Top Ten: Policyholder Coverage Responses

INTRODUCTION

When a defendant with liability insurance gets sued, the insurer has ten critical coverage decisions to make.[1] If the insurer challenges coverage, the policyholder also has ten critical coverage decision to make, including whether the policyholder should:

1. Cooperate With the Plaintiff?

2. Develop Evidence of the Insurer’s Decisions?

3. Seek a Judicial Determination of Conflicts of Interest?

4. Challenge Dependent Counsel’s Ethics?

5. Develop Evidence of Ethical Violations?

6. Accept Representation by Dependent Counsel?

7. Hire Independent Counsel?

8. Settle with the Plaintiff?

9. Sue and If So, When?

10. Resist the Insurer’s Reimbursement Claims?

No. 1. Should the Policyholder Cooperate With the Plaintiff? Notwithstanding the fact that the plaintiff and the policyholder are adversaries in the liability dispute, they may properly cooperate with each other to try to win a coverage dispute.[2] Because the policyholder is involved in not one, but two disputes, cooperation between the policyholder and the plaintiff in the coverage dispute is fundamentally no different than cooperation between the policyholder and the insurer in the liability dispute. The policyholder has a contractual duty to cooperate with the insurer that generally includes a duty to appear and truthfully testify at deposition and trial.[3] However, the policyholder has no contractual, statutory, regulatory, nor common law prohibition against plaintiff cooperating with the plaintiff to resist an insurer’s coverage challenge. There is a legal prohibition against fraud and collusion.[4] The difference between cooperation and collusion is clear in the law.[5]

No. 2. Should the Policyholder Develop Admissible Evidence of the Insurer’s Decisions? A policyholder and separately a plaintiff may decide to actively develop admissible evidence of the insurer’s ten critical decisions. Insurers do not always clearly or completely explain the decisions they have made. It is quite easy to seek and obtain clarification of the decisions the insurer has make and the nature and extent of conflicts of interest created by the insurer’s reservation of rights: Just ask. “Upon receiving any communication from a [policyholder or a plaintiff] regarding a claim, that reasonably suggests that a response is expected, every [insurer] shall immediately, but in no event more than fifteen (15) calendar days after receipt of that communication, furnish the claimant with a complete response based on the facts as then known by the [insurer].”[6] There are two distinct lines of cases in California law; in one of which the policyholder always wins[7] and in the other of which the insurer always wins.[8] There are two major differences between these lines of cases: 1) the policyholder wins when admissible evidence illuminates conflicts of interest; and 2) the policyholder wins when the conflict of interest issues are resolved while the liability dispute is still pending.[9]

No. 3. Should the Policyholder Seek a Judicial Determination of Conflicts of Interest? A policyholder may decide whether, and if so when, to seek to resolve an array of conflict of interest issues. These may include whether the insurer’s reservation of rights creates any disqualifying conflicts,[10] whether dependent counsel must comply with Rule 3-310,[11] and whether the insurer qualifies for the protections of Civil Code §2860.[12] There are several procedural options available by which conflict of interest issues may be resolved.[13]

No. 4. Should the Policyholder Challenge Dependent Counsel’s Ethics? The policyholder may decide whether to enforce the ethical obligations of dependent counsel. The attorney client relationship[14] is such that the attorney owes numerous fiduciary duties to the policyholder.[15] By definition, dependent counsel always represents the insurer as a client even though the insurer is not typically a party to the plaintiff’s lawsuit[16] and enjoys a special relationship with the insurer. “As 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.”[17] “Insurance 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.”[18] “[D]efense counsel and the insurer frequently have a longstanding, if not collegial, relationship”.[19] As a result of this special relationship, dependent counsel is beholden to the insurer.[20] Because an insurer’s reservation of rights always creates some conflicts of interest[21] and because dependent counsel represents two client, the insurer and the policyholder, the lawyer must comply with ethical requirements regulating joint representation.[22] Thus, when an insurer reserves rights, dependent counsel must comply with Rule 3-310 in order to ethically represent the policyholder.[23]

No. 5. Should the Policyholder Develop Admissible Evidence of the Dependent Counsel’s Ethical Violations? Dependent counsel well know the foregoing body of law requiring compliance with Rule 3-310 when the insurer reserves rights. However, some dependent counsel have developed many excuses for not complying.[24] Often, the policyholder just acquiesces to the breach.[25] It is very easy for a policyholder to compel ethical compliance by dependent counsel: Just ask.[26] Most policyholders may resolve dependent counsel’s ethical obligations with as few as three letters to the lawyer.[27] These letters progressively: 1) request strict compliance with Rule 3-310; 2) ask that dependent counsel complete a ethical questionnaire; and 3) expressly withhold consent and authorization for the lawyer to represent the client.

 

No. 6. Should the Policyholder Accept Representation by Dependent Counsel? There are several common situations in which the policyholder should accept legal representation by dependent counsel. These include: 1) when the insurer asserts no reservation of rights; 2) when an insurer does assert a reservation of rights, but it does not create any disqualifying conflict of interest[28] because the grounds for challenging coverage “have nothing to do with”[29] the subjectI matter of the plaintiff’s lawsuit; 3) dependent counsel complies with Rule 3-310; or 4) dependent counsel is limited to monitoring the work of independent counsel. Dependent counsel may have a right to “participate” in the defense if the insurer qualifies[30] for the protections of Civil Code §2860.[31] However, accepting representation by dependent counsel may be especially dangerous when dependent counsel drafts discovery responses and coaches the policyholder to give sworn testimony if there is a risk that such verified statements may adversely impact coverage.

No. 7. Should the Policyholder Hire Independent Counsel? If an insurer’s reservation of rights creates any disqualifying conflict of interest, the policyholder may select and direct independent counsel to conduct the policyholder’s defense at the insurer’s expense.[32] Some insurers may refuse to pay for independent counsel by denying that a disqualifying conflict of interest exists, often improperly insisting that the policyholder carry the burden of establishing the existence of a conflict.[33] The insurer may be required to pay independent counsel within 40 days.[34] Unless the insurer qualifies for the protections of Civil Code §2860,[35] it must pay the full hourly rates charged by independent counsel[36] plus interest.[37]

No. 8. Should the Policyholder Settle with the Plaintiff? Several contractual provisions of a standard liability policy confer upon the insurer the right to control settlement.[38] As a rule, the insurer may not be required to pay a settlement reached without its consent. However, an insurer that is itself in breach of its duty to defend may be precluded from enforcing such provisions of the policy. As a result, the insurer may lose control of the defense[39] and the policyholder may be free to reach a reasonable, non-collusive settlement with the plaintiff and require the insurer to pay it.[40] Such settlements carry favorable evidentiary presumptions in a subsequent action to require the insurer to pay the settlement.[41] Procedural due process concerns simply do not permit a policyholder and a plaintiff to set-up an insurer, even a defaulting insurer, who are liberally permitted to challenge the bona fides of a settlement so as to avoid fraud and collusion.[42]

No. 9. Should a Policyholder Sue the Insurer and/or Dependent Counsel and If So, When? When an insurer reserves its right to later deny coverage to its policyholder, most resulting points of contention may be resolved by clear written communication. Even recalcitrant and reluctant insurers who are accustomed to having their own way with acquiescing policyholders are not likely to risk bad faith liability to a policyholder who has carefully developed admissible evidence of conflicts of interest. However, if it becomes necessary to seek judicial rulings regarding conflicts of interest and the duties of insurers and dependent counsel, then timing becomes critical. Courts that are asked to rule on these issues while the plaintiff’s liability suit is still pending tend to apply a foresight test that is favorable to the policyholder. In contrast, courts that are asked to rule on these issues after the plaintiff’s liability suit is resolved tend to apply a hindsight test that is favorable to the insurer.[43] Because an insurer’s obligation to pay for independent counsel is directly related to dependent counsel’s ethical compliance to the policyholder, it is usually important for the policyholder to address and resolve both dependent counsel’s obligations to comply with Rule 3-310 and to resolve the insurer’s obligations to pay for the policyholder’s defense through independent counsel. Also, federal diversity jurisdiction may be destroyed if a policyholders sues dependent counsel (both of whom usually reside in California) and the insurer (that is often domiciled outside of California).

No. 10. Should the Policyholder Resist the Insurer’s Reimbursement Claims? An insurer must specifically reserve its right to seek reimbursement of defense costs[44] at the time that it agrees to provide a defense.[45] Defense costs allocable to claims that are potentially or actually covered are not reimbursable while defense costs allocable to claims that were never even potentially covered are reimbursable. Thus, the insurer’s claim for reimbursement of defense costs requires the introduction of evidence as to how much time defense counsel spent on each category of claim. Because of the close business relationship between the insurer and dependent counsel, the insurer’s chosen lawyer is logically more likely to give testimony that is favorable to the insurer and unfavorable to the policyholder. This creates an incentive for the policyholder to retain independent counsel to conduct the defense, who is logically more likely to give testimony that is favorable to the policyholder and unfavorable to the insurer. Also it may be important for the policyholder to expressly withhold consent from dependent counsel to accept compensation from the insurer.[46] If dependent counsel accepts compensation from the insurer in violation of Rule 3-310(F), dependent counsel may be required to disgorge the unlawful fees or the insurer may be barred from recovering reimbursement of the unlawfully paid fees.[47] An insurer must specifically reserve its right to seek reimbursement of settlement costs[48] at the time of settlement.[49] A policyholder may effectively avoid the insurer’s reimbursement in a number of ways.[50] The policyholder may take back the defense, split the settlement among multiple policyholders, or by the “third option” of rejecting the settlement while absolving the insurer of bad faith liability for not settling.

 

 


[2] See, Practice Pointer: Cooperation: A Strategic Choice.

[6] Code of Regs. §2695.5.

[7] See, Article: Cumis Line of Cases.

[8] See, Article: Dynamic Concepts Line of Cases.

[9] See, Article: Difference Between the Cumis and Dynamic Concepts Lines of Cases.

[17] Purdy v. Pacific Automobile Ins. Co.(1984) 157 Cal.App.3d 59, 76.

[18] San Diego Navy Fed. Credit Union v. Cumis Ins. Society, Inc. (1984) 162 Cal.App.3d 358, 364 (Cumis).

[19] Gulf Ins. Co. v. Berger, Kahn, Shafton, Moss, Figler, Simon & Gladstone (2000) 79 Cal.App.4th 114, 131.

[23] “[T]he 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. . . . Disregarding the common interests of both insured and insurer in finding total nonliability in the third party action, 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.)

[25] See, Practice Pointer: Acquiescence Is Dangerous.

[26] See, Practice Pointer: Develop Admissible Evidence.

[27] See, Action Guide: Policyholder Challenges Ethics of Conflicted Dependent Counsel.

[29] “[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.)

[31] “[T]he counsel provided by the insurer . . . shall be allowed to participate in all aspects of the litigation. . . consistent with . . . counsel’s ethical and legal obligation to the insured.” (Civil Code § 2860(f)).

[32] “[I]n the absence of [policyholder] 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. . . . [The] 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.)

[33] See, Practice Pointer: Burden to Establish the Existence of a Disqualifying Conflict of Interest.

[37] See, Article: Prejudgment Interest.

[38] See, Article: Control of Settlement" href="http://dutytodefend.com/control-of-settlement/">Control of Settlement.

[42] See, Practice Pointer: No Such Thing as a Set-Up.

[43] See, Article: Difference Between the Cumis and Dynamic Concepts Lines of Cases.

[45] “[I]n order to obtain reimbursement for defense costs, the insurer must reserve its right thereto. To the extent that this right is implied in law as quasi-contractual, it must indeed be reserved.” (Buss v. Superior Court (1997) 16 Cal.4th 35, 61, fn. 27.)

[46] “A [lawyer] shall not accept compensation for representing a [policyholder] from [an insurer] unless . . . The [lawyer] obtains the client’s informed written consent.” (Rule 3-310(F).)

[49] “[I]n an action in quasi-contract . . . , a demand is ordinarily a necessary prerequisite.” (Blue Ridge Ins. Co. v. Jacobsen (2001) 25 Cal.4th 489, 501.)

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