JurisdictionUnited States


Independent Counsel and the Law of Unintended Consequences

A. The Right to Independent Counsel

1. The Cumis Doctrine

In California, and most other states, if an insurer provides a defense to an insured under a reservation of rights based on a possible lack of coverage, the insurer must pay “the reasonable cost for hiring independent counsel [selected] by the insured.”1

As the court noted in San Diego Fed. Credit Union v. Cumis Ins. Society, Inc.:

It has long been the law in this state that when a conflict develops, the insurer cannot compel the insured to surrender control of the litigation, and must, if necessary, secure Independent Counsel for the insured, and, as was explained in Previews, Inc. v. California Union Ins. Co., 640 F. 2d 1026, 1028 (9th Cir. 1981), the insurer’s obligation [to defend, after the appearance of a conflict] “extends to paying the reasonable value of legal services and costs performed by Independent Counsel selected by the insured.” Cumis, 162 Cal. App. 3d at 364 N.3, 208 Cal. Rptr. 494 (quoting Purdy v. Pac. Auto. Ins. Co., 157 Cal. App. 3d 59, 76, (1984) (Citations omitted) [Brackets in original.]

Other cases of interest include:

Ÿ American Family Life Assurance Co. v. U.S. Fire Co., 885 F.2d 826, 831 (11th Cir. 1989) citing to 7C J. Appleman, Insurance Law and Practice § 4685.01, at 139;

Ÿ Cay Divers, Inc. v. Raven, 812 F. 2d 866, 870 n. 3 (3rd Cir. 1987);

Ÿ Rhodes v. Chicago Ins. Co., 719 F. 2d 116, 120 (5th Cir. 1983);

Ÿ U.S. Fid. & Guar. Co. v. Louis A. Roser Co., 585 F.2d 932, 939 (8th Cir. 1978);

Ÿ Employers Ins. Of Wausau v. Albert D. Seeno Constr. Co., 692 F. Supp. 1150, 1156 (N.D. Cal. 1988);

Ÿ Southern Maryland Agr. Ass’n v. Bituminous Cas. Corp., 539 F. Supp. 1295, 1300 (D. Md. 1982);

Ÿ Klein v. Salama, 545 F. Supp. 175, 179 (E.D.N.Y. 1982);

Ÿ Prahm v. Rupp Constr. Co., 277 N.W. 2d 389, 391 (Minn. 1979); and

Ÿ Public Serv. Mut. Ins. Co. v. Goldfarb, 425 N.E. 2d 810, 815 (N.Y. Ct. App. 1981).

The problems created by the Cumis decision have been handled differently in different states. Most have limited the application of the right to independent counsel by case law. Others have relied on the ability of the insurer to rewrite the policy wording. The majority of states have simply refused to adopt the California court’s Cumis doctrine.

In 1987, the California Legislature legislated what it hoped would be a cure to the abuse of the Cumis doctrine:

the insurer may exercise its right to require that the counsel selected by the insured possess certain minimum qualifications which may include that the selected counsel have (1) at least five years of civil litigation practice which includes substantial defense experience in the subject at issue in the litigation, and (2) errors and omissions coverage.2

The insurer’s obligation to pay fees to independent counsel is limited to the rates which are actually paid by the insurer to attorneys retained by it in the ordinary course of business in the defense of similar actions in the community where the claim arose or is being defended.3

The so-called “law of unintended consequences,” although never enacted by any legislature, is the proposition that every undertaking, however well-intentioned, is generally accompanied by unforeseen repercussions that can overshadow the principal endeavor.

As you read the seminal case that follows, consider that a lawyer owes a duty to fully and honestly represent the client and that when an insurer appoints an attorney to represent its insured, the client is the insured, not the insurer.

San Diego Navy Fed. Credit Union v. Cumis Ins. Soc’y Inc.
162 Cal. App. 3d 358, 208 Cal. Rptr. 494 (Cal. Ct. App. 1984)

Cumis Insurance Society, Inc. (Cumis) appeals a judgment requiring Cumis to pay the San Diego Navy Federal Credit Union (Credit Union), J. W. Jamieson and Larry R. Sharp (insureds) all reasonable past and future expenses of their independent counsel retained for the defense of a lawsuit filed against the insureds by Magdaline S. Eisenmann (Eisenmann action).4

The issue presented to this court by the appeal is whether an insurer is required to pay for independent counsel for an insured when the insurer provides its own counsel but reserves its right to assert noncoverage at a later date. We conclude under these circumstances there is a conflict of interest between the insurer and the insured, and therefore the insured has a right to independent counsel paid for by the insurer.

The Eisenmann action against the insureds seeks $750,000 general and $6.5 million punitive damages for tortious wrongful discharge, breach of the covenant of good faith and fair dealing, wrongful interference with and inducing breach of contract, breach of contract and intentional infliction of emotional distress. Under insurance policies issued by Cumis, the insureds tendered the defense of the Eisenmann action to Cumis.

Cumis associate counsel Willis E. McAllister reviewed the complaint in the Eisenmann action and concluded Cumis had a duty to provide a defense to the insureds. McAllister selected and retained, at Cumis’ expense, the San Diego law firm of Goebel & Monaghan to represent the interests of the insureds in the Eisenmann action. McAllister informed Goebel & Monaghan it was to represent the insureds as to all claims in the Eisenmann action, including the punitive damages claim. He also told Goebel & Monaghan Cumis was reserving its right to deny coverage at a later date and the insurance policies did not cover punitive damages.

McAllister sent Goebel & Monaghan copies of the insurance policies in effect and letters accepting the defense and reserving rights which were delivered to the insureds. McAllister never asked Goebel & Monaghan for an opinion whether coverage existed under the insurance policies, nor did Goebel & Monaghan give any coverage advice to either Cumis or the insureds.

McAllister believed if the Eisenmann action resulted in a finding of wilful conduct or an award of punitive damages, the Cumis policies did not provide coverage for those damages. Moreover, his view was if the Eisenmann action resulted in a finding of breach of contract as against any of the insureds, there might be no coverage under the relevant Cumis policies. Accordingly, on behalf of Cumis, McAllister notified each insured by letter Cumis was reserving its rights to disclaim coverage and denying any coverage for punitive damages.5

The Credit Union retained the San Diego law firm of Saxon, Alt & Brewer (independent counsel) to provide independent representation to protect the insureds’ interests. Independent counsel notified Cumis it was retained to act as co-counsel with Goebel & Monaghan and presented Cumis a claim for its attorneys’ fees and costs. McAllister was persuaded California law required Cumis to pay the fees, and he agreed to pay the fees and costs incurred by independent counsel as co-counsel for the insureds. Cumis paid two separate invoices for legal services of independent counsel but additional invoices were not paid. After independent counsel sent a demand letter to Cumis and further discussed the matter with McAllister, McAllister sought a separate opinion on the question from Cumis’ home office and asked Goebel & Monaghan if it felt there was a conflict of interest in representing the insureds such that Cumis would be required to pay the expenses of separate counsel. Goebel & Monaghan told McAllister it did not see a conflict of interest. Cumis’ home office came to the same conclusion and McAllister notified independent counsel Cumis would pay no further invoices.

In the Eisenmann action settlement conference, the case did not settle after a demand within the Cumis policy limits. Cumis authorized Goebel & Monaghan to make an offer at the settlement conference but in an amount lower than Eisenmann’s demand. Goebel & Monaghan did not contact the Credit Union before or during the settlement conference, but informed the Credit Union about the conference afterward.

In this action, the trial court ruled Cumis is required to pay for the insureds’ hiring of independent counsel, rejecting Cumis’ argument the court was bound by Gray v. Zurich Ins. Co., 419 P.2d 168 (1966), and reasoning: “1. Gray involved a question of the duty to defend in an assault and battery case rather than the extent and scope of that duty. The reasoning thus used to support Gray is not controlling, especially if it makes little sense. “2. The reasoning of Gray, ‘[since] . . . the court in the third party suit does not adjudicate the issue of coverage the insurer’s argument (as to a conflict of interest) collapses,’ just does not stand scrutiny. What the defense attorney in the third party case does impacts the coverage case, in that, the questions of coverage depends [sic] on the development of facts in the third party case and their proper development is left to the attorney paid for by the Carrier. Gray recognized that a finding in the third party action would effect the issues of coverage in a subsequent case but analyzed the question from the point of view of the carrier. Gray recognized a possible conflict from the point of view of the insured in, where it stated: ‘In rare cases the issue of punitive damages or a special verdict might present a conflict of interest, but such possibility does not outweigh the advantages of the general rule. Even in such cases, however, the insurer will still be bound ethically and legally, to litigate in the interests of the insured.’ Additionally, Gray was looking for a way to avoid a conflict of interest, to hold that it was excluding all other approaches just does not make common sense.” The court further explained its ruling: “The Carrier is required to hire independent counsel because an attorney in actual trial would be tempted to develop the facts to help his real client, the Carrier Company, as opposed to the Insured, for whom he will never likely work again. In such a case as this, the...

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