Insurance Bad Faith and Mediation Confidentiality: Critical Policies on a Collision Course

March 2004

Do mediation confidentiality statutes permit insurer bad faith? Are mediation confidences protected in related lawsuits? These questions and dilemmas, if left unresolved, are certain to become major mediation issues.

by Jeff Kichaven
Jeff Kichaven, A Professional Corporation

As mediation becomes a more ubiquitous part of the claims resolution process, more litigation arising out of mediation must be, for better or worse, expected. Much of that litigation will involve issues of confidentiality. Some of these issues are foreshadowed in Epstein v Superior Court, 2d Civ. No. B 169884, previously pending in the California Court of Appeal but dismissed on March 9, 2004 ("Epstein II").

This article discusses how the resolution of these issues will have a significant impact on the confidence that users of mediation services will place in mediators, and on the extent to which mediation will bother to be used at all. It’s not entirely clear that our current rules do the trick. The time to think about these issues is now.

The Facts of the Case

Epstein II grows out of a sexual harassment case, Epstein v Endeavor Agency, LLC, et al., Los Angeles Superior Court Case No. BC 271224 ("Epstein I"), which settled at a mediation. Endeavor Agency is a leading Hollywood talent agency and Epstein’s former employer. Epstein II was an appeal from the denial of an injunction to prevent Endeavor from using evidence of things said and done at the mediation of Epstein I to prosecute a bad faith and malpractice case against its employment practices liability (EPL) insurer and its former attorneys, Endeavor Talent Agency v Certain Underwriters at Lloyds, London, et al., Los Angeles Superior Court Case No. BC 294910 (the "Endeavor Action").

The crux of the Endeavor Action is its claim that:

• The parties [to Epstein I] scheduled a mediation to resolve the case on November 18, 2002. However, only minutes before the mediation was set to begin, Underwriters terminated coverage and refused to participate in the mediation. Without trial counsel, and without an insurer to fund the defense (let alone indemnify any judgment), Endeavor was left with no choice but to settle the Epstein suit. It thereafter entered into a settlement agreement and the case was dismissed with prejudice. (Declaration of Thomas McGuire, General Counsel of Endeavor, filed August 12, 2003.)

The complaint in the Endeavor Action includes the following allegations, among others, regarding the mediation of Epstein I:

• Although [defense counsel] reported to Underwriters that Epstein’s case for sexual harassment was "weak," the mediator concluded—based on virtually the same evidence—that Epstein "had the better end of the sexual harassment argument" and that "a jury could easily come in with a verdict for lots and lots of money."
• Immediately prior to the mediation, [defense counsel] suggested a settlement between $330,000-$450,000; at the mediation, however, [defense counsel] conceded that Epstein’s economic damages alone "could approach or exceed $1 million."
• Although [defense counsel] constantly recommended nothing more than low-ball settlement offers to Underwriters, the mediator—who evaluated the same evidence—believed that the case was worth "well into the seven figures." (Paragraph 77d-f.)

Endeavor’s complaint also discloses that it paid $2.25 million to settle Epstein I. (Paragraph 42.)

All of this is seemingly in flat violation of the rule of Foxgate v Bramalea, 25 Cal 4th 1 (2001), where the California Supreme Court held that, to "carry out the purpose of encouraging mediation by ensuring confidentiality," California law "unqualifiedly bars disclosure of communications made during mediation." So, if she had pursued her appeal, Epstein likely would have obtained her injunction.

The Implications

The dismissal of Epstein II, however, allows us some time to consider the broader implications of the mediation confidentiality issues raised in that appeal. That litigation raised important questions about the limits and utility of mediation confidentiality, and requires us to think twice about whether the current mediation confidentiality regime will in fact further the goal articulated by the California Supreme Court, encouraging mediation.

Duties and Remedies

It is well established that insurers owe duties of good faith and fair dealing to their policyholders, and lawyers owe their clients a duty to perform competently. We are all familiar with the legal remedies available when these duties are breached. Any trial lawyer will tell you that the availability of those remedies is a powerful incentive for insurers and lawyers to fulfill their duties to act in good faith and provide quality service. It is only the existence of the remedy that gives the duty any teeth.

Hence the problem: If Epstein is right, and Endeavor cannot use evidence from the mediation of Epstein I to prosecute its bad faith and legal malpractice claims, then, as a practical matter, there may not be any remedy for insurance bad faith or legal malpractice if it takes place in a mediation. In turn, if there is no effective legal remedy for breaches of these duties when they take place in a mediation, it doesn’t do much good for policyholders or clients to say that the duties of good faith and competent representation exist during a mediation at all. Does this make mediation into anarchy, where society’s proscriptions against insurance bad faith and legal malpractice can be flouted with abandon? If so, then mediation hardly seems structured to carry out the purpose of encouraging its use.

For the precise bad faith allegations in the Endeavor Action, the problem is relatively easily solved. For other types of bad faith or legal malpractice actions, it’s not so simple. Finally, if one questions how malpractice by a mediator might be proved, it is clear that the discussion has just begun.

The Bad Faith Allegations in the Endeavor Action

The fact that Underwriters denied coverage right before the mediation is likely not a confidential mediation communication, and therefore likely not within the protection of the mediation confidentiality statute. If that is the essence of the alleged bad faith, Endeavor will likely be able to prosecute its bad faith claims and might not have been subject to the injunction Epstein sought. Indeed, in recognition of this reality, Endeavor filed a First Amended Complaint dated August 5, 2003, which omits the toxic allegations.

A more difficult question, though, is whether Endeavor can prove its damages. Endeavor’s damages relate to the amount paid to Epstein to settle Epstein I. But that number is subject to a confidentiality provision in the settlement agreement signed at the end of the mediation of Epstein I. So, in its First Amended Complaint, Endeavor simply alleges that it "... agreed to settle the Epstein Suit for an amount which is confidential but which is in excess of the minimal jurisdictional limit of this Court." (Paragraph 42.)

At the pretrial stage, Endeavor might be able to deal with the issue by asking the court to seal the file and enter a protective order. But what about trial? Trials are public and jurors could not be bound to a confidentiality agreement with a damages remedy. Suppose Endeavor obtains a judgment. That would be a public document. What could it say that would not disclose confidential information? There are no easy answers.

Other Possible Bad Faith Allegations

Consider the problems in this hypothetical example. An insurer attends mediation and says to its policyholder in a caucus attended by the two of them and the mediator:

• We are serious about our reservation of rights. So serious that we intend to pull coverage tomorrow. But we are here today, and still willing to contribute something to a settlement. We’ll go in for 50 percent of the money it takes to settle. So you’d better pitch in the other 50 percent, dear policyholder. Or else.

In fact, the insurer is bluffing. The bases of its reservations of rights are not nearly that strong. But neither the policyholder nor the mediator can be sure that it’s just a bluff. So the policyholder pays 50 percent, waives bad faith claims in exchange for the insurer’s release of potential reimbursement claims, and the case settles.

The policyholder then sues the insurer for bad faith. The insurer defends on the grounds, among others, that all evidence of the alleged bad faith is inadmissible because it took place in the format of confidential mediation communications. Does the mediation confidentiality statute thereby make our process a mischievous playground where bullying insurers can engage in bad faith conduct with license and abandon? You don’t have to be Shylock for this to make you pull out your hair and moan, "Is that the law?" (Shakespeare, The Merchant of Venice, Act IV, Sc. 1.)

Attorney Malpractice

Can an attorney’s client sue the attorney for malpractice if the error or omission took place at a mediation? At first blush, this problem seems relatively easy to solve. But further thought makes this one ticklish, too.

The first blush suggests that we draw an analogy to the rules governing the attorney-client privilege in a malpractice action. There, the general rule is that the attorney-client privilege does not apply, and that both client and attorney can use otherwise-privileged material to prosecute and defend the action between them. See, e.g., California Evidence Code section 958. By analogy, one might argue that mediation confidentiality statutes should not apply in this situation either. But there’s a problem. The California Legislature specifically enacted Evidence Code section 958 as an exception to a privilege. Without the statute, the exception presumably would not exist. The mediation confidentiality statute contains no similar exception. Courts should probably not imply one.

There’s another, bigger problem. Consider this hypothetical. A defendant ("Company") in a sexual harassment case claims malpractice by its attorneys. The alleged malpractice consists of the attorney’s incompetent responses to disclosures the plaintiff ("Woman") made at a mediation regarding her lurid sexual history, record of drug abuse, and immigration problems. The Woman disclosed these facts only because of her understanding of mediation confidentiality. Company’s use of this evidence in the subsequent legal malpractice suit—to which Woman is not a party and in the outcome of which Woman has no apparent interest—could subject Woman to criminal conviction, deportation, or worse.

Sure, reasoning along the lines of Evidence Code section 958 leads to the conclusion that it would probably work no unfairness to an attorney to allow his own client to use evidence derived from a mediation in a later malpractice case against him. But it could be outrageously unfair to other mediation participants, who disclosed facts at mediations in reliance on certain understandings of mediation confidentiality. And, it would eliminate any certainty that disclosures intended to be kept confidential will, in fact, be kept confidential. A later malpractice suit is always a possibility. Such a rule would hardly carry out the Supreme Court’s purpose of encouraging mediation by ensuring confidentiality.

Could a Mediator Ever Be Sued for Malpractice?

No less than any other professional, a mediator owes her clients a duty to perform competently. Our trial lawyer friends will remind us yet again that, for that duty to be meaningful, there must be a meaningful remedy if the duty is breached.

Thus this quandary: Everything a mediator says is arguably "for the purpose of, in the course of, or pursuant to a mediation or mediation consultation" within the meaning of California Evidence Code section 1119(a), which establishes the "confidentiality, nonadmissibility, and nondisclosure" of such evidence. Does this statute therefore render inadmissible all evidence of any error or omission by a mediator? If that is so, could we safely conclude that no error or omission by a mediator could ever be redressed by a malpractice suit?

At first, mediators might be pleased with that safe conclusion. But users of mediation might feel otherwise. Why would anybody trust a mediator with confidential information if there is no effective remedy for breach of that confidence? More bluntly, why would anybody pay good money for the services of a so-called professional who is under no duty, as a practical matter, to perform those services competently? Would such a regime encourage the use of mediation?

On the other hand, it is difficult to conjure a rule of law that would allow some mediation participants to use evidence of what happened at a mediation to prosecute a malpractice claim against a mediator effectively, and still protect the confidentiality expectations of other mediation participants. Legislatures as well as courts will have to listen to the voices of mediators and other stakeholders in the integrity and utility of mediation to see whether such rules should be conjured and, if so, what they should say.

To paraphrase Justice Frankfurter’s famous observations about fiduciaries in SEC v Chenery Corp., 318 U.S. 80, 85-86 (1943): To say that mediation is confidential only begins analysis; it gives direction to further inquiry.

Let the conversation begin.

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