CHAPTER 11 INDEPENDENT COUNSEL AND THE LAW OF UNINTENDED CONSEQUENCES

• Jurisdiction: United States

A. The Right to Independent Counsel

1. The Cumis Doctrine

In California, and many other states, if an insurer provides a defense to an insured under a reservation of rights based on a possible lack of coverage where there is a conflict of interest between the insurer and the insured, the insurer must pay "the reasonable cost for hiring independent counsel [selected] by the insured."¹

As the court itself 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., 9th Cir. (1981) 640 F. 2d 1026, 1028, 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. Pacific Auto. Ins. Co., 157 Cal. App. 3d 59, 76, 203, Cal. Rptr. 524 (1984)) (Citations omitted). [Brackets in original.]

Other cases of interest include:

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

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

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

• United States Fid. & Guar. Co. v. Louis A. Roser Co., 585 F.2d 932, 939 (8th Cir. 1978)

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

• Southern Maryland Agric. Ass'n v. Bituminous Cas. Corp., 539 F. Supp. 1295, 1300 (D. Md. 1982)

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

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

• Public Serv. Mut. Ins. Co. v. Goldfarb, 53 N.Y.2d 392, 425 N.E.2d 810, 815, 442 N.Y.S.2d 422 (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. Many states have simply refused to adopt the California court's Cumis doctrine.

In 1987, California legislated a cure:

the insurer may exercise its right to require that the counsel selected by the insured losses 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 the independent counsel selected by the insured 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.

In San Diego Navy Fed. Credit Union v. Cumis Ins. Society Inc., 162 Cal. App. 3d 358, 208 Cal. Rptr. 494 (Cal. Ct. App. 1984), the Cumis Insurance Society, Inc. (Cumis) unsuccessfully appealed a judgment requiring Cumis to pay the San Diego Navy Federal Credit Union, J.W. Jamieson and Larry R. Sharp 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.⁴

The court of appeal concluded that under the circumstances of the Eisenmann lawsuit, there existed 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.

In the usual tripartite relationship existing between insurer, insured and counsel, there is a single common interest shared among them. Dual representation by counsel is beneficial since the shared goal of minimizing or eliminating liability to a third party is the same.

The court concluded that a different situation is presented, however, when some or all of the allegations in the complaint do not fall within the scope of coverage under the policy. In such a case, the standard practice of an insurer is to defend under a reservation of rights where the insurer promises to defend but states that it may not indemnify the insured if liability is found. In this situation, there may be little commonality of interest.⁵

Opposing poles of interest are represented on the one hand in the insurer's desire to establish in the third party suit that the insured's liability rested on intentional conduct, and thus no coverage under the policy, and on the other hand in the insured's desire to obtain a ruling that such liability emanated from the nonintentional conduct within his insurance coverage. Although issues of coverage under the policy are not actually litigated in the third-party suit, this does not detract from the force of these opposing interests as they operate on the attorney selected by the insurer, who has a dual agency status. ⁶

Here, it is uncontested that the basis for liability, if any, might rest on conduct excluded by the terms of the insurance policy. Insurer-retained defense counsel, for example, will have to seek or oppose special verdicts, the answers to which may benefit the insureds by finding non-excluded conduct and harm either Cumis position on coverage or the insureds by finding excluded conduct. These decisions are numerous and varied. Each time one of them must be made, the lawyer is placed in the dilemma of helping one of his clients concerning insurance coverage and harming the other.

The court of appeal wrote:

No matter how honest the intentions, counsel cannot discharge inconsistent duties.

The potential problems may develop during pretrial discovery, which must go beyond simple preparation for a favorable verdict to develop alternate strategies minimizing exposure. The American Bar Association Code of Professional Responsibility (ABA Code), Ethical Consideration EC5-1 reads: "The professional judgment of a lawyer should be exercised, within the bounds of the new law, solely for the benefit of his client and free of compromising influences and loyalties. Neither his personal interests, the interests of other clients, nor the desires of third persons should be permitted to dilute his loyalty to his client."

ABA Code, Ethical Consideration EC5-15 states, in pertinent part:

If a lawyer is requested to undertake or to continue representation of multiple clients having potentially differing interests, he must weigh carefully the possibility that his judgment may be impaired or his loyalty divided if he accepts or continues the employment. He should resolve all doubts against the propriety of the representation. A lawyer should never represent in litigation multiple clients with differing interests, and there are few situations in which he would be justified in representing in litigation multiple clients with potentially differing interests. If a lawyer accepted such employment and the interests did become actually differing, he would have to withdraw from employment with likelihood of resulting hardship on the clients; and for this reason, it is preferable that he refuse the employment initially.

Customarily, insurers, in cases involving tort claims in excess of policy limits, notify the insured that he may employ his own attorney to participate in the defense. The court concluded that a like duty must arise in a case where potential conflict stemmed not only from the multiple theories of the complaint and the propriety of settlement, but from the total absence in defendant of any economic interest in the outcome of the suit.

In Executive Aviation, Inc. v. National Ins. Underwriters, 16 Cal. App. 3d 799, 94 Cal. Rptr. 347 (Cal. Ct. App. 1971), the same insurer-selected attorney represented the insurer in a property coverage action by the insured against the insurer and represented the insured and insurer in a third-party suit against the insured:

Both actions arose from the same accident, a plane crash during a flight where there was a question whether the plane was being used in "common carriage." If the plane was ultimately found to have been used in common carriage, there would be no coverage under the terms of the policy. The attorney defending the property damage action against the insurer on this basis would be operating directly against the insured's interest in obtaining coverage for the third-party suit.

The Executive Aviation case concluded that if the insured and the insurer are represented by two different attorneys, each of whom is pledged to promote and protect the prime interests of his client, adequate representation is guaranteed and the deleterious effect of the conflict of interest imposed on an attorney who attempts the difficult task of representing both parties is averted. In a conflict of interest situation, the insurer's desire to exclusively control the defense must yield to its obligation to defend its policy holder.

The conflict in Executive Aviation is no more "real and existing" than the conflict in Cumis. In both instances, the interests of the insured and the insurer diverge and conflict, differing only in degree of immediacy. The result of the existing conflict is the same in each instance.

In Previews, Inc. v. California Union Ins. Co., 640 F.2d 1026 (9th Cir. 1981), independent counsel were appointed due in part to a claim for punitive damages. The court of appeals concluded that the district court properly decided that Previews was...