The Measure of "Reasonable" Defense Costs in Independent Counsel Situations

In personal lines insurance as well as other lines of insurance, this conflict of interest may arise when the insurance company denies coverage or reserves its right to later deny coverage. While the insured will wish to establish coverage, the insurance company will wish to deny it. Whether an insurer has the right to control the defense, which involves the right to select counsel, is a matter of contract. See North County Mut. Ins. Co. v. Davalos, 140 S.W.3d 658, 688 (Tex. 2004); also State Farm Mut. Auto. Ins. Co. v. Traver, 980 S.W.2d 625 at 627 (Tex. 1998).

Most policies vest this right in insurers. Under certain circumstances, however, an insurer may not insist on its contractual right to control the defense. San Diego Navy Fed. Credit Union v. Cumis Ins. Soc'y, Inc., 162 Cal. App. 3d 358 (1984); Davalos, 140 S.W.3d at 688; see also R. Brent Cooper, Coverage Disputes Give Rise to Independent Counsel, IRMI June 2005). Once it is determined that the insured is entitled to independent counsel of his or her choice, may he or she choose any attorney at any price?

Reasonable Fee

Conflicts will escalate with respect to what constitutes a "reasonable" fee for independent counsel. A policyholder who is not funding the defense may be motivated to choose the most skilled (and expensive) attorney to establish coverage and will want this attorney to spend the maximum number of hours on his or her claim. Further, an attorney who is aware that he is being paid by an insurance company with "deep pockets" may not attempt to control costs or may use the case as an opportunity to train inexperienced associates or allow partners to learn a new area of law. See Elaynne B. Cothran, Can Carriers Legitimately Evaluate Independent Counsel Fees without Impeding Counsel's Independent Legal Judgment, Brief, Spring 2000, at 38, 40.

On the other hand, an insurer who is required to pay for such counsel will contend that a reasonable attorney's fee rate would be the rate that would have been charged by captive counsel or panel counsel.

The Louisiana Supreme Court has established a 10-factor test to determine the reasonableness of attorney's fees in independent counsel situations. These factors are:

1. the ultimate result obtained;
2. the responsibility incurred;
3. the importance of the litigation;
4. the amount of money involved;
5. the extent and character of the work performed;
6. the legal knowledge, attainment, and skill of the attorneys;
7. the number of appearances involved;
8. the intricacies of the facts involved;
9. the diligence and skill of counsel; and
10. the court's own knowledge.

Rivet v. State, 680 So. 2d 1154, 1161 (La. 1996) (citing State v. Williamson, 597 So. 2d 439, 441-42 (La. 1992)

Several states have enacted statutes declaring that in independent counsel situations, the reasonableness of defense costs must be measured from the insurer's perspective based on what the insurer typically pays defense counsel. California Civil Code Section 2860 provides that the insurer may require that the independent counsel have 5 years of litigation experience in the relevant field of law and that the rates are limited to those actually paid by the insurer in the ordinary course of business in the community. Cal. Civ. Code § 2860(c) (Deering 2005).

Furthermore, Section 2860(c) provides that disputes regarding attorney's fees shall be resolved by arbitration. Id. This statute was applied in Truck Ins. Exch. v. Superior Court, in which the court held that arbitration prior to the legal determination of the coverage issues is appropriate to resolve disputes over the independent counsel's fees. 59 Cal. Rptr. 2d 529, 537 (Cal. Ct. App. 1996); but see Caiafa Prof'l Law Corp. v. State Farm Fire & Cas. Co., 19 Cal. Rptr. 2d 138, 142-43 (Cal. Ct. App. 1993) (holding that the trial court did not abuse its discretion by staying the state court Section 2860 arbitration proceedings pending the outcome of the federal fraud action).

Similar to the California statute, the Alaska statute provides that the insurer may require a minimum number of years of experience that the fees are limited to those paid by the insurer in the ordinary course of business, and that disputes about attorney's fees not solved by the statute or the insurance policy will be resolved by arbitration. Alaska Stat. §21.89.100(d) (2004). The Alaska statute also provides that the insurer is not responsible for fees incurred in defending coverage that has been properly denied and that the attorney shall keep detailed records. Id.

Section 21.89.100(d) provides as follows:

If the insured selects independent counsel at the insurer's expense, the insurer may require that the independent counsel have at least four years of experience in civil litigation, including defense experience in the general subject area at issue in the civil action, and malpractice insurance. Unless otherwise provided in the insurance policy, the obligation of the insurer to pay the fee charged by the independent counsel is limited to the rate that is actually paid by the insurer to an attorney in the ordinary course of business in the defense of a similar civil action in the community in which the claim arose or is being defended. In providing independent counsel, the insurer is not responsible for the fees and costs of defending an allegation for which coverage is properly denied and shall be responsible only for the fees and costs to defend those allegations for which the insurer either reserves its position as to coverage or accepts coverage. The independent counsel shall keep detailed records allocating fees and costs accordingly. A dispute between the insurer and insured regarding attorney fees that is not resolved by the insurance policy or this section shall be resolved by arbitration….

The statute also provides:

An insurance policy may contain a provision that provides a method of selecting independent counsel if the provision complies with this section." §21.89.100(a).

Florida briefly addresses the problem through legislation providing that the independent counsel should be mutually agreeable to the parties and should be paid reasonable fees agreed on by the parties or set by the court. Fla. Stat. Ann. §627.426 (West 2004) (provides that the insurer must "retain independent counsel which is mutually agreeable to the parties"). Reasonable fees for the counsel may be agreed on between the parties or, if no agreement is reached, shall be set by the court." Fla. Stat. Ann. §627.426(2)(b)(3) (West 2004).

This statutory requirement of a mutually agreeable attorney was not satisfied when the insurer retained the independent counsel but did not inform the insured of its right to mutually agreeable counsel, did not ask the insured whether the counsel was acceptable, and did not consult with the insured when selecting the attorney. American Empire Surplus Lines Ins. Co. v. Gold Coast Elevator, Inc., 701 So. 2d 904, 906 (Fla. Dist. Ct. App. 1997).

Some jurisdictions do not agree with the legislatures of Alaska and California, finding that these legislatures ignore the fact that defense counsel who receive a large volume of work from a particular insurer oftentimes discount their rates and thus their fees usually are significantly lower than those charged by independent counsel selected by insureds in conflict-of-interest situations. It is estimated that defense attorneys who serve as "panel counsel" are paid 15-50 percent less than the hourly rate of outside counsel selected by the insured. See Charles Silver, Does Insurance Defense Counsel Represent the Company or the Insured?, 72 Tex. L. Rev. 1583, 1597-98 (1994). Should independent counsel, who may or may not ever have another case involving the insurer, be forced to accept the discounted rate?

Texas is one of the jurisdictions in disagreement with the legislatures of Alaska and California. In Housing Auth. of City of Dallas v. Northland Ins. Co., 333 F. Supp. 2d 595 (N.D. Tex. 2004), after deciding that the insurer had breached its duty to defend, Judge Lindsay issued a subsequent opinion in which he concluded that the fees charged by the lawyers whom the insured had retained to represent it after the insured refused to accept the insurer's qualified defense were "on the low end of reasonableness," despite the fact that they were significantly higher than the rates that would have been charged by the insurer's selected counsel. In determining the amount of fees to be awarded, Judge Lindsay relied on the factors set out in Johnson v. Georgia Hwy. Express, Inc., 488 F.2d 714 (5th Cir. 1974).

The Johnson factors are virtually identical to the factors the Texas Supreme Court set out as a guide when awarding attorneys' fees. SeeArthur Anderson & Co. v. Perry Equip. Corp., 945 S.W.2d 812,818 (Tex. 1997). The factors that the court stated should be considered when determining the reasonableness of a fee included:

1. the time and labor required, the novelty and difficulty of the questions involved, and the skill required to perform the legal service properly;

2. the likelihood . . . that the acceptance of the particular employment will preclude other employment by the lawyer;

3. the fee customarily charged in the locality for similar legal services;

4. the amount involved and the results obtained;

5. the time limitations imposed by the client or by the circumstances;

6. the nature and length of the professional relationship with the client;

7. the experience, reputation, and ability of the lawyer or lawyers performing the services; and

8. whether the fee is fixed or contingent on results obtained or uncertainty of collection before the legal services have been rendered.

Johnson at 717-18. However, it should be noted that there is no published Texas caselaw at this time that applies the Johnson (Arthur Anderson) factors in the independent counsel context.

The caselaw from other jurisdictions varies as to what constitutes a reasonable fee for independent counsel. See, e.g.:

• Golotrade Shipping & Chartering, Inc. v. Travelers Indent. Co., 706 F. Supp. 214, 219 (S.D.N.Y. 1989) (stating that once a conflict of interest arises, "the duty to defend includes a duty to provide independent defense counsel to the insured, whose reasonable fee is to be paid by the insurer but who is to be appointed by the insured").

• U.S. Fid. & Guar. Co. v. Louis A. Roser Co., 585 F.2d 932, 941 (8th Cir. 1978) ("USF&G must now reimburse appellant for the fair and reasonable value of the services rendered by appellant's independent counsel in defending the Kemp action.")

• Armstrong Cleaners, Inc. v. Erie Ins. Exch., 364 F. Supp 2d 797, 801 (S.D. Ind, 2005) ("[T]he policyholders are entitled to select their own counsel to defend the underlying claim, subject to reasonable approval by the insurer, with reasonable fees and expenses paid by the insurer.")

• HK Sys. Inc. v Admiral Ins. Co., 2005 WL 1563.340, at *18 (E.D. Wis. June 27, 2005) (opining that the Wisconsin Supreme Court "would find that the insurer's responsibility for defense costs extends only to a reasonable charge").

• Aquino v. State Farm Ins. Co., 793 A.2d 824, 832 (N.J. Super. 2002) ("It does not follow, however, that he is entitled to be compensated by the insurers for that defense work on the same basis that he is entitled to be compensated for work performed in connection with the declaratory judgment action. While [the insured] may have been entitled to an attorney of his selection to handle the claim of intentional conduct, he does not have the right to dictate to the insurers the hourly rate they must pay. The trial court here should have determined a reasonable hourly rate for defense work of this nature and set a fee accordingly.")

Conclusion

Insurers need a means by which to measure their risk under the insurance policies they issue, to forecast and budget for the outlay of defense costs for that risk, and to thereby establish a means by which to set policy premiums for the benefit of all insureds. To expose insurers to costs for which they did not bargain and cannot control could create disruptions and uncertainty for the insurance industry and for every policyholder. This would be poor public policy. A shift in the right to control the defense, and to select defense counsel, should not increase the financial obligations the insurer bargained for under the insurance contract nor afford the insured a more expensive defense than for which it paid. It therefore makes sense to measure the "reasonableness" of the defense costs incurred directly by an insured from the insurer's perspective as set forth in the independent counsel statutes of California and Alaska. No other rule more closely adheres to the bargain struck by the parties or offers a more manageable and predictable rule for the parties and the courts. Thus, an insured with a right to select its own counsel should be provided the same defense, in terms of cost, as other similarly situated insureds.

Dana Harbin is an attorney in the Dallas office of Cooper & Scully, P.C. where she specializes in insurance coverage and bad faith involving all types of insurance policies, both first and third party. Ms. Harbin earned her BA degree from the University of Texas in Arlington and her JD degree from the University of Texas at Austin. She can be reached at