Zalma’s Insurance Fraud Letter – March 15, 2019

Independent Counsel and the Law of Unintended Consequences

The standard provision in a liability insurance policy that provides an insurance policy requiring the insured to permit the insurer’s lawyer to defend claims against the insured amounts to an advance consent by the insured to have such attorney defend such claims. An insurer’s employment of an attorney to defend a claim against the insured establishes a joint client relationship — a “tripartite” relationship between attorney-insurer-insured. When an insurer, as required by its insurance contract, employs counsel to defend the insured, any communication with the lawyer concerning the handling of the claim against the insured is necessarily a matter of common interest to both the insured and the insurer. However, in such a tripartite relationship, the attorney’s primary duty is to the insured. (McDonold v. Superior Court (Cal. App., 2018)) The right to independent “Cumis” counsel if fraught with danger and it is essential that the insurance fraud investigator understand the law and how it can be abused.

The Right to Independent Counsel

The Cumis Doctrine

In California, and many other states, if an insurer provides a defense to an insured under a reservation of rights based on a possible lack of coverage where there is a conflict of interest between the insurer and the insured, the insurer must pay “the reasonable cost for hiring independent counsel [selected] by the insured.” [San Diego Navy Fed. Credit Union v. Cumis Ins. Soc. Inc., 162 Cal. App. 3d 358, 208 Cal. Rptr. 494 (Cal. Ct. App. 1984)]
As the court noted in San Diego Fed. Credit Union v. Cumis Ins. Soc., Inc.:

It has long been the law in this state that when a conflict develops, the insurer cannot compel the insured to surrender control of the litigation, and must, if necessary, secure Independent Counsel for the insured, and, as was explained in Previews, Inc. v. California Union Ins. Co., 9th Cir. (1981) 640 F. 2d 1026, 1028, the insurer’s obligation [to defend, after the appearance of a conflict] “extends to paying the reasonable value of legal services and costs performed by Independent Counsel selected by the insured.” Cumis, 162 Cal. App. 3d at 364 N.3, 208 Cal. Rptr. 494 (quoting Purdy v. Pacific Auto. Ins. Co., 157 Cal. App. 3d 59, 76, 203, Cal. Rptr. 524 (1984)) (Citations omitted) (Brackets in original).

Cases of interest outside California include:

• American Family Life Assurance Co. v. United States Fire Co., 885 F.2d 826, 831 (11th Cir. 1989) (citing to 7C J. Appleman, Insurance Law and Practice §4685.01, at 139)
• Cay Divers, Inc. v. Raven, 812 F. 2d 866, 870 n.3 (3rd Cir. 1987)
• Rhodes v. Chicago Ins. Co., 719 F. 2d 116, 120 (5th Cir. 1983)
• United States Fid. & Guar. Co. v. Louis A. Roser Co., 585 F.2d 932, 939 (8th Cir. 1978);
• Employers Ins. v. Albert D. Seeno Constr. Co., 692 F. Supp. 1150, 1156 (N.D. Cal. 1988)
• Southern Maryland Agric. Ass’n v. Bituminous Cas. Corp., 539 F. Supp. 1295, 1300 (D. Md. 1982)
• Klein v. Salama, 545 F. Supp. 175, 179 (E.D.N.Y. 1982)
• Prahm v. Rupp Constr. Co., 277 N.W. 2d 389, 391 (Minn. 1979)
• Public Serv. Mut. Ins. Co. v. Goldfarb, 53 N.Y. 2d 392, 425 N.E. 2d 810, 815, 442 N.Y.S. 2d 422 (N.Y. Ct. App. 1981)

In 1987, California legislated a cure:

[T]he insurer may exercise its right to require that the counsel selected by the insured possess certain minimum qualifications which may include that the selected counsel have (1) at least five years of civil litigation practice which includes substantial defense experience in the subject at issue in the litigation, and (2) errors and omissions coverage

The insurer’s obligation to pay fees to the independent counsel selected by the insured is limited to the rates which are actually paid by the insurer to attorneys retained by it in the ordinary course of business in the defense of similar actions in the community where the claim arose or is being defended.

The so-called “law of unintended consequences,” although never enacted by any legislature, is the proposition that every undertaking, however well intentioned, is generally accompanied by unforeseen repercussions that can overshadow the principal endeavor.

In Cumis the Cumis Insurance Society unsuccessfully appealed a judgment requiring Cumis to pay the San Diego Navy Federal Credit Union and J.W. Jamieson and Larry R. Sharp (insureds) all reasonable past and future expenses of their independent counsel retained for the defense of a lawsuit filed against the insureds by Magdaline S. Eisenmann.
Opposing poles of interest are represented on the one hand in the insurer’s desire to establish in the third party suit the insured’s liability rested on intentional conduct, and thus no coverage under the policy, and on the other hand in the insured’s desire to obtain a ruling such liability emanated from the nonintentional conduct within his insurance coverage. Although issues of coverage under the policy are not actually litigated in the third-party suit, this does not detract from the force of these opposing interests as they operate on the attorney selected by the insurer, who has a dual agency status.

Here, it is uncontested that the basis for liability, if any, might rest on conduct excluded by the terms of the insurance policy. Insurer-retained defense counsel, for example, will have to seek or oppose special verdicts, the answers to which may benefit the insureds by finding non-excluded conduct, which would have harmed either Cumis’ position on coverage or the insureds by finding excluded conduct. These decisions are numerous and varied. Each time one of them must be made, the lawyer is placed in the dilemma of helping one of his clients concerning insurance coverage and harming the other.
The potential problems may develop during pretrial discovery [that] must go beyond simple preparation for a favorable verdict to develop alternate strategies minimizing exposure. The American Bar Association Code of Professional Responsibility (ABA Code), Ethical Consideration EC5-1 reads: “The professional judgment of a lawyer should be exercised, within the bounds of the new law, solely for the benefit of his client and free of compromising influences and loyalties. Neither his personal interests, the interests of other clients, nor the desires of third persons should be permitted to dilute his loyalty to his client.”

ABA Code, Ethical Consideration EC515 states, in pertinent part:

If a lawyer is requested to undertake or to continue representation of multiple clients having potentially differing interests, he must weigh carefully the possibility that his judgment may be impaired or his loyalty divided if he accepts or continues the employment. He should resolve all doubts against the propriety of the representation. A lawyer should never represent in litigation multiple clients with differing interests, and there are few situations in which he would be justified in representing in litigation multiple clients with potentially differing interests. If a lawyer accepted such employment and the interests did become actually differing, he would have to withdraw from employment with likelihood of resulting hardship on the clients; and for this reason, it is preferable that he refuse the employment initially.

Customarily, insurers, in cases involving tort claims in excess of policy limits, notify the insured that he may employ his own attorney to participate in the defense. The court concluded that a like duty must arise in a case where potential conflict stemmed not only from the multiple theories of the complaint and the propriety of settlement, but from the total absence in the defendant of any economic interest in the outcome of the suit.
In Previews, Inc. v. California Union Ins. Co., 640 F.2d 1026 (9th Cir. 1981), independent counsel were appointed due in part to a claim for punitive damages. The court of appeals concluded that the district court properly decided that Previews was entitled to engage outside counsel.

Read the full article here.

Adapted from Barry Zalma’s book, The California Insurance Law Deskbook


The Current Issue Contains the Following  

  •  Independent Counsel and the Law of Unintended Consequences
  •  Ohio Insurance Department Collects from Frauds
  •  It’s a Crime to take Insurance Money to Repair a Roof and Not do the Work
  •  Ninth Circuit Lets Intentional Acts to be Covered by Stretching the word “Potential”
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  • Spirit Commercial Auto Risk Retention Group Insolvent
  • Health Insurance Fraud Convictions
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