Declaratory Relief

INTRODUCTION

            Declaratory relief provides a prompt and efficient means of resolving insurance coverage disputes while a plaintiff’s liability suit is still pending. This remedy may often result in a summary judgment and is entitled to priority in trial setting. However, because early resolution of coverage challenges may prejudice the policyholders defense of plaintiff’s claim, the policyholder may stay discovery, motion work, and trial of a declaratory relief action on any disputed issue of law or fact that is “logically related” to the liability dispute. Accordingly declaratory relief may be limited to narrow circumstances where a pure issue of law may be resolved on undisputed facts or the coverage issue turns on facts and law that have “nothing to do with” the issues raised by the liability suit, of which there are several reported examples.

PRIORITY FOR DECLARATORY RELIEF

An insurance coverage dispute may be resolved by declaratory relief. “Any person interested under a . . . contract, or who desires a declaration of his or her rights or duties with respect to another . . .  may, in cases of actual controversy . . . bring an original action . . . for a declaration of his or her rights and duties. . . . [T]he court may make a binding declaration of these rights or duties, whether or not further relief is or could be claimed at the time. The declaration . . . shall have the force of a final judgment. The declaration may be had before there has been any breach of the obligation in respect to which said declaration is sought.”[1] However, the court has wide discretion to grant declaratory relief, or not. “The court may refuse to exercise the power granted by this chapter in any case where its declaration or determination is not necessary or proper at the time under all the circumstances.”[2]  Actions for declaratory relief “shall be set for trial at the earliest possible date and shall take precedence over all other cases.”[3]

RISKS OF EARLY COVERAGE DETERMINATION

1.   Insurer Must Defend When Coverage Is In Doubt

“[A] liability insurer owes a broad duty to defend its insured against claims that create a potential for indemnity. [T]he carrier must defend a suit which potentially seeks damages within the coverage of the policy. Implicit in this rule is the principle that the duty to defend is broader than the duty to indemnify; an insurer may owe a duty to defend its insured in an action in which no damages ultimately are awarded.”[4] “Any doubt as to whether the facts establish the existence of the defense duty must be resolved in the insured’s favor.”[5] Significant public policy considerations are served by encouraging “insurers to defend and settle cases for which insurance coverage is uncertain. In so doing, it transfers from the injured party to the insurer the risk that the insured may not be financially able to pay the injured party’s damages.”[6] If potential coverage is very weak, the policyholder may eleceek defer or forego a determination of the existence of a duty to defend to assure that the insurer will continue paying for the defense.

2.   Early Determination May Not Prejudice the Policyholder’s Defense

For “the insurer to commence litigation of defense and coverage issues, and to press for early resolution of those issues, while the third party litigation is still pending . . . is a tactic which, in many cases, the insurer is not allowed to pursue, and in general should be discouraged for policy reasons.”[7]

“When an insured calls upon a liability insurer to defend a third party action, the insurer as a general rule may not escape the burden of defense by obtaining a declaratory judgment that it has no duty to defend. Were the rule otherwise, the insured would be forced to defend simultaneously against both the insurer’s declaratory relief action and the third party’s liability action. . . . Indeed, “[i]t is only where there is no potential conflict between the trial of the coverage dispute and the underlying action that an insurer can obtain an early trial date and resolution of its claim that coverage does not exist.”[8] “[W]hen the coverage question is logically unrelated to the issues of consequence in the underlying case, the declaratory relief action may properly proceed to judgment.”[9]

3.   Trial and Discovery May be Stayed

“Because the duty to defend turns on the potential for coverage, and because coverage frequently turns on factual issues to be litigated in the third party liability action, litigating the duty to defend in the declaratory relief action may prejudice the insured in the liability action. To prevent this form of prejudice, the insurer’s action for declaratory relief may be either stayed or dismissed.”[10] “We conclude that . . . [the policyholder] is entitled to a stay of prejudicial discovery.”[11]

Neither a confidentiality agreement nor a protective order may insulate the policyholder from prejudice. In one case, the Court of Appeal required the trial court that had previously required discovery pursuant to a protective order to “issue an order staying all discovery in the action pending a factual determination by the trial court as to whether any pending discovery by the insurers is so logically related to the issues in the underlying action that further pursuit of that discovery would prejudice [the policyholder]’s interests in that action; if it finds that to be the case, the trial court shall make the discovery stay permanent unless it finds that a properly drafted confidentiality order will be adequate to fully protect [the policyholder] from any prejudice to its interests in the underlying action. The insurers shall, in any event, be entitled to proceed with any discovery which is not logically related to the issues in the underlying action and thus not prejudicial to [the policyholder]’s interests.”[12]

The scope of a proper prejudice inquiry is substantial. “The trial court can obtain and review the evidentiary claims and supporting affidavits and exhibits in order to make its decision. In doing so it should determine: (1) what is the exact nature of the claims asserted in the underlying action, (2) what defenses to coverage are asserted by the insurers, and to what extent, if at all, are they logically related to the liability issues raised in the underlying action, (3) what factual questions have to be resolved in order to sustain or defeat such defenses, (4) what is the likely nature of the available evidence, (5) to what extent, if at all, will [the policyholder] suffer prejudice by the enforced discovery of the evidence which tends to support or defeat its claim of coverage or the defenses raised by the insurers and (6) to what extent, if at all, will a confidentiality order realistically protect [the policyholder] from prejudicial disclosure. The trial court should make specific findings with respect to each of these matters before resolving [the policyholder]’s request for a stay of further discovery.”[13]

An insurer may be guilty of malicious prosecution for improperly prosecuting a declaratory relief action.[14]

4.   The Insurer Has a High Burden of Proof

“We conclude that [the policyholder] was entitled to have its summary adjudication motion considered and, if (1) a showing of a potential for coverage under the several policies is made, and (2) the insurers do not produce undisputed evidence which conclusively eliminates any possibility of coverage, the motion should be granted.”[15]

A NARROW SCOPE OF ISSUES MAY BE RESOLVED EARLY

Early development of admissible evidence that the insurer waives specified grounds to deny coverage may narrow coverage issues.[16]

1.   Issues of Law on Undisputed Facts

“The Court of Appeal . . . reason[ed] that ‘neither logic, common sense, nor fair play supports a rule allowing only the insured to rely on extrinsic facts to determine the potential for coverage. It would be pointless, for example, to require an insurer to defend an action where undisputed facts developed early in the investigation conclusively showed, despite a contrary allegation in the complaint, that the underlying acts occurred on a date when the policy was not in effect or at a location concededly not covered by the policy. Similarly, where extrinsic evidence establishes that the ultimate question of coverage can be determined as a matter of law on undisputed facts, we see no reason to prevent an insurer from seeking summary adjudication that no potential for liability exists and thus that it has no duty to defend. We see the critical distinction as not whether extrinsic evidence may be considered, but whether such evidence presents undisputed facts which conclusively eliminate a potential for liability.’ We concur in the reasoning of the Court of Appeal on this point.”[17]

One court found that “resolution of the [underlying] claims did not control the outcome of the parties’ coverage dispute. Coverage of the [underlying] claim turned solely upon interpretation of [the insurer’s] policy. The [liability] action did not place in issue any rule of law or fact which would bear upon the meaning of [the insurer’s] policy.”[18] Another court found that “[i]t is only when the basis for the reservation of rights is such as to cause assertion of factual or legal theories which undermine or are contrary to the positions to be asserted in the liability case that a conflict of interest sufficient to require independent counsel, to be chosen by the insured, will arise.”[19]

2.   Logically Unrelated Issues

“[W]hen the coverage question is logically unrelated to the issues of consequence in the underlying case, the declaratory relief action may properly proceed to judgment. An illustration of this latter sort of case is . . . the question whether the owner had granted permission for the driver’s use of the car [that] was irrelevant to the third party’s personal injury claim, and could properly be determined in the declaratory relief action independently of the timing of the third party suit.”[20] Examples follow:

A.  No Express Reservation Based on Specific Exclusion

“Where the insurer has not expressly reserved its right to deny coverage under a particular exclusion in its policy, there can be no actual conflict based on the application of that exclusion during the pendency of the action.”[21] In one case, an insurer that “conceded its liability for compensatory damages for willful misconduct” on a defamation claim, did not reserve its rights to disclaim coverage because of a “knowledge of the falsity” exclusion, but did disclaim liability to pay punitive damages was found not liable to pay for independent counsel where dependent counsel offered to limit disclosure of the policyholder’s confidential information from the insurer.[22]

B.  Reservation as to Damages Only

An insurer “agree[d] to defend [the policyholder] in the suit by the [plaintiff], but reserve[d] the right to deny coverage . . . for damages excluded by the policy language” the policyholder did not dispute the insurer’s “interpretation of [excluded] damages payable under the policy” and settled the claim without contribution by the policyholder.[23] The court concluded that no disqualifying conflict of interest arose because “[t]he coverage issue involved only damages.”[24]

C. Disclaimer of Coverage for Breach of Contract Claims

“The only specific reservation was that [the insurer’s] policy did not afford coverage for the contract claims while providing coverage for the negligence and negligent misrepresentation claims. However, this reservation created no disqualifying conflict” because dependent counsel did not have “the ability to transfer liability from the covered claims to the uncovered ones.”[25]

D.  Buss Reservation

An insurer’s “reservation of the right to seek reimbursement of defense costs allocable to non-covered claims, standing alone, does not constitute[] a ‘coverage issue,’ because it does not involve the possibility that policy coverage will be determined or affected by the nature of Plaintiffs’ conduct as developed at trial. ¶ . . . Furthermore, the coverage dispute must be one that will be litigated in the underlying action.”[26]

E.   General Reservation

“A general reservation of rights does not give rise to a conflict of interest or create a duty to provide independent counsel. ¶ General reservations are just that: general reservations. At most, they create a theoretical, potential conflict of interest-nothing more.”[27]

THREE LESSONS

California law has developed two incompatible lines of case law impacting whether an insurer must pay for independent counsel to represent its policyholder. The Cumis line of cases[28] tend to emphasize a moral core rooted in an attorney’s ethical obligations to a client, that address the legal issue of an insurer’s duty to pay for independent counsel while the underlying liability action is still pending, reference evidence supporting a conflicted lawyer’s ethical lapses, and do not recite rude conduct by the policyholder or independent counsel. The Dynamic Concepts line of cases[29] tend to mention no moral core, address conflict issues after resolution of the liability action, rely heavily on the absence of evidence of conflicts, and emphasize rude conduct by the policyholder and/or independent counsel. Three lessons for policyholders emerge from a comparison of these irreconcilable lines of cases: 1) Resolve conflict issues early; 2) Develop evidence of conflicts; and 3) Don’t be rude.[30]

1.   Resolve Conflict Issues Early

The Cumis line of cases apply a foresight test to evaluate the potential that conflicts of interest may prejudice the policyholder, while the Dynamic Concepts line of cases apply a hindsight test to find no “actual” conflict of interest if the record before the court shows that the insurer fulfilled most of its obligations to the policyholder. This difference in temporal perspective has a substantial impact on the substantive outcome of the issue. The courts tend to find conflicts of interest and rule in the policyholder’s favor that the insurer must pay for independent counsel when the underlying liability suit is still pending and no one can know how conflicts may adversely impact the policyholder. In contrast, the courts tend to rule that no conflict of interest is shown when the underlying liability suit has already been resolved with resulting harm to the policyholder except a debt to independent counsel on an apparent but unspoken basis of “no-harm-no-foul.”

Accordingly, policyholders and their lawyers should seek early resolution of conflict issues, while insurers and their lawyers should delay resolution of conflict issues.

2.   Develop Evidence of Conflicts of Interest

The Cumis line of cases tend to cite evidence that dependent counsel represents two clients (the insurer and the policyholder) who has not complied with Rule 3-310 while the Dynamic Concepts line of cases tend to cite the lack of evidence that dependent counsel has committed some egregious ethical breach that caused demonstrable, substantial damage to the policyholder. Accordingly, policyholders and their lawyers should seek to engage dependent counsel and the insurer in a written discourse regarding potential conflicts of interest and resolution of them.[31]

3.   Don’t Be Rude

The Dynamic Concepts line of cases tend to focus critically upon rude pre-litigation and litigation tactics of the policyholder and independent counsel to bolster conclusion that such unruly boors do not deserve the support of the courts to achieve nefarious results. The Cumis line of cases is marked by the absence of any such unseemly conduct. Accordingly, conflict of interest issues should be addressed in a very respectful and civil manner by the policyholder (and not independent counsel) primarily in the form as asking questions of dependent counsel and the insurer rather than rants about an adversary’s conduct.[32]