RISKVUE ARCHIVE | FEATURE STORIES

The Policyholder’s Right to Select Defense Counsel, Part 2

By Thomas C. Mielenhausen
Lindquist & Vennum, PLLP

In the last issue of riskVue we discussed how the informed consent requirements in the Rules of Professional Conduct and fiduciary law effectively give a liability insurance policyholder the ultimate right to select defense counsel, regardless of the language in the policy. In this issue, we will discuss what information the policyholder should receive to give truly “informed” consent to representation by insurer-proposed defense counsel.

For “Informed” Consent, What Information Must the Insurer and Its Proposed Defense Counsel Provide To the Policyholder?

Courts typically define the “informed” part of informed consent broadly. It can include: (a) any information a lawyer obtains that may affect her client’s interests as to the matters entrusted to her; (b) any material matters bearing upon the lawyer’s duty of undivided loyalty or duty to protect confidentiality; and (c) adequate information and explanation about the material risks of and reasonably available alternatives to the lawyer’s proposed course of conduct. See, e.g., ABA Model Rules of Professional Conduct (“MRPC”) 1.0(f).

To meet these standards, the insurer and its proposed defense counsel must disclose all information necessary for the policyholder to assess whether a difference might arise between their interests and the policyholder’s, and whether those differences could:

• result in the proposed defense counsel or her law firm disfavoring the policyholder’s interests, even if inadvertently or unconsciously;
  
  
• jeopardize the confidentiality of information, including information protected by the attorney-client privilege and work product doctrine;
  
  
• interfere with the proposed defense counsel or her law firm’s independent professional judgment in considering alternatives; or
  
  
• foreclose courses of action that reasonably should be pursued on behalf of the policyholder.

See, e.g., MRCP 1.7, cmt. [8]; U.S. Fid. & Guar. Co. v. Louis A. Roser Co., Inc., 585 F.2d 932, 938 (8th Cir. 1978).

The following is a suggested outline, albeit not exhaustive, of the types of information the policyholder should request from the insurer and its proposed defense counsel, in order to make an informed decision as to legal representation.

All of Insurer’s Coverage Issues, and Whether Any Involve Facts or Strategies That Could Be Developed during the Course of the Defense

Coverage issues significantly increase the likelihood that differing interests between an insurer and its policyholder will arise. For a policyholder to give truly “informed” consent to representation by insurer-proposed defense counsel, the insurer must completely inform the policyholder and proposed counsel of any and all coverage issues that could create a risk of the counsel shifting liability—even if inadvertently or unconsciously—toward non-covered claims or damages.

Many coverage issues involve facts that might be investigated or discovered during the course of defending a claim against the policyholder, including issues regarding a policyholder’s knowledge, expectations or intent, and issues about fortuity, insurance-application misrepresentation, rescission, notice, timing, trigger of coverage, apportionment, recoupment or choice of law. The insurer’s failure or refusal to disclose all such issues increases the likelihood that insurer-selected defense counsel will inadvertently choose courses of action that disfavor the policyholder’s interests, compromise the confidentiality of information, or foreclose strategies that reasonably should be pursued on behalf of the policyholder. If a policyholder is not fully informed of all such coverage issues and the insurer’s conflicting interest in their outcome, or if the insurer does not expressly waive all such coverage issues, the policyholder is in no position to consent to representation by the lawyer chosen by the insurer.

Coverage issues can give rise to a host of opportunities for insurer-selected defense counsel to inadvertently or unconsciously shift liability from the insurer to the policyholder. For example, insurers sometimes argue that they have no duty to pay defense costs that can be clearly apportioned to non-covered claims, counterclaims or “satellite” litigation. An insurer-selected defense counsel inadvertently could record his time in a way that makes it appear his activities are related to purportedly non-covered claims, even though the activities were advantageous or necessary to defeat covered claims. Similarly, the policyholder’s interest is to resist any effort to apportion a settlement or judgment to non-covered claims. During settlement negotiations or in drafting an agreement, an insurance-selected defense counsel unconsciously could over-emphasize the importance or merit of a non-covered claim. During trial of the claims against the policyholder, insurance-selected defense counsel unconsciously could be less than zealous in arguing to the court that any attempt by the insurer to burden a verdict form with additional questions would severely prejudice the policyholder’s defense.

Similar problems arise in states where a liability insurer can withdraw from defending its policyholder after independently settling with the claimant all covered claims against the policyholder without the policyholder’s consent. As part of a vigorous defense against the claimant, the policyholder’s interest is to thwart a claimant from obtaining this type of settlement. But insurer-selected defense counsel unconsciously could be less than zealous in pursuing a strategy that disfavors the insurer. A policyholder-selected defense counsel, on the other hand, would employ various measures that disfavor the insurer, but that are necessary to provide the policyholder with a full defense.

Coverage issues can also create a situation where a policyholder may, without its insurer’s consent, enter into a settlement with the claimant whereby the policyholder confesses to a judgment and the claimant agrees to collect only against the insurer. As part of a vigorous defense against the claimant, the policyholder’s interest might be to set up the opportunity for this type of settlement, if possible, by forcing the case into a settlement posture where the insurer must admit or deny coverage, and then allocating the settlement favorably to the policyholder. But because the insurer would look disfavorably upon that defense strategy, an insurer-selected defense counsel unconsciously could be less than zealous in setting it up for the policyholder.

Coverage issues can generate concerns about leverage by the insurer against the policyholder, and vice-versa, during the course of the defense. By threatening a settlement of only covered claims or an expensive declaratory judgment action, an insurer might improperly attempt to pressure its policyholder into contributing to a settlement. The same concern applies to threats of a recoupment claim. Such leveraging efforts by the insurer impede and distract from the full and faithful defense to which a policyholder is entitled, yet an insurer-selected defense counsel unconsciously could be less than vigilant in resisting the insurer’s pressure. Conversely, a policyholder may need to pressure the insurer to waive coverage issues by threatening a settlement whereby claimant can collect only against the insurer. Unconsciously, an insurer-selected defense counsel could be less than zealous in applying such leverage against the insurer as part of his defense strategy.

Coverage issues can also raise concerns about defense counsel’s position on choice of law. In a future coverage action between the insurer and policyholder, the court might decide that the policyholder is bound by the same choice of law arguments its defense counsel made in the underlying action. Inadvertently, an insurer-selected defense counsel could argue for the law of a state that, on balance, has little impact on defense issues but significantly undercuts the policyholder’s interests as to coverage.

For a policyholder to give truly informed consent to representation by an insurer-proposed defense counsel, the insurer must completely inform the policyholder and defense counsel of all of the insurer’s potential coverage issues that could limit or eliminate the insurer’s defense and indemnity obligations, and whether any of those issues involve facts or strategies that could be developed during the defense. Without complete disclosure of that information, the policyholder is in no position to assess the likelihood that a difference in interests between the insurer and policyholder will eventuate. See MRCP 1.7, cmt. [8]. Representation by the insurer-proposed defense counsel would be improper, unless the insurer provides an express written waiver of all coverage issues, known or unknown, which involve facts or strategies that could be developed during the course of the defense.

All Ways Confidentiality of Information Could Be Jeopardized

The common law and Rules of Professional Conduct prohibit a lawyer from breaching the confidentiality of information relating to representation of a client, including information protected by the attorney-client privilege and work product doctrine. See, e.g., MRPC 1.6. For a policyholder to give truly informed consent to representation by an insurer-proposed defense counsel, the policyholder must be informed of the ways in which confidentiality of information relating to the policyholder’s interests could be jeopardized.

In reporting to an insurer, a policyholder’s defense counsel may not reveal confidential information that may adversely affect the policyholder’s interests, including information relating to any potential coverage issue that the insurer could assert to limit or eliminate its duty to defend or indemnify. ABA Comm. on Ethics and Prof’l Responsibility, Formal Op. 421 (2001). This prohibition applies regardless of whether the insurer has issued a reservation of rights identifying coverage issues. Restatement (Third) of the Law Governing Lawyers §§ 60(1)(a) & 134 cmt. f (2000).

As discussed above, most coverage issues involve facts that may be investigated or discovered during the course of defending the claim against the policyholder. Unless an insurer completely identifies and explains all of its potential coverage issues, and expressly waives all those not asserted, there is a significant risk that insurer-selected defense counsel, when reporting to the insurer, could inadvertently reveal confidential information supporting an undisclosed coverage issue against the policyholder. And, even as to coverage issues the insurer does disclose, an insurer-selected defense counsel unconsciously could be less than zealous in appreciating what kinds of confidential information could disfavor the policyholder if reported to the insurer.

Another risk relates to waiver of the attorney-client privilege. The privilege potentially may be waived through disclosure of information to a party who has an adverse interest as to that information. When an insurer defends its policyholder and expressly waives all coverage issues, known and unknown, the insurer and policyholder share a common interest and may exchange privileged information without risk of waiving the privilege. But when an insurer defends under a reservation of rights, the insurer and policyholder have both adverse and common interests. If the insurer-selected defense counsel reports privileged information to the insurer relating to the adverse interests, there is a risk that a court could deem the privilege waived as to that information and any similar confidential information. See Remington Arms Co. v. Liberty Mut. Ins. Co., 142 F.R.D. 408, 418 (D. Del. 1992) (observing that “common interest” exception to privilege waiver rule should not apply where there was an “atmosphere of uncertainty” as to scope of any identity of interest shared by policyholder and insurer).

All Potentially Divergent Interests Regarding Settlement

To meaningfully assess the likelihood that a difference in interests between the insurer and policyholder will arise, the policyholder must be completely informed about all potentially divergent interests relating to settlement of the claim against it. In many cases, it may be in the policyholder’s best interest to settle a case quickly, thereby avoiding drawn-out litigation that will distract a business’s employees and impair productivity and morale. A policyholder may also have a “wasting” insurance policy, in which the insurer deducts the defense costs it pays from the total coverage limits, thereby rapidly reducing the amount of coverage available for a future settlement or judgment. The claim may involve multiple insureds under the same policy, in which case the policyholder would want its case settled first before policy limits are depleted.

The insurer’s interest, on the other hand, could be to delay settlement as long as possible in order to gain maximum investment return on premium dollars and reserves. The insurer’s interest could be to wear down the claimant through extended litigation, in order to try to reduce the settlement amount it must pay, and to send a message to other claimants in unrelated cases that the insurer will not settle any case without a fight. Unconsciously, an insurer-selected defense counsel may have the same interest and motivation. In cases involving multiple insureds under the same policy, the insurer might favor one insured over another because of that insured’s relative exposure, future potential to buy additional insurance, or any other self-interested reason. All of these interests would diverge with the policyholder’s interest in moving on and focusing its time and energy on its business.

The reverse situation, of course, might also arise. For example, the policyholder may have an interest in not settling in order to preserve its reputation or long-term business interests, whereas the insurer may be attempting to clear its books of claims because it is exiting the market for the type of insurance involved. For truly informed consent, the policyholder must be completely informed of these divergent interests.

The policyholder must also be provided information to assess how zealously the insurer-proposed defense counsel will pursue a settlement at or just under policy limits. The policyholder’s interest may be to pursue such a settlement, because an insurer who forgoes such a settlement may be subjected to liability for the full amount of a verdict in excess of its policy limits. Often, an element of proving the insurer’s excess liability is the reasonableness of the within-limits settlement offer, and defense counsel’s settlement assessment and recommendation is an important part of that proof. But, unconsciously or not, an insurer-selected defense counsel may be less than zealous in doing what is necessary to set up an insurer for excess-of-limits liability.

The Nature and Extent of the Relationship between Insurer and Its Proposed Defense Counsel

To give truly informed consent to representation by an insurer-proposed defense counsel, a policyholder must be advised of the full nature and extent of the insurer’s relationship with the defense counsel and her law firm. Otherwise, the policyholder is not in a position to evaluate the likelihood that divergent interests of the insurer or defense counsel could impair the defense counsel’s duty of undivided loyalty to the policyholder’s interests, interfere with the counsel’s independent professional judgment in considering alternatives, or foreclose courses of action that reasonably should be pursued on the policyholder’s behalf.

Informed consent thus means that the insurer and insurer-proposed defense counsel must provide the policyholder with complete information relating to the closeness of the insurer’s relationship with the defense counsel and her law firm, all financial arrangements or other agreements between them, all ways in which the defense counsel and her law firm represents or provides legal services to or for the insurer, all of the defense counsel and her law firm’s express or implied responsibilities to the insurer, and any financial pressure or other leverage the insurer could unconsciously or deliberately use to influence the defense counsel or her law firm. The policyholder should insist that the insurer and defense counsel provide complete explanation and documentation in response to the following questions, among others:

• Has the insurer-proposed defense counsel or her law firm ever had a “coverage counsel” relationship with the insurer, or does it intend to have one in the future? Are the rates the insurer pays for coverage counsel work higher than the rates it pays for policyholder defense work? Has the defense counsel or her law firm ever advocated a coverage-limiting or coverage-defeating issue on behalf of the insurer? Has the defense counsel or her law firm ever advocated such an issue on behalf of any insurer as to any of the language contained in the policyholder’s standard form insurance policy? Has the defense counsel or her law firm ever advocated issues in favor of a policyholder and, if so, how many times in comparison to its coverage work in favor of insurers?
  
  
• Has the insurer-proposed defense counsel or her law firm ever had a “panel counsel” relationship with the insurer, or does it intend to have one in the future? What are the responsibilities and financial arrangements associated with the insurer’s relationship with the defense counsel and her law firm? In connection with that relationship, does the defense counsel or her law firm provide any legal advice or services that are not specific to a particular policyholder-defense file? Does the insurer have conferences, intranet sites or other means in which it seeks or receives such legal advice from its panel counsel? Will the insurer and defense counsel produce all agreements, requirements, expectations, policies, guidelines or similar documents relating to the panel counsel relationship?
  
  
• Does the insurer-proposed defense counsel or her law firm consider the insurer to be a past, existing or potential future client? Has the law firm’s lawyers, files or systems ever referred to the insurer as a client? Has the defense counsel or her law firm ever done policyholder-defense work for the insurer in a state where the insurer is considered a client by virtue of that defense work? Are there any other indicia that the insurer is or is perceived as a client?
  
  
• What is the nature and extent of the insurer-proposed defense counsel and her law firm’s connections with the insurer’s employees, officers and directors? Has the law firm or insurer ever sponsored private meetings or other events involving communications between their personnel that are not specific to a particular policyholder-defense file?
  
  
• What percentage of the insurer-proposed defense counsel and her law firm’s hours and billings are associated with the insurer, and with other insurers? Does the defense counsel or her law firm wish to increase its business from the insurer? What would happen if they no longer received business from the insurer?

Most courts recognize that a lawyer and her law firm have a duty of undivided and unquestioned loyalty to their clients’ interests, regardless of their conscious intent, motives or good faith. The informed consent requirement means that the policyholder, not just the insurer-proposed defense counsel, must be able to assess the likelihood that the counsel’s loyalty could be breached. The policyholder is not in a reasonable position to make that assessment without the type of information listed above.

All Insurer Limitations on Authorization and Payment for Legal Services

The insurer and its proposed defense counsel must explain and document to the policyholder all of the insurer’s litigation guidelines, fee and expense restrictions, internal and external audit procedures, write-off practices, and any other limitation on the insurer’s authorization and payment for legal services to be provided by the defense counsel and her law firm to the policyholder. Otherwise, the policyholder is not in a reasonable position to give informed consent, because it cannot assess the likelihood that any or all such limitations could restrict the diligence and competence of the proposed defense counsel’s representation, materially interfere with the proposed defense counsel’s independent professional judgment in considering alternatives, and foreclose defense activities that reasonably should be pursued on the policyholder’s behalf.

An insurer’s guidelines and restrictions on authorization and payment for defense activities can result in significant financial pressure on an insurer-selected defense counsel and her law firm. Insurance defense firms may try to overcome the negative impact of the substantially discounted rates demanded by the insurer, and the insurer’s non-payment for necessary defense activities, by significantly increasing the volume of files it handles for the insurer, and shifting much of the heightened workload on files to underpaid associate lawyers with lower rates and limited experience. The volume of files and inexperience of an assigned lawyer could result in delay and an ineffective defense, thereby impairing the ability of the lawyer’s ability to provide diligent and competent representation to the policyholder.

Again, the good intentions and motivations of the insurer-proposed defense counsel are irrelevant. She may believe in good faith that the insurer’s litigation guidelines and payment restrictions will not impair her services and decisions. But informed consent means that the policyholder is entitled to make that assessment based upon complete information provided by the insurer and its proposed defense counsel. They may not put the policyholder in a position of merely having to accept their beliefs and assurances.

Conclusion

When a liability insurer proposes defense counsel to represent its policyholder, the insurer and its proposed counsel must obtain the policyholder’s informed consent to the representation. In exercising its right to truly “informed” consent, the policyholder should insist that the insurer and its proposed defense counsel provide complete information and documentation on all matters that might adversely affect the policyholder’s interests, including: (a) all of the insurer’s coverage issues, and whether any involve facts or strategies that could be developed during the course of the defense; (b) all of the ways in which confidentiality of information could be jeopardized through the proposed counsel’s representation; (c) all of the insurer’s potentially divergent interests regarding settlement; (d) the exact nature and extent of the relationship between insurer and its proposed defense counsel; and (e) all of the insurer’s limitations on authorization and payment for legal services.

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In the next issue of riskVue, we will discuss when it is reasonable for a policyholder to withhold its consent to representation by insurer-proposed defense counsel, and make its own selection of defense counsel to be paid by the insurer.

Read The Policyholder's Right to Select Defense Counsel (Part 1)
Read The Policyholder's Right to Select Defense Counsel (Part 3)

ABOUT THE AUTHOR

Thomas Mielenhausen is co-chair of Lindquist & Vennum’s Insurance Recovery practice group. He can be reached at 612-371-3559 or tmielenhausen@lindquist.com.

This article is only a general summary for informational purposes and does not constitute legal advice. Consult a qualified and experienced insurance advisor for your specific situation or particular questions.

riskVue | The webzine for risk management professionals
December 2006