The independent counsel doctrine and legal advice on insurance coverage – a review of US case law

February 24th, 2016
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Feature - Botes

By Marietjie Botes

Litigious matters of large companies often involve complex legal issues, which may also result in complex insurance issues.

The tripartite relationship between insurer, insured and legal representative originates from the standard liability insurance policy, which typically provides protection against damages arising from a claim against the insured company and the legal costs for defending such a claim. Unless the claim against the insured company clearly shows no grounds for insurance coverage, the insurer will generally defend the claim on behalf of the insured. For these defences the insurer will normally appoint a defence attorney (from their panel of attorneys) with whom they have an ongoing relationship, while the appointed attorney and the insured company will only have limited interaction for the duration of the matter.

Considering the difference and degree of interaction between the parties to this tripartite relationship, it is clear that conflicting interests may arise. In United States Fidelity & Guar. Co. v Louis A. Roser Co. 585 F2d 932 n.5 (8th Cir. 1978) the court vocalised this concern by stating that –

‘… the most optimistic view of human nature requires us to realize that an attorney employed by an insurance company will slant his efforts, perhaps unconsciously, in the interests of his real client – the one who is paying his fee and from whom he hopes to receive future business – the insurance company’.

My experience with the conflict of interests between a large corporate client, with international dealings, and its insurance company, led me to investigate the below issues which, although not yet embedded in our legal system, is worth noting for future similar developments in South Africa’s legal system. Accordingly, considering that case law dealing with these issues is extremely rare in the United States of America (US) and non-existing in South Africa, I will, therefore, only discuss the US case law.

The independent counsel doctrine

The principle that an insured, notwithstanding the insurer’s reservation of rights in this regard, may choose its own attorney (counsel), or so-called off-panel representation is called the independent counsel doctrine in the US.

Globally, insurance companies are increasingly implementing Service Level Agreements containing stringent billing guidelines that often mandate attorneys to first obtain approval from the insurer before proceeding with particular litigation activities such as discovery, pre-
trials, etcetera. In this regard the court, in the matter of The Rules of Professional Conduct and Insurer Imposed Billing Rules and Procedure, 2 P.3d 806. 814 (Mont. 2000), held that:

‘… the requirement of prior approval fundamentally interferes with defence counsel’s exercise of their independent judgement.’

By limiting an attorney’s independent judgement in this way, it is easy to see how major disputes may arise between parties of the tripartite relationship regarding litigation strategy and its effect on issues such as the insured company’s reputation and commercial relations with international business partners, the bottom line of the insurer and legal fees.

When these disputes indeed arise, or are foreseen prior to involving the insurer (see discussion below), or when the insured refuses to accept the appointment of specific legal representation by the insurer in accordance with the insurance policy, the policy holder should be entitled to choose its own defence attorney, whose reasonable fee is to be paid by the insurance company, especially considering that most corporate clients already have their own trusted attorneys with whom they have a long and ongoing relationship.

In San Diego Navy Federal Credit Union v Cumis Insurance Society, Inc, 208 Cal. Rptr. 494 (Cal. App. 1984) the court held that where the policyholder does not consent to representation by the insurance company’s chosen counsel, the insurance company must pay the reasonable cost of independent counsel hired by the policyholder.

The court in CHI of Alaska, Inc. v Employers Reinsurance Corp., 844 P.2d 1113 (Alaska 1993) held similar convictions and determined that –

‘… the general rule is that, if an insured refuses to accede to the insurer’s reservation of rights, the carrier must either accept liability under the policy and defend unconditionally or surrender control of the defence’.

It is, however, questionable whether South African insurance companies will pay the fees of independent legal representation appointed by the policy holder if they have to surrender control of the litigation process. In my experience, the insurance company is willing to pay same, on condition that they remain very closely involved in the whole litigation process.

Legal advice on insurance coverage

Although s 3(2) of the Contingency Fees Act 66 of 1997 allows juristic persons to enter into contingency fees agreements, corporate clients never sign such agreements, as opposed to individuals who cannot afford legal services and claim for damages resulting from personal injuries, as it is generally accepted that companies will have the necessary means to pay legal fees, thus there seems to be no need for legal representatives to carry the risk of cost recovery. Accordingly, attorneys hardly ever discuss litigation financing options with corporate clients as provided for in s 3(3)(b)(i) of the Contingency Fees Act.

Policies providing insurance coverage for liability generally also include coverage of legal fees incurred to defend such actions instituted against the policy holder. Subsequently, an insurance claim may provide to be one viable form of litigation financing. However, considering that commercial litigation usually entail complex legal and business issues, attorneys are usually so involved with the management of these issues that inquiring about and advising a corporate client regarding insurance coverage as a form of financing litigation costs and escaping financial liability, hardly ever surface. But in some circumstances a legal malpractice action may be instituted against an attorney for failing to investigate such insurance coverage.

This is exactly what happened with Darby & Darby P.C. v VSI International Inc et al 1 No. 114 2000 NY Int. 111 (Darby), one of America’s oldest intellectual property firms. Darby defended VSI in two patent, trademark and trade dress infringement cases. Eventually VSI fell behind with the payment of Darby’s bills and VSI’s files were turned over to new counsel, who immediately advised VSI that the company’s comprehensive general liability (CGL) insurance policy might cover the legal fees and costs incurred by Darby in the initial litigation. VSI’s insurance carrier agreed to pay VSI’s legal fees going forward, but denied coverage of all legal expenses VSI incurred prior to filing their insurance claim. Darby sued VSI for their outstanding legal fees and VSI responded with a counter claim based on legal malpractice committed by Darby for their failure to advice VSI that their insurance might cover the defence litigation costs.

During the ensuing hearing Darby argued that:

‘… [their professional duties and responsibilities as VSI’s attorneys] only extended to the actual litigation and that it was not incumbent upon the law firm to advise the defendants about matters which related to the financing of the litigation’

and ‘… [that VSI] had the sole responsibility for realizing that the policy might cover the lawsuits against them and for submitting a claim for coverage.’

VSI countered by arguing that:

‘… [an attorney who is retained to represent a client in litigation] is not merely a technician whose responsibilities … are limited to legal strategy … [but also] a counsellor who has a duty to advise a client who has been sued on all matters pertaining to the litigation so as to minimize the client’s liability.’

Eventually on appeal a unanimous panel decided this dispute and held that:

‘In the absence of a factual assertion that the scope of the task for which counsel was retained specifically included inquiry into the nature and extent of its insurance coverage and whether it was applicable to the claim, the retention of counsel for the defence of such an action simply does not include any responsibility for assisting the client in determining whether sources exist from which to pay for that defence and any ultimate liability finding.

[There is] no support for the proposition that an attorney who was retained to defend a business client in intellectual property litigation has a duty to inquire into the existence, nature and scope of insurance policies previously procured by the client, and to determine whether any such policy provides the client with any entitlement in relation to the claim being litigated.

[T]his court will not impose an obligation upon a law firm not otherwise imposed by law, based upon the tasks performed by successor counsel.’

Accordingly an attorney’s duty to advise clients about all available causes of action and avenues of defence does not include a broad duty to inquire into the client’s insurance coverage. The court made it clear that it was VSI themselves who procured the general liability insurance policy and thus their duty to access coverage in respect thereof.

In another matter, O’Shea v Brennan, 2004 WL 583766 (S.D.N.Y. 2004), Brennan similarly instituted a counter claim against O’Shea resulting from alleged legal malpractice for failing to advise him about insurance coverage, when O’Shea sued Brennan for outstanding legal fees resulting from legal services rendered in a defamation matter. In this matter the court held that:

‘… it is not clear, given the complexity of the law in this area, whether a jury could conclude, without the benefit of expert testimony, either that O’Shea’s failure to advise his client about his insurance coverage was a breach of his professional duty of care or that his conduct caused the defendant’s alleged damages.’

By critically considering these cases it is clear that an attorney may not always escape liability for failing to advise on insurance coverage, but rather that the nature or complexity of the theory or possibility of coverage must be considered before liability is decided. If the availability of insurance coverage is clear and simple at the time an attorney is appointed, there will be no excuse for failing to advise a client regarding insurance coverage, and might the courts, under such circumstances, have reached different conclusions to the above discussed matters.

Whether an attorney would be negligent by failing to advise a client on insurance coverage would primarily turn on the scope of the client’s mandate, which is ultimately a question of fact, and if, considering all relevant circumstances, an attorney failed to exercise reasonable skill and knowledge commonly possessed by a member of the legal profession.

In this regard the court, in the matter of Fireman’s Fund Ins. Co. v Farrell 289 AD2d 286 [2001] and Perks v Lauto & Garabedian, 306 AD2d 261 [2003] held that an attorney’s duty to investigate insurance coverage arises only if the attorney is in a better position than the client to ascertain the existence of such coverage.

‘[W]here the circumstances are such that the client has superior or equal knowledge of potential sources of additional coverage, unless requested to investigate by the client, the attorney has no duty to explore hypothetical theories of additional insurance coverage.’

The above issues and debates have only started in the US and I foresee that it is only a matter of time before the South African courts will be faced with similar disputes. In the meantime I would advise colleagues to promptly advise clients to ascertain whether they have insurance coverage for the legal issues or litigation you have been mandated with, alternatively ask for a copy of their complete insurance policy and propose a legal opinion regarding their possible insurance coverage, to avoid any notification to, and consultation with your own professional liability insurer.

Marietjie Botes BProc LLB (UP) LLM (Intellectual Property) (Unisa) is an attorney at Dyason Inc in Pretoria.

This article was first published in De Rebus in 2016 (March) DR 24.

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