Expensive Favor? Courtesy Counsel Held to High Standard
of Care

By William Funderburk Jr. and Ruben Castellon

© Copyright 1998 Daily Journal Corp. Reprinted with Permission.

William W. Funderburk Jr. is a partner in the Los Angeles office of Radcliff, Frandsen and Dongell.
Ruben A. Castellon, a partner in the San Francisco office, handles insurance coverage matters.

Insurance carriers have historically provided courtesy defenses to uninsued defendants for a variety of reasons. Courtesy defenses are probably most often provided to corporate entities in which a professional is the owner.

For example, accountants, brokers, doctors and lawyers often operate enterprises with numerous professionals under well-known marketing names. The errors-and-omissions malpractice policy for such professionals frequently does not include coverage for the entities. Similarly, directors and officers are rarely insured under commercial general liability policies and instead require separate insurance under a directors and officers policy.

The insurance carrier will often, nevertheless, provide the uninsured entity a courtesy defense in a lawsuit, since the defense costs will increase only nominally if the insured professional is also a named defendant. If the insured professional is not a named defendant, the insurer may still provide a courtesy defense, since denial of coverage will probably create ill will on the part of the insured and may only serve to motivate the plaintiff to amend the complaint to include the previously unnamed insured.

Insurance carriers have also provided courtesy defenses in situations in which they believe their interests, as well as those of their insureds, are furthered by providing a defense to an uninsured defendant.

In the underlying medical malpractice action giving rise to Mosier
v. Southern California Physicians Ins. Exchange, 98 Daily Journal D.A.R. 4851 (Cal.App. May 12, 1998), the insurance carrier, Southern California Physicians Insurance Exchange, insured the hospital and at least four doctors in a medical malpractice action. Due to a lapse in coverage, a fifth doctor did not have any insurance. This doctor was initially represented by an attorney who withdrew for nonpayment of fees two years before trial commenced. Thereafter, the doctor represented himself until a few days prior to the scheduled trial.

SCPIE and counsel for some of the insured doctors came to the conclusion that it would be "disastrous" to have the doctor appear at trial unrepresented by counsel. The insurance carrier and counsel were concerned, among other things, about the potential joint and several liability among the remaining doctors in the lawsuit.

As a result, the insurance carrier contacted the doctor and made an offer to provide a courtesy defense with the understanding that the carrier would select and pay for an attorney and that the doctor would not be entitled to indemnity.

The uninsured doctor’s new attorney substituted in on the day the trial was initially scheduled to begin. The trial was ultimately continued to a date a few months later. Counsel later made a number of questionable strategic and tactical decisions. The insurance carrier was apprised of most legal developments by correspondence while the uninsured doctor was not. The jury returned with a verdict in the plaintiffs favor, finding the uninsured doctor 70 percent at fault and the two remaining insured doctors each 15 percent at fault.

Prior to the entry of judgment, the insured doctors settled for less than their pro-rata share of the judgment. Judgment was subsequently entered against the uninsured doctor in an amount close to $10 million. The uninsured doctor filed for bankruptcy and the bankruptcy trustee, Robert Mosier, later filed a lawsuit against SCPIE, which led to the Mosier decision.

The court ultimately concluded that there was sufficient evidence to support findings relating to fraud and breach of fiduciary duty. The court, however, determined there was insufficient evidence to show that the uninsured defendant was injured or that the compensatory damages were causally related to SCPIE’s breaches of duty.

The court stated that an insurance company becomes bound to exercise due care, even where it has no contractual obligation, if it voluntarily chooses to provide a defense to a defendant An insurance carrier cannot, therefore, place its interests above those of the uninsured defendant. Such a heightened duty of care is akin to requiring the insurance carrier to meet and satisfy the covenant of good faith and fair dealing or face bad-faith exposure.

According to the court, any control imposed by the insurance carrier will be examined with scrutiny as in any other insured-insurer relationship. This scrutiny may include, but is not limited to, failure to recognize the retention of certain consultants and experts or failure to promptly compensate the consultants and experts, thereby prejudicing the defense.

The court added that such an uninsured defendant will also be entitled to Cumis counsel if the insurance carrier states it will not provide indemnity. The court expressly adopted the framework set forth in California Civil Code Section 2860 and other Cumis decisions. The court further noted that Cumis counsel’s obligations to the insurance companies are, thereafter, limited to disclosing, informing, consulting and cooperating with the carrier regarding "unprivileged" information.

This standard is different than the standard set forth in Civil Code Section 2860. This section reads: "When independent counsel has been selected by the insured, it shall be the duty of that counsel and the insured to disclose to the insurer all information concerning the action except privileged materials relevant to coverage disputes, and timely to inform and consult with the insurer on all matters relating to the action."

In all probability, the Mosier court recognized the need to broadly apply Section 2860 in all actions, including courtesy defenses, based on the reasoning reflected in First Pacific Networks Ins. v. Atlantic
Mutual Ins. Co., 164 F.R.D. 574 (1995), which held that Cumis counsel’s reporting obligations to an insurance company are strictly of an informational character, and not obligations of a lawyer to a client, since a lawyer cannot simultaneously represent two parties with different interests.

In any case, this decision means that all privileged information may remain confidential when a courtesy defense is being provided, notwithstanding that payments are being made by the insurance carrier. This privilege, however, could serve to discourage the insured and uninsured defendants from working together to reach a potential global settlement.

The outcome in Mosier is significant in that it may likely discourage insurance carriers from providing uninsured defendants with courtesy defenses in any context. Insurance carriers must now deal with the reality of greater potential liability and increased defense fees. Insurance carriers must also recognize that merely providing a courtesy defense may not serve the best interests of an insured and, occasionally, invite additional litigation.

There is little doubt that the uninsured doctor ultimately received little, if any, benefit in the underlying medical malpractice action giving rise to Mosier. Time, however, will tell whether any future uninsured defendants will even be in a position to accept courtesy defenses and possibly benefit from such defenses.