Insurer’s Reservation Of Rights On Coverage Condition Created Conflict Of Interest Requiring Provision Of Independent Counsel

Insurer’s Reservation Of Rights On Coverage Condition Created Conflict Of Interest Requiring Provision Of Independent Counsel

07.18.2013

In Schaefer v. Elder, 217 Cal.App.4th 1 (5/16/2013), the California Court of Appeal held that an insurer’s reservation of rights relating to a condition of coverage created a conflict of interest requiring the insurer to provide for independent counsel pursuant to California Civil Code §2860 and upheld disqualification of insurer-appointed defense counsel because the firm presumably obtained confidential information from the insured regarding the coverage issue.

Elder Construction was hired by an owner to build a residence. Later, the owner sued Elder for construction defects. Upon tender, Elder’s insurer accepted the tender under a reservation of rights and appointed defense counsel to defend Elder in the suit.
 
The insurer reserved on a condition that excluded coverage for work performed by independent contractors unless they met certain conditions, including an agreement to indemnify Elder. Answers to interrogatories prepared by appointed counsel stated that Elder “primarily contracted with . . . subcontractors to construct the subject property,” implicating the condition to coverage. The insurer filed a declaratory relief action against Elder to determine whether the policy covered the claim.
 
Elder hired a law firm to move to disqualify appointed counsel and determine Elder’s right to independent counsel under Civil Code §2860. The trial court granted the motion, finding that Elder had a right to independent counsel and disqualified appointed counsel. The insurer appealed.
 
The Court of Appeal affirmed, citing Civil Code §2860 and Blanchard v.  State Farm Fire & Casualty Company, 2 Cal. App.4th 345 (1991), for the proposition that an insurer may be required to provide for independent counsel to defend an insured “where 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 the claim.” Here, the issue was whether the workers were Elder’s employees or independent contractors.
 
The insurer argued that, because the owner could establish liability regardless of the status of the workers, appointed counsel did not have an “actual” conflict of interest. The Court disagreed, stating: “It is in Elder’s interest to argue that the work was done by employees because the insurance policy would apply even if Elder did not comply with the contractor’s special condition. On the other hand, it is in the insurer’s interest to argue that the work was done by independent contractors so that, in the declaratory relief action, the insurer could argue that Elder was not covered because he failed to comply with the contractors special condition.”

The Court found that appointed counsel had an ethical duty to Elder to try to establish that the workers were employees, and, at the same time, had an ethical duty to the insurer to try to establish they were independent contractors. The Court determined this created a disqualifying conflict that entitled Elder to independent counsel.

The Court further held it was necessary to disqualify appointed counsel from all representation, stating it had to assume that appointed counsel received confidential information from Elder bearing on the coverage issue in preparing the interrogatory responses on behalf of Elder stating that Elder hired primarily subcontractors to construct the property. The Court reasoned that appointed counsel simultaneously represented Elder and the insurer, which had conflicting interests. Therefore, the Court concluded, appointed counsel was disqualified from continuing to represent Elder at all.

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