Disputes Over Control of Counsel Between Policyholders and Insurers

Disputes Over Control of Counsel Between Policyholders and Insurers

By David A. Gauntlett[*]

Introduction

Because the insurer has a duty to defend if a claim is even potentially covered, insurers usually take on defense of a claim that may be covered. However, if an insurer disputes coverage, it may initiate a Declaratory Judgment Action to determine whether it owes a duty to defend the policyholder in the underlying action. Alternatively, it could simply decline coverage altogether, in which case the policyholder may file a declaratory judgment action (or a third-party declaratory judgment claim in the underlying action) or wait until the underlying litigation ends and file suit against the insurance company seeking reimbursement (also called recoupment of defense).

Policyholder Pathways to Securing Control of the Defense

An insurer may agree to provide a legal defense against an action while reserving the right to withdraw if it becomes apparent that the claim is not covered as facts emerge. The insured should consider (and consult coverage counsel to assess) whether this creates a conflict of interest requiring the insurer to appoint separate counsel to represent the insured in the underlying action. Where the defense counsel selected by the insured has been in place for a significant period of time, a policyholder can ask the insurer to agree to allow them to continue that representation even if they do not agree that they are obligated to provide independent counsel. 

This is especially the case, where the previously retained defense counsel agrees to work at rates acceptable to the insurer and to follow its “appointed counsel” costs. This will permit the insurer to avoid the dual expense and hiring its own appointed counsel in the suit. Critically, its retention of appointed counsel to defend the lawsuit may not meet its duty to defend under California Civil Code §2860. But be aware that insurers must prove a benchmark role because this statute seeks to limit the rate of reimbursement of fees charged by defense counsel for similar actions in the same community where the underlying action arose for similar claims to those charged by counsel appointed by the insured (also known as “panel counsel” defense fee rate). 

Pursuing a Declaratory Relief Action Against the Insurer

An alternative to pursing an insurance coverage claims including securing the right to independent counsel by an adjudication in court is a pursuit of a Declaratory Relief Action against the insurer. An insured can pay independent counsel if no such control was owed and then seek reimbursement for their defense fees securing all reasonable expenses plus prejudgment interest accruing at the legal rate charges in the forum whose coverage law applies to the recovery.[2]

Choices Faced by Policyholders Who Cannot Defend Without Insurer Assistance

An insured may await the resolution of the action against it under California law and then recover the full amount of its reasonable attorney’s fees by securing an adjudication that it was entitled to independent counsel at the insurer’s expense. [3] Once established, that determination allows it to recover all fees incurred to date at reasonable rates.[4]

Waiting to pursue coverage suits after the underlying action is resolved may eliminate many insurer defense obligations. These include the right, under California law, to limit the rate payable to the rate paid to attorney’s typically hired by the insurer to defend similar action in similar communities pursuant to Civil Code §2860. Instead, a reasonable rate that the applicable standard in every other jurisdiction (e.g. Alaska, which has a statute following California) applies.[5] 

Demanding a Reservation of Rights Letter to Evaluate Independent Counsel Entitlement

An insured should demand a reservation of rights letter from the insurer before agreeing to accept counsel the insurer wishes to appoint.[6] During the period of time when the issue of the insurer’s right to appoint is in controversy, in California, the insurer is entitled to appoint counsel but may not, by doing so, discharge its duty to defend if, in fact, an obligation to provide independent counsel was owed. 

On occasion, a reservation of rights letter issued by the insurer will clarify with specificity what grounds the insurer may rely upon to deny indemnity benefits to the insured under the policy that it has agreed to defend under a reservation of rights may create benefits that flow to an insured. More often, policyholders must request this letter. If the insurer insists on controlling the defense, the insured should demand the insurer articulate with more particularity any grounds it will reserve rights to deny policy benefits.

The Right to Independent Counsel Has Three Dimensions

First, policyholders may agree to accept the rate offered by the insurer that they claim their independent counsel accepts to defend similar actions in the community but reserve the right to contest that payment of this rate exhausts the insurer’s duty to pay such defense counsel. 

Second, policyholders may accept appointed counsel (paid for by the insurer) to avoid any fee differential expense by reserved rights to contest “appointed counsel” representation; and maintaining the legal rights to sue such counsel for legal malpractice if their representation fails to meet the applicable standard of expertise in defense for the IP lawsuit. 

Third, policyholders may retain IP counsel as independent counsel which, even if not acknowledged by the insurer, can seek fee reimbursement after the insured establishes that it was entitled to retain its chosen defense at the insurer’s expense because the insurer’s reservation of rights letter revealed a conflict of interest entitling the insured to retain its own counsel at the insurer’s expense. 

A Reservation of Rights Can Make Independent Counsel Necessary

When an insurer reserves its rights, appointed counsel can face a conflict of interest. The prototypical example of this conflict is when a policy covers negligent acts but not intentional ones, and the attorney’s decisions will inevitably push toward one of those results.[7] In this case, the insured and insurer have different desires, and the attorney is unable to ethically serve both parties.

California courts have held that the right to independent counsel can arise even in a broad range of circumstances. In one recent case, the court concluded appointed counsel had a conflict and independent counsel was needed where it was:

in [the insured’s] interest in the [underlying action] that [appointed counsel] marshal facts that establish [the insured’s] actions did not amount to a breach of his professional duties. But it is in [the insurer’s] interest here to marshal facts that establish the contrary — or at the very least, undermine [the insured’s] defense with facts that establish [the insured] had at least a reasonable basis to believe that his medical treatment of Limon would result in a lawsuit. This results in an incentive for [the insurer] to attach liability to [the insured]. Therefore… there is an actual conflict of interest and [the insured] has met his burden to show that, as a matter of law, he has a right independent counsel at [the insurer’s] expense.[8]

Conclusion

Even when coverage is not obvious from the face of a policy (or coverage seems to be excluded based on a policy exclusion), fact allegations in the underlying actions may provide a basis to claim coverage. When an insurer denies coverage, the policyholder may retain insurance coverage counsel to:

·        Advise on whether there are grounds to claim coverage.

·         Correspond with the insurer to dispute the rejection of coverage.

·         Handle any coverage litigation.

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[*] David A. Gauntlett is a principal of Gauntlett & Associates and represents policyholders in insurance coverage disputes regarding intellectual property, antitrust, and business tort claims, as well as in the underlying actions. He also serves as an expert witness on insurance coverage issues and represents policyholders and their counsel on a range of fee dispute issues with their insurers. Mr. Gauntlett can be reached at (949) 514-5662 or dag@gauntlettlaw.com. For more information, visit Gauntlett & Associates at www.gauntlettlaw.com.

[2] Longs Drug Stores, Inc v. Federal Ins. Co., 2005 WL 2072296, *4 (N.D. Cal. Aug. 25, 2005) (“The Court concludes that the date on which Federal could have computed the amount owed was the date Longs was billed for the attorneys fees and costs in the [relevant] action.”)

[3] Browne George Ross LLP v. Lexington Ins. Co., No. CV 12-2148 SVW (PLA), 2012 U.S. Dist. LEXIS 199489, *7 (C.D. Cal. May 29, 2012) (Citing several cases in which this occurred).

[4] Id. at *4 (Holding that an insurer that does not properly defend its insured must reimburse all reasonable defense fees incurred by the insured, stating “‘[t]he Court concludes that if a plaintiff is able to establish a breach of the duty to defend, its damages are not limited by California Civil Code § 2860.’”) (Quoting Atmel Corp. v. St. Paul Fire & Marine, 426 F. Supp. 2d 1039, 1047–48 (N.D. Cal. 2005)).

[5] See David A. Gauntlett, Battling for Equity-Securing Appropriate Fee Rates in C. C. §2860 Disputes, https://www.gauntlettlaw.com/news/battling-for-equity-securing-appropriate-fee-rates-in-c-c-2860-disputes (Mar. 31, 2022).

[6] Restatement of the Law of Liability Insurance § 25.

[7] San Diego Fed. Credit Union v. Cumis Ins. Soc'y, 162 Cal. App. 3d 358, 364 (1984) (“Opposing poles of interest are represented on the one hand in the insurer's desire to establish in the third party suit 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 . . . such liability emanated from the nonintentional conduct within his insurance coverage.’”) (Quoting Gray v. Zurich Ins. Co., 65 Cal. 2d 263, 279 (1966)).

[8] Aspen Am. Ins. Co. v. William Ou, No. CV 18-2312 DSF (GJSx), 2019 U.S. Dist. LEXIS 77822, *13 (C.D. Cal. Mar. 14, 2019).