Defense Counsel Can Be Accountable to the Insurance Carrier for Malpractice

An insured who is provided a defense and indemnity by its carrier has no incentive to pursue a malpractice action against defense counsel when the carrier is forced to settle the action because defense counsel's misfeasance or omission compromised the defense of the action. In such a circumstance, the insured has not suffered any pecuniary loss and therefore has no reason to sue its counsel for malpractice .

However, the defalcating defense counsel may find itself the subject of a legal malpractice action, not by the client/insured, but by the insurance carrier which paid an increased judgment or a larger settlement to protect itself and the insured from a greater judgment due to defense counsel's malpractice. Under certain circumstances, the insurer can sue defense counsel for legal malpractice either based upon a breach of the attorney-client relationship between the insurer and defense counsel, or based upon the doctrine of equitable subrogation.


An Attorney-Client Relationship Between Insurer and Defense Counsel

Many jurisdictions recognize the existence of a tripartite relationship whereby defense counsel represents the interests of both the insurer and insured. Unigard Ins. Group v. O'Flaherty & Belgum, 38 Cal.App.4th 1229, 45 Cal.Rptr.2d 565 (1995); Nandorf, Inc. v. CNA Insurance Companies, 134 Ill.App.3d 134, 479 N.E.2d 988 (1985); Gray v. Commercial Union Ins. Co., 191 N.J.Super. 590, 468 A.2d 721 (1983). Some courts have held that an insurer can sue defense counsel for legal malpractice based upon the tripartite relationship creating an attorney-client relationship between the attorney and insured, as well as the attorney and insurer. See, Unigard Insurance Group v. O'Flaherty & Belgum, supra, 38 Cal.App.4th at 1236-1237 (1995). In Unigard, the plaintiff insurer filed its complaint premised upon an independent right to assert a malpractice claim against defense counsel for its allegedly negligent representation of the insured. The Unigard court held that when, pursuant to insurance company obligations, an insurer hired counsel to defend its insured, the retained attorney owes a duty of care to the insurer which will support its independent right to bring a legal malpractice action for acts committed in the representation of the insured, provided the interests of the insurer and insured are not in conflict. Id. at 1236-1237.

The Unigard court adopted the rationale for its conclusion from Atlanta Intern. Ins. Co. v. Bell, 438 Mich. 512, 475 N.W.2d 294 (1991). The Bell court declined to find an attorney-client relationship between an insurer and insurer and defense counsel, reasoning that a rule of law expanding the parameters of the attorney-client relationship in the defense counsel-insurer context might well detract from the attorney's duty of loyalty to the client in a potentially conflict-ridden setting. Despite this, both the Unigard and Bell courts recognized that to completely absolve a negligent defense counsel from malpractice liability would not rationally advance the attorney-client relationship. Moreover, defense counsel's immunity from suit by the insurer would place the loss for the attorney's misconduct on the insurer. The only winner produced by an analysis precluding liability would be the malpracticing attorney. The Unigard court recognized that in a malpractice action against defense counsel, the interests of the insurer and the insured generally merge. The client and the insurer both have the interest in not having the case compromised because of attorney malpractice. The best interest of both insurer and insured converge in expectations of competent representation. The Unigard court therefore concluded “that where the insurer hires counsel to defend its insured and does not raise or reserve any coverage dispute, and where there is otherwise no actual or apparent conflict of interest between the insurer and the insured which would preclude an attorney from representing both, the attorney has a dual attorney-client relationship with both insurer and insured.” Id. at 1236-1237.

The California Court of Appeal very recently applied the Unigard holding in Gulf Insurance Company v. Berger, Kahn, Shafton, Moss, Figler, Simon & Gladstone, __ Cal.App.4th __, 93 Cal.Rptr.2d 534, 2000 WL 284066 (Feb. 17, 2000). Gulf involved a legal malpractice action within a legal malpractice action. In the underlying action, Coleman sued his attorney and a legal services plan (the “Plan defendants”) for allegedly mishandling Coleman's bankruptcy and related issues. As to the Plan defendants, Coleman asserted breach of contract and negligence theories on the grounds that the plan failed to investigate the lawyer's qualifications and abilities and negligently referred the lawyer to the Coleman matter. The Plan defendants, which were insured by Gulf, retained Berger, Kahn to defend it in the Coleman action. Gulf consented to the retention upon the condition that Berger, Kahn agree to and sign Gulf's written defense guidelines and insure that Gulf participated in key decisions involving strategy, motions, discovery, experts and settlement. Gulf also wrote a letter to the insured advising that it was assuming the defense with a full reservation of all rights under the law and the insurance policies. Berger, Kahn never asserted any conflict of interest in representing both the Plan defendants and Gulf, and never sought to be appointed independent or “Cumis” counsel.

Berger, Kahn failed to take any action to prepare a defense of the Coleman action other than tender the Plan defendants’ defense to another carrier who only had $100,000 of eroding limits. When the tender was accepted and new counsel appointed, only weeks before trial, the case had been compromised because Berger, Kahn failed to conduct any investigation or discovery. Gulf was required to pay Coleman's $1 million settlement demand the day before trial because of Berger, Kahn’s failures.

Thereafter, Gulf sued Berger, Kahn for negligence and breach of contract. Berger, Kahn moved for summary judgment on the grounds that Gulf lacked standing to sue and could not establish causation. With respect to the former, Berger, Kahn argued that it had no attorney-client relationship with Gulf because Gulf assumed the defense under a full reservation of rights. The trial court granted Berger, Kahn summary judgment in part based on the Unigard decision, concluding that Gulf's reservation of rights created a conflict of interest so that Gulf lacked standing.

The court of appeal in Gulf reversed the trial court’s grant of summary judgment. First, the Gulf court analyzed whether an attorney-client relationship existed between Gulf and Berger, Kahn. The Gulf court rejected Berger, Kahn's argument that no attorney-client relationship existed because the Plan defendants, not Gulf, first hired Berger, Kahn. The court stated that whether an attorney-client relationship is established is not determined by who was first to contact defense counsel, but rather with whom the attorney-client relationship was established. The Gulf court concluded that Berger, Kahn was counsel for both the Plan defendants and Gulf because it was clear that the Plan defendants selected counsel acceptable to Gulf and that Gulf’s acceptance of Berger, Kahn as defense counsel was conditioned upon it following Gulf's defense guidelines, which in fact Berger, Kahn did, including negotiating an increased hourly rate.

Having established that an attorney-client relationship existed between Gulf and Berger, Kahn, the Gulf court next determined whether Gulf could sue Berger, Kahn for alleged malpractice committed while representing the Plan defendants. Applying the rationale and holding of the Unigard decision, the Gulf court concluded that Gulf could sue Berger, Kahn so long as there existed no conflict of interest in Berger, Kahn's dual representation of Gulf and the Plan defendants. Although Gulf had stated it was reserving its rights, the Gulf court recognized that not every reservation of rights creates a conflict of interest requiring appointment of independent counsel. The court stated that there “is no talismanic rule that allows a facile determination of whether a disqualifying conflict of interest exists.” A disqualifying conflict exists if insurance counsel had incentive to attach liability to the insured where defense counsel was defending both covered and uncovered claims. Based on these principles, the Gulf court concluded that Berger, Kahn had no conflict that precluded Gulf from suing them for malpractice. The reservation of rights asserted by Gulf was largely general in nature and for protecting against unknown eventualities that might subsequently arise. The Gulf court further concluded that Berger, Kahn could not have had the ability to transfer liability from the covered negligence claims to the uncovered breach of contract claim because essentially the same factual charges formed the basis for both claims. If Berger, Kahn could defeat liability on the covered claim, it could also defeat liability on the uncovered claim such that it could not transfer liability from covered to uncovered claims by presenting different facts. Id. at 11.

Lessons Learned by the Gulf Decision

A number of important lessons can be learned from the Gulf decision. First, the decision reinforces that, at least in California, an insurance carrier in certain circumstances can assert a legal malpractice claim against defense counsel. Second, the mere fact that defense counsel was not originally retained by the carrier does not affect the carrier's standing to sue for malpractice. Instead, the court should analyze whether a tripartite relationship existed which created an attorney-client relationship between the insurer and defense counsel. Finally, the Gulf decision emphasized that not every reservation of rights creates a conflict of interest which can preclude the insurer from suing defense counsel. A general reservation or rights, without more, does not create an apparent or actual conflict of interest. Instead, a court will look to the facts supporting the covered and uncovered causes of action to determine whether defense counsel can transfer liability from covered to uncovered claims by presenting or developing different facts.

Jurisdictions Which Do Not Recognize A Dual Attorney-Client Relationship

Some jurisdictions have declined to recognize the existence of a dual attorney-client relationship created by the tripartite relationship. Instead, these jurisdictions rely on the attorney’s ethical obligation to act consistent with the insured’s best interest, and the insured’s ability to sue the insurer for bad faith.

A good example of this approach was recently set forth in Finley v. Home Ins. Co., 90 Haw. 25, 275 P.2d 1145 (1998). In Finley, the Hawaii Supreme Court declined to follow other jurisdictions, including California, which recognize a dual attorney-client relationship between the attorney and insured, as well as the attorney and insurer, when the insurer is required to provide a defense to its insured. Instead, the court adopted the view that any conflict of interest created by an insurer’s reservation of its rights when providing a defense to the insured is to be left to the integrity of retained defense counsel to protect the interests of the insured by following the Hawaii Rules of Professional Conduct.

In Finley , plaintiffs obtained an assignment of rights to recoup unreimbursed attorney’s fees of the independent counsel of an insured defendant. Plaintiffs then sought to obtain the unreimbursed attorneys fees from the insurer, Hawaii Insurance Guaranty Association (“HIGA”). Plaintiffs sought the unreimbursed attorney’s fees on the ground that the insured was entitled to reimbursement of fees for its independent counsel because HIGA asserted a reservation of rights which allegedly created a conflict of interest. The Hawaii Supreme Court in Finley denied plaintiff’s recovery of attorney’s fees incurred by the insured’s independent counsel. The Finley court held that a dual attorney-client relationship is not created when an insurer retains defense counsel for an insured. Further, an insured does not have the right to select independent counsel to represent its interest solely due to an insurer’s reservation of rights. The Finley court reasoned that adequate safeguards existed to protect the insured in the case of misconduct by appointed defense counsel or the insurer. First, the court noted that appointed defense counsel is obligated to follow the mandates of the Hawaii Rules of Professional Conduct, requiring counsel to solely represent the insured when a conflict arises between the interest of the insurer and the insured. Id. at 32. If appointed defense counsel fails to abide by the rules of professional conduct, and favor the interest of the insurer over the insured, the insured can protect itself by suing appointed defense counsel for malpractice. Second, the insurer can be sued for bad faith if it directs appointed defense counsel to steer liability to uncovered versus uncovered claims.

The Finley court recognized that some jurisdictions lack faith in the ability of retained counsel to place the interest of the insured above the attorney’s alleged interest in future employment by the insurer. However, the Finley court believed that an attorney may accept payment for defense of the insured without compromising his or her duty of loyalty to the client. Citing Federal Ins. Co. X-Rite, Inc., 748 F.Supp. 1223, 1229 (W.D.Mich. 1990), the Finley court agreed that it was unable to conclude that an insurer, who under a reservation of rights participates in the selection of counsel, automatically breaches its duty of good faith. The court also declined to apply the conclusive presumption that counsel will be unable to fully represent its client, the insured, without consciously or unconsciously comprising the insured’s interests.

The rationale followed by the Hawaii Supreme Court in Finley precludes an insurer from bringing a legal malpractice action against retained defense counsel because no attorney-client relationship is recognized in Hawaii between the insurer and appointed defense counsel. In Gulf, supra, the insurer was required to protect its insured by paying a substantial settlement because the defense of the insured had been compromised by defense counsel. If these facts were applied under Hawaii law, the insurer would have no remedy against defense counsel even though the latter's malpractice caused damages to the insurer. The Hawaii courts have not yet addressed this issue in any published opinion. Likewise, the Hawaii courts have not addressed whether an insurer can seek equitable subrogation against defense counsel in such a situation.

Defense Counsel May Be Sued For Malpractice Based Upon The Doctrine Of Equitable Subrogation

Some jurisdictions have declined to recognize an attorney-client relationship between an insurer and defense counsel, but have recognized that to do so may absolve negligent defense counsel from liability where the insurer, rather than the insured, has been damaged. These jurisdictions have instead applied the doctrine of equitable subrogation, allowing the insurer to stand in the shoes of the insured to pursue a legal malpractice action against defense counsel.

In Atlanta International Insurance Company v. Bell, 438 Mich. 512, 475 N.W.2d 294 (1991), the Supreme Court of Michigan declined to recognize an attorney-client relationship between an insurer and defense counsel. The court stated that to hold an attorney-client relationship between insurer and defense counsel could indeed “work mischief” because of an attorney's duty of loyalty to the insured and a potential for a conflict of interest by the insurer, which hired defense counsel. However, the Bell court also recognized that to hold that a mere commercial relationship exists between an insurer and defense counsel would work obfuscation and injustice. The court therefore held that the gap is best bridged by resort to the doctrine of equitable subrogation to allow recovery by the insurer. The court stated that equitable subrogation best vindicates the attorney-client relationship and the interests of the insured, properly imposing the social costs of malpractice where they belong. Allowing the insurer to stand in the shoes of the insured under the doctrine of equitable subrogation best serves the public policy underlying the attorney-client relationship by minimizing conflicts of interest. Id. at 297. See also, American Centennial Insurance Co. v. Canal Insurance Co., 843 S.W.2d 480 (Tex. 1992); Allstate Insurance Co. v. American Transit Insurance Co., 977 F.Supp. 197 (E.D. N.Y. 1997) (under New York law, excess insurer may sue insured's attorney hired by primary liability insurer for malpractice under theory of equitable subrogation); National Union Fire Insurance Co. v. Dowd & Dowd, 2 F.Supp.2d 1013, 1024 (N.D. Ill. 1998) (“it would be inequitable to place the burden of legal malpractice upon the excess insurer, allowing a negligent attorney to escape the consequences of his misconduct, merely because the insured lacks the economic incentive to sue”).

Thus, some jurisdictions have declined to recognize an attorney-client relationship between an insurer and defense counsel. These jurisdictions instead have applied the “legal fiction” of equitable subrogation to provide a remedy to the insurer and avoid the unjust result of negligent defense counsel avoiding responsibility for its misfeasance.

Conclusion

Retained defense counsel cannot be cavalier in its defense of the insured on the assumption that the only adverse consequence will be that the insurer will be left holding the bag. A number of courts have either recognized an attorney-client relationship between insurer and defense counsel or applied the doctrine of equitable subrogation to remedy this otherwise unjust result.

The Gulf decision applied a broader depth of facts to California’s recognition that the tripartite relationship may create an attorney-client relationship between an insurer and defense counsel which can create standing for an insurer to sue defense counsel for malpractice when defending the insured. Other jurisdictions do not recognize an attorney-client relationship between an insurer and defense counsel. In these jurisdictions a defalcating lawyer may escape liability for its malpractice because the insurer lacks standing to sue defense counsel and the insured has no incentive to do so because it was indemnified by the insurer. Some jurisdictions have recognized the inequitable and unjust result created by declining to recognize an attorney-client relationship between an insurer and defense counsel. These jurisdictions have invoked the doctrine of equitable subrogation to remedy this otherwise inequitable result and allow the insurer to hold defense counsel responsible for its negligent conduct.