July 08, 2020 Feature

The Right to Select Counsel and the Rules of Professional Conduct

By Christopher H. Yetka
Sorbetto/GettyImages/DigitalVision Vectors

Sorbetto/GettyImages/DigitalVision Vectors

A policyholder cannot give informed consent unless it is told of all material facts that could affect the representation, including the relationship between defense counsel and the insurer.

Third-party liability policies often state that the insurer has both the duty and the right to defend the policyholder. Most courts interpret these policy terms to give the insurer the right to select defense counsel. However, many courts recognize that the right to defend is limited by both the rules of professional conduct and fiduciary duties inherent in the contract. These limitations can, in many circumstances, create a policyholder’s right to select defense counsel.

The Rules of Professional Conduct, Conflicts, and Informed Consent

Defense counsel hired by an insurer to defend its policyholder are obligated to follow the applicable rules of professional conduct in their jurisdiction, regardless of any language in the applicable insurance policy. Two particularly applicable rules are Rules 1.7 and 1.8(f) of the American Bar Association’s Model Rules of Professional Conduct. Most states have adopted these rules or an equivalent.

Conflicts of interest. Rule 1.7(a) prohibits counsel from representing a policyholder 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.1

The comments to the rule reiterate that conflicts of interest can arise not just from the lawyer’s and law firm’s responsibilities to another client, but also from their responsibilities to a third person or from their own personal interests.2 Thus, regardless of whether the liability insurer is a client, the defense counsel selected by the insurer must evaluate whether there is a significant risk that representation of the policyholder will be materially limited by the responsibilities and personal interests inherent in counsel’s relationship with the liability insurer. The proposed defense counsel has an affirmative obligation to assess “the likelihood that a difference in interests will eventuate,” and if it does, whether that difference in interests will: (1) “materially interfere with the lawyer’s independent professional judgment in considering alternatives,” or (2) “foreclose courses of action that reasonably should be pursued on behalf of the client.”3

Counsel must also assess Rule 1.8(f), dealing with payments on behalf of clients. This rule prohibits a lawyer from accepting compensation from a third party for representation of the client, unless:

(1) the client gives informed consent;

(2) there is no interference with the lawyer’s independence of professional judgment or with the client-lawyer relationship; and

(3) information relating to the representation of a client is protected as required by Rule 1.6.4

The insurance contract between the insurer and policyholder may constitute implied authorization for counsel’s acceptance of compensation from the insurer. However, insurer-imposed conditions or limitations, like litigation guidelines, would not be impliedly authorized if they run afoul of the rules of professional conduct or defense counsel’s obligations to their policyholder client.5

On its face, Rule 1.8(f)’s protections of confidentiality and against third-party interference apply regardless of the need to obtain informed consent. Defense counsel may not defend a client if they believe that the confidentiality of the client’s information would not be protected, or that there would be interference with the client-lawyer relationship.

Informed consent. If, after conducting the above conflict analysis, counsel believe that their defense would comply with Rule 1.8(f) but would pose a conflict under Rule 1.7(a), counsel may nevertheless defend the policyholder if all of the following conditions are met:

(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.6

“Reasonable belief” means that the circumstances are such that a lawyer of reasonable prudence and competence would hold that belief under the circumstances.7 “Informed consent” requires a decision after the lawyer has communicated adequate information and explanation about the material risks of and alternatives to the proposed course of conduct.8

If, after conducting the conflict analysis required by Rules 1.7 and 1.8(f), counsel believe that their representation of the insurer’s policyholder would pose no conflict of interest under those rules, the Model Rules of Professional Conduct do not appear to require informed consent. However, prudent counsel would still seek the policyholder’s informed consent in order to avoid the risk of breaching their fiduciary duties to the client.

Lawyers have a fiduciary duty to represent each of their clients with undivided loyalty, competence, and diligence; to preserve confidences; and to disclose to the client any material matters that could affect the lawyer’s fulfillment of those obligations.

What Information Must Be Provided to Satisfy the Obligation of “Informed” Consent?

“Informed” should be read broadly. It can include: (1) the facts and circumstances giving rise to the matter; (2) an explanation reasonably necessary to inform the client of the material advantages and disadvantages of the proposed course of conduct; (3) a discussion of the client’s options and alternatives; (4) any material matters bearing upon the lawyer’s duty of undivided loyalty or duty to protect confidentiality; and (5) in some circumstances, whether it is appropriate to seek the advice of other counsel.9

Courts have recognized that where there are both covered and uncovered claims, and defense counsel have been selected by the insurer, there can be an inherent conflict of interest where counsel can steer the case, however unconsciously, toward a theory of recovery that is not covered by the policy.10

Coverage issues and related facts or strategies that could be developed during the defense. Defense counsel satisfy their obligation to provide informed consent by first sharing coverage issues that could significantly increase the likelihood of differing interests between an insurer and its policyholder. For a policyholder to give truly “informed” consent to representation by insurer-proposed defense counsel, it must be informed of any and all coverage issues that could create a risk of defense counsel shifting liability—even if inadvertently or unconsciously—toward noncovered claims or damages.

Discovery and the handling of the underlying case can expose facts and other evidence that might affect coverage but are not material to the underlying case. Evidence and strategies can include a policyholder’s knowledge, expectations, or intent; insurance-application representations; notice; issues affecting trigger of coverage; apportionment; recoupment; or choice of law. Counsel’s or the insurer’s failure or refusal to disclose possible conflicts relating to these issues increases the likelihood that insurer-selected defense counsel will inadvertently choose courses of action that harm their client’s interests, disclose potentially confidential information, or foreclose strategies that reasonably should be pursued on behalf of the client. For example, defense invoices can be created in a way that allows an insurer to allocate defense costs to noncovered claims, even though the work was also required for the covered claims. Settlements can be reached on issues that lead to the loss of coverage or a defense. Proposed settlements can also create inappropriate leverage where a policyholder can be pressured into contributing to settlements to avoid being left without a defense or coverage. Choice of law decisions can be made that may be disadvantageous to a subsequent coverage dispute. Without complete disclosure of such information, the policyholder would be in no position to assess the likelihood that a difference in interests between the insurer and policyholder could occur.11 Without that complete informed consent, continued representation by insurer-selected counsel would be improper, unless the insurer provides an express written waiver of all coverage issues, known or unknown, which involve facts or strategies that could be developed during the course of the defense.

Protection of confidential information. Counsel must also identify and protect confidential information. Lawyers are prohibited, except in certain limited circumstances, from sharing confidential information relating to the representation of a client, including information protected by the attorney-client privilege and work product doctrine.12

A policyholder’s defense counsel may not reveal confidential information that may adversely affect the policyholder’s interests. This information includes documents or evidence that relate to or affect the insurer’s duty to defend or indemnify.13 This prohibition applies regardless of whether the insurer has issued a reservation of rights identifying coverage issues.14

Another risk relates to waiver of the attorney-client privilege. When an insurer defends its policyholder and expressly waives all coverage issues, known and unknown, the insurer and policyholder share a common interest and may exchange privileged information without risk of waiving the privilege. But when an insurer defends under a reservation of rights, the insurer and policyholder have both adverse and common interests. If the insurer-selected defense counsel report privileged information to the insurer relating to the adverse interests, there is a risk that a court could deem the privilege waived as to that information and any similar confidential information in a subsequent dispute with the insurer.15

Settlement. To meaningfully assess the likelihood that a difference in interests between the insurer and policyholder will arise, the policyholder must be completely informed about any conflicting interests in the settlement of claims. In some instances, a policyholder may want to quickly settle a claim to avoid drawn-out litigation that will impair company productivity and morale. A policyholder may also have a “wasting” insurance policy, in which defense costs reduce the policy limits available to pay a future settlement or judgment. The claim may also involve multiple insureds under the same policy, where an early settlement will preserve policy limits.

The insurer’s interest, on the other hand, could be to wear down the claimant through extended litigation to reduce the settlement amount it must pay, or to send a message to other potential claimants. Unconsciously, insurer-selected defense counsel may have the same interest and motivation. In cases involving multiple insureds under the same policy, the insurer might favor one insured over another because of that insured’s relative exposure or for other reasons. All of these interests could diverge with the policyholder’s interests.

The reverse situation, of course, might also arise. For example, the policyholder may have an interest in not settling in order to preserve its reputation or long-term business interests, whereas the insurer may be attempting to eliminate claims or avoid potentially higher exposure. For truly informed consent, the policyholder must be completely informed of these divergent interests.

The insurer’s relationship with defense counsel. Additionally, a policyholder must be advised of the full nature and extent of the insurer’s relationship with the defense counsel and their law firm. Without that information, a policyholder cannot evaluate potential divergent issues, independence, or exposure of confidential information.

Informed consent would therefore require disclosure of financial arrangements and agreements, the nature of legal services provided, and any financial pressure or other leverage the insurer has that could influence the defense counsel or their law firm. Specifically, the policyholder should be informed of any client relationship between the lawyers, firm, and insurers; the handling of coverage issues for the insurance company; the existence of a panel counsel relationship; the nature of rates paid by the insurer; and how important the relationship is to the lawyers and firm.

Litigation guidelines. Finally, the insurer and its proposed defense counsel must explain and document to the policyholder all of the insurer’s litigation guidelines, fee and expense restrictions, internal and external audit procedures, write-off practices, and any other limitation on the insurer’s authorization and payment for legal services to be provided by the defense counsel and their law firm.

An insurer’s guidelines and restrictions on authorization and payment for defense activities can result in significant financial pressure on insurer-selected counsel and their law firm. A defense firm may try to overcome the negative impact of discounted rates and reductions by increasing the volume of files it handles for the insurer and shifting workload to lower-rate associate lawyers with less experience. The volume and experience can lead to instances where the defense of a file is impaired.

Informed consent means that the policyholder is entitled to make an assessment based upon complete information provided by the insurer and its proposed defense counsel.

When May the Policyholder Select Defense Counsel?

A policyholder may reasonably withhold its consent, and make its own selection of defense counsel to be paid by the insurer, if: (1) the insurer and its proposed defense counsel fail to provide the information necessary for the policyholder to give truly informed consent; or (2) the information provided shows that the policyholder’s withholding of its consent is reasonable. Although a policyholder has a duty to cooperate with its insurer in the defense against a claim, the policyholder also has a right to protect itself. The policyholder need not subordinate its interests to that of the insurer, or comply with an unreasonable or unnecessary request by the insurer. The insurer, on the other hand, is obligated to give as much consideration to the policyholder’s interests as its own.

As described above, circumstances may arise where the policyholder is not provided with an explanation of the coverage issues and their effect on handling the underlying case. When a policyholder is not provided with an explanation of how the development of facts could impact coverage, when confidential information may be jeopardized, when interests conflict regarding settlement or due to the nature of the relationship between defense counsel and the insurer, or when litigation guidelines could impair diligence, competence, or independence of defense counsel, a policyholder may have the right to select counsel.

Conclusion

The insurer’s duty to defend and duty of good faith and fair dealing require the insurer to provide defense counsel whose representation will comply with the rules of professional conduct and common-law fiduciary duties. To comply with the common-law obligations and the rules of professional conduct, insurer-proposed defense counsel must obtain the policyholder’s fully informed consent to the representation. As a practical matter, the policyholder holds an important card—the entitlement to informed consent—that trumps any language in the insurance policy regarding selection of counsel.

Notes

1. Model Rules of Prof’l Conduct r. 1.7(a) (Am. Bar Ass’n 2019).

2. Id. r. 1.7 cmt. 1.

3. Id. r. 1.7 cmt. 8.

4. Id. r. 1.8(f).

5. See, e.g., id. r. 5.4 (prohibiting a lawyer from allowing the person who pays the lawyer to render legal services for another to direct or regulate the lawyer’s professional judgment in rendering such legal services).

6. Id. r. 1.7(b).

7. Id. r. 1.0(h), (i).

8. Id. r. 1.0(e).

9. See, e.g., id. r. 1.0 cmt. 6.

10. U.S. Fid. & Guar. Co. v. Louis A. Roser Co., 585 F.2d 932, 938 (8th Cir. 1978).

11. See Model Rules of Prof’l Conduct r. 1.7 cmt. 8.

12. See, e.g., id. r. 1.6.

13. ABA Comm’n on Ethics & Prof’l Responsibility, Formal Op. 01-421 (2001).

14. Restatement (Third) of the Law Governing Lawyers §§ 60(1)(a), 134 cmt. f (Am. Law Inst. 2000).

15. See Remington Arms Co. v. Liberty Mut. Ins. Co., 142 F.R.D. 408, 418 (D. Del. 1992) (observing that the “common interest” exception to the privilege waiver rule should not apply where there was an “atmosphere of uncertainty” as to the scope of any identity of interest shared by the policyholder and the insurer).

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Christopher H. Yetka

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Christopher H. Yetka is a shareholder with Larkin, Hoffman, Daly & Lindgren Ltd. in Minneapolis, Minnesota, where he focuses his practice on representing policyholders in insurance coverage disputes. He is past chair of the TIPS Insurance Coverage Litigation Committee. The author expresses gratitude and debt to his former law partner, Tom Mielenhausen, for allowing the author to use and build upon his earlier paper “When Do the Rules of Professional Conduct Trump an Insurer’s Right to Select Defense Counsel?”