Insurance Law: Third Party Coverage in Texas Ethical Considerations in Third Party Insurance Coverage


Liability insurance policies generally provide benefits to an insured in the form of the insurance company's obligation to defend and indemnify the policyholder for claims brought by third parties against the insured. These relationships create situations in which ethical considerations must be examined. The focus of this paper will examine the obligations and responsibilities of attorneys and insurance adjusters who handle insurance disputes and are confronted with potential conflict of interests.

  1. Ethical Guidelines for Attorneys
  2. The statutes, regulations, and cannons of ethics, which govern Texas lawyers primarily, may be found in the Texas Disciplinary Rules of Professional Conduct. The Texas Disciplinary Rules of Professional Conduct, Rules 105, 106 and 108 give attorneys guidance for the proper conduct of professional responsibility when a potential conflict arises. These Rules of Professional Conduct are:

    Rule 1.05. Confidentiality of Information

    (a) "Confidential information" includes both "privileged information" and "unprivileged client information." "Privileged information" refers to the information of a client protected by the lawyer-client privilege of Rule 503 of the Texas Rules of Evidence or of Rule 503 of the Texas Rules of Criminal Evidence or by the principles of attorney-client privilege governed by Rule 501 of the Federal Rules of Evidence for United States Courts and Magistrates. "Unprivileged client information" means all information relating to a client or furnished by the client, other than privileged information, acquired by the lawyer during the course of or by reason of the representation of the client.

    (b) Except as permitted by paragraphs (c) and (d), or as required by paragraphs (e) and (f), a lawyer shall not knowingly:

    (1) Reveal confidential information of a client or a former client to:

    (i) a person that the client has instructed is not to receive the information; or

    (ii) anyone else, other than the client, the client's representatives, or the members, associates, or employees of the lawyer's law firm.

    (2) Use confidential information of a client to the disadvantage of the client unless the client consents after consultation.

    (3) Use confidential information of a former client to the disadvantage of the former client after the representation is concluded unless the former client consents after consultation or the confidential information has become generally known.

    (4) Use privileged information of a client for the advantage of the lawyer or of a third person, unless the client consents after consultation.

    (c) A lawyer may reveal confidential information:

    (1) When the lawyer has been expressly authorized to do so in order to carry out the representation.

    (2) When the client consents after consultation.

    (3) To the client, the client's representatives, or the members, associates, and employees of the lawyer's firm, except when otherwise instructed by the client.

    (4) When the lawyer has reason to believe it is necessary to do so in order to comply with a court order, a Texas Disciplinary Rule of Professional Conduct, or other law.

    (5) To the extent reasonably necessary to enforce a claim or establish a defense on behalf of the lawyer in a controversy between the lawyer and the client.

    (6) To establish a defense to a criminal charge, civil claim or disciplinary complaint against the lawyer or the lawyer's associates based upon conduct involving the client or the representation of the client.

    (7) When the lawyer has reason to believe it is necessary to do so in order to prevent the client from committing a criminal or fraudulent act.

    (8) To the extent revelation reasonably appears necessary to rectify the consequences of a client's criminal or fraudulent act in the commission of which the lawyer's services had been used.

    (d) A lawyer also may reveal unprivileged client information:

    (1) When impliedly authorized to do so in order to carry out the representation.

    (2) When the lawyer has reason to believe it is necessary to do so in order to:

    (i) carry out the representation effectively;

    (ii) defend the lawyer or the lawyer's employees or associates against a claim of wrongful conduct;

    (iii) respond to allegations in any proceeding concerning the lawyer's representation of the client; or

    (iv) prove the services rendered to a client, or the reasonable value thereof, or both, in an action against another person or organization responsible for the payment of the fee for services rendered to the client.

    (e) When a lawyer has confidential information clearly establishing that a client is likely to commit a criminal or fraudulent act that is likely to result in death or substantial bodily harm to a person, the lawyer shall reveal confidential information to the extent revelation reasonably appears necessary to prevent the client from committing the criminal or fraudulent act.

    (f) A lawyer shall reveal confidential information when required to do so by Rule 3.03(a)(2), 3.03(b), or by Rule 4.01(b).

    The Texas Disciplinary Rules of Professional Conduct, Rule 1.06, addresses the general rule in Texas for conflicts of interest.

    Rule 1.06, Conflict of Interest:

    General Rule

    (a) A lawyer shall not represent opposing parties to the same litigation.

    (b) In other situations and except to the extent permitted by paragraph (c), a lawyer shall not represent a person if the representation of that person:

    (1) involves a substantially related matter in which that person's interests are materially and directly adverse to the interests of another client of the lawyer or the lawyer's firm; or

    (2) reasonably appears to be or become adversely limited by the lawyer's or law firm's responsibilities to another client or to a third person or by the lawyer's or law firm's own interest.

    (c) A lawyer may represent a client under the circumstances described in (b) if:

    (1) the lawyer reasonably believes the representation of each client will not be materially affected; and

    (2) each affected or potentially affected client consents to such representation after full disclosure of the existence, nature, implications, and possible adverse consequences of the common representation and the advantages involved, if any.

    (d) A lawyer who has represented multiple parties in a matter shall not thereafter represent any of such parties in a dispute among the parties arising out of the matter, unless prior consent is obtained from all such parties to the dispute.

    (e) If a lawyer has accepted representation in violation of this Rule, or if multiple representation properly accepted becomes improper under this Rule, the lawyer shall promptly withdraw from one or more representations to the extent necessary for any remaining representation not to be in violation of these rules.

    (f) If a lawyer would be prohibited by this Rule from engaging in a particular conduct, no other lawyer or member associated with that lawyer's firm may engage in that conduct.

    Rule 1.08 Conflict of Interest: Prohibited Transactions

    (a) A lawyer shall not enter into a business transaction with a client unless:

    (1) the transaction and terms on which the lawyer acquires the interest are fair and reasonable to the client and are fully disclosed in a manner that can be reasonably understood by the client;

    (2) the client is given a reasonable opportunity to seek the advice of independent counsel in the transaction; and

    (3) the client consents in writing thereto.

    (b) A lawyer shall not prepare an instrument giving the lawyer or a person related to the lawyer as a parent, child, sibling, or spouse any substantial gift from a client, including a testamentary gift, except where the client is related to the donee.

    (c) Prior to the conclusion of all aspects of the matter giving rise to the lawyer's employment, a lawyer shall not make or negotiate an agreement with a client, prospective client, or former client giving the lawyer literary or media rights to a portrayal or account based in substantial part on information relating to the representation.

    (d) A lawyer shall not provide financial assistance to a client in connection with pending or contemplated litigation or administrative proceedings, except that:

    (1) a lawyer may advance or guarantee court costs, expenses of litigation or administrative proceedings, and reasonably necessary medical and living expenses, the repayment of which may be contingent on the outcome of the matter; and

    (2) a lawyer representing an indigent client may pay court costs and expenses of litigation on behalf of the client.

    (e) A lawyer shall not accept compensation for representing a client from one other than the client unless:

    (1) the client consents;

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

    (3) information relating to representation of a client is protected as required by Rule 1.05.

    (f) A lawyer who represents two or more clients shall not participate in making an aggregate settlement of the claims of or against the clients, or in a criminal case an aggregated agreement to guilty or nolo contendere pleas, unless each client has consented after consultation, including disclosure of the existence and nature of all the claims or pleas involved and of the nature and extent of the participation of each person in the settlement.

    (g) A lawyer shall not make an agreement prospectively limiting the lawyer's liability to a client for malpractice unless permitted by law and the client is independently represented in making the agreement, or settle a claim for such liability with an unrepresented client or former client without first advising that person in writing that independent representation is appropriate in connection therewith.

    (h) A lawyer shall not acquire a proprietary interest in the cause of action or subject matter of litigation the lawyer is conducting for a client, except that the lawyer may:

    (1) acquire a lien granted by law to secure the lawyer's fee or expenses; and

    (2) contract in a civil case with a client for a contingent fee that is permissible under Rule 1.04.

    (i) If a lawyer would be prohibited by this Rule from engaging in particular conduct, no other lawyer while a member of or associated with that lawyer's firm may engage in that conduct.

    (j) As used in this Rule, "business transaction" does not include standard commercial transactions between the lawyer and the client for products or services that the client generally markets to others.

  3. Ethical Guidelines for Insurance Industry Personnel
  4. Insurance industry personnel are regulated by the Texas Insurance Code. For the purpose of this paper the primary focus will be on the obligations and responsibilities of claims adjusters. The Texas Department of Insurance has the statutory power to suspend or revoke an adjuster's license. As stated in Art. 21.07-4, §17.

    Sec. 17. (a) The department may discipline an adjuster or deny an application under Section 5, Article 21.01-2, Insurance Code, for any of the following causes:

    (1) for any cause for which issuance of the license could have been refused had it been existent and been known to the Board;

    (2) if the applicant or licensee willfully violates or knowingly participates in the violation of any provision of this Act

    (3) if the applicant or licensee has obtained or attempted to obtain any such license through willful misrepresentation or fraud, or has failed to pass any examination required under this Act;

    (4) if the applicant or licensee has misappropriated, or converted to the applicant's or licensee's own use, or has illegally withheld moneys required to be held in a fiduciary capacity;

(5) if the applicant or licensee has, with intent to deceive, materially misrepresented the terms or effect of an insurance contract, or has engaged in any fraudulent transactions; or

(6) if the applicant or licensee is convicted by final judgment, of a felony.

Texas Insurance Code, Art. 21.07-4 (17a).


  • Acknowledgment of Actual Relationship Needed
  • The following is a depiction of the potential conflict under current disciplinary rules and common law.

    Narrative between Mr. Jones, the insurance defense attorney and Mr. Smith, the insurance adjuster.

    "Now let me get this straight" says Mr. Jones, "you are going to hire me to defend Mr. Davis, who is being sued by Mr. Williams." "You are going to pay all of my bills and expenses related to Mr. Davis' case. You know that I will do a good job because your insurance company has hired me on hundreds of occasions to defend its policyholders when they have been sued. Additionally, my Firm is handling dozens of cases that your insurance company has sent to other members of our Firm. Furthermore, you know I'm motivated to do a good job because I have three children in college and a wife who feels as though purchases made with a credit card don't really count. But you must understand, Mr. Smith, that my only true loyalties lie with this person, Mr. Davis, to whom I have never met and will probably never see again once this case is over. You must understand that it is irrelevant to me how you or your insurance company are damaged as long as Mr. Davis is protected."

    This scenario exemplifies the current problems insurance defense attorneys face when coverage issues arise in third party insurance litigation under the current disciplinary rules and case law. The logic that the policyholder is the sole client of the attorney is not always possible or practical. There exists a special relationship between the counsel hired by the insurance company and the insurance carrier that will not disappear. By contract, the insurer is entitled to be notified on the progress of the litigation. The insured also has a contractual obligation to cooperate with the defense of his or her case. The carrier is also entitled to know of all pleadings and/or defensive strategies of the attorney since they are required to properly evaluate the true value of the lawsuit. Due to this inescapable relationship between the insurer, the insured, and the attorney hired by the insurer to defend the insured, legal commentators have suggested that the "insured is the only client", rule be substituted with a uniform recognition that the insurance company can also be a client.


    a. Obligations of Insurance Company

    Liability insurance policies obligate the insurer to provide a defense and indemnify the insured in the event that a third party brings a claim or lawsuit against the insured. In order to understand potential conflicts of interest, one must first identify the relationship of the participants in a third party claim. Commentators who have written excellent articles on the potential conflict have referred to this triangular matrix as tripartite relationship. The pertinent parties for these discussions are:

    1. A third party claim will always include the insured or policyholder.
    2. The second participant is the insurance company who accepted premiums in exchange for assuming the risk of the insurance contract.

    1. Lastly, the defense counsel hired by the insurance company to defend the insured.

      1. Complaint Allegation Rule
      2. The insured will typically purchase liability insurance to protect themselves against any potential claims and in order to obtain a defense for these claims. The insurance contract contains an obligation of the insurer to defend its insured once notice is received by the insurer of a covered claim. In Texas, whether an insurer must defend its insured is determined exclusively by reviewing the adverse pleadings and assuming all allegations therein to be true.

        The rule in Texas is commonly referred to as the "complaint allegation" rule. This rule of strict construction was first recognized in a Supreme Court opinion, Heyden Newport Chemical Corp. v. Southern General Insurance Co.. In that case, the applicable policy insured any person while using an automobile of the insured and any person or organization legally responsible for the use thereof. Plaintiff alleged that the driver of the offending vehicle was an agent of the insured. The allegations were within the coverage afforded by the policy of insurance. After these allegations were made, however, the insured notified his insurer that the driver was not in fact his agent at any relevant time. The insured, therefore, refused to further defend the lawsuit based upon that information. The Texas Supreme Court, however, stated that the Plaintiff's allegations in its petition controlled the determination of when the duty to defend arose. The court held:

      We think that in determining the duty of the liability insurance company to defend the lawsuit, the allegations of the complaint should be considered in light of policy provisions without reference to truth or falsity of such allegations and without reference to whether the parties know or believe the true facts to be, and without reference to a legal determination thereof.

      In conjunction with the "complaint allegation rule," Texas courts, following the criteria set forth in the Heyden case, have additionally applied the concept referred to as the "four corners" rule whereby the duty to defend is determined by looking only to the allegations within the four corners of the Plaintiff's complaint. In so doing, courts will not consider evidence contrary to the allegations. The four corner's rule, then, is clearly a mechanical one and the guiding principal for its application was also set forth in the Heyden opinion as follows:

      The court is limited to a consideration of the allegations and the insurance policy in determining an insurer's duty to defend. We wish to point out that in considering such allegations, a liberal interpretation of their meaning should be indulged.

      Consequently, only in a situation where the allegations in Plaintiff's pleadings clearly fall outside the scope of policy coverage, will there be no duty to defend on behalf of the insurer. Courts have been quite liberal in holding that an insurer has a duty to defend in situations where some of the allegations are covered by the policy while others are not. If the Plaintiff's petition includes at least one allegation that is potentially covered under the insurance policy, the insurance company has a duty to defend against any and all causes of action brought pursuant to that petition. The insurer's duty to defend can also arise even if the Plaintiff has pled certain acts which clearly fall outside the policy coverage, so long as the Plaintiff has pled alternatively any cause of action which is covered under the insurance policy. While the complaint allegation and four corner's rules are determinative of an insurer's duty to defend, those rules and the cases cited above dealt with policies containing mandatory defense obligations. When a lawsuit is filed, the insurer must fulfill its contractual obligations by hiring an attorney to defend the claim against its insured.

      c. Employers Casualty Company v. Tilley

      The leading Texas case discussing the duties owed by an insurance defense attorney and the conflict of interest between the insurer and the insured is Employers Casualty Company vs. Tilley. The Tilley case was a declaratory judgment action. This declaratory judgment action arose out of a separate lawsuit in which Douglas Starkey sued Joe Tilley to recover damages for personal injury. Mr. Tilley had informed Employers Casualty that he did not know of Mr. Starkey's injury until he was sued almost two years after the date of injury. The defense attorney hired to defend Mr. Tilley performed certain investigations that assisted Employers Casualty in its defense of the declaratory judgment action. Employers Casualty, upon believing that Mr. Tilley had failed to timely notify them of Mr. Starkey's injury filed a declaratory judgment cause of action seeking a ruling that Mr. Tilley's failure to timely notify Employers Casualty of the claims against him relieved Employers Casualty of any obligation to defend Mr. Tilley. The attorney retained by Employers Casualty to defend Mr. Tilley was aware that Employers Casualty was building its defense related to the late notice. However, this attorney did not inform his client that the insurance carrier was preparing to deny his claim for these reasons. The Tilley court held that the insurance defense counsel becomes a legal representative of the insured and owes the insured the same type of unqualified loyalty as if he had been originally employed by the insured. The court held that the defense attorney hired by the insurance company must immediately advise the insured of any conflict that arises between the interest of the insurer and the insured. Since neither Employers Casualty nor the defense attorney retained by Employers Casualty to represent Mr. Tilley advised Mr. Tilley of the potential conflict and of the coverage defense, Employers Casualty was held to be estopped from denying coverage under its policy for the claims against Mr. Tilley.


      a. Message from Tilley

      The obvious message from the Tilley decision dictates that an insurance defense attorney cannot knowingly and accurably work for the insurer in establishing a coverage defense against the insured.

    1. Problems with Tilley

    The Tilley decision fails to give practitioners proper guidance when the defense attorney finds out information that might exclude coverage defense and indemnification. The most obvious area that reveals the discrepancy of the new disciplinary rules and Tilley decision evolves around the situation when an attorney learns of facts which give rise to a coverage defense. Robert E. O'Malley has inferred that an attorney would be foolish to adhere to the mandates of Tilley which require that the attorney inform both the insured and the carrier of facts giving rise to coverage defense. As Dion Raymos pointed out in his article, the Texas Disciplinary Rules of Professional Conduct have been changed since the Tilley decision and strict compliance with Tilley would subject the defense counsel to violations. The Texas Supreme Court in the case of American Physician Exchange v. Garcia held that the attorney hired by the insurer to defend the insured was the insured's attorney and not the insurance carrier's. Based upon Texas Disciplinary Rules 105 and 108, it would be a violation for the defense attorney to reveal any confidential information about the insured to the carrier. Additionally, Texas Disciplinary Rule 1.08(E)(3), the lawyer hired by the insurance company must maintain the confidential information relating to the representation of the client and may only work on the matter if he maintains a confidential relationship with whatever information he receives on behalf of the insured and does not pass that information on to the insurance company. If it can be shown that the adjuster actively tried to violate the privileged relationship, the insuring company could be estopped from assembling the coverage defense and the adjuster could be held personally liable for violating Article 21.07-4 §17A(2) and (5).


    a. Qualified Defenses

    In some cases the insurance company will have already identified certain facts which in their opinion exclude coverage. Should a coverage issue arise, the insurer may offer the insured a conditional or qualified defense. An insured is not required to accept a conditional or qualified defense. Pursuant to the applicable Texas law, the insured in a reservation of rights situation has the right to choose counsel in whom they have confidence. As discussed in Windt Insurance Claims and Disputes, the correct rule is that when an insurer issues a reservation of rights, it has the choice between allowing the insured to choose a defense counsel (to be paid by the insurer) or hiring "independent counsel to defend the insured."

    The case of Steel Erection Company vs. Travelers Indemnity Company, exemplifies the rights of an insured once a qualified defense is rejected. In that case, the defendants, Higdon and Steel rented a heavy construction crane from the Plaintiff, Mr. Sullivan. When Higdon and Steel were served, they notified Travelers and requested a defense. Travelers refused to provide a defense upon the ground that there was an exception clause in the insurance policy that exempted equipment in the possession, or under the supervision and control of Higdon and Steel. Higdon and Steel then employed Earl Cobb, Jr. to defend this lawsuit for them. Travelers offered a qualified defense reserving certain rights and remedies under the policy of the insurance. Higdon and Steel offered to permit Travelers to defend the lawsuit provided Travelers would extend to them full coverage under its policy. Neither party accepted the other's proposal and Mr. Cobb successfully defended Steel Erection Company in the lawsuit. The question of liability for the damage to the crane became unimportant; however, the question as to who would pay the attorney's fees and Mr. Cobb remained. The Court held that when the insurer is denying coverage but at the same time demanding the right to defend the lawsuit on behalf of the insured, and where coverage will depend upon the finding of the trier of facts as to certain issues in the main case, which in the Steel Erection case was a question of whether the crane at the time it was damaged was being operated by Sullivan as an independent contractor or by Higdon and Steel under a bailment agreement, the insurer is not in a position to defend the insured. The Court further held Travelers was confronted with a situation that it must acknowledge coverage and thus eliminate the controversy between it and Higdon and Steel or stand upon its contention that there was no coverage. By its actions in denying full coverage, Travelers brought itself in a position where it could not properly represent Higdon and Steel. Travelers chose not to admit full coverage and thus Higdon and Steel had a right to be defended by Earl Cobb, Jr. Travelers, not being in a position to defend the lawsuit due to its conflict with Higdon and Steel was liable for the attorney's fees. The attorney should demand an unqualified defense. He should advise that a potential conflict exists and inform the client that they have the right to demand independent counsel and have the insurance company pay for the bill.