Reimbursement Is Improper Where Appointed Counsel Is Conflicted
Reimbursement Is Improper Where Appointed Counsel Is Conflicted
By David A. Gauntlett*
Introduction
When policyholders submit a claim requesting defense of a lawsuit, insurers often agree to defend under a Reservation of Rights (“ROR”). In many states,[1] the ROR allows an insurer to retain the right to seek reimbursement of defense expenses should it later be determined that no defense was actually due under the policy. But what if the counsel appointed by the insurer faced a conflict of interest throughout the defense? Cases examining this issue are sparse, but authority suggests that no reimbursement is proper under such circumstances.
Policy Voided Ab Initio Does Not Necessarily Entitle Insurer to Reimbursement
In Century Sur. Co. v. Robin Singh Educ. Servs., Inc.,[2] Judge Snyder determined rescission was appropriate as against the policyholder (Testmasters) for alleged failure to properly answer a policy application question requiring disclosure of claims within the proceeding five years.
The court observed that:
“The consequence of rescission is not only the termination of further liability, but also the restoration of the parties to their former positions by requiring each to return whatever consideration has been received. . . The policy would be ‘extinguished’ ab initio, as though it had never existed.” [Imperial Casualty & Indem. Co. v. Sogomonian, 198 Cal. App. 3d 169 (1988)] at 184. “A policy void ab initio . . . cannot be breached.” LA Sound USA, Inc. v. St. Paul Fire & Marine Ins. Co., 156 Cal. App. 4th 1259, 1266 (2007).[3]
Looking at the issue further, however, the court noted that “‘[i]n a rescission action, the complaining party may receive restitution for all benefits conferred on the other party, restoring both parties to economic status quo ante.’ Ogden Martin Sys., Inc. v. San Bernardino County, 932 F.2d 1284, 1287 (9th Cir. 1991).”[4]
Nevertheless, even though conceding that such a policy was eviscerated ab initio, the court challenged whether the insurer, Century Surety, was capable of receiving reimbursement for monies expended through appointed counsel, where an issue was raised as to whether the insured was entitled to independent counsel as it had sought. Under such circumstances, there would not be any value created by appointed counsel’s legal services, even assuming the services were otherwise reasonable and the amounts charged appropriate. Finding a fact issue posed, the court sent this issue to trial.[5]
Conflicted Counsel Provides No Benefit to the Insured
The court stated “Century is entitled to reimbursement for monies paid on TestMasters’ behalf only to the extent that these monies conferred a benefit upon TestMasters.”[6] Under California law, appointed counsel represents both the insurer and the insured but independent counsel only the insured.[7]
A “conflicted attorney” appointed by the insurer cannot discharge its contractual defense obligation. This follows because an insurer must provide its insured with a full defense[8] by competent counsel.[9] Ordinarily, that duty is met by hiring one defense lawyer to represent the interests of both the insured and insurer, but it cannot be met by hiring a single lawyer where there is a conflict of interest.[10]
This is especially the case where, as in the Robin Singh case, the insured retained its own independent counsel to concurrently represent its interests because of the conflict. The appointed counsel was of no value to it in providing a defense. Where a conflicted attorney is provided, no value is received, and thus no right to reimbursement is possible:
As part of its duty to defend, the insurer must provide a full defense by competent counsel. That duty is breached when an insurer furnishes defense counsel whose ability to represent the insured is impaired by a disqualifying conflict of interest. In such cases, the insured is usually permitted to hire independent counsel at the insurer’s expense.[11]
Since no benefit is conferred on the “other contracting party” (i.e., the insured) where appointed counsel is provided and “independent counsel” was due, there can be no right to reimbursement.[12]
This also follows because the right to restitution following rescission is an equitable right and a valueless conflicted defense cannot satisfy its requirements.
Section 1691, subdivision 2 of the Civil Code, requires the restoration only of property possessing a value. It has been repeatedly held that where the thing involved in a rescission suit has no value . . . it is not necessary, as a prerequisite to the cancellation of a contract, to restore the property.[13]
“Flat Fee” Arrangements Not Reimbursable Due to Inherent Conflict
Courts have recognized that the nature of conflicts that entitle an insured to independent counsel extend to any circumstance that would negatively impact representation:
Some of the circumstances that may create a conflict of interest requiring the insurer to provide independent counsel include: . . . (5) any other situation where an attorney who represents the interests of both the insurer and the insured finds that his or her “representation of the one is rendered less effective by reason of his [or her] representation of the other.” (Spindle v. Chubb/Pacific Indemnity Group (1979) 89 Cal.App.3d 706, 713, 152 Cal.Rptr. 776; Golden Eagle Ins. Co. v. Foremost Ins. Co., supra, 20 Cal.App.4th at p. 1396, 25 Cal.Rptr.2d 242.)[14]
When insurers hire counsel to provide an insured’s defense based on a “flat fee” agreement, it creates a perverse incentive for the hired counsel to resolve the case as quickly as possible rather than as effectively as possible. This often violates the ethical guidelines imposed on attorneys.[15] Operating under such conditions naturally leads to counsel concerned with matters other than representing the insured, which, according to the Robin Singh court, creates no benefit to the insured and thereby deprives the insurer of any right to reimbursement.
Conclusion
Despite insurer assertions to the contrary, reimbursement of defense fees paid to appointed counsel is rarely appropriate due to a variety of conflicts that may arise. Where such conflicts exist, only independent counsel would have provided any value to the insured. Absent such value, there is nothing for the insurer to recover.
*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. Mr. Gauntlett can be reached at (949) 553-1010 by voicemail or dag@gauntlettlaw.com. For more information, visit Gauntlett & Associates at www.gauntlettlaw.com.
[1] Some states allow for this right to be declared in the ROR, other require it to be in the policy itself, and others simply deny insurers the ability to recoup defense expenses. See David A. Gauntlett, Insurance Coverage of Intellectual Property Assets, 2d ed., Appendix N (2023) for a breakdown of all states’ positions on this issue.
[2] Century Sur. Co. v. Robin Singh Educ. Servs., Inc., No. CV-06-8066 CAS (EX), 2008 WL 11333841, at *17 (C.D. Cal. Apr. 14, 2008).
[3] Id. at *17.
[4] Id. at *18.
[5] The case was resolved via settlement before the issue received a conclusive ruling by the court.
[6] Robin Singh, 2008 WL 11333841 at *19.
[7] Rockwell Internat. Corp. v. Superior Court, 26 Cal.App.4th 1255, 1264 (1994); see also Employers Ins. of Wausau v. Albert D. Seeno Const. Co., 692 F.Supp. 1150, 1157 (N.D. Cal. 1988) (”Case law thus leaves little doubt that Cumis counsel represent solely the insured . . .”)
[8] Montrose Chem. Corp. v. Superior Court, 6 Cal. 4th 287, 295 (Cal. 1993).
[9] Assurance Co. of America v. Haven, 32 Cal.App.4th 78, 90 (1995).
[10] Rockwell, 26 Cal. App.4th at 1263-64.
[11] Croskey, Et al., California Practice Guide: Insurance Litigation, Chap. 7B-K, p. 7B-91, § 7:769 (Rutter Group 2006) (emphasis added).
[12] Modoc Mineral & Oil Co. v. Cal-Vada Drilling & Exploration Co., 236 Cal. App. 2d 868, 873 (1965); see also Ambassador Hotel Co. v. Wei-Chuan Inv., 189 F.3d 1017, 1031 (9th Cir. 1999) (“Under true rescission, the plaintiff returns to the defendant the subject of the transaction, plus any other benefit received under the contract, and the defendant returns to the plaintiff the consideration furnished, plus interest.”).
[13] Dunn v. Stringer, 41 Cal. App. 2d 638, 646 (1940).
[14] James 3 Corp. v. Truck Ins. Exch., 91 Cal. App. 4th 1093, 1101-02 (2001).
[15] Cal. R. Prof. Cond. 3-310(F). See, e.g., American Ins. v. Kentucky State Bar Ass’n, 917 S.W.2d 568, 572 (1996) (“[T]he pressure exerted by the insurer through the set fee interferes with the exercise of the attorney’s independent professional judgment.”); West Virginia Legal Ethics Opinion 98-01 (“To guard against harm to the insured client, lawyers must insure that the fixed fee is sufficient to allow them to provide a competent defense.”); Florida Bar Ethics Opinion 98-2 (holding an attorney “may not enter into a set fee agreement in which the set fee is so low as to impair her independent professional judgment or cause her to limit the representation of the insured.”)