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November 19, 2014

Defense and Coverage Conflict

Defense and Coverage Conflict: Important Considerations for Selection of Counsel

Mike A. Orlando, Jr., Texas Lawyer

Reprinted with permission from the November 17, 2014 edition of Texas Lawyer. © 2014 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited.


Panels of pre-selected attorneys are prevalent in today’s business world; companies want representation of their own choosing and that want has crept into the insurance company’s traditional domain of choosing counsel to defend its insureds.

While the common rule remains that the insurer retains the right to appoint counsel if the insurer is contractually obligated to provide a defense to the insured, what happens if an insured uses a perceived conflict between the insurer’s duty to defend and potential questions regarding coverage of the claim to select its own defense counsel?

Issues regarding representation appointed by an insurer continue to arise due to insurer’s practice of providing defense and costs to insureds but also reserving its right to deny coverage of the claim if certain facts present themselves at trial. Insureds placed in this situation have begun appointing their own defense counsel and demanding payment of such defense from the insurer by citing a conflicting interest with counsel appointed by the insurer as justification; insured’s are worried the insurer-appointed, and insurer-compensated, counsel would steer their defense towards a finding of “no coverage.”

Courts have consistently found that insureds may only appoint their own counsel, and then expect payment for such by the insurer, when the facts to be adjudicated in the insured’s defense are the same as the facts upon which coverage will be determined.

The Texas Supreme Court laid the foundation for instances in which conflicts of interest arise between insurer-appointed counsel and insureds in Northern County Mut. Ins. Co. v. Davalos in 2004. The insured tendered a lawsuit against it to its insurer but disagreed with the insurer’s selected defense counsel over venue of the defense. The insured then selected its own counsel and demanded the insurer cover the costs of the insured’s defense through the insured’s chosen attorney.

After affirming the insurer’s contractual right to conduct the defense of its insured, which includes the right to select the defense attorney, the court issued a hardline rule regarding conflicts: “when the facts to be adjudicated in the liability lawsuit are the same facts upon which coverage depends, the conflict of interest will prevent the insurer from conducting the defense.”

The court also found that insureds may refuse an inadequate defense or a defense conditioned on unreasonable and extra-contractual demand that threatens the insured’s independent legal rights. The court concluded no conflict existed because the only real dispute between the parties was choice of venue for the defense case and that decision is within the discretion of the insurer-appointed defense attorney. The insured’s choice to reject the insurer’s defense and attempt to transfer venue of the lawsuit against it precluded the insured’s right to recover the costs of that defense. The court effectively outlined the only avenue to an insured’s unilateral selection of its own defense counsel.

Importantly, the court also stated that had the insured accepted the insurer’s defense and defense attorney, the defense attorney would “owe unqualified loyalty to the insured, and must at all times protect the interest of the insured if those interests would be compromised by the insurer’s instructions.”

In Downhole Navigator v. Nautilus Ins. in 2012, the U.S. Court of Appeals for the Fifth Circuit built on the Texas Supreme Court’s Davalos opinion in reviewing the issue of conflicts created by reservation of rights letters and insureds hiring their own counsel as a result of those letters.

The insured was sued by a third party for negligently executing an oil well drilling plan; the insurer agreed to defend the lawsuit on behalf of the insured but reserved its right to deny coverage of the claim by citing, among others, a professional liability exclusion in the policy. The insurer rejected this defense by claiming a conflict existed and the same facts to be adjudicated regarding its alleged negligent work would also be the same facts by which the insurer could deny coverage of damages arising from the rendering or failure to render professional services.

Citing Davalos, the Fifth Circuit found that no conflict existed because the insured was being sued for negligent conduct and the policy did not contain an exclusion, nor did the insurer reserve its right to deny coverage for the insured’s negligent conduct. Whether the insured was performing professional services that might fit within the professional liabilities exclusion was not going to be adjudicated; the court refused to recognize a conflict merely because evidence of facts concerning the professional liabilities exclusion might appear during litigation.

The court rejected the insurer’s argument that conflicts could arise if the insurer-selected attorney steered its defense towards facts that could later be used to deny coverage; the court reaffirmed that the insurer-appointed attorney owes unqualified loyalty to the insured and would be in breach of its duty to defend if such steering occurred.

The Fifth Circuit reconfirmed this year in Graper v. Mid-Continent Cas. Co. that in order to choose its own defense counsel independent of the insurer, insureds must prove that the same facts concerning coverage are at issue in the underlying defense litigation.

To avoid costly and time-consuming coverage litigation, insureds seeking use of their own defense counsel should carefully analyze the claims against it, compare those to the coverages and exclusions in their insurance policy and review the insurer’s reasons for reserving its right to deny coverage. These three elements must align to properly appoint chosen counsel. For example, a conflict exists if an insured is sued for fraud and the insurer reserves its right to deny coverage based on its policy’s fraud exclusion; the outcome of the defense litigation will also fundamentally determine coverage. Contrast that example with the outcome of Downhole Navigator; even though facts that could determine whether the professional liability exclusion would bar coverage might arise during the defense litigation, the purpose of the litigation was to determine the insured’s negligence, not whether the insured performed professional services as defined by the exclusion.

Courts have uniformly upheld the insurer’s contractual right to choose defense counsel and will carefully examine any allegation of conflict using the stringent “same facts” test. For obvious reasons, companies have a strong predisposition toward selecting familiar counsel for its defense; however, it is a wise and cost-effective strategy for insureds to conduct the “same facts” test before appointing counsel against its insurer’s wishes.

Courts have uniformly upheld the insurer’s contractual right to choose defense counsel and will carefully examine any allegation of conflict using the stringent “same facts” test. For obvious reasons, companies have a strong predisposition toward selecting familiar counsel for its defense; however, it is a wise and cost-effective strategy for insureds to conduct the “same facts” test before appointing counsel against its insurer’s wishes.

Read more: http://www.texaslawyer.com/id=1202676397029/Defense-and-Coverage-Conflict-Important-Considerations-for-Selection-of-Counsel#ixzz3JX2xK6QR