When is an insurer obligated to provide independent counsel for its insured?

Cumis Counsel 1

State Farm Mut. Auto. Ins. Co. v. Hansen (Nev. Supreme Ct. – Sep. 24, 2015)

The Federal District Court for the District of Nevada certified two questions to the Supreme Court of Nevada concerning Nevada’s conflict-of-interest rules in insurance litigation. The first question asked whether Nevada law requires an insurer to provide independent counsel for its insured when a conflict of interest arises between the insurer and the insured. The second asked whether, if the first question is answered affirmatively, the court would find that a reservation of rights letter creates a per se conflict of interest.

While leaving a house party, Hansen was injured in an altercation with other guests. The other party guests tried to prevent Hansen and his friends from leaving the party by sitting on or standing around their vehicle. Eventually Hansen and his friends were able to leave the party in their vehicle, but they later had to stop at the gated exit of the residential subdivision. While stopped at the gate, the vehicle of another party guest, Aguilar, struck the vehicle in which Hansen was riding. Hansen filed a complaint against Aguilar and others in Nevada state district court alleging both negligence and various intentional torts.

Aguilar was insured by State Farm Mutual Automobile Insurance Company. State Farm agreed to defend Aguilar under a reservation of rights. The reservation of rights letter reserved the right to deny coverage for liability resulting from intentional acts and punitive damages.

Aguilar admitted to negligently striking the other vehicle, and the district court granted summary judgment in favor of Hansen on the negligence claim. Aguilar then agreed to a settlement with Hansen, in which he assigned his rights against State Farm to Hansen.

Hansen filed a lawsuit in the United States District Court for the District of Nevada, alleging that State Farm, in its representation of Aguilar, breached a contract, contractually or tortiously breached an implied covenant of good faith and fair dealing, and violated the Nevada Unfair Claims Practices Act. Hansen also asked for declaratory relief based on the stipulated judgments and assignment of rights. State Farm moved for summary judgment, arguing that Aguilar’s assignment of rights to Hansen was void because it violated Aguilar’s insurance contract. Hansen responded that, even if Aguilar violated the insurance contract, State Farm’s prior breach terminated Aguilar’s obligations under the contract.

The federal district court found that State Farm breached its contractual duty to defend Aguilar because it did not provide Aguilar with independent counsel of his choosing. The court said that State Farm’s interests conflicted with Aguilar’s interests because the insurance policy only covered Aguilar if he acted negligently; the policy did not cover intentional tortious acts. The court therefore applied the rule from San Diego Navy Federal Credit Union v. Cumis Insurance Society, Inc., 208 Cal. Rptr. 494 (Ct. App. 1984), which states that an insurance company must provide independent counsel if its interests conflict with the insured’s. Because State Farm did not comply with the Cumis rule, the district court found that State Farm violated its contractual duty to defend Aguilar.

State Farm moved for reconsideration. The federal district court granted, in part, State Farm’s motion and certified these questions to the Supreme Court of Nevada.

The right to insurer-provided independent counsel

The Court explained that Nevada Rules of Professional Conduct (RPC) Rule 1.7(a) states the general rule that a lawyer shall not represent a client if the representation involves a concurrent conflict of interest. But when an insurer provides counsel to defend its insured, a conflict of interest may arise because the outcome of litigation may also decide the outcome of a coverage determination—a determination that may pit the insured’s interests against the insurer’s. For example, an insurer will want the litigation outcome to determine coverage in a way favorable to the insurer, such as by deciding that the insured’s acts were intentional and therefore not covered. Conversely, the insured will want to be found negligent so that the insurer will pay his liabilities. By reserving the right to determine coverage after litigation, the insurer hopes that the litigation outcome effectively determines coverage on its behalf and in its favor. The insurer-provided lawyer will have a relationship with both the insured and the insurer, who each have legal interests opposing the other.

The Cumis rule says that, in order to avoid a conflict of interest resulting when an insurer reserves its rights to determine coverage, an insurer must satisfy its contractual duty to provide counsel by paying for counsel of the insured’s choosing. The issue here is whether the Cumis rule, or some alternative, applies in Nevada.

The Court explained that Nevada is a dual-representation state. Insurer- appointed counsel represents both the insurer and the insured. Because Nevada is a dual-representation state, counsel may not represent both the insurer and the insured when their interests conflict and no special exception applies. The Court noted that this suggests that the Cumis rule, where the insurer must satisfy its contractual duty to provide counsel by paying for counsel of the insured’s choosing, is appropriate for Nevada.

Nevada, like California, recognizes that the insurer and the insured are dual clients of insurer-appointed counsel. Where the clients’ interests conflict, the rules of professional conduct prevent the same lawyer from representing both clients. The Court explained that California’s Cumis rule is well-adapted to this scenario. It requires insurers to fulfill their duty to defend by allowing insureds to select their own counsel and paying the reasonable costs for the independent counsel’s representation. The Court found this approach more workable than the alternatives. Therefore, the Court answered the first certified question in the affirmative: When a conflict of interest exists between an insurer and its insured, Nevada law requires the insurer to satisfy its contractual duty to provide representation by permitting the insured to select independent counsel and by paying the reasonable costs of such counsel.

The effect of a reservation of rights

The Court explained that jurisdictions are divided on whether a reservation of rights creates a per se conflict of interest. Some jurisdictions apply a per se rule that a reservation of rights creates a conflict of interest between the insured and insurer-appointed counsel. Courts in these jurisdictions have reasoned that, if an insurer could control the case under a reservation of rights, it could insist on full litigation. The insurer would thereby expose the insured to the risk of personal liability and then seek to deny coverage if the verdict is unfavorable to the insured. Courts see it as unfair to give insurers an opportunity for a second bite of the apple.

Other jurisdictions look to the facts of the case to determine whether there is an actual conflict. Courts in these jurisdictions stress that the point of the Cumis rule is to enforce conflict-of-interest rules, so the focus should be on whether there is actually a conflict. Courts must therefore consider whether a conflict of interest exists and not simply look for a reservation of rights.

For example, in California, the codified Cumis rule requires an actual conflict of interest; it does not apply to every case in which there is a reservation of rights. There are two elements: (1) a reservation of rights and (2) that the outcome of the coverage determination can be controlled by counsel in the underlying defense of the claim. The Court noted that even after laying out those two elements, the statute uses the word “may,” implying that it is still an issue of fact whether a conflict of interest actually exists.

The Court then asked, what, then, is the standard that a trial court must apply when looking at whether the facts of the case create a conflict of interest? In California, courts apply the rules of ethics: The Cumis rule is not based on insurance law but on the ethical duty of an attorney to avoid representing conflicting interests. For independent counsel to be required, the conflict of interest must be significant, not merely theoretical, actual, not merely potential. Therefore, even when (1) there is a reservation of rights and (2) insurer-provided counsel has control over an issue in the case that will also decide the coverage issue, courts must still determine whether there is an actual conflict of interest. This means that there is no conflict if the reservation of rights is based on coverage issues that are only extrinsic or ancillary to the issues actually litigated in the underlying action.

The Court concluded that the California approach, that a reservation of rights did not create a per se conflict, was most compatible with Nevada law. Courts must inquire, on a case-by-case basis, whether there is an actual conflict of interest. This approach follows Nevada law: Dual representation is appropriate as long as there is no actual conflict. And the court has approvingly cited opinions holding that joint representation is permissible as long as any conflict remains speculative. Moreover, because the Cumis rule derives from rules of professional conduct, it follows that the appropriate standard is whether there is an actual conflict under RPC 1.7. Therefore, The Court found that an insurer is obligated to provide independent counsel of the insured’s choosing only when an actual conflict of interest exists. The Court also found that a reservation of rights does not create a per se conflict of interest.

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