Insurers improperly use Section 2860 to limit their defense obligations
Since insurers must pay for the insured's selected independent counsel in all conflict of interest situations, it is in their financial interest to pay as little as possible. Insurers rely upon Civil Code ' 2860(c) to accomplish this goal. Section 2860(c) provides the following with respect to the payment of fees to independent counsel:
The insurer's obligation to pay fees to the independent counsel selected by the insured is limited to the rates which are actually paid by the insurer to attorneys retained by it in the ordinary course of business in the defense of similar actions in the community where the claim arose or is being defended.Based upon this provision, insurers argue that they only have to reimburse the insured's selected counsel at unconscionably low rates, in many instances as low as $115 per hour (even for complex cases), because they claim that those are the rates that they pay counsel to defend their insured's when there is no conflict of interest. These non-conflict of interest situations are extremely rare and, if they ever arise, are usually in the context of simple claims, such as automobile cases, where relatively little is at stake. If a case is complex, with a lot of money is at stake, the insurer almost certainly will be required to pay for counsel selected by the policyholder. Since insurers normally do not retain attorneys "in the ordinary course of business" to defend their policyholders in "similar actions," the rates that the insurers attempt to impose on their insureds are misleading at best. Moreover, most insurers hire counsel with whom they have special arrangements whereby, for a reduced rate, the insurer will provide large amounts of business to the firm. In many cases, carriers have captive law firms that they will use to defend their insureds. Thus, the rates "actually paid by insurers" are not market rates, and cannot be obtained by policyholders even if they were to hire the same firms that their carriers typically hire.
In many cases, if the policyholders accept the rates quoted by their carriers, they will end up paying at least as much per hour as their insurers are paying, just to make up the difference between the rates charged by their selected counsel and the rates that their carriers have agreed to pay.
This situation clearly could not have been expected by policyholders who paid substantial premiums to purchase liability policies from their carriers who agreed to defend, without limitation, all claims potentially covered by their policies. Nor could this situation have been contemplated by the legislature when it adopted Civil Code ' 2860. The legislature certainly did not intend to provide such a windfall to insurers at the expense of policyholders who contracted for a complete defense to liability claims. The legislature also could not have meant to force policyholders into the Hobson's choice of either (1) being defended by competent skilled counsel, while having to foot the bill for a large portion of the defense costs or, (2) having their entire defense completely paid for, while being defended by less-skilled, less-competent counsel.
At least one court has rejected this improper use of ' 2860. In National Union Fire Ins. Co. v. Hilton Hotels Corp., 1991 WL 405182 (N.D. Cal. 1991), Judge Patel recognized that Civil Code '2860 applies when an insured elects to be represented by independent counsel in a conflict of interest situation where the insurer has selected its own counsel to provide a defense. Thus, the fee limitation provisions apply only in a two counsel situation, where both the insurer's and insured's independent counsel are participating in the underlying action. As Judge Patel explained, the purpose behind the fee limitation provision "is to strike an equitable balance between the insurer and the insured when the former is paying for two counsel to defend the latter. In such cases the insurer is already paying full-price for its own appointed counsel and must now pay for additional independent counsel to avoid a conflict of interests." Without such a "double-burden," therefore, the fee limitation provisions cannot properly be invoked. Id.
In the typical case, an insurer will delay providing a defense for a period of time while it conducts its "investigation" of the claim. In the meantime, the insured must retain counsel to protect its interests by defending the underlying litigation. If the insurer ultimately agrees to defend subject to a reservation of rights, the insurer will not retain its own counsel in addition to the insured's independent counsel. Thus, the insurer only will be required to pay for one firm in connection with the underlying claim. Nevertheless, because National Union is an unpublished trial court decision, insurers routinely ignore the logic of its holding and continue to use ' 2860(c) to deny their policyholders the right to a complete defense as promised.
Judge Patel's reasoning in National Union, however, is well supported by the court decisions upon which ' 2860 was based, in the legislative history of the statute and in the words of the statute itself. The conflict of interest situation addressed by the court decisions which led to the enactment of ' 2860 arises when the insurer retains counsel to defend its insured and, at the same time, reserves its right to deny coverage on some issue that could be controlled by counsel. Because of this conflict, the courts determined that the insured was entitled to independent counsel paid for by the insurer. Prior to the enactment of ' 2860, insurers were required to pay the full rates of their own selected counsel, as well as the full "reasonable" rates of the insured's independent counsel. In Executive Aviation, Inc. v. National Insurance Underwriters (1971) 16 Cal.App.3d 799, 810, the court specifically discussed this scenario, as follows:
We hold . . . that in a conflict of interest situation, the insurer's desire to exclusively control the defense must yield to its obligation to defend its policy holder. Accordingly, the insurer's obligation to defend extends to paying the reasonable value of the legal services and costs performed by independent counsel, selected by the insured. While the insured may be dismayed at having to pay the cost of two attorneys for one action, we are cognizant that the necessity for this action stems from its failure to provide with any degree of clarity for this conflict of interest contingency in drafting the terms of its contract.
Similarly, in the Cumis case, the court described the issue to be resolved as follows:
The issue presented to this court by the appeal is whether an insurer is required to pay for independent counsel for an insured when the insurer provides its own counsel but reserves its right to assert noncoverage at a later date.Cumis, supra at 358.
In Cumis, the insurer agreed to provide a defense to the underlying wrongful termination claim subject to a reservation of rights. The insurer retained a law firm to provide a defense to its insureds, and the insured retained its own independent counsel to provide independent representation to protect its interests. The insurer agreed to pay the fees and costs incurred by the independent counsel. Thus, the insurer agreed to pay for two sets of lawyers in connection with the defense of the underlying lawsuit. The insurer, however, paid only two invoices of independent counsel and refused to pay any more after its own counsel concluded that there was no conflict of interest. The court held that the insurer was not entitled to terminate its payment of fees incurred by the insured's independent counsel:
We conclude the Canons of Ethics impose upon lawyers hired by the insurer an obligation to explain to the insured and insurer the full implications of joint representations in situations where the insurer has reserved its rights to deny coverage. If the insured does not give an informed consent to continued representations, counsel must cease to represent both. Moreover, in the absence of such consent, where there are divergent interests of the insured and the insurer brought about by the insurer's reservation of rights based on possible noncoverage under the insurance policy, the insurer must pay the reasonable cost for hiring independent counsel by the insured. The insurer may not compel the insured to surrender control of litigation.Id. at 375.
The Cumis decision was predicated upon the insurer's initial hiring of counsel to represent its insured, followed by a conflict of interest requiring the insurer to retain independent counsel in addition to the counsel that it previously retained to provide a defense. It was in response to this "dual counsel" situation that the insurance industry sought the enactment of Civil Code ' 2860's fee limitation provisions. In a letter to then Governor Deukmajian dated September 15, 1987, urging the Governor's approval of Senate Bill 241, pursuant to which ' 2860 was enacted, the Association of California Insurance Companies described the proposed statute as follows:
The instances are reduced in which defense counsel selected and paid for by insurers for their insured's must be supplemented by additional independent counsel selected by insureds but paid for by insurers . . . . This will provide a savings to insurers which now are forced to pay for unnecessary duplicative counsel in many situations.
The letter to Governor Deukmajian added that the proposed statute spelled out "the mutual rights and obligations of insurer-selected and additional counsel." It seems clear, therefore, that the fee limitation provisions of ' 2860 (and ' 2860 in general) was intended to address the situation where a conflict arises between the insured and counsel first appointed by the insurer. Indeed, the language of the statute itself provides that a conflict exists "when an insurer reserves its rights on a given issue and the outcome of that coverage issue can be controlled by counsel first retained by the insurer for the defense of a claim."
Despite the clear intent of the statute, insurers continue to take the position that, even where only the policyholder's independent counsel is involved in the defense of a claim (as is almost always the case) the insurers need only reimburse the policyholder's independent counsel at severely reduced hourly rates, thus, providing an unintended windfall to insurers, and less than a complete defense to their policyholders. Insurers even will insist on paying reduced rates when more than one insurance company is contributing towards the defense. In that situation, each insurer is provided with an even greater windfall. Section 2860, clearly was not intended to result in a savings to insurers at the expense of the rights of policyholders to obtain a full and complete defense.
Insurers also claim that ' 2860's fee limitation provisions apply retroactively to policies issued prior to the effective date of the statute -- January 1, 1988. Since many claims, such as claims for environmental contamination, involve allegations of continuing injuries over time, insurers that issued policies well before the enactment of the statute are called upon to provide their policyholders with a defense. These insurers are not entitled to rely upon ' 2860 as a means to limit their defense obligations. Under California law, a statute acts retroactively if it substantially changes the legal effect of past transactions. Kizer v. Hanna (1989) 48 Cal.3d 1, 7. A statute which impairs vested rights may not be applied retroactively. McBarron v. Kimball (1967) 210 Cal.App.2d 218, 220.
A contract right, such as a right obtained under an insurance policy, is created as soon as the contract becomes effective. Prior to the effective date of the statute insurers were required to pay the full "reasonable value" of the defense, even in conflict of interest situations where two sets of attorneys were retained. See Executive Aviation, Inc. v. National Insurance Underwriters (1971) 16 Cal.App.3d 799, 810. Following enactment of the statute, however, an insurer's obligation to pay fees in a two counsel situation was "limited to the rates which are actually paid by the insurer to attorneys retained by it in similar actions in the community where the claim arose or is being defended." Civil Code ' 2860(c). These obligations are not the same. Thus, in Diamond Walnut Growers, Inc. v. American Motorists Insurance Co., 1991 U.S. Dist. LEXIS 7317, *6-*11 (N.D. Cal. May 10, 1991), the court held:
Insurance policies are a means of risk allocation, and when and insurer and an insured enter into a contract of insurance, the risks and costs of coverage are predetermined and reflected in the price of insurance. Applying ' 2860 to attorney fee agreements and insurance policies which predate the effective date of the statute is not supported by any case law nor by any evidence of legislative intent.
- Introduction
- The obligation to provide independent counsel
- Policyholders must challenge the use of Section 2860 by insurers to limit their coverage obligations