Zenith Insurance Company v. Cozen O'Connor (2007)
__ Cal.App.4th __ (March 21, 2007)
07 C.D.O.S. 2940

Ceding Insurer's Attorney Owes No Attorney Client Duty to Reinsurer

The California Court of Appeal for the Second Appellate District affirmed judgment entered after a trial court sustained a demurrer to a complaint filed by a reinsurer against counsel retained by a ceding insurer to defend an insured. The Court of Appeal held that the allegations in the complaint were inadequate to establish the existence of an attorney-client relationship between the reinsurer and the counsel retained by the ceding insurer under either a third-party beneficiary theory or an implied contract theory.

According to the allegations, Royal Insurance Company ("Royal") entered into a Reinsurance Agreement with Pacific Basin Insurance Company ("Pacific Basin"), which obligated Pacific Basin to reinsure Royal with regard to four general liability policies issued to Dillingham Corporation and its subsidiaries during a two year period. The Reinsurance Agreement obligated Pacific Basin to reinsure Royal for 100 percent of the limits of the underlying Dillingham policies. Royal had the right and duty to investigate, settle or defend suits against its insureds. More specifically, Royal retained the "sole discretion" to make settlements and Pacific Basin had no right to associate in the defense or settlement of claims made under the Dillingham policies.

Pacific Basin's obligations under the Reinsurance Agreement were subsequently properly assumed by Zenith Insurance Company ("Zenith").

One of Dillingham's subsidiaries, Foss Maritime ("Foss"), notified Royal that the United States Environmental Protection Agency had alleged that Foss was liable for environmental cleanup at certain sites in the State of Washington. Royal advised Zenith that there were 22 other insurers on the risk.

Royal retained the law firm of Cozen O'Connor ("Cozen") to provide legal services with respect to environmental cleanup claims against Foss. Several years later, Zenith asked Cozen about the failure to seek contribution from the 22 other insurers and Cozen informed Zenith that conflicts of interest precluded the firm from seeking such contribution. Consequently, Zenith asked Royal to retain other counsel to do so and Royal complied.

Foss was eventually paid $3.8 million by Royal in defense costs and settlement of the claims. Thereafter, Zenith filed a lawsuit against Royal for breach of contract and declaratory relief based upon Royal's failure to seek contribution from the 22 other insurers.¹ Zenith then amended its complaint to allege professional negligence against Cozen.

Cozen successfully demurred to several amended pleadings filed by Zenith on the grounds that the pleadings did not allege facts showing the Cozen owed Zenith a duty of care. Although Zenith acknowledged no express agreement with Cozen, it argued that it was owed a duty of care as a third-party beneficiary of the agreement between Cozen and Royal and based upon an implied contract with Cozen. The trial court disagreed that the complaint stated facts sufficient to establish the existence of a duty under either theory advanced by Zenith and eventually sustained the demurrer without leave to amend.

The Court of Appeal concluded that in the absence of a written agreement between a reinsurer and counsel retained by the ceding insurer, no attorney-client relationship was created by the facts alleged by Zenith.

With regard to the allegation that Zenith was a third-party beneficiary of the agreement between Cozen and Royal, the Court of Appeal noted that Zenith would not be considered a third-party beneficiary unless both Cozen and Royal intended it. Cozen's knowledge that Zenith would be impacted by its representation of Royal was insufficient to transform Zenith into a third-party beneficiary.

In addition, Cozen was unable to ethically represent both Royal and Zenith because its advice to Royal with respect to settlement of the claims against Foss may not be in Zenith's best interests. For instance, Royal, but not Zenith, could be found liable for any bad faith failure to fulfill all of its obligations under the Dillinger policies. The existence of this conflict precluded any implication that Cozen intended Zenith to be a third party beneficiary and the complaint failed to provide any facts showing that Cozen actually had that intention.

The Court of Appeal also rejected Zenith's argument that its payment of Cozen's fees established its third-party beneficiary status. First, the Court of Appeal noted that the Reinsurance Agreement required Zenith to reimburse Royal and that Zenith did not directly pay Cozen's fees. Second, the Court of Appeal cited to case law holding that the mere payment of attorneys' fees does not establish and attorney-client relationship.

Zenith's argument that its numerous conversations with Cozen about the Foss claims established its status as a third-party beneficiary did not impress the Court of Appeal either. The court noted that Royal was obligated by Insurance Code section 622 to provide Zenith with information regarding the Foss claims. Any communication between Cozen and Zenith about the claims was intended to discharge Royal's legal duty to Zenith and could not be relied upon to create an attorney-client relationship between Cozen and Zenith.

With regard to the implied contract theory, the Court of Appeal stated that an implied contract is created by the conduct of the parties but, like a written contract, must be based upon the mutual intent of the parties. Similarly, the attorney-client relationship cannot be created based only upon the subjective belief of one of the parties that such a relationship exists.

Zenith owed no legal obligation to Dillinger, Royal's insured, nor did it have any role in selecting or directing Cozen. Indeed, when Zenith instructed Cozen to seek contribution from the 22 other insurers on the risk, Cozen declined to do so causing Zenith to demand that Royal hire separate counsel to take such action.

The Court of Appeal concluded that Zenith's complaint failed to allege facts showing anything other than its own subjective belief that Cozen was acting as its attorney. This alone was insufficient to show the existence of an implied contract between the Cozen and Zenith.

Judgment in Cozen's favor was affirmed.

This opinion is not final. Though it has been certified for publication, it may be withdrawn from publication, modified on rehearing, or granted review by the California Supreme Court. Should any of these events occur, the opinion would be unavailable for use as authority in other cases.

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¹Although Royal apparently retained a separate firm to seek contribution, the opinion of the Court of Appeal offers no additional information regarding the result of that effort.