On May 5, the California Supreme Court will hear argument in a case that has the potential to profoundly change the relationship between the insurer, its insured and the insured’s independent defense counsel under Civil Code section 2860.  The case is Hartford Casualty Insurance Company v. J.R. Marketing, LLC, Case No. S211645.  If Hartford convinces the Supreme Court to reverse the dismissal of its case, independent defense counsel may be exposed to claims for reimbursement of defense costs they’ve been paid by their client’s insurers.  This would be a very unfortunate outcome, both for law firms and Section 2860’s independent counsel regime.

In J.R. Marketing, Hartford refused to defend its insureds against several lawsuits.  The insureds hired their own defense counsel and sued Hartford for breaching its duty to defend.  Hartford then agreed to defend, albeit partially, and continued to insist that certain defense costs were not covered and that it was not required to provide independent counsel under Section 2860.  The court ruled that Hartford was wrong on both scores and indicated that, after the underlying litigation concluded, Hartford could seek reimbursement of any defense costs it paid that it believed were solely attributable to uncovered claims or parties.  Helpful to insureds, the trial court and Court of Appeal added to a growing line of cases holding that an insurer, after having breached its duty to defend, is not entitled to the billing rate limitations of Section 2860.

After paying $15 million in defense costs through the conclusion of the underlying litigation, Hartford sued for reimbursement.  And Hartford took a very unusual step.  In addition to suing the insured, Hartford also sued its insured’s defense counsel for reimbursement, alleging a novel quasi-contractual theory.  According to Hartford, the law firm that the insured hired (after Hartford initially refused to defend) was unjustly enriched by Hartford’s court-ordered defense cost payments relating to uncovered claims, so the law firm naturally should pay it back.

If Hartford’s theory succeeds, Hartford will have not only established its right to seek reimbursement of some defense costs from its insured’s law firm.  More fundamentally, it will have gutted some of the foundational principles of Section 2860, the California Supreme Court’s seminal duty-to-defend decision in Buss v. Superior Court, 16 Cal. 4th 35 (1997), and the attorney-client relationship. 

Section 2860 recognizes that, where an insurer agrees to defend but reserves its rights to deny coverage in a way that creates a conflict of interest between the insurer and its insured, the insured must be permitted to hire its own independent defense counsel.  Section 2860 requires the insurer to pay independent counsel, though its obligation is “limited to the [billing] rates which are actually paid by the insurer to attorneys retained by it in the ordinary course of business in the defense of similar actions in the community where the claim arose or is being defended.”  Cal. Civ. Code § 2860(c).

The fundamental purpose of Section 2860 is to ensure that the insured receives a truly independent defense.  The statute accomplishes that goal by giving the insured the right to select its own defense counsel and control its defense.  The alternative would be to allow an insurer to appoint and control defense counsel, but the insurer-appointed attorney could handle the case in a way that results in uncovered liability to the insured – a win for the attorney’s insurer-client, but a potential catastrophe for its insured-client.  Thus, while Section 2860 requires the insured and its independent counsel to provide the insurer with certain information regarding the underlying litigation, the insurer may not interfere with the attorney-client relationship. 

Buss further protects insureds by requiring insurers to defend all claims even if some of them are uncovered.  To ensure that insurers do not pay for defense costs they did not bargain for, Buss allows insurers to seek reimbursement of defense costs that are solely attributable to uncovered claims after the underlying litigation has concluded (if the insurers properly reserved their rights to do so).   

While Buss contains some general language about the insurer’s reimbursement right that does not expressly specify who must reimburse the insurer, it is unlikely that the Buss court intended the rule to extend to the insured’s independent defense counsel.  If the California Supreme Court now interprets Buss as having done so, the independent relationship between insureds and their defense counsel under Section 2860 will likely suffer, regardless of whether the Court limits its ruling to insurers that have breached their duties to defend, as Hartford had.

If insurers are permitted to pursue the insured’s counsel for reimbursement, those attorneys will no longer be truly “independent.”  Insurers will be able to wield a threat, expressly or implicitly, of a lawsuit over the insured’s attorneys as they provide advice and recommendations to the insured about how to defend the underlying litigation.  The insurers’ threat may influence the attorneys’ advice to their clients regarding case strategy.  To reduce their own risk, defense counsel may recommend pursuing a less expensive defense strategy that is less effective than the higher cost alternative they otherwise would have pursued.  Or defense attorneys may just do more conservative (or less) work for their clients, nervous about being second-guessed by the insurer years after the fact.

If Hartford’s position prevails, insureds may find it more difficult to find attorneys willing to take on their cases in the first place.  Will prospective defense attorneys want to evaluate not just the merits of the insured’s defenses, but also the strength of its coverage position, before accepting an engagement?  Will they discourage their clients from seeking insurance to avoid the risk of a reimbursement suit altogether?  Will they require their clients to agree up-front to indemnify them against any insurer reimbursement suit?

Injecting these unnecessary tensions into the attorney-client relationship could undermine not just the insured’s defense, but also the insured’s coverage position vis-à-vis its insurer.  Insurers may have a new point of leverage to use in coverage disputes, as insureds may be more reluctant to press insurance claims knowing that their independent defense counsel could be sued because of it.  Remember that insurers often are required to pay for insureds’ independent counsel under Section 2860 even when they are vigorously disputing coverage.  If Hartford prevails, what is to stop insurers from threatening their insureds’ defense counsel as an additional tactic to obtain a concession on coverage?

If the Court in J.R. Marketing gives insurers the right to seek reimbursement from “independent” defense counsel, it could drive a significant wedge into the relationship between attorney and client and undermine insureds’ rights.  Hopefully, the J.R. Marketing Court will recognize these harmful effects of Hartford’s position and affirm the dismissal of its reimbursement action.

We will be following this case and will report further after the California Supreme Court hears argument.