A cornerstone of California law is that the duty to defend arises whenever the lawsuit against the insured seeks damages on any theory that, if proved, would be covered by the policy.  Indeed the duty to defend is so broad that it is excused only when “the third party complaint can by no conceivable theory raise a single issue which would bring it with the policy coverage.” (Montrose Chem. Corp. v. Superior Court (1993) 6 Cal 4th 287, 295 –applying law first set forth in Gray v. Zurich Ins. Co. (1966) 65 Cal 2d 263.)  It took almost fifty-one years of litigation for the courts to clarify the duty to defend, but with each new case, the Insurers will continue to contest both their duty to defend and if they must defend, whether independent counsel is required.

Back some forty-six years ago in Executive Aviation Inc. v. National Ins. Underwriters (1971) 16 Cal App 3d 799, 810, the appellate court recognized that “the insurer’s desire to exclusively control the defense must yield to its obligation to defend its policyholder” and pay for independent counsel under the facts of that case.  Where the insurer defends under reservations and appoints its panel defense counsel, such counsel may find himself or herself in conflict!  If counsel can favor his or her insurer client when developing evidence or undertaking defense strategy in a way to negate coverage, the courts have fashioned a remedy: the right to independent counsel paid for by the insurer.

The insurer must thus pay for independent counsel where the circumstances demonstrate a disqualifying conflict of interest. San Diego Navy Fed. Credit Union v Cumis Ins. Society (1984) 162 Cal App 3d 358, 364 and later Civil Code Section 2860 (a).  What conflicts create the disqualifying conflict of interest? Here are some examples:

  • The outcome of the coverage dispute can be affected by the manner in which the case is defended.
  • Several insureds are defendants and they have conflicting claims against each other.
  • The same attorney is representing the insurer in a DRA seeking to avoid coverage who the insurer appoints as defense counsel for the insured (!!—this was the circumstance in Executive Aviation).
  • The insurer seeks to settle the claim for more than policy limits exposing their insureds to the excess liability (!! a real case where that happened is Golden Eagle Ins. Co. v. Foremost Ins. Co. (1993) 20 Cal App 4th 1372, 1396)

The “paradigm cases” for disqualifying conflict include the one just cited Golden Eagle Ins. Co. v. Foremost and others, i.e., Long v. Century Indem. Co.  (2008) 163 Cal App 4th 1460, 1471, because the coverage issue in those cases rested on whether the insureds acted negligently or intentionally.  Under those circumstances, the appointed defense counsel could control the production of evidence to disfavor coverage.

There are two strong reasons the Insurers attack these decades of common law and statutory law, however: Cost and Control.  The insurers hope to 1) rein in the costs of litigation only paying their panel counsel negotiated below market bargain rates, and 2) dictate defense strategies to those cheaper counsel;  sometimes they succeed.

It is common for insurers to argue that their beleaguered insureds (who are fighting off underlying lawsuits) must also first prove the disqualifying circumstances to secure the benefits of unconflicted defense. In two recently reported cases, the insurer prevailed where the policyholders did not submit evidence supporting a potential conflict, and the insurers avoided any obligation to pay for independent counsel.  In both cases the insured simply failed to produce any evidence of actual potential conflict of interest. A review of these cases is instructive and demonstrate the pitfalls of over-reaching.

The insurer won a summary judgment affirmed on appeal in Centex Homes v. St. Paul Fire and Marine Ins. Co., 2018 Cal. App. LEXIS 45, just filed on January 22, 2018.  The Centex court determined that the insured did not “establish a triable issue of material fact” to show the St. Paul appointed panel defense counsel Mr. Lee could influence the outcome of the coverage dispute, so St. Paul did not have to pay for independent counsel.  Homeowners brought the underlying suit against Centex and others for damages from construction defects for which Centex may be strictly liable.  Centex tendered the suit for a defense, as an additional insured on its contractor’s policy issued by St. Paul.  There was active coverage litigation pending between St. Paul and Centex, but panel counsel Lee testified that St. Paul did not control what he did, and did not ask him to settle claims against the named insured (to leave Centex without coverage.) Further Lee did not represent St. Paul in the coverage lawsuit. Centex offered no contrary facts or other evidence tending to show any conflict.

The Centex opinion recites the applicable standards and accepted the evidence offered by St. Paul (Lee deposition testimony), and rejected the Centex argument that a potential conflict may arise without more detail as to what constitutes the actual conflict.  The Court was unimpressed with the Centex theoretical argument and its reliance on its legal briefing, and noted the absence of admissible evidence of any potential conflict.  The opinion contains an excellent overview of most of the law on these issues and demonstrates the pitfalls of relying on purely theoretical arguments to show potential conflicts.

In Illinois, another opinion confirmed the insured had no right to independent counsel in Bean Products, Inc. v. Scottsdale Ins. Co. filed January 22,2018, as case no 16 CH 7504. Again the policyholder lost a summary judgment motion by not submitting sufficient admissible evidence demonstrating the conflict and it was affirmed on appeal. A competitor brought a trademark and copyright infringement suit against the insured Bean, and Bean’s counsel Gauntlett & Associates (“G&A”) tendered it to Scottsdale for a defense. G&A was attempting to be Bean’s “independent counsel” but Scottsdale agreed to defend under a very limited reservation of rights (only denying coverage for punitive damages), appointed counsel, and contested any conflict. Scottsdale demanded cooperation and that G&A relinquish control of the defense.  G&A refused and instead argued for independent counsel rights, refused to provide documents requested (including with regard to settlement discussions with plaintiff and the insured’s evaluation of the merits of the suit.)

Despite the foregoing, Scottsdale’s appointed counsel managed to settle the case very economically for $30,000.  Bean then demanded Scottsdale pay G&A’s fees in the amount of just over half–$15,373.75.  Bean’s argument was that the appointed counsel was not as expert as G&A and that G&A did more to bring about the settlement. Under Illinois law, the allegations of the complaint determine the duty to defend, which includes the right to control the litigation.  The insured failed to show any actual conflict existed, however, that would somehow impair the defense Scottsdale was providing. Scottsdale declined coverage for punitive damages, but that did not create a conflict under Illinois law nor would it under California law.

The Bean opinion cited to cases where the facts presented an actual conflict: 1) the driver of the insured company was aligned with the plaintiff in the accident suit, whereas the insurer would seek to separate the driver from the insured company and 2) a builder was being sued for mold damage—the insured seeks to prove no liability but the insurer would be protected if the mold damage occurred before the policy inception regardless of the insured’s liability.

Bean was unable to submit any such conflict facts.  The court ultimately determined the insured voluntarily assumed the G&A bills, and had no right to secure reimbursement from Scottsdale.

Policyholders must pick their fights carefully.  Bad facts make for bad law and these most recent cases are great examples of coverage suits that should not have been litigated.