by providing a reliable source of collection, for which the plaintiff has a statutory right to recover directly from the insurer, even if the policyholder is insolvent and files for bankruptcy. The mere potential of insurance coverage fundamentally changes the economic risks and benefits of the parties and resultant litigation strategies.
If the Insurer Concedes Coverage
In the vase majority of claims, the insurer quietly concedes full coverage. “The general rule supported by the great weight of authority is that if a liability insurer, with knowledge of a ground of forfeiture or noncoverage under the policy, assumes and conducts the defense of an action brought against the insured, without disclaiming liability and giving notice of its reservation of rights, it is thereafter precluded in an action upon the policy from setting up such ground of forfeiture or noncoverage. In other words, the insurer’s unconditional defense of an action brought against its insured constitutes a waiver of the terms of the policy and an estoppel of the insurer to assert such grounds.”
When the insurer concedes full coverage, the tripartite relationship among the policyholder, the insurer, and their shared lawyer is simple and clear. The policyholder has no monetary exposure in the lawsuit, except a modest deductible and possible exposure in excess of policy limits. The policyholder’s role is essentially limited to that of a witness. As the only participant with financial exposure, the insurer has the contractual right to control the defense and settlement in the name of the policyholder. The insurer and the policyholder usually have no conflicts of interest because everybody knows that the insurer and only the insurer will pay. The insurer chooses the lawyer to represent the policyholder and to protect the insurer’s money. Dependent counsel cannot do anything to harm the policyholder’s economic interests (because he has none), so no conflict of interest usually troubles one lawyer representing two clients. The defense team of policyholder, insurer and its lawyer may work harmoniously, united as uncompromising allies in opposing the plaintiff – so long as the insurer concedes coverage.
Two Forms of Coverage Denial
An insurer’s denial of coverage may take two forms: 1) a complete denial of all coverage, or 2) a conditional agreement to advance defense costs while reserving rights to later deny all coverage. If the insurer denies all coverage, it may not control the defense or settlement and may not enforce several contractual provisions. If the insurer’s denial is wrongful, the normally adversarial relationship between the plaintiff and the policyholder may yield to an incentive to cooperate to resolve their lawsuit by an independent adjudication or a settlement with favorable presumptions of liability and damages which the defaulting insurer may find difficult to resist.
When the insurer agrees to defend under a reservation of rights, the insurer may seek reimbursement of all defense and settlement costs. Under such circumstances, the plaintiff and the policyholder may cooperate properly. While insurers and their lawyers may complain that cooperating plaintiffs and policyholders are guilty of fraud and collusion, the application of these concepts to liability insurance is quite limited. Because a reservation of rights serves to warn the policyholder that the insurer may not pay so that the policyholder must, the harmonious tripartite relationship may dissolve into cacophony. Traditional relationships may become “torn and shredded.”
Relationships Are Altered by a Coverage Denial
The Plaintiff and the Defendant/Policyholder
When the insurer denies coverage in either form, the plaintiff and the policyholder remain adversaries, but they may develop an incentive to focus on their common goals without forgetting their differences. This may create a tense, but workable arrangement. The plaintiff and the policyholder may no longer be uncompromising adversaries – just cautious friendemies. Both the plaintiff and the policyholder may unite in their shared desire for a prompt closure with a fair and equitable settlement funded by the insurer.
Both the plaintiff and the policyholder want many of the same things from litigation, including ending it, soon, at minimum expense, and without unnecessary effort. Both the plaintiff and the policyholder benefit by prompt closure. Litigation is a distraction which keeps them from more productive enterprises. Neither want to drag out the litigation process. Neither want to pay for lawyers to conduct the fight. Even if the plaintiff thinks she can collect from the policyholder directly, she may prefer to collect more easily from the insurer. Plus, there is a risk that the defendant will be impecunious with dwindling assets and secret, unreachable bank accounts in the Grand Cayman Islands.
The Policyholder and the Insurer
Upon the denial of coverage, the insurer and the policyholder may continue to try to defeat or minimize the plaintiff’s claim, tempered by the realization that the vast majority of civil cases settle. The insurer may still want to control the defense and settlement, notwithstanding its denial of all financial liability. The policyholder may develop an incentive to focus on their differences without forgetting their common goals. Relationships may become strained. The policyholder and his insurer may no longer be uncompromising allies. Instead, the relationship may become quite complex.
As a result, the insurer may develop an incentive for the defense of the plaintiff’s lawsuit to produce evidence that the policyholder is legally liable for wrongdoing that is not covered by its policy. In contrast, the policyholder wants the opposite. The policyholder may develop an incentive for the defense of the plaintiff’s lawsuit to produce evidence that the policyholder is legally liable for wrongdoing that is covered by his policy.
Important disputes may erupt promptly. Who gets to control the policyholder’s defense? Who gets to select and direct the policyholder’s lawyer? Who has to pay for the defense? How much? Who controls settlement?
The Policyholder and Dependent Counsel
Similarly, upon the insurer’s denial of coverage, the policyholder and dependent counsel may no longer be uncompromising allies. Instead, dependent counsel must walk an ethical tightrope. Dependent counsel now has two clients who may not share the same goals in the litigation. The insurer’s chosen lawyer may have the power to direct the lawsuit to an outcome which favors one client while harming the other. The harmonious tripartite relationship may dissolve into an acrimonious menage a trois.
Often, dependent counsel cannot ethically represent both the policyholder as a defendant and the economic interests of the insurer as a financier who may end up paying. Dependent counsel may be disqualified from representing the policyholder if any issue in the liability suit is related to issues in the coverage dispute.
 See, Ins. Code § 11580.
 Miller v. Elite Ins. Co. (1980) 100 Cal.App.3d 739, 754.
 But see fn. 4 & 5 articles for a discussion of conflicts arising with a policy limit settlement offer.
 American Mut. Liab. Ins. Co. v. Superior Court (1974) 38 Cal.App.3d 579, 593 (“The situation has changed. Partners have become adversaries. The closely knit fabric of confidentiality is torn and shredded.”)
 In contrast, neither the insurer nor its lawyers may support a quick, cheap or fair resolution. “Such a [liability] policy handcuffs the insured’s ability to protect himself and creates a fiduciary agency between the two. The interests of the insurer are to delay payment or indulge in other tactical conduct to achieve frugal disposition of claims or reject them. The interest of the insured is that claims against him be finally disposed of as promptly as good faith and fair dealing requires.” (Gruenberg v. Aetna Ins. Co. (1973) 9 Cal.3d 566, 582.)
 San Diego Navy Fed. Credit Union v. Cumis Ins. Society, Inc. (1984) 162 Cal.App.3d 358, 366 (“As between counsel’s two clients, there is no confidentiality regarding communications intended to promote common goals (Evid. Code, § 962). But confidentiality is essential where communication can affect coverage. Thus, the lawyer is forced to walk an ethical tightrope, and not communicate relevant information which is beneficial to one or the other of his clients.”)