• To Use Staff Counsel or Not to Use Staff Counsel - That is the Ethical Question
  • December 5, 2006
  • Law Firm: Fineman Krekstein & Harris, P.C. - Haddonfield Office
  • Under the terms and conditions of a liability insurance policy, an insurer promises to pay on behalf of its insured any amount for which the insured is liable for claims falling within the policy's coverage. The insurer also assumes the duty to defend the insured against those claims. In exchange, the insured cedes to the insurer control over the direction of the defense and settlement authority. See John Alan Appleman and Jean Appleman, Insurance Law and Practices, Section 4681 (1979).

    This contractual provision gives rise to the tri-partite relationship. By terms of this relationship, the insurer, when notified of the lawsuit by the insured, retains counsel for the insured. Absent a conflict, the lawyer represents the insurer and the insured. Once the client-lawyer relationship is established, the rules of professional responsibility, not the insurance contract or the lawyer's employer, govern the lawyer's ethical obligation to his or her client. ABA Committee on Ethics and Professional Responsibility Formal Opinion 96-403 (obligations of a lawyer representing an insured who objects to a proposed settlement within the policy limits) (August 2, 1996), in FORMAL AND INFORMAL ethics opinions 1983 through 1988 at 405 (ABA 2000).

    Insurers utilize two primary methods for addressing their contractual obligation to defend their insureds. First, insurers hire defense lawyers who practice in private law firms. Second, insurers retain staff counsel (employees of the insurance company), to represent insureds. This paper will explore the ethical dilemmas posed by the hiring of staff counsel to represent insureds.

    A. Background

    The use of staff counsel is not a new phenomenon. Reportedly, insurers have employed insurance staff counsel to defend insureds since the 1890's. Its use has continued to expand to the extent that it has been estimated there are several thousand insurance staff counsel presently representing hundreds of thousands of insureds. See Charles M. Silver, Flat Fees and Staff Attorneys; Unnecessary Casualties in the Continuing Battle Over the Law Governing Insurance Defense Counsel, 4 Connecticut Insurance Law Journal 205, 237-40, 1997-98.

    On occasion, insureds have challenged the use of staff counsel. Insureds have contended that the use of staff counsel constitutes the unauthorized practice of law. They have also contended that employing staff counsel to represent insureds constitutes a conflict of interest and that once a conflict exists, the insured should have the right to choose counsel. In this paper, we will explore the validity of the challenges to the use of staff counsel to represent insureds.

    B. The Unauthorized Practice of Law

    It is well-settled that only a member of a state's bar may practice law on behalf of another in that state. See Gafcon, Inc. v. Posner & Associates, 98 Cal. App. 4th 1388, 1405 (2002); Cincinnati Ins. Co. v. Wills, 717 N.E.2d 151, 163 (1999); King v. Guiliani, 1993 Conn. Super. LEXIS 1889, *8-9. This rule excludes any person, including a corporation, from practicing law. However, most courts have repeatedly have held that an insurance company does not engage in the per se unauthorized practice of law by employing in-house or outside counsel to represent its insureds. See Gafcon, 98 Cal. App. 4th at 1405; Wills, 717 N.E.2d at 163; King, 1993 Conn. Super. 1889; Coscia v. Cunningham, 250 Ga. 521 (1983).

    North Carolina is the only state to have found the per se unauthorized practice of law when an insurer's employee-attorney represents one of its insureds. Gardner v. North Carolina State Bar, 341 S.E.2d 517 (1986). In Gardner, the court held that the state's unauthorized practice of law statute precluded the use of salaried house counsel. The Gardner court observed that by making an appearance, the lawyer was in effect appearing for his corporate employer. If that lawyer appeared for an insured, then the insurer would be appearing for someone else, in violation of the North Carolina statute. Since the insurance company, itself, could not be a party to the action, it violated the North Carolina statute which makes it unlawful "... for any corporation to practice law or appear as an attorney for any person in any court in this state." Id. at 520.

    The Gardner court ruling fails to take into account a lawyer's duty to abide by the state's code of ethics. Whether an attorney is an insurer's employee or is in "private" practice, once that lawyer enters his or her appearance on behalf of an insured, he or she is obligated under the code of ethics to use his or her independent professional judgment. Consequently, that lawyer is not aiding the insurer in the unauthorized practice of law. Rather, he is representing the insured to the fullest extent allowed under the appropriate code of ethics. Taken to its extreme, the Gardner rule would prevent any lawyer or employee of a corporation, association or public entity, from representing that entity in any litigation matters. For example, employees of the Attorney General's Office, who are appointed to represent individual state employees, would be aiding the unauthorized practice of the law of the state.

    Fortunately, most other states have refused to follow the North Carolina decision. Courts generally have found as long as the corporate employer retains some interest in the employee-attorney's representation of a client, the practice is not unauthorized. See King, 1993 Conn. Super. LEXIS 1889 at *16-17 ("the salaried employee attorney may properly represent the interests of the insured and the insurance company provided they do not conflict."); In re Allstate Insurance Co., 722 S.W.2d 947 (Mo. 1987). Normally, the fact the insurer has a contractual obligation to indemnify the insured is sufficient to satisfy this requirement.

    C. Conflicts of Interest

    (1) Potential Conflicts of Interest

    One reason to disallow staff counsel to represent insureds is the potential for conflict of interest. This theory is predicated upon the fact that the staff counsel cannot serve two masters and that his or her judgment, will somehow be impaired because the lawyer is being paid a salary by the insurer while representing the insured. The basis for his criticism is the ABA Model Rules of Professional Conduct which find a conflict to exist if, "there is a significant risk that the representation of one or more clients will be materially limited by the lawyer's responsibilities to another client, a former client or a third person or by a personal interest of the lawyer." ABA R. Prof. Cond. 1.7(a)(2) Most states have adopted a rule of conduct with identical or similar language. See eg. Ind. R. Prof. Cond. 1.7(a)(2).

    Only Kentucky has concluded that the potential for conflict is so great that a per se disqualification rule is required. American Insurance Association v. Kentucky Bar Association, 917 S.W.2nd 568, 569 (Ky. 1996). In that case, the Kentucky Supreme Court acknowledged the trends of other jurisdictions, but concluded that staff counsel would be incapable of providing undivided loyalty to the insured. Its analysis presumes unethical conduct on the part of the lawyer. Given the lawyer's duty to follow the professional code of ethics, it seems overreaching to presume that a lawyer will ignore his or her professional responsibility to his or her client.

    Most other jurisdictions have concluded that the relationship of staff counsel to the insured is no different than any other potential conflict of interest situation, including private counsel, finding a rule against the use of salaried staff counsel to be overly restrictive. Therefore, the courts have held that a potential for conflict does not mean that the lawyer must, in all cases, avoid the representation.

    The New Jersey Supreme Court Committee on unauthorized practice put this issue in perspective. The Committee concluded that an insured's representation by a salaried attorney was permissible. It noted the ethical issues confronting in-house counsel were no different than those confronting appointed counsel in most insurance defense contexts. Consequently, having the insured represented by a salaried attorney or outside counsel was a distinction without difference. See New Jersey Supreme Court Committee on Unauthorized Practice, Opinion 23 (1996).

    (2) Real Conflicts of Interest

    Several specific conflicts of interest commonly arise in the insurance context, including "situations where a defense is afforded under a reservation of rights, where there is a defense of alternative claims, one with coverage and the other with no coverage, where there is a defense of claims for damages in excess of the policy limits, and where the defense involves multiple insureds." In re Youngblood, 895 S.W.2d at 328.

    A major issue in determining whether an impermissible conflict of interest exists is the issue of whether the lawyer represents one or two client. Under the one-client approach, the lawyer's sole duty is to the insured. Under the two-client approach, both the insured and the insurer are considered clients. The distinction can be important, as one with the status of "client" has certain rights that one without this status does not have. "A client may complain about a lawyer's lack of competence and even sue the lawyer for malpractice. A client may define the objectives of representation, decide when to settle a case, and is entitled to be kept informed by the lawyer. A client is entitled to have information kept confidential." Thomas D. Morgan, Article: What Insurance Scholars Should Know About Professional Responsibility, 4 Conn. Ins. L.J. 1, *6 (1997-98); see also Model Rules of Professional Conduct, 1.1 (competence); 1.2 (client's power to make decisions); 1.3 (diligence); 1.4 (keeping client informed); 1.6 (confidentiality)

    Under the one-client approach, where only the insured is a client, the insurer loses many of its rights, while still paying for the representation. Where the lawyer represents the insured and the insurer, problems may arise with the sharing of confidential information, as the two parties will be seen as co-clients. Model Rule 1.2 states that at the beginning of representation, "the lawyer must make appropriate disclosure sufficient to apprise the insured of the limited nature of his representation as well as the insurer's right to control the defense in accordance with the terms of the insurance contract."

    The Supreme Court of Missouri has adopted the two-client approach by recognizing an insurer's right to exercise control over litigation involving an insured. See In re: Allstate Insurance Company, 722 S.W.2d 947 (S. Ct. Mo. 1987); Helm v. Inter-Insurance Exchange, 354 Mo. 935 (1946) (holding it a proper course of action to cease defense until a reservation of rights could issue, where the insured's son misrepresented his age so as to fall within policy coverage).

     

      The insurer has the contract right to direct the litigation against its insured. It may evaluate claims and decide whether to settle or try. It may make economic decisions without the assent of the insured. The insured may want a quick settlement to eliminate further demands on time and energy, but the insurer does not have to settle unless a satisfactory offer is forthcoming. Or the insurer may accept a settlement offer even though the insured wants to go to trial to establish freedom from fault. The insurer may decide what to spend in defense, what discovery is to be had, and what experts to hire. It also has the right to select counsel to defend its interests.

    In re: Allstate, 722 S.W.2d at 952 (internal citations omitted). Addressing the issue of staff counsel and independent counsel, the court found no distinction in the two roles' ethical obligations:

     

      Employed lawyers are bound by the same rules of professional conduct as are independent practitioners. If a conflict appears, the lawyer, employed or retained, must immediately resolve it by terminating representation of one or both parties. If a client suffers damage because his attorney represents conflicting interests, a civil action is available. If the attorney is an employee, the employer is undoubtedly liable jointly and severally, which would not be the case if an independent contractor were retained. The lawyers involved are also subject to professional discipline. There is no basis for a conclusion that employed lawyers have less regard for the Rules of Professional Conduct than private practitioners do.

    Id. at 953 (internal citations omitted).

    Jurisdictions have reached different results as to when a conflict necessitates the use of independent counsel. Generally, the approaches taken by the courts are: 1) a rule of per se disqualification of counsel when any conflict arises; 2) a rule finding an impermissible conflict only when the insurer and insured are "complete adversaries" on an issue that would necessarily affect coverage or liability, Maneikis v. St. Paul Ins. Co. of Illinois, 655 F.2d 818 (7th Cir. 1981); and 3) a middle ground rule requiring disqualification where the attorney would have some interest in "providing a less than vigorous defense" to a claim, Nandorf v. CNA Insurance Co, 134 Ill. App. 3d 134 (1st Dist. 1985).

    San Diego Navy Federal Credit Union v. Cumis, 162 Cal. App. 3d 358, 359 (1984), is the seminal case for per se disqualification of an insurer-hired attorney when a coverage dispute arises and leads to a reservation of rights, allowing the insured the right to choose its own counsel at the insurer's expense. However, jurisdictions largely have refused to adopt such broad grounds for disqualification and this grant of control to the insured. California also has superseded by statute this holding of per se disqualification.

    In Utica Mutual v. The David Agency, the district court required the insurer and insured to be "complete adversaries" in order to find a conflict necessary to necessitate independent counsel. This situation arose where the insurer failed to timely issue a reservation of rights. The court cited with favor the Maneikis ruling requiring that the insured and insurer be "complete adversaries on a crucial issue which would necessarily be decided either one way or the other if liability was imposed," and where the disputed issue "could only resolve into one of two mutually exclusive outcomes, one of which would benefit the insurer, one of which would benefit the insured." 655 F.2d 818 (7th Cir. 1981).

    For example, a plaintiff alleges that he was injured because the insured committed a battery, which is excluded or because the insured was negligent. The alleged act was either intentional or negligent. Thus, the insurer and insured are complete adversaries on a crucial issue which would necessarily be decided either way if liability were to be imposed. Filing a declaratory judgment action would not alleviate the conflict because a judgment in the insurer's favor (i.e.) that a battery had occurred would have bound the insured in the underlying action. However, this analysis ignores that the insurer and insured also have a common interest in having the insured found not liable under any theory.

    Nandorf v. CNA Insurance Co, found Maneikis's interpretation too strict, and redefined the conflict of interest test as "whether, in comparing the allegations of the complaint to the policy terms, the interest of the insurer would be furthered by providing a less than vigorous defense to those allegations." 134 Ill. App. 3d 134 (1st Dist. 1985); (at Sears, 22, quoting Nandorf). In Nandorf, the plaintiff sought a large amount of punitive damages and a relatively small amount of compensatory damages. The insurer disclaimed coverage for the punitive damages. Although the insurer and insured share a common interest in finding no liability, the court found a conflict of interest existed because punitive damages formed a substantial portion of the potential liability leaving the insured with a greater interest and risk in the litigation. The insurer's interest would have been served by an award of minimal compensatory damages and substantial punitive damages. Since such an award was conceivable, the insurer had an interest in providing a less-than-vigorous defense to the punitive damage claim. Consequently, a conflict existed and independent counsel was necessary.

    Clearly, the courts are having difficulty in addressing this sensitive ethical issue. The insurance contract provides the insurer with the right to select staff counsel to represent the insured. Because coverage issues can place the insurer and insured at odds, the courts have been receptive to challenges to the appearance of impropriety where an insurer retains staff counsel to represent an insured in that instance. One practice to avoid many of these minefields is to adopt a policy that where issues of coverage are raised, the insurers will retain outside counsel to defend the insured.

    Ostensibly, this policy should resolve most, if not all, of the issues. However, many of the same arguments raised against staff counsel can be raised against outside counsel (i.e.) that outside counsel has a greater interest in protecting the insurer. In responding to these arguments, insurers should focus upon the common interest which the insurer and insured share to exonerate the insured, that a mere "whiff" of conflict is not sufficient and that the rules of professional conduct are designed to protect the insured. Even with these safeguards, instances will arise where a conflict exists. At that point, the issue is whether the insurer's contractual right to choose counsel trumps the insured's interest in selecting counsel.

    D. The Right To Choose Independent Counsel

    If a conflict arises that necessitates the use of independent counsel, jurisdictions do not agree on whether the insurer or insured may select independent counsel with the insurer being responsible to pay for the representation. A federal court applying Michigan law examined this issue and the jurisdictional split. Federal Insurance Company v. X-Rite, Inc., 748 F. Supp. 1223 (W.D. Mich. 1990). The court noted that the 11th and 9th Circuits, New York, Arkansas, and Illinois had adopted the Cumis rule that gives the insured the "absolute right to choose counsel where a conflict exists." Id. at 1228.

    However, the court ultimately decided that the insured in this case was not entitled to choose its own counsel at the insurer's expense. In recognizing the insurer's right to choose, the court cited case law from the Second, Third, and Eighth Circuits, as well as from Wisconsin, Indiana, Alabama, and New Jersey. The court also noted as relevant the language contained in the policy that the insurer had the "right to defend" along with the "duty to defend" its insured. Id. at 1229. The court adopted a "prophylactic rule which requires the insurer to relinquish control of the litigation, but permits the insurer to select independent counsel." Id.

    Later Michigan cases have approved of the district court's holding. See Cent. Mich. Bd. of Trs. v. Emplrs Reinsurance Corp., 117 F. Supp. 2d 627, 635 (E.D. Mich. 2000) ("The insured has no absolute right to select the attorney himself so long as the insurer exercises good faith in its selection and the attorney selected is truly independent."); Connecticut Indemnity Co. v. Spartan Travel, Inc., 2001 U.S. Dist. LEXIS 4558 (W.D. Mich. Mar. 28, 2001). See also Travelers Indemnity Company of Illinois v. Royal Oak Enterprises, Inc., 344 F. Supp. 2d 1358 (M.D. Fla. 2004).

    In a 1995 Arkansas case, that district court also addressed the issue of who may select independent counsel when a conflict of interest exists. Union Insurance Company v. The Knife Company, Inc., 902 F. Supp. 877 (W.D. Ark. 1995). Looking to prior Arkansas law and other jurisdictions, the court noted that the "majority rule" tended to allow the insured to choose counsel, and this view was supported by case law applying the law of Georgia, New York and California. Id. at 881.

    CONCLUSION

    Where conflicts arise, the use of staff counsel becomes problematic. Fortunately, the courts have not adopted a "knee jerk" approach, disqualifying staff counsel at the instant a potential conflict arises. Rather, the courts, for the most part, have taken a more realistic approach, recognizing that staff counsel is an appropriate choice to allow insurers to defend its insureds and that many of the same ethical issues exist whether staff or private counsel are hired.

    For their part, insurers can alleviate much of the anxiety of utilizing staff counsel to defend its policyholders, by informing its insureds of its practice at the time insurance is purchased. When a claim arises, the insurer should inform its insured that it is appointing staff counsel and fully explain its implications.

    When actual coverage conflicts arise, the insurers' best practice is to retain private counsel. This policy will not solve the problems, but will limit the challengers to the use of staff counsel, and smooth the bumps to allow its effective use.