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Chi of Alaska, Inc. v. Employers Reinsurance Corp. (1/15/93), 844 P 2d 1113
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Notice: This is subject to formal correction before
publication in the Pacific Reporter. Readers are
requested to bring typographical or other formal errors
to the attention of the Clerk of the Appellate Courts,
303 K Street, Anchorage, Alaska 99501, in order that
corrections may be made prior to permanent publication.
THE SUPREME COURT OF THE STATE OF ALASKA
CHI OF ALASKA, INC., )
) Supreme Court No. S-4323
Appellant, )
) Trial Court No.
v. ) 3AN-90-1610 Civil
)
EMPLOYERS REINSURANCE ) O P I N I O N
CORPORATION, )
)
Appellee. ) [No. 3917, January 15, 1993]
______________________________)
Appeal from the Superior Court of the
State of Alaska, Third Judicial District,
Anchorage,
Dana Fabe, Judge.
Appearances: Brett von Gemmingen,
Anchorage, for Appellant. Michael N. White,
Nicole R. Faghin, Preston, Thorgrimson,
Shidler, Gates & Ellis, Anchorage, for
Appellee.
Before: Rabinowitz, Chief Justice,
Burke, Matthews, Compton, and Moore,
Justices.
MATTHEWS, Justice.
MOORE, Justice, concurring in part and dissenting
in part.
COMPTON, Justice, dissenting.
A seaman aboard a vessel owned by Oceanic Research
Services, Inc. (Oceanic) accidentally sustained serious injuries.
Oceanic believed it was insured against the loss by a $500,000
bodily injury insurance policy it purchased through CHI of
Alaska, Inc. (CHI). That policy, however, actually had a bodily
injury limit of only $100,000. Oceanic sued CHI, asserting
contract and negligent tort claims, as well as a claim that CHI
had intentionally misrepresented that the policy coverage was
$500,000. Oceanic sought compensatory and punitive damages.
CHI tendered the defense of this suit to its liability
insurer, Employers Reinsurance Corporation (Employers).
Employers agreed to defend CHI, conditional on reserving its
rights to disclaim coverage with respect to Oceanic's claim of
intentional misconduct. Employers claimed that intentional
misconduct would be excluded under the policy if such misconduct
was ratified by CHI.
CHI objected, noting that the reservation of rights
created a conflict of interest between Employers and CHI, and
demanded independent counsel paid for by Employers and selected
by CHI. CHI stated that it wanted its personal attorney Brett
von Gemmingen to defend it. Employers expressed reservations
about von Gemmingen's experience in handling claims of this
nature and suggested that CHI provide the names of other
attorneys with more experience who might be retained by Employers
to defend CHI. This was not acceptable to CHI. Next Employers
offered to pay von Gemmingen to defend that portion of the
lawsuit pertaining to the intentional misconduct claim while
retaining the law firm of Hughes, Thorsness, Gantz, Powell &
Brundin to act as co-counsel for CHI with responsibility for the
defense of all claims. CHI declined this offer. CHI then
brought the present action for declaratory relief, seeking
vindication of its position that it is entitled to select
independent counsel. In the meanwhile, the Oceanic case has been
jointly defended by Hughes Thorsness and von Gemmingen.
CHI and Employers each moved for summary judgment in
the present case. CHI contended that there was necessarily a
conflict of interest between CHI and Employers respecting the
defense of Oceanic's claim because Employers could win either by
defeating all claims of liability or by establishing that CHI is
liable for intentional misconduct. Given this conflict of
interest, CHI contended that Employers should have no role in the
selection of defense counsel because any attorney selected by an
insurance company "will attempt to help his real client, the
insurance company, at the expense of the insured." CHI argued
that the retention of von Gemmingen "to defend claims as they are
pushed outside the policy coverage does not resolve the
conflict." Instead, dual representation, according to CHI, would
still permit the attorney hired by the insurance company to work
against the interests of the insured and in addition would cause
confusion concerning who is to control various litigation
decisions. In response and in support of its motion for summary
judgment, Employers argued that potential conflicts were
eliminated by allowing CHI to have its personal attorney handle
the non-covered claim at Employers' expense.
The superior court granted Employers' motion for
summary judgment. The court ruled that Employers' offer to allow
CHI to retain counsel of its choice to defend it on the
intentional tort claim adequately resolved potential conflicts of
interest. In addition, the court stated that if CHI contends at
the conclusion of the Oceanic lawsuit "that a conflict existed
despite Employers' action in allowing it to retain its own
counsel to defend uncovered claims, then it can raise this issue
at the coverage trial." Following the order granting Employers'
motion for summary judgment, a final judgment was entered which
contained no explicit declaration. CHI has appealed from this
judgment.
There are three issues on appeal:
1. Did Employers' reservation of rights to disclaim
coverage give CHI a right to retain independent
counsel?
2. Does the two-counsel scheme proposed by Employers
and approved by the superior court satisfy CHI's right
to independent counsel?
3. Does CHI have the unilateral right to select
independent counsel?
We turn to a discussion of these issues.
1. Did Employers' reservation of rights to disclaim
coverage give CHI a right to retain independent
counsel?
We answer this question in the affirmative.
Liability insurers have separate duties to defend and
to indemnify their insureds.1 In order to discharge their duty
to defend, insurers hire counsel to conduct the defense of their
insureds.2 Often there is no conflict of interest between the
interests of the insurers and the interests of the insureds.
Both wish to successfully defend and, if that is not possible,
minimize damages.
Sometimes, however, the insurer claims that the policy
has been breached by the insured. These are so-called policy
defenses3 of which the insured's failure to give notice or to
cooperate are typical examples. The insurer may wish to preserve
its policy defenses and still provide a defense to the insured.
By doing so it may be able to avoid paying the underlying claim
either by succeeding in its defense of the insured or, failing
that, by successfully asserting its policy defense. The insurer
can preserve these options by defending the insured under a
reservation of rights to later disclaim coverage if the
reservation of rights is acquiesced in by the insured.
Continental Ins. Co. v. Bayless & Roberts, Inc., 608 P.2d 281,
288 (Alaska 1980).
Similarly, the insurer may claim that although no
condition of the policy has been breached by the insured, a
particular claim made by the plaintiff does not come within the
coverage of the policy. Such defenses are called coverage
defenses. The most typical example is the coverage defense in
this case where alternative theories of negligent and intentional
tort are plead and negligent acts are covered by the policy but
intentional acts are not.4 In such cases the insurer's duty to
defend may require it to defend even if the most likely theory of
recovery is one for which there is no insurance coverage.5 The
insurer can preserve its coverage defense and fulfill its duty to
defend by defending under a reservation of rights to later
disclaim coverage if liability is attributable to the excluded
theory.
In cases where an insurer asserts either policy or
coverage defenses, and defends its insured under a reservation of
rights, there are various conflicts of interest between the
insurer and the insured. We identified three of these in
Continental. First, if the insurer knows that it can later
assert non-coverage, or if it thinks that the loss which it is
defending will not be covered under the policy, it may only go
through the motions of defending: "it may offer only a token
defense. . . . [I]t may not be motivated to achieve the lowest
possible settlement or in other ways treat the interests of the
insured as its own." Id. at 289. Second, if there are several
theories of recovery, at least one of which is not covered under
the policy, the insurer might conduct the defense in such a
manner as to make the likelihood of a plaintiff's verdict greater
under the uninsured theory. Id. Third, the insurer might gain
access to confidential or privileged information in the process
of the defense which it might later use to its advantage in
litigation concerning coverage. Id. at 291.
Merely because the insurer and the insured have
divergent interests when the insurer seeks to defend under a
reservation of rights does not necessarily mean that appointed
counsel also has conflicting interests. If appointed counsel
makes it clear at the outset of his engagement that he is going
to be involved only in the defense of the liability claim, not in
coverage issues, and that his client is the insured, not the
insurer, conflicts should be rare.6 A number of authorities hold
that this is the appropriate role of appointed counsel. For
example, the Arizona Supreme Court held that appointed counsel
who in the course of representing the insured gains access to
information which may give rise to a policy defense is prohibited
from communicating that information to the insurance company.
Farmers Ins. Co. of Arizona v. Vagnozzi, 675 P.2d 703, 708 (Ariz.
1983): "We emphasize that the attorney who represents the
insured owes him an undeviating allegiance whether compensated by
the insurer or the insured and cannot act as an agent of the
insurance company by supplying information detrimental to the
insured." Employers agrees with this view, noting that counsel
has "an absolute duty of fidelity to the insured over the
interests of the insurer."
Other authorities, however, take the view that
appointed counsel represents both the insured and the insurer. A
former president of the Defense Research Institute has written
that appointed counsel has an obligation to disclose to the
insurance company information detrimental to the insured. Thomas
A. Ford, The Insurance Contract: The Conflicts of Interest it
Breeds, Ins. Couns. J. 610, 620 (Oct. 1969):
In order for the attorney to perform his
role properly, he must never lose sight of
the fact that he is working for two different
and distinct parties -- the insured and the
insurer. He must fully disclose to both
parties the information he has obtained as a
result of his unique relationship with them.
See also Shafer v. Utica Mutual Ins. Co., 289 N.Y.S. 577, 587
(App. Div. 1936) (appointed attorney acted properly in disclosing
to insurer information which enabled insurer to disclaim
liability); Alaska Code of Professional Responsibility EC 5-17
(stating that one typically recurring situation involving
potentially different interests is dual representation of insured
and insurer).
Where there is a conflict between insurer and insured,
appointed counsel may tend to favor the interests of the insurer
primarily because of the prospect of future employment. United
States Fidelity & Guar. Co. v. Lewis A. Roser Co., 585 F.2d 932,
938 n.5 (8th Cir. 1978) ("Even 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 interest of his real client -- the one who is paying his
fee and from whom he hopes to receive future business -- the
insurance company."); San Diego Navy Fed. Credit Union v. Cumis
Ins. Soc'y, Inc., 208 Cal. Rptr. 494, 498 (App. 1984) ("`A lawyer
who does not look out for the carrier's best interest may soon
find himself out of work.'"(quoting the trial court)); Michael
A. Berch and Rebecca W. Berch, Will the Real Counsel for the
Insured Please Rise?, 19 Ariz. St. L.J. 27, 29-30 (1987) ("[T]he
attorney's economic interests weigh heavily in favor of the
insurer, which, after all, may retain his services in other
cases; yet the rules of professional responsibility tip the
scales toward the insured."); Arthur P. Berg, Losing Control of
the Defense -- The Insured's Right to Select His Own Counsel, 26
For the Defense 10, 15 (July 1984) ("Although [some] courts seem
to trust the insurer and attorney to act in the best interests of
the insured, the more common view is that the longstanding ties
that defense counsel has with the insurer will inevitably
influence his conduct of the case."); Sampson A. Brown and John
L. Romaker, Cumis, Conflicts and the Civil Code: Section 2860
Changes Little, 25 Cal. W. L. Rev. 45, 54 (1988) ("The attorney,
wishing to maintain the insurer's business, does not want to
aggravate the company."); Mark A. Saxon, Conflicts of Interest:
Insurers' Expanding Duty to Defend and the Impact of "Cumis"
Counsel, 23 Idaho L. Rev. 351, 353 (1987) (Insurance counsel's
"relationship with the insurer is contractual, usually ongoing,
supported by strong financial interests, and often strengthened
by sincere friendships.").7 In recognition of this, most courts
hold that in conflict situations the insured has the right to
independent counsel to conduct its defense and the insurance
company has the obligation to pay the reasonable value of the
defense conducted by independent counsel.8
In dicta in National Indemnity Co. v. Flesher, 469 P.2d
360, 367 n.22 (Alaska 1970), we recognized the right of the
insured to independent counsel under circumstances involving a
coverage defense: "In such circumstances, the insurer must
provide the insured with independent counsel." Ten years later
in Continental Insurance Co. v. Bayless & Roberts, Inc., 608 P.2d
281 (Alaska 1980), we recognized the right of the insured to
independent counsel in cases involving policy defenses. However,
we reserved the question whether the insured had the same right
in coverage defense cases. Id. at 289.
In Continental the insurer claimed that the insured had
breached the cooperation clause of the policy, but offered to
defend the insured under a reservation of rights. Id. at 283.
The insured rejected the insurer's offer of a conditional defense
and demanded a defense without a reservation of rights. Id. at
286. This the insurer refused to do. Id. Subsequently, the
insured's personal counsel took over the defense of the case and
entered into a settlement which resulted in a consent judgment
against the insured. Id. In the ensuing litigation between the
insured and the insurer, the insurer contended that the insured
had breached the insurance policy by refusing to accept the
insurer's offer to defend under a reservation of rights. Id. at
288. We held that the insured did not breach the policy and that
it was within its rights to require the insurer to defend
unconditionally or withdraw from the defense. Id. at 291. We
also affirmed the jury's award which included $4,000 expended by
the insured as its defense costs. Id. at 296 n.28.
In reaching this result, we expressed and adopted in
policy defense cases the general rule that the insurer must
surrender its right to control the defense to the insured if the
insured refuses to accept a defense under a reservation of
rights:
[T]he 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 defense . . . .
Id. at 288. We explained in some detail the types of conflicts
of interests which arise when the insurer asserts a right to
later contest its liability. Id. at 289-90. We noted that these
conflicts might be avoided if the insured were offered the right
to retain independent counsel:
The possibility of a conflict might
be avoided in such cases if the insurance
company were to offer its insured the right
to retain independent counsel to conduct his
defense, and agree to pay all the necessary
costs of that defense. In that event, it
would seem that the company should be
entitled to reserve the right to later
litigate an alleged policy defense.
Id. at 291 n.17. As already stated, the holding in Continental
was limited to policy defenses; the question as to whether the
same rules should apply where coverage defenses are involved was
reserved. Id. at 289.
All three general types of conflicts of interests
between insurer and insured which we identified in Continental --
the insurer may offer mere token defense, the insurer may steer
result to judgment under an uninsured theory of recovery, the
insurer may gain access to confidential or privileged information
which it may later use to its advantage -- apply in coverage
defense cases. However, the second reason does not apply in
policy defense cases. Policy defenses, such as lack of notice or
non-cooperation, involve facts which are generally irrelevant to
the litigation between the plaintiff and the insured. Therefore,
appointed counsel has no opportunity to "covertly frame [a]
defense to achieve a verdict based upon [a theory under which no
coverage would result] so that [the insurer] could later assert
that the defense was not covered . . . ." Id. at 289. Thus, the
need for independent counsel is, if anything, greater in coverage
than in policy defense cases.9 We conclude that the right to
independent counsel recognized in Continental should also apply
to cases involving coverage defenses.10 We thus adhere to the
dicta contained in National Indemnity, which we noted above.
2. Does the two-counsel scheme proposed by Employers
and approved by the superior court satisfy CHI's right
to independent counsel?
We answer this question in the negative.
The trial court was of the view that neither CHI nor
Employers was bound by any determination of fact made in the
underlying tort suit concerning whether CHI's conduct was
negligent or intentional. From this the trial court concluded
that Employers' two-counsel scheme would solve the conflict of
interest between the insurer and the insured.11 The view that
issues determined in the initial action as to which a conflict of
interest exists between insurer and insured may be subsequently
relitigated appears to be sensible and in accordance with a
number of authorities.12 That view, however, does not resolve all
conflicts of interest between insurer and insured. It does not
alleviate the access of appointed counsel to information in
possession of the insured which may be used against the insured
in subsequent coverage litigation:
This solution overlooks the fact that,
during the initial litigation, the insured
may transmit information to counsel that the
insurer could use in subsequent litigation to
the insured's disadvantage. A heavy burden
of silence falls on the attorney the insurer
selects to defend the insured.
Berch & Berch, supra, at 32 n.23. The fact that personal counsel
for CHI is acting as co-counsel with counsel appointed by the
insurer also does not eliminate this conflict. Appointed counsel
has and should have full access to the client so that the defense
may be effectively conducted.
Moreover, even where the facts in conflict may be
relitigated, the opportunity to direct a case through witness
selection, interrogation, and discovery may afford a dispositive
advantage in subsequent litigation:
In such cases, the insured's attorney
has the opportunity to develop the facts
through discovery and to shape the case for,
and present the evidence at, the trial. So
even though the insured or the insurer may
relitigate the coverage issue in a subsequent
proceeding, controlling the defense in the
main proceeding could be critical.
Testifying under oath in the main proceeding
may freeze in the witnesses' minds one
version of the facts. Very little latitude
may remain in subsequent proceedings to mold
the evidence bearing upon coverage.
Id. at 37-38.13
We conclude therefore that the two-counsel solution
does not satisfactorily resolve the conflicts which have given
rise to the right to independent counsel.
3. Does CHI have the unilateral right to select
independent counsel?
We answer this question in the affirmative.
Most cases which recognize the right to independent
counsel express the view that the insured has the right to select
independent counsel of its choice. American Family Life Assur.
Co. v. United States Fire Co., 885 F.2d 826, 831 (11th Cir. 1989)
(if insured had rejected conflicted counsel, insurer "would have
been obligated to pay" for defense conducted by insured)
(interpreting Georgia law); Rhodes v. Chicago Ins. Co., 719 F.2d
116, 120-21 (5th Cir. 1983) ("When a reservation of rights is
made . . . the insured may . . . pursue his own defense [and the]
insurer remains liable for attorneys' fees") (interpreting Texas
law); Previews Inc. v. California Union Ins. Co., 640 F.2d 1026
(9th Cir. 1981) ("the insurer's obligation to defend extends to
paying the reasonable value of the legal services and costs
performed by independent counsel selected by the insured")
(interpreting California law); San Diego Navy Fed. Credit Union
v. Cumis Ins. Soc'y, 208 Cal. Rptr. 494, 501-02 (App. 1984) ("the
insurer must pay the reasonable cost for hiring independent
counsel by the insured"); Maryland Casualty Co. v. Peppers, 355
N.E.2d 24, 31 (Ill. 1976) (The insured "has the right to be
defended . . . by an attorney of his own choice who shall have
the right to control the conduct of the case."); Illinois Masonic
Medical Ctr. v. Turegum Ins. Co., 522 N.E.2d 611, 613 (Ill. App.
1988) ("where a conflict of interest exists the insured, rather
than the insurer, is entitled to assume control of the defense of
the underlying action; . . . the insurer must underwrite the
reasonable costs incurred by the insured in defending the action
with counsel of his own choosing."); Prashker v. United States
Guar. Co., 136 N.E.2d 871, 876 (N.Y. 1956) ("the selection of the
attorneys to represent the assureds should be made by them rather
than by the insurance company, which should remain liable for the
reasonable value of the services"); Allstate Ins. Co. v.
Noorhassan, 551 N.Y.S.2d 942, 944 (App. Div. 1990) (the insured
"should be permitted to select their own attorney [and the
insurer] is liable for the reasonable value of the services");
Gorman v. Pattengell, 535 N.Y.S.2d 402, 404 (App. 1988) (the
insured "is entitled to retain, at her insurer's expense, an
attorney with no business connection to her insurance carrier and
who will defend solely her interests"); see also Mallen, supra,
at 118 ("The right to independent counsel means an attorney of
the insured's choice."); Smyth, supra, at 938 ("Most courts
appear to allow the insured to select independent counsel when a
conflict of interests arises."). Under this line of authority
the insurance company is obligated to pay the "reasonable cost
for hiring independent counsel by the insured." Cumis, 208 Cal.
Rptr. at 506; see also Mallen, supra, at 120.
A recent California case, Center Foundation v. Chicago
Insurance Co., 278 Cal. Rptr. 13 (App. 1991), has noted that the
insured's right to select independent counsel is subject to the
implied covenant of good faith and fair dealing. In context,
this means that the insured must act reasonably to select an
attorney who is capable of presenting an effective defense and
who will bill reasonably for his or her services. The court
stated:
In our view, the duty of good faith
imposed upon an insured includes the
obligation to act reasonably in selecting as
independent counsel an experienced attorney
qualified to present a meaningful defense and
willing to engage in ethical billing
practices susceptible to review at a standard
stricter than that of the marketplace.
Conduct arguably acceptable in the ordinary
attorney-client relationship where the latter
pays the former from his own pocket is not
necessarily appropriate in the tripartite
context created when independent counsel
undertakes to represent the insured at the
expense of the insurer.
Center Foundation, 278 Cal. Rptr. at 21 (footnote omitted).
A few cases support Employers' argument that it should
have the right to approve of CHI's choice for independent
counsel. In Employers' Fire Insurance Co. v. Beals, 240 A.2d
397, 404 (R.I. 1968), the court approved of the solution
suggested in Prashker, that the insured should be allowed to
select independent counsel. However, the Beals court added the
proviso that counsel selected by the insured should be approved
by the insurer and that "[s]uch approval, however, should not be
unreasonably withheld." Id. at 404. Fireman's Fund Insurance
Co. v. Waste Management of Wisconsin, 777 F.2d 366 (7th Cir.
1985) (apparently interpreting Wisconsin law), involves an
atypical fact pattern. The question whether the insurer should
have approval rights for independent counsel was not the issue;
however, the case does contain dicta which states that giving the
insurer the right to approve or disapprove of independent counsel
selected by the insured is "fair, sensible and reasonable." Id.
at 370.
We conclude that the insured should have the unilateral
right to select independent counsel and that this right should be
subject to the implied covenant of good faith and fair dealing.14
In our view the covenant of good faith and fair dealing in this
context requires that the insured select an attorney who is, by
experience and training, reasonably thought to be competent to
conduct the defense of the insured. Such a result, in our view,
fairly balances the interest of the insured -- being defended by
competent counsel of undivided loyalty -- with the interests of
the insurer -- having the defense of the insured conducted by
competent counsel. The insurer is only required to pay the
reasonable cost of the defense. See, e.g., Turegum, 522 N.E.2d
at 613 ("insurer must underwrite reasonable costs incurred by the
insured in defending the action"); Noorhassan, 551 N.Y.S.2d at
944 (same). This provides a measure of protection for insurers
against overbilling -- and overlitigating -- by independent
counsel.
In the present case the record is unclear as to whether
it is reasonable for CHI to select von Gemmingen as independent
counsel. On remand, a hearing should be conducted promptly in
order to determine this question. If the trial court finds that
von Gemmingen is a reasonable selection, a declaration should be
entered that he may conduct the defense of CHI as independent
counsel. If the court finds that he is not a reasonable
selection, the court should so declare and CHI should proceed to
select qualified counsel.
For the above reasons the judgment of the superior
court is REVERSED and this case is REMANDED for further
proceedings and entry of a declaration in accordance with this
opinion.
MOORE, J., concurring in part and dissenting in part.
In its decision today, the court holds that an insured
has the right to reject the counsel appointed by the insurer and
to unilaterally select replacement counsel whenever dual
representation creates a potential conflict of interest. Under
the guise of balancing the interests of the insured and the
insurer, the court completely abrogates the insurer's right to
participate in the insured's defense. Neither existing case law
nor sound policy mandates such a drastic curtailment of the
insurer's contract rights. Although I agree that the insured is
entitled to select independent counsel in conflict of interest
situations, I believe the insurer retains the right of reasonable
approval. Such a rule accommodates both the important interest
of the insured in controlling the litigation and the legitimate
interest of the insurer in assuring that the defense will be
competently handled by qualified counsel in a cost-effective
manner.
Most courts agree that an insured may reject insurer-
selected counsel when the insurer assumes the defense under a
reservation of rights because of a coverage question.15 See
Ronald E. Mallen, A New Definition of Insurance Defense Counsel,
53 Ins. Couns. J. 108, 113 (Jan. 1986). Most courts also
conclude that the presence of a conflict of interest does not
relieve an insurer of its obligation to pay defense costs under
its duty to defend. See Babcock & Wilcox Co. v. Parsons Corp.,
430 F.2d 531, 538 (8th Cir. 1970). The critical issue, which few
courts have identified, is whether, in this context, an insured
has the unilateral right to select replacement counsel when the
insurance agreement gives the insurer the right to defend the
insured. This is a matter of first impression in Alaska.16 I
would hold that the insurer has the right to approve the counsel
selected by the insured, but that the insurer may not
unreasonably withhold such approval.17
The court simply fails to recognize that Employers has
both a contractual right as well as the contractual duty to
defend CHI.18 An insurer's right to control the defense is "a
valuable one in that it reserves to the insurer the right to
protect itself against unwarranted liability claims and is
essential in protecting its financial interest in the outcome of
litigation." 7C John A. Appleman, Insurance Law and Practice
4681 (Walter F. Berdal ed., rev. ed. 1979). Such an important
right should not be ignored in the analysis. Although the
insurer's right to control the litigation must yield to the
insured's right to independent representation when a conflict
arises, this does not mean that the insurer's right to defend is
completely extinguished.
Although the court purports to align itself with what
it considers to be the "majority view,"an analysis of the cases
it relies on reveals that most courts which have recognized the
insured's "right to independent counsel"have not explicitly
analyzed the scope of this right or fully considered its impact
on the rights of the insurer.
Two cases cited by the court, while speaking of a
"right to independent counsel,"implicitly recognize the right of
an insurer to participate in the defense of its insured. The
courts in both American Family Life Assur. Co. v. U.S. Fire Co.,
885 F.2d 826 (11th Cir. 1989), and San Diego Navy Fed. Credit
Union v. Cumis Ins. Soc'y, Inc., 208 Cal. Rptr. 494 (Cal. App.
1984), required an insurer to pay the cost of "independent
counsel" selected by the insured to act as co-counsel with an
attorney selected by the insurer.19 Neither case stands for the
proposition that an insured has a unilateral right to select
exclusive defense counsel when a coverage dispute creates a
conflict of interest.20 In fact, American Family Life includes a
partial quote from Appleman which recognizes the right of an
insured "to refuse to accept an offer of counsel appointed by the
insurer," 885 F.2d at 831 (citing 7C Appleman, supra,
4685.01), but omits that part of the sentence which recognizes
the insurer's right to approve of substitute counsel.21
Some courts and commentators recognize that cases
permitting an insured to select "independent counsel" do not
define what is meant by that term. See, e.g., Federal Ins. Co.
v. X-Rite, Inc., 748 F. Supp. 1223, 1228 n.1 (W.D. Mich. 1990)
("_Independent Counsel' is a term which has not been defined in
the case law."); Allan D. Windt, Insurance Claims and Disputes-
Representation of Insurance Companies and Insureds 4.20 at 179
(2d ed. 1988). Courts have used the phrase in a variety of
contexts,22 some of them diametrically opposed. Commentators have
stated that "[t]he right to independent counsel means an attorney
of the insured's choice." Ronald E. Mallen & Jeffrey M. Smith,
Legal Malpractice 23.16 at 418 (3d ed. 1989). On the other
hand, courts have also recognized "a right in the insurer to
determine whether to provide independent counsel of its choosing
or to reimburse the insured for counsel of its choice." Federal
Ins. Co., 748 F. Supp. at 1228 (citing nine cases for this
proposition). Because there is disagreement as to what the right
to independent counsel entails, and because many cases recognize
the insurer's right to select replacement "independent counsel,"
or at a minimum, to participate in the defense of the insured
alongside counsel selected by the insured, it is questionable
whether the view espoused by the court represents a "majority
view," statements by courts and commentators to that effect
notwithstanding.
However, if, as the court apparently believes, an
insured's interest in fair representation requires the complete
abrogation of an insurer's right to participate in the defense,
the insurer's right should at least be addressed in terms of
established principles of contract law. In interpreting a
contract, a court must give effect to the reasonable expectation
of the parties. Peterson v. Wirum, 625 P.2d 866 (Alaska 1981);
Fairbanks N. Star Borough v. Tundra Tours, Inc., 719 P.2d 1020
(Alaska 1986) (in order to give effect to the parties' reasonable
expectations, a court should look to the contract language,
relevant extrinsic evidence and case law interpreting similar
provisions). Clearly, the insurance agreement here gave
Employers a reasonable expectation that it would have some
control over the defense. Even if the right to defend provision
is deemed ambiguous and is therefore construed against the
insurer, see Puritan Life Ins. Co. v. Guess, 598 P.2d 900 (Alaska
1979), it is not necessary to extinguish the right entirely.
Rather, the right to defend provision can and should be
interpreted in a way which balances the interests of both the
insurer and the insured.
As one court has stated when considering the scope of
an insurer's contractual right to defend in conflict situations:
Unless "right to defend"is to be deemed
mere surplusage, . . . it must be viewed as
conferring upon [the insurer] some
prerogative with respect to the defense
beyond simply paying expenses. This
prerogative cannot, in a conflict of interest
situation, include an absolute right to
control the litigation. On the other hand,
[the insured's] apparent presumption that the
conflict of interest, posing a potential of
prejudice to its interests, automatically and
completely negated all prerogative, is not
reasonable.
. . . [The] "right to defend"can
hardly be deemed to contemplate anything less
than participation in selection of counsel,
which contractual right ought to be enforced
unless contrary to public policy.
Federal Ins. Co., 748 F. Supp. at 1229; see also New York State
Urban Dev. Corp. v. VSL Corp., 738 F.2d 61, 65-66 (2d Cir. 1984).
Here, Employers' right to participate in CHI's defense should
encompass, at a minimum, the right to have a role in the
selection of defense counsel.
Courts which have recognized the right of the insurer
to participate in the selection of substitute counsel do not
agree as to the latitude an insurer should have. In Federal Ins.
Co., the court concluded that, under Michigan law, an insurer is
entitled to select replacement counsel, but its selection must be
made with the utmost of good faith. 748 F. Supp. at 1229. On
the other hand, in Employers' Fire Ins. Co. v. Beals, 240 A.2d
397 (R.I. 1968), the court held that an insured may elect to
choose its own counsel, but that the insurer has a right to
approve of the counsel selected by the insured. The Beals court
stated:
Because the insurer has a legitimate
interest in seeing that any recovery based on
finding of negligence on the part of its
insured is kept within reasonable bounds, and
since the total expense of this defense is to
be assumed by the insurer under its promise
to defend, we believe that . . . the
engagement of an independent counsel to
represent the insured should be approved by
the insurer. Such approval, however, should
not be unreasonably withheld.
240 A.2d at 404; see Fireman's Fund Ins. Co. v. Waste Management
of Wis. Inc., 777 F.2d 366, 370 (7th Cir. 1985) (approving
parties' agreement to allow insured to select replacement counsel
subject to insurer's approval as the most "fair, sensible, and
reasonable way for both parties to terminate [conflict of
interest] dispute and to get on with trial of the [cases against
insured] on their merits"). This approach is also recommended by
a noted commentator on insurance law who stated:
[W]here a conflict of interest exists
between the insurer and the insured in the
conduct of the defense of the action brought
against the insured, the insured has the
right to refuse to accept an offer of the
counsel appointed by the insurer and
insurer's desire to control the defense must
yield to its obligation to defend the
policyholder; and where a conflict of
interest exists the engagement of independent
counsel to represent the insured should be
approved by the insurer to assure the
employment of competent counsel. Such
approval should not be unreasonably withheld.
7C Appleman, supra, 4685.01 (footnotes omitted).
The majority dismisses these authorities without
analysis, summarily concluding that the insurer's interests are
sufficiently protected by the implied covenant of good faith and
fair dealing inherent in all contracts. Principally relying on a
recent California court of appeals decision, Center Found. v.
Chicago Ins. Co., 278 Cal. Rptr. 13 (Cal. App. 1991), the
majority observes that the covenant of good faith and fair
dealing requires that the insured "select an attorney who is, by
experience and training, reasonably thought to be competent to
conduct the defense of the insured."23 (emphasis added) The
majority asserts that the implied covenant "provides a measure of
protection for insurers against overbilling - and overlitigating
- by independent counsel." Unfortunately, the majority
fails to specify by whose standards the competency of replacement
counsel should be measured. In the absence of any objective
criteria by which to judge whether replacement counsel is
"reasonably competent," I believe that this "measure of
protection"is both inadequate and unworkable. Although I
have found no cases discussing what constitutes an insurer's
reasonable withholding of approval of substitute counsel chosen
by the insured, I believe that an insurer should approve of an
insured's selection of counsel where the attorney is qualified to
handle the case and where there is no reason to expect that the
attorney will be unable to maintain a professional working
relationship with the insurance company.
In ascertaining whether an attorney is qualified, it
may be useful to look to the statute of a state which has turned
to the legislature to resolve this issue. California Civil Code
Section 2860(c)24 provides in part:
When the insured has selected
independent counsel to represent him or her,
the insurer may exercise its right to require
that the counsel selected by the insured
possess certain minimum qualifications which
may include that the selected counsel have
(1) at least five years of civil litigation
practice which includes substantial defense
experience in the subject at issue in the
litigation, and (2) errors and omissions
coverage.
While I would not adopt this standard as a per se rule in Alaska,
I believe that section 2860(c) provides reasonable guidance as to
whether an insurer must approve of its insured's selection of
substitute counsel.
Here, it is undisputed that attorney Von Gemmingen
graduated from law school in May, 1985. When this dispute arose
in late 1989, he had been practicing law for approximately four
years. Nothing in the record indicates that he had substantial
defense experience in the types of disputes at issue in the suit
against CHI. For these reasons, I would hold that Employers did
not unreasonably withhold its approval of CHI's choice of
attorney.
Apparently, the court believes that any participation
by the insurer in the appointment of independent counsel
automatically taints the outcome. However, it is far from clear
that the scope of the conflict of interest problem in the defense
context is so broad and the frequency of harm to the insured so
great as to warrant such a drastic curtailment of the insurer's
contract rights. None of the authorities cited by the court
address the prevalence of the problem in quantifiable terms, nor
do they address effectiveness of malpractice actions,
disciplinary actions, or insurance bad faith actions in remedying
the problem. As one commentator has noted, "[t]he validity of
the assumption that there exists a severe risk that an insurer
will favor its coverage interests over the insured's liability
has not been critically examined." Mallen, supra, at 108. The
same can be said of the assumption that there is a severe risk
that defense attorneys will favor the interests of the insurer
over the insured.25 Assuming without conceding that these risks
are great, conflict of interest concerns would be a compelling
policy reason for permitting an insured to reject counsel
selected by the insurer. They would also be a reason for
allowing the insured to select a new attorney at the insurer's
expense. But it goes too far to ignore the insurer's contractual
right to defend and to hold that these perceived dangers warrant
allowing an insured to unilaterally select substitute counsel
regardless of the attorney's qualifications.
In Continental Ins. Co. v. Bayless & Roberts, Inc., 608
P.2d 281, 288-91 (Alaska 1980), we discussed the conflicts which
can arise between the interests of the insured and the insurer
where coverage may be an issue and the insurer defends under a
reservation of rights. We noted that when an insurer knows it
can assert a coverage defense, it may only offer a token defense
of the insured. Id. at 289. We further noted that where
coverage depends on which theory of recovery in the suit against
the insured is successful, an insurer might conduct the defense
in a way which steers the case toward liability based on an
uncovered theory. Id.
The situations discussed in Continental represent two distinct
areas of conflict -- those between an insured and its insurer and
those between the insured and its attorney. When this important
distinction is made, an attorney's ethical obligations in these
situations are clearly delineated by the Alaska Code of
Professional Responsibility.
A potential conflict of interest between the insurer
and the insured arises when, as in this case, a plaintiff brings
an action against an insured which is based on both covered and
uncovered theories of liability. When the complaint alleges both
negligent conduct, which is covered under the policy, and
intentional conduct, which is not covered, it would be in the
best interest of the insurer if liability were ultimately found
based on intentional conduct. In such a case, an attorney
selected by the insurer to defend the insured would be under an
ethical obligation to disclose the effect of this conflict "on
the exercise of [the attorney's] independent professional
judgment on behalf of each." Alaska Code of Professional
Responsibility DR 5-105. Unless "it is obvious that [the
attorney] can adequately represent the interest of each" and
"each consents to the representation after full disclosure," the
attorney would be required to decline the employment.26 Id.
Whether the attorney declines, accepts, or withdraws from the
employment, he would be obligated to preserve the confidences of
the insured. Alaska Code of Professional Responsibility DR 4-
101.
The conflict between the insured and the insurer is to
be distinguished from that which arises between the insured and
the attorney under these circumstances. As commentators have
stated:
In this situation, . . . separate
counsel retained by the insurance company is
under the less-than-subtle influence of the
insurance company. Insurance companies
concentrate their legal representation into a
few firms. The attorney, wishing to maintain
the insurer's business, does not want to
aggravate the company. Furthermore, the
insurance counsel has close ties and a long-
term relationship with the insurer, while he
has only a transient relationship with the
insured. These factors could, unconsciously,
dilute the loyalty of the most honest
attorney.
Sampson A. Brown & John L. Romaker, Cumis, Conflicts and the
Civil Code: Section 2860 Changes Little, 25 Cal. W. L. Rev. 45,
54 (1988) (footnotes omitted). Here again, the attorney's duties
are clear. If the exercise of the attorney's professional
judgment on behalf of the insured may be affected by these
interests, an attorney can only accept the employment if the
client consents after full disclosure. Alaska Code of
Professional Responsibility DR 5-101(A). Furthermore, the
attorney is prohibited from permitting the insurer to "direct or
regulate his professional judgment"in representing the insured.
Alaska Code of Professional Responsibility DR 5-107(B). A breach
of these ethical obligations may subject an attorney to
disciplinary actions and may serve as the basis for a legal
malpractice action, thus serving as a deterrent to the kinds of
abuses which concern the court. Absent a showing that the Code
of Professional Responsibility and the threat of legal
malpractice actions are ineffective in preventing such abuses,
the broad prophylactic rule adopted by the court seems
superfluous.27
In further support of its conclusion, the majority
voices its concern over the danger that an insurer might gain
access to information not otherwise available to it which could
be used to its advantage in the coverage dispute. In Continental
we discussed this danger in the policy defense context. 608 P.2d
at 291. However, in the context of a coverage dispute, I believe
this danger to be more imagined than real. It is difficult to
imagine a case or set of facts where information tending to
defeat coverage would be unavailable to the insurer. Under most
insurance agreements, the insured has a duty to cooperate with
the insurer.28 "The duties of the insured have been held to
require a fair, frank and truthful disclosure of information
reasonably demanded by the insurer, for the purpose of enabling
it to determine whether or not there is a genuine defense." 8
John A. Appleman & Jean Appleman, Insurance Law and Practice
4774 (1981). In addition, facts tending to defeat coverage will
most likely be developed in the liability trial and will be
discoverable by the insurer in subsequent coverage litigation.29
Even confidential attorney-client communications may be
discoverable by an insurer under certain circumstances. See,
e.g., Glacier Gen. Assur. Co. v. Superior Court, 157 Cal. Rptr.
435 (Cal. App. 1979). See generally John P. Ludington,
Annotation, Insured-Insurer Communications As Privileged, 55
A.L.R.4th 336, 354-59 (1987).
Of course this does not mean the insured's attorney is
free to share any confidential or privileged information with the
insurer. Regardless of whether defense counsel is selected by
the insured or the insurer, the attorney is bound by the same
ethical duties regarding confidentiality. See Alaska Code of
Professional Responsibility DR 4-101. In those rare cases where
such a breach of confidentiality actually occurs, the law affords
adequate protection and recourse to the insured. An attorney who
breaches a client's confidentiality may be subject to discipline
for a violation of his professional responsibility or to a suit
by the insured for legal malpractice. Of more significance to
the insured, an insurer who relies on breach of confidentiality
by defense counsel to assert non-coverage may be subsequently
estopped from denying coverage based on policy exclusion. See
Parsons v. Continental Nat'l Am. Group, 113 P.2d 94, 99 (Ariz.
1976). Such remedies serve as adequate protection of the insured
and as a strong disincentive to both insurers and defense counsel
to compromise the insured's interest.
Other considerations prevent me from supporting the
rule adopted today. First, "[t]ypically, the coverage issue [and
resulting conflict of interest are] not created by the insurer
but by the allegations of the claimant. Often those allegations
bear little relationship to reality." Mallen & Smith, supra,
23.16. In light of this, a rule which operates to deprive an
insurer of its contractual right to participate in the defense
whenever the insurer reserves its rights unnecessarily penalizes
the insurer. Second, an insurer may be required to issue a
reservation of rights letter or risk its right to later challenge
coverage of the claim under the policy. See Continental Ins. Co.
v. Bayless & Roberts, Inc., 608 P.2d 281, 289 n.13 (Alaska 1980).
The insurer should not be forced to sacrifice its right to
participate in the selection of counsel in order to preserve its
right to subsequently contest coverage. Third, because an
insurer, under agency principles, may be subject to liability for
the malpractice of the attorney which represents the insured, see
Mallen & Smith, supra, 23.6, it is fair and reasonable that the
insurer should have a role in selection of counsel. Finally, the
rule adopted by the court today presupposes that no counsel
selected or approved of by an insurer can represent an insured
without consciously or unconsciously compromising the insured's
interests in favor of those of the insurer. My confidence in the
integrity of the members of the Alaska Bar will not allow me to
support the adoption of a rule of law based on such an
assumption.
In summary, I would hold that CHI was within its rights
to reject the tender of a defense by Employers and was entitled
to select replacement counsel, subject to the reasonable approval
of Employers. Here, Employers' approval of Von Gemmingen was not
unreasonably withheld. Nonetheless, because I conclude that the
insured has the right to select replacement counsel subject to
the reasonable approval of the insurer, CHI cannot be forced to
proceed with defense counsel selected by Employers. Accordingly,
I concur in the reversal but dissent from the court's reasoning
and the rule of law which it adopts.
COMPTON, Justice, dissenting.
I agree with Justice Moore's analysis of the court's
opinion. While I prefer his solution to that selected by this
court, I believe a third alternative selected by the superior
court is preferable to either. Also, I wish to emphasize what I
find particularly disturbing with the court's solution.
Since the court abrogates entirely a contractual right,
the language of the insurance contract ought at least be
reviewed. It provides:
SECTION II
DEFENSE AND SETTLEMENTS. The
Corporation, in the Insured's name and
behalf, shall have the right to investigate,
defend and conduct settlement negotiations in
any claim or suit.
The Corporation shall not settle any
claim without the consent of the Insured.
Should the Insured refuse to consent to any
settlement recommended by the Corporation and
elect to contest the claim, or continue any
legal proceedings in connection with such
claim, the Corporation's liability for the
claim shall not exceed the amount in excess
of the Insured's deductible for which the
claim could have been so settled, or the
applicable limit of liability, whichever is
less, plus the costs and expenses incurred
with its consent up to the date of such
refusal.
The Insured shall not admit liability
for, or make any voluntary settlement, or
incur any costs or expenses in connection
with any claim involving payment by the
Corporation, except with the written consent
of the Corporation.
(Emphasis supplied).
The court holds that the insurer forfeits the right
even to participate in the selection of counsel, encompassed in
the insurer's right to defend, (1) despite its contractual right
to do so; and (2) despite the fact that as to covered claims, it
is undisputed that the insurer's money is at risk, not the
insured's.30
Justice Moore has highlighted the flaw in the court's
effort to legitimize its result by proclaiming the result to be
in keeping with the "majority view." As the result is not
dictated by case law, what compels the court to hold that the
insurer has forfeited its contractual right to select counsel to
defend covered claims for which its money is at risk?
The court points to perceived problems with selection
of counsel hired by insurers to conduct the defense of their
insured. These "appointed" counsel may tend to favor the
insurer's interests, not the insured's, because of longstanding
ties between the insurer and counsel. Appointed counsel may
consciously or subconsciously `slant' efforts in favor of the
insurer to receive future business from the insurer. Ongoing
contractual relationships, strong financial ties, and sincere
friendships between the insurer and appointed counsel will
influence counsel's conduct.
To cure this problem, the court first implies a
contractual right in the insured to select "independent" counsel
to represent the insured on both covered and reserved claims. To
modify this implied right, the court then applies the implied
covenant of good faith and fair dealing. The insured must
"select an attorney who is, by experience and training,
reasonably thought to be competent to conduct the defense of the
insured." "[T]hought"by whom to be competent? The court does
not give an answer.
I do not doubt the potential for conflict of interest
problems to intrude into relationships between the insurer, the
insured and appointed counsel. Yet given the court's view of the
willingness of counsel to follow the dollar and not the Code of
Professional Responsibility, why does the court not apply the
same standard to independent counsel selected by the insured? If
counsel selected by the insured `slants' efforts in favor of the
insured, is this a less disturbing result? If ongoing
contractual relationships, strong financial ties, and sincere
friendships between the insured and independent counsel influence
counsel's conduct, is this a less disturbing result? Worse, if
an insured does not happen to be a significant factor in
independent counsel's financial wellbeing, counsel selected by
the insured may (consciously or subconsciously) curry favor with
the insurer in order to establish an ongoing contractual,
financially rewarding relationship with the insurer. Is this a
less disturbing result? The dollar still comes out of the same
pocket. Once the Code of Professional Responsibility is
discarded as setting ethical guidelines for the profession, no
attorney/client relationship is safe from manipulation.
The alternative suggested by Justice Moore, but
rejected by the court, does not contemplate selection of counsel
by an insurer. The insured would select counsel, subject to the
insurer's approval. Approval could not be unreasonably withheld.
Counsel would be paid for by the insurer. Yet in the court's
view, permitting the insurer to approve independent counsel
selected by the insured would still taint counsel.
In my view the interests of both the insurer and
insured would be better served if this court, the insurer, and
the insured acknowledged the irremedial conflict created when
reserved claims are asserted against the insured. The insured
should be entitled to select counsel, paid for by the insurer, to
represent it on the reserved claims, subject only to the
insured's contractual obligation to cooperate with the insurer.31
The insurer will thereby satisfy its obligation to defend the
insured against any claim, while at the same time exercising its
contractual right to defend against covered claims for which its
money is at risk. The insured will be assured of the loyalty of
its counsel. Counsel will not have to wonder whether their
client is the insurer or insured. We do not need to strip the
insurer of its contractual right to defend covered claims because
of a jaded view of an industry.32
While the court is correct in pointing out the
potential
for conflicts when multiple counsel cooperate in a single
defense, such conflicts are not unique to insurance defense
litigation. Problems of cooperation and strategy are present
whenever there are multiple defendants. In this case there are
two real parties in interest; the insurer for the covered claims,
and the insured for the reserved claims. There is no reason to
treat insurance defense litigation differently than other
multiple defendant litigation.
I am disturbed that the court is willing to embrace a
solution that abrogates entirely a contractual right. This is
particularly so because the court rejects reasonable alternatives
which would give some effect to the contractual provision.
Neither case law nor reason provides more than token support for
the court's solution. The court determines what it perceives to
be the necessary result, apparently on the basis of its view of
an industry. It reforms the contract accordingly. Contract law
does not give a court such license. I would affirm the superior
court.
_______________________________
1 Sauer v. The Home Indemnity Co., __ P.2d __, Op. No. 3898
at 8 (Alaska, November 13, 1992); Alaska Pac. Assur. Co. v.
Collins, 794 P.2d 936, 945 (Alaska 1990); National Indem. Co. v.
Flesher, 469 P.2d 360, 366 (Alaska 1970); Theodore v. Zurich Gen.
Accident & Liab. Ins. Co., 364 P.2d 51, 55 (Alaska 1961).
2 In this opinion we will refer to such counsel as appointed
counsel.
3 Continental Ins. Co. v. Bayless & Roberts, Inc., 608 P.2d
281, 288-89 (Alaska 1980).
4 See Continental, 608 P.2d at 289.
5 The duty to defend arises "if the complaint on its face
alleges facts which, standing alone, give rise to a possible
finding of liability covered by the policy," Afcan v. Mutual
Fire, Marine & Inland Ins. Co., 595 P.2d 638, 645 (Alaska 1979);
or, if the complaint does not contain such allegations, where
"the true facts are within, or potentially within, the policy
coverage and are known or reasonably ascertainable to the
insurer." National Indem. Co. v. Flesher, 469 P.2d 360, 366
(Alaska 1970).
6 Ronald E. Mallen, A New Definition of Insurance Defense
Counsel, Ins. Couns. J. 108, 108-109 (Jan. 1986).
7 In addition, at least two of our reported cases
demonstrate that appointed counsel sometimes favor the interest
of the insurer over those of the insured. Continental, 608 P.2d
at 294 ("it is quite apparent that both [appointed counsel] and
Continental believed that [appointed counsel's] first loyalty was
to Continental, and that throughout the course of the litigation
he acted for and on behalf of the insurance company"); Bohna v.
Hughes, Thorsness, Gantz, Powell & Brundin, 828 P.2d 745, 749-50
(Alaska 1992) (appointed counsel proposed to put insured through
bankruptcy in order to reduce insurer's liability to plaintiff).
8 "The prevailing view is that the presence of a coverage
issue enables the insured to reject appointed counsel, select his
own lawyer and control the defense at the expense of the
insurer." Mallen, supra, at 113; see, e.g., American Family Life
Assur. Co. v. United States Fire Co., 885 F.2d 826, 831 (11th
Cir. 1989) (interpreting Georgia law); Rhodes v. Chicago Ins.
Co., 719 F.2d 116, 120-21 (5th Cir. 1983) (interpreting Texas
law); Previews Inc. v. California Union Ins. Co., 640 F.2d 1026
(9th Cir. 1981) (interpreting California law); San Diego Navy
Fed. Credit Union v. Cumis Ins. Soc'y, 208 Cal. Rptr. 494, 501-02
(App. 1984); Maryland Casualty Co. v. Peppers, 355 N.E.2d 24
(Ill. 1976); Illinois Masonic Medical Ctr. v. Turegum Ins. Co.,
522 N.E.2d 611 (Ill. App. 1988); Prashker v. United States Guar.
Co., 136 N.E.2d 871, 876 (N.Y. 1956); Allstate Ins. Co. v.
Noorhassan, 551 N.Y.S.2d 942, 944 (App. Div. 1990); Gorman v.
Pattengell, 535 N.Y.S.2d 402, 404 (App. Div. 1988); see also Todd
R. Smyth, Annotation, Duty of Insurer to Pay for Independent
Counsel When Conflict of Interest Exists Between Insured and
Insurer, 50 A.L.R.4th 932, 938 (1986). A minority of courts hold
that the insured has no right to independent counsel. Mallen,
supra, at 113. They rely on appointed counsel to resolve
conflicts in favor of the insured. Id.; see, e.g., Federal Ins.
Co. v. X-Rite, Inc., 748 F. Supp. 1223, 1229 (W.D.Mich. 1990).
9 See also Berch & Berch, supra, at 38 ("[policy defense]
cases do not present the same dangers [of conflicting interests]
that coverage cases present").
10 We have recently recognized the application of the right
to independent counsel expressed in Continental in the context of
a coverage defense case in Sauer v. The Home Indemnity Co., __
P.2d __, Op. No. 3898 at 13, 14 (Alaska, November 13, 1992),
where we stated:
However, if the insured does not
consent to a non-waiver agreement, or to a
defense under a reservation of rights, then
the insurance company must choose whether it
wishes to defend unconditionally or pursue
other options. One such option is to permit
the insured to exercise its right to reject
the defense offered by the insurer and to
obtain substitute counsel at the insurer's
expense. In the event the defense is
conducted by substitute counsel, the
insurance company retains the right to later
contest policy coverage. See Continental
Ins. Co. v. Bayless & Roberts, Inc., 608 P.2d
281, 291 n.17 (Alaska 1980).
11 As noted earlier, Employers offered to pay CHI's personal
attorney, von Gemmingen, to defend against the noncovered claims.
12 See Theodore v. Zurich Gen. Accident & Liab. Ins. Co., 364
P.2d 51, 56 (Alaska 1961) (issues determined in initial action as
to which interests of insurer and insured were not conflicting
held to be binding on insurer); Farmers Ins. Co. v. Vagnozzi, 675
P.2d 703, 708 (Ariz. 1983); Ferguson v. Birmingham Fire Ins. Co.,
460 P.2d 342, 349 (Or. 1970); Restatement (Second) of Judgments
58 (1982). Section 58 of Restatement (Second) of Judgments
provides:
Effect of Judgment Against
Indemnitee on Indemnitor Who Has Independent
Duty to Defend Indemnitee
(1) When an indemnitor has an obligation
to indemnify an indemnitee (such as an
insured) against liability to third persons
and also to provide the indemnitee with a
defense of actions involving claims that
might be within the scope of the indemnity
obligation, and an action is brought against
the indemnitee involving such a claim and the
indemnitor is given reasonable notice of the
action and an opportunity to assume its
defense, a judgment for the injured person
has the following effects on the indemnitor
in a subsequent action by the indemnitee for
indemnification:
(a) The indemnitor is estopped from
disputing the existence and extent of the
indemnitee's liability to the injured person;
and
(b) The indemnitor is precluded
from relitigating those issues determined in
the action against the indemnitee as to which
there was no conflict of interest between the
indemnitor and the indemnitee.
(2) A "conflict of interest" for
purposes of this Section exists when the
injured person's claim against the indemnitee
is such that it could be sustained on
different grounds, one of which is within the
indemnitor's obligation to indemnify and
another of which is not.
13 CHI also notes that there are unresolved problems of which
of the two counsel is to control discovery and trial strategy.
One commentator has noted: "The role of a second lawyer with
clearly antagonistic coverage interests to the insured is
uncertain and seems inappropriate." Mallen, supra, at 119.
14 We have held that the implied covenant of good faith and
fair dealing is inherent in all contractual relationships
including the insured-insurer relationship. Guin v. Ha, 591 P.2d
1281, 1291 (Alaska 1979).
15. The mere reservation of rights in response to a third
party complaint alleging covered and uncovered conduct does not
in and of itself create a conflict of interest warranting
withdrawal of counsel selected by the insurer. Because the
liberal rules of pleading permit third party plaintiffs to allege
a variety of legal theories, the pleading alone should not be
permitted to precipitate a conflict of interest between an
insurer and the insured requiring withdrawal of the attorney
chosen by the insurer. Nor should the mere fact that an attorney
has previously been utilized by an insurer have this effect.
Clearly, under the circumstances of this case, an attorney has an
obligation to make the insured and the insurer aware of the
potential for conflict and to proceed with the representation
only with the consent of both. Alaska Code of Professional
Responsibility DR 5-105. This is a continuing duty so the
appropriateness of representation will have to be constantly
monitored by counsel.
16. CHI, citing National Indem. Co. v. Flesher, 469 P.2d
360, 367-68 n.22 (Alaska 1970) and Continental Ins. Co. v.
Bayless & Roberts, Inc., 608 P.2d 281, 291 n.17 (Alaska 1980),
contends that we have previously held that an insured has a right
to select independent counsel in a conflict of interest
situation. Neither of the passages cited by CHI constitutes a
holding of this court, as the issue the court decides today was
not before us in either Continental or Flesher. These passages
are thus not dispositive of this issue.
17. Other alternatives also balance the interests of the
insurer and the insured. For example, the insured could agree to
proceed with an attorney of its choice to serve as co-counsel to
the insurer-selected attorney. Here, because CHI rejected this
alternative, I limit my discussion to the approach to be taken
when the insured rejects the co-counsel approach.
18. Section II of the contract of insurance between CHI and
Employers provides that
[Employers], in Insured's name and
behalf, shall have the right to investigate,
defend and conduct settlement negotiations in
any claim or suit.
. . .
The Insured shall not admit liability
for, or make any voluntary settlement, or
incur any costs or expenses in connection
with any claim involving payment by
[Employers], except with the written consent
of [Employers].
Section III obligates Employers to pay "all expenses incurred in
the defense of any claim or suit against Insured"alleging acts
covered by the policy.
19. In American Family Life, the court affirmed an award of
attorneys' fees to an insured who hired co-counsel to "monitor
and aid in the defense"provided by the insurer. 885 F.2d at
831. In Cumis, the court held that the insurer must pay the fees
of an attorney retained by the insured to act as co-counsel to
the attorney selected by the insurer. 208 Cal. Rptr. at 497,
506.
20. The other cases cited for the "majority view"do not
hold that an insured has the unilateral right to select defense
counsel to the exclusion of any right of the insurer to
participate in the defense.
In Rhodes v. Chicago Ins. Co., 719 F.2d 116 (5th Cir.
1983), an insured rejected the insurer's tender of a defense
under a reservation of rights and pursued its own defense. The
party injured by the insured sued the insurer to collect damages
assessed against the insured under a settlement approved by the
state court. The Fifth Circuit reversed the grant of summary
judgment for the insurer, finding unresolved issues of material
fact. The right to "independent counsel"was not even an issue
in the case; rather, the issue was whether the insurer had
breached a duty to defend, and if so, the consequences of the
breach. Id. at 119.
In Previews, Inc. v. California Union Ins. Co., 640
F.2d 1026, 1028 (9th Cir. 1981), the court, interpreting
California law, concludes with little discussion that a conflict
existed, that the insured "was entitled to engage outside
counsel," and that the insurer was responsible for "reasonable
value of the legal services and costs performed by independent
counsel selected by the insured."
In Maryland Casualty Co. v. Peppers, 355 N.E.2d 24, 30-
32 (Ill. 1976), the court held that an insured had the right to
select independent counsel and control the case in cases of
potential conflict of interest. However, the court also
explicitly recognized the insurer's right to have its attorney
participate "in all phases of [the] litigation subject to the
control of the case by [the insured's] attorney." Id. at 31.
In Illinois Masonic Medical Ctr. v. Turegum Ins. Co.,
522 N.E.2d 611, 618-19 (Ill. App. 1988), the court held that,
under Maryland Casualty, an insured may select its own attorney
and control its defense in conflict situations. The court also
held that it was within the discretion of the replacement counsel
to determine to what extent the counsel appointed by the insurer
and rejected by the insured could also participate in the
defense. Id.
In Prashker v. U.S. Guar. Co., 136 N.E.2d 871 (N.Y.
1956), the question of the right of the insured to select
independent counsel was not directly before the court. The court
stated in dicta that in a conflict of interest situation, the
insured, rather than the insurer, should select defense counsel.
Id. at 876. The court provided no analysis, reasoning, or
authority to support its statement.
In Gorman v. Pattengell, 535 N.Y.S.2d 402, 404 (N.Y.
App. 1988), the court summarily concluded, citing Prashker, that
the insured is entitled to independent counsel at the insurer's
expense where there is a conflict of interest.
In Allstate Ins. Co. v. Noorhassan, 551 N.Y.S.2d 942,
944 (N.Y. App. 1990), the court stated without explanation or
analysis that an insured has the right to select independent
counsel and the insurer has the duty to pay for this defense
whenever a potential conflict of interest arises.
21. The full sentence from Appleman reads:
But it has been held that where a
conflict of interest exists between the
insurer and the insured in the conduct of the
defense of the action brought against the
insured, the insured has the right to refuse
to accept an offer of the counsel appointed
by the insurer and insurer's desire to
control the defense must yield to its
obligation to defend the policyholder; and
where a conflict of interest exists the
engagement of independent counsel to
represent the insured should be approved by
the insurer to assure the employment of
competent counsel. Such approval should not
be unreasonably withheld.
7C Appleman, supra, 4685.01 (emphasis added) (footnotes
omitted).
22. The "right to independent counsel" could be read
narrowly to mean the right to reject an insurer's choice of
attorney. It could be read more broadly to encompass the right
to select substitute or replacement counsel, either unilaterally
or subject to the approval of the insurer.
23. In Center Foundation, the insureds filed a claim for
breach of contract against the insurer after the insurer refused
to accept the independent counsel selected by the insureds when
the insurer reserved the right to contest coverage. 278 Cal.
Rptr. at 15-16. Under the California law operative at the time
of the litigation, the court of appeals held that the implied
covenant of good faith and fair dealing required the insured to
act reasonably in selecting independent counsel. Id. at 21. The
court concluded that the insurer therefore did not breach its
obligations to the insured by asserting a right to approve the
counsel they selected provided that such approval was not
unreasonably withheld. Id. The Center Foundation court cited
with approval the Beals decision and explicitly recognized the
insurer's right to approve the replacement counsel selected by
the insured. Id. at 21 & n.12.
24. California Civil Code 2860 was a legislative response
to the flood of litigation spawned by the California court of
appeals decision in the case of San Diego Navy Fed. Credit Union
v. Cumis Ins. Soc'y, Inc., 208 Cal. Rptr. 494 (Cal. App. 1984).
See Sampson A. Brown & John L. Romaker, Cumis, Conflicts and the
Civil Code: Section 2860 Changes Little, 25 Cal. W. L. Rev. 45
(1988). The Cumis court held that an insurer who assumed a
defense under a reservation of rights must pay the reasonable
cost of "independent counsel"hired by the insured. 208 Cal.
Rptr. at 506. The Cumis decision created considerable confusion,
led to abuses by insurers and attorneys selected by insureds, and
probably had an adverse economic impact on the public. Brown &
Romaker, supra, at 63-68.
The majority opinion is likely to have similar effects
in Alaska and will probably require legislative intervention to
ultimately bring fairness and order to this complex area of law.
25. It seems an equally probable danger that an
"independent" attorney selected by the insured would have an
interest in favoring the insurer in the hope of establishing a
continuing relationship with the insurer, while his relationship
with the insured is likely to be transitory. After all, it is
the insurer who pays "independent"counsel's fees, too. The rule
adopted by the majority does not address this danger and is a
radical step which will be of doubtful effectiveness in resolving
a problem which may be more pervasive in the minds of
academicians than in the real world.
26. DR 5-105 applies to the situation in which a lawyer
represents two clients. In the circumstances discussed here, the
attorney has but one client, the insured. See Tank v. State Farm
Fire & Casualty Co., 715 P.2d 1133, 1137 (Wash. 1986) ("Both
retained defense counsel and the insurer must understand that
only the insured is the client."). Nonetheless, DR 5-105 is
applicable by virtue of the obligations the attorney has toward
the insurer as a result of the insurance agreement between
insurer and insured. While we need not decide the scope of that
obligation here, at a minimum it encompasses a duty to
communicate with the insurer, to share non-confidential and
unprivileged information regarding the case with the insurer, and
to cooperate with the insurer in efforts to settle the case.
27. While that case did not involve the same type of
conflict of interest present here, this court's recent decision
in Bohna v. Hughes, Thorsness, Gantz, Powell & Brundin, 828 P.2d
745 (Alaska 1992) suggests that existing law is adequate to
remedy the abuses of attorneys and insurers who compromise the
interest of the insured.
28. The agreement between CHI and Employers provided:
[CHI] shall cooperate with [Employers],
and upon [Employers] request, shall attend
hearings and trials and shall assist in
effecting settlements, securing and giving
evidence, obtaining the attendance of
witnesses and in the conduct of suits.
29. In the typical coverage dispute case where the party
suing the insured alleges both intentional and negligent conduct,
the plaintiff has a strong interest in developing facts
indicating intentional conduct, as this enhances the strength of
the plaintiff's case and may be a basis for an award of punitive
damages. Such facts would be discoverable by the insurer in
subsequent coverage litigation with the insured.
30. Interestingly the court affords CHI a right which it
did not believe it had, and which it claimed not to be asserting
if it did. In a letter from Lee Houston of Clement-Houston
Insurance, Inc. (CHI of Alaska, Inc.) to counsel initially
selected by Employers, Houston remarks:
I said, as I am repeating here, that we
preferred having our own lawyer. Now - you
are twisting this around to indicate we have
terminated you. This is not true. I doubt
the policy gives us authority to unilaterally
dismiss counsel . . . and we are not going to
try to do so.
Houston doubted too much. Not only did CHI have the
right to unilaterally dismiss counsel selected by Employers, but
also it had the unfettered right to unilaterally select counsel
regardless of its policy with Employers.
31. Section X of the insurance contract provides in part:
The Insured shall cooperate with the
Corporation, and, upon the Corporation's
request, shall attend hearings and trials and
assist in effecting settlements, securing and
giving evidence, obtaining the attendance of
witnesses and in the conduct of suits.
32. This is not to say that there must be multiple counsel.
The insurer may accept the insured's choice of counsel to
represent its interests, or the insured may accept the insurer's
choice of counsel to represent its interests. This would be a
matter of choice, not contract.
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