When a policyholder asks a liability insurer for help with a plaintiff’s lawsuit, the insurer must promptly answer: “Yes”, “No”, or “Maybe”. A “Yes” answer means that the insurer accepts full coverage, agreeing to defend and indemnify its policyholder up to the policy limit for a plaintiff’s lawsuit. A “No” answer means that the insurer denies all coverage, refusing to either defend or indemnify its policyholder. A “Maybe” answer means a little bit of both. The insurer agrees to fulfill one of its primary promises – to defend – while reserving its rights to decide later whether or not to deny indemnity coverage. A reservation of rights qualifies as a coverage denial requiring the insurer to give a detailed written explanation, and urge the policyholder to fight back.
With a “Yes” or a “No” answer, at least the policyholder has a degree of certainty. “Yes” means the insurer is afriend – “No” means the insurer is a foe. But “Maybe” is not so simple. The insurer is friend and foe. Saying that there “may be” no coverage for a liability dispute creates a second, usually related coverage dispute. Double the trouble is usually disheartening because the policyholder does not want two lawsuit or any lawsuits.
“Maybe” creates uncertainty and challenges trust. In the liability dispute, the policyholder, the insurer, and its lawyer are like the “Three Musketeers” – “All for one and one for all” in opposing the lone plaintiff. In contrast, in the coverage dispute, the policyholder and the plaintiff usually share common interests in securing insurance coverage – while the insurer and its lawyers are oppose securing coverage. The result is complex and shifting alliances. From the policyholder’s perspective, the plaintiff, the insurer, and its lawyers may be enemies and allies – all at the same time. “All for one and one for all” dissolves into a “free-for-all”.
This melee of “Maybe” results in a labyrinth of conflicts of interest that may rival international relations. For example, while the U.S. has lots of reasons to be mad to China, they can work well together to make sure that North Korea does not get nukes. Despite its complexity, the situation can be managed.
This Practice Pointer is the first of what will become a series of legal research tools exploring California law that controls each of ten major decisions many liability insurers make and ten responses policyholders can give.
Liability Insurer’s Two Primary Promises
A liability insurance policy makes two primary promises: 1) the promise to defend; and 2) the promise to indemnify. These two promises create two distinct duties that differ from one another in three distinct ways: 1) timing; 2) certainty; and 3) complexity. The duty to defend must be discharged early, when facts are uncertain, based on very little language of the contract. The duty to indemnify cannot be discharged until the end of the lawsuit, when disputed facts have been established, and may turn on language found anywhere in the entire contract or even circumstances beyond the contract. Thus, the duty to defend is said to be broader than the duty to indemnify.
1. The Nature of the Duty to Indemnify
“Insurance is a contract whereby one undertakes to indemnify another against loss, damage, or liability arising from a contingent or unknown event.” Indemnity is “a contract by which [the insurer] engages to save [the policyholder] from a legal consequence of the conduct of some other person.” “Indemnity is defined as the obligation resting on one party to make good a loss or damage another party has incurred.” An insurer “can only indemnify against ‘claims’ that have been resolved against the [policyholder, who] has actually sustained liability. Indemnification, after all, is the act of saving another from the legal consequence of an act.”
2. The Nature of the Duty to Defend
“Recently we [the California Supreme Court] had occasion to restate the familiar principles governing adjudication of the insurer’s duty to defend. [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. The determination whether the insurer owes a duty to defend usually is made in the first instance by comparing the allegations of the complaint with the terms of the policy. Facts extrinsic to the complaint also give rise to a duty to defend when they reveal a possibility that the claim may be covered by the policy. [F]or an insurer, the existence of a duty to defend turns not upon the ultimate adjudication of coverage under its policy of insurance, but upon those facts known by the insurer at the inception of a third party lawsuit. Hence, the duty may exist even where coverage is in doubt and ultimately does not develop. The defense duty is a continuing one, arising on tender of defense and lasting until the underlying lawsuit is concluded or until it has been shown that there is no potential for coverage, as we demonstrate below. Imposition of an immediate duty to defend is necessary to afford the insured what it is entitled to: the full protection of a defense on its behalf. The insured’s desire to secure the right to call on the insurer’s superior resources for the defense of third party claims is, in all likelihood, typically as significant a motive for the purchase of insurance as is the wish to obtain indemnity for possible liability. As a consequence, California courts have been consistently solicitous of insureds’ expectations on this score. [F]acts known to the insurer and extrinsic to the third party complaint can generate a duty to defend, even though the face of the complaint does not reflect a potential for liability under the policy. This is so because current pleading rules liberally allow amendment; the third party plaintiff cannot be the arbiter of coverage.”
An Insurer Cannot Practice Law
Ironically, as important the duty to defend is, it is a promise that the insurer cannot legally discharge by itself because it is not licenced to practice law. “No person shall practice law in California unless the person is an active member of the State Bar.” “By its very nature the duty assumed by [the insurer] to defend its assured against suits must necessarily be classified as a delegable duty, understood by all parties as such, for [the insurer] had no authority to perform that duty itself and, in fact, was prohibited from appearing in the California courts. [I]t must rely on independent counsel for the conduct of the litigation.”
An Attorney Cannot Serve Two Masters
“The mandatory rule of disqualification in cases of dual representations involving unrelated matters – analogous to the biblical injunction against ‘serving two masters’ (Matthew 6:24) – is such a self-evident one that there are few published appellate decisions elaborating on it.”
“A [lawyer] shall not accept or continue representation of a [policyholder/client] without providing written disclosure to the [policyholder/client] where [t]he [lawyer] has a legal, business, [or] financial relationship with another entity [such as an insurer that] would be affected substantially by resolution of the matter. Disclosure means informing the [policyholder/client] of the relevant circumstances and of the actual and reasonably foreseeable adverse consequences to the [policyholder/client]. 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 actually conflict. A [lawyer] shall not accept compensation for representing a [policyholder] from [an insurer] unless [t]he [lawyer] obtains the client’s informed written consent.”
“[O]nce the insurer decides to assert a coverage defense, the same attorney may not represent both the insured and the insurer. [W]hen coverage is disputed, the interests of the insured and the insurer are always divergent. The attorney should not be placed in the position of divided loyalties. Such an arrangement would be adverse to the best interests of the insured, the insurer, the attorney, and the profession.”
“The potential for conflict requires a careful analysis of the parties’ respective interests.” “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.’”
Simple notice of a lawsuit or pre-litigation claim to a liability insurer is like a Certs mint: “It’s two, two, two claims in one”: First, the plaintiff makes a “third party” liability claim against the policyholder (the “first party”) for which the insurer (the “second party”) may be responsible. Second, the policyholder makes a “first party” claim for two kinds of payments: 1) to pay the costs of defense to or on behalf of the policyholder; and 2) to pay the cost of a settlement or judgment to the plaintiff on behalf of the policyholder.
Top Ten Insurer Decisions
Against this backdrop, whenever a liability claim is made, the insurer has a series of as many as ten major decisions to make regarding the claim. They are: Should the insurer:
No. 1. Accept full coverage? (Previously rejected, but possibly fixable)
No. 2. Deny all coverage? (Deferred by a reservation of rights)
No. 3. Reserve rights? (This decision necessitates consideration of the remaining decisions)
No. 4. Hire dependent counsel?
No. 5. Agree to pay independent counsel?
No. 6. Actually pay independent counsel? (Agreeing to pay and actually paying are different)
No. 7. Accept a settlement offer?
No. 8. Sue for declaratory relief?
No. 9. Seek reimbursement of defense costs?
No. 10. Seek reimbursement of settlement costs?
Top Ten Policyholder Responses
Many policyholders falsely assume that they must do whatever the insurer and its lawyers ask of them. But like a virgin on a blind date, the policyholder has a right to say “No”. As the insurer makes its ten major decisions, the policyholder may make as many as ten major decisions. They are:
No. 1. Cooperate with the plaintiff?
No. 2. Develop evidence of each of the insurer’s ten decisions?
No. 3. Challenge dependent counsel’s ethics?
No. 4. Seek a judicial determination of conflicts of interest?
No. 5. Develop evidence of the attorney’s ethical violations?
No. 6. Accept representation by dependent counsel?
No. 7. Hire independent counsel?
No. 8. Settle with the plaintiff?
No. 9. Sue the insurer and/or dependent counsel and if so, when?
No. 10. Resist the insurer’s reimbursement claims?
What to do?
Sorting out these numerous, interrelated, and unpredictable decisions and responses can be formidable. But like Paul Newman eating eggs in Cool Hand Luke, it can be done by those who are dedicated, diligent, motivated, and methodical. In due time, this website will refer readers to additional Memoranda, Practice Pointers, and Action Guides to address each of the twenty decisions and responses just mentioned.
In the meantime, a simple option for policyholders who choose to protect their interests is: 1) Challenge the reserving insurer to clarify, if not modify, its coverage position; 2) Challenge dependent counsel to comply with Rule 3-310; and until they do, 3) withhold consent to representation by dependent counsel and authority to appear in court on behalf of the policyholder with a simple letter.
If the insurer or its lawyers telephone or asks for a face-to-face, accept the invitation , but take copious notes, ask that others to confirm in writing, send one’s own confirming letter, and insist that these oral communications do not relieve either the insurer or its lawyers from responding in writing to either Questionnaire. If threats ensue, ask that those threats be expressed in writing by the speaker and send one’s own confirming letter. If the cooperation clause is invokes, ask that the speaker quote the language of the policy and cite case law stating that the cooperation clause says what they say it says. This without more, should either satisfy the policyholder that both the insurer and its lawyers are trustworthy or its opposite. Also, the policyholder may benefit by making both the insurer and its lawyers nervous.
 “[E]very insurer shall immediately accept [“Yes”] or deny the claim, in whole [“No”] or in part [“Maybe”].” (Cal. Code Regs. § 2695.7(b) (text in parentheses added).)
 Every insurer that denies a third party claim, in whole or in part, or disputes liability or damages shall do so in writing [including] a statement that [the policyholder] may have the matter reviewed by the California Department of Insurance.” (Ibid. (ellipses omitted).)
 “[T]he policy sets forth the duty to defend as a primary one.” (Gray v. Zurich Insurance Co. (1966) 65 Cal.2d 263, 268.)
 “Unlike the obligation to indemnify, which is only determined when the insured’s underlying liability is established, the duty to defend must be assessed at the very outset of a case.” (Hartford Casualty Ins. Co. v. Swift Distribution, Inc. (2014) 59 Cal.4th 277, 287; see also, Ringler Associates Inc. v. Maryland Casualty Co. (2000) 80 Cal.App.4th 1165, 1185).
 “[T]he carrier must defend a suit which potentially seeks damages within the [indemnity] coverage of the policy. [A]n insurer may owe a duty to defend its insured in an action in which no damages ultimately are awarded.” (Horace Mann Ins. Co. v. Barbara B. (1993) 4 Cal.4th 1076, 1081 (ellipses omitted).) “[T]he existence of a duty to defend turns not upon the ultimate adjudication of coverage under its policy of insurance, but upon those facts known by the insurer at the inception of a third party lawsuit. Hence, the duty may exist even where coverage is in doubt.” (Montrose Chemical Corp. v. Superior Court (1993) 6 Cal.4th 287, 295.)
 “An insurer may have a duty to defend even when it ultimately has no obligation to indemnify, either because no damages are awarded in the underlying action against the insured, or because the actual judgment is for damages not covered under the policy.” (Hartford Casualty Ins. Co. v. Swift Distribution, Inc. (2014) 59 Cal.4th 277, 287; see also, Ringler Associates Inc. v. Maryland Casualty Co. (2000) 80 Cal.App.4th 1165, 1185).
 “[T]he duty to defend is broader than the duty to indemnify.” (Horace Mann, supra, 4 Cal.4th at 1081.
 Ins. Code § 22.
 Civ. Code § 2772.
 PPG Industries, Inc. v. Transamerica Ins. Co. (1999) 20 Cal.4th 310, 318 (ellipses and quotation marks omitted).
 Crawford v Weather Shield Mfg., Inc. (2008) 44 Cal. 4th 541, 559 (ellipses omitted).
 Montrose Chemical Corp. v. Superior Court (1993) 6 Cal.4th 287, 295-96 (citations, ellipses and quotation marks omitted); see also, Horace Mann Ins. Co. v. Barbara B. (1993) 4 Cal.4th 1076, 1081; Scottsdale Ins. Co. v. MV Transp. (2005) 36 Cal.4th 643, 654-55.
 “[S]o far as the insured is concerned, the duty to defend may be as important as the duty to indemnify. (Montrose Chemical Corp. v. Superior Court (1993) 6 Cal.4th 287, 295-296; see Continental Cas. Co. v. Zurich Ins. Co. (1961) 57 Cal.2d 27, 37.)” (Buss v. Superior Court (1997) 16 Cal.4th 35, 45.)
 Bus. & Prof. Code § 6125.
 Merritt v. Reserve Ins. Co. (1973) 34 Cal.App.3d 858, 880-881 (citations omitted).
 Flatt v. Superior Court (1994) 9 Cal.4th 275, 286.
 Rule 3-310(A)(B)(C)(F) (ellipses omitted).
 Dynamic Concepts, supra, 61 Cal.App.4th at 1007.
 Berger, Kahn, supra 79 Cal.App.4th at 131.
 The burden is on the lawyer to clear potential conflicts before starting work. (Rule 3-310.)
 “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. Code § 6104.)
 “Dear Sir: Until you have complied with Rule 3-310, you do not have my consent to represent me nor my authority to appear in court. Very truly yours.”
 “Upon receiving any communication from a [policyholder] that reasonably suggests that a response is expected, every [insurer] shall immediately, but in no event more than fifteen (15) calendar days after receipt of that communication, furnish the [policyholder] with a complete response based on the facts as then known by the [insurer].” (Cal. Code Regs. § 2695.5(b).)
 “We conclude the 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. The insurer may not compel the insured to surrender control of the litigation. Disregarding the common interests of both insured and insurer in finding total nonliability in the third party action, the remaining interests of the two diverge to such an extent as to create an actual, ethical conflict of interest warranting payment for the insureds’ independent counsel.” San Diego Navy Fed. Credit Union v. Cumis Ins. Society, Inc. (1984) 162 Cal.App.3d 358, 375 (citations omitted).