Defense by salaried counsel: a bane or a blessing?

• Author: Mallen, Ronald E.

WITHIN recent years, there has been a noticeable increase by insurance companies in the use of salaried counsel to defend their insureds.(1) The insurers' objective is to save money over the cost of outside counsel and to achieve more efficient claims handling. The initial saving is the elimination of the profit margin of outside counsel. Insurers also believe that the quality of representation can be enhanced. By training staff counsel in the particular liability lines written by the insurer, significant expertise and efficiency can be developed, as augmented by the repeated handling of such cases.

But there is another perspective. Not everyone perceives the development of staff counsel operations to be beneficial. Most critics are other lawyers--usually defense lawyers. Some people believe that salaried counsel are neither as competent nor as loyal to clients as outside counsel, and they assert that the cost savings of using salaried counsel are achieved by providing less able and less loyal representation.

Some of these remarks proceed from a distrust that insurers' motivations place their own economic interests above that of their insureds. That distrust taints salaried attorneys. Some critics are sincere; others may be reacting to an actual or threatened loss of business in a recessionary legal economy, Tension already exists for defense lawyers concerning insurers' billing and case handling policies.(2)

The legality and ethical propriety of salaried counsel operations have been challenged.(3) The attacks have been on two grounds. First is the claim that the use of salaried counsel to defend insureds engages the insurance corporation in the unauthorized practice of law. Second is the contention that the insurance company's use of employee-lawyers creates an environment of actual or potential conflicting interests. Political action has been one consequence. In Tennessee, for example, the state supreme court's Board of Professional Responsibility adopted a formal opinion prohibiting the use of staff counsel, but the court stayed the effectiveness of that position pending hearings. As of September 1994, no decision had been issued.(4)

Ironically, the recessionary forces and increased development of staff counsel operations have accelerated their use. More lawyers are looking toward staff counsel operations as a career. The salaries offered have become more competitive because many insurers recognize the importance of hiring better qualified lawyers. One consequence is a heightened professionalism on the part of salaried counsel, who insist that their employers assure working environments that comport to high ethical standards.

These developments, coupled with the increased ethical responsibilities imposed on defense counsel generally, require that insurers structure their staff counsel operations comparable to law firms. In fact, the larger staff counsel operations resemble the large, interstate law firms both in management and in dealing with ethical and professional problems that need to be anticipated and solved.

This article examines these issues. One goal is to evaluate the validity of the various perceptions. Another is to discuss both the differences and commonality between outside counsel and staff counsel. The issues peculiar to staff counsel operations are discussed and suggestions are offered. Underlying this examination is the author's belief that staff counsel operations are not a mere economic fad, but a permanent reality. Insurers, as other corporations, have found the establishment of inhouse law firms to be prudent for certain legal needs.

LEGALITY OF STAFF COUNSEL OPERATIONS

1. Unauthorized Practice of Law

   The most common challenge to house counsel operations is the claim that the use of salaried lawyers to defend insureds by insurance corporations is the unauthorized practice of law. The courts usually have rejected this contention.(5) The rationale is that the insurer is financially at risk to pay damages under its policy. Because the insurer acts to protect its own financial interest, the use of salaried counsel is proper. Published opinions of the American Bar Association and state bar ethics committees are in accord.(6) Some states have statutory exceptions that expressly allow insurance companies to defend their insureds.(7)

   Not all courts agree, however. In Gardner v. North Carolina State Bar,(8) the North Carolina Supreme Court upheld the bar association's 1983 ethics opinion that precluded house counsel from defending a company's insureds. The court held that the use of house counsel by an insurer to defend insureds was the unauthorized practice of law under North Carolina statutes. The premise of the court's opinion was a statute that forbid a corporation to practice law for "any person."

   Although acknowledging that an insurance company has a financial interest in its insured's liability for covered damages, the court said that did not enable the insurer to appear for other persons. The court distinguished decisions from other jurisdictions on supposed differences in the statutory verbiage--a distinction, however, not supported by the language of the statutes or reasoning of the courts. A strong and special North Carolina policy was espoused favoring personal representation. Thus, salaried counsel could appear only for and in the name of the insurer, and not for its insureds.

   Other jurisdictions have declined to use that reasoning or have distinguished or disagreed with Gardner. A 1987 Missouri Supreme Court decision(9) expressly disagreed with Gardner, the court noting that its statutes regarding the practice of law by corporations were enacted more than 70 years before its decision. Observing that the insurance industry existed then, the court concluded that the statutes were not intended to change industry practice.

   More recently, the issue was examined in a widely publicized Connecticut trial court opinion, in King v. Guiliani, regarding a suit by a United States Fidelity & Guaranty staff counsel who had been fired.(10) He sought to regain representation of the defense cases, contending that his former employer was engaged in the unauthorized practice of law. The court held that the plaintiff's challenge to the alleged misconduct, a practice in which he engaged, precluded his claim, but it also rejected the contention on the merits. Disagreeing with and distinguishing Gardner, it held that there was no inherent conflict for staff counsel. The court found no improper influences by the insurer on the ethical conduct of its salaried lawyers, and it added that the ability of counsel to follow ethical dictates was supported by a remedy for damages if counsel was improperly fired.

2. Use of Salaried Counsel Other Than to Defend Insureds

   Insurers have considered a variety of uses for salaried counsel other than to defend insureds. An insurer may believe that a quality staff counsel operation is marketable to other insurers. Then the insurer's motivation is not the defense of its own insureds but the ability to make a profit. If so, unlike the defense of its insureds, an insurer has no economic interest to protect by using its employed attorneys, and the issue is whether salaried counsel can be contracted to perform services for other insurers. An example would be use by an insurer that does not have a staff counsel operation. Other programs considered concern risk retention or self-insured management services.

   There are two primary legal-ethical concerns. The first is whether these activities involve the unauthorized practice of the law, and the second is whether the staff counsel attorneys are exposed to charges of ethical misconduct, such as sharing a fee with a lay person, that being the insurance company.

   Analysis starts from the premise that insurers can use salaried counsel to defend its insureds because its own monies are at risk. This financial interest allows an exception to the rule that a corporation may not practice law, directly or indirectly.(11) The decisions concerning a corporation's use of employed counsel for others have drawn a bright line. The principle is that a corporation may not perform legal services for others for a fee or profit. The insurer can be enjoined because of the prohibition against corporations practicing law.(12)

   The illustrative reported decisions are older. A 1930 Minnesota Supreme Court

   case concerned a bank's agreement that salaried counsel could continue to practice law for others, but that all fees would be rendered to the bank.(13) The court held that although the bank could employ an attorney to conduct its own business, receiving monies for representing others was the unlawful practice of law.

   A 1922 California decision involved a corporation formed for the purpose of bringing together law firms and clients for the rendition of legal services.(14) The attorneys received a portion of the membership fee, the remainder going to the corporation. The corporation had no financial interest that required representation. The court held that the corporation was engaged in the unauthorized practice of law.

   For insurers, the principle to be derived is that the use of salaried counsel must be limited to those services that protect a financial interest of the insurance corporation. The marketing of a staff counsel operation for profit and a situation involving receipt of fees paid by another could be the unauthorized practice of law.

   The adverse consequences are not limited to the insurance corporation. Rule 5.5(b) of the American Bar Association Model Rules of Professional Conduct and the predecessor Disciplinary Rule 3-1O1(A) of the ABA Model Code of Professional Responsibility, as well as comparable provisions in most states, prohibit a lawyer from assisting any person or entity in an activity that is the unauthorized practice of law. The concern for salaried counsel is that if a corporation is engaged in unauthorized practice, then...