One of the main reasons policyholders purchase liability insurance is to ensure that they have an insurer-funded defense in the event of a potentially covered lawsuit. But when an insurer pays for a policyholder’s defense, it can raise certain conflicts and ethical issues, especially when the defense is subject to a reservation of rights.

Independent (Cumis) Counsel

San Diego Navy Federal Credit Union, et al. v. Cumis Ins. Society, Inc., 162 Cal.App.3d 358 (1984) (“Cumis”) established the right of a policyholder to select its own independent defense counsel (Cumis counsel) in situations where an insurer has a duty to defend and a potential conflict of interest arises. This right was later codified in Civil Code § 2860. Section 2860(b) specifically provides that “when an insurer reserves its rights on a given issue and the outcome of that coverage issue can be controlled by counsel first retained by the insurer for the defense of the claim, a conflict of interest may exist.” A classic example is when an insurer reserves the right to deny coverage for bodily injury or property damage that is expected or intended from the standpoint of the insured.

Insurer Billing Guidelines for Cumis Counsel

When insurers agree to provide Cumis counsel to a policyholder, they may insist on imposing billing guidelines which ostensibly limit or restrict the independent counsel’s ability to, among other things, conduct certain types of discovery, perform legal research, or hire experts. These guidelines arguably constitute improper and unethical restraints on defense counsel’s independent professional judgment. See Dynamic Concepts, Inc. v. Truck Ins. Exch., 61 Cal. App. 4th 999, 1009, n. 9 (1998). In fact, Cumis counsel may actually be barred from complying with these guidelines to the extent they interfere with the attorney’s independence of professional judgment. See California Rule of Professional Conduct 3-310(F)(1). Independent counsel should also be wary of guidelines that require submission of bills to a third-party auditor for review, as this can lead to disclosure of privileged information. See ABA Form. Opn. 01-421, fn. 7.

Conflicts Between Insureds

Finally, conflicts can also arise when an insurer is obligated to provide a defense to two or more of its insureds in the same action, such as when an insurer insures both the plaintiff and a cross-complaining defendant. See O’Morrow v. Borad, 27 Cal. 2d 794, 800 (1946) (requiring that insurer give up control of the defense).

Potential conflicts can also exist between co-defendants who are insured by the same insurance company, such as when an additional insured seeks to establish that its liability arises out of the insured’s conduct in order to obtain coverage under the insured’s policy. Cross-claims for indemnity and contribution can also create conflicts among co-defendants. All of these situations would call for an insurer to provide independent defense counsel.

Because the “tripartite relationship” that exists among an insured, its defense counsel, and its insurer can lead to conflicts and ethical dilemmas, attorneys whose clients are being defended by an insurer must always be mindful of these issues and carefully review reservation of rights letters so that they can adequately protect their clients’ interests.

Peter Roldan is a partner with Emergent LLP, a commercial litigation firm based in San Francisco. He represents policyholders in insurance coverage and bad faith litigation.