Insurance Law Alert: Withdrawal of Reservation of Rights Eliminates Obligation for Independent Counsel

In Swanson v. State Farm General Insurance Company (No. B240016, filed 9/23/13), a California appeals court held that an insurer’s withdrawal of a conflict-creating reservation of rights eliminated the insurer’s duty to pay for the insured’s independent Cumis counsel.

In Swanson, a homeowner sued her adjoining neighbors over injuries and damage from the collapse of a retaining wall between their properties following a heavy rainfall. The neighbors cross-complained for premises liability and negligence, and the homeowner tendered the cross-complaint to her insurer, State Farm. The appeals court did not recite the specific facts of the loss, but stated that the insurer reserved its rights based on the policy’s definitions of bodily injury and property damage, the requirement for an occurrence, and certain exclusions from coverage for bodily injury and property damage. In so doing, the insurer agreed to representation by the insured’s choice of counsel (Cumis counsel), subject to compliance with the provisions of the independent counsel statute, Civil Code section 2860.

A dispute over the rate payable to the insured’s counsel was resolved when the insured agreed to pay the difference between the insurer’s rate and her counsel’s rate. After several months, State Farm amended its reservation of rights to withdraw certain policy defenses, which all parties agreed eliminated the Cumis-triggering conflict. State Farm then advised the insured that it had appointed panel counsel to assume the defense, and that it had no further obligation to pay for independent counsel. The insured permitted State Farm’s chosen counsel to associate into the defense, but did not discharge her independent counsel, who continued to participate in the defense and submit bills, none of which were paid by State Farm.

In the subsequent breach of contract and bad faith action, the court denied a summary judgment motion from the insured, and granted summary judgment for State Farm. Citing San Diego Federal Credit Union v. Cumis Ins. Society, Inc. (1984) 162 Cal.App.3d 358, the Swanson court noted that the right to Cumis counsel actually flows from the ethical duties of defense counsel first retained by the insurer to defend the insured:

“[T]he Canons of Ethics impose upon lawyers hired by the insurer an obligation to explain to the insured and the insurer the full implications of joint representation in situations where the insurer has reserved its rights to deny coverage. If the insured does not give an informed consent to continued representation, counsel must cease to represent both.”

However, the Swanson court held that an insurer only has a duty to provide Cumis counsel to its insured while the insurer maintains a Cumis-triggering reservation of rights. When the insurer withdraws its Cumis-triggering reservation of rights, it has the right to take control of the litigation with an attorney of its choosing and to cease paying Cumis counsel.

The Swanson court rejected an argument that the reservation of rights letter initially agreeing to pay for the insured’s choice of counsel constituted a modification of the policy terms, noting that this was actually the vehicle by which State Farm had preserved its rights.

The Swanson court also distinguished the case Behnke v. State Farm General Ins. Co. (2011) 196 Cal.App.4th 1443, where State Farm had agreed to continued representation by the insured’s chosen counsel, even after withdrawing its reservation of right. By contrast, in Swanson, State Farm refused to continue paying the insured’s counsel after waiving the disqualifying coverage defenses.

Finally, the Swanson court rejected the insured’s claim that State Farm had waived a right to retake control of the defense by failing to specifically reserve the right in the first instance. The court repeated that the right to independent counsel flows from the ethical obligations of defense counsel, not insurance law, with the apparent point being that there can be no presumption of a waiver of the right to control the defense, assuming the absence of a conflict.

This document is intended to provide you with general information about insurance law developments. The contents of this document are not intended to provide specific legal advice. This communication may be considered advertising in some jurisdictions.

September 24, 2013