Tripartite Relationship: When Harmony Turns to Dissonance

Prologue
“Take my wife – Please!” (Henny Youngman)

Introduction
There are complex relationships among a liability insurer, its policyholder, and their common lawyer that arise when an injured plaintiff makes a claim against the policyholder. The insurer-policyholder relationship is defined by contract and insurance regulations. The common lawyer (here described as “dependent counsel”) has an attorney-client relationship with both the insurer and the policyholder, which are governed by contract and ethics. So long as no conflicts of interest cleave the insurer from the policyholder, dependent counsel may harmoniously represent both. But if any conflicts of interest arise, the common lawyer must comply with Canons of Ethics. Dependent counsel may be tempted to favor the insurer over the policyholder because the lawyers get virtually all of their business from insurers. If the policyholder does not waive conflicts of interest, dependent counsel must quit and the insurer must pay for independent counsel to conduct the policyholder’s defense.
The Liability Insurer – Policyholder Relationship
Liability insurance is a regulated industry in which insurer’s owe fiduciary-like duties to the policyholder arising from statutes, regulations, and case law. The insurer-policyholder relationship arises from the policy contract, insurance regulations, and law. “Insurance is a contract whereby one undertakes to indemnify another against liability” by which the insurer agrees “to pay on behalf of” the policyholder a judgment entered against the policyholder, even though the insurer is not a party to the lawsuit resulting in the judgment. Cases holding that “the judgment in the underlying action is conclusive as to the insurer’s liability hold only that if factual matters upon which the issue of coverage turns are expressly or impliedly determined in the prior action such determinations bind the insurer in the subsequent suit to enforce the provisions of the policy.” The doctrine of collateral estoppel generally binds an insurer to the outcome of a plaintiff’s lawsuit.
“[T]he insurer’s duty to defend entails the rendering of a service, viz., the mounting and funding of a defense in order to avoid or at least minimize liability.” “An indemnity against liability embraces the costs of defense incurred [by the policyholder] in good faith. The [insurer] is bound to defend actions brought against [the policyholder], but [the policyholder] has the right to conduct such defenses, if he chooses to do so. If the [insurer] neglects to defend the [policyholder], a recovery against the [policyholder] suffered by him in good faith, is conclusive in his favor against the [insurer].”
Liability Insurer – Dependent Counsel Relationship
The relationship between a liability insurance company and dependent counsel is both unique and ubiquitous. Liability insurance is one of the few written business contracts by which someone agrees to hire a lawyer for someone else while seeking to control the lawyer and has a prearranged stable ready to fill the bill, all of whose loyalty are thus suspect. Hundreds of liability insurers hire hundreds of thousands of dependent counsel annually. “[The] courts have acknowledged the existence of an attorney-client relationship between an insurer and the counsel it hires to represent the insured.” “As a practical matter, however, there has been recognition that, 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.” “Insurance companies hire relatively few lawyers and concentrate their business. A lawyer who does not look out for the [insurer]’s best interest might soon find himself out of work”. “Common logic dictates that counsel for [the insurer] would be inclined to bend his efforts, however unconsciously, toward establishing that any recovery by [the plaintiff] would be grounded on the theory of [the plaintiff’s] claim which was not covered by the policy.” “[W]e simply cannot ignore the practical reality that the insurer may seek to exercise actual control over its retained attorneys in this context. [I]t would be imprudent for this Court to hold that attorneys are independent contractors vis-à-vis insurers, but then to ignore the practical realities of that relationship when it causes injury.”
Dependent Counsel – Policyholder Relationship
The attorney client relationship is sacrosanct in the law. What sets the American system of justice apart from many other arrangements in the world is the integrity of its participants. To assure that integrity, lawyers are regulated by the State Bar, the State Bar Act, and Canons of Ethics. The Constitutional guarantee of procedural due process is meaningless if lawyers cannot be trusted to fulfill their four primary duties to their clients: 1) undivided loyalty; 2) disclosure; 3) confidentiality; and 4) competence.
“One of the principal obligations which bind an attorney is that of fidelity, the maintaining inviolate the confidence reposed in him by those who employ him, and at every peril to himself to preserve the secrets of his client. This obligation is a very high and stringent one. It is also an attorney’s duty to protect his client in every possible way, and it is a violation of that duty for him to assume a position adverse or antagonistic to his client without the latter’s free and intelligent consent given after full knowledge of all the facts and circumstances. By virtue of this rule an attorney is precluded from assuming any relation which would prevent him from devoting his entire energies to his client’s interests. Nor does it matter that the intention and motives of the attorney are honest. The rule is designed not alone to prevent the dishonest practitioner from fraudulent conduct, but as well to preclude the honest practitioner from putting himself in a position where he may be required to choose between conflicting duties, or be led to an attempt to reconcile conflicting interests, rather than to enforce to their full extent the rights of the interest which he should alone represent.”
“In the insured-insurer relationship, the attorney characteristically is engaged and paid by the [insurer] to defend the insured. If the matter reaches litigation, the attorney appears of record for the insured and at all times represents him. In such a situation, the attorney has two clients.” “In California, it is settled that absent a conflict of interest, an attorney retained by an insurance company to defend its insured under the insurer’s contractual obligation to do so represents and owes a fiduciary duty to both the insurer and insured.” “The lawyer’s duty to his client arises from his contractual obligation as well as ethical demands. When a lawyer negligently advises his client, a violation of his duty occurs.” “It is a well accepted and oft repeated principle that the attorney retained by the insurance company for the purpose of defending the insured under the insurance policy owes the same duties to the insured as if the insured had hired the attorney him or herself.” “However, whether in the insurer-insured context or otherwise, the attorney who undertakes to represent parties with divergent interests owes the ‘highest duty’ to each to make a ‘full disclosure of all facts and circumstances which are necessary to enable the parties to make a fully informed decision regarding the subject matter of litigation, including the areas of potential conflict and the possibility and desirability of seeking independent legal advice.’”
Generally, lawyers may not represent clients with conflicting interests. Rules of Professional Conduct, Rule 1.7(a) provides: “a lawyer shall not represent a client if the representation involves a concurrent conflict of interest”. However, a “lawyer may represent a client if the representation does not involve the assertion of a claim by one client against another client.” These ethical rules are designed to prevent the lawyer from doing harm. “The primary purpose of this prophylactic rule [1.7] is to prevent situations in which an attorney might compromise his or her representation of the client.” “[T]he purpose of a [lawyer] disqualification order must be prophylactic, not punitive.”
The Harmonious “Tripartite Relationship” When No Conflicts of Interest Exist
“In California, it is settled that absent a conflict of interest, an attorney retained by an insurance company to defend its insured under the insurer’s contractual obligation to do so represents and owes a fiduciary duty to both the insurer and insured. So long as the interests of the insurer and the insured coincide, they are both the clients of the defense attorney and the defense attorney’s fiduciary duty runs to both the insurer and the insured. [T]he attorney retained by the insurance company for the purpose of defending the insured under the insurance policy owes the same duties to the insured as if the insured had hired the attorney him or herself. In the insured-insurer relationship, the attorney characteristically is engaged and paid by the carrier to defend the insured. The insured and the insurer have certain obligations each to the other arising from the insurance contract. Both the insured and the carrier have a common interest in defeating or settling the third party’s claim. If the matter reaches litigation, the attorney appears of record for the insured and at all times represents him in terms measured by the extent of his employment. In such a situation, the attorney has two clients whose primary, overlapping and common interest is the speedy and successful resolution of the claim and litigation. Conceptually, each member of the trio, attorney, client-insured, and client-insurer has corresponding rights and obligations founded largely on contract, and as to the attorney, by the Rules of Professional Conduct as well. The three parties may be viewed as a loose partnership, coalition or alliance directed toward a common goal, sharing a common purpose which lasts during the pendency of the claim or litigation against the insured. Communications are routinely exchanged between them relating to the joint and common purpose – the successful defense and resolution of the claim. Insured, carrier, and attorney, together form an entity – the defense team – arising from the obligations to defend and to cooperate, imposed by contract and professional duty. This entity may be conceived as comprising a unitary whole with intramural relationships and reciprocal obligations and duties each to the other quite separate and apart from the extramural relations with third parties or with the world at large. Together, the team occupies one side of the litigating arena.” This seemingly idyllic harmony of the tripartite relationship is conditioned upon the absence of any conflict of interest. Reported cases describing the tripartite relationship concur.
Harmony Becomes Dissonance When Conflicts of Interest Emerge
“A different situation is presented, however, when some or all of the allegations in the complaint do not fall within the scope of coverage under the policy. Opposing poles of interest are represented.” “In certain circumstances a conflict of interest between insurer and insured will trigger the insured’s right to retain independent counsel at the insurer’s expense.” “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 interests of his real client – the one who is paying his fee and from whom he hopes to receive future business – the insurance company. Matthew 6:24 retains a particular relevancy, ‘No man can serve two masters’. [T]he conflict situation cannot be eliminated so long as the insurance company selects the counsel. It is simply a matter of human nature.” “The tranquility of this coalition is disturbed however, where disagreement arises between the members. Dissatisfaction may disrupt the harmony of the arrangement. [T]he attorney must withdrawn from further representation of the insured in all pending matters involving the insured. The situation has changed. Partners have become adversaries. The closely knit fabric of confidentiality is torn and shredded.”
1. Dependent Counsel Has the Burden of Conflict Analysis, Disclosure, and Consent
In the Attorney-Client relationship it is the lawyer, not the client, who bears the burden of resolving potential conflicts of interest. Rule 1.7 prohibits a lawyer from representing dual clients with conflicting interests unless the lawyer: 1) analyzes potential conflicts of interest; 2) makes written disclosure to the policyholder; and 3) if an actual conflict of interest exists, obtains both clients’ informed written consent.
There is considerable confusion in the law regarding the distinction between “potential” and “actual” conflicts of interest. Thorough research has disclosed no definition of either ilk of conflict. “[The insurer] makes a distinction between ‘potential’ and ‘actual’ conflicts of interest which is invalid and unworkable. [W]hen coverage is disputed, the interests of the insured and the insurer are always divergent.” “But where the [insurer] questions the availability of coverage and provides a defense in the third party action subject to a reservation of rights, a conflict exists – because the insured’s goal is coverage, which flies in the face of the insurer’s desire to avoid its duty to indemnify.” Still, some courts enforce a distinction in the magnitude of a conflict. “ [T]here can be a cause of action for failure to compensate independent counsel retained by an insured [which] lies where there is a conflict of interest of such magnitude that the courts impose a duty on the insurer to provide independent counsel to the insured.” “A mere possibility of an unspecified conflict does not require independent counsel. The conflict must be significant, not merely theoretical, actual, not merely potential.” But the simple truth is that no one can know whether circumstances create a potential or actual conflict of interest until a thorough analysis has been concluded.
“Conflicts [of interest] come in all shapes and sizes”. Proper conflict analysis “must therefore consider whether a conflict of interest exists and not simply look for a reservation of rights.” “Some of the circumstances that may create a conflict of interest requiring the insurer to provide independent counsel include: (1) where the insurer reserves its rights on a given issue and the outcome of that coverage issue can be controlled by the insurer’s retained counsel; (2) where the insurer insures both the plaintiff and the defendant; (3) where the insurer has filed suit against the insured, whether or not the suit is related to the lawsuit the insurer is obligated to defend; (4) where the insurer pursues settlement in excess of policy limits without the insured’s consent and leaving the insured exposed to claims by third parties; and (5) any other situation where an attorney who represents the interests of both the insurer and the insured finds that his or her ‘representation of the one is rendered less effective by reason of his [or her] representation of the other.’” Neither the insurer nor dependent counsel may not give conflict analysis short shrift. “[I]t was simply wishful thinking by [dependent counsel] when he [or she summarily denied the existence of any conflicts of interest].”
As the beneficiary in a fiduciary relationship, the policyholder has no corresponding duty to anyone to analyze conflicts of interest.
2. The Shared Duty to Advise the Policyholder of the Right to Independent Counsel
Both dependent counsel and the insurer share the duty to advise the policyholder of conflicts of interest and the right to independent counsel.
A. Dependent Counsel’s Fiduciary Duty to Analyze Potential Conflicts of Interest
“The conflict situation [places] a duty squarely on the attorney for the insurer to withdraw from representation or make full disclosure to both clients in the event of a conflict between them, or risk exposure to liability for harm resulting from his failure so to act, as well as to a charge of professional misconduct.” “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.” “In short, an attorney representing two parties with divergent interests must disclose all facts and circumstances which, in the judgment of a lawyer of ordinary skill and capacity, are necessary to enable his client to make free and intelligent decisions regarding the subject matter of the representation”
B. The Insurer’s Duty to Analyze Potential Conflicts of Interest
The policyholder’s right to have independent counsel paid for by the insurer is a policy benefit. “Every insurer shall disclose to a [policyholder] all benefits that might reasonably be payable and cooperate with and assist the insured in determining the extent of the insurer’s additional liability.” “Moreover, attorneys may be liable for participation in tortious acts with their clients, and such liability may rest on a conspiracy. By parity of reasoning, an insurer may be held liable for participation in tortious acts with attorneys it hires on behalf of its insured. Conspiratorial conduct on the part of insurers to avoid the contractual liability they undertake is not countenanced in California.” “It seems doubtful that the conflict of interest can be avoided merely by the insurer’s instructing defense counsel to ignore coverage defenses. Insureds are likely to contend that defense counsel will make litigation decisions with the insurer’s interests in mind even if instructed by the insurer not to do so (after all, the insurer is paying counsel’s bills, etc.). Also, this holding requires ‘hindsight evaluation’ as to the adequacy of defense counsel’s representation.”
Conflict Analysis Among Insurer, Policyholder, and
Dependent Counsel Is Like Three Dimensional Chess
Civil litigation is analogous to chess, the ancient Persian game that simulates war. But complex civil litigation in which conflicts of interest infect the relationship among a liability insurer, its policyholder, and their common lawyer is analogous to three-dimensional chess. Instead of one checkerboard, there are three, each representing a venue on which three tussles play out: 1) a liability dispute in which an injured plaintiff opposes the policyholder; 2) a coverage contest in which the insurer opposes the policyholder; and 3) an ethical imbroglio in which dependent counsel opposes the policyholder. While the tussles fought in each of these venues are distinct, they are closely related with many participants free in move onto each playing field, lending assistance or wreaking havoc. While the harmonious tripartite relationship correctly describes the defense team’s respective roles of insurer (as financier), policyholder (as witness), and dependent counsel (as warrior) in the liability dispute, conflicts of interest greatly complicate this model. With conflicts, the defense team may still maintain a shared goal of minimizing or defeating a plaintiff’s liability dispute, but the team members simultaneously oppose each other in the other venues. Because the players may move freely among the venues, alternately supporting or opposing each other, their relationships are far more complex than may appear at first glance.

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