Malpractice claims by primary and excess insurers: is the honeymoon over?

• Author: Baldwin, Susan McParland

THE elements of legal malpractice are the same as for any other type of negligence action--duty, breach, causation and damages. "An attorney who fails in his duty, causing actual loss to the client, is liable for the damages sustained." The duty to the client is breached by failing to exercise the knowledge, skill, and ability ordinarily possessed and exercised by members of the legal profession similarly situated.(1)

While generally an attorney's duty of care is owed only to the client, courts have extended the duty to third parties in certain circumstances, considering these factors: (1) the extent to which the transaction was intended to affect the third party; (2) the foreseeability of harm to the third party; (3) the degree of certainty that the third party suffered injury; (4) the closeness of the connection between the attorney's conduct and the injury; and (5) the policy of preventing future harm.(2) In several jurisdictions, the attorney's duty of care and the scope of liability have been expanded to include primary and excess insurance carriers that are directly affected by the malpractice of the defense counsel retained by the primary insurer to represent the insured.

Ten to 15 years ago malpractice suits by insurance carriers against their retained defense counsel were virtually unheard of, but today these suits appear to be on the rise. Malpractice suits have been brought not only by primary carriers, which generally have a direct relationship with defense counsel, but also by excess carriers. The suits by excess carriers against defense counsel are based on direct duty notions, as well as equitable subrogation principles. Excess carriers also have sued primary insurers, seeking to hold the primary insurer vicariously liable for the malpractice of defense counsel.(3) Where such actions have been allowed, it is likely that defense counsel would be added to the action through a third-party complaint.

There are several reasons for the apparent increase in these types of suits.

First, years ago claims were unlikely to be prosecuted by primary carriers because of the long-standing relationship that often existed between them and their retained counsel. While an unhappy carrier may have stopped sending cases to a particular attorney or firm, insurers were reluctant to sue. As the legal marker has become more competitive and insurance companies have re-structured their claim departments, however, there has been a breakdown in many instances in that traditional relationship. Insurers no longer send all their legal work to a particular firm. Many have increased the use of in-house counsel, and all insurers now emphasize cost, efficiency and the bottom line when they choose outside defense counsel. This means that the strong ties once present are not always formed or maintained. As a result, carriers may not be as reluctant to prosecute a malpractice action.

Second, insurers are much more cost conscious today. Through computerization they now have a greater ability to track and study where their defense and indemnity dollars are going. The increased pressure to streamline costs and indemnity exposure can cause an insurance company to look to other sources to share responsibility for an excess verdict or settlement, or for excessive defense costs and expenses.(4) Malpractice suits at least offer insurers the potential for some recovery of their indemnity outlays and where defense counsel's negligence increased the indemnity exposure expense and the costs of defense.(5)

All these factors contribute to a climate in which defense counsel must be aware that they may be vulnerable to a malpractice claim. While some of the courts that have addressed the issue of defense counsel malpractice have refused to allow such actions by primary and excess carriers, many have allowed the actions.

Actions by Primary Carriers

While typically the primary carrier retains, controls or at least monitors defense counsel's activities and pays defense counsel's fees, not all courts have allowed primary carriers to bring malpractice actions against defense counsel, even though the carrier must bear the economic burden of their mishandling of a case. Several theories have been advanced by primary insurers to support their attempts to assert malpractice claims against defense counsel, including:

* that an attorney-client relationship exists between the insurer and defense counsel, who usually is selected by the insurer;

* that malpractice liability should be extended to all foreseeable parties;

* that the insurer should be subrogated, either contractually or equitable, to the rights of the insured;(6)

* that the defense counsel breached the contract;

* that the defense counsel negligently performed the contract;(7) and

* that the defense counsel and the insurer are jointly liable for any bad faith, permitting joinder of the defense counsel as a third-party defendant in a bad faith action.(8)

Insurers that have been successful have relied on a direct duty theory or equitable subrogation principles.

1. Actions Allowed

   One of the earlier decisions recognizing a cause of action by a primary insurer against its defense counsel is Smiley v. Manchester Insurance Indemnity Co.,(9) in which the insurer was found liable for a judgment in excess of the policy limits after failing to settle the case when the plaintiffs demanded the full $20,000 policy limits.

   The insurer brought a third-party action for professional negligence against the attorney it selected to represent the insured on the grounds that the attorney failed to accept the policy limits demand, although authorized to do so, and also failed to make any counteroffer, although that was within his authority. The Illinois Supreme Court held that the attorney's failure to secure the settlement amounted to a breach of the duty to the insurer since it was the attorney's actions, as agent of the insurer, that "firmly established the excess liability case" against the insurer. Thus, the court implicitly held that the attorney had a direct duty to the insurer under those circumstances.

   In Atlanta International Insurance Co. v. Bell(10) the Michigan Supreme Court, reversing the intermediate appellate court, allowed an equitable subrogation claim for malpractice to proceed by the primary insurer against the defense counsel and law firm the insurer selected to represent the insured.

   The malpractice claim was predicated on the defense attorneys' failure to raise an affirmative defense on behalf of the insured in the underlying suit, an omission which the lead defense attorney later admitted did not conform to the required standard of care. After the insurer paid the judgment entered against the insured, it brought suit against the attorney and law firm for malpractice.

   The Michigan Court of Appeals recognized that the modem realities of practice are that an insurance company selects the attorney for the insured and pays his fees, but it held that this did not give rise to an attorney-client relationship between the company and that attorney. Rather, since the attorney's sole loyalty and duty is to the client, the insured, the court concluded that the insurer had no ground on which to bring a malpractice action.

   That court also rejected the insurer's argument that there was a direct contractual relationship between it and the defense counsel, which was breached by negligent performance. The court reasoned that since the attorney represents the insured client, not the insurer, the only "contract" was between the insurer and the insured, and the insurer at most was acting as the insured's agent in selecting the attorney and compensating him. This nexus was deemed insufficient to create a separate contractual duty on the part of the attorney to the insurer. Moreover, the court held that it would be ethically improper and would violate public policy for the defense counsel to enter into any such contractual relationship with the insurer, as it would interfere with the attorney-client relationship.

   While the Michigan Supreme Court reversed the Court of Appeals disposition of the case, it agreed with the lower court that no attorney-client relationship existed between the insurer and defense counsel, because such a holding could, in its words, "work mischief." The court added, however, that the insurer-attorney relationship, while less than attorney-client, was greater than the relationship between the defense counsel and some unrelated third party. It noted that the relationship differs because liability policies...