Introduction

California case law has developed two distinct and incompatible lines of common law authority addressing whether an insurer that reserves its rights to later deny coverage to its policyholder must pay for independent counsel. The Cumis[1] line of cases reasons that an insurer must pay for independent counsel because its chosen dependent counsel cannot ethically represent the interests of both the insurer and the policyholder. Dependent counsel must analyze potential conflicts, and make written disclosure to and obtain informed written consent from both the insurer and the policyholder in compliance with Rules of Professional Conduct, Rule 3-310. Alternatively, the Dynamic Concepts[2] line of cases reasons that an insurer is not obligated to pay for independent counsel without regard to dependent counsel’s conflicts of interests unless the policyholder proves that a reservation of rights creates a conflict of interest that is significant and actual, not merely theoretical or potential.

Table of Cases

This memorandum of law collects and summarizes in chronological order the following reported California opinions, all of which follow Dynamic Concepts.

Dynamic Concepts, Inc. v. Truck Ins. Exch. (1998) 61 Cal.App.4th 999 (Dynamic Concepts);

Federal Ins. Co. v. MBL, Inc. (2013) 219 Cal.App.4th 29 (MBL);

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

James 3 Corp. v. Truck Ins. Exchange (2001) 91 Cal.App.4th 1093 (James 3);

Midiman v. Farmers Ins. Exchange (1999) 76 Cal.App.4th 102 (Midiman);

Advanced Network, Inc. v. Peerless Ins. Co. (2010) 190 Cal. App. 4th 1054 (Peerless); and

Centex Homes v. St. Paul Fire & Marine Ins. Co. (2015) 237 Cal.App.4th 23 (Centex).

Dynamic Concepts

In Dynamic Concepts, an insurer agreed to defend its policyholder under a reservation of rights, hired dependent counsel, and hired separate coverage counsel to determine whether the insurer was required to pay for independent counsel. In a very short period of time, independent counsel excluded the insurer and its counsel from settlement negotiations and unilaterally settled the case without the consent or participation of the insurer. The policyholder then sued the insurer to recover the cost independent counsel and the cost of the settlement. The trial court awarded defense costs incurred by independent counsel, but denied the cost of settlement. Thus the issue on appeal was “whether an insurer in an action involving covered and uncovered claims is automatically obliged to provide independent counsel pursuant to Civil Code section 2860, subdivision (b). Does the insurer breach its duty to defend when it assigns competent outside counsel pending a further analysis of the Cumis issue?”[3] Noting that “insurers are entitled to a reasonable period of time to analyze a situation requiring a coverage decision”[4], the Ccourt stated in dicta: “A mere possibility of an unspecified conflict does not require independent counsel. The conflict must be significant, not merely theoretical, actual, not merely potential.”[5] The authority cited for this dicta does not support the court’s conclusion. Lehto v. Allstate Ins. Co. (1994) 31 Cal.App.4th 60, 71 does not so hold. Croskey et al., Cal. Practice Guide: Insurance Litigation 2 (The Rutter Group 1995) ¶ 7:855 rev. #1, 1997 now cites Dynamic Concepts.

The Court concluded: “There is no basis on the record to presume [dependent counsel] would have violated their stringent ethical responsibilities to completely defend [the policyholder] for all allegations of the entire complaint, covered or uncovered. There similarly is no support for the proposition [the insurer] intended to offer merely a token defense for uncovered claims or that [dependent counsel] were retained to act as ‘coverage spies’ to generate potential coverage defenses.”[6]

MBL

In MBL, several liability insurers agreed to defend their policyholder under a reservation of rights in an action for damages due to ground water pollution. The insurers filed a declaratory relief action and moved for summary judgment to establish that they had no obligation to pay for independent counsel because their reservation of rights did not create a disqualifying conflict of interest.[7] The trial court granted the motions for summary judgment and Court of Appeal affirmed, finding: “MBL failed to present evidence demonstrating a triable issue of material fact on the question of whether there exists a conflict of interest under section 2860.”[8] Analyzing a series of policy provisions, the court concluded that either the insurers did not reserve their rights on those grounds or that there was no evidence that dependent counsel could control the outcome of a reserved issue.

The court extensively quoted language from Dynamic Concepts, rejecting the argument that “the Insurers’ general reservations of rights gave rise to a conflict of interest. . . General reservations are just that: general reservations. At most, they create a theoretical, potential conflict of interest-nothing more.”[9]

Berger Kahn

In Berger Kahn, a law firm was hired by policyholders, following which the law firm entered into a written contract with an insurer, agreeing to defend the policyholders at a negotiated rate, to follow the insurer’s litigation guidelines, and to provide confidential reports to the insurer. The insurer asserted a broad and general reservation of rights, but no one raised any issue that the insurer’s reservation of rights created any conflict of interest. Instead, the policyholder expressly stated: “[W]e . . . choose not to disagree with [the insurer’s] position regarding coverage.”[10] After the insurer settled the liability dispute for $1 million, it sued the law firm for legal malpractice. The law firm moved for summary judgment that the insurer lacked standing to sue. The trial court granted the motion, accepting the argument that the insurer’s reservation of rights created a conflict of interest that precluded the existence of an attorney-client relationship between the insurer and dependent counsel. The Court of Appeal reversed finding that “[t]his argument is fatally flawed, resting as it does on the implicit assumption that as between the insurer and the insured, only one can establish an attorney-client relationship with the insured’s defense attorney, and that that relationship is established only by the first to contact that counsel.”[11] The Court found “an agreement between [the insurer and dependent counsel] and an attorney-client relationship as a matter of law”[12] and that the insurer “had the right to sue [dependent counsel] for malpractice so long as there existed no conflict of interest.”[13] “We conclude that [dependent counsel] had no conflict that would preclude [the insurer] from suing them for their malpractice.”[14] “It is thus anomalous for the [dependent counsel] to now urge, in order to escape the malpractice action by [the insurer], that they had a disqualifying conflict of interest in their dual representation of [the insurer] and the [policyholder] which they were under an ethical duty at the time of the representation to divulge, and they did not.”[15]

Against this backdrop, the court quoted extensively from Dynamic Concepts[16] to the effect that establishing a disqualifying conflict of interest requires proof, of which dependent counsel offered none.

James 3

In James 3, an insurer agreed to defend its policyholders under an expressly limited reservation of rights: “As to the remaining reservations, [the insurer] will waive them.”[17] The insurer hired dependent counsel to defend the insured but refused to pay for independent counsel. The policyholder sued for declaratory relief that the insurer must pay for independent counsel. The trial court granted the insurer’s motion for summary judgment finding that the policyholders “fail to demonstrate the existence of a triable issue of fact material to determining whether [the insurer] is obligated to provide Plaintiffs Cumis counsel.” The Court of Appeal affirmed, holding that: 1) an insurer’s refusal to pursue an affirmative defense as to which it has not reserved rights to deny coverage does not create a disqualifying conflict of interest; 2) an insurer’s refusal to pursue a affirmative relief does not create a disqualifying conflict of interest; and 3) an insurer’s Buss reservation to seek reimbursement of defense costs does not create a disqualifying conflict of interest. The court quoted Dynamic Concepts extensively.

Midiman

In Midiman, “[t]he issue raised [was] whether the insured was entitled to a presumption establishing (1) that the underlying claim was legitimate and that the insured was liable in the amount which it agreed to pay in settlement and, at the same time, (2) that the insured had valid defenses to the underlying claim which it was precluded from presenting by the insurer’s refusal to pay for independent counsel, justifying recovery of lost profits from its insurer. We conclude that the insured was entitled to no such contradictory and illogical presumption. We further conclude, in connection with the insurer’s cross-appeal, that the trial court erred in ruling that Cumis counsel was required at the inception of the underlying litigation.”[18]

The Court of Appeal quoted Dynamic Concepts for the propositions that: 1) “We are not prepared to assume appointed defense counsel’s misfeasance in the absence of any evidence”[19]; and 2) it is “better practice . . . to cooperate with appointed counsel until an actual conflict develops.”[20]

Peerless

The Peerless court quotes Dynamic Concepts for the proposition that “there was no potential for coverage under the “loss of use” prong of the property damage insuring provision”[21]

Centex

In Centex, a policyholder sued an insurer for declaratory relief. The Court of Appeal affirmed the trial court ruling sustaining a demurrer without leave to amend finding that the “claims are neither ‘ripe’ nor ‘actual’”[22] “We conclude the facts alleged do not support [a] claim of a conflict of interest. An insurer has the right to control a defense. [The policyholder] argues [the insurer] will manipulate [the conduct of the defense] to its advantage without giving any explanation about how that will be accomplished. Similarly, [the policyholder] offers a host of allegations about how [the insurer] will control the litigation without describing how this is occurring in the underlying [liability] litigation. [The policyholder] is alleging conclusions without substance, not facts. As Gertrude Stein famously said about Oakland, there is no there there.”[23] The court quoted Dynamic Concepts for the propositions that conflict “[t]he potential for conflict requires a careful analysis” and that “[t]he conflict must be ‘significant, not merely theoretical, actual, not merely potential.’”[24]

^[1] San Diego Navy Fed. Credit Union v. Cumis Ins. Society, Inc. (1984) 162 Cal.App.3d 358, 375.

^[2] Dynamic Concepts, Inc. v. Truck Ins. Exch. (1998) 61 Cal.App.4th 999.

^[3] Id. at 1006.

^[4] Id. at 1010.

^[5] Id. at 1006.

^[6] Id. at 1008.

^[7] Disqualifying Conflicts of Interest

^[8] MBL, supra, 219 Cal.App.4th at 48.

^[9] Id. at 47.

^[10] Berger Kahn, supra, 79 Cal.App.4th at 121.

^[11] Id. at 126.

^[12] Id. at 127.

^[13] Id. at 129.

^[14] Id. at 131.

^[15] Id. at 132-33.

^[16] Id. at 130-31.

^[17] James 3, supra, 91 Cal.App.4th at 1099.

^[18] Midiman, supra, 76 Cal.App.4th at 106.

^[19] Id. at 120.

^[20] Id. at 123.

^[21] Peerless, supra, 190 Cal. App. 4th at 1062.

^[22] Centex, supra, 237 Cal.App.4th at 26.

^[23] Id. at 31-32.

^[24] Id. at 30-31.