Policyholder's Rights to Challenge Insurer's Control of Counsel

POLICYHOLDER’S RIGHTS TO CHALLENGE INSURER’S CONTROL OF COUNSEL

By David A. Gauntlett*

It is not uncommon under Directors & Officers (D&O), Employment Practices Liability Insurance (“EPLI”), Cyber/Media (“C&M”), and Professional Liability (“PL”) policies for the policyholder to either designate counsel at the time the policy is procured or to thereafter contest appointed defense counsel (assuming its contest is asserted in good faith).

Insurer’s “Reservation of Rights” Under California Civil Code §2860

Commercial General Liability (“CGL”) policies, however, rarely bestow a right on the policyholder to select counsel. Nonetheless, policyholders may still secure its choice of counsel where an ethical conflict arises because of the insurer’s “reservation of rights” (“ROR”). Where an insurer advises its intention to reserve rights but does not articulate the grounds, per se, in a ROR, the policyholder must insist that the insurer do so. Absent the ROR, a policyholder cannot evaluate whether it will implicate a right to independent counsel.

Before Independent Counsel is Secured

During the interim period, an insurer may appoint counsel to serve as co-counsel while the issue of entitlement to independent counsel is addressed.[1] The appointment does not satisfy the insurer’s duty to defend.[2] Nor does it vindicate the policyholder to post notice pre-appointment defense fees at reasonable rates.[3] All reasonable defense fees incurred after the date of notice to the insurer must be promptly paid.[4] So understood, an insurer could reject a policyholder’s choice of counsel if they do not have substantial defense experience in the subject at issue in the litigation.[5]

 A Four Part Test Applies to Secure Application of Civil Code §2860

Under California Civil Code §2860(c), an insurer may require independent counsel to have: (1) at least five years of civil litigation practice which includes substantial defense experience in the subject at issue in the litigation; and (2) errors and omissions coverage. The insurer must show: (1) rates which are actually paid by the insurer; (2) to attorneys retained by it in the ordinary course of business; (3) in the defense of similar actions; and (4) in the community where the claim arose or is being defended.

Meeting the Four Part Test

Section §2860 (c) requires that the rates be the “rates which are actually paid” by the insurer and requires the insurer to pay rates that it pays in the community where the claim arose or is being defended. Absent proof of the rates, the “reasonableness” standard governs.[6] The rates actually paid are objective evidence that they are “reasonable”.[7] When applying a “reasonableness” standard, it is presumed that the insured paid reasonable defense fees.[8] As such, it is the insurer’s burden to prove unreasonableness.[9]  

Case Law Defines Independent Counsel Entitlement in Distinct Fact Scenarios  

Where the alleged conduct of the insured creates liability that could fall within an exclusion based on its “state of mind” such as knowing that is conduct would cause “personal or advertising injury”, a ROR asserting such an exclusion triggers a right to independent counsel.[10] Similarly, the timing of an event could fall within coverage.[11] Depending upon how the facts are presented at trial can establish a right to independent counsel or claims that potentially fall outside of coverage depending on the basis for the asserted liability. [12]  

Civil Code §2860 Does Not Apply Where Non-California Coverage Law Applies

The California legislature enacted Civil Code Section §2860 to apply to Californians that purchase insurance in California. California cannot extend the benefit it provided to insurers to non-California entities nor does Section §2860 renders its provisions applicable to an out-of-state insured.

Multiple courts have held applicable law to the state in which the corporation resides rather than California where an underlying complaint has been filed.[13] In PhotoMedex, Inc. v. St. Paul Fire & Marine Ins. Co.,[14] a Pennsylvania district court held that “the factors favoring application of Pennsylvania law are especially relevant when weighed under the general policy considerations…Likewise, Pennsylvania has greater governmental interests in the application of its substantive law to this case.”

CONCLUSION 

Many policyholders are justly concerned that appointed counsel may not: (1) aggressively defend a suit in order to limit the insurer’s defense expenses; (2) appointed counsel will provide information to the insurer that could adversely impact insurance coverage; or (3) improperly pursue motions against the insured’s interest that would divest the insured of coverage.[15] These legitimate concerns require the policyholder to carefully assess whether it is entitled to independent counsel.

If you enjoy this content, you can find my full list of blogs here: https://docs.google.com/document/d/1N3YsMmn0Ii1GqHWSBEE1pPzh1jQbU6htkJZ2e55Y2eM/edit?usp=sharing

* David A. Gauntlett is the principal of Gauntlett & Associates. For more information, visit Gauntlett & Associates at www.gauntlettlaw.com.

[1] California Civil Code §2860(f); see, Atmel Corp. v. St. Paul Fire & Marine, 426 F. Supp. 2d 1039, 1047 (N.D. Cal. 2005) (“‘[t]o take advantage of the provisions of § 2860, an insurer must meet its duty to defend and accept tender of the insured's defense, subject to a reservation of rights’… St. Paul did not defend Atmel in the Seagate Action, and thus…cannot avail itself of the protections and limitations set forth in § 2860.”)

[2] Seagate Technology LLC v. National Union, 737 F. Supp. 2d 1013, 1017 (N.D. Cal. 2010). (Where an insurer denies a defense, it is obligated to pay reasonable defense fees until it changes its view agreeing to defend in order to claim the benefits of Civil Code §2860.)

[3] Behnke v. State Farm Gen. Ins. Co., 196 Cal. App. 4th 1443, 1460-61 (2011) (This reasonableness standard applies to both the general duty to defend and the duty to defend in independent counsel situations.)

[4] The Housing Group v. PMA Capital Ins. Co., 193 Cal. App. 4th 1150, 1156 (2011) (“[W]e see no merit to Caliber One's argument that it could not be found to have ‘failed to defend’ the Engleman action once it paid some but not all of plaintiffs' defense fees.”)

[5] James River Ins. Co. v. Diana's Care Home, No. C10-0446 BZ, 2010 U.S. Dist. LEXIS 70367 (N.D. Cal. June 24, 2010), *6-7 (N.D. Cal. June 9, 2010) (upholding insurer’s rejection of independent counsel with 30 years of litigation experience, but minimal experience in elder abuse litigation which was the main subject of wrongful death lawsuit). 

[6] California Rule of Professional Conduct 4–200 focuses on the relative sophistication of the attorney and the client, the nature and length of the professional relationship with the client, and the experience and reputation of the attorney.

[7] Hartford Cas. Ins. Co. v. J.R. Mktg., LLC, 61 Cal. 4th 988, 1001 (2015) insurer's obligation to finance its insureds defense is “the duty to pay the reasonable cost defense.”) (e.g. Cal. Rules of Prof. Conduct rule 4–200 [setting forth factors in determining the reasonableness of attorneys’ fees.)

[8] Kershaw v. Maryland Casualty Co., 172 Cal. App. 2d 248, 258 (1959) (“When it does not appear that attorney’s fees and other expenses are obviously excessive, testimony of the amounts paid will constitute a prima facie case; and it will be assumed in such a case that the attorneys’ fees so paid were reasonable, unless the contrary appears.”)

[9] Aerojet-General Corp v. Transport Indem. Co., 17 Cal. 4th 38, 64 (1997) (“What matters here is whether [the defense fees incurred] would be conducted against liability by a reasonable insured under the same circumstances…[when the insurer has breached its duty to defend] it is the insurer that must carry the burden of proof that [the defense fees] are in fact unreasonable and unnecessary.”); see also, Hartfort Cas. Ins. Co. v. J.R. Marketing, LLC, 216 Cal. App. 4th 1444, 1450 (2013) (“[T]he burden to prove that Cumis counsel's fees were in fact unreasonable and unnecessary falls entirely on the insurer.”)

[10] See, Citizens Ins. Co. of Am. v. Chief Digital Advisors, 2020 U.S. Dist. LEXIS 220528, *13-14 (S.D. Cal. Nov. 24, 2020) (“Taking the allegations as true, CICA relied on the Knowing Violation of Rights exclusion when it reserved its rights – thus creating a conflict…[therefore] CICA’s refusal to provide independent counsel was ‘unreasonable or without proper cause.’”)

[11] J.R. Marketing, LLC v. Hartford Cas. Ins. Co., 2008 Cal. LEXIS 1373, *2 (Cal. Jan. 8, 2008) (“With respect to the prior publication exclusion, Hartford, for example, may benefit at trial - to respondents’ detriment – form developing a theory that the defamatory statements respondents’ allegedly made during the policy period were substantially…the same as those they allegedly made before the policy period.”)

[12] See, Travelers Indem. Co. v. Newlin, 2021 U.S. Dist. LEXIS 65019, *31-33 (S.D. Cal. Apr. 2, 2021) (“Blanket Additional Insured Endorsement in CCL policies…does not cover ‘independent acts or omissions”…[as such] Travelers ‘could potentially deny indemnity to the Newlins’ [pending a jury determination]… Accordingly, the Court concludes…a conflict of interest requiring independent counsel.”)

[13] RSUI Indem. Co. v. Murdock, 248 A. 3d 887, 901 (Del. 2021) (“Delaware’s interest in protecting the ability of its considerable corporate citizenry…[as such] Delaware has the most significant relationship to the Policy and the parties”.)

[14] No. 09-00896, 2009 U.S. Dist. LEXIS 65335, at *37-38 (E.D. Pa. July 28, 2009)

[15] Nelson Elec. Contr. Corp. v. Transcontinental Inc. Co., 231 A.D.2d 207, 209 (N.Y. App. Div. 1997)(“[T]o defeat the motion, plaintiff would have had to present evidence that Pyramid bore some of the liability for the accident. While this would have advanced defendant's [insurer] interests, by reducing or eliminating Pyramid's possible recovery on the covered claims, it would have done so at plaintiff's [insured’s] expense, by shifting its potential liability to the uncovered breach of contract claim.”)