Conflicts of Interest Between an Insurer and Its Insured

In most instances, commercial general liability insurance policies provide that an insurer retains exclusive control over defending the insured in litigation, including selecting and directing defense counsel. However, in certain circumstances, an insurer may encounter an irreconcilable conflict of interest in connection with honoring its duty to defend. In such cases, courts consistently have held that the existence of such a conflict obligates the insurer to retain independent counsel on behalf of the insured, at the insurer's expense. See, e.g., San Diego Navy Fed. Credit Union v. Cumis Ins. Society, Inc., 162 Cal. App. 3d 358, 208 Cal. Rptr. 494 (Cal. Ct. App. 1984). While Cumis is not the first case to address the issue, it is one of the most frequently cited cases on this topic.

In Cumis, a tort claimant sued the defendants-insureds, seeking both general and punitive damages. In accordance with insurance policies potentially covering the claim, the insureds tendered the defense of the tort action to their insurer. After reviewing the complaint and determining that it had an obligation toprovide a defense to the insureds, the insurer selected and retained (at its own cost) a law firm to represent and defend the insureds from all claims in the action, including the punitive damages claim. At the same time, the insurer informed both the law firm and its insureds that it was reserving its right to deny coverage at a later date, since, among other reasons, the insurance policies did not cover punitive damages.

Upon receiving the insurer's reservation of rights, the insured retained a second law firm as independent counsel to protect its interests. Independent counsel notified the insurer that it was retained to act as co-counsel with the law firm selected by the insurer. While the insurer initially paid the fees of independent counsel, it later refused to continue paying independent counsel's fees.

The insured then sued the insurer, seeking to force the insurer to pay its independent counsel fees. The trial court held that the insurer was required to pay the reasonable fees of independent counsel, reasoning as follows:

The [insurer] is required to hire independent counsel because an attorney in actual trial would be tempted to develop the facts to help his real client, the [insurer], as opposed to the Insured, for whom he will never likely work again. In such a case as this, the Insured is placed in an impossible position; on the one hand the [insurer] says it will happily defend him and on the other it says it may dispute paying any judgment, but trust us. [Allowing an insurer to choose the counsel under these circumstances] flies in the face of the reality of insurance defense work. Insurance companies hire relatively few lawyers and concentrate their business. A lawyer who does not look out for the [insurer's] best interest might soon find himself out of work. Cumis, 162 Cal. App. 3d at 364.

The California Court of Appeals agreed with the trial court, holding that a conflict between the insurer and insured arises where an insurer is obligated to provide a defense to its insured under an insurance policy but also reserves its right to later deny coverage. Under these circumstances, the insurer would benefit from a decision at trial that the insured is not covered under the policy, while the insured conversely would benefit from a decision that confirms coverage. All the while, the attorney selected by the insurance company would have to 'walk an ethical tightrope' of communicating all relevant information regarding the case to the insurer (including any facts developed that may bar coverage), while simultaneously attempting to defend vigorously the insured in the underlying suit. Id. at 366.

Given the problems presented under this scenario, the Court of Appeals concluded that where such a conflict arises, the insured may retain independent counsel, and the insurer is obligated to pay the reasonable fees of the counsel selected by the insured:

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. Id. at 375.

Following Cumis, many courts around the country embraced its holding. See, e.g., Williams v. Amer. Country Ins. Co., 833 N.E.2d 971 (Ill. App. 2005) (holding that conflict arising from insurer's reservation of rights gives insured right to choose independent counsel); CHI of Alaska, Inc. v. Employers Reins. Corp., 844 P.2d 1113 (Alaska 1993) (same); Armstrong Cleaners, Inc. v. Erie Ins. Exchange, 364 F. Supp. 2d 797 (S.D. Ind. 2005) (holding that a conflict arising from the insurer's reservation of rights gives the insured the right to choose independent counsel despite the efforts by the insurer to erect a 'Chinese Wall' to protect against a conflict of interest); additional cases infra at 'Who Selects Independent Counsel?' See also Twin City Fire Ins. Co. v. Ben Arnold-Sunbelt Beverage Co. of South Carolina, LP, 336 F. Supp 2d 610 (D.S.C. 2004) (holding that the insurer's obligation to provide independent counsel is not based on insurance law; rather it is based on the lawyer's duty of loyalty which prevents him or her from practicing with a conflict of interests). But see Yeomans v. Allstate Ins. Co., 324 A.2d 906 (N.J. Super. A.D. 1974) (holding that insurer had right to select independent counsel). Additionally, the California legislature subsequently codified the rules regarding an insurer's duty to pay for independent counsel, which partially changed the Cumis rule. See Cal. Civ. Code '2860 (detailing insurer's obligations to provide independent counsel). To this day, Cumis remains one of the most frequently cited cases on the topic of an insurer's duty to provide independent counsel to its insured.

Other Scenarios

There are a number of different circumstances under which the duty to provide independent counsel arises. The Cumis case, discussed above, provides an example of one of the most common situations where a conflict necessitates the retention of independent counsel: where an insurer reserves its right to deny coverage based on the development of the facts giving rise to the asserted claim. However, a number of other scenarios may also trigger an insured's right to independent counsel.

Allegations Within and Outside the Scope of Coverage

A plaintiff may file a complaint against an insured that contains several different types of claims. In these multi-claim lawsuits, it is not uncommon for certain claims to be covered by the subject policy (e.g., negligence), while others may arguably be outside the scope of coverage (e.g., intentional tort). Because this scenario creates a divergence of interest between the insurer and insured with respect to how the claim ultimately is characterized, courts have held that such circumstances give rise to a duty to provide the insured with independent counsel. In circumstances such as these, some courts have held that the insurer must either waive its coverage defenses and defend without reserving its rights or allow its insured to choose its own attorney, at the insurer's expense. See, e.g., Maryland Cas. Co. v. Peppers, 355 N.E.2d 24 (Ill. 1976) (holding that if the insurer waives its defense of non-coverage and defends the insured without asserting a reservation of rights or non-waiver agreement, the conflict would be eliminated); State Farm Mut. Auto. Ins. Co. v. Van Dyke, 247 N.Y.S.2d 821 (4th Dept. 1998) (holding that factual dispute regarding whether the driver of the insured vehicle intentionally or negligently struck pedestrians entitled the driver and the vehicle owner to retain independent counsel with fees paid for by insurer).

Damages Sought in Excess of Policy Limits

Under most current liability policies, an insurer is relieved of any further obligation to pay defense costs once its policy limits have been exhausted. However, in at least one case, based upon the adversarial position taken by the insurer and insured, a court held that an insurer was responsible for paying independent counsel to defend an insured in a subsequent suit, notwithstanding the fact that the insurer had already paid its policy limits in connection with the first lawsuit. St. Paul Fire & Marine Ins. Co. v. Thompson, 433 P.2d 795 (Mont. 1967).

In Thompson, the Supreme Court of Montana concluded that State Farm was obligated to pay attorneys' fees for the independent counsel of its insured, Thompson. There, an employer, Haggerty-Messmer Company (insured by St. Paul) and its employee Thompson (insured by State Farm) were sued jointly for bodily injury arising out of an auto accident in which Thompson allegedly negligently drove his own car while acting in the course and scope of his employment. State Farm paid its limits under Thompson's policy in a joint settlement of the personal injury case. Thereafter, St. Paul sued Thompson on the employer's subrogated claim for contribution. Thompson then notified State Farm of St. Paul's claim and requested that State Farm defend him in the indemnity action. State Farm refused, arguing that it already had paid out its policy limits.

The court held that the duty to defend was independent of the duty to indemnify and that State Farm continued to owe Thompson a duty to defend. Id. at 798-99. The court's decision appears to have interpreted pre-1966 policy language that has been construed to create a continuing duty to defend after the exhaustion of policy limits. See Keene Corp. v. Ins. Co. of N. Am., 597 F. Supp. 946, 951-52 (D.D.C. 1984) (distinguishing Thompson).

In so holding, the court awarded attorneys' fees to Thompson's independent counsel. While State Farm thought its attorneys should be allowed to defend, the court disagreed, finding State Farm's position inconsistent and at odds with Thompson's position. The court explained: