Can Your Insurance Company Stop Defending Midstream?

In a disturbing new trend, we have seen insurers simply withdrawing from defending their insureds in the middle of the litigation.  There is substantial case law supporting the proposition that once defending, an insurer can only withdraw if a court permits it.  However, generally an insurer cannot sue its insured while the law suit the insurer is defending is still on going because that would unfairly put an insured in a two front war.  The solution for the insurer:  Put the insured in an even worse situation by yanking the defense midstream in the lawsuit!

As the primary reason a business would purchase the liability insurance in the first place is for financial protection against law suits, it hardly seems fair that an insurer can start defending but in the middle of the suit because some claims were dismissed, the insurer can just walk out and leave the insured twisting in the wind.  There are a number of courts who agree insurers cannot do so.  For example in Goerner v Axis  the directors and officers insurer settled claims against the corporation and the plaintiff amended the complaint taking most references to the corporation away.  Axis then asserted the second amended complaint (that lacked claims against the insured's company) then only asserted claims against the insured as an individual and walked away leaving the insured defenseless against the claims.  The insurer studiously ignored that the insured was sued for acts he undertook for the benefit of his company.  The insured had to settle the claims as he could not afford to fund his own defense and sue Axis for wrongfully pulling the defense.  The Ninth Circuit court of appeals agreed with the insured and applied the standard rule that where the facts support the conclusion that there was a continuing potential for coverage (in this case that the insured was acting for his company) then Axis had to continue to defend. The insured is now entitled to damages from Axis including the cost of his defense and the settlement, and perhaps tort damages as well.

We have seen other insurers attempt the same gambit--if it happens to you, call coverage counsel for assistance, as the law is on your side!

Insurer Not Required to Give 'Adequate' Notice to Insured Before Settling and Then Seeking Recovery From Insured

The law is settled, though not often enforced, that an insurer defending under a reservation of rights may settle the claim and seek to recover the settlement funds from the insured if there was in fact no coverage for the claim; provided that the insurer must give the insured the option to undertake the further defense of the claim if it does not wish to risk such a claim for indemnity.  Blue Ridge Ins. Co. v. Jacobsen (2001) 25 Cal. 4th 489.  But how much notice must the insurer give the insured?
 
In a recent case, the trial court submitted to the jury the question whether the notice had been given in sufficient time to allow the insured to evaluate its options.  The jury found "no;" but the appellate court ruled that this was not a proper issue in the case.  It relied on language in the Blue Ridge case, which did not involve this precise issue, to rule that adequate notice was given when the insurer originally advised the insured that it would defend under a reservation of rights and might seek recovery of any judgment or settlement funds later.  That, the court held, was all the notice to which the insured was entitled.   American Modern Home Ins. Co. v. Fahmian (April 8, 2011) 2011 DJDAR 5152.  
 
This is a terrible decision.   In  Blue Ridge, the insurer had submitted the offer to the policyholders and engaged in some correspondence with them about the matter.  The policyholders then squarely rejected the proposed settlement, with notice that Blue Ridge might settle and try to hold them responsible for the settlement.  Only then did Blue Ridge settle the case and then sue the insureds for its recovery.  Thus, whatever language in Blue Ridge stated that the insurer had met its obligations when it had initially  advised  the policyholders that it might settle and try to recover from them, and when it later gave them notice, really did not address the question whether the insureds should be allowed sufficient time to evaluate their position before they made their decision.  The Fahmian court should have respected the jury's finding that the insured clients were not given time to evaluate the difficult situation they faced:

Their insurer had been defending the case, although under a reservation of rights and advice that it might seek recovery from the insureds if there was a pay-out.  The average insured  would be relieved that he was being defended, and not spend too much time worrying about a possible indemnity claim that might never come.  He should be given a reasonable time to evaluate his options if and when that abstract danger became real.  Interestingly, in the reverse situation the Second Circuit Court of Appeals in New York, applying California law, held recently that an insurer's refusal to fund its insured's settlement of a case in a large amount during trial was in bad faith, precisely because the limited time in which the insurer had to evaluate the settlement was sufficient. Schwartz v. Liberty Mutual Ins. Co., 539 F. 3d 135.
 
The Supreme Court should take this case and review it.

No Halfway Defense Under Cumis

Most people with any knowledge of insurance coverage are familiar with the Cumis rule, first announced by a California appellate court in 1984. It allows an insured whose insurer has agreed to defend a claim but reserved its right to contest coverage, to defend the case through counsel of the insured’s (not the insurer’s) choice, and requires the insurer to pay for that counsel. The California legislature soon followed up with a framework for such “Cumis” defenses, under which among other things, the insurer needs to pay only at “panel counsel” rates (usually significantly lower than general market rates), and the insurer can compel arbitration of any fee disputes for the Cumis counsel.

Obviously, this is not necessarily a bed of roses for the insured, who may have to fight the insurer about the fees and may find arbitration not the most hospitable forum. However, a new case this week should help to cut down the more unreasonable demands of insurers in this area.

The Housing Group and others sued their insurers for breach of contract, bad faith, fraud and other wrongs, apparently because the insurers failed to provide and pay for a Cumis defense against certain third party actions. The insurers responded by demanding arbitration, claiming they had paid some of the Cumis fees and this was simply a dispute about whether the payments were sufficient. The trial court denied arbitration, and the court of appeal affirmed.

Plaintiffs’ contention was that the insurer could not compel arbitration because it had never agreed to defend the underlying cases and because it had made only very partial, untimely payments after the underlying case had been resolved, instead of currently. The trial court ruled for the plaintiffs, finding that the insurers either paid no fees or paid only partially and after the case had been completed.

In a brief opinion, McGuiness, P.J., ruled that without producing evidence that it had fully paid the defense costs currently, at least to the limits of the “panel counsel“ levels, the insurer had in effect refused to defend the underlying cases. That left it in the position of having breached its contract. Thus, it could not dispute the extent of its performance through arbitration.

Thus, if in a situation that requires Cumis counsel the insurer does not unequivocally and timely pay defense costs, at least at the alleged panel counsel rates, it is simply in breach of its contractual obligations and can be sued for breach of contract, possibly for bad faith as well. Housing Group v. PMA Capital Insurance Co., Cal. Ct of Appeal, 3/25/11.

Score one for fair play to policyholders!

When an Insurer Fails To Defend--They Must Pay The Bill In Full

Once an insurer is obliged to pay for the defense of a claim it initially failed to defend, may that insurer criticize the rates?  Or how the defense counsel billed?  Or the defense strategy?  Not likely.  If the insured is forced to defend itself, it would hardly be equitible for the insurer to "Monday Morning Quarterback" the selection of counsel, the billing format, even the litigation strategies.  Inequity has not prevented such arguments from dilatory insurers, but the courts have looked askance at them.

A good 17 year ago in Foxfire Inc v New Hampshire Insurance Company, 1994 U.S. Dist. LEXIS 9249, the memorandum opinion began by noting that an insurance company that wrongfully fails to defend may not later dispute litigation strategies undertaken by the defense in an action it refused to cover, citing to Stalberg v. Western Title Ins. Co.  230 Cal App 3d 1223,1233 (1991).  Further, to allocate the insurer must produce undeniable evidence supporting the targetted expenses were solely incurred as to non covered claims.  Horace Mann Ins. Co. v. Barbara B.   4 Cal 4th, 1076, 1081 (1993).  This is obviously a heavy burden rarely met. 

As to the insurer's complaint that the rates were too high, the court noted "Having forced its insured into the marketplace to retain counsel, NHICO cannot complain of paying marketplace rates..." As to the insurer's complaint that the defense counsel spent too much time or spent time on unnecessary tasks, the court found "NHICO lost any right to control Foxfire's litigation strategy ...the court will niether engage in a post hoc critique of Foxfire's litigation strategy nor allow NIHCO to do so."  Indeed the standard of evidence insurers must produce to overcome the presumption that all the defense costs incurred were reasonable and necessary is high--"that no reasonable defense attorney would have undertaken those services in defense of a client in such an action".  Firemen's Fund Ins. Co. v. Ex-Cell-O 790 F Supp 1339, 1346 (E. D.  Mich. 1992).  We are seeing the same insurer (through another of the AIG group of companies) and other insurers as well, make these arguments again even today 17 years later.  Slow learners.

When Does An Insurer Waive its Subrogation Rights?

OK, so how many insurance coverage published opinions begin with “What the Heck?!?” Not too many (although given some of the arcane inverted logic that is sometimes in play one would expect a few more). The case of Essex Insurance Company v. Richard Heck, MD filed on July 29, 2010 (2010 DJAR 11835) does begin with this memorable phrase and serves as a warning to insurers as well as any other litigants who take contradictory positions in multiple simultaneous or seriatim lawsuits. There the Fifth Appellate District affirmed a summary judgment by a subrogee against an insurer’s subrogation action, on the basis that the conduct of the insurer supported the trial court’s determination that the insurer impliedly waived its subrogation rights. This was a case of first impression on this precise issue although the general concept of implied waiver was applied in an earlier case to an insured who impliedly waived his “bad faith” claim when he accepted an insurer’s settlement of the third party claim (in the absence of any evidence of coercion, duress or fraud). United Services Automobile Assn v. Alaska Ins. Co. (2001) 94 Cal App 4th 638.

Before reciting the facts of this twisted tale, we will summarize who was suing who and for what. The matter is complicated because of the rather tortured gyrations the insurer went through to avoid paying the eventual judgment against its insured. Initially the insurer did provide defense counsel for its insured, but it pursued a declaratory relief case against its insured at the same time the claimant’s suit was pending. The insurer stubbornly refused to pay the judgment awarded to the claimant after trial. When cornered after the claimant brought fraud and bad faith claims, the insurer ultimately paid less that the claimant’s judgment, but failed in its effort to pass that cost to a subrogee (a third party allegedly responsible for the injury to the claimant).

The suits discussed in this opinion include: 1) the injured claimant’s premises liability suit against the insured(s); 2) the insurer’s declaratory relief suit against the insured(s); 3) the injured claimant’s suit for bad faith and fraud against the insurer and finally 4) the insurer’s suit against a third party (who was allegedly responsible for the claimant’s injury).

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What Happens When an Insurer Reserves Rights?

As promised our next note focuses on a common circumstance for insureds who are sued and ask their liability insurers to defend them.  Insurers will often extend a defense, by appointing their panel counsel (sometimes even employee counsel like Early Maslach who actually are a division of Farmers),  but at the same time issue 20 page letters describing all the ways the claims aren't covered.  Is this right?  Perhaps not where the facts to be developed by that defense counsel will determine which way coverage goes.

Some years back, policyholders took note of the fact that when insurers appoint the defense counsel, those lawyers might have conflicts of interest if the insurer asserts some claims would or might not be covered.  Those counsel may favor the insurer point of view--Why?  Appointed counsel are paid by the insurer (especially true for "panel" counsel who are the "go-to" defense counsel for an insurance company and thus receive scores of cases every few months.  Some appointed counsel are actually in "captive" or "in house" firms who are part of the insurance company, like Early Maslach which is a part of Farmers Insurance.)  The conflict of interest problem was first recognized in Executive Aviation Inc. v National Ins. Underwriters (1971) 16 CA3d 799,810: The rational is that in a conflict of interest situation "the insurer's desire to exclusively control the defense must yield to its obligation to defend the policyholder".   This case was followed by the famous San Diego Federal Credit Union v Cumis Ins. (1984) 162 CA3d 358,364 confirming the same point--that where such a conflict arises, the insurer must allow the insured to be defended by its own independent counsel paid for by the insurer, recognizing that otherwise the insurer appointed counsel has a built in economics based bias to favor the insurer's view of the facts--to tilt away from coverage.

Therafter the Insurance Industry lobbied the Legislature to pass Civil Code Section 2860 in 1987, after having to pay for expensive private counsel selected by the policyholders.  Section 2860 both codifies this right, but also severely limits it: insurers are now entited to impose a limit on what independent counsel can charge (rates the same as panel counsel).  The code also allow insurers to impose qualifications on the "independent" counsel and to expect reports and full participation.  Even with this favorable statute, many insurers still try to avoid having to pay for independent or "Cumis" counsel.  One common way insurers try to avoid admitting the conflict a reservation establishes is by asserting coverage is denied as to some claims, but potentially covered as to others but they will defend the whole case, reserving the right of reimbursement if they can show what amount is paid as to the denied claims.  Sound like a reservation of rights doesn't it?  If one of those circumstances comes up what can a policyholder do?  Time to call in coverage counsel (keep in mind any insurer who is reserving rights undoubtedly already has consulted coverage counsel).  Next few blogs will look at particular circumstances where an insurer did not escape defending despite their best efforts to do so.