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Category | Briefing Papers
One of great benefits of Commercial General Liability (“CGL”) insurance is that it should provide a complete defense to a lawsuit even if only part of that lawsuit involves a covered claim. Typically the insurer reserves the right to select defense counsel for the insured, but the value of that defense can be seriously eroded if you are unable to obtain counsel of your choice to defend the claims at the insurer’s expense. Imagine this scenario:
Your company (the insured) is sued. Part of the claim arguably triggers your CGL policy’s duty to defend you, but there are policy exclusions that could arguably void coverage. The classic example in a construction defect claim is when part of the damage is due to your subcontractor’s negligence (covered), but part may be attributed to your own self-performed work (excluded). The insurer accepts your tender of the defense under a “reservation of rights” which allows the insurer to later deny coverage and stop defending you should the insurer discover facts justifying that action. The insurer appoints one of its employee attorneys with little or no construction law experience to represent you, and the attorney starts discovery by focusing not on defending the claim but determining whether facts exist to deny coverage!
This hypothetical illustrates the three main risks at issue when counsel is appointed by the insurer instead of selected by you: First, the counsel appointed by the insurance company may be a subsidiary or employee of the insurer and may focus on its employer’s interests rather than exclusively serving the interests of you, the insured. Second, due to the relatively low rates paid by the insurer to its captive or panel counsel, the insured may not obtain experienced defense counsel familiar with construction law. Third, insurer-appointed attorney may have a professional conflict of interest because the defense they choose to pursue undermines eventual insurance coverage for the claim. This Briefing Paper will examine the grounds on which you as an insured can insist that the insurance company provide independent, competent counsel of your choice at their expense to defend a covered claim.
The insurer’s duty to defend a covered claim is broader than its duty to indemnify or pay the insured for a covered loss. For example, in order to obtain indemnity (i.e., payment) of a claim, the insured must prove the claim was a covered by the policy. To obtain defense of a claim, however, the insured must only allege that part of the claim is covered by the policy. Accordingly, if even part of a complaint or arbitration demand alleges a covered claim, then the insurer must provide a complete defense to all of the claims asserted in the lawsuit or arbitration.
Recognizing their broad duty to defend, insurers often accept the tender of defense under a reservation of rights to later deny indemnity (and defense) if the facts or theories developed later establish that actual coverage does not exist. Obviously, the counsel chosen to defend the insured can influence what facts are developed and what theories are pursued, and if the insurer controls the selection of defense counsel, a potential conflict could arise between the goals of the insurer (to deny coverage) and the insured (to obtain coverage). It would be naïve to assume all of the attorneys regularly retained by the insurer would turn a blind eye to these issues. The United States Court of Appeals for the Eighth Circuit once explained this issue with uncharacteristic bluntness:
Even the most optimistic view of human nature requires us to realize that an attorney employed by an insurance company will slant his efforts, perhaps unconsciously, in the interests of his real client the one who is paying his fee and from whom he hopes to receive future business the insurance company.
Although it has perhaps become trite, the biblical injunction found in Matthew 6:24 retains a particular relevancy in circumstances such as these, “No man can serve two masters . . . .”
U.S. Fidelity and Guaranty Co. v. Louis A. Roser Co., Inc., 585 F.2d 932, 938 n.5 (8th Cir. 1978).
Each state has a different rule to determine whether the insurer’s acceptance of defense under a reservation of rights creates a potential conflict of interest sufficient to require the insurer to retain independent counsel for the insured at the insurer’s expense (i.e., counsel not selected by the insurer). Some states require the insurer to appoint independent counsel if there is only an appearance of a conflict, and others require that an actual conflict be present. Thus, the court venue — i.e. the choice of the state in which this decision is made — is important, as the location of the court could decide the issue.
Minnesota follows the majority rule that an insurer must offer independent counsel if the reservation of rights creates an actual conflict of interest, not just the appearance of one. Mut. Serv. Cas. Ins. Co. v. Luetmer, 474 N.W.2d 365, 368 (Minn. App. 1991). The question then becomes, what constitutes an actual conflict of interest that entitles the insured to select its own counsel at the insurer’s expense?
A typical statement of the actual conflict standards was provided by the Texas Supreme Court:
if “the facts to be adjudicated in the liability lawsuit are the same facts upon which coverage depends,” an actual conflict of interest exists allowing the insured to demand independent counsel.
N. County Mut. Ins. Co. v. Davalos, 140 S.W.3d 685, 699 (Tex. 2004). Fortunately for contractors, the facts developed in most construction disputes will bear on whether or not an exclusion to coverage applies, so the “same facts” exception gives contractors a broad opportunity to argue that a conflict exists and select counsel of their choice from the beginning of the case.
All of these instances could allow the counsel for the insurer to steer the arbitrator, court, or jury to find the claims fell under a coverage exclusion which creates the actual conflict.
Not all disputes between an insurer and the insured rise to the level of an actual conflict. For instance, disputes over the proper venue for a coverage dispute or over a reservation of rights to seek reimbursement of defense costs have been held not to create an actual conflict.
Another major and commonly-encountered situation giving rise to an actual conflict is the defense of multiple insureds by the same counsel. Due to the nature of construction and the presence of multiple tiers of contracts, subcontractors, and suppliers, multiple defendants and third-party defendants are the norm in construction litigation. Often, many of the defense parties have the same insurer and, in order to save fees, insurers sometimes seek to hire the same counsel for all its insureds involved in a claim. But if the interests of all the insureds are not aligned, then an actual conflict exists requiring independent counsel. This issue often arises when an additional insured wants to prove the insured’s conduct is at fault (and thereby obtain additional insured coverage for their claim) but the insured wants to blame the additional insured in order to avoid liability. Obviously, the additional insured and the insured are adverse, and each is entitled to separate and independent counsel. The existence of commonly plead cross-claims for contribution and indemnity has been held to require independent counsel for all, especially if there is the potential for a verdict in excess of policy limits.
The right to separate and independent counsel arises not only from multiple adverse defendants, but also from multiple but mutually exclusive theories of liability. The potential conflict is readily apparent when an insured is sued under a covered theory such as negligent property damage and a non-covered theory such as intentional property damage (because intentional conduct is excluded from coverage). Thus, if the insurer has the incentive to lay the groundwork during discovery to show that the insured acted intentionally, thereby removing the possibility of coverage, then an actual conflict exists and the insured is entitled to independent counsel. See U.S.F.&G. v. Louis A. Rosier Co., Inc., 585 F2d 932 (8th Cir. 1978) (applying Minnesota law).
The potential for awards or verdicts in excess of policy limits also should entitle the insured to independent counsel at the insurer’s expense. In R.C. Wegman Construction Co. v. Admiral Ins. Co., 629 F.3d 724 (7th Cir. 2011), the court noted, “The conflict in this case arose when [the insurer] learned that an excess judgment (and therefore a settlement in excess of the policy limits, as judgment prospects guide settlement) was a nontrivial probability” in the lawsuit. In holding that the conflict warranted independent counsel, the court concluded, “Gambling with the insured’s money is a breach of fiduciary duty.” Conversely, a conflict exists if the insurer wants to settle for more than the policy limits (requiring a contribution from the insured) but the insured does not agree with the insurer’s evaluation. Golden Eagle Ins. Co. v. Foremost Ins. Co., 25 Rptr. Fd. 242, 20 Cal. App. 4th 2372 (1999).
Insureds should carefully investigate potential conflicts between themselves and their insurers whenever panel counsel is first appointed by the insurer. The client of counsel appointed by the insurer is supposed to be the insured, not the insurer. Where the interests of the insurer and insured actually diverge, the insured is entitled to independent counsel of the insured’s choice paid for by the insurer. Insist on being copied on any updates or reports that counsel appointed by the insurer sends to the insurer. Also, require that any developments that could effect coverage be immediately reported. This type of information will help you determine whether the insurer is showing a greater concern for its own bottom line rather than for the welfare of its insured.
This discussion is generalized in nature and should not be considered a substitute for professional advice. © FWH&T