In many situations, an insured and the carrier have conflicts of interest that would require each party to have its own attorneys. But when is an independent counsel a "must have" versus a "nice to have"?
According to a federal district court in California, notwithstanding an insurer's reservation of rights, the issue turns on whether there is an actual conflict with the insurer, not a potential conflict.
The case
On July 5, 2017, the owners of property in Laguna Beach, Calif., filed a lawsuit against the City of Laguna Beach, seeking damages arising from an April 26, 2016, sewer backup. The property owners alleged that the city had "created a dangerous condition of public property and acted with general negligence in managing its property by negligently failing to establish, operate, inspect, manage, maintain, repair, and clean its sewer lines causing a blockage to occur on the [c]ity-owned sewer line on Hillview Drive, Laguna Beach, California."
Two days later, the city tendered the complaint to its insurer, Tokio Marine Specialty Insurance.
Tokio Marine agreed to defend the city, subject to a complete reservation of rights. It took the coverage position that the claims asserted in the property owners' lawsuit were "not potentially covered under the policy."
Notwithstanding its reservation of rights, Tokio Marine concluded that there was no conflict of interest that would require it to provide independent counsel to the city under California Civil Code Section 2860.
The city responded in a letter to Tokio Marine stating that it "must provide independent counsel" because one of the primary coverage issues involved "the location of the blockage which caused the damage to the residence." In the city's view, the location of the blockage — and the definition of the "insured location," specifically as to whether it extended to the sewer main line — was "a determination which must be made in both the underlying damage action and the coverage action."
Tokio Marine refused to revise its position, and filed a coverage action against the city.
The city moved for partial summary judgment on its claim for declaratory relief that it was entitled to independent counsel.
The Tokio Marine policy
The Tokio Marine policy provided environmental coverage insurance for "remediation expense resulting from contamination migrating from and beyond the boundaries of your insured location," which was defined as "any property or location approved by use and listed in ITEM 3 of the Declarations Page or Your Insured Location Schedule endorsed to this policy."
The policy's endorsement defined it as:
[A]ny location owned, leased, rented or occupied by an additional named insured at the inception of the date of the policy or upon the additional named insureds addition to the policy via endorsement and listed on one of the property schedules made a party of the underwriting file and listed below, including, but not limited to, associated streets, roads, sanitary sewer trunk lines, storm drain outfalls, easements and rights of ways owned by any insured, wastewater treatment plants, water treatment plants, portable water wells, municipal airports, lift and pump stations, parks, civic or community centers, schools, donated land, easements for [*3] utility lines, roadways or bridges, landfills, maintenance garages, libraries, police and fire stations, or other government buildings, and associated shorelines and beaches.
California law
The California Civil Code provides that, absent a waiver in writing:
[i]f the provisions of a policy of insurance impose a duty to defend upon an insurer and a conflict of interest arises which creates a duty on the part of the insurer to provide independent counsel to the insured, the insurer shall provide independent counsel to represent the insured. [Section 2860(a)]
It also provides that a conflict of interest "does not exist as to allegations or facts in the litigation for which the insurer denies coverage."
However, a conflict of interest may exist "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." [Section 2860(b)]
The district court's decision
The district court denied the city's motion.
In its decision, the district court explained that a mere possibility of an unspecified conflict did not require independent counsel. The conflict, the district court continued, had to be "significant, not merely theoretical, and actual, not merely potential." Moreover, the district court added, a reservation of rights by an insurer did "not necessarily constitute a conflict of interest requiring the insurer to provide independent counsel."
The district court then ruled that the city had not demonstrated how Tokio Marine's reservation of rights as to the definition of the insured location required appointed counsel. According to the district court, the focus of the property owners' action was the city's liability — that is, whether a city-owned line was involved in causing the sewer backup. Thus, the district court reasoned, a reasonable defense would advocate that none of the city-owned sewer lines had caused the backup, regardless of its type.
According to the district court, for an actual conflict to materialize, Tokio Marine's appointed counsel would have to advocate that a blockage in the main line, rather than a trunk line, was the causal factor leading to the backup — a position that would necessarily concede the city's liability.
In the district court's opinion, the city provided no evidence to support why appointed counsel would take such a position when a defense that denied the city's liability would both align with the interests of the city and Tokio Marine and fulfill counsel's fiduciary duties to both clients.
Accordingly, the district court concluded, because Tokio Marine and the city had the same interest in minimizing the city's liability, the asserted conflict was "merely potential," and the city failed to show that it was entitled to independent counsel as a matter of law.
The case is Tokio Marine Specialty Ins. Co. v. City of Laguna Beach.
Steven A. Meyerowitz, Esq., (smeyerowitz@meyerowitzcommunications.com) is the director of FC&S Legal, the editor-in-chief of the Insurance Coverage Law Report, and the founder and president of Meyerowitz Communications Inc. This story is reprinted with permission from FC&S Legal, the industry's only comprehensive digital resource designed for insurance coverage law.
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