An Insurer’s Reservation of Rights Pertaining to Independent Contractors Created a Conflict of Interest Under Civil Code Section 2860

Schaefer v. Elder
(Cal. Ct. of App., 3d Dist.), filed May 16, 2013, published June 12, 2013

KEY FACTS

Steve Schaefer contracted with Kelly Elder, doing business as Elder Construction, to design and build a house.  Later, Schaefer sued Elder, for breach of contract, negligence, breach of implied warranty, strict liability, money lent, diversion of funds, failure to enter into a written contract, and excessive down payment.

Elder asked his insurer, CastlePoint National Insurance Company, to defend.  CastlePoint reserved its rights and appointed counsel to defend Elder.  CastlePoint’s reservation of rights was based on a policy provision, referred to as the contractor’s special condition.  It provided that the policy would not cover work independent contractors performed unless those independent contractors agreed to indemnify Elder and provided a certificate of insurance.

Elder engaged independent counsel and moved to disqualify the firm CastlePoint had appointed.  Elder also sought a determination that CastlePoint had a duty to provide “Cumis” counsel.  The trial court granted Elder’s motion.

HOLDING & REASONING 

The Court of Appeal affirmed.

The court concluded that CastlePoint’s reliance on the contractor’s special condition as a basis for reserving its rights created a conflict of interest between it and Elder.

In the case against Elder, the status of workers on the job was at issue.  They might have been Elder’s employees or might have been independent contractors.  If they were employees, then Elder’s policy would have covered his liability.

If they were independent contractors it would not.  It was in Elder’s interest to argue that the workers were employees while it was in CastlePoint’s interest to argue they were independent contractors.  Since appointed counsel would have to advise Elder on what to argue regarding the workers, there was a conflict of interest.

Elder was therefore entitled to “Cumis” counsel.  Because the firm CastlePoint appointed had represented both Elder and CastlePoint, it had to be disqualified.  The court noted that if the firm had represented only CastlePoint, it would have been permitted to continue to participate in Elder’s defense because Civil Code Section 2860 says:

“Where the insured selects independent counsel pursuant to the provisions of this section, both the counsel provided by the insurer and independent counsel selected by the insured shall be allowed to participate in all aspects of the litigation.”

ANALYSIS

This decision is likely to cause controversy, particularly with respect to the disqualification.  Insurer retained counsel usually represents the policyholder.  To “participate in all aspects of the litigation,” an attorney typically associates in as an attorney of record for the policyholder.  Where the reservation of rights creates a conflict of interest, independent counsel protects the policyholder by providing advice and exercising control over defense strategy issues.  This approach avoids interpreting Civil Code Section 2860 to allow disqualification of insurer-retained defense counsel.