5.4.2 State Farm v. Lee (Implied Waiver)

• Jurisdiction: Arizona

In State Farm Mutual Automobile Insurance Co. v. Lee,^[329] the Arizona Supreme Court explored the contours of the "at issue" implied waiver doctrine as it related to the attorney-client privilege.^[330]

In Lee, a class representing approximately one thousand State Farm insureds brought suit against State Farm contesting the systematic denial of uninsured and underinsured motorist coverage stacking claims.^[331] Between 1988 and 1995, State Farm rejected stacking^[332] claims in single loss situations. It was State Farm's practice to issue separate insurance policies covering each vehicle in a multiple vehicle household.^[333] When losses occurred for which there were insufficient insurance funds to compensate the insured from the other tortfeasor's insurance policies, the State Farm class members presented underinsured motorist claims to State Farm for additional compensation.^[334] State Farm rejected these claims based on the wording of A.R.S. Sec. 20-259.01(H),^[335] which permitted insurance companies to use anti-stacking policy clauses to eliminate stacking.^[336] In 1995, however, the Arizona Supreme Court, in State Farm Mutual Automobile Insurance Co. v. Lindsey,^[337] determined that the anti-stacking language used by State Farm was legally insufficient to prevent stacking.^[338]

The class member insureds argued that even before the court's decision in Lindsey, State Farm knew the anti-stacking clause was invalid.^[339] Therefore, State Farm acted in bad faith when, from 1988 to 1997, State Farm denied its insureds' requests to stack coverage.^[340] State Farm maintained that until Lindsey was decided, it had acted reasonably in interpreting A.R.S. Sec. 20-259.01(H) in conjunction with its policy language in order to preclude stacking.^[341]

During discovery, State Farm acknowledged having received the advice of counsel regarding whether to pay or reject class member claims.^[342] State Farm asserted the attorney-client privilege regarding the production of counsel's coverage analysis, but declared that it would not advance a good faith defense based on the advice of counsel.^[343] The trial court accepted State Farm's position that it would not advance an advice-of-counsel defense directly.^[344] Thus, State Farm would not be able to rely upon the objective reasonableness of its decision to deny stacking.^[345] State Farm did assert the subjective good faith of its claims managers in deciding to deny stacking, and argued that their beliefs were reasonable in light of their understanding of the law at that time.^[346] Because State Farm avowed to the trial court "that it would defend in part on what its decisionmakers knew, thought and did," the trial court determined that State Farm's knowledge "included advice of counsel because that was a part of the basis for the defense."^[347] The trial court held, therefore, "that State Farm impliedly waived the privilege when it put at issue the subjective legal knowledge of its managers after they sought and received legal advice."^[348]

The Arizona Court of Appeals accepted jurisdiction and vacated the trial court's discovery order.^[349] The court of appeals held that State Farm had not impliedly waived the privilege or put its attorney-client communications at issue because it had only refuted plaintiff's allegations, and had not injected privilege-related issues into the case.^[350] As a threshold matter, the court adopted^[351] the three-prong test for "at issue" implied waivers set forth in Hearn v. Rhay.^[352]

The Arizona Supreme Court rejected the view that implied waiver will be found only when the party advances an express claim of reliance on advice of counsel.^[353] The court noted that if the client's intent not to abandon the privilege could alone control the situation, then waiver would seldom be found.^[354] Thus, the determination of whether implied waiver has occurred also includes an objective consideration: when one's conduct reaches a "certain point of disclosure," fairness demands that the privilege be waived regardless of the privileged person's intentions.^[355] Turning to this inquiry, the court recognized that there was "a great deal of confusion" in this area, and then quoted the Restatement (Third) of the Law Governing Lawyers in describing various approaches used in other jurisdictions:

At least three approaches to the waiver [issue exist]: The first approach radically holds that, whenever a party seeks judicial relief, the party impliedly waives the privilege. A second approach would attempt to balance the need for disclosure against the need for protecting the confidentiality of the client's communications on the facts of the individual case. The third approach avoids the extremes of an over-inclusive automatic-waiver rule or an indeterminate, ad hoc balancing approach. Instead, it focuses on whether the client asserting the privilege has interjected the issue into the litigation and whether the claim of privilege, if upheld, would deny the inquiring party access to proof needed fairly to resist the client's own evidence on that very issue.^[356]

Privilege is waived under the first two views "whenever a client's mental state was in issue."^[357] The court observed that this approach was "dubious absent acceptance of the Benthamite principle that the privilege ought to be overthrown to facilitate the search for truth."^[358] The court in Lee adopted the third, intermediate approach as being least restrictive of the three approaches outlined above.^[359] By adopting this approach, the court "reject[ed] the idea that the mere filing of a bad faith action, the denial of bad faith, or the affirmative claim of good faith may be found to constitute an implied waiver of the privilege."^[360] Waiver will occur, however, if the privileged party has asserted a claim or defense?for example, that its evaluation of the law was reasonable?which would include, necessarily, the information received from its counsel.^[361] At that point the privileged party has injected "the issue of advice of counsel into the litigation to the extent that recognition of the privilege would deny the opposing party access to proof without which it would be impossible for the factfinder to fairly determine the very issue raised by that party."^[362]

The court in Lee concluded that the "certain point" at which fairness requires waiver is reached when "the party asserting the privilege claims its conduct was proper and permitted by law and based in whole or in part on its evaluation of the state of the law."^[363] When this occurs, the privileged party's knowledge about the law becomes central, and the advice of its counsel, highly relevant to the legal implications of the privileged party's conduct.^[364] In this situation, "the truth cannot be found absent exploration of [the] issue."^[365] A contrary finding would result in "unfairness not just to the party opposing assertion of the privilege but to the entire [judicial] system."^[366]

Preemptively, the majority focused on Justice Martone's dissenting opinion. The court agreed with the dissent that it was the plaintiffs who had raised the issue of subjective bad faith among State Farm's employees, but noted that the waiver of the privilege was not based on State Farm's denial of that allegation.^[367] Further, State Farm's affirmative assertion of good faith did not waive the privilege.^[368] The court then identified the basis for its decision:

It is, rather, State Farm's affirmative assertion that its actions were reasonable because of its evaluation of the law, based on its interpretation of the policies, statutes, and case law, and because of what its personnel actually knew and did.

But what its personnel did, presumably among other things, was to consult counsel and obtain counsel's views of the meaning of the policies, statutes, and case law. Having asserted that its actions were reasonable because of what it knew about the applicable law, State Farm has put in issue the information it obtained from counsel.^[369]

Although State Farm did not specifically state that legal "advice was relevant to the legal significance of its conduct,"^[370] an assertion that the insurance company relied upon advice of counsel would be "the functional equivalent of an express advice-of-counsel defense."^[371] The court noted that "[m]ost sophisticated litigants [would] know better than to dig that hole for themselves."^[372] The concept of implied waiver does not "require such a magical admission," nor does it require the court to "accept as dispositive the client's assertion that it did not rely on the advice it received."^[373] The majority found that a contrary holding would make "a mockery of the law."^[374] On the one hand, an insurance...