Principal David Ezra examines the upcoming review on aspects of a recent decision by the Third Appellate district — Schaefer v. Elder, 217 Cal.App.4th 1 (2013) which discusses an interesting nuance in insurance law regarding insurer-appointed defense attorneys.

Loose lips sink ships: panel counsel and confidentiality
By David Ezra       

In Schaefer v. Elder, 217 Cal. App. 4th 1 (2013), the 3rd District Court of Appeal held that the policyholder was entitled to independent counsel when a liability insurer reserved the right to decline coverage if the insured’s workers were independent contractors rather than employees. The insurer-appointed defense attorney was disqualified and removed from the case.

This second holding — that panel counsel can be disqualified in cases involving reserved rights and conflicting interests — could seriously disrupt an important part of the “Cumis” compromise that has long guided California policyholders and insurers.

Virtually every California attorney who litigates will confront “Cumis counsel” issues. The need for Cumis or “independent” counsel may arise when a liability insurer defends a policyholder under reservation of rights. The insurance company often appoints a defense attorney it supplies with many assignments (a “panel” attorney). When the issues to be litigated overlap with the insurance company’s coverage reservations, the panel attorney may face a conflict of interest.

Let’s take a simple example. Two men collide on a dance floor; one falls down and breaks his arm. He sues the other dancer for negligence and battery. The defendant dancer’s insurance company agrees to defend the suit, but it reserves the right to decline coverage based on the intentional acts exclusion. Two witnesses will testify that the plaintiff was interacting with the defendant’s wife moments before the collision, and after a heated verbal exchange, the policyholder was seen quickly moving across the dance floor when he ran into the plaintiff. Was it an accident? Or was the policyholder trying to knock the plaintiff over?

In Long v. Century Ind. Co., 163 Cal. App. 4th 1460, 1471 (2008), the court described this dichotomy (intentional/accidental) as the prototypical case where Cumis counsel may be required. In our bad dancer hypothetical, a defense attorney who benefitted from noncoverage might be tempted to develop some sort of “he had it coming to him” defense strategy. If the jury accepts the argument and blames the plaintiff, there is no liability. If the jury rejects the defense, there is no covered liability. Either way, the liability insurer is a “winner.” At least that’s the theory.

And that is why, at least since Executive Aviation, Inc. v. National Ins. Underwriters, 16 Cal. App. 3d 799, 810 (1971), was decided, California courts have recognized situations where the “insurer’s desire to exclusively control the defense must yield” and the policyholder selects independent counsel, at the insurer’s expense. This occurs when the “basis for the reservation of rights is such as to cause assertion of factual or legal theories which undermine or are contrary to the positions to be asserted in the liability case.” State Farm Fire & Casualty Co. v. Superior Court, 216 Cal. App. 3d 1222, 1226 fn. 3 (1989).

In 1984, the “Cumis” moniker was affixed to independent counsel. In San Diego Fed. Credit Union v. Cumis Ins. Soc’y, 162 Cal. App. 3d 358, 361 (1984), the court broadly ruled that “when an insurer provides its own counsel but reserves its right to assert noncoverage at a later date … there is a conflict of interest … and therefore the insured has a right to independent counsel paid for by the insurer.”

This statement left many unanswered questions. After all, not every reservation of rights creates a conflict. In 1987, the Legislature enacted Civil Code Section 2860. Instead of calling for disqualification of panel counsel, Section 2860(f) seems to mandate the opposite approach: “[B]oth the counsel provided by the insurer and independent counsel selected by the insured shall be allowed to participate in all aspects of the litigation.”

The justices who decided Schaefer seemed to read Section 2860(f) as if it contemplated a panel attorney who only represents the insurer. According to the court, “[i]f the Koeller firm had not simultaneously represented Elder and CastlePoint, but instead represented CastlePoint only, it might be allowed  [660]  to further participate in the litigation.” The court was concerned that the policyholder may have given panel counsel confidential information pertaining to the coverage dispute.

But was disqualification really required? Before Section 2860 took effect, many assumed that only the independent attorney would defend the insured in conflict-producing reservation of rights situations. But Section 2860 was interpreted to “envision[] both the independent counsel and a carrier-appointed counsel cooperating on each case.” Rich Moratti, Note, “Reconstructing Cumis: What The California Legislature Got Wrong About California Civil Code Section 2860 And How To Fix It,” 60 Hastings L. J. 881, 889 (2009).

This dual-counsel arrangement, while not universal, has become a common and accepted approach. Panel and independent counsel work together to defend the case. See Novak v. Low Ball & Lynch, 77 Cal. App. 4th 278, 284 (1999) (characterizing the argument that panel counsel represented only the insurer’s interests as “an amazing proposition”). Independent counsel, in contrast, has very limited duties to the insurer. Independent counsel does not represent the insurer. Assurance Co. of America v. Haven, 32 Cal. App. 4th 78, 88-89 (1995).

A panel firm typically represents the policyholder as an attorney of record. While the panel firm also protects the insurer’s interest in defending, the panel firm is not there to be a “coverage spy” for the insurer. Dynamic Concepts, Inc. v. Truck Ins. Exch., 61 Cal. App. 4th 999, 1008.

The Schaefer court assumed disqualification was required because the panel defense attorney may have obtained confidential information. But that may not require disqualification. As the court mentioned in Dynamic Concepts, panel “defense counsel owes [a] duty not to reveal” the policyholder’s “confidential information … regarding coverage.”

A formal State Bar ethics opinion emphatically articulates the rule — even if “the attorney gains information during the course of representation which the attorney believes demonstrates that the insured is actually not entitled to coverage — the attorney nevertheless owes a duty to the insured/client not to reveal this information to the insurer.” Formal Opinion No. 1995-139.

Where a panel firm faces a conflict, Section 2860 seems to assume independent counsel’s presence protects the policyholder. Both independent and panel counsel have a duty to protect confidential or privileged information pertaining to the reserved coverage issues. The independent attorney’s ability to advise the client and control defense strategy alleviates any concern that panel counsel might make strategy decisions that will reduce or eliminate coverage.

Depending on the particular circumstances, decisions such as which defenses to advance, what evidence to try to develop through discovery, etc. are decisions for the policyholder client and its independent attorney. However, nothing stops the panel attorney (allowed “to participate in all aspects of the litigation”) from offering advice or carrying out these strategy decisions.

In fact, the “I only represent the insurer” approach Schaefer suggests seems impracticable, if not impossible. We cannot expect insurer-appointed attorneys to tell juries they represent the defendant’s liability insurer. Attorneys are either in the case, representing the policyholder, arguing motions and appearing at trial, or are merely monitoring the case for the insurer, without becoming an attorney of record.

A “monitoring” attorney acts either as a coverage attorney for the insurer, or as attorney who passively provides defense strategy suggestions to the policyholder’s attorney (or a second opinion on liability, damages and verdict range potential.) But monitoring attorneys do not make court appearances for policyholders. They generally do not have private discussions with policyholders.

Instead of disqualifying panel defense attorneys who receive confidential information relating to coverage, we should expect panel attorneys to carefully maintain client confidentiality and to vigilantly guard against inadvertent disclosures that pertain to disputed coverage issues. In those (hopefully) few instances when panel attorneys improperly disclose confidential information, the remedy Dynamic Concepts suggested ranges from “malpractice liability” or “disciplinary actions” to a “possible loss of coverage defenses by” the liability insurer.

With that serious potential downiside looming for panel attorneys who improperly share policyholder confidences (and for the insurers who appoint them), one would think the dual-counsel arrangement that has endured for 25 years can persist. And it can persist without persistent motions to disqualify panel counsel becoming a new routine feature of garden variety litigation.

David Ezra is a shareholder with the Berger Kahn law firm in Irvine. His practice concentrates on insurance law.