Caught in the Middle: What to Do When Conflicts Arise Between Policyholders and Insurers Robert A. Shults Jacob A. DeLeon McFall, Sherwood & Breitbeil, P.C. Houston, Texas Within the tripartite relationship, jurisdictions have acknowledged two separate conclusions regarding the identity of the client. Under the dual client model used by some jurisdictions, both the insured and the insurer are clients, at least until a conflict of interest develops. See Charles Silver and Kent Syverud, Professional Responsibilities of Insurance Defense Lawyers, 45 Duke L.J. 255, 273 (1995). Under the single client model the insured, not the insurer is the only client and has the status of principal with the attorney as its agent. See State Farm Mut. Auto. Ins. Co. v. Traver, 980 S.W.2d 625 (Tex. 1998). Although jurisdictions apply different models, in both scenarios the insured is a client. This relationship between insured and insurance defense counsel imposes the same duties as if the insured has personally retained the attorney. Employers Cas. Co. v. Tilley, 496 S.W.2d 552 (Tex. 1973). Thus, state and federal disciplinary rules of conduct should guide the defense lawyer s decisions when advocating on behalf of the insured. Although case law and ethical rules are clear regarding the unqualified duty owed by the defense lawyer to the insured, inherent to this tripartite relationship is the balancing of the competing interests of the insured and the insurer.
A. Insurer Sharply Restricts Defense Expenditures The interest of the insurance company and the insured may diverge if the insurance company has a paramount interest in controlling or reducing its defense costs and the insured s main interest is to receive the best possible defense. Although defense lawyers must be cognizant of the economic interests of the insurers that employ them, they must not allow their professional judgment or the quality of their legal service to be compromised materially by the insurer. ABA Formal Op. 01-421 (2001). Both the Texas Bar and American Bar Association (ABA) are very clear on the issue. The September 2000 Texas Ethics Opinion 533 stated in pertinent part that it is impermissible under the Texas Disciplinary Rules of Professional Conduct for a lawyer to agree with an insurance company to restrictions which interfere with the lawyer s exercise of his or her independent professional judgment in rendering such legal services to the insured/client. Tex. Formal Op. 533 (2000). Although the lawyer is free to enter into an agreement with the insurer regarding fees and services to be rendered for the insured, such an agreement cannot override the ethical responsibilities of the lawyer under the Texas Disciplinary Rules. In other words, regardless of such an agreement with the insurer, the lawyer must at all times be free to exercise his or her independent professional judgment in rendering legal services to the client. Id. Similarly, the ABA s Standing Committee opined, A lawyer must not permit compliance with guidelines and other directives of an insurer relating to the lawyer s services to impair materially the lawyer s independent professional judgment in representing an insured. ABA Formal Op. 01-421 (2001). There may be instances when a lawyer reasonably believes a limitation imposed by the insurer is materially compromising the defense lawyer s ability to fully represent the insured. When such a conflict arises, the defense lawyer should first try to resolve the issue by 2
communicating the insured s desires to the insurer and perhaps reach a compromise. However, if the lawyer is unable to persuade the insurer to release the limitation, the resulting conflict between the insurer s directives and the insured s interests requires the lawyer to protect the immediate interests of the insured. Id. This may require the defense lawyer to withdraw from representing both the insured and the insurer. Id. However, the defense lawyer should understand that withdrawal is limited to situations where the withdrawal can be accomplished without harming the insured. TDRPC Rule 1.15; ABA Model Rule 1.16. B. Insurer and Policyholder Disagree on Manner in which Defense is Conducted Generally, insurance contracts between the insured and the insurer provide the insurance company the right to choose counsel, direct the litigation, and accept or reject settlement demands. Usually these provisions are found in right to control and duty to cooperate clauses of the policy. The insurer s duties to indemnify the insured and to provide a defense may entitle the insurer to take complete and exclusive control of the suit against the insured. G.A. Stowers Furniture Co. v. Am. Indem. Co., 15 S.W.2d 544, 547 (Tex Comm n App. 1929, holding approved). Yet even in those circumstances, the carrier remains the agent of the insured, and the ethical obligations of defense counsel remain unwavering. Id. at 547. However, absent a substantive conflict, the manner in which the defense is conducted will lie with the insurer. An illustrative case is County Mutual Insurance Co. v. Davalos, 140 S.W.3d 685 (Tex. 2004). In Davalos, the Court evaluated whether a disagreement over venue between the insured and the insurer was a sufficient reason for the insurer to lose its right to conduct the defense, while remaining obligated to pay for it. Id. The Court held that a dispute over proper venue was not a sufficient reason to take the contractual right to conduct the defense away from the insurer. Id. at 686. The insurer in Davalos offered to defend the insured without a reservation of rights 3
and instructed the insured to request the withdrawal of his chosen attorney and the substitution of the insurer s choice of counsel. Id. at 687-688. However, the insured rejected the insurer s tender and proceeded with his own choice of counsel. Id. at 690. The Court stated that, Davalos chose to reject Northern s tender and conduct his own defense because he really did not want the case defended in Dallas County. That was his right. But having rejected the insurer s defense without a sufficient conflict, Davalos lost his right to recover the costs of that defense Northern did not breach its duty to defend. Id. The Court further stated, [o]rdinarily, the existence or scope of coverage is the basis for a disqualifying conflict. Id. at 689. Thus, when a conflict arises regarding the manner in which the defense is conducted, the defense lawyer should first try to resolve the issue by communicating the insured s desires to the insurer and reach a compromise. At that juncture, the defense attorney should also advise the insured that the policy gives the insurance company the right to direct the litigation, and that rejecting the insurer s defense might result in a waiver of rights under the policy. If neither party compromises, then the defense lawyer may need to withdraw as defense attorney as a last resort. However, the defense lawyer should understand that withdrawal is limited to situations where the withdrawal can be accomplished without harming the insured. TDRPC Rule 1.15; ABA Model Rule 1.16. C. Policyholder Opposes Settlement By entering into a liability insurance contract with an insurance company, the insured gives certain contractual rights to the insurer and consents to giving the company some control over the direction of the defense and any settlement of the matter. See 7C John Alan Appleman and Jean Appleman, Insurance Law and Practice, 4681 at 203 (1979). Most insurance policies 4
between an insurance company and its insured provide that the insurance company can independently decide to accept or reject settlement demands within policy limits. However, the insurance company must act in good faith towards the insured in the context of any settlement negotiations. See Republic Ins. Co. v. Stoker, 903 S.W.2d 338, 340 (Tex. 1995). If the insured objects to a proposed settlement that the insurer wishes to settle, the defense lawyer cannot proceed with the settlement negotiations without giving the insured an opportunity to assume responsibility for his own defense. ABA Formal Op. 96-403 (1996). At that juncture, the defense attorney should advise the insured that the policy gives the insurance company the right to settle the claim without the insured s consent, and that rejecting the proposed settlement might result in a waiver of rights under the policy. In anticipation of this potential conflict, insurance defense counsel should send a letter to the insured as soon as practicable, informing the insured of not only the defense counsel s obligations and duties owed to the insured, but also of the nature of the representation and the insurer s right to control defense and settlement. Although no formal written consent is necessary, some states hold that lawyer s ethical obligations require the insured s informed consent before a settlement can occur. See e.g. Rogers v. Robson, Masters, Ryan, Brumund and Belom, 81 Ill. 2d 201 (1980). See also ABA Formal Op. 01-421 (2001). The insured manifests consent to the limited representation by accepting the defense offered by the insurer after being advised of the terms of the representation being offered. ABA Formal Op. 01-421 (2001). Once this communication takes place, the lawyer is free to settle the claim at the direction of the insurer. Id. D. Conclusion It is clear that the defense lawyer s primary duties are to the insured. To this end, the best policy is complete candor between the defense lawyer and the insured. The defense lawyer 5
must immediately apprise the insured of any potential conflicts with the insurer and zealously advocate on the insured s behalf. However, in a relationship where a third-party contractually controls and pays for the litigation, it is important to also effectively communicate with the insurer so long as such information was not revealed by the insured in confidence. When conflicts do arise, the defense lawyer should serve the interests of the insured first and foremost, and comply with the interests of the insurance company only to the extent that those interests do not adversely affect the insured. 6