CONTROL OF THE DEFENSE:

YES, NO, MAYBE

INTRODUCTION

While a defendant has the initial statutory right to control the defense of a lawsuit to which he or she is a party, a liability insurance policy may confer upon the insurer the right to control the defense. Determining whether the insurer or the policyholder has the right to control the defense requires two separate analyses: 1) what contractual, statutory and common law standards control the insurer-policyholder relationship; and 2) what ethical standards impede dependent counsel1 from representing both the insurer and the policyholder.2

COMMON LAW STANDARD TO CONTROL THE DEFENSE

California case law is clear that the right to control the conduct of the defense depends upon: 1) the agreement of the parties, if any;3 2) whether the insurer is faithfully performing its duty to defend;4 and 3) whether a disqualifying conflict of interest exists.5 While there are exceptions to the rules: 1) An insurer that says "yes" may control its policyholder's defense; 2) An insurer that says "no" may not; and 3) The right of an insurer that says "maybe" to control the defense turns on whether a disqualifying conflict of interest exists.

1.	An Insurer That Says "Yes" May Control the Defense

When an insurer unqualifiedly agrees to defend and indemnify its policyholder, it may control the defense.6 Liability insurers usually concede full coverage for their policyholders through silence.7 "The general rule supported by the great weight of authority is that if a liability insurer, with knowledge of a ground of forfeiture or noncoverage under the policy, assumes and conducts the defense of an action brought against the insured, without disclaiming liability and giving notice of its reservation of rights, it is thereafter precluded in an action upon the policy from setting up such ground of forfeiture or noncoverage. In other words, the insurer's unconditional defense of an action brought against its insured constitutes a waiver of the terms of the policy and an estoppel of the insurer to assert such grounds."8

It is both logical and generally accepted in California that an insurer which concedes full coverage, agreeing to defend and indemnify, may control the defense. After all, the insurer thus bears the entire risk of financial loss resulting from the outcome of the plaintiff's lawsuit. The rationale for the rule is that since only the insurer's assets are at risk, it should have the right to select and direct dependent counsel. This rule causes no mischief among the parties because no conflict of interest is present between insurer and policyholder. The policyholder only stake in the action is a modest deductible. The notion that the insurer that concedes coverage may control its policyholder's defense is so well accepted that it has garnered little judicial discussion. "The insurer thus has the right to control the defense of claims" when a liability insurer concedes coverage.9

2.	An Insurer That Says "No" May Not Control the Defense

When an insurer refuses to defend or indemnify its policyholder, it has no right to control the defense or settlement of a plaintiff's lawsuit.10 "Courts have for some time accepted the principle that an insured who is abandoned by its liability insurer is free to make the best [of the situation]."11 "[O]nce the insurer had wrongfully denied liability and refused to defend, the insured was released from his obligation to leave the management of the claim to the insurer and was justified in proceeding on her own account in whatever manner seemed proper to her under the circumstances."12 "When an insurer wrongfully refuses to defend, the insured is relieved of his or her obligation to allow the insurer to manage the litigation and may proceed in whatever manner is deemed appropriate."13

3.	A Insurer That Agrees to Defend But Fails to

Faithfully Pay May Not Control the Defense

Lip service does not satisfy the duty to defend. Some insurers say that they will provide a defense, but then fail to keep this promise by adequately funding the defense. Reservation of rights letters are "only an expression of [the insurer]'s future intent to comply with its duty to defend, and not an actual acceptance or agreement to provide a defense or to appoint plaintiffs' chosen counsel as Cumis counsel. [The insurer]'s payment of defense fees at the end of the litigation [was] the equivalent of a defense denial. [Any other rule] would encourage insurers to reject their Cumis obligations for as long as they chose."14 An insurer which wrongfully fails to defend immediately and entirely15 loses all control of its policyholder's defense, which in turn frees to policyholder to protect her own interests without regard to the interests of the defaulting insurer, such as settling the liability suit without the insurer's consent.16

Money is power. As a financial institution, an insurer wields the power of the purse. An insurer's decisions to pay or not to pay for its policyholder's defense immediately and entirely is very likely to have an immediate and significant impact on the quality of the defense that defense counsel can provide without adequate funds. An insurer's duty to defend through independent counsel requires it to defend immediately and entirely by paying defense invoices in full within 30 days.17 Paying too little "would force the insured to finance his own investigation and the defense of the lawsuit, and then to seek reimbursement in a second lawsuit against the insurance company. This, in turn, could not only impose an undue financial burden on persons who have purchased insurance protection, but it could deprive them of the expertise and resources available to insurance carriers in making prompt and competent investigations as to the merits of lawsuits filed against their insureds."18

Civil Code §2860 provides an array of protections for insurer that qualify, including a favorable hourly rate limitation. However, in order to qualify, the insurer must irrevocably agree or obtain a final judicial determination that: (A) the insurer has a duty to defend; (B) a disqualifying conflict of interest exists; and (C) the insurer is faithfully providing a defense.19 Thus, an insurer that agrees to defend under a reservation of rights to later disclaim that: 1) it ever had any duty to defend; or 2) that a disqualifying conflict exists is not entitled to pay reduced hourly rates.20 "[I]n the absence of a stipulation or unconditional agreement between the insurer and insured, unless and until there has been a judicial determination of an insurer's duty to defend and the existence of a conflict of interest, the provisions of Civil Code section 2860 are inapplicable."21

4.	An Insurer Whose Reservation of Rights Creates a

Disqualify Conflict May Not Control the Defense

A.	A Reservation of Rights Always Creates a Conflict of Interest

By its nature, a reservation of rights always creates some sort of conflict of interest between the insurer and its policyholder. A reservation of rights confers upon the insurer the right to later deny coverage to its policyholder, which is contrary to the interests of the insured. "In any event, if the insurer adequately reserves its right to assert the noncoverage defense later, it will not be bound by the judgment. If the injured party prevails, that party or the insured will assert his claim against the insurer. At this time the insurer can raise the noncoverage defense previously reserved."22

B.	Not All Reservations Create a Disqualifying Conflict

"[N]ot every conflict of interest triggers an obligation on the part of the insurer to provide the insured with independent counsel at the insurer's expense."23 "[A] conflict of interest does not arise every time the insurer proposes to provide a defense under a reservation of rights."24

C.	Disqualifying Conflicts Are Governed by Rule 3-310

Disqualifying conflicts of interest as those in which dependent counsel cannot ethically represent the policyholder.25 Rules of Professional Conduct, Rule 3-310 governs an attorney's ethical obligation when representing joint client.26 "[T]he Cumis rule is not based on insurance law but on the ethical duty of an attorney to avoid representing conflicting interests.27 "Conflict of interest between jointly represented clients occurs whenever their common lawyer's representation of the one is rendered less effective by reason of his representation of the other."28 Accordingly, control of a policyholder's defense is ultimately governed by the attorney-client relationship and the lawyer's canons of ethics.29 "[O]nce the insurer decides to assert a coverage defense, the same attorney may not represent both the insured and the insurer."30 "[T]he potential conflict exists because the interests of the insurer and its insured diverge. [T]he insured retains its right to independent counsel that it selects and controls."31 Accordingly, in order for the insurer to successfully seize control of its policyholder's defense, it must show that no conflict of interest32 precludes its chosen lawyer from ethically representing both the insurer and the policyholder.33

California attorneys may generally represent both the insurer and the policyholder so long as the two clients' interests do not conflict.34 Thus, it is generally accepted that a liability insurer has a right to control the policyholder's defense when the insurer concedes coverage.35 "The insurer thus has the right to control the defense of claims."36 However, lawyers may not ethically represent multiple clients whose interests conflict without making appropriate written disclosure to and obtaining informed written consent from each client.37 The difference between dependent counsel and independent counsel38 is that the former represents only the policyholder, while the later represents the interests of the insurer and represents the policyholder as a client.39

D.	Disqualifying Conflicts of Interest Exist In a Wide Variety of Circumstances

"Some of the circumstances that may create a conflict of interest requiring the insurer to provide independent counsel include: (1) where the insurer reserves its rights on a given issue and the outcome of that coverage issue can be controlled by the insurer's retained counsel; (2) where the insurer insures both the plaintiff and the defendant; (3) where the insurer has filed suit against the insured, whether or not the suit is related to the lawsuit the insurer is obligated to defend; (4) where the insurer pursues settlement in excess of policy limits without the insured's consent and leaving the insured exposed to claims by third parties; and (5) any other situation where an attorney who represents the interests of both the insurer and the insured finds that his or her 'representation of the one is rendered less effective by reason of his [or her] representation of the other.'"40 An insurer should not make "the erroneous assumption that it could exclusively control the case even though it lacked an economic interest in its outcome. In actions in which the insurer lacks an economic motive for a vigorous defense of the insured . . ., the insurer may not compel the insured to surrender control of the litigation."41 "[T]he potential conflict exists because the interests of the insurer and its insured diverge. [T]he insured retains its right to independent counsel that it selects and controls."42 "The insurer may not compel the insured to surrender control of the litigation."43 "[I]n a conflict of interest situation, the insurer's desire to exclusively control the defense must yield to its obligation to defend its policy holder."44 This is so because "the insurer may be subject to substantial temptation to shape its defense so as to place the risk of loss entirely upon the insured."45

Although courts have used a variety of nomenclature, a reservation of rights always creates disqualifying conflicts of interest unless all grounds upon which the insurer may disclaim coverage are unrelated to,46 irrelevant to,47 extrinsic to, independent of,48 or have nothing to do with49 the third party litigation.

Neither the wealth of case law addressing conflicts of interest nor the variety of verbiage used by the courts should confuse lawyers or judges who seek to understand this field of law. At its core, the Cumis rule controls: When an insurer reserves its rights, dependent counsel cannot represent both the insurer and the policyholder without their informed written consent. (See fn. 2.)