National Insurance Law Forum : Insurance Litigation Lawyer & Attorney : National Insurance Law Forum : Insurance Coverage, Bad Faith Litigation

Centex asserted that Travelers had a conflict in controlling its defense as Travelers insured both Centex and its named insured subcontractors in the construction defect actions, and Centex had filed cross-complaints against the subcontractors. The court rejected this argument on the ground that Centex’s cross-complaints against the subcontractors were for indemnification. Centex’s liability in the actions would be derivative of the liability of the subcontractors who performed the work. The court recognized that Travelers would have the same interest in defending both its named insured subcontractors and Centex against the plaintiffs’ claims in both lawsuits.    Centex also argued that Travelers’ reservation of rights to deny an indemnity obligation for property damage occurring outside of the Travelers’ policy periods created a conflict of interest. The court rejected that argument, noting that a conflict exists only “when an insurer reserves its rights on a given issue and the outcome of that coverage issue can be controlled by counsel… retained by the insurer for the defense of the claim.”    The court found that independent counsel was not required under California Civil Code Section 2860 as Travelers’ reservation  did not give rise to a conflict of interest because the timing of the property damage was a factual issue outside of defense counsel’s control.

This case had been pending for several years and was closely watched by both members of the Texas defense bar and the insurance industry.   The Texas Supreme Court began its analysis by citing Tilley and Traver and reaffirming that in every instance, the insured’s lawyer “owes the insured the same type of unqualified loyalty as if he had been originally employed by the insured” and “must at all times protect the interests of the insured if those interests would be compromised by the insurer’s instructions.”

In essence, the appeal presented two issues:

1. In using staff attorneys to discharge their contractual duty to defend insureds against liability claims, are [Insurance Companies] engaging in the unauthorized practice of law?; and
2. If not, must a staff attorney’s affiliation with an insurer be fully disclosed to the insured?

The court began its analysis by noting the American Bar Association Committee on Ethics and Professional Responsibility and the State Bar of Texas Committee on Interpretation of the Canons of Ethics have both concluded the use of staff attorneys was not unethical.  The court then reviewed its analysis from a 1944 opinion in Hexter Title & Abstract Co. v. Grievance Committee, 179 S.W.2d 946 (Tex. 1944), and applied three factors to be considered in determining whether a liability insurer is practicing law by using staff attorneys to defend claims against insureds. 

One factor is whether the company’s interest being served by the rendition of legal services is an existing interest or only a prospective interest.  A second factor is whether the company has a direct, substantial financial interest in the matter for which it provides legal services.  Most important, a third factor is whether the company’s interest is aligned with that of the person to whom the company is providing legal services.  Applying these factors, the high court concluded a liability insurer does not engage in the practice of law by providing staff attorneys to defend claims against insureds, provided that the insurer’s interests and the insured’s interests in the defense in the particular case at bar are “congruent.”  The court indicated the insurer’s interests are congruent with their insured’s interests when they are aligned in defeating the third party claim against the insured and there is no conflict of interest between the insurer and the insured.  The staff attorneys must, however, disclose their relationship (i.e. the identity of their employer) to the insured. 

It is important to note the high court did not hold that a conflict of interest existed automatically just because the liability insurer issued a reservation of rights or non-waiver agreement.  Instead, the court held such conflicts had to be addressed on a case-by-case basis.  The court did caution that the safer course of action was to only use staff counsel where there are no coverage issues raised by the claims against the insured.   

This decision will generate some confusion. For example, the court properly recognized that merely issuing a reservation of rights letter does not create an automatic conflict of interest between the insurer and insured.  The court, however, didn’t use this opinion to explain the factors or standards to evaluate and resolve such potential or alleged conflicts.  Of similar importance, some carriers have been defending UM/UIM value disputes in Texas with staff counsel.  Although not specifically addressed in Friday’s decision, a disputed UM/UIM claim would seem to involve non-congruent interests and would presumably no longer be appropriate for handling by staff counsel in Texas.

After Friday's decision by the Texas Supreme Court, North Carolina and Kentucky remain the only two states whose supreme courts have adopted a per se ban on the use of staff counsel to represent policyholders.