We all know the maxim that “bad facts make bad law.” Two years after J.R. Marketing, LLC prevailed in the Court of Appeal concerning its dispute with its commercial general liability insurer, Hartford, it ran out of luck before the California Supreme Court in its fight over important Cumis counsel issues. Hartford Cas. Ins. Co. v. J.R. Marketing, LLC, 190 Cal. Rptr. 3d 599, 2015 DJDAR 9111 (Cal. Aug. 10, 2015). This is a must read for every lawyer in California that acts as Cumis counsel.
The High Court held an insurance company can sue independent counsel (i.e., Cumis counsel) directly for reimbursement of unreasonable or unnecessary legal charges counsel billed it to defend its insured. This decision may dramatically change the entire Cumis counsel landscape. Previously, an insurer could only sue its insured for reimbursement of defense fees. The High Court’s decision, no doubt, will have a chilling effect on how Cumis lawyers represent their clients. They will fear subsequent fee litigation from the insurer. One has to wonder if “independent counsel” will truly be independent anymore. Quite possibly, this case will practically (though not legally) relegate Cumis counsel to a similar role as an insurance company’s panel counsel, who has to pander to the “hand that feeds them” even though, under the law, Cumis counsel has two clients, the insured and the insurer.
The facts of this case were unique because Cumis counsel racked-up a whopping $15 million in legal bills under a court order it drafted that allowed it to bill the insurer without any fear whether or not the bills would be immediately paid in full. Hartford had issued J.R. Marketing a commercial general liability policy that covered business-related defamation and disparagement. J.R. Marketing was sued in Marin County (and other liability actions) for interference with business relationships, defamation, unfair competition and other business-related torts. It tendered the defamation lawsuit to Hartford under the policy. Hartford denied any duty to defend or indemnify.
J.R. Marketing sued Hartford for breaching the insurance policy. Hartford, only after the coverage action was filed, agreed to defend under a reservation of rights but only prospectively. It refused to pay J.R. Marketing’s legal bills back to the date of tender, and it also refused to provide Cumis counsel in place of its own panel defense counsel. The trial court in the coverage action found Hartford breached it duty to defend by failing to provide and pay for Cumis counsel from the date of tender.
A few months later, because Hartford still had not paid Cumis counsel’s bills violating the trial court’s summary adjudication order, the trial court entered an enforcement order in the coverage action. The order, drafted by J.R. Marketing’s Cumis counsel, Squire Sanders, required Hartford to promptly pay all of Squire Sanders’s past defense invoices within 15 days and to pay “all future defense costs” in the defamation action “within 30 days of receipt.” The order stated Hartford breached its duty to defend by failing to honor it until ordered to do so by the court and by thereafter failing to pay counsel’s submitted bills in a timely fashion. The order further stated that Squire Sanders’s bills had to be reasonable and necessary and that, to “the extent Hartford seeks to challenge fees and costs as unreasonable or unnecessary, it may do so by way of reimbursement after resolution of the” underlying defamation action. The trial court’s order did not specify from whom Hartford could seek reimbursement, i.e. from its insured, J.R. Marketing or from Squire Sanders.
After the defamation suit ended, Hartford filed a cross-complaint in the coverage action for “reimbursement pursuant to the enforcement order,” unjust enrichment and other claims. It directly sued Cumis counsel, Squire Sanders, as well as its insured J.R. Marketing. “The cross-complaint asserted that Hartford was entitled to recoup from the cross-defendants a significant portion of some $15 million in defense fees and expenses, including some $13.5 million Hartford paid to Squire Sanders pursuant to the enforcement order.”
Squire Sanders, representing itself and J.R. Marketing, demurred to Hartford’s cross-complaint. It argued, among other things, that an insurer has no direct claim against an insured’s independent counsel for reimbursement. The trial court agreed and “concluded that Hartford’s right to reimbursement, if any, was from its insureds, not directly from Cumis counsel.” The appellate court affirmed the decision. It rejected Hartford’s argument that an insurer has a right to recover directly from Cumis counsel unreasonable and excessive fees it pays counsel because counsel (and not just the insured) is unjustly enriched in that scenario.
The California Supreme Court reversed. The Court was very careful to narrowly frame the issue before it because it did not want its holding to apply to all Cumis counsel cases, just ones where the insurer had a reimbursement right rooted in a trial court order. It therefore stated the issue in great detail as:
From whom may a CGL insurer seek reimbursement when: (1) the insurer initially refused to defend its insured against a third-party lawsuit; (2) compelled by a court order, the insurer subsequently provided independent counsel under a reservation of rights . . . to defend its insured in the third party suit; (3) the court order required the insurer to pay all “reasonable and necessary defense costs,” but expressly preserved the insurer’s right to later challenge and recover payments for “unreasonable and unnecessary” charges by counsel; and (4) the insurer now alleges that independent counsel “padded” their bills by charging fees that were, in part, excessive, unreasonable, and unnecessary?
The Court emphasized again, “We granted Hartford’s petition for review, which raised a narrow question: May an insurer seek reimbursement directly from counsel when, in satisfaction of its duty to fund its insureds’ defense in a third party action against them, the insurer paid bills submitted by the insureds’ independent counsel for the fees and costs of mounting this defense, and has done so in compliance with a court order expressly preserving the insurer’s post-litigation right to recover ‘unreasonable and unnecessary’ amounts billed by counsel?” [Emphasis added].
To that very narrow issue the High Court responded:
We conclude that under the circumstances of this case, the insurer may seek reimbursement directly from Cumis counsel. If Cumis counsel, operating under a court order that expressly provided that the insurer would be able to recover payments of excessive fees, sought and received from the insurer payment for time and costs that were fraudulent, or were otherwise manifestly and objectively useless and wasteful when incurred, Cumis counsel have been unjustly enriched at the insurer’s expense. [Emphasis added].
As alluded to earlier, bad facts make bad law. The Court could not ignore the fact that the law firm acting as independent counsel, Squire Sanders, had racked up $15 million in legal bills defending the insured! Moreover, the Squire firm had written its own meal-ticket. It drafted the proposed order adopted by the trial court finding the defendant insurance company owed a duty to defend its insured through independent counsel. But Squire Sanders did not stop there. It included language in the order requiring Hartford to pay all of its legal bills in the case within thirty days, no questions asked, and that Hartford could not challenge any of the bills until after the underlying liability action had ended. The Squire firm’s aggressive and expensive litigation tactics completely unchecked by anyone, and the fact that the firm had drafted the very order permitting that highly advantageous scenario to them, lead the High Court to decide it had to allow a direct reimbursement action by Hartford against Squire Sanders. It could not allow $15 million in legal bills to stand without affording Hartford an opportunity to contest their reasonableness.
Unfortunately, the extreme facts of J.R. Marketing may forever change the Cumis counsel landscape, and not in a good way. While the Supreme Court was careful to clarify its holding was limited to the unusual facts of the case before it, its opinion unrealistically downplays the chilling effect it will have on Cumis counsel’s ability to zealously represent their client’s interests independent from the influence of its insurer.
We emphasize that our conclusion hinges on the particular facts and procedural history of this litigation. . . . We . . . express no view as to what rights an insurer that breaches its defense obligations might have to seek reimbursement directly from Cumis counsel in situations other than the rather unusual one before us in this case.
While firms acting as independent counsel will try to zealously defend their clients and look out solely for their interests (as the law requires), the threat of fee litigation looming over their heads by insurance companies will shape Cumis counsel’s strategy. Cumis lawyers will consider whether the insurance company is likely to challenge their defense strategies as unnecessary in a subsequent reimbursement action for fear of having to re-pay large legal bills. They are likely to decide how to defend the case based not just on their client’s best interests but, on their own and the insurer’s too.
If insurance companies had a record of integrity and looking out for their insured’s interests (and the lawyers that defend them), the Court’s opinion might work. But they don’t. They have a well-earned reputation of unreasonably nitpicking lawyer’s bills, refusing to pay for necessary legal work, demanding to pay antiquated hourly rates rather than market rates, employing auditing firms paid on a commission by how much of a lawyer’s bills they cut, and by trying to impose unreasonable billing guidelines on law firms. Cumis firms therefore will make legal strategy decisions against that backdrop. They will decide strategy based not only on whether they think legal work is necessary to their client’s defense, but, the possibility that the insurer paying their bills will file an expensive reimbursement action against them that unreasonably challenges their fees.
In the proceedings below, the trial court and the appellate court held a breaching insurer has no right to seek reimbursement directly from Cumis counsel. The lower court’s opinion enhanced the ability of independent counsel retained by insureds to vigorously prosecute their clients’ cases without fear of a possible action for reimbursement by insurers. It sent a strong message: insurers who reserve their rights and refuse to fund the defense of Cumis counsel take a big chance that they will be stuck paying those fees without any real ability to challenge them.
The California Supreme Court obliterated that vitally important message and sent its own. Cumis lawyers better carefully scrutinize their bills and only perform legal work that is absolutely reasonable and necessary to defending their clients because, if they cross the line, they will end up with a huge legal bill of their own. This decision, no doubt, will have a chilling effect on how Cumis lawyers represent their clients.
This decision would appear to undermine the purpose of the Cumis doctrine codified in Civil Code section 2860: when the insurer has a conflict with its insured on how to defend the underlying liability case because the outcome of a reserved coverage issue can be controlled by how it is defended, the insurer must pay for an independent defense lawyer chosen by and with allegiance solely to its insured to defend the case. How can a lawyer be truly independent from the client’s insurer and solely dedicated to protecting the insured’s interests when the insurer has the power to question every defense decision the lawyer makes and recoup legal fees that were arguably not wisely spent? Even the most ethical, skilled lawyer will measure each strategy decision he makes not just by whether it will benefit his client’s defense but by whether an insurer may have room to argue against the strategy. What is the silver lining? Perhaps the courts will indeed limit this holding to its very unique facts and confine its application. We can only hope.
California Court of Appeal Emphasizes Just How Broad the Duty to Defend Is, which Includes Suits Alleging Even RapeApril 01, 2015 Robert McKennon
A liability insurer’s duty to defend its insured against lawsuits is extremely broad, much broader than its duty to indemnify its insured for a judgment entered against it. That has been the law in California for decades. But just how broad is the duty to defend? Does it extend to civil lawsuits alleging the insured raped and sexually assaulted the plaintiff? Does it extend to lawsuits alleging intentional acts by the insured? You bet it does if the policy contains the right language.
General liability insurers and their agents often lure commercial clients with grandiose promises of coverage for business operations, but upon receiving a notice of a claim, interpret their policy exclusions liberally to limit what they consider covered business operations so as to deny coverage. A recent case from the California Court of Appeal, Baek v. Continental, 2014 Cal App. LEXIS 893 (2d Dist. Oct. 6, 2014) (“Baek”), expanded on an insurer’s broad duty to defend wherever there is a potential for coverage but in this case denied a duty to defend.
Baek involved a Heaven Massage Wellness Center (“HMWC”) client, “Jaime W.,” who brought suit against HMWC and her massage therapist (“Jaime W. action”), Luiz Baek (“Baek”), for sexual assault during a massage, alleging Baek handled the “Plaintiff’s breasts, buttocks, inner thighs and genitals.” HMWC had a general liability insurance policy with Continental Casualty Co. (“Continental”) which covered employees or partners “only for acts within the scope of their employment” or committed “while performing duties related to the conduct of [HMWC’s] business.” Continental asserted there was no coverage, and HMWC sued for breach of contract and bad faith. The trial court granted summary judgment for Continental. Subsequently, Baek filed suit against Continental, alleging it had a duty to defend and indemnify him in the Jaime W. action as a covered employee of HMWC. Continental demurred on the ground that Baek was acting beyond his scope of employment. Baek then amended his complaint to include a breach of contract, breach of the implied covenant of good faith and fair dealing and fraud against Continental. Once again, Continental demurred and trial court again sustained the demurrer, finding there was no coverage, and no potential for coverage, because Baek’s actions did not fall within his scope of his employment. Baek filed a timely appeal.
The California Court of Appeal first addressed whether Baek qualified as an “employee” of HMWC eligible for coverage. Baek argued Continental owed him a duty of defense because the complaint in the Jaime W. action alleged that Baek was either a partner or employee of HMWC and the alleged sexual assault occurred within the scope of his employment, or while performing his duties related to HMWC’s business. Conversely, Continental argued that Baek did not qualify for coverage because his complaint alleged he was an independent contractor, and thus he did not qualify as an employee or partner of HMWC. As an initial matter, the court explained an insurer’s duty to defend was triggered when the insured becomes aware of, or a third party suit pleads, facts sufficient to give rise to the potential for coverage under the policy. This duty to defend is broader than the duty to indemnify, and an insurer may have a duty to defend if there is a potential of coverage, even if no damages are awarded and any doubts concerning the potential for coverage and a duty to defend were resolved in favor of the insured. Continental knew the plaintiff in the Jaime W. action would attempt to prove Baek was HMWC’s employee or partner under the HMWC policy. However, Continental argued Baek’s complaint alleged he signed an independent contractor agreement, and thus did not qualify as an employee or partner of HMWC. The court disagreed, noting that although Baek signed an independent contractor agreement with HMWC, he did not allege he was an independent contractor so as to preclude coverage. The court clarified that an insurer’s duty to defend arises if allegations by the third party, rather than the potential insured, taken as true, reveal a potential for coverage. Here, the complaint in the Jaime W. action alleged that Baek was, at all relevant times, an employee, owner or partner of HMWC. The court explained that in its coverage determination, Continental was bound to accept these allegations as true unless extrinsic facts established otherwise. Therefore, for coverage purposes, Continental had to assume Baek’s status as an employee under HMWC’s policy to determine whether there was a duty to defend.
Next, the court addressed whether Baek’s alleged sexual assault fell within the scope of his employment so as to trigger coverage by reviewing two cases involving similar issues. First, the court reviewed Lisa M. v. Henry Mayo Newhall Memorial Hospital, 12 Cal. 4th 291 (1995) which involved an ultrasound technician who sexually molested a patient during an ultrasound exam by inserting the ultrasound wand and his fingers into her vagina. There, the court held the technician’s employment did not motivate or engender the sexual molestation; rather, the technician took advantage of his work environment and consciously committed an assault for reasons unrelated to his work. In addition, the court clarified that although the technician’s job involved examining or physical contact with a patient’s otherwise private areas, his assault on the ultrasound patient was not a foreseeable consequence of that contact. Accordingly, the sexual assault was an independent decision unrelated to his duties. Next, the Court of Appeal examined Farmers Ins. Group v. County of Santa Clara, 11 Cal. 4th 992 (1995) where a deputy sheriff’s lewd propositioning and offensive touching of others at a county jail were found to fall outside the scope of employment, despite the proximity to the workplace. The ruling court noted that where an employee’s tort was “‘personal in nature, mere presence at the place of employment and attendance to occupational duties prior or subsequent to the offense’” did not “bring the tort within the scope of employment.” The Court of Appeal explained that like the ultrasound technician in Lisa M., Baek’s employment as a massage therapist gave him the opportunity to be alone with Jaime W., but nothing in the facts suggested the alleged assault was “‘engendered by’ or an ‘outgrowth’ of his employment,” and his motivation for committing the sexual assault was unrelated to his work. Hence, his action did not occur within the scope of his employment contemplated under the Continental policy.
The Court of Appeal determined Baek’s alleged touching of Plaintiff’s breasts, buttocks, inner thighs and genitals “indisputably were not ‘duties related to the conduct of [HMWC’s] business’” or the acts he was hired to perform, but constituted a “stepping away” from HMWC’s business, as the acts were performed for Baek’s own benefit, rather than HMWC’s. Accordingly, the court concluded Baek’s acts were not related to, and did not occur, with respect to the conduct of HMWC’s business so as to trigger coverage.
Finally, the Court of Appeal rejected Baek’s arguments that even if Continental had no duty to defend the sexual assault allegations, it had a duty to defend Jaime W.’s claims of negligence and false imprisonment. Briefly, the court explained the duty to defend depended on whether the alleged facts reveal a possibility of coverage, not the labels given to the causes of action. The complaint in the Jaime W. action alleged the massage was negligent, each defendant was negligent in hiring, training and supervising Baek and Baek deprived Plaintiff of her freedom of movement by use of deceit in setting up the massage room. First, the court explained that sexual fondling is an intentional act such that Baek could not be found to liable for negligence or failing to use due care in performing the massage or supervising his own actions. Second, the court stated the false imprisonment allegations were “inextricably intertwined” with the alleged assault, for which there was no coverage. Accordingly, Continental had no duty to defend these allegations.
The good holding in Baek for insureds is that persons who work under an independent contractor agreement may be eligible for coverage under the employer’s general liability policy because a third party complaint alleges he or she was a covered “employee.” Although the court ultimately held there was no coverage, this decision is significant for policyholders as it explains that even though the insured executed an independent contractor agreement, the acts by its so-called independent contractor may be within the scope of coverage under such a policy.
Policyholder Wins Handed Down in Insurance Decisions. Daily Journal Publishes McKennon Law Group PC Article.February 12, 2014 Scott Calvert
The February 10, 2014 edition of the Los Angeles Daily Journal featured Robert McKennon’s article entitled: “Policyholder Wins Handed Down in Insurance Decisions.” In it, Mr. McKennon discusses six insurance decisions handed down in California and federal courts in 2013 that were favorable to policyholders.
The Reasonable Expectations of the Covered Party, Even an Additional Insured, Determines the Interpretation of Ambiguous Policy LanguageJanuary 27, 2014 Robert McKennon
In California, courts have long held that where a policy provision is ambiguous because it is susceptible to multiple interpretations, the reasonable expectation of the covered party governs. But which parties’ objectively reasonable expectations should govern where there are both a named insured and an additional named insured claiming coverage? In its significant decision in Transport Insurance Company v. Superior Court of Los Angeles County, __ Cal. App. 4th __, 2014 Cal. App. LEXIS 28 (Jan. 13, 2014), the Court of Appeal of California held that it is the objectively reasonable expectation of each party seeking coverage that is applied in determining the meaning of language within an insurance contract as it applies to that party, even where it is an additional insured who is not a party to the contact.
Insurers providing general liability insurance cannot shirk their duty to defend insureds at the outset of litigation by relying on self-insured retention (SIR) provisions in those policies unless the policies expressly and unambiguously make the insurer’s duty to defend contingent upon the SIR. So held the Fourth District Court of Appeals in American Safety Indemnity Company v. Admiral Insurance Company, __ Cal. App. 4th ___, 2013 Cal. App. LEXIS 779 (2013). The court’s decision in American Safety is highly favorable to insureds because it substantially limits the ability of insurers to circumvent their obligation to pay first-dollar for the defense of their insured by arguing that the SIR has not been exhausted.
In a recent ruling, the California Court of Appeal held that an insurer’s general reservation of rights to deny coverage of damages outside its policy does not create a conflict of interest with the insured, such that the insured in entitled to Cumis counsel. The decision in Federal Insurance Co. v. MBL, Inc. __ Cal. App. 4th __, 2013 Cal. App. LEXIS 679, 2013 WL 4506149 (August 26, 2013) follows California precedent denying insureds the right to select independent counsel at the insurer’s expense absent an actual conflict of interest.
Insurers Forfeit Their Protections Under Civil Code Section 2860 (Cumis Statute) When They Fail to Meet Their Duty to Defend ObligationsJune 27, 2013 Robert McKennon
If you want to read an important case on Cumis counsel and the consequences to insurers who fail to fulfill their obligations relating thereto, we have one for you. J.R. Marketing LLC v. The Hartford Cas. Insurance Co., __ Cal.App.4th __ (May 17, 2013). This case has a lot to offer: Cumis counsel, attorneys’ fees, Buss allocations, duty to defend, and insurance bad faith issues. In this case, the California Court of Appeal for the First District handed down a very important decision that is highly beneficial to insureds and their independent counsel (i.e., Cumis counsel). Significantly, the court expanded upon the limitations on the ability of insurers to impose upon their insureds’ choice of defense counsel when they do not properly defend their insureds, most likely committing insurance bad faith. Specifically, the Court found that insurers who wrongfully refuse to defend their insureds are barred from maintaining suits against their insureds’ independent counsel for reimbursement of fees and costs charged by such counsel and are barred from relying on the protections afforded insurers under Civil Code section 2860.
Reasonable Interpretation of Statute Does Not Preclude Triable Issue of Fact on Insurance Bad Faith ClaimMay 10, 2013 Sean Crane
A recent California Court of Appeals decision sought to clarify the application of California Insurance Code Section 533.5(b) concerning the statute’s preclusion of an insurer’s duty to defend its insured in criminal actions. In Mt. Hawley Insurance Co. v. Richard Lopez, Jr.,__Cal.App.4th___, 2013 Cal. App. LEXIS 346 (May 1, 2013) the Court of Appeals held that Section 533.5 (b) is not applicable to criminal actions brought by federal prosecuting authorities, and thus is limited to precluding the insurer’s duty to defend its insured in state criminal actions brought by the Attorney General, any district attorney, any city prosecutor, or any county counsel. The Court importantly held that the insurer’s Motion for Adjudication of the insured’s bad faith claim should be denied given the insurer’s potentially unreasonable actions even though the insurer gave a reasonable interpretation to an insurance code section.
California Court of Appeal Upholds Insurance Coverage for Health Net Finding The "Dishonest Acts" Exclusion Did Not Preclude CoverageMay 29, 2012 Robert McKennon
In Health Net, Inc. v. RLI Insurance Company, et al., the California Court of Appeal, Second District, reversed a trial court’s entry of judgment on a Motion for Summary Judgment finding some coverage for Health Net, Inc. (“Health Net”) in connection with numerous lawsuits filed against it arising under the Employee Retirement Income Security Act of 1974 (“ERISA”). Health Net brought suit against four of its insurers (one primary and three excess carriers) seeking a declaratory judgment that the insurers had a duty to defend and indemnify Health Net in over 20 underlying actions involving Health Net’s insurance plans provided by employers, which plans were subject to the requirements of the ERISA. The parties, however, directed their attention to two specific underlying actions, as the amount of indemnity sought in those actions would far exceed the combined policy limits of the defendant insurers. Relying on a policy exclusion for “dishonest acts,” the trial court granted summary adjudication to the insurers with respect to Health Net’s claim for reimbursement of its defense costs and the costs of settling the specified underlying actions. The parties subsequently settled their dispute regarding the remaining underlying actions, and summary judgment was granted in favor of the insurers. Health Net appealed the ruling.