Coverage Disputes Give Rise to "Independent" Counsel—Test Announced in Davalos
June 2005
Over the last 15 years, perhaps no area has
generated more controversy than the issue of independent counsel. The term "independent
counsel" means those situations in which an insured is entitled to select his
counsel and control the defense because of the existence of a specific type
of a conflict of interest with the insurer.
by R. Brent
Cooper
Cooper & Scully
While this concept has been lurking in the depths of legal waters since 1941,
it did not emerge from those waters until the mid-eighties with the decision
by the California Court of Appeals in San Diego Navy
Federal Credit Union v Cumis Ins. Society, Inc., 28 Cal Rptr 494 (Cal
App 1984). Following Cumis, there was tremendous
uncertainty regarding the application operation of the doctrine. To this extent,
at least three states have adopted statutes regulating this situation.1
Northern County Mut. Ins. v Davalos
The Texas Supreme Court squarely addressed the issue of independent counsel
for the first time in Northern County Mutual Ins. Co.
v Davalos, 140 SW3d 685 (Tex 2004). Davalos was an insured of Northern
County and a resident of Matagorda County. While in Dallas County, he was injured
in an automobile accident. Davalos sued the driver of the other vehicle in Matagorda
County. The other driver and his wife sued Davalos and another person who was
involved in the accident in Dallas County.
Davalos sent the Dallas petition in which he was named as a defendant to
the attorneys who were representing him as a plaintiff in the Matagorda action.
These attorneys moved to transfer the case to Matagorda County. After filing
such a motion, they then notified Northern of the Dallas litigation and tendered
the petition to Northern. Northern responded to the tender in writing and told
Davalos they did not wish to engage the attorneys he had selected to defend
the action and had chosen a different law firm to represent him in the Dallas
action. They also indicated that they were opposed to transferring the case
to Matagorda County.
The letter also set forth the cooperation clause and indicated that if the
motion to withdraw was not withdrawn, the coverage could be jeopardized. Northern
requested that Davalos have his attorneys withdraw from the Dallas County case
and allow the attorneys suggested by Northern replace them. Northern did indicate
to Davalos that he was free to obtain his own attorney at his own expense and
that Northern would cooperate with that lawyer to the extent that he did not
jeopardize the defense of the case.
The attorneys representing Davalos did not withdraw from the case. Davalos's
attorneys wrote to reject the defense tendered by Northern and suggested that
Northern had only offered a qualified defense which was insufficient to satisfy
the obligations owed under the policy. The attorneys advised Northern that it
could not select defense counsel because of the conflict with Davalos over the
venue motion, and that they expected Northern to pay their fees in defending
Davalos. Northern ultimately settled the claims against Davalos approximately
a year after the suit was filed, obtaining a full and final release with no
payment being made by Davalos. Davalos sued Northern County Mutual in Matagorda
County asserting breach of the duty to defend, bad faith, as well as violations
of the insurance code.
The Appeal
The supreme court in Davalos made five holdings
regarding the conduct of the defense:
-
The right to conduct the defense by the insurer is a matter of contract.
Under most policies, the right to conduct the defense includes the authority
to select the attorney who will defend the claim and make other decisions
that would normally be vested in the insured as the named party in the case.
[Davalos at 688.]
-
The supreme court held that this right to conduct the defense is not
without its limits. The court then addressed what situations would and would
not give rise to the right of the insured to control its own defense.
-
Generally, disagreement about how the defense should be conducted would
not amount to a conflict of interest. [Davalos at 689.]
-
The supreme court held that where there is a question regarding the existence
of scope of coverage, there may exist a right for disqualifying conflict.
A disqualifying conflict exists when the facts to be adjudicated in the
liability lawsuit are the same facts upon which coverage depends. [Davalos at 689.]
-
Finally, the court referenced other types of conflicts which may also
justify an insured's refusal to a defense which are outside the scope of
coverage. These are as follows:
- When the defense tendered "is not a complete defense under circumstances
in which it should have been."
- When the "attorney hired by the carrier acts unethically and, at
the insurer's direction, advances the insurer's interest at the expense
of the insured's."
- When "the defense would not come under the governing law, satisfy
the insurer's duty to defend"; and
- When, though the defense is nevertheless proper, "the insurer intends
to obtain some type of concession from the insured before it will defend."2
Test Employed by Davalos for Independent
Counsel
The test was announced in Davalos as to what
coverage questions give rise to independent counsel:
- An insurer can lose its right to select the insured's defense counsel
only if a conflict of interest exists between the insurer and the insured
as to the defense,
- Such a conflict of interest does not exist simply because the insurer
has issued a reservation of rights letter, and
- A conflict of interest exists only if the facts that will be adjudicated
in the lawsuit against the insured are the same facts upon which the existence
of coverage depends.
When Independent Counsel Is Required
The supreme court in Davalos held that an
insured might rightfully refuse to accept the insured's defense and appoint
counsel of their own choosing at the expense of the insurer in the situations
discussed below.
Reservation of Rights Letter—Some Causes of Action Covered; Some Not
In a situation where an insurer tenders a defense pursuant to a reservation-of-rights
letter to an insured, where some of the causes of action are covered and some
are not, the right to independent counsel is triggered. In Steel Erection Co. v Travelers Indemnity Co.,
392 SW2d 713 (Tex Civ App—San Antonio 1965, writ ref'd, n.r.e.), the allegations
included that the crane which had been damaged was under the care, custody,
and control of the insured (which would be excluded), or was being operated
by an independent contractor (which would not be excluded). The court of appeals
held that in that situation, because coverage could depend on the outcome of
the underlying case, the insured had a right to control its own defense.
Similarly, in Rhodes v Chicago Ins. Co., 719
F2d 116 (5th Cir 1983), the allegations included sexual misconduct (which would
be excluded) as well as allegations of professional negligence (which would
not be excluded). Again, the court in Rhodes found that because the outcome of the underlying case could determine the coverage
issue, that the insured would have a right to independent counsel.3 Allan D. Windt opines that this situation would likewise create a conflict of
interest that would require independent counsel:
This is not to say, however, that a conflict of interest will not, under
certain circumstances, arise with regard to the conduct of the insureds' defense.
Specifically, a conflict over the existence of coverage will serve to create
a conflict of interest with regard to the insured's defense when the insurers'
potential liability could be reduced if the insured were defended in a particular
manner.
Manner of Defense
The Texas Supreme Court in Davalos listed
four other situations which might justify an insured's refusal of an offer of
defense. With respect to these four instances, the court held that an insured
might rightfully refuse to accept the insured's defense and appoint counsel
of its own choosing at the expense of the insurer. These four situations are
as follows:
- When the defense tendered "is not a complete defense under the circumstances
in which it should have been,"
- When "the attorney hired by the carrier acts unethically and, at the
insurer's direction, advances the insurer's interest at the expense of the
insured's,"
- When "the defense would not, under the governing law, satisfy the insured's
duty to defend," and
- When though the defense is otherwise proper, "the insurer attempts to
obtain some type of concession from the insured before it will defend."
[1 WINDT § 4.25 at 393.]
The supreme court concluded that the insured may rightfully refuse an inadequate
defense and may also refuse any defense conditioned on an unreasonable, extra-contractual
demand that threatens the insured's independent legal rights. One example given
by the court in Davalos was that Northern could
not have required Davalos to dismiss his Matagorda suit as a condition for defending him. If such a demand had been made by Northern,
Davalos would have been justified in rejecting the defense.
When Independent Counsel Is Not Required
There are, however, situations when independent counsel is not required,
and these are outlined below.
Punitive Damages
Some states have adopted statutes to specifically provide that no independent
counsel is required solely on the basis of the plaintiff seeking punitive damages.4 In Texas the issue is unclear. Where there is a claim for punitive damages,
and the claim for actual damages is covered, the interest of the insured and
the insurer are completely aligned. By statute, there can be no recovery of
punitive damages unless there is a recovery of actual damages.5 Allan D. Windt also concurs in the proposition that an allegation of punitive
damages will not trigger the right to independent counsel:
- Since, under those circumstances, the interest of the insured and the
insurer would parallel each other with respect to the plaintiff's claims
for compensatory damages, the fact that the insured might be liable for
additional damages would not create a conflict of interest between the insured
and the carrier. [1 WINDT §4.20 AT 376-77.]
Excess Demand
As in the case of punitive damages, an excess demand will not trigger the
right of the insured to independent counsel. Again, the reason for this result
is that there is no conflict between the insured and the insurer. Both the insured
and the insurer have the joint goal of seeking that little or no damages are
awarded by the jury. If there is a verdict in excess of the policy limits, the
insurer will have its entire limits exposed.
Courts in other jurisdictions have adopted this approach. In Pekin Ins. v Home Ins., 479 NE2d 1078 (Ill App
1985), the insurer paid its policy limits but continued defending the insured.
The insured asserted that the exhaustion of the limits of liability created
a conflict of interest for the insurer. The insured argued that the insurer
had an interest in keeping the litigation costs as low as possible. On the other
hand, the insured believed that a full and vigorous defense was required. This
contention by the insured was rejected by the court. The court held that the
insured's concerns about the zealousness of the defense tendered by the insurer
were insufficient to create a right to independent counsel.
At least two states, California and Alaska, have adopted statutes that hold
a claim in excess of the policy limits does not create a conflict of interest.6 Allan D. Windt also agrees that an excess demand will not create the right to
independent counsel. He argues that:
- The insured's defense counsel would not, under the foregoing circumstances,
be able to reduce the insurer's liability by the manner in which he or she
defended the lawsuit. [1 WINDT § 420 at 377.]
Claim Against Multiple Insureds
Some courts have held that where there are claims against multiple insureds,
the right to independent counsel may arise. This includes cases where insureds
are insured under the same policy or the insureds are insured under different
policies.7 Other courts find this reasoning erroneous,
for several reasons. First, no conflict exists between the insurer and the insureds.
Rather, the conflict is between the two insureds. Regardless of which insured
is found to be liable, the insurer in that case would have a responsibility
to pay. Also any payment of a judgment or settlement on behalf of one insured
would benefit the other.8
Insured versus Insured Suits
Similarly, some states have held that where the plaintiff and the defendant
are represented by the same insurer, the conflict exists. O'Norrow v Borad, 167 P2d 483 (Cal 1946). Likewise,
in Hoffman v Austin Ins., 188 NYS2d 408 (Sup
Ct 1959), the court held that in a suit by one insured against the other, the
insurer had an obligation to appoint independent counsel. There is not a conflict
between the insurer and the respective insured.
Persons Insured
On many occasions, an insurer may reserve rights on the issue as to whether
or not a person is an insured under the policy. In many of those cases, coverage
will depend on determinations in the underlying lawsuit. For example, whether
a person was an employee acting in the course and scope of employment not only
is an issue for liability but also is an issue for coverage. In that situation,
the employee should have the right to independent counsel.
Policy Period
On numerous occasions, an insurer may reserve its rights based on whether
there was a trigger during the particular insured's policy period. In most cases,
this will not be an issue which will be determined in the underlying case. When
bodily injury or when property damage occurred, in most cases, is not an issue
to be determined in the underlying case. However, there could be circumstances,
particularly where the statute of limitations is involved, where a conflict
could exist and the issue is to be determined in the underlying case. In those
circumstances, then the insured would have the right to independent counsel.
Conditions
On many occasions, reservation-of-rights letters contain reference to breach
of conditions by the insured. The most frequent reference is to the failure
of the insured to give prompt notice of the occurrence, claim, or suit. The
issue is presented as to whether a reservation-of-rights letter that sets a
breach of condition would be sufficient to justify the use of independent counsel.
Again, in most cases, the answer is no. With respect to late notice, the issue
of whether the occurrence, claim, or lawsuit was timely reported to the insurer
is not going to be an issue in the underlying case. If it is ever to be determined,
it will be determined separately in a declaratory judgment action. In the defense
of the underlying case, the insurer would have every incentive to obtain a favorable
ruling on behalf of the insured in order to obviate a later coverage battle
with the insured.
Mr. Windt also agrees that a dispute over compliance with the condition will
not give rise to the right to independent counsel. He states that:
- With rare exceptions, those issues are irrelevant to the issues involved
in defending the insured against the plaintiff's claims. [1 WINDT § 4:20
at 376.]
Coverage Issues Where Facts Will Not Be Decided in the Underlying Case
Under the Davalos decision, if the coverage
issue involves facts that will not be decided in the underlying case, there
is no conflict of interest which would entitle the insured to independent counsel.
The reason there is no conflict of interest is that the defense counsel could
not be in a position to move the case toward coverage or noncoverage by the
conduct of the defense.
Independent Wrongdoing
Mr. Windt also asserts that there is no right to independent counsel where
the complaint contains more than one cause of action, each of which is based
on a different, independent alleged wrongdoing by the defendant-insured. The
fact that the insurance policy does not provide coverage with respect to every
cause of action does not create a conflict of interest between insured and an
insurer, insofar as the insured's defense is concerned. [1 WINDT § 4:20 at 375.]
Disagreement on Potential Exposure
Finally, a disagreement over the potential exposure of the insured will not
create a conflict of interest which will give rise to the right of independent
counsel. [1 WINDT § 4:20 at 378.]
Conclusion
The Davolos case provided us with an insight
as to how generally the Independent Counsel Rule should be applied. This Texas
Supreme Court case set out a test as to what coverage questions will give rise
to independent counsel. There still remains a tremendous amount of disagreement
regarding the breadth of this court's opinion and what circumstances do trigger
the right of an insured to independent counsel. Various other states have adopted
statutes regulating the type of situations in which an insured is entitled to
select his counsel and control his defense due to a conflict of interest with
his insurer, to alleviate this problem. It appears that the courts will continue
wrestle with this controversy over independent counsel.
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