Corporate policyholders/insureds who have been sued share a common interest with their liability insurers—successfully defending those lawsuits. Yet insureds and insurers often disagree on the choice of defense counsel and how much the insurer must pay toward legal bills. These disputes are costly and, in most instances, can be avoided.
Many primary commercial liability policies purchased by corporate policyholders not only impose a “duty to defend,” but also afford insurers the “right to defend.” This express “right” allows the insurer, rather than the insured, to select defense counsel. Upon seeking a defense under that policy, the insured has relinquished its right to select defense counsel.
There are two schools of thought regarding whether the assigned defense counsel owes duties only to one client (insured) or to two clients (insured and insurer). Many courts have adopted the two-client or “tripartite relationship” theory, under which insurer-selected counsel (commonly “insurance defense counsel”) has an attorney-client relationship with both insured and insurer. Where the insurer has agreed to provide a defense to the insured under a reservation of rights, and that reservation raises a conflict of interest such that defense counsel in theory could face divided loyalties, courts have held that the insured is entitled to a defense through counsel of its choice (“independent counsel”). Most courts hold that not every reservation of rights creates a conflict of interest. Rather, a conflict of interest has been found where coverage turns on facts or issues to be determined in the underlying action such that the insurer-assigned defense attorney would face a conflict in deciding how to conduct the defense given the duty of loyalty owed to both clients.
Other courts follow the one-client theory, under which insurance defense counsel represents only the policyholder, not the insurer. Therefore, the attorney owes no duties to the insurer. Accordingly, in the states following the one-client rule, a reservation of rights cannot give rise to the insured’s right to select its own counsel.
Policyholders often take the position they can select their own counsel, who normally charge higher hourly rates than insurance defense counsel. The typical arguments include: (1) the two-client/tripartite relationship model applies, and the insurer’s reservation of rights creates a conflict allowing the insured to select counsel; (2) the insurer’s litigation management guidelines constrain insurance defense counsel from exercising independent professional judgment in the insured’s best interests; and (3) the litigation is particularly important to the insured. Even when the insurer might acquiesce in the insured’s choice of counsel, disputes arise as to the difference between the insured-selected firm’s proposed rates and the rates the insurer typically pays for that type of case. Some states have addressed this issue by statute (e.g., California Civil Code Section 2860, limiting hourly rates to those the insurer ordinarily pays) or by case law. Often, the dispute is left to negotiation and either a compromise (typically by which fees are shared between insurer and insured) or an agreement to disagree, coupled with litigation or arbitration.
There are several solutions to this recurring problem that can eliminate or substantially minimize disputes. First, the issue can be addressed at the policy negotiation stage. An insured may insist on controlling the right to select counsel, which often is achieved through a policy endorsement allowing the insured to select counsel or even identifying specific lawyers who will defend lawsuits. An insurer may protect against a dispute over its future defense cost exposure by including policy language specifying the maximum rates it will pay to defend lawsuits or that it will pay no more than the hourly rates it ordinarily pays in the jurisdiction where a case pends.
Second, insureds should better appreciate that leading property and casualty insurers afford their insureds a full, high quality, and professionally independent defense (regardless of whether of a reservation of rights is asserted). This is expected of all counsel engaged by insurers. Significantly, the Defense Research Institute (DRI) Recommended Guidelines for Insurers and Law Firms, which are followed in whole or in substantial part by many insurers, provide: “Nothing contained herein is intended to nor shall restrict Counsel’s independent exercise of professional judgment in rendering legal services for the Insured or otherwise interfere with any ethical directive governing the conduct of counsel.” Elsewhere the guidelines provide that “in the event of disagreement [over litigation strategy], the final decision will remain the independent professional judgment of defense counsel.” Whether expressed in an insurer’s guidelines, an engagement letter, or as a matter of practice and expectation, all carriers expect assigned counsel to uphold the ethical obligations they owe their client, the insured. Further, an insurer may consider emphasizing this reality by agreeing it has no attorney-client relationship with assigned counsel. See Michael M. Marick and Karen M. Dixon, “The Insurer’s Contract ‘Right’ To Defend–The ‘Tripartite’ Relationship Reconsidered,” 39 Tort Trial & Ins. Prac. L. J. 1119 (2004) (absence of an agreement in fact to an attorney-client relationship obviates the two-client model, and thus an insured’s ability to select counsel in reservation of rights situations).
Third, insureds and insurers should have an open-minded and transparent discussion on counsel selection immediately after a lawsuit has been filed. Insurers may consider offering the insured several qualified firms from which to choose. A “beauty contest” among potential law firms is often highly instructive. Insurance defense firms often are selected by insureds, even in high exposure cases, both because of their capabilities and they will be paid fully by the insurer.
Fourth, at the same time counsel is selected, insured and insurer should agree upon litigation management guidelines (including anticipated staffing and budgeting). It is in the interest of all parties—insured, insurer, and attorneys—to reach a meeting of the minds at the outset of a lawsuit, which facilitates a cooperative and focused defense. Insureds approaching the discussion by taking the position that guidelines are not “binding” on their counsel miss the point. Both by their language and implementation, leading insurers do not apply guidelines to constrain a lawyer’s ability to fully defend the insured. Ongoing three-way communication throughout the life of a litigated matter will solve most billing and case management issues.
In sum, insureds and insurers can and should find common ground on how to properly defend high exposure lawsuits. There is no legitimate reason for insureds to be skeptical of an insurer’s counsel selection and litigation management protocols. An honest and open-minded dialogue from the beginning of a lawsuit, and throughout the litigation, should resolve most issues.