Introduction

One of the four primary duties which California attorneys owe to all clients is a duty of full disclosure. The duty of disclosure arises from the fiduciary nature of the attorney-client relationship.[1] A lawyer’s affirmative duty to keep clients informed of significant developments and to respond to inquiries arises out the State Bar Act and the California Rules of Professional Conduct (Rule) promulgated by the California Supreme Court.[2]

The Lawyer’s Duty to Analyze Conflicts

The attorney must analyze “the relevant circumstances and of the actual and reasonably foreseeable adverse consequences” of conflicts of interest.[3] “There is no talismanic rule that allows a facile determination of whether a disqualifying conflict of interest exists. Instead, ‘[t]he potential for conflict requires a careful analysis of the parties’ respective interests to determine whether they can be reconciled . . . or whether an actual conflict of interest precludes insurer-appointed defense counsel from presenting a quality defense for the insured.’”[4]

“Where there is a duty to disclose, the disclosure must be full and complete, and any material concealment or misrepresentation will amount to fraud. Cases in which the defendant stands in a fiduciary relationship to the plaintiff are frequently treated as if they involved fraudulent concealment of the cause of action by the defendant. The theory is that although the defendant makes no active misrepresentation, this element is supplied by an affirmative obligation to make full disclosure, and the non-disclosure itself is a ‘fraud.”’[5] “[T]he existence of a conflict of interest should be identified early in the proceedings so it can be treated effectively before prejudice has occurred to either party.”[6]

The California Supreme Court is in the process of revising the Rules of Professional Conduct. Rule 3-310 will be replaced by proposed Rule 1-7, which provides in part: “Resolution of a conflict of interest under this Rule requires the lawyer to: (3) determine whether a conflict of interest exists. . . . To determine whether a conflict of interest exists, a lawyer should adopt reasonable procedures . . . to determine . . . the persons and issues involved. . . . Ignorance caused by a failure to institute such procedures will not excuse a lawyer’s violation of this Rule.”

Potential and Actual Conflicts

While a lawyer must analyze both potential and actual conflicts of interest, mere potential conflicts trigger the duty of disclosure. “A [lawyer] shall not, without the informed written consent of each client: (1) Accept representation of more than one client in a matter in which the interests of the clients potentially conflict; or (2) . . . actually conflict.”[7] “Thus, this provision [Rule 3-310(C)] states that at the outset, an attorney may not accept representation if there is a potential conflict; it does not require an actual conflict.”[8]

Rule 3-310 does not define the words “potential” or “actual”. However, the distinction between the two has been defined as follows: “A conflict of interest is potential if there is no present actual conflict of interest, but there is a possibility of an actual conflict arising in the future, resulting from developments that have not yet occurred or facts that have not yet become known.”[9] “A conflict arises once the insurer takes the view a coverage issue is present.”[10] A “distinction between ‘potential’ and ‘actual’ conflicts of interest . . . is invalid and unworkable.”[11] Proposed Rule 1-7 eliminates the distinction between potential and actual conflicts of interest.

The Lawyer’s Duty to Initiate Disclosure

An attorney must take the initiative to make disclosure. In order to make intelligent decisions about the subject matter of an engagement, the client must be adequately educated by the lawyer. Thus, lawyers have “the obligation to render a full and fair disclosure to the [client] of all facts which materially affect his rights and interests.”[12] “Adequate communication with clients is an integral part of competent professional performance as an attorney.”[13]

The lawyer has “an affirmative obligation to make full disclosure, and the non-disclosure itself is a ‘fraud.”’[14] The lawyer must initiate communications regarding settlement offers,[15] to “keep the client so informed”[16], and to refrain from accepting or continuing employment by clients with adverse interests without written disclosure.[17] An attorney must also respond to inquiry by a client. “A [lawyer] shall . . . promptly comply with reasonable requests for information and copies of significant documents when necessary to keep the client so informed.”[18] This includes the duty to promptly return a client’s telephone calls.[19] The duty may require the lawyer to disclose one’s own malpractice.[20]

Proposed Rule 1.7 states in part: “Resolution of a conflict of interest under this Rule requires the lawyer to: (1) clearly identify the client or clients; (2) determine the scope of each relevant representation of a client or proposed representation of a client; (3) determine whether a conflict of interest exists; (4) decide whether the representation may be undertaken despite the existence of a conflict, i.e., whether lawyer has the ability to obtain the client’s consent to the conflict; and (5) if so, consult with the clients affected under paragraph (a) and obtain their informed written consent.”

The Duty to Disclose Adverse Interests

Rule 3-310 prohibits an attorney from representing multiple clients or entities that may be affected substantially by the outcome of a dispute whose interests conflict without satisfying three requirements. First, the attorney must analyze potential conflicts, as just mentioned. Second, the attorney must make “written disclosure” to each clients.[21] Third, the attorney must obtain the “informed written consent”[22] of a client.

The lawyer must disclose to each client significant past and present relationships with others. The relationships include “a legal, business, financial, professional, or personal relationship.” The persons or entities with whom the lawyer has or had relationships include “a party or witness in the same matter” and “another person or entity the [lawyer] knows or reasonably should know would be affected substantially by resolution of the matter.” Disclosure is also required if the lawyer has an “interest in the subject matter of the representation.”[23] Each present or former client’s written consent is required if the lawyer “has obtained confidential information material to the employment.”[24] The clients with conflicting interests may be involved in the same or separate matters.[25]

Disclosure and consent are a prerequisite to the lawyer starting work. The lawyer “shall not accept or continue representation of a client without providing written disclosure to the client.”[26] The lawyer “shall not, without the informed written consent of each client . . . [a]ccept or continue representation of more than one client.”[27] A lawyer may, however, represent a policyholder in one matter and at the same time in a separate matter represent the interests of an adverse insurer which is not a direct party to the action.[28]

Insurers Are Always “Affected Substantially be Resolution of the Matter

As just mentioned, a lawyer must comply with Rule 3-310 if she or he has any relationship with “another person or entity the [lawyer] knows or reasonably should know would be affected substantially by resolution of the matter.” Because of the very nature of a liability insurance policy as a contract of indemnity, all liability insurer are always and necessarily “affected substantially by resolution” of a judgment entered against its policyholder. A final judgment is the singular event that triggers the insurer’s duty to indemnify the policyholder for the judgment in the amount of damages established by the judgment (up to the stated policy limit).

Civil Code § 2778[29] governs “the interpretation of a contract of indemnity”, which a liability policy is. A typical CGL insuring clause states that the insurer will “pay those sums that the insured becomes legally obligated to pay as damages”, ie. a judgment is entered. The statute provides: “Upon an indemnity against liability, the [policyholder] is entitled to recover [from the insurer] upon becoming liable [to the plaintiff].”[30] “The [insurer] is bound, on request of the [policyholder by] actions brought against the [policyholder] in respect to the matters embraced by the [policy], but the [policyholder] has the right to conduct such defenses, if he chooses to do so.”[31] “If, after request, the [insurer] neglects to defend the [policyholder], a recovery against the [policyholder] suffered by him in good faith, is conclusive in favor [of the policyholder] against the [insurer].”[32] “A stipulation that a judgment against the [policyholder] shall be conclusive upon the [insurer], is inapplicable if [the policyholder] had a good defense upon the merits, which by want of ordinary care [the policyholder] failed to establish in the action.”

Contracts of liability like liability insurance policies are unique for their interplay with judicial concepts of procedural due process of law, res judicata, and collateral estoppel[33] because insurers agree contractually to be bound by the outcome of a lawsuit in which they are not actual parties, but are in privity with a party, the policyholder. A soft condition of the binding effect on the insurer of a judgment against the policyholder is notice of the action. “If the [insurer], has not reasonable notice of the action against the [policyholder] judgment against the [policyholder] is only presumptive evidence against the [insurer].”[34]

Supporting Views Among the Fifty States

Most American jurisdictions have weighed in on the importance that dependent counsel, as a lawyer hired by an insurer, make full disclosure to a policyholder.[35] Nearly two-thirds of states have adopted a strict “per se” rule that all reservations of rights require a reserving insurer to pay for independent counsel selected and directed by the policyholder to control the defense. The sole exception in these states is that the lawyer may comply with the disclosure requirements of the Canons of Ethics and obtain the policyholder’s informed written consent to representation, despite the existence of otherwise disqualifying conflicts of interest. California and a growing number of sister states have modified the “per se” rule to recognize that only reservations of rights that create a disqualifying conflict of interest for dependent counsel require the insurer to pay for independent counsel, but dependent counsel must comply with requirements of Rule 3-310 of analysis, disclosure, and consent. In California the legal test is that an insurer must pay for independent counsel selected and directed by the policyholder is it reserves its rights to deny coverage on any ground the is related to the subject matter of the liability dispute. Put another way, a reserving insurer has no obligation to pay for independent counsel if the reservation of rights has “nothing to do with” the liability dispute, such as non-payment of premium.[36]

A small handful of states have adopted an “enhanced duties” rule, that some other jurisdictions find peculiar. The “enhanced duties” rule permits a reserving insurer to control the policyholder’s defense through dependent counsel if both the insurer and dependent counsel comply with a laundry list of specified “enhanced duties” of disclosure and good faith and the policyholder fails to object. The concept of “enhances duties” stands in contrast to the fact that in California at lease “[t]he relation between attorney and client is a fiduciary relation of the very highest character.”[37] “Enhancing” a duty that is already of “the very highest character” challenges logic for some jurisdiction that have considered and rejected this view.

Nonetheless, this minority view contributes to the body of law imposing on reserving insurers and dependent counsel their mutual duty of disclosure to the policyholder. “Failure to satisfy this enhanced obligation may result in liability of the company, or retained defense counsel, or both. [D]efense counsel owes a duty of full and ongoing disclosure to the insured. This duty of disclosure has three aspects. First, potential conflicts of interest between insurer and insured must be fully disclosed and resolved in favor of the insured. The dictates of [Canons of Ethics], which address conflicts of interest such as this, must be strictly followed.”[38]

The Duty to Communicate Settlement Opportunities

All attorneys have a duty to promptly communicate settlement offers to their client. “A [lawyer] shall promptly communicate to the [lawyer]’s client: . . . (2) All amounts, terms, and conditions of any written offer of settlement made to the client.[39] “Any oral offers of settlement made to the client in a civil matter should also be communicated if they are ‘significant’.”[40] Non-binding offers must be communicated to the client.[41] The duty to disclose settlement offers extends to insurers who may authority to accept a settlement offer. “As used in this rule, ‘client’ includes a person who possesses the authority to accept an offer of settlement.”[42]

Limits of the Duty of Disclosure

One limitation on a lawyer’s duty of disclosure to a client is the lawyer’s duty of confidentiality to another client. “It is the duty of an attorney to do all of the following: (e)(1) To maintain inviolate the confidence, and at every peril to himself or herself to preserve the secrets, of his or her client.”[43] A lawyer may be excused of making disclosure if so ordered by a court. For example, a court may order that certain information disclosed to a lawyer through discovery may not be transmitted to the client. An attorney may rely on such orders in refusing to disclose such information to the client.[44] If disclosure might cause the client serious harm, the lawyer may be justified in delaying the communication of such information to the client.[45]

Consequences of Failure to Make Disclosure

An attorney may not accept or continue representation of a client without prior disclosure of potential conflicts of interest.[46] Appearing in court without the client’s authority to do so may expose the lawyer to discipline or civil liability.[47] A lawyer’s failure to make written disclosure and obtain informed written consent may preclude the attorney from receiving payment from one other than the client.[48] “[A] lawyer who, while purporting to continue to represent an insured and who devotes himself to the interests of the insurer without notification or disclosure to the insured, breaches his obligations to the insured and is guilty of negligence.”[49]

^[1] “The relation between attorney and client is a fiduciary relation of the very highest character. [An attorney] owes a duty to communicate to his client whatever information he acquires in relation to the subject matter involved in the transaction.” (Neel v. Magana, Olney, Levy, Cathcart & Gelfand (1971) 6 Cal.3d 176, 189-190 (Neel) (citations, ellipses, and quotation marks omitted).)

^[2] “It is the duty of an attorney to do all of the following: . . . (m) To respond promptly to reasonable status inquiries of clients and to keep clients reasonably informed of significant developments in matters with regard to which the attorney has agreed to provide legal services.” (Bus.&Prof. Cd. §6068(m); See, Neel, supra, 6 Cal.3d at 188-89.)

^[3] Rule 3-310.

^[4] Dynamic Concepts, Inc. v. Truck Ins. Exchange (1998) 61 Cal.App.4th 999, 1007-1008.

^[5] Neel, supra, 6 Cal.3d at188-189. (Citations, ellipses, and quotation marks omitted.)

^[6] San Diego Navy Fed. Credit Union v. Cumis Ins. Society, Inc. (1984) 162 Cal.App.3d 358, 371, fn. 7 (Cumis).

^[7] Rule 3-310(C).

^[8] In re Celine R. (2003) 31 Cal. 4th 45, 56-57.

^[9] In re Jaeger 213 B.R. 578 (Bkrtcy. C.D. Cal. 1997).

^[10] Cumis, supra, 162 Cal.App.3d at 370.

^[11] Id. at 371, fn. 7.

^[12] Neel, supra, 6 Cal.3d at 188-89.

^[13] Calvert v. State Bar (1991) 54 Cal.3d 765, 782.

^[14] Neel, supra, 6 Cal.3d at 189.

^[15] “(A) A [lawyer] shall promptly communicate to the [lawyer]’s client: . . . (2) All amounts, terms, and conditions of any written offer of settlement made to the client in all other matters. (B) As used in this rule, ‘client’ includes a person who possesses the authority to accept an offer of settlement.” (Rule 3-510.)

^[16] “A [lawyer] shall keep a client reasonably informed about significant developments relating to the employment or representation.” (Rule 3-500.)

^[17] “A [lawyer] shall not accept or continue representation of a client without providing written disclosure to the client.” (Rule 3-310(B).)

^[18] Rule 3-500.

^[19] In re O.S. (2002) 102 Cal.App.4th 1402, 1410-1411.

^[20] See, Rest.3d Law Governing Lawyers § 20, Comment c.

^[21] “‘Disclosure’ means informing the client or former client of the relevant circumstances and of the actual and reasonably foreseeable adverse consequences to the client or former client.” (Rule 3-310(A)(1).)

^[22] “‘Informed written consent’ means the client’s or former client’s written agreement to the representation following written disclosure.” (Rule 3-310(A)(2).)

^[23] Rule 3-310(B).

^[24] Rule 3-310(E).

^[25] “A [lawyer] shall not, without the informed written consent of each client: (1) Accept representation of more than one client in a matter. . . . or (3) Represent a client in a matter and at the same time in a separate matter accept as a client a person or entity whose interest in the first matter is adverse to the client in the first matter.” (Rule 3-310(C).)

^[26] Rule 3-310(B).

^[27] Rule 3-310(C).

^[28] “[S]ubparagraph (C)(3) is not intended to apply with respect to the relationship between an insurer and a [lawyer] when, in each matter, the insurer’s interest is only as an indemnity provider and not as a direct party to the action.” (Rule 3-310, Discussion.)

^[29] This statute was enacted in California in 1872 as part of the Field Code and remained unmodified since that time.

^[30] Civ. Code § 2778(1) (ellipsis omitted).

^[31] Civ. Code § 2778(4) (ellipses omitted).

^[32] Civ. Code § 2778(5) (ellipsis omitted).

^[33] See, Res Judicata – Collateral Estoppel.

^[34] Civ. Code § 2778(6) (ellipsis omitted).

^[35] 50 State Survey – Does an Insurer’s Reservation of Rights Require It to Pay Independent Counsel?

^[36] “Thus, when the reservation of rights is based on coverage disputes that have nothing to do with the issues being litigated in the underlying action.” (Long v. Century Indemnity Co. (2008) 163 Cal.App.4th 1460, 1470.)

^[37] Neel, supra, 6 Cal.3d at 189.

^[38] Tank v. State Farm Fire & Casualty Co., 105 Wash.2d 381, 387-88, 715 P.2d 1133 (1986) (ellipsis omitted).

^[39] Rule 3-510(A).

^[40] Rule 3-510, Discussion.

^[41] “[R]ule 3-510 does not require that there be an offer in the contract law sense.” (Matter of Yagman (Rev.Dept. 1997) 3 Cal. State Bar Ct.Rptr. 788, 795.)

^[42] Rule 3-510(B).

^[43] Bus. & Prof. Code § 6068(e)(1) (ellipsis omitted).

^[44] “A wilful disobedience or violation of an order of the court requiring him to do or forbear an act connected with or in the course of his profession, which he ought in good faith to do or forbear, and any violation of the oath taken by him, or of his duties as such attorney, constitute causes for disbarment or suspension.” (Bus.& Prof. Cd. §6103.)

^[45] ABA Model Rule 1.4, Comment (7); Bar Ass’n of San Francisco Form.Opn. 1979-3.

^[46] “A [lawyer] shall not accept or continue representation of a client without providing written disclosure to the client where: (1) The [lawyer] has a . . . relationship with a party or witness” or “(3) The [lawyer] has or had a . . . relationship with another . . .[who] would be affected substantially by resolution of the matter.” (Rule 3-310(B).)

^[47] “Corruptly or wilfully and without authority appearing as attorney for a party to an action or proceeding constitutes a cause for disbarment or suspension.” (Bus.&Prof. Cd. §6104. See, Chefsky v. State Bar (1984) 36 Cal.3d 116, 127; Spindell v. State Bar (1975) 13 Cal.3d 253, 260.)

^[48] “A [lawyer] shall not accept compensation for representing a client from one other than the client unless: . . . The [lawyer] obtains the client’s informed written consent. . . . (Rule 3-310(F).)

^[49] Betts v. Allstate Ins. Co. (1984) 154 Cal.App.3d 688, 716.