Liability Insurance and the Duty to Defend: The Policyholder's Right to Independent Counsel
The bad news: you've been sued. The good news: your liability insurer has hired a lawyer to defend you. But wait! Is that really good news? It is if you and your insurance company are completely on the same side.
Most businesses and individuals buy liability insurance to protect themselves against claims brought by third parties. In exchange for your premium, the liability insurer assumes two duties: the duty to defend you against lawsuits and the duty to indemnify you for judgments or settlements you may become legally obligated to pay as damages. Because litigation can be so expensive, the duty to defend is one of the most valuable features of a liability policy.
In the typical general liability policy, the insurer's duty to defend is triggered when you are sued and the insurer has received notice of the suit. (As discussed in a recent Much Shelist Litigation & Counseling Alert, failing to give timely and adequate notice can result in loss of coverage for a claim that might otherwise have been covered.) The duty to defend is broad: the insurer must defend any suit containing allegations that are even potentially covered by the policy. An insurer cannot refuse to defend you unless it is clear from the face of the lawsuit that the complaint fails to allege even a single fact potentially covered by the policy.
Once a lawsuit triggers the policy's duty to defend, the insurer has the right and the duty to appoint a lawyer to defend you. Under the law of many states (including Illinois), an attorney retained by an insurer to defend you has ethical obligations both to you and to the insurer. As long as you and the insurer share a common interest—that is, both of you want a finding of "no liability"—there should be no problem. But in some cases, your interests may diverge. When they do, a conflict of interest arises that entitles you—the policyholder—to defend the suit with a lawyer of your own choosing, at the insurer's expense.
Liability: A Mixed Scenario
Suppose you've been sued because your child hit a baseball through someone's window. The lawsuit alleges first that your child did it intentionally and, alternatively, that he or she acted negligently. You could be in for a problem because most liability policies cover damage due only to negligence. Most intentional conduct is not covered. In this scenario, the best result for both you and your insurance company is a finding of "no liability." The second best result for you is a finding of "liability due to negligence," which means the occurrence will be covered by your insurer. The second best result for your insurance company, however, is a finding of "liability due to intentional conduct," in which case the occurrence will not be covered and your insurer does not have to pay.
What does this divergence of interests mean for a policyholder? When your insurance company hires a lawyer to handle a liability issue, the lawyer, in effect, has two clients: the insurer and the insured. If a finding of "no liability" is not possible, does the lawyer serve the insurer's interest by trying to dismiss the negligence count, or the policyholder's interest by trying to dismiss the intentional-conduct count? In situations such as this, where you and your insurance company have different interests, there may be a conflict that entitles you to choose independent counsel, whose fees must be paid by your insurance company.
What Constitutes a Conflict of Interest?
Courts have said that there is a conflict of interest when the insurer would benefit by providing a "less than vigorous defense" of the policyholder. Even though you and your insurance company share at least one common interest—proving that you are not liable—the insurer may be equally protected if you are found liable for something that is not covered by your policy. As a result, there is a conflict of interest that requires the insurer to relinquish its right to control your defense and choose your lawyer.
Although many situations can give rise to a conflict of interest, here are four of the most common:
The lawsuit alleges both negligent conduct and intentional conduct. Since most insurance policies do not cover certain intentional acts, the insurer would be equally protected if you won the lawsuit outright or if the negligence count was dismissed, leaving you liable (but not covered) for intentional conduct.
The lawsuit alleges negligent conduct that occurred both before and during the policy period. Most general liability policies only cover occurrences that took place during the policy period (regardless of when the lawsuit was filed). Therefore, the insurer would benefit by fleshing out facts showing that the occurrence took place before the policy period, resulting in no coverage.
The plaintiff asks for both compensatory and punitive damages. As the name implies, punitive damages punish defendants for outrageous or vexatious conduct. Such conduct, as well as the punitive damages themselves, may not be covered under the policy, hence the conflict.
The lawsuit is brought against two or more policyholders whose interests are not aligned. In such a case, a conflict exists because the insureds cannot be represented by the same lawyer.
The insurer may agree to defend you while reserving the right to deny coverage if facts come to light that would, if proven, result in the claim not being covered. Defending under a "reservation of rights," however, does not necessarily mean that the insurer retains the right to control your defense and select your lawyer. In fact, most courts agree that defending a policyholder under a "reservation of rights" raises a conflict of interest. If you receive a "reservation of rights" letter after notifying your insurance company of a lawsuit, you should consult your own attorney immediately to determine if you are entitled to select independent counsel at the insurer's expense.
Understand Your Rights and Obligations
The right to independent counsel is an important issue that all liability policyholders should understand. In order to be prepared for the range of possible scenarios, here are a few additional points to keep in mind:
The laws regarding the duty to defend and the right to independent counsel vary from state to state. If your business has locations in more than one state and a claim is made against you, consult your attorney right away to determine which state's law will apply and what your rights are under that law.
Not all liability policies are subject to the same provisions and rules, especially those that protect against specialized risks (such as directors and officers liability, errors and omissions and other forms of professional liability, and employment practices liability). For example, while most general liability insurers are not obligated to defend you until a lawsuit has been filed, a professional liability insurer may be required to provide you with a defense as soon as someone makes a demand or initiates a formal investigation against you.
Defense costs typically do not use up the limits of liability of a general liability policy. That may not be the case with other types of liability policies, where such costs may reduce the amount of money available to pay judgments or settlements.
Under the typical general liability policy, the duty to defend is triggered by an allegation that an "occurrence" took place during the policy period. Other types of liability policies are triggered by a "claim" being made during the policy period, usually regardless of when the act giving rise to the claim allegedly took place.
Most of all, it is important to talk with your lawyer and your insurance broker when a claim is made against you, or even when you think a claim may be made against you. The sooner you know and understand your rights, the sooner you can get the legal protection you need and are entitled to receive.