TWENTY FIRST ANNUAL NORTHEAST SURETY AND FIDELITY CLAIMS CONFERENCE

TWENTY FIRST ANNUAL NORTHEAST SURETY AND FIDELITY CLAIMS CONFERENCE rd th SEPTEMBER 23-24, 2010 ETHICAL ISSUES IN TENDERS OF DEFENSE AND JOINT DEFENSE AGREEMENTS PRESENTED BY: JONATHAN BONDY, ESQ. WOLFF & SAMSON PC One Boland Drive West Orange, New Jersey 07052 DAVID PIKULIN, ESQ. LIBERTY MUTUAL INSURANCE COMPANY Seattle, Washington 98185

TABLE OF CONTENTS Page TENDERS... 1 I. To Tender or Not to Tender... 1 II. Who Does Counsel Represent?... 3 III. Counsel s Ethical Duty of Diligent Representation... 7 IV. Counsel s Ethical Duty Regarding Confidentiality of Communications... 9 V. Ethical Concerns When the Principal Does Not Pay Counsel... 12 VI. VII. Ethical Concerns When the Principal Does Not Provide Collateral... 15 Ethical Concerns When the Surety and Principal Disagree as to How the Case Should be Handled and/or Settled... 17 VIII. Conflicts When Counsel Becomes Adverse to the Surety... 21 JOINT DEFENSE AGREEMENTS... 25 IX. Why Enter into a Joint Defense Agreement?... 25 X. Must Joint Defense Agreements be in Writing... 26 XI. XII. Potential Conflicts When Counsel Becomes Adverse to a Former Co-Party to a Joint Defense Agreement... 28 Ethical Concerns When the Surety and Principal Take Inconsistent Positions... 31 CONCLUSION... 35 i

ETHICAL ISSUES IN TENDERS OF DEFENSE AND JOINT DEFENSE AGREEMENTS1 Jonathan Bondy, Esq. Wolff & Samson Pc West Orange, NJ & New York, NY David Pikulin, Esq. Liberty Mutual Insurance Company Seattle, WA I. To Tender or Not to Tender TENDERS Even for an experienced Surety claims practitioner, deciding whether, and on what conditions, to tender the Surety s defense in a pending litigation to the bond Principal, and Principal s chosen counsel, can be difficult. The factors may appear straightforward: simply consider the financial stability of the Principal, the relationship between the Principal and the Surety (including any past claims and the Principal s communication with the Surety regarding them), whether the Principal appears to have valid defenses to the claims, and whether chosen counsel is competent but a potential tender of the Surety s defense can also give rise to a broad range of ethical issues. Among them are the proposed counsel s duties of loyalty and candor, and potential conflicts of interest that may arise, should the Surety and Principal later become adverse to one another. Consider this quote from a Federal court litigation, which provides a cautionary tale of the problems Sureties sometimes face when they have tendered their defense: [The Surety] tendered the defense of the claims to the Indemnitors, who undertook the defense. [The Surety] learned in July of 1986, that in January of 1986 the [claimant] had amended its complaint to allege bad faith and to seek punitive damages against [the Surety]. [The Surety] also learned that counsel on the tender of the defense, John Kugler, had failed to answer some interrogatories and had agreed to pay the [claimant] its attorney fees for the motion it filed to compel responses to those interrogatories. Finally, the Surety learned that it had not been notified of a settlement offer from the [claimant]. 2 1 This paper was previously presented at the 2010 meeting of the Surety & Fidelity Claims Institute. The authors thank Graham Claybrook of Wolff & Samson PC for his assistance with the research and preparation of this paper. 2 United States ex rel. Board of Elec. Workers Local No. 449, 697 F. Supp. 378, 380 (D. Idaho 1988). The Surety obtained its own counsel and quickly settled the Union s claims after it became aware

In spite of these hazards, Sureties often accommodate a Principal s request rather than risk alienating what may otherwise be a good customer in good standing. Additionally, courts are increasingly expecting the Surety to reasonably assess the need for its own attorney, or possibly risk failing to recover full indemnity for such fees if the Surety unnecessarily engages its own counsel when the Principal offers to assume the Surety s defense. These factors often motivate the Surety to tender. Ethical considerations are also important when determining whether or not the Surety should tender in a given situation. These considerations should take place at the initial claims review stage, since determining whether to tender can become relevant both during the litigation (if, for instance, the Surety rescinds its tender and must pay an attorney to get up to speed on the litigation) and after the litigation, should the Surety seek reimbursement of its attorneys fees pursuant to its rights of common law or contractual indemnification. For instance, a leading case on the Surety s right to full indemnity after refusing to tender its defense is Central Towers Apartments, Inc. v. Martin. 3 In Central Towers, the Court cited a list of 12 factors to be considered in reviewing the reasonableness of a Surety s claims for counsel fees after the Surety declined the Principal s offer to assume the Surety s defense: 1. The amount of risk to which the Surety was exposed; 2. whether the Principal was solvent; 3. whether the Surety has called on the Principal to deposit with it funds to cover the potential liability; 4. whether the Principal on demand by the Surety to deposit with it the amount of the claim has refused to do so; 5. whether the Principal was notified of the action and given opportunity to defend for itself and the Surety; 6. whether the Principal hired the attorney for both himself and the Surety; 7. whether the Principal notified the Surety of the hiring of the attorney; 8. the competency of the attorney hired by the Principal; 9. the diligence displayed by the Principal and his attorney in the defense; 10. whether there is a conflict of interest between the parties; of this behavior. Id. 3 453 S.W.2d 789, 800 (Tenn. Ct. App. 1970). See also Gulf Ins. Co. v. AMSCO, Inc., 889 A.2d 1040, 1049 (N.H. 2005) (quoting Central Towers); Perkins v. Thompson, 551 So.2d 204, 210 (Miss. 1989) (same); Jackson v. Hollowell, 685 F.2d 961, 966 n. 15 (5th Cir. 1982) (same). 2

11. the attitude and cooperativeness of the Surety; 12. the amount charged and diligence of the attorney hired by the Surety. 4 Thus, ethical considerations are relevant not just to the Surety s relationship with its potential counsel, but also for the Surety s relationship with its Indemnitors. This paper will first explore the ethical issues that may arise from the offer of tender, the tender itself, and the relationship between the Surety and Principal, as well as counsel for both parties, during and after the litigation. II. Who Does Counsel Represent? When the Surety and Principal agree to tender the Surety s defense to the Principal s attorney, the Principal s attorney and the Surety enter into an attorney-client relationship. 5 It does not require much foresight to anticipate that the Principal s attorney will have a stronger sense of loyalty to the Principal than the Surety. As a cautionary tale, the following question was actually posed to the Ethics Committee for the North Carolina State Bar by a Principal s attorney considering the implications of undertaking a Principal-Surety defense tender: The general contractor gives notice that it is tendering a defense on behalf of itself and the Surety. Discussions between the Surety and the claimant cease. The claimant files a complaint to perfect the bond claim. The complaint names the subcontractor, the general contractor, and the Surety as defendants who are jointly and severally liable for the debt. The Surety has an obligation to the claimant, absent valid defenses, timely to resolve a payment bond claim. The general contractor does not have any valid defenses under the law, but wants to delay the proceeding to avoid payment. Under these circumstances, may one lawyer represent both the Surety and the general contractor in defense of the claim? 6 4 A full analysis of each factor of this test is beyond the scope of this article, which will focus primarily on the ethical factor. For an excellent and thorough discussion of the various factors the Surety should consider when its Principal offers to defend (in addition to the ethical considerations herein), see Cranston, Kenneth A. and Kent, Andrew S., To Tender or Not to Tender, That is the Question; When and How?, presented at the 19th Annual Northeast Surety & Fidelity Conference, Sept. 18-19, 2008? 5 See, e.g., Ins. Co. of N. Am. V. Westergren, 794 S.W.2d 812, 814 (Tex. Ct. App. 1990) (attorney-client relationship existed between Surety and Principal s counsel based on tendered defense, even though Principal s counsel was paid by Principal and relationship was merely an accommodation or pro forma ). 6 2003 N.C. ETH. OP. 1, 2003 WL 24306940 (N.C. St. Bar.). 3

The Ethics Committee answered the question by stating that it is unethical for an attorney to assert invalid defenses or unnecessarily delay legal proceedings on behalf of any client, and added: Similarly, if the lawyer believes that an appropriate defensive action taken on behalf of the general contractor would interfere with a legal duty the Surety owes to the claimant/supplier, such that the Surety could be exposed to a bad faith claim, a conflict arises. In this situation, the lawyer must withdraw from the representation of both parties and may only continue with the representation of the general contractor with the consent of the Surety. 7 The foregoing should be of concern simply because the question was put to the Committee at all, and the inquiry reflects the difficulties the Surety faces when tendering to the Principal. Thus, the first and most basic concern of the Surety in tender considerations is whether the proposed tender counsel can properly exercise his duty of loyalty to the Surety. The ABA Model Rules of Professional Conduct, 8 and state professional responsibility codes or statutes, touch specifically on this issue. 9 RPC 1.7 states: (a) Except as provided in paragraph (b), a lawyer shall not represent a client if the representation involves a concurrent conflict of interest. A concurrent conflict of interest exists if: (1) the representation of one client will be directly adverse to another client; or (2) there is a significant risk that the representation of one or more clients will be materially limited by the lawyer's responsibilities to another client, a former client or a third person or by a personal interest of the lawyer. (b) Notwithstanding the existence of a concurrent conflict of interest under paragraph (a), a lawyer may represent a client if: 7 Id. 8 Hereinafter RPC. 9 This paper only deals specifically with RPCs. Claims representatives and their counsel are strongly encouraged to conduct an independent review of the state s law where the claim is pending for any deviation from the RPCs discussed in this paper. 4

(1) the lawyer reasonably believes that the lawyer will be able to provide competent and diligent representation to each affected client; (2) the representation is not prohibited by law; (3) the representation does not involve the assertion of a claim by one client against another client represented by the lawyer in the same litigation or other proceeding before a tribunal; and (4) each affected client gives informed consent, confirmed in writing. 10 The official comment to RPC 1.7 explains the purpose of the rule as being in terms of the attorney s duty to his client: [l]oyalty and independent judgment are essential elements in the lawyer s relationship to a client. 11 In other words, RPC 1.7 requires that the attorney be able to represent each client fully and without limitation by the interest of the other client. There are many situations in which counsel s ethical obligation to be loyal to both the Surety and Principal seems impossible. The most common situation is where the Surety wishes to assert a Surety-specific defense to liability under the bond that may adversely effect the Principal s position. For example, the Surety may allege an overpayment by an owner, particularly where the Principal claims that it was underpaid for the same work. 12 The Surety could claim that it was fraudulently induced to write the bonds at issue. 13 The Surety could raise a joint-venture defense. 14 Or, the Surety 10 MODEL RULES OF PROF L CONDUCT RULE 1.7. 11 Id. 12 But see Central Towers, 453 S.W.2d at 797 (court found that Surety s defense of overpayment was not sufficient to create a necessity that the Surety retain separate counsel). However, the Central Towers court s conclusion may be limited to its unique facts. There, the alleged overpayment related only to the owner s release of 10% retainage at the end of the project, and the court held that since the exact amount of possible overpayment was not disputed and could be determined during the litigation, the Surety would be made whole. This is quite different from the common overpayment defense where, for instance, the owner has paid 50% of the contract price, and the principal claims to be 75% complete, while the Surety complains that the work was only 30% complete and thus the owner overpaid. Such a theory by the Surety could create an irreconcilable conflict. The Surety should also consider Safeco Insurance Co. of America v. Criterion Investment Corp., 732 F. Supp. 834 (E.D. Tenn. 1989), where the court distinguished Central Towers on the grounds that principal in Central Towers cooperat[ed] to keep the Surety from exposure to risk on the bond. 13 For a full discussion of fraud in the inducement as a defense to the Surety s liability, see Clarke, Bogda M.B., Ferrucci, James D. and Shahinian, Armen, Fraud in the Inducement as a Defense to Fidelity and Surety Claims, 42 TORT TRIAL & INS. PRAC. L.J. 181 (2007). The Surety s successful defense of fraud in the inducement requires some culpability by the obligee as well as the Principal. However, the fact that 5

could allege a material discharge defense. 15 In each of these situations, the interests of the Surety and the interests of the Principal may be sufficiently unaligned that an attorney cannot ethically represent both Principal and Surety. 16 Where such potential Surety defenses exist, a tender of defense may not be practical, or ethically permissible, from the outset. However, RPC 1.7 also provides that an attorney may represent two parties even if they have a concurrent conflict of interest if both clients give informed consent, confirmed in writing. Informed consent is defined as: [T]he agreement by a person to a proposed course of conduct after the lawyer has communicated adequate information and explanation about the material risks of and reasonably available alternatives to the proposed course of conduct. 17 Thus, if both the Surety and Principal understand and acknowledge the risks inherent in a joint representation, and are informed of the problems that might arise therein, the lawyer can comply with his ethical responsibility under RPC 1.7 by getting the written consent of both parties waiving the conflict. On the other hand, the Oregon State Bar Legal Ethics Committee has held that it is only appropriate to defend a Surety and Principal together where there is a definite unity of interest, and that it is never appropriate to represent a Surety and Principal when there are conflicting interests, even if the lawyer has received informed consent. 18 The potential for such a conflict of interest may provide the Surety with good cause to refuse a tender, but the Surety should research the relevant state ethics rules to determine if concurrent representation is even permitted. the Surety suspects fraud on the part of the Principal in the first place should be sufficient grounds for the Surety to refuse to tender its defense. 14 That is, a defense that a subcontractor making a claim on a bond is actually a joint venturer with the Principal, in which case it has no right to recover against the bond. This theory is analyzed in detail in United States ex rel. PCC Construction v. Star Insurance Co., 90 F. Supp. 2d 512, 518-521 (D.N.J. 2000). Again, the fact that the Surety suspects such dishonesty on the part of the Principal in the first place should be sufficient grounds for the Surety to refuse to tender its defense. 15 See, generally, Egan, Michael M., Eastwood, Marla, Discharge of the Performance Bond Surety, ch. 7, THE LAW OF SURETYSHIP, 2nd Ed. (ABA TIPS, E. Gallagher, Ed. 2000). In this situation, the Surety and Principal again have adverse interests in the Surety s understanding of the Principal s bonded obligations. 16 A tender attorney that learns facts during his representation of the Principal that are relevant to any of these defenses is also under an ethical obligation to inform the Surety. See Point III, infra. 17 MODEL RULES OF PROF L CONDUCT RULE 1.0(e). 18 See OR. STATE BAR LEGAL ETHICS COMM., Opinion 49894 (1984). 6

It is not, on the other hand, an ethical issue for the attorney that the Surety s defense is being funded by the Principal. It may, though, create certain limitations to the attorney s interest and loyalty that the Surety must consider and consent to. Comment 13 to RPC 1.7 states: A lawyer may be paid from a source other than the client, including a coclient, if the client is informed of that fact and consents and the arrangement does not compromise the lawyer's duty of loyalty or independent judgment to the client. See [RPC] 1.8(f). If acceptance of the payment from any other source presents a significant risk that the lawyer's representation of the client will be materially limited by the lawyer's own interest in accommodating the person paying the lawyer's fee or by the lawyer's responsibilities to a payer who is also a co-client, then the lawyer must comply with the requirements of paragraph (b) before accepting the representation, including determining whether the conflict is consentable and, if so, that the client has adequate information about the material risks of the representation. 19 In light of these special ethical and representational concerns, whether to grant a written waiver of a conflict is within the Surety s business judgment. Other ethical obligations of the proposed attorney to the Surety discussed below should be considered before the Surety gives its consent and tenders its defense. III. Counsel s Ethical Duty of Diligent Representation Another ethical duty that is relevant to the co-representation relationship present when the Surety tenders its defense is the attorney s duty of diligent representation to the Surety. RPC 1.4 sets out this ethical duty as follows: (a) A lawyer shall: (1) promptly inform the client of any decision or circumstance with respect to which the client s informed consent, as defined in [RPC] 1.0(e), is required by these Rules; (2) reasonably consult with the client about the means by which the client s objectives are to be accomplished; (3) keep the client reasonably informed about the status of the matter; (4) promptly comply with reasonable requests for information; and 19 MODEL RULES OF PROF L CONDUCT RULE 1.7, CMT. 13. 7

(5) consult with the client about any relevant limitation on the lawyer s conduct when the lawyer knows that the client expects assistance not permitted by the Rules of Professional Conduct or other law. (b) A lawyer shall explain a matter to the extent reasonably necessary to permit the client to make informed decisions regarding the representation. 20 This rule requires that the attorney inform the Surety of facts necessary to make informed decisions regarding its representation. But, the Principal s counsel may sometimes fail in his obligation to inform the Surety of important facts, including those learned from the Principal, which counsel is ethically obligated to disclose to the Surety. RPC 1.4 is, therefore, sometimes in conflict with RPC 1.6, which obligates an attorney to maintain a client s confidences. 21 Comment 31 of RPC 1.7 (entitled Special Considerations in Common Representation ) puts the tension this way: [C]ontinued common representation will almost certainly be inadequate if one client asks the lawyer not to disclose to the other client information relevant to the common representation. This is so because the lawyer has an equal duty of loyalty to each client, and each client has the right to be informed of anything bearing on the representation that might affect that client s interests. 22 Situations where such tension between the Surety and Principal could exist include: Where the Principal admits to its attorney that it has no defense to claims in litigation but asks the attorney to delay resolution of the claims (such as the facts described in 2003 N.C. Ethics Opinion 1). Such conduct may arguably give rise to sanctions, or even bad faith claims, against the Surety. 23 Where the attorney is informed, or determines based on his access to confidential information, that the Principal and/or Indemnitors are 20 MODEL RULES OF PROF L CONDUCT RULE 1.4. 21 MODEL RULE OF PROFESSIONAL CONDUCT 1.6 and its effect on the Surety s tender of its defense will be discussed in greater detail in Point III, infra. 22 MODEL RULES OF PROF L CONDUCT RULE 1.7, CMT. 31 (emphasis added). 23 See, e.g., Local No. 449, 697 F. Supp. at 381. 8

insolvent, which could later adversely affect the Surety s indemnification rights. Where the attorney is informed of the potential for other claims beyond those known to the Surety such as prevailing wage claims that could exceed the Surety s anticipated losses. Where the attorney fails to inform the Surety of settlement offers. 24 These are just a few of the possible situations in which a Principal s attorney may violate his duty of loyalty to the Surety by failing to disclose material information to the Surety, which is also the attorney s client. In such situations, it is impossible for the Surety to continue to give informed consent to the joint representation. 25 IV. Counsel s Ethical Duty Regarding Confidentiality of Communications As touched upon previously, the duty to maintain client confidences, set forth in RPC 1.6, often creates the greatest tension in the counsel s joint representation of the Surety and Principal. RPC 1.6 states: (a) (b) A lawyer shall not reveal information relating to the representation of a client unless the client gives informed consent, the disclosure is impliedly authorized in order to carry out the representation or the disclosure is permitted by paragraph (b). A lawyer may reveal information relating to the representation of a client to the extent the lawyer reasonably believes necessary: (1) to prevent reasonably certain death or substantial bodily harm; (2) to prevent the client from committing a crime or fraud that is reasonably certain to result in substantial injury to the financial interests or property of another and in furtherance of which the client has used or is using the lawyer s services; (3) to prevent, mitigate or rectify substantial injury to the financial interests or property of another that is reasonably certain to result or has resulted from the client's commission 24 Id. 25 See MODEL RULES OF PROF L CONDUCT RULE 1.4, CMT. 5: In certain circumstances, such as when a lawyer asks a client to consent to a representation affected by a conflict of interest, the client must give informed consent, as defined in Rule 1.(e). 9

of a crime or fraud in furtherance of which the client has used the lawyer s services; (4) to secure legal advice about the lawyer s compliance with these Rules; (5) to establish a claim or defense on behalf of the lawyer in a controversy between the lawyer and the client, to establish a defense to a criminal charge or civil claim against the lawyer based upon conduct in which the client was involved, or to respond to allegations in any proceeding concerning the lawyer s representation of the client; or (6) to comply with other law or a court order. 26 The commentary to RPC 1.6 states that the ethical duty of confidentiality applies not only to matters communicated in confidence by the client but also to all information relating to the representation, whatever its source. 27 Thus, counsel s obligation to keep communications confidential upon his client s request (assuming that none of the subsection (b) exceptions apply) is often at odds with RPC 1.4 s requirement that both clients be kept informed of relevant information known to the attorney. Counsel to whom the Surety s defense is tendered may be in breach of his ethical duties to the Surety in situations such as those described in Part II, supra, if he fails to inform the Surety of facts adverse to its position or interest in the litigation. On the other hand, if he communicates his knowledge of such adverse information to the Surety, he may be violating his duty to keep the Principal s communications confidential. The RPC, and state codes and statutes, attempt to deal with such potential ethical issues in practical terms. Comment 30 to RPC 1.7 states: A particularly important factor in determining the appropriateness of common representation is the effect on client-lawyer confidentiality and the attorney-client privilege. With regard to the attorney-client privilege, the prevailing rule is that, as between commonly represented clients, the privilege does not attach. Hence, it must be assumed that if litigation eventuates between the clients, the privilege will not protect any such communications, and the clients should be so advised. 28 26 MODEL RULES OF PROF L CONDUCT RULE 1.6. 27 MODEL RULES OF PROF L CONDUCT RULE 1.6, CMT 1. 28 MODEL RULES OF PROF L CONDUCT RULE 1.7, CMT 30 (emphasis added). 10

Similarly, many states have enacted laws that set forth the same basic rule. For example, New Jersey law provides that [w]here 2 or more persons have employed a lawyer to act for them in common, none of them can assert such privilege as against the others as to communications with respect to that matter. 29 This is also true in many other jurisdictions, including California 30 and Florida. 31 However, counsel that ends up in this predicament must either inform both parties of (a) the information he has learned and (b) his determination to share it (and thus receive informed consent to continue as counsel for both) or withdraw from representing both parties. 32 The potential for conflicts arises in numerous situations, including settlement offers and when the attorney learns, or the Principal discloses to him, information that the Principal does not want shared with the Surety. Thus, comment 29 to RPC 1.7 cautions: In considering whether to represent multiple clients in the same matter, a lawyer should be mindful that if the common representation fails because the potentially adverse interests cannot be reconciled, the result can be additional cost, embarrassment and recrimination. Ordinarily, the lawyer will be forced to withdraw from representing all of the clients if the common representation fails. In some situations, the risk of failure is so great that multiple representation is plainly impossible. For example, a lawyer cannot undertake common representation of clients where contentious litigation or negotiations between them are imminent or contemplated. Moreover, because the lawyer is required to be impartial between commonly represented clients, representation of multiple clients is improper when it is unlikely that impartiality can be maintained. Generally, if the relationship between the parties has already assumed antagonism, the possibility that the clients interests can be adequately served by common representation is not very good. 33 29 N.J.S.A. 2A:84A-20(2) (West 2010). 30 CAL. EVID. CODE 962 (West 2010) (providing that no attorney client privilege exists between joint clients or their successors in interest in a dispute between them). 31 FLA. STAT. ANN. 90.502(4)(e) (West 2010), stating: There is no lawyer-client privilege under this section when: (e) A communication is relevant to a matter of common interest between two or more clients, or their successors in interest, if the communication was made by any of them to a lawyer retained or consulted in common when offered in a civil action between the clients or their successors in interest. 32 See MODEL RULES OF PROF L CONDUCT RULE 1.7, CMT. 30 ( Ordinarily, the lawyer will be forced to withdraw from representing all of the clients if the common representation fails. ). The possibility of this situation should certainly be considered by the parties as part of the informed consent process in considering and negotiating the tender. 33 Id. Antagonism created by the Surety s and Principal s divergent interests in settling a claim and/or 11

Likewise, the Surety should be cognizant of the potential for such conflicts and the costs associated with a failed joint representation before tendering its defense. V. Ethical Concerns When the Principal Does Not Pay Counsel Potential ethical issues also arise when a Principal fails to pay the tendered counsel s bills. Generally, a tender is entered into because the Surety wishes to avoid paying costly, redundant, and potentially unrecoverable counsel s fees. 34 Under the terms of most indemnity agreements, it is the Principal and/or Indemnitors responsibility to pay for all losses sustained by the Surety, including professional s fees. Thus, many tender/joint defense agreements state, in substance, that all attorneys fees, costs, disbursements, and expenses of the defense shall be borne solely by the Principal. 35 One common factor leading to a failed tender, however, is where the Principal fails to pay counsel fees due. A Principal s failure to pay the fees of counsel for the Surety and Principal can raise issues that touch upon both the practical obligations and the ethical duties of the attorney. These potential issues increase, quantitatively and qualitatively, the longer a Surety goes without notice of the Principal s non-payment of counsel s fees. Knowledge of the Principal s inability to pay attorneys fees in full constitutes a particularly good reason for the Surety to decline to tender its defense. Of course, the attorney does have an obligation under RPCs 1.4 and 1.0(e) to keep the Surety reasonably informed regarding facts known to the attorney that affect the Surety s interests. Certainly the Principal s failure to pay the attorney s fees is one such situation. 36 One could also argue that the attorney owes a duty of fair representation to the innocent party that is not aware of the Principal s default in payment. However, as the next few paragraphs will make clear, neither attorneys nor courts are necessarily inclined to act that way. Although not necessarily ethical in nature, there are several legal consequences flowing from the Principal s failure to pay the attorney that may have a significant impact on the Surety s ability to defend itself. These include: (1) Retaining liens. Retaining liens are a lien recognized in some jurisdictions which permit[] [an] attorney to retain all of the client s papers and files until all outstanding fees are paid. 37 This equitable right creates an extremely difficult situation negotiations regarding collateral deposit and indemnity will be discussed in greater detail infra. 34 See, e.g., Central Towers, 453 S.W.2d at 797. 35 Joint defense agreements will be taken up in greater detail infra. 36 Though, again, the attorney may wish to keep this knowledge private upon the Principal s specific request or out of a sense of duty to the Principal potentially, but not necessarily, based on Rule 1.6, as discussed in Point III, supra. 37 Wankel v. Spodek, 767 N.Y.S.2d 429 (N.Y. Sup. Ct. App. Div. 2003). See also D Urso v. Lyons, 903 12

for the Surety because any new counsel that the Surety engages will need a copy of the entire file. Thus, the Surety may go from paying for no attorneys to paying for two, in a matter of days. It is vitally important, then, that the Surety consider this risk and deal with it when determining whether or not to tender its defense. For instance, an agreement with the tendered counsel to provide the Surety with regular copies of all relevant pleadings as well as copies of all files upon request may allow the Surety to circumnavigate a retaining lien. In addition, the initial retainer agreement should provide that notwithstanding any retaining lien, counsel will provide copies of the litigation files to the Surety if the Principal does not pay. (2) Charging liens/attorney liens. Under common law and many state statutes, an attorney has a lien against his clients affirmative recovery in a lawsuit handled by that attorney for any outstanding fees. 38 If the Principal s attorney is representing the Surety in a matter in which the Surety seeks recovery against the obligee and/or claimants, he may assert a lien against the funds recovered. Although in such cases the Surety has generally prevailed, it can still lead to a costly and entirely unnecessary headache. 39 It is advisable for the parties to clarify these issues when initially entering into the tender relationship. (3) Equitable rights. Contrary to decisions relating to charging liens and/or attorney s liens, the New Jersey Supreme Court has indicated a willingness to consider an equitable claim by a Principal s attorney to the Surety s affirmative recovery, even though it acknowledged that a charging lien could not attach to the funds due the Surety s pursuant to its subrogation rights. In Montefusco Excavating & Contracting Co. v. Middlesex County, 40 the Court stated: Though the monies paid by the [obligee] may fall within the category of a trust fund and not be subject to the attorneys charging lien, the attorneys who made that fund available for the subrogee of the fund s beneficiary may still be entitled to a counsel fee for services rendered. Subrogation is not an absolute right but is to be applied with due regard to the legal and equitable rights of others. Accordingly, a Surety, when exercising its subrogation right, may be required to pay its pro rata share of counsel A.2d 697 (Conn. App. Ct. 2006). 38 See, e.g., N.J.S.A. 2A:13-5; N.Y. JUDICIARY LAW 475. 39 See, e.g., Bros. in Christ, Inc. v. Am. Fid. Fire Ins. Co., 680 F. Supp. 815 (S.D. Miss. 1987) (denying Principal s attorney the right to file a charging lien against the funds held by a subrogated Surety); In re Colt Eng g, Inc., 196 Fed. Appx. 598, 2006 WL 2255842, *1 (9th Cir. Aug. 7, 2006) ( any interest in settlement proceeds or retained funds [the Principal] may have had became [the Surety s] to the extent necessary to reimburse [it] for its payments to laborers and material suppliers, and never became property of [the Principal] to with [an] attorney s lien could attach. ). 40 414 A.2d 961 (N.J. 1980). 13

fees incurred by the subrogor in establishing the judgment which enures to the Surety s benefit. When the Principal incurs counsel fees to collect funds belonging to the subrogor which enure to the Surety s benefit in the same manner as if the subrogor had himself incurred those counsel fees, the same rule should apply. This would be particularly so when the Surety acquiesces in the legal proceedings instituted and carried on to fruition by the attorney. 41 The Court then noted that some facts indicated that the Surety owed an equitable duty to the Principal s counsel, and remanded the case for further proceedings. 42 Conversely, the Court in Brothers in Christ rejected a similar claim by the Principal s attorney for payment from settlement proceeds, instead holding that the equities where in the Surety s favor. The Court stated: The court next considers [the Principal s attorney] argument that allowing [the Surety] to have priority to the funds would work an injustice since [the Surety] would never have had access to the money but for the efforts of [the Principal s attorney]. [I]t appears from the sequence of events described in the stipulated facts that [the Surety s] payment to [the subcontractor] contributed to the owner s decision to release the funds. Additionally, counsel for [the Surety] states that he played an active role in obtaining the funds from the [owner]. Accordingly, the court cannot conclude that [the Principal s attorney ] provision of services resulted in the [owner s] release of the funds. 43 Based on these considerations, the Surety should consider monitoring payment to the counsel by the Principal. Clearly this creates both ethical and practical concerns, and can lead to an adverse result for the Surety. As noted in Part I, supra, the Principal s solvency (which directly affects its ability to pay its attorney) and its diligence in defending against the Surety s loss (which directly affects its interest in paying its attorney) are both relevant considerations in whether the Surety should choose to tender (or continue to tender) its defense to its Principal. 44 41 Id. at 965 (internal citations and formatting omitted). 42 Id. at 965-66. 43 680 F. Supp. at 818-19. 44 See Notes 3-4, supra, and accompanying text. 14

VI. Ethical Concerns When the Principal Does Not Provide Collateral What impact does the Principal s failure to provide collateral have on the Surety s decision to tender? The request for collateral is potentially critical in determining whether an attorney can ethically represent both Principal and Surety. For instance, the Surety s demand and the Principal s refusal to provide collateral could create the sort of situation described in comment 29 to RPC 1.7, which cautions that a lawyer cannot undertake common representation of clients where contentious litigation or negotiations between them are imminent or contemplated. 45 Very little case law exists which addresses the attorney s ethical responsibilities to the Principal and Surety where the Principal refuses to provide collateral. However, there are cases that address whether the Surety properly retained its own attorney for the defense of claims where the Principal failed to deposit collateral with the Surety. By analogy, these cases illuminate the courts opinion of the importance of depositing collateral with the Surety so as to confirm that the interests of both the Surety and the Principal remain aligned. The place to begin a discussion of whether the Surety properly retained its own attorney for the defense of claims is Central Towers, 46 where the Court found that the Surety s defense of overpayment was not sufficient to necessitate the Surety s retention of separate counsel. 47 The Central Towers court determined that the Surety s right to indemnity for attorneys fees is not absolute; rather the Surety s decision to engage separate counsel assert a separate defense must be undertaken in good faith. 48 The court then listed twelve factors 49 to be considered in deciding whether the Surety exercised good faith. 50 Since that time, courts have either highlighted the Central Towers factors 51 or come to the same conclusion that the Surety s must incur expenses in good faith 52 when determining if a Surety s requested indemnity is appropriate. 45 MODEL RULES OF PROF L CONDUCT RULE 1.7, CMT. 29. 46 453 S.W.2d at 797. 47 See Note 10, supra, and accompanying text. 48 453 S.W.2d at 797. 49 See Part I, supra. 50 453 S.W.2d at 799-800. 51 See, e.g., Note 3, supra. 52 See, e.g., Toporoff Eng rs, P.C. v. Fireman s Fund Ins. Co., No. 00-CIV-5963, 2006 WL 1539341, *2 (S.D.N.Y. June 5, 2006). 15

Thus certain cases in which courts have explored the Surety s right to indemnity for litigation expenses shed light on the impact that collateral, or the Principal s failure to provide it, has in the ethics of accepting or declining a tender. In Toporoff Engineers, P.C. v. Fireman s Fund Insurance Co., 53 for instance, the Court determined that the Surety was justified in its refusal to tender its defense to the Principal and ruled that the Surety could collect all reasonable attorneys fees. 54 The Court stated: Although the Court was initially skeptical about the necessity of the Sureties [sic] conducting its own independent defense, the Court finds that there is sufficient evidence indicating that the Sureties separate defense was not completely unnecessary. Specifically, the Court pays considerable credence to the letters drafted by Sureties counsel, in which collateral is requested by the Sureties as a requirement for tendering the defense. 55 Accordingly, the Sureties request for collateral and the Principal s refusal (or inability) to provide it proved to be the pivotal fact justifying the Sureties retaining separate counsel. Several other cases hold similarly. In United Riggers & Erectors, Inc. v. Marathon Steel Co., Tenth Circuit found that the Principal s inability to post collateral was one factor that justified the Surety s hiring of separate counsel. 56 In James Constructors, Inc. v. Salt Lake City Corp., an appeals court affirmed the trial court s finding that the Surety s own defense was necessary, noting the Principal s stubborn refusal to post collateral or to provide other adequate and acceptable security to the Surety. 57 These cases illustrate the importance of a Surety s demand for collateral and the effect that it has on the litigation. 58 They also illustrate how RPC 1.7 s requirement that the attorney s representation of his client may not be limited by the lawyer s responsibility to its other clients is probably fulfilled if the Principal provides the Surety with collateral security to cover any loss. Otherwise, an irreconcilable conflict likely exists, which prohibits an attorney from representing both the Principal and the Surety in the matter. 53 Id. 54 Id. at *3. 55 Id. (emphasis added). 56 725 F.2d 87, 90 (10th Cir. 1984). 57 888 P.2d 665, 671 (Utah Ct. App. 1994). 58 See also Gulf Ins. Co. v. AMSCO, Inc., 889 A.2d 1040, 1050 (N.H. 2005). In AMSCO, the New Hampshire Supreme Court ruled that a Surety s one-time request for collateral and lack of follow-up on that request was a sufficient basis for the trial court to reject the Surety s position that it refused to tender its defense to its Principal based on a lack of collateral. Id. 16

VII. Ethical Concerns When the Surety and Principal Disagree As to How the Case Should be Handled and/or Settled Sureties and Principals can, and of course often do, disagree on how a claim should be handled and/or settled from the time a claim is known, even if not asserted, to the time the Surety s bonds are finally discharged, and perhaps even thereafter. The engagement and conduct of the Surety s own counsel and/or claims representative before a claim ends up in litigation is a fertile area for discussion that is beyond the scope of this article. Suffice it to say, the following quote from a well-respected commentary on the issue gives sound advice: [S]ureties should perform an independent investigation and evaluation of the claim. While it is important to obtain as much information as possible from the principal, it is also important for a claims professional to exercise his own judgment about the compensability of a claim. The level of investigation will necessarily depend upon the nature of the claim. In that regard, a claims professional should determine whether there are reasonable defenses (including Surety defenses) to a claim when considering whether to tender defense to the principal. The nature of the claim, the status of the project, and the allegations dictate the parameters of any investigation. The days of obtaining information from the principal, asserting those defenses without investigating the basis of the defenses are over. Having said that, ignoring the principal s defenses, facts, or information and relying on the terms of any indemnity agreement expose a Surety to the allegations of bad faith from a principal and the indemnitors. 59 Assuming that the Surety chooses to heed that advice, it may have formed its own definite opinions regarding case strategy and development, and potential settlement, before a tender is even offered by the Principal. Clearly, where the Surety and Principal diverge in their needs and opinions in handling a case, an attorney cannot ethically represent both, pursuant to RPC 1.7, without written, informed consent waiving the conflict. 60 But in certain situations, the tension between the Surety s and the Principal s opinions may be so divergent that even informed consent is not enough. This was the situation, for instance, in Capriotty v. Bell 61 where the Court granted a 59 Cochrane, R. Scott & Kain, Cole S., Extra-Contractual Damages, ch. 10, BOND DEFAULT MANUAL, 3RD ED. (ABA TIPS, D. Clore, R. Towle, & M. Sugar, eds. 2005), at p. 389 (emphasis added). 60 Informed consent is discussed in greater detail in Part II, supra. 61 Civ. A. No. 89-8609, 1991 WL 22134 (E.D. Pa. Feb. 19, 1991). 17

motion to disqualify counsel jointly representing a Principal and Surety. 62 In Capriotty, the Principal, the former joint-administer of an estate, and her Surety sued the Principal s former attorney (and joint-administer of the same estate) and his law partners for losses incurred by the Surety on its administration bond. 63 The defendants moved to disqualify the plaintiffs attorney from the joint representation due to an irreconcilable conflict of interest created by the Surety s right to indemnity from the Principal. 64 The Court noted that RPC 1.7 contemplates two levels of conduct : Where a conflict among clients is so severe that no lawyer could reasonably believe that representation of one will not adversely affect the representation of the other, representation of both cannot be allowed. On the other hand, if a lawyer reasonably believes that he can fully serve two clients, despite a difference in interest between them, representation is allowed if each client consents. When the clients with opposing interests are represented together in common litigation, [RPC] 1.7(b)(2) requires that the attorney make full disclosure of the risks and implications of joint representation before consent is valid. 65 The Court did note that, on the surface, the Surety and Principal both wished to prove the liability of the defendants, which would hold the Principal harmless for the Surety s loss. 66 However, there existed a substantial conflict of interest between the Principal and Surety regarding settlement, which the Court set forth as follows: [The Surety] can benefit from settling with [the defendants] for less than the full relief demanded, for the standard reason that some recovery is better than none, and for the additional reason that [the Surety] can move against [the principal] for the balance of [its] claim. The same is not true for [the principal]. Because both [the Surety] and the estate wait in the wings, ready to assert their claims, any settlement of the present actions for less than the demand will leave [the principal s] assets vulnerable. Depending on the size of her assets, (which presumably are not very large), some recovery for her may not be better than none, relief coming only if recovery is complete. [The principal] thus has a greater interest 62 Id. at *6. 63 Id. at *2. The joint-administrator was sued in state court by the Principal and Surety while the law partners were sued concurrently in federal court. See id. 64 Id. at *2. 65 Id. at *3. 66 Id. 18

than [the Surety] in gambling on trial, in the hopes of receiving full relief from a jury. 67 The Court thus determined that the attorney in question was in a difficult position as advocate and advisor to them all and that he could not reasonably do his job in obtaining the information each needs without sacrificing loyalty to the other, and risking the exchange of client confidences. 68 Although the attorney objected to disqualification on the basis of full disclosure and informed consent 69 the Court held that [s]ince the merits of settlement here are colored by the merits of the claims [the attorney] cannot explore settlement with each client without working against the interests of the others, and thus the conflict of interest was irreconcilable. 70 On that basis, the Court ruled that the attorney could not ethically represent both the Surety and Principal. 71 Similarly, the issue of whether the Surety and Principal have unified interests during the litigation has also been considered in the context of whether the Surety can recoup its full counsel s fees under an indemnity agreement. 72 For instance, in United Riggers & Erectors, Inc. v. Marathon Steel Co. 73 the Tenth Circuit held that the Surety was justified in conducting a separate defense under the facts and circumstances of the case. 74 The first factor noted by the court was that the Surety had two independent defenses to liability, one of which material alteration of the contract between the 67 Id. at *4. Such an attitude by a Principal should sound familiar to any Surety paying for an ongoing litigation with an owner for an insolvent or nearly insolvent Principal. 68 Id. at *4 (citing Rule 2.1, requiring attorneys to exercise independent professional judgment and render candid advice ). 69 Id. at *5. In this instance, the attorney averred that his clients should be given an opportunity to consent after the Court had ruled that a conflict of interest existed, which he had either not known or had not shared with his clients. 70 Id. The Court did, however, grant the attorney leave to request the Principal s consent that he continue to represent the Surety in the pending litigation. Id. at *6. 71 Id. 72 A full discussion of the factors relevant to lawsuits for counsel s fees where the Surety declines to tender its defense is, as noted above, outside of the scope of this article. See Note 4, supra, and accompanying text. 73 725 F.2d 87 (10th Cir. 1984). 74 Id. at 89. 19

principal and the oblige necessarily conflicted with the Principal s own interest in the lawsuit. 75 The second factor was that the Surety had [R]eason to doubt [the Principal s] ability to satisfy a judgment and perhaps even its ability to remain solvent until the completion of the litigation. [The Surety] had requested collateral for its potential liability from [the Principal] pursuant to section V of the indemnity agreement, but [the Principal] was unable to supply that collateral. 76 Based on these factors, the court held that the Surety was entitled to a reimbursement of fees incurred in the litigation and appeal. 77 A similar result was reached by the Fifth Circuit in Jackson v. Hollowell. 78 In Jackson, the Fifth Circuit affirmed the district court s decision, issued as a judgment notwithstanding the verdict, that the Surety could recover its attorneys fees from its Principal because those expenses were reasonable and incurred in good faith. 79 The Court noted that there was a defense that the Surety made in the course of the litigation specifically related to the penal sum of the relevant bond that the Principal had no interest at all in raising at trial. 80 The Court noted that this constituted overwhelming proof that it was at least reasonably necessary for the Sureties to retain separate counsel in order to protect their separate interests. 81 The Court further noted that the attorneys retained by the Surety companies each testified that throughout the [pending] litigation, the attorneys attempted as far as possible to avoid duplicating the legal work which evidenced the Surety s good faith. 82 In a concurring opinion, one member of the Court stated: 75 Id. at 90. 76 Id. 77 Id. at 91. 78 685 F.2d 961 (5th Cir. 1982). 79 Id. at 966 (noting that the issue of reasonable necessity and good faith is one of fact ). 80 Id. at 968. 81 Id. 82 Id. 20