January 15, 2016

Avoiding the Dark Side: A Guide for Policyholders and Defense Counsel

While Star Wars may not conjure up thoughts of corporate insurance for everyone, it certainly does for corporate insurance recovery lawyers. The “Dark Side” can be a tempting and powerful force, as illustrated in the dialogue below — a conversation that takes place in a galaxy far, far way, between in-house counsel (“IH”) and corporate defense counsel (“DC”):

Star Wars-1

IHC:  “You’ve done such a good job defending our company in these types of matters, but our insurance company has refused to pay for this litigation.  Can you help?”

DC:  [sensing the presence of the Dark Side] “Of course we can.”

Star Wars-2

IHC:  “But doesn’t your law firm also represent insurance companies and don’t insurers use your firm as panel counsel?”

DC [fighting temptations of the Dark Side]:  “Yes, but that doesn’t mean we can’t represent you.  We know this insurer well because we work with them so often.”

Star Wars-3

IHC:  “Can your firm sue them if they don’t pay?  How about suing the insurance carrier for bad faith?”

DC [Still resisting the pull of the Dark Side]:  “This isn’t a bad faith case. Why would you want to sue your insurance carrier?” 

Star Wars-5 

This play on the Star Wars theme is a lighthearted way to look at what can happen when a law firm with insurance company relationships, and a corporate client with an interest in maximizing insurance recoveries, attempt to work through difficult issues related to the representation of policyholders in insurance recovery matters.

A Guide for Defense Counsel

It is tempting for panel counsel law firms to accept policyholder insurance claims, but many have hard and fast rules against doing so. Likewise, corporate policyholders may find it easier to utilize large panel counsel firms with insurance matters, even if those firms are limited in what they can do.

In order to maintain the utmost integrity, panel counsel law firms routinely bring in a separate boutique insurance recovery firm to handle insurance recovery claims for their clients. The reason for this is that when law firms are confronted with the question of whether or not they can zealously advocate against an insurance carrier on behalf of a client, honesty is always the best policy.  Panel counsel firms should steer clear of any resulting professional conduct issues, and should not compromise their obligations to either their policyholder corporate clients, or the insures who pay the bills.  Defense firms should be vigilant about identifying potential conflicts, and about informing corporate clients exactly what they are permitted and not permitted to do with respect to insurance carriers.  If panel counsel or insurance carrier representation could prevent a firm from zealous advocacy against an insurer, separate coverage counsel must be retained.

A Guide for Policyholders

“Full service” law firms make a lot of sense in the majority of practice areas. They offer a wide array of legal services to effectively and efficiently handle whatever kind of legal issue arises for a client.  One of the most important areas of representation for these clients is litigation defense.  When a corporate client is sued, it needs a team of great lawyers to defend the company.  But, defense of these corporate lawsuits, is, in many instances, paid for by insurance carriers.  Successful corporate litigation practices need insurance carrier approval.  As one might expect, insurance carrier approval comes with restrictions.

1. Recognizing Conflicts is Difficult

Recognizing potential insurance conflicts can be particularly challenging, as they are not always apparent to policyholders. Many large law firms represent domestic or international insurance clients, whether for litigation, transactional work, tax advice, or regulatory matters.  At the same time, those same firms represent corporate defendants in governmental investigations, administrative proceedings, and litigation.  When corporate defendants find themselves in disputes with their insurance carriers, these different client relationships can create a divergence of interests between a client and a law firm.

2. Conflicts are Real

Here, insurance industry interests can result in a conflict of interest affecting the firm’s ability to zealously represent a policyholder in a coverage dispute. Pursuant to the Model Rules of Professional Conduct, counsel is obligated to “zealously assert . . . the client’s position under the rules of the adversary system.” See Preamble to Model Rules of Professional Conduct.  However, counsel may be prevented from fulfilling this obligation if a conflict arises between two clients.  A “conflict of interest exists … if the representation of one client will be directly adverse to another client; or … there is a significant risk that representation of one or more clients will be materially limited by the lawyer’s responsibilities to another client … .” See Model Rule 1.7.  In this context, a conflict exists if the firm is limited in its ability to pursue the maximum possible amount of insurance coverage.  Typical insurance industry restrictions on panel counsel firms, such as preventing them from bringing bad faith claims, creates a conflict of interest that must be addressed under the Rules of Professional Conduct.

3. Waivers Are the Problem, Not the Solution

As with most conflicts, clients in insurance disputes can sign waivers to permit their law firm to pursue claims pursuant to the various restrictions imposed by insurance carriers. Many insurers refuse to sign waivers and this can prevent panel counsel firms from handling any insurance policy enforcement matters.  However, when an insurance carrier does grant a waiver, that waiver is not necessarily good for the policyholder.  Insurers often threaten to de-list a law firm as panel counsel if the insurer finds itself on the losing side of a ruling, or if the carrier otherwise becomes aggravated by the insurance claim.

In practice, an attempted “work around” that permits panel counsel to represent a policyholder in a coverage dispute despite the firm’s relationship with the insurer can do more damage to the policyholder than if the insurer simply refused to sign a waiver in the first instance. Panel counsel cannot serve in that capacity unless they agree to do certain things for the insurer.  This may include such benign concessions as entering into an agreement to limit hourly rates.  But it also typically includes entering into an agreement limiting how aggressive the law firm can be in pursuit of coverage for its corporate clients.  It is difficult, if not impossible to articulate these restrictions in a waiver, because the rules can change at the whim of the insurance carrier.  The fact that a policyholder is required to waive the right to bring a bad faith or extra-contractual damages claim may only be the tip of the iceberg.  The real risk comes after the firm begins pursuing a claim on behalf of a policyholder, because the insurer knows that it can exert great financial pressure on the law firm, because most law firms don’t want to risk losing panel counsel work.

Avoiding the Dark Side

When a defense firm takes on a policyholder’s insurance coverage dispute that also involves an insurer with a firm relationship, there is a real risk of being tempted by the Dark Side.

There is no question that defense counsel have the best interests of their clients at heart, but with insurance, things can get tricky fast. At the start, there is no adversarial relationship between the policyholder and the insurer, so there is no conflict.  At the early stage, defense counsel, after all, is just notifying the insurer of a claim and tendering defense bills.  But then, the insurance carrier asks some questions, the insurance policy is reviewed, and before you know it, the policyholder has spent $50,000 on insurance coverage advice.  If the insurance carrier then denies coverage, both the law firm and the policyholder find themselves in a difficult situation, as, at this point, outside insurance recovery counsel must be retained.

The situation defense counsel find themselves in with respect to insurance is even more precarious than they may realize. On the one hand, defense counsel should not take on coverage matters adverse to an insurer that pays for the firm’s services.  Yet, courts have required defense counsel to evaluate insurance, and make the right decisions with respect to complex issues. SeeCourt Slams Defense Counsel For Not Being D&O Insurance Experts”  Given these risks, the only foolproof way for defense counsel to address insurance issues is for them to hire separate insurance recovery counsel at the onset of any matter.


In the end, insurance conflicts can be simplified by looking at how insurance carriers view the issue. To insurers, as a law firm, you are either with them, or you are against them.  Practically speaking, insurance carriers have it right.  The best way to prevent the Dark Side from prevailing is to recognize this at the outset, as any deviation from this can lead to trouble.

Subscribe for Updates