Introduction

A liability insurer’s reservation of rights always creates conflicts of interest between the policyholder, the insurer,[1] and their common lawyer, dependent counsel.[2] Although there are some ten procedural options to resolve conflict of interest issues that arise when an insurer reserves rights,[3] an overwhelming majority of policyholder and their independent counsel meekly and foolishly acquiesces to an insurer’s reservation of rights. But acquiescence creates several harsh and unintended consequences: 1) A policyholder’s silence may be deemed acceptance of the terms of a reservation; 2) California courts tend to apply different substantive standards depending on whether conflict issues are resolved before or after the liability suit is concluded; and 3) opportunities to develop admissible evidence are often lost.[4] Since the purpose of a reservation of rights is to alert the policyholder to protect oneself from the reserving insurer, most policyholders would be well advised to actively resolve the issues raised by a reservation of rights at the earliest possible time.

A Reservation of Rights Means War

Like a slap in the face, a reservation of rights is deemed in law to alert the policyholder to protect oneself from the insurer which has given fair warning. “Through reservation, the insurer gives the insured notice of how it will, or at least may, proceed and thereby provides it an opportunity to take any steps that it may deem reasonable or necessary in response – including whether to accept defense at the insurer’s hands and under the insurer’s control or, instead, to defend itself as it chooses.”[5]

Silence = Consent

California statutes generally imply consent by acquiescence. “Acquiescence in error takes away the right of objecting to it.”[6] “He who consents to an act is not wronged by it.”[7] “All objections to the mode of an offer of performance, which the creditor has an opportunity to state at the time to the person making the offer, and which could be then obviated by him, are waived by the creditor, if not then stated.”[8] “He who can and does not forbid that which is done on his behalf, is deemed to have bidden it.”[9]

Similarly, case law easily implies acceptance by silence. “An insurer can reserve its right to assert noncoverage unilaterally merely by giving notice to the insured. By accepting the insurer’s defense under these circumstances, the insured is deemed to have accepted this condition.”[10] Although the policyholder did not agree to the terms of a reservation of rights, “California law . . . recognizes the insurer’s right to make a unilateral reservation of rights, and the insured’s nonqualified acceptance of the defense is deemed to be acquiescence. . . . Thus, the courts could reasonably conclude that by accepting the defense, the insured impliedly agreed to the reservation.”[11] “The insurer need only notify, or attempt to notify, the assured that it is conducting the investigation and defense of the tort claim under a reservation of the right to assert policy defenses at a later time, and the assured’s silence will usually be deemed acquiescence.”[12] An old Supreme Court opinion states in dicta that a policyholders express rejection of a reservation puts the insurer to an election.[13] However, the more recent Buss and Blue Ridge opinions clarify that an insurer may reserve its rights unilaterally.

Two Incompatible Legal Standards

California law has developed two lines of cases that are very difficult to reconcile. The Cumis case[14] state the Cumis rule[15] that because dependent counsel always represents joint clients[16] the lawyer may not commence work unless he or she analyzes potential conflicts, makes written disclosure, and obtains informed written consent of both clients.[17] “[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. Moreover, in the absence of such 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.”[18]

The Dynamic Concepts case[19] states a different substantive standard[20] that a “mere possibility of an unspecified conflict does not require independent counsel. The conflict must be significant, not merely theoretical, actual, not merely potential.”[21] Because the policyholder is usually suing for damages in the Dynamic Concepts line of cases, the client bears the burden of proof of establishing that conflicts of interest exist[22] rather than the lawyer bearing the burden of proving that he or she analyzed potential conflicts, made written disclose, and obtain the informed written pursuant to Rule 3-310.[23]

Timing is critical in distinguishing these two lines of cases.[24] The Cumis line of cases tend to resolve the conflict of interest issue while the underlying liability dispute is still pending, thus necessitating the application a foresight test. Because it is difficult to foresee what conflicts might arise during the pendency of the liability suit, the courts apply a prophylactic test.[25] In contrast, the Dynamic Concepts line of cases tend to address conflict of interest issues long after the liability suit is resolved, thus allowing the application of a hindsight test. The policyholder tends to lose upon failure to prove that dependent counsel actually caused significant harm. The Dynamic Concepts line of cases tends to rule on a “no-harm-no-foul” basis with the clarity of hindsight.

Develop Admissible Evidence

Acquiescence to an insurer’s reservation of rights often results in the failure to develop admissible evidence of the nature and extent of the insurer’s reservation of rights,[26] the nature and extent of dependent counsel’s ethical conflicts of interest,[27] and a lost opportunity to cooperate with the plaintiff[28] to properly plead into coverage[29] and truthfully testify into coverage.[30] Many of the reported opinions in the Dynamic Concepts line of cases were decided on motions for summary judgment and emphasize the complete lack of evidence to support the existence of disqualifying conflicts of interest.[31] The evidentiary burden on the policyholder is much lighter if conflict of interest issues are resolved while the liability suit is pending since the court needs only to find some potential for harm.[32]