THE COVENANT OF GOOD FAITH IS AN ETHICAL DOCTRINE

Ethics and the Reservation of Rights

Post 4867

An insurer that reserves its rights under a policy of insurance will usually raise a request by the insured for independent counsel. However, unless the reservation actually raises the need for the application of the ethical duty of an attorney to avoid representing conflicting interests, there is no obligation to retain independent counsel. If that duty exists independent counsel is required. If there is no conflict the insurer may assert its right to control the defense of the insured with counsel of its choice.

FACTUAL BACKGROUND

In Federal Insurance Company v. MBL, Inc., 219 Cal.App.4th 29, after soil and groundwater contamination in the City of Modesto was traced back to a dry-cleaning facility known as Halford’s Cleaner’s (Halford’s), the federal government brought a Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) action against the owners of the property on which Halford’s was located, as well as the lessees who owned and/or operated the facility, to recover the costs of monitoring and remediating the contamination. The defendants in the Lyon action subsequently filed third-party actions against, among others, appellant MBL, Inc. (MBL), a supplier of dry cleaning products including perchloroethylene (PCE), seeking indemnity, contribution and declaratory relief.

MBL tendered the defense of these third-party actions to its insurers, Federal Insurance Company (Federal), Centennial Insurance Company (Centennial), Atlantic Mutual Insurance Company (Atlantic), Nationwide Indemnity Company (Nationwide), Utica Mutual Insurance Company (Utica) and Great American Insurance Company (Great American) (hereafter collectively referred to as Insurers). The Insurers accepted the tender of defense, subject to reservations of various rights, and retained counsel to provide MBL with a defense.

MBL refused to accept retained counsel, arguing the Insurers’ reservations of rights created a conflict of interest and demanding the Insurers instead pay for counsel of MBL’s choosing. The Insurers denied there was any such conflict of interest and filed declaratory relief actions. The trial court granted summary judgment in favor of the Insurers, finding there was no actual conflict of interest.

In a related appeal, Great American sought to preserve its right to equitable contribution from the other Insurers in the event MBL’s appeal is successful. Alone among the Insurers, Great American paid MBL’s independent counsel for the costs of defending the third-party actions, subject to a reservation of the right to reimbursement from MBL if it succeeded in its declaratory relief action.

MBL supplies PCE, and other dry-cleaning products, to dry cleaning facilities, and has done so for a number of years. In 2007, MBL was named as a defendant in a number of third-party complaints and cross-complaints filed in the Lyon action. According to the allegations of the Lyon action, wastewater containing PCE was discharged into the sewer system as part of Halford’s dry cleaning operations until the mid-1980s. PCE was also leaking from an old dry-cleaning machine through the floor of the facility into the soil and groundwater. In 1989, the site was placed on the National Priorities List of hazardous waste sites.

MBL retained defense counsel, who tendered the defense of the Lyon action to the Insurers, requesting they appoint Cumis counsel. The Insurers accepted the tender of defense subject to various reservations of rights, detailed below, and appointed counsel to defend MBL.

MBL refused to allow the Insurers’ appointed counsel to associate as defense counsel, asserting it was entitled to independent counsel of its own choosing pursuant to Civil Code section 2860. The Insurers advised MBL it was only entitled to Cumis counsel if their reservations of rights created a conflict of interest and, with the exception of Great American, refused to pay the defense costs incurred by MBL’s counsel.

INSURERS’ COMPLAINTS FOR DECLARATORY RELIEF

The Insurers moved for summary adjudication of the causes of action for declaratory relief regarding their duty to provide independent counsel to represent MBL. The Insurers argued that the limited reservations of rights asserted by these insurers did not create a conflict of interest under California Civil Code section 2860 which modified the Cumis decision.

In June 2009, after the matter was briefed and argued, the trial court granted the Insurers’ motions. In its order, the court noted that the specific reservations of rights by [the] insurers did not present a conflict which would require the appointment of independent counsel. The court further found the general reservation of rights to deny coverage does not present a conflict which would require the appointment of independent counsel.

After amending its complaint to add a cause of action for reimbursement against MBL, Great American filed a motion for summary adjudication and summary judgment against MBL. The motion further sought summary judgment on MBL’s cross-complaint against Great American.

The trial court granted Great American’s motion in its entirety and entered a declaratory and money judgment in favor of Great American and against MBL.

Adapted from my book The Compact Book on Ethics for the Insurance Professional, the book is available from Amazon.com as a Kindle book, a Paperback or a Hardcover

(c) 2024 Barry Zalma & ClaimSchool, Inc.

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