Expert Commentary

Insurer's Lawyer's Advice Not Privileged

More than a century ago, George Orwell wrote a book, Animal Farm, about the dangers of communism. When the question of equality arose in the operation of the farm, the pigs, who had taken control, concluded that all animals were equal but some were more equal than others. In Washington state, it appears that all lawyers and litigants are equal except for insurers and their lawyers, who are less equal than all others are.


Claims Practices
April 2013

The attorney-client privilege was designed to make a litigant, such as an insurer, feel secure from the potential risk of having sensitive information fall into the wrong hands when speaking to his or her lawyer. By its nature, the attorney-client relationship affords a distinct, invaluable right to have communications protected from compelled disclosure to any third party, including business associates and competitors, government agencies, and even criminal justice authorities.

The attorney-client privilege is the oldest privilege recognized by Anglo-American jurisprudence. In fact, the principles of the testimonial privilege may be traced all the way back to the Roman Republic, and its use was firmly established in English law as early as the reign of Elizabeth I in the 16th century. Grounded in the concept of honor, the privilege worked to bar any testimony by the attorney against the client.

The Washington Supreme Court was called on, in Cedell v. Farmers Ins. Co. of Wash., 171 Wash. 2d 1005, 249 P.3d 182 (2013), to determine the right of an insured to discover communications between an insurer and its lawyer. The Washington Supreme Court concluded that, in a dispute over a first-party claim, the privilege is presumed not to apply to most communications between a lawyer and his or her insurer client.

Facts of the Case

A fire destroyed Bruce Cedell's home. After being unresponsive for 7 months, his insurer threatened to deny coverage and made a take it or leave it one-time offer for only a quarter of what the court eventually found the claims to be worth. Cedell brought suit alleging bad faith. The company resisted disclosing its claims file, among other things, and Cedell moved to compel production. After a hearing and a review of the claims file in camera, the trial court granted Cedell's motion.

On interlocutory review, the Washington Court of Appeals held that the attorney-client privilege applies to a bad faith claim by a first-party insured, that the fraud exception to the attorney-client privilege requires a showing of actual fraud, and that the trial court erred in reviewing Cedell's claims file in camera because Cedell had not made a sufficient prima facie showing of fraud. The Washington Court of Appeals vacated the trial court's sanctions and discovery orders. This case turns on the application and scope of the attorney-client privilege in a claim for insurance bad faith.

Cedell insured his home in Elma with Farmers Insurance Company of Washington for over 20 years. In November 2006, when Cedell was not at home, a fire broke out in his bedroom. His girlfriend, Ms. Ackley, called the fire department and carried their 2-month-old child outside. The fire completely destroyed the second story of the home. Ackley claimed that a candle had started the fire. The Elma Fire Department and Farmers concluded that the fire was "likely" accidental.

In January 2007, a Farmers adjuster estimated that Farmers' exposure would be about $70,000 for the house and $35,000 for its contents. A few months later, a Farmers estimator, Joe Mendoza, concluded that the fire-related damage to the residence alone was about $56,498. Farmers hired an attorney, Ryan Hall, to assist in making a coverage determination.

Hall examined Cedell and Ackley under oath. In July 2007, Hall sent Cedell a letter stating that the origin of the fire was unknown and that Farmers might deny coverage based on a delay in reporting and Ackley's and Cedell's inconsistent statements about the fire. The letter extended to Cedell a one-time offer of $30,000, good for 10 days. Cedell tried unsuccessfully to contact Farmers about the offer during the 10 days, but no one from Farmers returned his call.

In November 2007, Cedell sued Farmers, alleging, among other things, that it acted in bad faith in handling his claim. In response to his discovery requests, Farmers produced a heavily redacted claims file, asserting that the redacted information was not relevant or was privileged. Farmers also declined to answer some of Cedell's interrogatories on the ground of attorney-client privilege, including Cedell's question of why it "gave Bruce Cedell 10 days to either accept or reject the above offer."

Cedell filed a motion to compel. Cedell contended that the claim of privilege and work product in bad faith litigation is severely limited and does not apply to the insurer's benefit in a bad faith action by a first-party insured. Cedell moved for disclosure or, in the alternative, for an in camera review of the files. Farmers opposed the motion, argued that Cedell had to make an initial showing of civil fraud to obtain the full claims file, and sought an order protecting from discovery all privileged communication with its counsel, Ryan Hall.

Judge David Edwards held a hearing to consider the competing motions. He concluded that the insured was not required to make a showing of civil fraud before the claims file could be released, but instead merely "some foundation [in] fact to support a good faith belief by a reasonable person that [] there may have been wrongful conduct which could invoke the fraud exception." Judge Edwards found that:

  1. Cedell was not home at the time of the fire.
  2. The fire department and Farmers' fire investigator had concluded that the fire was accidental.
  3. Farmers knew that the fire had left Cedell homeless.
  4. A Farmers adjuster appraised the damage to the house at $56,498.84.
  5. Another adjuster estimated the damage at $70,000 for the house and $35,000 for its contents.
  6. Farmers made a one-time offer of $30,000 with an acceptance period that fell when Hall was out of town.
  7. Farmers threatened to deny Cedell coverage and claimed he misrepresented material information without explanation.
  8. The damage to the house was eventually valued at over $115,000 and more than $16,000 in code updates.

The judge found these facts adequate to support a good faith belief by a reasonable person that wrongful conduct sufficient to invoke the fraud exception to the attorney-client privilege had occurred and ordered the claim files produced for an in camera review. He also awarded Cedell his attorneys' fees for the motion, capped at $2,500, and assessed punitive sanctions against Farmers of $5,000, payable to the court.

After reviewing the documents in camera, Judge Edwards revised his view of what was required to release an un-redacted claim file in a first-party bad faith action and found that the privilege did not apply. He ordered Farmers to provide Cedell with all documents that it had withheld or redacted based on the attorney-client privilege, increased the sanctions payable to Cedell to $15,000, and increased the sanctions payable to the court to $25,000.

The Washington Court of Appeals reversed, finding that "a factual showing of bad faith" was insufficient to trigger an in camera review of the claims file. The lower court impliedly found that a showing that the insurer used the attorney to further a bad faith denial of the claim was not sufficient grounds to pierce the attorney-client privilege.

Analysis

The scope of discovery is very broad. The right to discovery is an integral part of the right to access of the courts embedded in the Washington constitution.

Besides its constitutional cornerstone, there are practical reasons for discovery. Earlier experiences with a "blindman's bluff" approach to litigation, where each side was required literally to guess at what its opponent would offer as evidence, were unsatisfactory. As modern day pretrial discovery has evolved, it has contributed enormously to a more fair, just, and efficient process. A party wishing to assert a privilege may not simply keep quiet about the information it believes is protected from discovery; it must:

  • reveal the information,
  • disclose that it has it and assert that it is privileged, or
  • seek a protective order.

Farmers disclosed that it had the information and sought protection from its revelation by court order. However, the Washington Supreme Court concluded that, when an insured asserts bad faith against his or her insurer in the way the insurer has handled the insured's claim, unique considerations arise. There are numerous recognized actions for bad faith against medical, homeowners, automobile, and other insurers in which the insured must have access to the claims file to prove the claim. For example, there are bad faith investigations, untimely investigations, failure to inform the insured of available benefits, and making unreasonably low offers. A first-party bad faith claim arises from the fact that the insurer has a quasi-fiduciary duty to act in good faith toward its insured. The insured needs access to the insurer's file maintained for the insured in order to discover facts to support a claim of bad faith. Implicit in an insurance company's handing of a claim is litigation or the threat of litigation that involves the advice of counsel.

To permit a blanket privilege in insurance bad faith claims (as exists for every other type of litigation) because of the participation of lawyers hired or employed by insurers would, the Washington Supreme Court concluded, "unreasonably obstruct discovery of meritorious claims and conceal unwarranted practices."

The Washington Supreme Court also concluded that "[i]t is a well-established principle in bad faith actions brought by an insured against an insurer under the terms of an insurance contract that communications between the insurer and the attorney are not privileged with respect to the insured" (Baker v. CNA Ins. Co., 123 F.R.D. 322 (D. Mont. 1988); Escalante v. Sentry Ins. Co., 49 Wn. App. 375; Silva v. Fire Ins. Exch.,  112 F.R.D. 699 (D. Mont. 1986)). In Silva, the Montana court noted, "The time-worn claims of work product and attorney-client privilege cannot be invoked to the insurance company's benefit where the only issue in the case is whether the company breached its duty of good faith in processing the insured's claim."

First, the trial court must determine whether there is a factual showing adequate to support a good faith belief by a reasonable person that wrongful conduct sufficient to evoke the fraud exception has occurred. Second, if so, the trial court must subject the documents to an in camera inspection to determine whether there is a foundation in fact for the charge of civil fraud. The in camera inspection is a matter of trial court discretion.

The Washington Supreme Court recognized that two important principles are in tension in insurance bad faith claims. The purpose of discovery is to allow production of all relevant facts and thereby narrow the issues and promote efficient and early resolution of claims. The purpose of attorney-client privilege is to allow clients to fully inform their attorneys of all relevant facts without fear of consequent disclosure. First-party bad faith claims by insureds against their own insurer are unique and founded on two important public policy pillars: that an insurance company has a quasi-fiduciary duty to its insured and that insurance contracts, practices, and procedures are highly regulated and of substantial public interest.

The fraud exception to the attorney-client privilege is deeply rooted. "In first-party insurance claims by insureds claiming bad faith in the handling and processing of claims, there is a presumption of no attorney-client privilege." (Emphasis added.)

The insurer may assert an attorney-client privilege upon a showing in camera that the attorney was providing counsel to the insurer and not engaged in a quasi-fiduciary function. If the civil fraud exception is asserted, the trial court must engage in a two-step process. First, upon a showing that a reasonable person would have a reasonable belief that an act of bad faith has occurred, the trial court will perform an in camera review of the claimed privileged materials; and second, after in camera review and upon a finding that there is a foundation to permit a claim of bad faith to proceed, the attorney-client privilege shall be deemed to be waived.

Addressing the Facts of This Case

Farmers hired an attorney, Hall, to advise it on legal issues of coverage. To the extent Hall issued legal opinions as to Cedell's coverage under the policy, Farmers would be able to seek to overcome the presumption favoring disclosure by showing that Hall was not acting in one of the ways the insurer must act in a quasi-fiduciary way toward its insured. However, Farmers hired Hall to do more than give legal opinions. The record suggests that Hall assisted in the investigation. Hall took sworn statements from Cedell and a witness and corresponded with Cedell. Hall assisted in adjusting the claim by negotiating with Cedell. Seven months after the fire, Hall wrote to Cedell offering a "one-time offer" of $30,000, which was open for only 10 days, and threatened denial of coverage if the offer was not accepted. It was Hall who was negotiating with Cedell on behalf of Farmers, and it was Hall who did not return his calls when Cedell was attempting to respond to the offer.

While Hall may have advised Farmers as to the law and strategy, he also performed the functions of investigating, evaluating, negotiating, and processing the claim. These functions and prompt and responsive communications with the insured are among the quasi-fiduciary activities that Farmers owed to Cedell.

Assuming Farmers was able to overcome the presumption of disclosure based on a showing that Hall was not engaged in quasi-fiduciary activities, it was entitled to an in camera review and the redaction of his advice and mental impressions he provided to his client. Here, the court said that the trial court did examine in camera the documents to which Farmers asserted an attorney-client privilege.

Ruling

The court held that Cedell was entitled to broad discovery, including, presumptively, the entire claims file. The insurer may overcome this presumption by showing in camera that its attorney was not engaged in the quasi-fiduciary tasks of investigating and evaluating the claim. Upon such a showing, the court held that the insurance company is entitled to the redaction of communications from counsel that reflected the mental impressions of the attorney to the insurance company, unless those mental impressions are directly at issue in its quasi-fiduciary responsibilities to its insured.

The insured is then entitled to attempt to pierce the attorney-client privilege. If the insured asserts the civil fraud exception, the court must engage in a two-step process to determine whether the claimed privileged documents are discoverable.

The Washington Supreme Court reversed the Washington Court of Appeals in part, affirmed in part, and remanded the case to the trial court for further proceedings consistent with its opinion since it could not tell if its in camera review was a privileged communication.

Conclusion

This is an exceedingly dangerous decision. Lawyers do many things, some of which are not necessarily providing a legal opinion to their clients. A real estate lawyer will view a property, interview witnesses, etc.; a personal injury lawyer will review an accident scene, hire experts, communicate with the potential defendant, and examine witnesses, etc. There are many other variations on the theme.

I have, in my career, taken hundreds of examinations under oath because my insurer client found it necessary so that I could give it good and appropriate legal advice. In so doing, I did not act as an adjuster or in a quasi-fiduciary capacity. I acted as a lawyer.

The Washington Supreme Court has proven Mr. Orwell correct since, there, a lawyer for an insurer is not as equal as a lawyer for any other client. The ancient privilege should protect his or her advice and, if insurers cannot be certain of the protection of the privilege, they will be put at a disadvantage in breach, in my opinion, of the equal protection of the law.

Mr. Cedell had no more right to see Hall's communications with his client, Farmers, than Farmers had to review the communications between Mr. Cedell and his lawyer. This case will chill, if not eliminate, the ability of an insurer to investigate questionable claims.


Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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