RECENT CASES CLARIFY WHEN INSUREDS HAVE THE RIGHT TO CHOOSE THEIR OWN COUNSEL AND CONTROL THEIR OWN DEFENSE
The authors of this article discuss recent cases evaluating the duty of panel counsel to avoid conflicts of interest and the limits of an insured’s right to independent counsel when potential conflicts arise.
Insurers are taking a harder line on coverage, and it is crucial for insureds to know when they can select independent counsel[1] at the insurer’s expense and control their own defense. This is a cutting-edge area of insurance law. California courts are currently evaluating the duty of panel counsel to avoid conflicts of interest and the limits of an insured’s right to independent counsel when potential conflicts arise. As discussed below, the court of appeal sought to clarify the right to independent counsel at the insurer’s expense in Swanson v. State Farm General Insurance Company. An attorney’s ethical duty in representing multiple clients was recently explored in Havasu Lakeshore Investments, LLC v. Fleming.[2]
Panel Counsel and the Insured’s Right to Independent Counsel
When a lawsuit against an insured is potentially covered under an insurance policy, the insurer must defend but is authorized to select the defense counsel who will control the defense. This authorization is based on language contained in a typical liability policy which provides the insurer with the right and duty to defend any suit. Selection of defense counsel allows the insurer to control the costs of litigation by engaging lawyers on their “panel.” Panel counsel are firms that are willing to accept hourly rates that are significantly lower than the rates typically charged in the legal community in exchange for a high volume of cases. In California, defense counsel selected by the insurer have an attorney-client and fiduciary relationship with both the insurer and insured.[3]
Because of their dual relationship, panel counsel must thoroughly disclose to both the insurer and insured any potential and actual conflicts of interest they may have and obtain from both parties a voluntary and informed written waiver of such conflicts.[4] A potential conflict must be disclosed by panel counsel if there is a reasonable likelihood it will become an actual conflict.[5] Actual and potential conflicts that must be disclosed arise in a variety of circumstances. Such conflicts may exist because of panel counsel’s close personal or significant business relationship with the insurer.[6] Such conflicts also exist when the manner in which panel counsel may defend the case could affect determination of coverage under the policy. [7] In sum, conflicts may arise whenever panel counsel’s fiduciary duty to one client could reasonably require panel counsel to act in a way that breaches a fiduciary duty to the other client, or to contend for one client a position or argument what must be opposed by the other client.
Swanson v. State Farm General Insurance Company
The California Court of Appeal recently considered an insured’s right to independent counsel in Swanson v. State Farm General Insurance Co.[8] In Swanson, State Farm’s insured, Swanson, was sued by her neighbors, the Bitettis, for property damage and personal injury arising from the failure of a retaining wall after substantial rainfall.[9] Swanson submitted the claim to State Farm, who agreed to defend subject to certain reservations of rights. State Farm reserved rights based on whether some of the claimed damages would qualify as “bodily injury” or “property damage,” whether the damages arose out of an “occurrence” as defined in the policy, and whether damages were excluded from “bodily injury” or “property damage” under the policy.[10]
Based upon its reservation of rights, State Farm agreed to allow Swanson’s personal attorney, Blasco, to act as her Cumis counsel, subject to compliance with Civil Code Section 2860 and his acceptance of State Farm’s panel counsel rates.[11] Several months after agreeing to Blasco’s representation of Swanson, State Farm changed its position, amended its reservation of rights, and withdrew certain policy defenses it had previously asserted. State Farm then retained panel counsel, Procter, McCarthy and Slaughter, to take over the defense and refused to make further payments to Blasco. The Bitettis action went to trial with both Blasco and Proctor representing Swanson. The jury found in favor of Swanson.[12] Swanson then filed a coverage action against State Farm, asserting claims for breach of insurance contract and breach of the covenant of good faith and fair dealing.[13] The trial court considered cross-motions for summary judgment on whether withdrawal of State Farm’s reservations impacted Swanson’s right to independent counsel. The trial court granted State Farm’s motion, denied Swanson’s motion, and entered judgment in favor of State Farm.[14] Swanson appealed.
The primary issue on appeal was whether State Farm could control the litigation with an attorney of its choice, and cease paying Blasco, after State Farm withdrew its reservations of rights. The court of appeal affirmed the lower court’s holding that State Farm was not obligated to pay for Cumis counsel once it withdrew the reservations that potentially created a conflict.[15]
Swanson supports the proposition that the only way an insurer can nullify its insured’s right to Cumis counsel is by withdrawing the reservations of right that create a conflict of interest for panel counsel. More importantly, however, the Swanson decision is consistent with a growing line of cases holding that an insured is entitled to independent counsel, not just because of Insurance Code Section 2860, but also because of panel counsel’s ethical duty to avoid conflicts of interests.[16]
The Swanson decision also provides guidance on Cumis-triggering reservations. Reservations involving whether claimed damages would qualify as “bodily injury” or “property damage,” whether damages arose out of an “occurrence,” and whether damages were excluded by certain policy provisions, may create conflicts between the carrier and the insured that warrant retention of independent counsel.[17] In Swanson, prior to State Farm’s withdrawal of its reservations, panel counsel had a fiduciary duty to Swanson to prove that the Bitellis’ injuries fell within the policy, and a conflicting duty to State Farm to show that they did not. To the extent such reservations are asserted by carriers in other matters, Swanson supports the insured’s right to retain independent counsel.
Havasu Lakeshore Investments v. Fleming
Havasu Lakeshore Investments v. Fleming involved a dispute between members of a limited liability company (“LLC”) in a mobile home development project. The LLC’s members included Terry L. Fleming, Sr., Terry L. Fleming, Jr., Capital Source Partners and J. Victor Construction, Inc. The latter two members were businesses owned by Jean Victor Peloquin, a non-member of the LLC.[18] Fleming, Jr. sued Peloquin individually alleging that Peloquin refused to allow Fleming, Jr. to exercise an option agreement with Peloquin to have Peloquin buy out Fleming, Jr.’s interest in the LLC.[19] The LLC, Peloquin, and Peloquin’s entities cross-complained against the Flemings for breach of contract and bad faith, seeking to set aside a trustee’s sale of property owned by the LLC and to cancel Fleming, Jr.’s option agreement. The law firm of Hart, King & Coldren (“HKC”) represented all cross-complainants in filing the lawsuit.
Fleming Sr. moved to disqualify HKC from representing the LLC, claiming that HKC had breached its duty of loyalty under California Rule of Professional Conduct, Rule 3-310(E), which prohibits an attorney from accepting employment adverse to a client or former client where the attorney has obtained confidential information material to the engagement. Peloquin and the LLC opposed the motion to disqualify, arguing that HKC never represented Fleming Sr. and never received confidential information from him.[20]
The trial court granted Fleming, Sr.’s motion to disqualify HKC from representing the LLC based on Rule 3-310(C), which provides that an attorney shall not simultaneously represent clients whose interests are adverse to one another.[21] The court ruled that HKC could not represent the LLC and “non-member Peloquin” in a cross complaint against the Flemings, who were members of the LLC, because the interests of the LLC and of non-member Peloquin were “at least potentially conflicting.”[22] The court permitted HKC to continue representing Peloquin and his entities. The cross-complainants appealed.
On appeal, the court of appeal observed that an attorney bears two ethical duties to a client: (1) a duty of loyalty whereby an attorney invests his or her “full energies” to the matter and the client, and (2) a duty of confidentiality which fosters communication between attorney and client.[23] The court of appeal further observed that the lower court decided the matter under Rule 3-310(C) with regard to an attorney’s duty of confidentiality, even though Fleming, Sr. argued in his motion to disqualify that a conflict existed under Rule 3-310(E) based upon HKC’s breach of its duty of loyalty.[24]
After reviewing the record, the court of appeal concluded that the interests of the LLC and Peloquin were not actually in conflict but may be potentially conflicting.[25] The court of appeal expressed that a “potential conflict” means “‘a reasonable likelihood an actual conflict will arise.’”[26] Under Rule 3–310, a “potential conflict” means “a reasonably foreseeable set of circumstances which could impair the attorney’s ability to fulfill his or her professional obligations to each client in the proposed representation.”[27] “[A] mere hypothetical conflict is insufficient to require disqualification.”[28]
The court of appeal then evaluated the substantive facts of the underlying matter to determine whether there was evidence supporting a reasonable likelihood of a conflict arising. Specifically, it considered HKC’s representation of the LLC’s members in the underlying cross-complaint, representation of each party in Fleming Jr.’s lawsuit, and the Flemings’ status as members of the LLC.[29] The court of appeal concluded there was no reasonable likelihood of a conflict arising between Peloquin and the LLC and, in any event, that the Flemings lacked standing to raise the issue:
[T]he alleged conflict is that HKC must defend Peloquin in Fleming Jr.’s action against him, while simultaneously prosecuting the cross-complaint on behalf of Peloquin, the LLC, and the other cross-complainants. Essentially, the risk is that HKC may spread itself too thin, become distracted, or prioritize one matter over the other. This is not the type of conflict addressed by rule 3-310(c). Even if it were, Fleming Jr. lacks standing to raise this concern as he “cannot show any legally cognizable interest that [was] harmed by [HKC’s] joint representation of [the Flemings] adversaries.”[30]
Havasu Lakeshore Investments stands for the proposition that an attorney’s conflict of interest triggering ethical disqualification and, by implication, an insured’s right to independent counsel, occurs when there is an actual conflict of interest or the reasonable likelihood of one arising. Absent an actual conflict of interest or the reasonable likelihood of one arising between Peloquin and the LLC, HKC was ethically permitted to jointly represent all cross-complainants against the Flemings.[31]
Conclusion
Liability insurers undoubtedly save considerable amounts of money by denying coverage, refusing to defend through independent counsel chosen by the insured, and/or paying the reduced hourly rates of panel counsel. While the need to keep defense costs down is understandable, such cost savings cannot be at the expense of defense counsels’ ethical obligations or the insured’s right to counsel who is loyal to the insured. The Havasu Lakeshore Investments case emphasizes that conflicts and potential conflicts must be supported by facts, and the Swanson case points out that a carriers’ obligation to pay for independent counsel is not limitless. Both cases, however, are consistent with Cumis and the growing line cases restricting insurers from imposing panel representation that has a reasonable likelihood of incurring conflicting obligations to the insurer and the insured.
[1]. Such independent counsel are often called “Cumis” counsel based upon a seminal case, San Diego Navy Federal Credit Union, et al. v. Cumis Ins. Society, Inc. (1984) 162 Cal.App.3d 358, in which Cumis Insurance Society, Inc. was forced to pay for its insured’s counsel of choice because panel counsel had a conflict of interest.
[2]. The California Supreme Court is expected to provide further guidance on application of the insured’s right to independent counsel. On September 18, 2013, the court granted review in Hartford Cas. Ins. Co. v. J.R. Marketing. (Hartford Cas. Ins. Co. v. J.R. Marketing, (Sept. 18, 2013, S211645) ___ Cal.App.4th ___ [2013 WL 5273021].) The authors will be submitting an amicus curiae brief.
[3]. Purdy v. Pacific Auto. Ins. Co. (1984) 157 Cal.App.3d 59, 76).
[4]. California Rules of Professional Conduct, Rule 3-310(C).
[5]. Havasu Lakeshore Investments LLC v. Fleming (2013) 217 Cal.App.4th 770, 779.
[6]. Long v. Century Indemnity Co. (2008) 163 Cal.App.4th 1460, 1469.
[7]. Civ. Code § 2860.
[8]. Swanson v. State Farm General Insurance Co., Sept. 23, 2013, B240016) __ Cal.App.4th ___ [2013 WL 5308877].
[9]. Id. at p. 3.
[10]. Ibid.
[11]. Swanson v. State Farm, supra, at 4.
[12]. Id. at 5.
[13]. Swanson v. State Farm, supra, at 5.
[14]. Id. at 6-7.
[15]. Swanson v. State Farm, supra, at 7.
[16]. Swanson v. State Farm, supra, at 12, citing James 3 Corp. v. Truck Ins. Exchange (2001) 91 Cal.App.4th 1109, 110 and Golden Eagle Ins. Co. v. Foremost Ins. Co. (1993) 20 Cal.App.4th 1372, 1394.
[17]. Havasu Lakeshore Investments LLC v. Fleming, supra, at 779.
[18]. Id. at 774.
[19]. Id.
[20]. Id. at 775.
[21]. Id. at 777.
[22]. Id.
[23]. Id. at 777, citing Flatt v. Superior Court (1994) 9 Cal.4th 275, 289 and San Francisco v. Cobra Solutions, Inc. (2006) 38 Cal.4th 839, 846).
[24]. Ibid.
[25]. Havasu Lakeshore Investments LLC v. Fleming, supra, at 778.
[26]. Id. at p. 779, citing Carroll v. Superior Court (2002) 101 Cal.App.4th 1423, 1430, italics original).
[27]. Ibid., citing Vapnek et al., Cal. Practice Guide: Professional Responsibility, ¶ 4:64, p. 4–24.14, italics original).
[28]. Ibid, citing Fox Searchlight Pictures, Inc. v. Paladino (2001) 89 Cal.App.4th 294, 302).
[29]. Havasu Lakeshore Investments LLC v. Fleming, supra at 779-780.
[30]. Id. at 779, citing Great Lakes Construction, Inc. v. Burman (2010) 186 Cal.App.4th 1347, 1358).
[31]. Havasu Lakeshore Investments LLC v. Fleming, supra, at 782.
About The Author
Gregory L. Dillion is one of the founding partners of Newmeyer & Dillion LLP. He represents developers, institutional lenders, general contractors, and other businesses in business, construction, and insurance coverage disputes. The author may be contact at greg.dillion@ndlf.com.
About The Author
Rondi J. Walsh is an associate at Newmeyer & Dillion, LLP, concentrating her practice in the representation of policyholders in insurance coverage and bad faith litigation. The author may be contacted at rondi.walsh@ndlf.com.
