The Insurer’s Duty to Provide Independent Counsel in California

This is part one of a three part series focusing on an insurer’s duty to provide independent counsel in Alaska, California and Illinois.

Under liability insurance policies, an insurer has a duty to indemnify the insured for loss as well as a duty to defend the insured in litigation involving the claim under the policy. The obligation to provide a defense to the insured typically comes with the insurer’s right to control the defense, which includes the ability of the insurer to select defense counsel. The insurer and the insured often share a common interest in limiting the liability of the insured. However, the interests of the insurer and insured can sometimes diverge, creating a conflict of interest between the insurer providing the defense, the defense counsel it chooses, and the insured.

Such was the situation in San Diego Fed. Credit Union v. Cumis Ins. Soc’y, 162 Cal. App. 3d 358 (1984), the landmark California decision that established an insured’s right to independent counsel where a conflict of interest arises with the insurer. In Cumis, the insured was sued and turned to its insurer to defend the claim under its policy. The insurer retained an attorney to defend the insured but also issued a reservation of rights letter, reserving its right to deny coverage at a later date. After receiving the reservation of rights letter, the insured retained its own attorney to provide independent representation and sought expenses for independent counsel from the insurer, but the insurer refused to pay.

As the court explained, “In the usual tripartite relationship existing between insurer, insured and counsel, there is a single, common interest shared among them. Dual representation of counsel is beneficial since the shared goal of minimizing or eliminating liability to a third party is the same.” But when the insurer issues a reservation of rights it positions itself apart from the insured and signals that it may have a divergent interest.

In Cumis, the insurer issued the reservation of rights after recognizing that the basis for liability of the insured, if any, “might rest on conduct excluded by the terms of the insurance policy.” If such conduct was found to have occurred, the insured would be liable but the insurer would avoid its coverage obligation. “The lawyer is placed in the dilemma of helping one of his clients concerning insurance coverage and harming the other… [and] counsel cannot discharge inconsistent duties.” The court concluded that the insurer had a duty to provide independent counsel for the insured because of the conflict of interest.

The Cumis decision was an important and broad decision, holding that whenever an insurer issues a reservation of rights letter, a conflict exists requiring the insurer to provide independent counsel for the insured. But California courts immediately began to refine the scope of the ruling in Cumis.

In McGee v. Superior Court, 176 Cal. App. 3d 221 (1985), the court said that Cumis used “overly broad language” and that the conflict necessitating independent counsel in Cumis was not the reservation of rights alone, but the fact that the reservation of rights letter was issued and the liability in the underlying case rested on conduct excluded by the policy. The court in Native Sun Investment Group v. Ticor Title Ins. Co. of Cal., 189 Cal. App. 3d 1265 (1987), came to a similar conclusion, determining that a reservation of rights alone is not enough to require the insured to provide independent counsel.

The California legislature subsequently passed Civil Code section 2860, modifying Cumis and limiting the duty of an insurer to provide independent counsel. Where the Cumis court required an insurer to provide independent counsel merely because of a potential conflict of interest, the statute imposes a duty only where “a conflict of interest arises” and states that a conflict does not necessarily arise simply because the insurer has reserved its rights.

Section 2860 codified the rule but did little to clarify the scope of the insurer’s duty to provide independent counsel and left much room for the courts to interpret when a conflict exists. The state’s courts have since adopted a restrained position requiring an actual and meaningful conflict to exist before the insurer’s duty to provide independent counsel arises.

The court in Dynamic Concepts v. Truck Ins. Exch., 61 Cal. App. 4th 999 (1998), did not want to encourage insureds to “cultivate conflicts with carriers” and stated that “Not every reservation of rights entitles an insured to select Cumis counsel. There is no such entitlement, for example, where the coverage issue is independent of, or extrinsic to, the issues in the underlying action, or where damages are only partially covered by the policy… the conflict must be significant, not merely theoretical, actual, not merely potential.” The case articulated an important standard limiting the applicability of the rule.

California courts have held that an actual, significant conflict exists where the facts of the underlying case between the insured and third party are determinative of whether coverage exists under the policy and the insurer-appointed counsel is in a position to control such coverage issues. Gafcon, Inc. v. Ponsor & Assoc., 98 Cal. App. 4th 1388 (2002); Long v. Century Indem. Co., 163 Cal. App. 4th 1460 (2008).

Courts have also suggested that where the attorney’s representation of the insured is rendered less effective by reason of his relationship with the insurer, a conflict may exist requiring independent counsel. Golden Eagle, 20 Cal. App. 4th 1372 (1993). In addition, where the insurer insures both the plaintiff and defendant in a case, a conflict exists requiring independent counsel for the insured. O’Morrow v. Borad, 27 Cal. 2d 794 (1946).

Section 2860 provides a number of limitations on situations that may create conflicts of interest. A potential conflict could exist where the underlying claim against the insured seeks punitive damages or seeks damages in excess of the policy limits because punitive damages are generally not covered and an insurer is obligated to indemnify the insured only up to the policy limits. Nevertheless, Section 2860 does not consider these situations alone to amount to a conflict requiring independent counsel despite the fact that the insurer has no intrinsic interest in defending claims for which it will not be liable.

However, if the insurer pursues a settlement in excess of the policy limits and does not have the insured’s consent to do so, the insurer has created a conflict by leaving the insured exposed to liability not covered by the policy. Golden Eagle, 20 Cal. App. 4th 1372.

Section 2860 offers protections for insurers required to provide independent counsel. Under the statute, an insurer must only pay independent counsel the rates that it would normally pay its own attorneys for a similar defense and may require that the independent counsel have a certain amount of civil litigation experience and carry errors and omissions coverage.

While the Cumis decision was a landmark decision establishing an insured’s right to independent counsel in conflict situations, California has since retreated from the broad implications of the Cumis ruling. Section 2860 limited Cumis but provided little guidance as to which conflicts require independent counsel. The resulting case law has narrowed the insurer’s obligation to provide independent counsel. Unless an actual and significant conflict of interest exists, courts are hesitant to impose any duty on an insurer to pay for independent counsel for an insured.

States have taken varying approaches to the insurer’s duty to provide independent counsel. Some states require independent counsel to be provided in a broad range of cases. Other states do not require insurers to provide independent counsel but instead rely on the state’s rules of professional conduct for attorneys to govern any actual or potential conflict of interest in the representation. California has struck a middle ground, offering a statutory framework that protects policyholders from certain actual and significant conflicts but that is limited in scope and largely favorable to insurers.