Chapter 12 Ethical Issues for Insurance Defense Counsel

• Library: The Handbook on Additional Insureds (ABA) (2018 Ed.)

CHAPTER 12 Ethical Issues for Insurance Defense Counsel

Samantha Johnson

I. Introduction

When an insurer undertakes the defense of an insured pursuant to a policy, the insurer generally provides the insured with representation by outside counsel. The relationship between the insurer, the insured, and the attorney hired by the insurer to represent or defend the insured is often called a tripartite relationship.¹ This relationship is unique to the insurance context.²

One court stated that the ethical dilemma created by the relationship among insurer, insured, and defense counsel "would tax Socrates, and no decision or authority . . . furnishes a completely satisfactory answer."³ The tripartite relationship has a tendency to lead to conflict of interest issues. In this chapter, we will discuss the ethical issues arising from the relationship between the insurer, the insured (or additional insured), and defense counsel.

II. The Role of the Insured's Counsel—Who Is the Client?

Courts take several different views of whether defense counsel represents the insurer, the insured, or both. These views are called the two-client, one-client, and third-party payor (or one-and-a-half client) theories.

A. Two-Client Theory

A majority of courts hold that the lawyer has two clients: the insurer and the insured.⁴ Courts that adopt this theory reason that both the insured and the insurer are beneficiaries of the insurance company's exclusive control over the litigation.⁵ These courts also recognize that, in general, "companies and insureds usually enjoy a substantial commonality of interests, even when their interests do not perfectly align."⁶

B. One-Client Theory

Although still the minority view, there is an increasing judicial trend toward holding that defense counsel's only client is the insured.⁷ For example, in Atlanta International Insurance Co. v. Bell,⁸ the Michigan Supreme Court held that no attorney-client relationship existed between an insurance company and defense counsel. Atlanta filed a malpractice suit against the attorneys that it retained to represent Atlanta's insured in a premises liability case, claiming that the attorneys failed to raise a particular defense.⁹ Whether Atlanta had the standing to sue the attorneys depended upon the existence of an attorney-client relationship between the insurer and the attorneys it hired to represent the insured.¹⁰ Stating that "courts have consistently held that the defense attorney's primary duty of loyalty lies with the insured, and not the insurer," the court nevertheless allowed the insurer to proceed pursuant to the doctrine of equitable subrogation.¹¹ The court noted that

To hold that an attorney-client relationship exists between insurer and defense counsel would indeed work mischief, yet to hold that a mere commercial relationship exists would work obfuscation and injustice. The gap is best bridged by resort to the doctrine of equitable subrogation to allow recovery by the insurer. Equitable subrogation best vindicates the attorney-client relationship and the interests of the insured, properly imposing the social costs of malpractice where they belong. Allowing the insurer to stand in the shoes of the insured under the doctrine of equitable subrogation best serves the public policy underlying the attorney-client relationship.¹²

C. Third-Party Payor Theory

The third-party payor or one-and-a-half-client theory "advocates that 'the lawyer be deemed to represent both the insurer and the insured until something goes wrong, at which point the insurer would no longer be a client, at least in the usual sense.'"¹³ The theory considers that the insurer is often in the best position to manage and control the litigation, and that the insurer relies on the attorney to protect its economic interests. If the defense attorney can do so without compromising the loyalty the attorney owes to the insured, then the attorney also owes a duty of care to the insurer. Since the insurer relies upon the attorney's representation of the insured, the insurer is permitted to proceed directly against the attorney who acts negligently.¹⁴ It is important to note, however, that although this theory allows insurers to control the costs of litigation, the control is limited, and insurers are not necessarily able to enjoy the full range of benefits or rights of control that they may desire.¹⁵

III. The Insured's Defense Counsel—Ethical Issues in the "Tripartite Relationship"

Ethical issues may arise in a number of different scenarios for an attorney hired by an insurer to represent the insured. In most cases, an insurer and its insured have a common interest in preventing liability from attaching to the insured. The relationship between the insurer, the insured, and counsel is "a coalition for a common purpose, a favorable disposition of the claim—with the attorney owing duties to both clients."¹⁶ However, "[a]s a practical matter. . . there has been recognition that, in reality, the insurer's attorneys may have closer ties with the insurer and a more compelling interest in protecting the insurer's position, whether or not it coincides with what is best for the insured."¹⁷ One commentator has observed that

A typical example of the judicial mindset is the following: Even the most optimistic view of human nature requires us to realize that an attorney employed by an insurance company will slant his efforts, perhaps unconsciously, in the interest of his real client—the one who is paying his fee and from whom he hopes to receive future business—the insurance company.¹⁸

The close relationship between defense counsel and the insurance company is often a concern of both insureds and the courts.¹⁹ Some common scenarios in which conflicts of interest may potentially arise are discussed in the following section.

A. Multiple Insureds under Same Policy

When a policy provides coverage for more than one insured (for example, a named insured and an additional insured), the insureds may have divergent interests. There may be rights of contribution, indemnity, subrogation or set-off that impact the relationship between the insureds. In matters involving additional insureds, the best defense strategy for the named insured may be to point the finger at the additional insured and vice versa, which creates a clear conflict. Where multiple insureds are entitled to a defense under the same policy for the same claim, the insurer may assign a single defense counsel to defend the insureds. However, conflicts often arise in these situations. For example, a passenger in a car may sue both the driver and the owner of the car after a wreck. An owner and a driver are typically entitled to a defense under the same policy. However, the driver and the owner are likely to have conflicting interests (if, for example, the owner asserts that the driver was operating the car without permission).²⁰

The doctrine of separation of insureds also enters into play where there is more than one potential insured under a policy. Most commercial general liability policies provide the following:

SECTION IV—COMMERCIAL GENERAL LIABILITY CONDITIONS
7. Separation of Insureds
Except with respect to the Limits of Insurance, and any rights or duties specifically assigned in this Coverage Part to the first Named Insured, this insurance applies:
a. As if each Named Insured were the only Named Insured; and
b. Separately to each insured against whom claim is made or "suit" is brought.²¹

The purpose of the separation of insureds provisions is to provide each insured with separate coverage, as if each were separately insured under a distinct policy.²²

If a defense attorney is hired to represent multiple insureds under the same policy, the attorney should, at the inception of the representation:

1. Analyze the potential conflicts among the insureds;
2. Disclose these potential conflicts in writing to each insured and the insurer;
3. Obtain valid conflict waivers from all parties.²³

Even after these initial disclosures, defense counsel should continue to monitor potential conflicts as they may ultimately require the defense attorney to withdraw from the representation.²⁴

B. Insurer Defends under a Reservation of Rights

A minority of jurisdictions holds that, where an insurer reserves its right to deny coverage for a particular claim, a conflict of interest arises between the insurer and the insured.²⁵ Courts that adopt this per se rule do so for a number of reasons: (1) the defense attorney may offer only a token defense of a potentially non-covered claim or conduct the defense in such a manner as to make the likelihood of the plaintiff's verdict greater on the non-covered claim; (2) the defense attorney might gain access to confidential information that the lawyer might provide to the insurer to enable the insurer to deny coverage; or (3) the defense attorney might tend to favor the insurer over the insured due to a desire to receive future legal work from the insurer.²⁶

However, a majority of courts hold that when an insurer provides a defense under a reservation of rights as to coverage, there is not a per se conflict.²⁷ These courts hold that whether a conflict of interest exists must be determined on a case-by-case basis and also often place the burden on defense counsel to determine the existence of conflicts of interest and deal with them appropriately. In Federal Insurance Co. v. X-Rite, Inc.,²⁸ the District Court for the Western District of Michigan explained:

Public policy requires the insurer to act with the utmost good faith. As long as this standard is observed, the Court may not interfere with the terms of the parties' agreement. To hold that the insurer who, under a reservation of rights, participates in selection of counsel, automatically breaches its duty of good faith is to indulge the conclusive presumption that counsel is unable to fully represent its client, the insured, without consciously or unconsciously compromising the insured's

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