In 1984, the California Court of Appeal for the Fourth Appellate District issued its opinion in San Diego Navy Federal Credit Union, et al. v. Cumis Insurance Society, Inc. ("Cumis").1 Cumis was the first attempt by a court to comprehensively analyze the problem of conflicts of interest that sometimes arise when a liability insurer appoints insurance defense counsel to defend its policyholder, while simultaneously reserving its right to deny coverage. This intermediate appellate decision from California almost single-handedly brought the issue of insurance defense conflicts of interest to the forefront and even created a new term within the lexicon of liability insurance – "Cumis counsel."2
Despite its notoriety, the decision in Cumis did not resolve the issue of how insurers should handle potential insurance defense conflicts of interest. Rather, Cumis marked the beginning of a debate regarding the rights of insurers and policyholders within the unique insurance defense arrangement. For insurers, the debate sparked by Cumis – which continues to this day – focuses on one practical issue: When, and under what circumstances, is an insurer obligated to offer and pay for independent counsel selected and controlled by the insured? This is a significant issue in most states.
Broadly speaking, states follow three basic approaches. Some states have adopted a "per se" rule – i.e., that an insurer's reservation of rights automatically entitles a policyholder to select independent counsel rather than accept counsel appointed by the insurer.3 Other states take the view that the possibility of an insurance defense conflict of interest is already adequately addressed by the Rules of Professional Conduct that apply to all attorneys, regardless of who pays their bill.4 Lastly, in a few states, including California, the question of potential insurance defense conflicts of interest has been addressed through legislation.5
Because insurers often defend insureds in a number of different jurisdictions, it is important for claim representatives to have a working knowledge of the different approaches states use in responding to potential insurance defense conflicts of interest. Accordingly, this article briefly discusses why this is an issue for insurers in the first place, and then summarizes the main approaches used by states to address the problem.
Under most general liability policies, the insurer is contractually entitled to control the defense of its insured.6 This is based upon the standard language in general liability policies, which typically grant to the insurer "the right and duty to defend any suit" and also permit insurers to "make such investigation and settlement of any claim as it deems expedient."7
In certain states, the unique relationship between policyholder, insurer, and insurance defense counsel constitutes the so-called "tripartite relationship." In the "tripartite relationship," insurance defense counsel has two clients – the policyholder being defended and the insurer that retains and pays counsel.8 Having multiple clients in the same transaction creates the possibility of a conflict of interest, particularly when one of the clients – the insurer – reserves its right to deny coverage. However, even in states where insurance defense counsel only represents the policyholder, conflicts of interest can still arise because the insurer that pays for and is contractually entitled to control the defense may have interests that are inconsistent with those of the policyholder.
- The "Per Se" Approach
A number of jurisdictions follow the "per se" approach when handling potential insurance defense conflicts of interest. Under this approach, whenever an insurer reserves its right to deny coverage, the reservation automatically triggers a policyholder's right to independent counsel.9 The analysis supporting this approach is simple: an insurer should not be allowed to control the defense of its insured unless it also accepts coverage for the claim.10
The main problem with the "per se" approach is that it operates to fundamentally alter the insurance contract.11 It does so by wresting from the insurer its contractual right to control the defense, even in situations where there is no actual conflict of interest. The "per se" rule is also problematic because it presumes that insurance defense counsel is incapable of ethically defending policyholders because an insurer is paying the bill.12 While the simplistic "per se" rule provides insurers and policyholders with certainty regarding their rights and obligations, in recent years, the trend appears to be for courts to reject this approach.13
- The "Rules of Professional Conduct" Approach
A number of jurisdictions have eschewed adopting special rules to govern potential insurance defense conflicts of interest. Instead, these jurisdictions conclude that any potential conflict of interest is best left to the Rules of Professional Conduct that already exist to govern attorney conduct.14 Jurisdictions that follow this approach reject the idea that insurance defense counsel should be treated differently from other attorneys, just because an insurer pays their fees.15
The "Rules of Professional Conduct" approach is generally followed in jurisdictions that do not adhere to the "tripartite relationship" concept.16 Indeed, by limiting insurance defense counsel to "one client" – the policyholder – these jurisdictions can easily justify leaving the question of insurance defense conflicts of interest to the Rules of Professional Conduct. Nevertheless, the "Rules of Professional Conduct" approach has even gained some acceptance in "multiple client" states – i.e., those that recognize the "tripartite relationship."17
Although the "Rules of Professional Conduct" approach appears to place much of the burden on insurance defense attorneys to decide whether a conflict of interest exists, insurers should be careful not to blindly assign cases to attorneys without regard to potential conflicts of interest. In states that follow this approach, courts often hold that insurers owe their policyholders an "enhanced obligation of fairness" when it comes to assigning insurance defense counsel. This "enhanced obligation" requires the insurer to appoint competent counsel and it places some responsibility on the insurer to make sure that the policyholder is provided a conflict-free defense.18
- The "Legislation" Approach
Rather than letting the courts deal with this problem, a few states – California, Alaska, and Florida – have elected to address potential insurance defense conflicts of interest through legislation. These legislative approaches differ significantly.
After the Cumis decision in 1984, the California Legislature responded by enacting California Civil Code §2860.19 This was the first attempt by a state legislature to address insurance defense conflicts of interest through legislation. Rather than endorsing Cumis, the California Legislature overruled it, in part, by rejecting the idea that a mere potential conflict of interest creates a right to independent counsel.20
Under Section 2860, a conflict of interest does not arise simply because an insurer has reserved its rights.21 The insurer's reservation of rights must create a conflict that is "significant, not merely theoretical, actual, not merely potential."22 A claim for punitive damages or a claim in excess of policy limits does not create a conflict of interest under this statute.23 A Section 2860 conflict of interest may only arise when an insurer reserves its rights with respect to an insurance coverage issue, the outcome of which can be controlled by defense counsel.24 Thus, by requiring a careful analysis of the insurer's reservation of rights before mandating appointment of independent counsel, Section 2860 forges a middle course between the "per se" approach and the "Rules of Professional Conduct" approach.
Besides setting parameters for determining when a conflict requiring independent counsel exists, Section 2860 also institutes a number of safeguards for insurers. For example, under Section 2860 an insurer is only obligated to pay independent counsel "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."25 Insurers also have the right to require that independent counsel carry errors and omissions insurance, and possess "substantial defense experience in the subject area of the litigation."26 Further, any dispute regarding the amount of fees owed to independent counsel must be resolved though binding arbitration.27
Alaska also elected to address insurance defense conflicts of interest through legislation. In response to a decision from the Alaska Supreme Court, the Alaska Legislature adopted Alaska Statutes, §21.89.100 in 1995.28 This statute is similar to California Civil Code §2860 in many respects. Under Section 21.89.100, a conflict of interest does not arise merely because there is a claim for punitive damages, or a claim in excess of policy limits. The Alaska statute likewise limits the rate an insurer must pay independent counsel, and it allows the insurer to require that independent counsel be both experienced and insured. Like Section 2860, Section 21.89.100 also refers disputes regarding independent counsel to binding arbitration.29
The Alaska statute differs from Section 2860 in significant respects, however. While no conflict of interest arises under Section 21.89.100 with respect to "claims or facts ? for which the insurer denies coverage,"30 independent counsel is almost always required when an insurer reserves its right to deny coverage. In this regard, the Alaska statute states: "if the insurer reserves the insurer's right on an issue for which coverage is denied, the insurer shall provide independent counsel to the insured ?"31 Thus, unlike California which requires a detailed analysis in order to determine whether the policyholder is entitled to independent counsel, the Alaska Legislature opted for a rule that is much closer to the "per se" approach.
Florida, also has addressed potential insurance defense conflicts of interest through legislation. Similar to the Alaska statute – and unlike Section 2860 – Florida Statutes §627.426(2) assumes a conflict of interest whenever the insurer reserves its right to deny coverage. It is therefore much closer to the "per se" approach than the "Rules of Professional Conduct" approach.
The Florida statute gives the insurer only two options when the insurer elects to reserve its right to deny coverage: (1) the insurer may obtain a nonwaiver agreement from the policyholder after "full disclosure of the specific facts and policy provisions upon which the coverage defense is asserted and the duties, obligations, and liabilities of the insurer during and following the pendency of the subject litigation"; or (2) the insurer may retain "independent counsel which is mutually agreeable to the parties."32 For all practical purposes, therefore, the Florida statute entitles the policyholder to independent counsel in most instances where the insurer reserves its right to deny coverage.
How an insurer should handle potential insurance defense conflicts of interest is a matter of state law that necessarily changes from jurisdiction to jurisdiction. There are a limited number of approaches that most states follow when addressing this issue. Therefore, rather than treating all potential insurance defense conflicts of interest the same, insurers and their claims representatives should strive to be well versed in these different approaches. In this way, insurers will be better prepared to apply the correct rule in each jurisdiction in which they operate.
1 San Diego Navy Federal Credit Union, et al. v. Cumis Insurance Society, Inc., 162 Cal.App.3d 358. (1984)
2 See e.g. Finley v. Home Ins. Co., 975 P.2d 1145, 1150 (Haw. 1998) (In order to address the problem of conflicts of interest arising when an insurer appoints counsel to defend its insured, "many jurisdictions require the insurer to appoint 'independent counsel' for the insured, paid for by the insurer. This counsel is commonly referred to as 'Cumis counsel.'").
3 Moeller v. American Guarantee & Liab. Ins. Co., 707 So.2d 1062, 1069 (Miss. 1996).
4 See e.g. Tank v. State Farm Fire & Cas. Co., 715 P.2d 1133 (Wash. 1986); Delmonte v. State Farm Fire & Cas. Co., 975 P.2d 1159 (Haw. 1999).
5 See California Civil Code §2860, Alaska Statutes, §21.89.100, and Florida Statutes, § 627.426(2).
1 Spindle v. Chubb/Pacific Indemnity Group, 89 Cal.App.3d 706, 710 (1979); Gafcon, Inc. v. Ponsor & Associates, 98 Cal.App.4th 1388, 1406-1407 (2002).
1 See American Cas. Co. v. Timmons, 352 F.2d 563, 568 (6th Cir. 1965).
8 See American Mut. Liab. Ins. Co. v. Superior Court, 38 Cal.App.3d 579, 591-593 (1974); Hartford Ins. Co. v. Koeppel, 629 F.Supp.2d 1293, 1299 (M.D. Fla. 2009); Mitchum v. Mitchum, 533 So.2d 194, 198-199 (Ala. 1988).
9 See e.g. Medical Protective Co. v. Medical Protective Co., 581 S.W.2d 25, 26 (Ky. 1979); Rhodes v. Chicago Ins. Co., 719 F.2d 116, 120-121 (5th Cir. 1983); United Services Auto Assn. v. Morris, 741 P.2d 246, 252 (Ariz. 1987); Moeller v. American Guarantee, supra, 707 So.2d at 1069.
10 Medical Protective Co., supra, 581 S.W.2d at 26.
11 See e.g. Tews Funeral Home v. Ohio Cas. Ins. Co., 832 F.2d 1037, 1045-1046 (7th Cir. 1987).
12 See Twin City Fire Ins. Co. v. Ben Arnold-Sunbelt Beverage Co., 336 F.Supp.2d 610, 619 (D. S.C. 2004) (District Court refused to find a conflict of interest requiring appointment of independent counsel "based upon the presumption that insurance defense counsel will behave unethically").
13 See id.; see also Twin City Fire Ins. Co. v. Ben Arnold-Sunbelt Beverage Co., 433 F.3d 365, 372 (4th Cir. 2005).
14 Armstrong Cleaners v. Erie Ins. Co., 364 F.Supp.2d 797, 807 (S.D. Ind. 2005); see also Twin City v. Ben Arnold, supra, 336 F. Supp. 2d at 615; Delmonte v. State Farm, supra, 975 P.2d at 1173-1174.
15 See Travelers Indem. Co. v. Royal Oak Enters., 344 F.Supp. 2d 1358, 1375 (M.D. Fla. 2004) ("The Court is convinced that the rules governing the Florida bar and the attendant threat of malpractice liability provide sufficient assurance that counsel appointed by an insurer would not continue to represent an insured in the event that a conflict of interest interfered with counsel's ability to make independent professional judgments on behalf of his client."); but see United States Fid & Guar Co. v. Roser Co., 585 F.2d 932, 938, fn. 5 (8th Cir. 1978) (observing that "[e]ven the most optimistic view of human nature requires [the court] to realize that an attorney employed by an insurance company will slant his efforts, perhaps unconsciously, in the interests of his real client who is paying his fee ?").
16 Tank v. State Farm, supra, 715 P.2d 1133; Delmonte v. State Farm, supra, 975 P.2d 1159; L&S Roofing Supply Co. v. St. Paul Fire & Marine Ins. Co., 521 So.2d 1298, 1303 (Ala. 1987).
17 See e.g. Travelers v. Royal Oak, supra, 344 F. Supp.2d at 1375.
18 Tank v. State Farm, supra, 715 P.2d 1133; L&S Roofing v. St. Paul, supra, 521 So.2d at 1303.
19 Section 2860 began its life as Senate Bill 241 which originally involved medical malpractice reform. Eventually, though, Senate Bill 241 was transformed into California's Cumis statute and was enacted into law as part of a legislative package called the "Brown-Lockyer Civil Liability Reform Act of 1987." This legislative package included a number of "tort reform" statutes that were negotiated between various plaintiff and defense interests. Note: Reconstructing Cumis: What the California Legislature Got Wrong About California Civil Code Section 2860 and How to Fix It, 60 Hastings L. J. 881, 887-889 (2009).
20 Dynamic Concepts, Inc. v. Truck Ins. Exch., 61 Cal.App.4th 998, 1007 (1998).
21 Id. at 1006.
22 Id. at 1007.
23 California Civil Code §2860(b).
24 California Civil Code §2860(b); see also Western Polymer Technology v. Reliance Ins. Co., 32 Cal.App.4th 14, 21 (1995).
25 California Civil Code §2860(c).
28 See CHI of Alaska, Inc. v. Employers Reinsurance Group, 844 P.2d 1113 (Alaska 1993).
29 Alaska Statutes, §21.89.100(d).
30 Alaska Statutes, §21.89.100(b)(3).
31 Alaska Statutes, §21.89.100(c).
32 Florida Statutes, §627.426(2).