MEMORANDUM OF LAW

GOOD FAITH RELIANCE ON ADVICE OF COUNSEL

INTRODUCTION

Good faith reliance on the advice of counsel is an evidentiary defense available to insurers accused of bad faith. A liability insurer may be guilty of bad faith for a decision to deny or delay paying a policy benefit that is unreasonable or made without proper cause. Evidence that it consulted an attorney may support its claim that its denial of coverage was reasonable or was made with reasonable cause.

RELIANCE ON THE ADVICE OF COUNSEL

An evidentiary defense to bad faith is that "when the evidence shows (1) the defendant acted on the opinion and advice of counsel; (2) counsel's advice was based on full disclosure of all the facts by defendant or the advice was initiated by counsel based on counsel's familiarity with the case; and (3) the defendant's reliance on the advice of counsel was in good faith."1

However, the insurer must make full disclosure to the attorney from whom it seeks advice. One case found bad faith where "there was evidence in the record from which the jury could have properly concluded that [the insurer], in seeking the opinion of its attorney, failed to disclose to him all of the pertinent information available to it."2

"An insurer may defend itself against allegations of bad faith and malice in claims handling with evidence the insurer relied on the advice of competent counsel. The defense of advice of counsel is offered to show the insurer had 'proper cause' for its actions even if the advice it received is ultimately unsound or erroneous."3 "If the insurer has exercised good faith in all of its dealings under its policy, based upon an honest belief, and its judgments are based on a fair review of the evidence after reasonable diligence in ascertaining the facts, and upon sound legal advice, a court should not subject the insurer to further liability if it ultimately turns out that its judgment is a mistaken judgment. Such a responsibility could hardly be claimed to be in contemplation of the insurance relationship."4

The elements of the defense are that the insurer: 1) acted in good faith reliance upon advice of counsel and in what it believed was a manner necessary to protect its interests; 2) was not so knowledgeable as to the legal standard involved that it knew the advice of counsel was erroneous; 3) made full disclosure of all relevant facts to counsel; and 4) was willing to reconsider, and act accordingly, when it determined that the lawyer's advice was incorrect.5

The insurer may rely upon the advice of defense counsel to reject a settlement offer. "The company had the duty of consulting qualified persons on the matter of settlement. The person particularly charged with protecting the interests of both the company and the insured is the lawyer."6

DEFENSE NEED NOT BE PLED

"In response to a plaintiff's allegations of bad faith, a defendant is entitled to show it acted reasonably and with proper cause based on the advice of its counsel. Good faith reliance on counsel's advice simply negates allegations of bad faith and malice as it tends to show the insurer had proper cause for its actions. Because advice of counsel is directed to an essential element of a plaintiff's cause of action, it does not constitute new matter and need not be specifically alleged.7

BAD FAITH DEFINED

"[B]reach of the implied covenant requires unreasonable conduct or an action taken without proper cause."8 "An insurer's good or bad faith must be evaluated in light of the totality of the circumstances surrounding its actions."9 "What is good faith is essentially a question of fact."10

EVIDENCE OF REASONABLENESS

An insurer may offer proof that it acted in good faith reliance on advice of competent counsel to resist allegations of bad faith, to negate the element of scienter in claims such as fraud and intentional infliction of emotional distress, and to oppose claims of oppression, fraud or malice that are necessary for an award of punitive damages. However, evidence of reliance upon the advice of counsel may waive the attorney-client privilege.

The advice upon which an insurer relies must itself adhere to the insurer's standard of good faith. "In these circumstances, a jury would be permitted to find that [the insurer's] reliance on the advice of its attorney was the result of wishful thinking rather than a good faith balancing of its own and its insured's interests."11 "A company will not have acted [improperly] if it has diligently and in good faith attempted to fulfill its obligations and to determine the correct legal meaning of [its standard] and has thereby come to a tenable, albeit erroneous, interpretation. In contrast, neither a deliberate failure to determine the extent of its obligations nor reliance on creative lawyering that provides indefensible answers will ordinarily be sufficient to avoid a conclusion that a company acted [improperly]. Reliance on such implausible interpretations may constitute reckless disregard for the law and therefore amount to a willful violation of the law."12 The defense is not available where the insurer "knew, prior to denial of plaintiff's claim, that [its interpretation of] its policy did not accurately reflect California law."13

ATTORNEY-CLIENT PRIVILEGE AND WAIVER

An insurer's good faith reliance upon the advice of counsel necessarily involves communication between the insurer and its lawyer(s), which may be protected from disclosure by the attorney-client privilege.14 "While it is perhaps somewhat of a hyperbole to refer to the attorney-client privilege as 'sacred,' it is clearly one which our judicial system has carefully safeguarded with only a few specific exceptions."15

The attorney-client privilege may be waived by express consent or disclosure of "a significant part of the communication."16 "What constitutes a significant part of the communication is a matter of judicial interpretation."17

The attorney-client privilege may be impliedly waived when "the client has put the otherwise privileged communication directly at issue and that disclosure is essential for a fair adjudication of the action."18 "Generally, implied waivers are limited to situations where the client has placed into issue the decisions, conclusions, and mental state of the attorney who will be called as a witness to prove such matters."19 However, "the fact that [the insurer]'s state of mind was at issue in the insured's bad faith action did not place in issue its attorneys' state of mind or their advice."20 "Privileged communications do not become discoverable simply because they are related to issues raised in the litigation."21

DISCOVERY

"[A] plaintiff in an insurance bad faith case has the right to conduct discovery to obtain facts and theories, including advice of counsel, on which the denial of liability is based. The defense of advice of counsel generally waives the attorney-client privilege as to communications and documents relating to the advice."22

"Since the same rules of privilege govern the scope of discovery as generally govern the admissibility of evidence at trial, a party may obtain pretrial discovery of materials allegedly subject to the attorney-client privilege where the materials fall within some exception to the privilege or where the protection of the privilege will be waived at the trial."23

Practice Pointers: The policyholder and plaintiff may compel the insurer to waive the attorney-client privilege through discovery.24 Either may make a discovery motion to compel the insurer to disclose some or all evidence otherwise protected by the attorney-client privilege or suffer evidentiary sanctions.25 An insurer may limit discovery by stipulating to limit its use of at trial of reliance upon the advice of counsel.26

RECEIVING BUT NOT RELYING UPON ADVICE OF COUNSEL?

Some liability insurers consult counsel regarding difficult claims and may have counsel either draft for the insurer's signature or directly sign and send letters to a policyholder and/or independent counsel regarding coverage. Many such letters reserve the insurer's rights to later deny coverage. Such insurers may not consent to disclosure of a significant part of any attorney-
client communication. As a result difficult discovery issues and questions regarding the admissibility of evidence at trial may arise.

In one case, an insurer was found to have not waived the attorney-client privilege by disclosure of a letter from its counsel when it stipulated that it would introduce the letter at trial for the purpose of negating bad faith. "In view of [the insurer]'s stipulation that it will limit its use of the advice of counsel defense, the issue about whether [the insurer] continues to decline to pay the claim and is maintaining the litigation in bad faith is a question only about the state of mind of [the insurer]'s corporate decision makers."27