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.
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motion to withdraw was not withdrawn, the coverage could be jeopardized.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 certain
situations.
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
insurer'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.