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09.11.2013

In Federal Insurance Company v. MBL, Inc., 2013 WL 4506149 (Cal. Ct. App. Aug. 26, 2013), California’s Court of Appeal for the Sixth District recently clarified when an insurer is required to pay for independent counsel of the insured’s choosing.  This is an important issue to policyholders not only in California but across the country.  As the court made clear, the answer to this question depends upon whether a conflict of interest exists between an insurer and its insured based upon possible non-coverage under the insurance policy.  This issue was previously discussed in San Diego Navy Federal Credit Union v. Cumis Insurance Society, Inc., 162 Cal. App. 3d 358, 208 Cal. Rptr. 494 (Ct. App. 1984), and has since been codified at California Civil Code § 2860.  Analyzing the facts in light of this statutory and case law, the Federal Insurance Company court found that there existed no conflict of interest in the underlying litigation that required the insurers to appoint counsel of the insured’s choice.

When it was discovered that Halford’s Cleaners, a dry cleaning facility in the City of Modesto, California, had contaminated the nearby soil and groundwater, the federal government brought a Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”) action against the owners of the property on which Halford’s was located and the lessees who owned and/or operated the facility in order to recover the costs of remediating the contamination.  The defendants in that case then filed third-party actions against MBL, Inc. (“MBL”), a supplier of one of the dry cleaning products that had polluted the soil and water.  Subsequently, MBL tendered the defense of these third-party actions to its insurers: Federal Insurance Company, Centennial Insurance Company, Atlantic Mutual Insurance Company, Nationwide Indemnity Company, Utica Mutual Insurance Company, and Great American Insurance Company.  The insurers accepted the tender of defense, subject to reservations of various rights, and retained counsel to defend MBL.  MBL, however, refused to accept retained counsel and instead argued that the insurers’ reservations of rights created a conflict of interest that required the insurers to pay for counsel of MBL’s choosing.  In other words, MBL requested the appointment of Cumis counsel pursuant to § 2860.   The insurers, with the exception of Great American, filed declaratory relief actions denying that any such conflict of interest existed.  The trial court granted summary judgment in favor of the insurers, finding there was no actual conflict of interest.  MBL appealed the ruling in a continuing effort to have counsel of its choosing.

In deciding whether the insurers’ reservations of rights created a conflict of interest, the court first evaluated the insurers’ various policies, paying particular attention to the reservation of rights provisions.   Citing to the Cumis decision and § 2860, the court explained that not every conflict of interest triggers an obligation on the part of the insurer to provide the insured with independent counsel at the insurer’s expense.  For example, an insured is not necessarily entitled to Cumis counsel simply because the insurer disputes coverage or the complaint seeks damages in excess of the policy.  For independent counsel to be required, the conflict of interest must be significant and the coverage issue must be intertwined with the issues in the underlying action.  When there is a reservation of rights and the outcome of the coverage issue can be controlled by counsel first retained by the insurer for the defense of the claim, independent counsel is required.

In support of its argument that the insurers had a duty to provide independent counsel, MBL asserted that the qualified pollution exclusions contained in Utica’s and Federal’s policies created a conflict of interest because appointed counsel would have an interest in developing facts supporting the insurer’s denial of coverage.  Significantly, neither Federal nor Utica had reserved their rights to decline coverage under the qualified pollution exclusions set forth in their policies.  The court held that when the insurer has not expressly reserved its right to deny coverage under a particular exclusion, there can be no actual conflict based on the application of that exclusion.

Similarly, MBL unsuccessfully argued that Nationwide’s reservation of rights concerning the number of “accidents” or “occurrences” triggered MBL’s right to independent counsel.  MBL had not presented any evidence to establish that the number of occurrences was an issue in the underlying litigation; therefore, the court found that MBL was simply trying to manufacture a conflict where none existed.

The court further held that the fact that an insurer may have represented another third-party defendant, in addition to MBL, in the underlying litigation did not, by itself, create a conflict of interest.  In response to MBL’s argument that the insurers’ reservation of the right to deny coverage for damages occurring outside of their various policy periods gave rise to a conflict of interest, the court stated that where the coverage issue relates only to the timing of damages, there is no conflict under § 2860.

Finally, the court rejected MBL’s argument that an insurer’s general reservation of rights creates a conflict of interest.  A general reservation of rights does not give rise to a conflict of interest or create a duty to provide independent counsel.  The court emphasized that where the insurer has not expressly reserved its right to deny coverage under a particular exclusion in its policy, there can be no actual conflict based on the application of that exclusion during the pendency of the action.

Federal Insurance Company makes clear that an insured who wants to be provided with independent counsel must show a significant, not merely theoretical, conflict of interest.  Courts around the country have handled this issue differently since Cumis was first decided.  Policyholders need to be mindful of this potential conflict of interest scenario and be prepared to address it early in the case.  As for the standard in California, this the Federal case means that the insured must be able to show that the right expressly reserved by the insured relates to the issues being litigated in the underlying case.  A general reservation of rights by the insurer is insufficient to justify the provision of independent counsel.  Only when the insured can show that appointed counsel can influence the outcome of the coverage issue can the insured show that an actual conflict of interest exists that requires independent counsel.

Jaime Wisegarver is an associate in the Litigation Section, where she handles a variety of civil and commercial matters, including insurance recovery litigation and counseling. For more information, please contact Jaime at (804) 771-5634 or jwisegarver@hf-law.com.

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