LIABILITY insurance policies normally reserve to the insurer the right to defend potentially covered litigation and obligate the insured to cooperate in the defense. These provisions generally are construed to give the insurer the right to control the defense of the insured. But the law sometimes denies the insurer that right and allows the insured to direct the defense, using independent counsel. When the insurer is denied the right to control the defense, what rights concerning the defense are retained by the insurer even when the insured has independent counsel?
RIGHT TO CONTROL RESERVED BY POLICY
Individuals and businesses purchase insurance to shift financial risk to the insurer. To an insured, the cost of lawyers necessary to defend covered claims is part of that shifted risk. To the insurer, defense lawyers are critical to controlling insurance costs by defeating or limiting their insureds' liability in covered claims. Even so, the cost of defense counsel is a cost ultimately passed on to the insurance-buying public as part of insurance premiums. Thus, it would be wasteful to spend more on defense activities than those activities are expected to yield in reduced indemnity costs--judgments or settlements. Both costs ultimately are borne by the insurance-buying public in premiums.
Insurers have more expertise than most insureds in managing litigation. They have stronger, more immediate incentives to manage litigation efficiently than would insureds who expect their insurers to pay defense counsel's bills. Thus, most liability insurance markets have settled on contract terms that provide for the insurer to manage the defense and give it the "right and duty to defend."
This standard liability policy provision "gives the insurer the fight to control the defense of the claim" and "the insured has no right to interfere with the insurer's control of the defense." (1) Where the insured has no personal exposure, that control "is virtually absolute." (2)
Except in the rare case where insurer and insured have a conflict of interest precluding joint representation, the law in most jurisdictions recognizes both as clients of the defense counsel, as shown in the appendix to this article. So, both as a client and pursuant to the insurance contract, the insurer has the right to make expenditure and strategic decisions.
This works well for insureds. Typically they have no interest in how a claim is defended, so long as the insurer pays any resulting judgment or settlement. In the small percentage of cases in which the insurer and insured have inherently inconsistent interests in managing the defense, the insured is entitled to independent counsel. (3)
The vast bulk of cases defended by insurers are fully covered. In a sample of litigated cases, researchers found that insurance was involved in 80 percent, with lawyers on both sides agreeing that the claim was completely covered in 59 percent, so that just under 75 percent of the cases where insurance was involved were fully covered. (4) Of the remainder, some may have involved either independent counsel or indemnity policies under which the insured controls the defense as a matter of contract, precluding any tripartite relationship and problems that might arise from that relationship. Lawyers are more likely to mention doubts about adequacy of coverage when the doubts are objectively insubstantial than they are to omit mention of doubts that are objectively substantial. So the 75 percent figure is probably a significant understatement of the fraction of tripartite relationship claims where coverage is, objectively speaking, both clear and clearly adequate. Even when there is a genuine risk of exposure beyond the policy's coverage, cases are normally resolved without any payment by the insured.
And even where there is some risk of personal financial exposure to an insured, the insured typically relies willingly on the insurer to manage the defense. This is not surprising. The insured has significant protections in situations where the claim is not fully covered. These include (1) the insurer's obligation to pay covered settlements or judgments, (2) its duty to accept reasonable settlement demands within policy limits, and (3) its responsibility for any increased liability of the insured resulting from an inadequate defense. (5)
WHEN DOES INSURER LOSE CONTROL?
Reject the Defense States
A few states authorize the insured to reject the insurer's defense whenever there is a reservation of the right to deny indemnification. (6) In these jurisdictions, the insured is never obliged to accept a defense under reservation of the insurer's right to deny indemnification for any judgment rendered. Under this view, the insured's rejection of a defense under reservation may require the insurer either to affirm coverage unconditionally and defend or to disclaim coverage and refuse to defend, at the risk of breaching the policy if there actually was a duty to defend. Some jurisdictions permit the insurer to avoid the latter risk by agreeing to pay for a defense conducted by counsel selected and controlled by the insured. But none permits the insurer, over the insured's objection, to control the defense when there is any question of coverage for the liabilities asserted in the action to be defended. The insurer's role is limited to payment of counsel who represents and is directed by the insured alone.
The doctrine just described is sometimes said to be generally accepted, (7) but it is not generally accepted. Several states have explicitly rejected the contention that an insurer's reservation of rights is ineffective if the insured objects. (8) Moreover, most of the cases adopting the "reject the defense" rule were decided before development of the more precise conflict of interest rule, so the latter is the clear modern trend.
As will be discussed, most jurisdictions that have addressed the issue consider questions of the right to control the defense in terms of whether there is a conflict of interest, implying that a reservation of rights alone is not enough to deprive the insurer of this right. Finally, even jurisdictions ostensibly adhering to the rule that a reservation of rights is enough to entitle the insured to control the defense have often adopted that rule in cases where there was a conflict. They might be persuaded to limit the rule to such cases were the issue presented in a case where there was no conflict. This is particularly so where, as in most of the states at issue, the "reject the defense" rule was adopted before the conflict-based rule was developed.
Conflict of Interest States
Most states take the view that defense counsel appointed by an insurer pursuant to a standard liability policy ordinarily represents both the insurer and the insured, unless there is a conflict of interest precluding joint representation. (Authorities on this point are collected in the appendix.) A conflict precluding joint representation also is held to preclude insurer control of the defense, instead requiring the insurer to pay for independent counsel to represent only the insured.
Development of the Independent Counsel Rule
The implications of conflict-of-interest analysis for control of the defense were first raised by insurers, although the result of raising that issue was not the one they sought. In Prashker v. United States Guarantee Corp., (9) an insured was alleged to have negligently operated a plane, resulting in a crash that killed both pilot and passenger. Among the grounds of negligence alleged was violation of federal regulations limiting flying in certain conditions to pilots licensed for instrument flying, which the insured was not. Operation in violation of the instrument flight rules was excluded from coverage. In a declaratory judgment action, the insurer sought to be relieved of both the duty to defend and the duty to indemnify, urging, inter alia, that requiring a defense "would subject to divided loyalty any attorneys who might defend the action, in that their duty to the assureds would be to endeavor to defeat recovery on any ground, whereas their duty to the insurance company would be to defeat recovery only upon such grounds as might render the insurance company liable."
The New York Court of Appeals declined to relieve the insurer of the duty to defend plainly imposed by the covered allegations of the complaint or to permit piecemeal adjudication in the declaratory judgment action of the question, properly included in the underlying action, of whether the pilot had violated the instrument flight rules. As to the conflict of interest problem, the court pointed out that this could be solved by use of attorneys responsible only to the insured, with the insurer being liable for the reasonable value of their services.
Similar arguments were presented to the Rhode Island Supreme Court in Employers Fire Insurance Co. v. Beals, (10) in which the insured was alleged to have injured the plaintiff either negligently or willfully and maliciously, with the latter basis of liability not covered. The court declined to curtail the duty of defense or to permit premature and piecemeal adjudication of an issue presented in the underlying action. While noting that an insured might waive the conflict of interest, the interests of both parties must be protected if the insured chose not to waive:
We are as conscious of an insurer's concern that it control the defense of any action brought against one of its insureds as we are of an insured's expectations that his rights will be properly protected. In our opinion, however, an insured, when faced with the quandary posited by the facts of the instant case, has a legitimate right to refuse to accept the offer of a defense counsel appointed by the insurance company; and when an insured elects to exercise this prerogative, the insurer's desire to control the defense must yield to its obligation to defend its policyholder...