Of legal audits and legal ethics.

• Author: Richmond, Douglas R.
• Position: Insurance industry

There's no definitive answer to the issues raised by insurers' use of outside legal auditors, but it's a sore point with the defense bar that needs solutions

LIABILITY insurers are under considerable economic pressure. It began building in the early 1990s and has as its two most obvious sources the increased competition in the industry and rising loss adjustment expenses.(1) The increased competition is perhaps best evidenced by the number of recent mergers and acquisitions among and by property/casualty insurers.(2) As for expenses, some reports indicate that as much as 55 cents of every claim dollar now go to pay litigation costs.(3) Other contributing factors include soft markets, resulting in fiat or reduced premiums, and the increasing total cost of the tort system.

CONTROLLING DEFENSE COSTS

In their efforts to improve profitability, many insurers have focused on controlling defense costs--and, conjunctively, the performance of defense counsel--because they lend themselves to statistical analysis and objective performance measures, although many defense attorneys would vigorously debate this point. In short, cost-conscious liability insurers have focused on defense expenditures because they can.

1. Rise of Legal Auditing

   With this increased scrutiny of defense expenditures has come the growth of the legal auditing industry. Legal auditors review defense attorneys' bills to determine the reasonableness of charges and expenses, as well as counsel's compliance with insurers' billing requirements. Legal audits themselves are nothing new; insurers have long employed experienced claims professionals to evaluate defense counsel performance and the reasonableness of their charges. Now, however, many insurers require defense attorneys to submit their bills directly to outside auditors for review before payment. There are at least five major legal auditing firms nationwide, and a host of smaller operations.(4)

   Most liability insurers require great detail and specificity in their attorneys' bills, which means that bills sent to outside legal auditors often include information about the nature of the legal services and specific legal research performed, as well as information that could disclose counsel's mental impressions, strategic decisions and case theories. In some instances, bills might reveal information obtained from or about insureds that would otherwise be kept confidential.

2. Concerns of Defense Bar

   The defense bar has chafed under insurers' use of outside legal auditors. Outside auditors are insensitive to the intricacies of particular cases; complex cases routinely confuse them. A number of insurers employ outside auditors to review all attorneys' bills, not just suspect or questionable ones, a practice that dramatically slows payment of the bills. Some auditing firms work for contingent fees,(5) while others employ disbarred lawyers as auditors.(6) Even auditors who work for flat fees have a compelling interest in justifying their function and cost.(7)

   Outside auditors have no incentive to praise defense counsel's efficiency or to report that defense attorneys' charges are appropriate and reasonable. To the contrary, they are driven to cut and slash the bills without regard for whether the reductions they demand are reasonable or unreasonable.(8) Insurers' use of outside legal auditors has been described by the president of the Defense Research Institute as "the most serious issue confronting the [defense] bar."(9)

3. Professional Responsibility Problems

   The serious problem posed by outside auditing is not the resulting adversarial relationship between some insurers and their attorneys, nor is it the reported defection of some long-time insurance defense attorneys to the plaintiffs' bar.(10) Rather, the issue is the overlap between legal auditing and legal ethics and, more particularly, the application of the attorney-client privilege and duty of confidentiality imposed on lawyers by Rule 1.6 of the American Bar Association Model Rules of Professional Conduct and state counterparts. Privilege and confidentiality are critical issues because of the sensitive information sometimes contained in the bills and other materials outside legal auditors review.

   Some insurers and outside legal auditors argue that the defense lawyers' protests about the professional responsibility problems are disingenuous.(11) Defense lawyers who solicit or adhere to state ethics opinions limiting or forbidding the submission of fee bills to outside auditors do so solely to protect their practices and preferred ways of doing business. The issue is not ethics, insurers and auditors argue, but rather defense attorneys' dislike of the audit process and their desire to find an ostensibly legitimate means of avoiding insurers' billing requirements.

   If that cynicism is justified--and only the individual defense lawyers involved in given controversies know their true motives--it also is unimportant. Lawyers' motives in seeking professional guidance are irrelevant. Insurers' employment of outside legal auditors either raises valid ethics concerns or it does not. How or why the issue is presented does not affect its validity or seriousness.

   This article examines the attorney-client privilege and the Rule 1.6 confidentiality principle, discusses recent case law and ethics opinions addressing outside legal auditors' injection into the tripartite relationship, and examines the overlap between legal auditing and legal ethics. At the end, it offers some ideas for avoiding and mitigating related problems.

   ATTORNEY-CLIENT PRIVILEGE AND DUTY OF CONFIDENTIALITY

   Counsel hired by an insurer to defend its insured in a third-party action represent both the insurer and the insured. This concept of dual representation is best known as the "dual client doctrine." That doctrine holds, "So long as the interests of the insurer and the insured coincide, they are both the clients of the defense attorney and the defense attorney's fiduciary duty runs to both the insurer and the insured."(12) Defense counsel, therefore, serve two clients in most cases,(13) Defense counsel owe ethical and professional obligations to both the insurer and the insured.(14) A defense attorney shares a privileged relationship with both the insurer and the insured and owes each an equal duty of confidentiality.(15)

   An attorney's duty to keep clients' confidences inviolate is essential to the attorney-client relationship. Its observance facilitates the full development of facts necessary for proper representation of clients. The duty to maintain clients' confidences encourages clients to communicate fully and frankly with their counsel, even with respect to embarrassing or legally damaging subjects.(16)

   The principle of confidentiality is first given effect in the law of attorney-client privilege. This privilege has been variously described and defined, but the prevailing privilege test was announced nearly 50 years ago in United States v. United Shoe Machinery Corp.(17) The United Shoe test, which has been widely adopted, provides:

   The privilege applies only if (1) the asserted holder of the privilege is or sought to become a client; (2) the person to whom the communication was made (a) is the member of the bar of a court, or his subordinate and (b) in connection with this communication is acting as a lawyer; (3) the communication relates to a fact of which the attorney was informed (a) by his client (b) without the presence of strangers (c) for the purpose of securing primarily either (i) an opinion on law or (ii) legal services or (iii) assistance in some legal proceeding, and not (d) for the purpose of committing a crime or tort; and (4) the privilege has been (a) claimed and (b) not waived by the client.(18) Although the United Shoe test implies that the privilege attaches only to communications from the client to the lawyer, confidential communications by an attorney to a client also are privileged.(19)

   Courts construe the attorney-client privilege narrowly because it limits full disclosure of the truth.(20) The privilege is not absolute,(21) and it can be waived by almost any voluntary disclosure that is contrary to its assertion.(22)

   There is no attorney-client privilege between co-clients. When the same attorney acts for two parties having a common interest and each party communicates with the attorney, the communications are not privileged as between the parties. Their communications are, however, privileged from disclosure at the request of a third person.

   Confidentiality in the attorney-client relationship also is implemented via the ABA Model Rules of Professional Conduct. Rule 1.6(a) provides in pertinent part: "A lawyer shall not reveal information relating to representation of a client unless the client consents after consultation, except for disclosures that are impliedly authorized to carry out the representation." A defense lawyer surely owes the insured a duty of confidentiality under Rule 1.6, because the rules, not the insurance contract, govern insurance defense counsel's professional obligations.(23)

   The Rule 1.6 confidentiality obligation is broader than the attorney-client privilege.(24) The attorney-client privilege generally applies only if the communications at issue were intended to obtain legal advice or assistance, while a lawyer's duty of confidentiality under Rule 1.6 shields all information related to the client's representation, regardless of the source.(25) This broader duty of confidentiality reflects the duty of loyalty to clients in addition to the principles underlying the attorney-client privilege. Of course, loyalty is essential to the attorney-client relationship.(26)

   The attorney-client privilege and the Rule 1.6 duty of confidentiality are concerns in the legal auditing context because the release of defense counsel's bills to an outside auditing firm may waive the privilege and violate Rule 1.6. Aggressive plaintiffs' lawyers...