MEMORANDUM OF LAW

COMPENDIUM OF CONFLICTS OF INTEREST

INTRODUCTION

A liability dispute between a plaintiff and a defendant is a simple binary contest - mano a mano. When a liability insurer concedes full coverage, the traditional tripartite relationship1 among the policyholder (as witness) insurer (as financier), its lawyer (as joint advocate) coalesce as a defense team that operates in apparent idyllic harmony, dedicated to a single goal of defeating or minimizing the plaintiff's claim. With no money at risk in the action, the policyholder can afford to indulge in pride over profit.2 The defense team is like the Three Musketeers: "All for one and one for all."

But when a liability insurer denies coverage, the binary liability dispute between plaintiff and defendant may be supplemented by a simultaneous coverage dispute that may shatter this harmony. In its replace, 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. "All for one and one for all" may become a free-for-all.

TIME

The existence of a liability dispute and a coverage dispute implies a threat that resolution of these two disputes may take longer that would have been required if there were no coverage dispute. While entitled to priority in trial setting, a declaratory relief complaint to resolve a coverage dispute of consequence may be stayed if its subject matter is "related" to any disputed issue of fact or law that is being litigated in the liability dispute. "To eliminate the risk of inconsistent factual determinations that could prejudice the insured, a stay of the declaratory relief action pending resolution of the third party suit is appropriate when the coverage question turns on facts to be litigated in the underlying action. . . . By contrast, when the coverage question is logically unrelated to the issues of consequence in the underlying case, the declaratory relief action may properly proceed to judgment."3 Still, getting a coverage suit on file early may serve to advance its trial date because trial judges are likely to dispose of old cases before new ones.

EXPENSE

Prosecuting or defending two lawsuits is more expensive than just one lawsuit. Still, actively pursuing resolution of a coverage dispute may produce revenue from the insurer.

COMPLEXITY

The conduct of the defense of a liability dispute may impact the conduct of a coverage dispute by application of the doctrines of res judicata and collateral estoppel.4 "An insurer is bound by a judgment in the [liability] action as to all material findings of fact essential to the judgment of liability of the insured. The insurer is not bound, however, as to issues not necessarily adjudicated in the prior action."5 An insurer may or may not be bound by the outcome of a liability dispute depending on whether it has faithfully performed its duty to defend and whether it has adequately reserved its rights.6 "[T]he insured may be collaterally estopped from relitigating any adverse factual findings in the third party action, notwithstanding that any fact found in the insured's favor could not be used to its advantage."7

ARRAY OF POSSIBLE CONFLICTS OF INTEREST

A.	Policyholder v. Insurer

"[W]hen coverage is disputed, the interests of the insured and the insurer are always divergent."8 Their adverse interests are likely to invade all aspects of both the liability dispute and the coverage dispute. If the insurer seeks reimbursement from its policyholder of the costs of defense9 or the costs of settlement,10 the policyholder may develop an incentive to confess covered liability.11 The policyholder and the plaintiff may cooperate with each other12 provided that do not commit fraud or collusion.13 However, collusion is a very limited defense14 so that as a practical matter there is very little an insurer can do to prevent nor complain about a policyholder and a plaintiff from cooperating properly. The plaintiff may choose to plead into or out of coverage15 and both the policyholder and the plaintiff may truthfully testify into or out of coverage.16

"When an offer is made to settle a claim in excess of policy limits for an amount within policy limits, a genuine and immediate conflict of interest arises between carrier and assured."17 "In such a situation, it will always be to the insured's advantage to have settlement effected within policy limits; the insurer, in deciding whether to compromise a claim, must consider the insured's best interests as much as its own."18 "'[A] belief that the policy does not provide coverage . . . should not affect a decision as to whether the settlement offer in question is a reasonable one."19

B.	Policyholder v. Dependent Counsel

Dependent counsel has a fiduciary relationship with the policyholder20 that creates a host of nearly sacred duties.21 But dependent counsel always represents the insurer as a client22 and is always beholden to the insurer upon whom dependent counsel relies for a livelihood.23 "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."24 "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."25 "[D]efense counsel and the insurer frequently have a longstanding, if not collegial, relationship."26

When an insurer reserves rights to deny coverage to its policyholder,27 dependent counsel must comply with Rule 3-310 governing dual representation of clients with adverse interests.28 "[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."29 Still, some dependent counsel are reluctant to comply with ethical obligations.30 Dependent counsel have disqualifying conflicts of interest anytime an insurer's reservation of rights raises issues that are related to the liability dispute.31 A policyholder may fire dependent counsel at any time for any reason.32

C.	Plaintiff v. Defendant

While a plaintiff and a defendant are always adverse to one another in a liability dispute, they are usually simpatico regarding coverage in that both benefit by the insurer protecting the policyholder by paying the plaintiff. A plaintiff and a defendant may cooperate with each other to achieve their shared goals33 provided they are not guilty of collusion.34 Still, additional conflicts of interest may arise between a plaintiff and a defendant in a coverage dispute, especially regarding who may collect how much in a joint action against the insurer.35

D.	Plaintiff v. Plaintiff's Counsel

The existence of both a liability dispute and a coverage dispute may create conflicts between a plaintiff and plaintiff's counsel regarding an appropriate fee, especially when the successful prosecution of a liability suit produces no collectible revenue and requires the prosecution of a second lawsuit against a defaulting insurer.36

E.	Policyholder v. Independent Counsel

While independent counsel does not have the same conflicts of interest problems that burden dependent counsel,37 conflicts may nonetheless arise regarding ethical payment by the insurer for defending the liability dispute38 and negotiating a settlement with the plaintiff including an assignment of rights, a division of recovery, and which lawyers will be paid for what effort in pursuing recovery from a defaulting insurer.39

F.	Dependent Counsel v. Insurer

Just as a reservation of rights creates conflicts of interest dependent counsel with the policyholder client, parallel conflicts arise with dependent counsel's insurer client. Despite the close relationship between dependent counsel and the insurer, California law recognizes a differential in the degree of loyalty that dependent counsel owes to the two clients that favors the policyholder. "The attorney's primary duty has been said to be to further the best interests of the insured."40 Dependent counsel has "enhanced" duties to the policyholder.41 Dependent counsel cannot avoid these conflicts simply by the insurer instructing the lawyer to ignore coverage issues.42 Dependent counsel may not disclose to the insurer certain confidential information learned from the policyholder.43 Dependent counsel may not attack the policyholder's credibility in order to protect the insurer.44 Dependent counsel may be civilly liable to the policyholder for conspiracy with the insurer to harm the policyholder.45