When Is an Insured Entitled to Independent Counsel?

A claim is made against the insured. The insurer has a duty to defend. The insurer agrees to defend subject to a reservation of rights, and refers the matter to panel counsel. The insured asserts that the reservation of rights creates a right to independent counsel, paid for by the insurer. Is the insurer obligated to provide independent counsel? Not necessarily.

This article discusses the judicial and legislative bases for the right to independent counsel and identifies situations/circumstances where courts have or have not found that such a right exists. Somewhat surprisingly, the courts have been relatively restrictive as to what situations create a right to independent counsel. Please note that this is not an exhaustive review of the law in all states, but is designed more as a survey of those states that generally have a more developed body of insurance law.

The Cumis Case and California Civil Code ' 2860

In 1984, the California Supreme Court issued its decision in San Diego Navy Federal Credit Union v. Cumis Insurance Society. San Diego Navy Federal Credit Union v. Cumis Ins. Society Inc., 162 Cal. App. 3d 358, 375 (1984), superseded by statute, Cal. Civ. Code ' 2860. The underlying litigation in Cumis involved an employee suing the employer (the insured) for wrongful discharge, breach of contract and intentional infliction of emotional distress. Cumis Insurance Society defended under a reservation of rights on the allegation of intentional conduct. The court determined that a conflict of interest was present because liability, if any, would rest on conduct excluded by the terms of the insurance policy. Defense counsel would have been forced to make certain decisions, which may have either benefited the insurer or the insured. Each time defense counsel were to make a decision in this case, “the lawyer [would be] placed in the dilemma of helping one of his clients concerning insurance coverage and harming the other.” Thus, under Cumis, in the absence of consent by the insured, where there are differing interests between the insurer and the insured brought about by a reservation of rights for possible non-coverage, the insurer must pay the reasonable fees for hiring independent counsel selected by the insured and the control of the litigation must be in the hands of the insured.

Cumis initially was interpreted to mean that independent counsel was required any time an insurer defended under a reservation of rights. In 1987, the California legislature enacted Civil Code ' 2860 to clarify Cumis, providing that in not every instance does a reservation of rights confer upon the insured the right to independent counsel. Cal. Civ. Code ' 2860 [PROVISION OF INDEPENDENT COUNSEL TO INSURED; CONFLICTS OF INTEREST; SELECTION OF COUNSEL; WAIVER OF RIGHT TO COUNSEL].

The basic test set forth in Cumis (which is codified in ' 2860) is whether the issue on which the reservation of rights is based can be manipulated by counsel retained by the insurer such that a finding of no coverage might result. If this is the case, the insured is entitled to independent counsel.

There are several features to ' 2860, each one important:

• The statute only applies in duty-to-defend cases. The right to independent counsel can be knowingly waived in writing. An insurance policy may contain a provision that sets forth the method for selecting independent counsel.
• The statute sets forth the test for independent counsel: When an insurer reserves rights on an issue and the outcome of that issue can be controlled by counsel retained by the insurer, a conflict of interest may exist. No conflict of interest is deemed to exist due to a request for punitive damages, or when the insured is sued for an amount in excess of policy limits.
• Independent counsel must meet certain minimum qualifications including years of experience and E&O insurance.
• The insurer's obligation to pay fees to independent counsel is limited to the rates the insurer “actually” pays to panel counsel in the defense of similar actions in the community where the claim arose or is being defended. The policy may, however, provide otherwise. Any disputes concerning defense fees shall be resolved by binding arbitration.
• Independent counsel and the insured have a duty to disclose all relevant, non-privileged information to the insurer.
• The statute sets forth specific waiver language if the insured decides to waive its right to independent counsel.
• Finally, the insured is not relieved of its duty to cooperate with the insurer.

Thus, the right to independent counsel is not automatic; there must be an underlying coverage issue which, in theory, can be manipulated by panel counsel.

When Independent Counsel Is Required

We discuss below a variety of different holdings in cases from a sampling of jurisdictions that generally are more active in evaluating the rights of insurers and insureds.

California

California has a fairly well-developed body of case law on the right to independent counsel under a duty-to-defend policy, both pre- and post-enactment of ' 2860. The paradigm case requiring independent counsel is one in which the way counsel retained by the insurance company defends the action will affect an underlying coverage dispute. Golden Eagle Ins. Co. v. Foremost Ins. Co., 20 Cal. App. 4th 1372 (1993); Executive Aviation, Inc. v. National Ins. Underwriters, 16 Cal. App. 3d 799 (1971). However, courts have held that a conflict must be “actual and significant, not merely potential and theoretical”; no right to independent counsel arises where the coverage issue is independent of and extrinsic to the issues in the underlying action. Dynamic Concepts, Inc. v. Truck Ins. Exch., 61 Cal. App. 4th 999 (1998).

A number of situations in which a right to independent counsel has been found are discussed below.

• Allegations of intentional conduct.

The classic circumstance is when the alleged wrongful conduct of the insured in the underlying litigation could be found to have been intentional, thus triggering an intentional acts exclusion. Cumis, 162 Cal. App. 3d at 361.

• Settlements in excess of policy limits.

In Golden Eagle Ins. Co. v. Foremost Ins. Co., the insureds refused to consent to a settlement that would exceed the policy limits alleged by the insurer. Golden Eagle Ins. Co. v. Foremost Ins. Co., 20 Cal. App. 4th 1372, 1396 (1993). The attorney retained by the insurer to represent the insureds failed to oppose the insurer's petition for permission to settle even though he knew his clients, the insureds, would be exposed to excess liability and that they opposed the settlement sought by the insurer. The court held that not only was counsel put in the position of representing clients with conflicting positions regarding settlement, but also the insurer was seeking to settle the case with (in part) the insureds' money. Under these circumstances, the insureds were entitled to independent counsel, at the insurer's expense, to represent them in settlement negotiations.

• Mixed actions.

A potential conflict of interest arises where a third-party complaint asserts both covered and non-covered claims against the insured. Dynamic Concepts, Inc., 61 Cal. App. 4th at 1006. The insured will want any judgment limited to covered claims, while the insurer will be better off if judgment is imposed on claims not covered under the policy. However, under this example, there is not an automatic right to independent counsel. Rather, the focus is on whether “the outcome of the coverage dispute can be controlled” by the defense counsel. Determination of whether independent counsel is warranted is done on a case-by-case basis and will be fact specific.

• Defense counsel issues.

Independent counsel is required when the insurer insures several insureds who have claims against one another. It is contrary to public policy for a law firm to control both sides of the litigation, thus independent counsel for each insured is required. The insurer loses the right to control the defense of each and the right to access confidential information. See O'Morrow v. Borad, 27 Cal. 2d 794, 800 (1946).

A conflict may exist when the same defense attorney defending the insured in the underlying action is representing the insurer in a separate declaratory relief action seeking to avoid coverage. See Executive Aviation, 16 Cal. App. 3d at 804 (1971). Additionally, a conflict of interest may exist when a law firm agrees to represent the insurer in a contribution claim against another insurer that the same law firm represented in another matter. Truck Ins. Exch. v. Fireman's Fund Ins. Co., 6 Cal. App. 4th 1050 (1992).

New York

The general rule in New York is “when an insurer has a duty to defend an insured, it also has the right to control the litigation and select the counsel it wishes to handle the defense.” Ottaviano v. Genex Coop Inc., 3 Misc. 3d 1024, 1027 (N.Y. Sup. Ct. 2004). In some cases, however, if the interests of the insured party conflict with those of the insurer, under New York case law, the right to select counsel shifts to the insured.

A conflict may exist between an insured's interests and an insurer's interests if, for example, an exclusionary clause operates to exempt some of the insured's potential liability from coverage. Id. (citing Mount Vernon Fire Ins. Co. v. J.J.C. Stucco & Carpentry Corp., 1997 U.S. Dist. LEXIS. In such a case, the insurer's interest in minimizing the insured's covered liabilities conflicts with the insured's interest in minimizing all of its liabilities.

New York courts have found that “independent counsel is only necessary in cases where the defense attorney's duty to the insured would require that he defeat liability on any ground and his duty to the insurer would require that he defeat liability only upon grounds which would render the insurer liable.” Public Serv. Mut. Ins. Co. v. Goldfarb, 53 N.Y.2d 392, 401 n (1981).

Texas

Texas has case law with respect to the independent counsel requirement. Ordinarily, the insurer's duty to defend includes the authority to select defense counsel and the right to control the case.

Texas courts have identified instances of conflicts that may disqualify defense counsel. The basic scenario is when the facts to be adjudicated in the liability lawsuit are the same facts upon which coverage depends. Such a conflict would prevent defense counsel retained by the insurer from handling the defense. Northern County Mut. Ins. Co. v. Davalos, 140 S.W.3d 685 (Tex. 2004). However, a disagreement between the insurer and the insured regarding defense strategy (e.g., proper venue) does not necessarily constitute a conflict requiring independent counsel.

Other conflicts include: 1) when the defense tendered is not a complete defense under the circumstances in which it should have been; 2) when the attorney hired by the insurer acts unethically and, at the insurer's direction, advances the insurer's interests at the expense of the insured's; 3) when the defense would not, under governing law, satisfy the full extent of the insurer's duty to defend; and 4) when, though the defense is otherwise proper, the insurer attempts to obtain some type of concession from the insured before it will defend. Id.

Florida

Florida does not have much case law discussing instances of when independent counsel is required. It does, however, have a statute that has a “mutually agreeable” requirement for selection of defense counsel within 60 days of issuing a reservation of rights (the ROR itself due within 30 days of when the insurer knew or should have known of a coverage issue). See Claims Administration Statute, ' 627.426(2), Fla. Stat. Anno. (2010). Pursuant to ' 627.426(2)(b), Florida Statutes Annotated, an insurer waives all “coverage defenses” unless within 60 days of receiving the lawsuit against its insured, the insurer: 1) gives written notice of its refusal to defend; 2) obtains a written non-waiver agreement; or 3) retains “mutually agreeable” counsel to defend the lawsuit. Id. One court found that unilateral retention of counsel by the insurer, after issuing a reservation of rights, was the antithesis of mutual selection and thus the insurer violated the statute. American Empire Surplus Lines Ins. Co. v. Gold Coast Elevator, Inc., 701 So.2d 904, 906 (Fla.App. 4 Dist. 1997).

Illinois

The general rule in Illinois is that an insurer is obligated to defend an action against an insured when the complaint contains allegations that bring the claim actually or potentially within coverage. American County Ins. Co. v. Williams, 791 N.E.2d 1268 (Ill. App. 2003). The test of whether a conflict of interest exists, which would allow the insured to assume control of the defense, is if, in comparing the allegations of the complaint to the terms of the policy, the insurer's interests would be furthered by providing a less than vigorous defense to the allegations. However, similar to California, the conflict must be actual and not merely potential. Id.

A conflict of interest has been found where the underlying action asserts claims that are covered by the policy and other claims that the insurer is required to defend, but asserts are not covered by the policy. Thornton v. Paul, 384 N.E.2d 335 (Ill. 1978), rehearing denied (1979), overruled on other grounds by American Family Mut. Ins. Co. v. Savickas, 739 N.E.2d 445 (Ill. Sept. 28, 2000), rehearing denied (Nov. 27, 2000). Another example of a conflict of interest is where an insurer provided a defense but reserved the right to deny coverage for punitive damages. Nandorf, Inc., v. CNA Ins. Companies, 479 N.E.2d 988, 994 (Ill. App. 1 Dist. 1985). However, the finding in this case did not imply that an insured is entitled to independent counsel in all cases where punitive damages are sought; in this case, punitive damages formed a substantial portion of the potential liability, and the insurer's disclaimer of liability for punitive damages left the insured with the greater interest and risk of litigation. Setting the common interests of the insurer and insured aside, the remaining interests of the two conflicted to such an extent as to create an actual ethical conflict warranting independent counsel.

Recently, the Seventh Circuit Court of Appeals held that under Illinois law the insurer must notify the insured when it is exposed to liability in excess of the policy limit. R.G. Wegman Construction Co. v. Admiral Insurance Co., No. 09-2022, 2011 WL 117086 (7th Cir. Jan. 14, 2011). Moreover, the insurer must permit the insured to select its own defense counsel and control the defense. Id. Finally, the insured will also have the right to settle a claim without the insurer's consent any time the insured is exposed to potential liability in excess of the policy limit. Id. Interestingly, this new case law stands in direct contrast to ' 2860 in California. As this case was decided by the Seventh Circuit, it is not binding on the state courts. It will be noteworthy, and a shift in the law surrounding the independent counsel issue, if the state courts choose to follow this case as persuasive authority.

Pennsylvania

Pennsylvania courts have not provided many examples of what constitutes a conflict of interest after an insurer agrees to defend under a reservation of rights. The courts have, however, recognized that insureds should at least be given the opportunity to retain independent counsel if and when a conflict of interest in fact does arise. Seasor v. Covington, 670 A.2d 157 (Pa. Super. 1996). In Seasor, the insured was found liable in a negligence action, and the plaintiffs sought an assignment of rights to proceed against the insurer. If the insured assigned the rights to the plaintiffs, the judgment against the insured would have been satisfied. However, counsel for the insured (who was also counsel for the insurer) refused to grant the assignment. As this presented a direct conflict of interest, the case was remanded and the insured was to be advised of her need for independent counsel. This case did not involve a reservation of rights, but the court recognized that conflicts will come up and thus independent counsel may be required.

Massachusetts

The general rule in Massachusetts appears to be that “where the insured's interest in controlling tort litigation against him conflicts with similar interest of the insurer, the insured may have good cause to ask that he be represented by counsel independent of the insurer.” Magoun v. Liberty Mut. Ins. Co., 195 N.E.2d 514, 518 (Mass. 1964).

Other courts have similarly found there is a conflict of interest if an insurer defends under a reservation of rights, but insists on retaining complete control of the defense. Three Sons, Inc. v. Phoenix Ins. Co., 257 N.E.2d 774, 777 (Mass. 1970). In Three Sons, the insurer agreed to defend the insured, subject to a reservation of rights concerning its obligation to indemnify the insured under the policy, but insisted on full control of the defense. Id. at 274. The insured agreed to the insurer's full control of the defense, but not to its reservation of rights. Id. The court agreed with the lower court and held that the insurer was obligated to defend without reservation so long as it insisted on retaining control of the defense.

Other examples of cases describing when independent counsel may be necessary are: Palermo v. Fireman's Fund Ins. Co., 676 N.E.2d 1158 (Mass. App. 1997) (Homeowner's liability insurer that provided its insureds with partial defense of underlying tort action was obligated to protect insureds' interests fully by apprising them of potential future problem of allocating any judgment between covered and noncovered claims, and of availability of special verdict to segregate covered damages, even though insureds were also represented by separate counsel); and Murach v. Massachusetts Bonding & Ins. Co., 158 N.E.2d 338 (Mass. 1959) (Where motor vehicle liability insurer communicated to its insureds the fact of a possible verdict in excess of the policy limits and suggested that they retain personal counsel, insurer fulfilled its duty of disclosing its adverse interest with respect to the extent of its liability under the policy).

Thus, a number of states recognize that the right to independent counsel is not automatic. Generally speaking, issuing a reservation of rights alone is not enough. Further, conflicts must be actual and concrete, not abstract or hypothetical.

When Independent Counsel Is Not Required

Courts have found numerous instances where independent counsel is not required. The examples below are illustrative.

California

Section 2860(b) provides that, categorically, a conflict of interest does not exist (and thus independent counsel is not required) simply because punitive damages (not insurable in California) are sought, or when the insured is sued for an amount in excess of policy limits. Independent counsel was not required during an administrative proceeding involving the insured where damages are not awardable. United Pacific Ins. Co. v. Hall, 199 Cal. App. 3d 551 (1988).

Other examples of where no conflict requiring independent counsel was found include:

• Issues pertaining to which of the defendants is an insured. Long v. Century Indemn. Ins. Co., 163 Cal. App. 4th 1460 (2008).
• Where there is an exclusion for status ( e.g., “resident relative” auto exclusion). McGee v. Superior Court, 176 Cal. App. 3d 221 (1985).
• Carrier appointed counsel's refusal to bring cross-claims or assert affirmative defenses. James 3 Corp v. Truck Ins. Exch., 91 Cal. App. 4th 1093 (2001).
• Partially covered damages ( e.g., exclusion for damages from faulty workmanship; insured produced no evidence to show in what specific way defense counsel could have controlled the outcome of the damage issue to the insured's detriment). Blanchard v. State Farm Fire & Cas. Co., 2 Cal. App. 4th 345 (1992).
• Claimed damages in excess of policy limits. Cal. Civ. Code ' 2860.
• Reservation of the right to seek to recover defense costs based upon non-covered claims. Dynamic Concepts v. Truck Ins. Exch., 61 Cal. App. 4th 999 (1998).
• A global reservation of rights does not instantly trigger the right to independent counsel. Id.
• Where the coverage issue is independent of, or extrinsic to, the issues in the underlying action. Id.
• Where the policy entitles the insurer to settle over the insured's objection. However, there may be a conflict requiring independent counsel where: 1) insurer insures both the plaintiff and the defendant; 2) the insurer is suing the insured, whether or not with regard to the underlying claim; 3) the insurer pursues an excess-of-limits settlement that leaves the insured bare or exposed to other third-party claims. James 3 Corp v. Truck Ins. Exch., 91 Cal. App. 4th 1093 (2001).

New York

Multiple claims do not necessarily require independent counsel, such as where the insurance policy was limited solely to coverage for personal injuries but the claim against the insured sought recovery for property damage. No threat of divided loyalty is present, and so there is no need for independent counsel. This is because in such a situation the question of insurance coverage is not intertwined with the question of the insured's liability. Public Serv. Mut. Ins. Co. v. Goldfarb, 53 N.Y.2d 392, 401 n (1981).

Texas

Texas has recognized that the right to independent counsel is not automatic. In one case, a dispute between the insurer and the insured regarding proper venue was found to not be a sufficient reason to take the contractual right to conduct the defense away from the insurer. Northern County Mut. Ins. Co. v. Davalos, 140 S.W.3d 685 (Tex. 2004). “An insurer's right of control generally includes the authority to make defense decisions as if it were the client where no conflict of interest exists.” Even though there was a disagreement about venue, not all disagreements can amount to a conflict of interest. If they did, the insured, not the insurer, could control the defense by merely disagreeing with the insurer's strategy.

Florida

Florida's unique statute requiring that defense counsel be “mutually agreed upon” within 60 days after an insurer issues a reservation of rights perhaps explains why there is little case law discussing the right to independent counsel. Under Florida's statute, when an insurer defends under a reservation of rights, choice of counsel must be agreed upon unless the insured waives its rights.

Illinois

Illinois requires independent counsel only if the conflict is actual, not merely potential. Allied American Ins. Co. v. Ayala, 616 N.E.2d 1349 (Ill.App. 2 Dist., 1993). In one case stemming from a car accident and where the insurer was seeking a declaratory judgment, the insured argued a conflict of interest existed because the insurer referred the defense of the negligence claims to attorneys who knew the insurer was providing a defense under a reservation of rights related to alleged material misrepresentations in the application, which could render the policy void. Id. The insureds argued that, under these circumstances, a conflict existed because the insurer's real defense no longer turned on the alleged negligence in driving the car, but instead on whether the policy was void. The court, however, found that although there was a theoretical conflict, an actual conflict is necessary to question the defense under a reservation of rights, and there was no actual conflict present. Id.

Pennsylvania

A Pennsylvania court noted that agreeing to defend under a reservation of rights by itself is not enough to constitute a conflict. Eckman v. Erie Ins. Exchange, 2010 WL 5312212 (Pa.Com.Pl. 2010). The insured argued that panel counsel violated a rule of professional conduct because counsel had two clients. The court found that the rule of professional conduct did not apply because the retained counsel had only one client, the insured. Moreover, the insured failed to produce any evidence that counsel retained by the insurer had breached his or her ethical obligations. The insurer had no control over defense counsel's decision-making or judgments regarding the defense, and thus no conflict existed.

Massachusetts

As noted previously in our discussion of Massachusetts, supra, where a claim is made for an amount greater than the limits of the policy, it is the duty of the insurer to disclose to its insured its adverse interest with respect to the extent of its liability under the policy. Murach v. Massachusetts Bonding & Ins. Co., 158 N.E.2d 338, 342 (Mass. 1959). However, there is no conflict if the insurer fulfilled its duty by advising the insured of the possibility of a verdict in excess of the policy limit, suggesting that the insured retain personal counsel, but the insured is unresponsive to details of settlement negotiations. Id.

Outside the insurance context, a judge's failure to provide independent counsel at a hearing when a defendant waives his rights does mean that the wavier is invalid. Commonwealth. v. Jones, 526 N.E.2d 1288, 1293 (Mass. 1988). Although the better practice would be to provide independent counsel at a hearing where a defendant waives his right to conflict-free counsel, that waiver is not necessarily invalid if it was knowingly and intelligently made. Id.

Conclusion

The issue of when an insured is entitled to independent counsel is not a fully developed area of insurance law in most states, but of those states that have addressed the issue, either judicially or statutorily, the consensus seems to be that the mere issuance of a reservation of rights does not require independent representation. Further, even if a conflict exists, it must be actual and significant, not hypothetical, and it must go to an issue that (at least in theory) insurer-appointed counsel could manipulate so as to eliminate the possibility of coverage.

Martin J. O'Leary is a partner and Kirsten A. Mickelson is an associate at Sedgwick LLP in the San Francisco office. O'Leary handles an array of professional liability insurance matters, including directors and officers liability insurance, employment practice liability policies, errors and omissions coverage, and fidelity and crime policies. He periodically speaks on the topic of professional liability insurance matters for the Bar Association of San Francisco and the American Bar Association's Fidelity and Surety Law Committee. He is a member of the Professional Liability Underwriting Society and has served on the Northern California Chapter Steering Committee. Mickelson advises insurers in matters of professional lines and commercial lines policies, including directors and officers liability, employment practices liability, commercial general liability and in connection with other aspects of coverage litigation.

A claim is made against the insured. The insurer has a duty to defend. The insurer agrees to defend subject to a reservation of rights, and refers the matter to panel counsel. The insured asserts that the reservation of rights creates a right to independent counsel, paid for by the insurer. Is the insurer obligated to provide independent counsel? Not necessarily.

This article discusses the judicial and legislative bases for the right to independent counsel and identifies situations/circumstances where courts have or have not found that such a right exists. Somewhat surprisingly, the courts have been relatively restrictive as to what situations create a right to independent counsel. Please note that this is not an exhaustive review of the law in all states, but is designed more as a survey of those states that generally have a more developed body of insurance law.

The Cumis Case and California Civil Code ' 2860

In 1984, the California Supreme Court issued its decision in San Diego Navy Federal Credit Union v. Cumis Insurance Society . San Diego Navy Federal Credit Union v. Cumis Ins. Society Inc. , 162 Cal. App. 3d 358, 375 (1984), superseded by statute, Cal. Civ. Code ' 2860. The underlying litigation in Cumis involved an employee suing the employer (the insured) for wrongful discharge, breach of contract and intentional infliction of emotional distress. Cumis Insurance Society defended under a reservation of rights on the allegation of intentional conduct. The court determined that a conflict of interest was present because liability, if any, would rest on conduct excluded by the terms of the insurance policy. Defense counsel would have been forced to make certain decisions, which may have either benefited the insurer or the insured. Each time defense counsel were to make a decision in this case, “the lawyer [would be] placed in the dilemma of helping one of his clients concerning insurance coverage and harming the other.” Thus, under Cumis, in the absence of consent by the insured, where there are differing interests between the insurer and the insured brought about by a reservation of rights for possible non-coverage, the insurer must pay the reasonable fees for hiring independent counsel selected by the insured and the control of the litigation must be in the hands of the insured.

Cumis initially was interpreted to mean that independent counsel was required any time an insurer defended under a reservation of rights. In 1987, the California legislature enacted Civil Code ' 2860 to clarify Cumis, providing that in not every instance does a reservation of rights confer upon the insured the right to independent counsel. Cal. Civ. Code ' 2860 [PROVISION OF INDEPENDENT COUNSEL TO INSURED; CONFLICTS OF INTEREST; SELECTION OF COUNSEL; WAIVER OF RIGHT TO COUNSEL].

The basic test set forth in Cumis (which is codified in ' 2860) is whether the issue on which the reservation of rights is based can be manipulated by counsel retained by the insurer such that a finding of no coverage might result. If this is the case, the insured is entitled to independent counsel.

There are several features to ' 2860, each one important:

• The statute only applies in duty-to-defend cases. The right to independent counsel can be knowingly waived in writing. An insurance policy may contain a provision that sets forth the method for selecting independent counsel.
• The statute sets forth the test for independent counsel: When an insurer reserves rights on an issue and the outcome of that issue can be controlled by counsel retained by the insurer, a conflict of interest may exist. No conflict of interest is deemed to exist due to a request for punitive damages, or when the insured is sued for an amount in excess of policy limits.
• Independent counsel must meet certain minimum qualifications including years of experience and E&O insurance.
• The insurer's obligation to pay fees to independent counsel is limited to the rates the insurer “actually” pays to panel counsel in the defense of similar actions in the community where the claim arose or is being defended. The policy may, however, provide otherwise. Any disputes concerning defense fees shall be resolved by binding arbitration.
• Independent counsel and the insured have a duty to disclose all relevant, non-privileged information to the insurer.
• The statute sets forth specific waiver language if the insured decides to waive its right to independent counsel.
• Finally, the insured is not relieved of its duty to cooperate with the insurer.

Thus, the right to independent counsel is not automatic; there must be an underlying coverage issue which, in theory, can be manipulated by panel counsel.

When Independent Counsel Is Required

We discuss below a variety of different holdings in cases from a sampling of jurisdictions that generally are more active in evaluating the rights of insurers and insureds.

California

California has a fairly well-developed body of case law on the right to independent counsel under a duty-to-defend policy, both pre- and post-enactment of ' 2860. The paradigm case requiring independent counsel is one in which the way counsel retained by the insurance company defends the action will affect an underlying coverage dispute. Golden Eagle Ins. Co. v. Foremost Ins. Co. , 20 Cal. App. 4th 1372 (1993); Executive Aviation, Inc. v. National Ins. Underwriters , 16 Cal. App. 3d 799 (1971). However, courts have held that a conflict must be “actual and significant, not merely potential and theoretical”; no right to independent counsel arises where the coverage issue is independent of and extrinsic to the issues in the underlying action. Dynamic Concepts, Inc. v. Truck Ins. Exch. , 61 Cal. App. 4th 999 (1998).

A number of situations in which a right to independent counsel has been found are discussed below.

• Allegations of intentional conduct.

The classic circumstance is when the alleged wrongful conduct of the insured in the underlying litigation could be found to have been intentional, thus triggering an intentional acts exclusion. Cumis, 162 Cal. App. 3d at 361.

• Settlements in excess of policy limits.

In Golden Eagle Ins. Co. v. Foremost Ins. Co., the insureds refused to consent to a settlement that would exceed the policy limits alleged by the insurer. Golden Eagle Ins. Co. v. Foremost Ins. Co. , 20 Cal. App. 4th 1372, 1396 (1993). The attorney retained by the insurer to represent the insureds failed to oppose the insurer's petition for permission to settle even though he knew his clients, the insureds, would be exposed to excess liability and that they opposed the settlement sought by the insurer. The court held that not only was counsel put in the position of representing clients with conflicting positions regarding settlement, but also the insurer was seeking to settle the case with (in part) the insureds' money. Under these circumstances, the insureds were entitled to independent counsel, at the insurer's expense, to represent them in settlement negotiations.

• Mixed actions.

A potential conflict of interest arises where a third-party complaint asserts both covered and non-covered claims against the insured. Dynamic Concepts, Inc., 61 Cal. App. 4th at 1006. The insured will want any judgment limited to covered claims, while the insurer will be better off if judgment is imposed on claims not covered under the policy. However, under this example, there is not an automatic right to independent counsel. Rather, the focus is on whether “the outcome of the coverage dispute can be controlled” by the defense counsel. Determination of whether independent counsel is warranted is done on a case-by-case basis and will be fact specific.

• Defense counsel issues.

Independent counsel is required when the insurer insures several insureds who have claims against one another. It is contrary to public policy for a law firm to control both sides of the litigation, thus independent counsel for each insured is required. The insurer loses the right to control the defense of each and the right to access confidential information. See O'Morrow v. Borad , 27 Cal. 2d 794, 800 (1946).

A conflict may exist when the same defense attorney defending the insured in the underlying action is representing the insurer in a separate declaratory relief action seeking to avoid coverage. See Executive Aviation, 16 Cal. App. 3d at 804 (1971). Additionally, a conflict of interest may exist when a law firm agrees to represent the insurer in a contribution claim against another insurer that the same law firm represented in another matter. Truck Ins. Exch. v. Fireman's Fund Ins. Co. , 6 Cal. App. 4th 1050 (1992).

New York

The general rule in New York is “when an insurer has a duty to defend an insured, it also has the right to control the litigation and select the counsel it wishes to handle the defense.” Ottaviano v. Genex Coop Inc. , 3 Misc. 3d 1024, 1027 (N.Y. Sup. Ct. 2004). In some cases, however, if the interests of the insured party conflict with those of the insurer, under New York case law, the right to select counsel shifts to the insured.

A conflict may exist between an insured's interests and an insurer's interests if, for example, an exclusionary clause operates to exempt some of the insured's potential liability from coverage. Id. (citing Mount Vernon Fire Ins. Co. v. J.J.C. Stucco & Carpentry Corp., 1997 U.S. Dist. LEXIS. In such a case, the insurer's interest in minimizing the insured's covered liabilities conflicts with the insured's interest in minimizing all of its liabilities.

New York courts have found that “independent counsel is only necessary in cases where the defense attorney's duty to the insured would require that he defeat liability on any ground and his duty to the insurer would require that he defeat liability only upon grounds which would render the insurer liable.” Public Serv. Mut. Ins. Co. v. Goldfarb , 53 N.Y.2d 392, 401 n (1981).

Texas

Texas has case law with respect to the independent counsel requirement. Ordinarily, the insurer's duty to defend includes the authority to select defense counsel and the right to control the case.

Texas courts have identified instances of conflicts that may disqualify defense counsel. The basic scenario is when the facts to be adjudicated in the liability lawsuit are the same facts upon which coverage depends. Such a conflict would prevent defense counsel retained by the insurer from handling the defense. Northern County Mut. Ins. Co. v. Davalos , 140 S.W.3d 685 (Tex. 2004). However, a disagreement between the insurer and the insured regarding defense strategy (e.g., proper venue) does not necessarily constitute a conflict requiring independent counsel.

Other conflicts include: 1) when the defense tendered is not a complete defense under the circumstances in which it should have been; 2) when the attorney hired by the insurer acts unethically and, at the insurer's direction, advances the insurer's interests at the expense of the insured's; 3) when the defense would not, under governing law, satisfy the full extent of the insurer's duty to defend; and 4) when, though the defense is otherwise proper, the insurer attempts to obtain some type of concession from the insured before it will defend. Id.

Florida

Florida does not have much case law discussing instances of when independent counsel is required. It does, however, have a statute that has a “mutually agreeable” requirement for selection of defense counsel within 60 days of issuing a reservation of rights (the ROR itself due within 30 days of when the insurer knew or should have known of a coverage issue). See Claims Administration Statute, ' 627.426(2), Fla. Stat. Anno. (2010). Pursuant to ' 627.426(2)(b), Florida Statutes Annotated, an insurer waives all “coverage defenses” unless within 60 days of receiving the lawsuit against its insured, the insurer: 1) gives written notice of its refusal to defend; 2) obtains a written non-waiver agreement; or 3) retains “mutually agreeable” counsel to defend the lawsuit. Id. One court found that unilateral retention of counsel by the insurer, after issuing a reservation of rights, was the antithesis of mutual selection and thus the insurer violated the statute. American Empire Surplus Lines Ins. Co. v. Gold Coast Elevator, Inc. , 701 So.2d 904, 906 (Fla.App. 4 Dist. 1997).

Illinois

The general rule in Illinois is that an insurer is obligated to defend an action against an insured when the complaint contains allegations that bring the claim actually or potentially within coverage. American County Ins. Co. v. Williams , 791 N.E.2d 1268 (Ill. App. 2003). The test of whether a conflict of interest exists, which would allow the insured to assume control of the defense, is if, in comparing the allegations of the complaint to the terms of the policy, the insurer's interests would be furthered by providing a less than vigorous defense to the allegations. However, similar to California, the conflict must be actual and not merely potential. Id.

A conflict of interest has been found where the underlying action asserts claims that are covered by the policy and other claims that the insurer is required to defend, but asserts are not covered by the policy. Thornton v. Paul , 384 N.E.2d 335 (Ill. 1978), rehearing denied (1979), overruled on other grounds by American Family Mut. Ins. Co. v. Savickas , 739 N.E.2d 445 (Ill. Sept. 28, 2000), rehearing denied (Nov. 27, 2000). Another example of a conflict of interest is where an insurer provided a defense but reserved the right to deny coverage for punitive damages. Nandorf, Inc., v. CNA Ins. Companies , 479 N.E.2d 988, 994 (Ill. App. 1 Dist. 1985). However, the finding in this case did not imply that an insured is entitled to independent counsel in all cases where punitive damages are sought; in this case, punitive damages formed a substantial portion of the potential liability, and the insurer's disclaimer of liability for punitive damages left the insured with the greater interest and risk of litigation. Setting the common interests of the insurer and insured aside, the remaining interests of the two conflicted to such an extent as to create an actual ethical conflict warranting independent counsel.

Recently, the Seventh Circuit Court of Appeals held that under Illinois law the insurer must notify the insured when it is exposed to liability in excess of the policy limit. R.G. Wegman Construction Co. v. Admiral Insurance Co., No. 09-2022, 2011 WL 117086 (7th Cir. Jan. 14, 2011). Moreover, the insurer must permit the insured to select its own defense counsel and control the defense. Id. Finally, the insured will also have the right to settle a claim without the insurer's consent any time the insured is exposed to potential liability in excess of the policy limit. Id. Interestingly, this new case law stands in direct contrast to ' 2860 in California. As this case was decided by the Seventh Circuit, it is not binding on the state courts. It will be noteworthy, and a shift in the law surrounding the independent counsel issue, if the state courts choose to follow this case as persuasive authority.

Pennsylvania

Pennsylvania courts have not provided many examples of what constitutes a conflict of interest after an insurer agrees to defend under a reservation of rights. The courts have, however, recognized that insureds should at least be given the opportunity to retain independent counsel if and when a conflict of interest in fact does arise. Seasor v. Covington , 670 A.2d 157 (Pa. Super. 1996). In Seasor, the insured was found liable in a negligence action, and the plaintiffs sought an assignment of rights to proceed against the insurer. If the insured assigned the rights to the plaintiffs, the judgment against the insured would have been satisfied. However, counsel for the insured (who was also counsel for the insurer) refused to grant the assignment. As this presented a direct conflict of interest, the case was remanded and the insured was to be advised of her need for independent counsel. This case did not involve a reservation of rights, but the court recognized that conflicts will come up and thus independent counsel may be required.

Massachusetts

The general rule in Massachusetts appears to be that “where the insured's interest in controlling tort litigation against him conflicts with similar interest of the insurer, the insured may have good cause to ask that he be represented by counsel independent of the insurer.” Magoun v. Liberty Mut. Ins. Co. , 195 N.E.2d 514, 518 (Mass. 1964).

Other courts have similarly found there is a conflict of interest if an insurer defends under a reservation of rights, but insists on retaining complete control of the defense. Three Sons, Inc. v. Phoenix Ins. Co. , 257 N.E.2d 774, 777 (Mass. 1970). In Three Sons, the insurer agreed to defend the insured, subject to a reservation of rights concerning its obligation to indemnify the insured under the policy, but insisted on full control of the defense. Id. at 274. The insured agreed to the insurer's full control of the defense, but not to its reservation of rights. Id. The court agreed with the lower court and held that the insurer was obligated to defend without reservation so long as it insisted on retaining control of the defense.

Other examples of cases describing when independent counsel may be necessary are: Palermo v. Fireman's Fund Ins. Co. , 676 N.E.2d 1158 (Mass. App. 1997) (Homeowner's liability insurer that provided its insureds with partial defense of underlying tort action was obligated to protect insureds' interests fully by apprising them of potential future problem of allocating any judgment between covered and noncovered claims, and of availability of special verdict to segregate covered damages, even though insureds were also represented by separate counsel); and Murach v. Massachusetts Bonding & Ins. Co. , 158 N.E.2d 338 (Mass. 1959) (Where motor vehicle liability insurer communicated to its insureds the fact of a possible verdict in excess of the policy limits and suggested that they retain personal counsel, insurer fulfilled its duty of disclosing its adverse interest with respect to the extent of its liability under the policy).

Thus, a number of states recognize that the right to independent counsel is not automatic. Generally speaking, issuing a reservation of rights alone is not enough. Further, conflicts must be actual and concrete, not abstract or hypothetical.

When Independent Counsel Is Not Required

Courts have found numerous instances where independent counsel is not required. The examples below are illustrative.

California

Section 2860(b) provides that, categorically, a conflict of interest does not exist (and thus independent counsel is not required) simply because punitive damages (not insurable in California) are sought, or when the insured is sued for an amount in excess of policy limits. Independent counsel was not required during an administrative proceeding involving the insured where damages are not awardable. United Pacific Ins. Co. v. Hall , 199 Cal. App. 3d 551 (1988).

Other examples of where no conflict requiring independent counsel was found include:

• Issues pertaining to which of the defendants is an insured. Long v. Century Indemn. Ins. Co. , 163 Cal. App. 4th 1460 (2008).
• Where there is an exclusion for status ( e.g., “resident relative” auto exclusion). McGee v. Superior Court , 176 Cal. App. 3d 221 (1985).
• Carrier appointed counsel's refusal to bring cross-claims or assert affirmative defenses. James 3 Corp v. Truck Ins. Exch. , 91 Cal. App. 4th 1093 (2001).
• Partially covered damages ( e.g., exclusion for damages from faulty workmanship; insured produced no evidence to show in what specific way defense counsel could have controlled the outcome of the damage issue to the insured's detriment). Blanchard v. State Farm Fire & Cas. Co. , 2 Cal. App. 4th 345 (1992).
• Claimed damages in excess of policy limits. Cal. Civ. Code ' 2860.
• Reservation of the right to seek to recover defense costs based upon non-covered claims. Dynamic Concepts v. Truck Ins. Exch. , 61 Cal. App. 4th 999 (1998).
• A global reservation of rights does not instantly trigger the right to independent counsel. Id.
• Where the coverage issue is independent of, or extrinsic to, the issues in the underlying action. Id.
• Where the policy entitles the insurer to settle over the insured's objection. However, there may be a conflict requiring independent counsel where: 1) insurer insures both the plaintiff and the defendant; 2) the insurer is suing the insured, whether or not with regard to the underlying claim; 3) the insurer pursues an excess-of-limits settlement that leaves the insured bare or exposed to other third-party claims. James 3 Corp v. Truck Ins. Exch. , 91 Cal. App. 4th 1093 (2001).

New York

Multiple claims do not necessarily require independent counsel, such as where the insurance policy was limited solely to coverage for personal injuries but the claim against the insured sought recovery for property damage. No threat of divided loyalty is present, and so there is no need for independent counsel. This is because in such a situation the question of insurance coverage is not intertwined with the question of the insured's liability. Public Serv. Mut. Ins. Co. v. Goldfarb , 53 N.Y.2d 392, 401 n (1981).

Texas

Texas has recognized that the right to independent counsel is not automatic. In one case, a dispute between the insurer and the insured regarding proper venue was found to not be a sufficient reason to take the contractual right to conduct the defense away from the insurer. Northern County Mut. Ins. Co. v. Davalos , 140 S.W.3d 685 (Tex. 2004). “An insurer's right of control generally includes the authority to make defense decisions as if it were the client where no conflict of interest exists.” Even though there was a disagreement about venue, not all disagreements can amount to a conflict of interest. If they did, the insured, not the insurer, could control the defense by merely disagreeing with the insurer's strategy.

Florida

Florida's unique statute requiring that defense counsel be “mutually agreed upon” within 60 days after an insurer issues a reservation of rights perhaps explains why there is little case law discussing the right to independent counsel. Under Florida's statute, when an insurer defends under a reservation of rights, choice of counsel must be agreed upon unless the insured waives its rights.

Illinois

Illinois requires independent counsel only if the conflict is actual, not merely potential. Allied American Ins. Co. v. Ayala , 616 N.E.2d 1349 (Ill.App. 2 Dist., 1993). In one case stemming from a car accident and where the insurer was seeking a declaratory judgment, the insured argued a conflict of interest existed because the insurer referred the defense of the negligence claims to attorneys who knew the insurer was providing a defense under a reservation of rights related to alleged material misrepresentations in the application, which could render the policy void. Id. The insureds argued that, under these circumstances, a conflict existed because the insurer's real defense no longer turned on the alleged negligence in driving the car, but instead on whether the policy was void. The court, however, found that although there was a theoretical conflict, an actual conflict is necessary to question the defense under a reservation of rights, and there was no actual conflict present. Id.

Pennsylvania

A Pennsylvania court noted that agreeing to defend under a reservation of rights by itself is not enough to constitute a conflict. Eckman v. Erie Ins. Exchange, 2010 WL 5312212 (Pa.Com.Pl. 2010). The insured argued that panel counsel violated a rule of professional conduct because counsel had two clients. The court found that the rule of professional conduct did not apply because the retained counsel had only one client, the insured. Moreover, the insured failed to produce any evidence that counsel retained by the insurer had breached his or her ethical obligations. The insurer had no control over defense counsel's decision-making or judgments regarding the defense, and thus no conflict existed.

Massachusetts

As noted previously in our discussion of Massachusetts, supra, where a claim is made for an amount greater than the limits of the policy, it is the duty of the insurer to disclose to its insured its adverse interest with respect to the extent of its liability under the policy. Murach v. Massachusetts Bonding & Ins. Co. , 158 N.E.2d 338, 342 (Mass. 1959). However, there is no conflict if the insurer fulfilled its duty by advising the insured of the possibility of a verdict in excess of the policy limit, suggesting that the insured retain personal counsel, but the insured is unresponsive to details of settlement negotiations. Id.

Outside the insurance context, a judge's failure to provide independent counsel at a hearing when a defendant waives his rights does mean that the wavier is invalid. Commonwealth. v. Jones , 526 N.E.2d 1288, 1293 (Mass. 1988). Although the better practice would be to provide independent counsel at a hearing where a defendant waives his right to conflict-free counsel, that waiver is not necessarily invalid if it was knowingly and intelligently made. Id.

Conclusion

The issue of when an insured is entitled to independent counsel is not a fully developed area of insurance law in most states, but of those states that have addressed the issue, either judicially or statutorily, the consensus seems to be that the mere issuance of a reservation of rights does not require independent representation. Further, even if a conflict exists, it must be actual and significant, not hypothetical, and it must go to an issue that (at least in theory) insurer-appointed counsel could manipulate so as to eliminate the possibility of coverage.

Martin J. O'Leary is a partner and Kirsten A. Mickelson is an associate at Sedgwick LLP in the San Francisco office. O'Leary handles an array of professional liability insurance matters, including directors and officers liability insurance, employment practice liability policies, errors and omissions coverage, and fidelity and crime policies. He periodically speaks on the topic of professional liability insurance matters for the Bar Association of San Francisco and the American Bar Association's Fidelity and Surety Law Committee. He is a member of the Professional Liability Underwriting Society and has served on the Northern California Chapter Steering Committee. Mickelson advises insurers in matters of professional lines and commercial lines policies, including directors and officers liability, employment practices liability, commercial general liability and in connection with other aspects of coverage litigation.