Employers Insurance v. Albert D. Seeno Construction Co.

ORDER

This diversity case began as a declaratory judgment action by an insurance company seeking a declaration that it is not liable for third-party claims alleging faulty work by one of its insureds, a home construction firm and developer. Plaintiff has now moved to disqualify the primary defendant’s lead counsel. Defendant has in turn cross-moved to disqualify plaintiff’s main counsel. For the reasons discussed below, the Court denies both motions.

BACKGROUND

Defendant Albert D. Seeno Construction Company (collectively with associated defendants “Seeno”) is a real estate developer that obtained various insurance policies from plaintiff Employers Insurance of Wausau (“Wausau”) in connection with Seeno’s construction of a large number of homes. Buyers of several hundred of those homes brought claims against Seeno for a variety of alleged construction defects. After Seeno submitted these claims to Wausau, dispute arose as to whether these claims are covered by Seeno’s policies with Wausau and regarding the proper method of handling these third-party claims. Wausau reserved its rights to deny coverage, and in March 1986 Seeno exercised its rights to engage independent Cumis counsel paid for by Wausau. 1 See-no has requested that Wausau take responsibility for handling claims that have not yet reached formal litigation (the “unlitigated claims”), but Seeno’s Cumis counsel *1153 have handled the claims that have reached litigation (the “litigated claims”).

In August 1986, Wausau brought this declaratory judgment action seeking a declaration that it is not liable for the claims. Plaintiff also asserts that Seeno has breached its contractual obligations and duties of good faith and fair dealing and seeks recovery of the sums Wausau has advanced to the insured to defend and settle the third-party claims. Seeno has brought various counterclaims including breach of contract, bad faith, fraud, and violation of the California Insurance Code.

In the latest stage of this acrimonious litigation, Wausau has moved to disqualify Seeno’s counsel, Archer, McComas & Lageson (“Archer”), and Seeno has responded by cross-moving to disqualify Wausau’s primary counsel, Robins, Zelle, Larson & Kaplan (“Robins”). The arguments of the parties are considered in turn below.

DISCUSSION

The Court of course has the duty of supervising the conduct of attorneys practicing before it, and part of that duty is to disqualify counsel if necessary. See, e.g., Trust Corp. of Montana v. Piper Aircraft Corp., 701 F.2d 85, 87 (9th Cir.1983); Cable Oakland v. Wilson, 201 Cal.App.3d 530, 534, 247 Cal.Rptr. 778 (1988). Counsel practicing before this Court are expressly made subject to the ethical requirements applicable to attorneys practicing law in the State of California pursuant to the Local Rules of the Northern District. 2 In addition to the Rules of Professional Conduct of the State Bar of California (the “California Rules”), these requirements include those contained in the American Bar Association Model Code of Professional Responsibility (the “Model Code”), because California courts look to the Model Code in determining issues not fully addressed in the California Rules. E.g., Paul E. Iacono Structural Engineer, Inc. v. Humphrey, 722 F.2d 435, 439-40 & n. 6 (9th Cir.), cert. denied, 464 U.S. 851, 104 S.Ct. 162, 78 L.Ed.2d 148 (1983); Atasi Corp. v. Seagate Technology, 847 F.2d 826, 830 & n. 4 (Fed. Cir.1988) (applying 9th Circuit law); see, e.g., Cable Oakland, 201 Cal.App.3d at 537-38, 247 Cal.Rptr. 778; Cumis, 162 Cal.App.3d at 366-67, 370, 374-75, 208 Cal.Rptr. 494.

I. CROSS-MOTIONS TO DISQUALIFY UNDER CUMIS

Both parties bring motions to disqualify based on alleged breaches of the duties of counsel in the Cumis context, i.e., where the insured has exercised its right to select independent counsel paid for by the insurer because a conflict or potential conflict has arisen between the insurer and the insured. In brief, the insurer Wausau argues that the insured Seeno’s choice of Cumis counsel, the Archer firm, has failed properly to represent Wausau’s interests. Seeno, on the other hand, argues that the counsel chosen by Wausau, the Robins firm, has failed properly to represent Seeno’s interests.

A. Wausau’s Motion to Disqualify the Archer Firm

Plaintiff’s first argument for disqualification of Seeno’s counsel Archer is based on that firm’s conceded double role as 1) Cumis counsel opposing liability in the underlying home buyers’ claims, and 2) counsel asserting coverage by Wausau. 3 Plaintiff argues that in its Cumis counsel role Archer is representing Wausau as well as Seeno, and that it is therefore an improper concurrent representation of adverse interests for Archer to represent See- *1154 no in a coverage dispute such as the instant case, where Seeno’s interests are directly adverse to Wausau. 4

Plaintiff relies chiefly on cases stating that counsel retained by an insurer to defend an insured have both the insured and the insurer as clients. E.g., Bogara v. Employers Casualty Co., 164 Cal.App.3d 602, 609, 210 Cal.Rptr. 578 (1985) (“The attorney hired by the insurance company to defend in an action against the insured owes fiduciary duties to two clients: the insurer and the insured.” (citations omitted)). Wausau argues that the Cumis line of decisions has not changed the dual duties of liability defense counsel; it simply allows the insured rather than the insurer to select such counsel. Cumis counsel thus always represents both the insured and the insurer.

Wausau views Cumis counsel as properly concerned only with minimizing liability to third parties, and as necessarily completely neutral with respect to any coverage dispute between its two clients, the insured and the insurer. Accordingly, Wausau asserts that Cumis counsel is “independent” not of the insurer but rather in the sense that such counsel seeks to minimize liability in a neutral fashion, independent of any regard for the coverage position of either client. According to this argument, as Cumis counsel chosen by Seeno, Archer represents Wausau as well as the insured, and it is therefore a patent conflict for Archer also to represent See-no’s interests against Wausau in this coverage action.

In order to decide the merits of this argument as well of that of defendant discussed below, it is necessary to examine the proper roles and duties of counsel under Cumis law, which has been undergoing a somewhat uncertain evolution. It is now beyond question that under certain circumstances an insurer is obligated to pay for “independent” counsel chosen by the insured. As noted above, the leading case, from which the name of such counsel is taken, is San Diego Navy Federal Credit Union v. Cumis Ins. Society, Inc., 162 Cal.App.3d 358, 208 Cal.Rptr. 494 (1984). In Cumis, the California Court of Appeal recognized that:

In the usual tripartite relationship existing between insurer, insured and counsel, there is a single, common interest shared among them. Dual representation by counsel is beneficial since the shared goal of minimizing or eliminating liability to a third party is the same. A different situation is presented, however, when some or all of the allegations in the [third-party] complaint do not fall within the scope of coverage under the policy. In such a case, the standard practice of an insurer is to defend under a reservation of rights where the insurer promises to defend but states it may not indemnify the insured if liability is found.

Id. at 364, 208 Cal.Rptr. 494.

In such situations, the court found, a conflict arises between the insurer and the insured, because it is in the insurer’s interest for the third-party action to establish that any liability is outside the coverage of the policy, while it is in the insured’s interest to show the opposite. 5 After reviewing *1155 the ethical dilemma posed for counsel in this conflict situation, the Cumis court held that:

[T]he [Model Code] 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. Moreover, ... the insurer must pay the reasonable cost for hiring independent counsel by the insured. The insurer may not compel the insured to surrender control of the litigation.

162 Cal.App.3d at 375, 208 Cal.Rptr. 494 (citations omitted).

Although the wisdom and cost of the Cumis decision 6 have been debated, the California Supreme Court has not indicated any inclination to depart from it, and the legislature has recently codified and to some extent clarified the Cumis approach. See 1987 Cal.Stat. ch. 1498, § 4 (codified at Cal.Civ.Code § 2860 (West Supp.1988) [hereinafter section 2860] ). 7 It is therefore the law in California and applicable by the Court in diversity actions such as this. See, e.g., Previews, Inc. v. California Union Ins. Co., 640 F.2d 1026, 1027-28 (9th Cir.1981).

Plaintiff Wausau does not challenge Cumis itself and indeed concedes the right and has paid the considerable cost of defendant Seeno to be provided with Cumis counsel to defend many of the home buyers’ claims. However, Wausau asserts that because the Archer firm is Cumis liability counsel, it is impermissible conflict for Archer to serve also as Seeno’s coverage counsel. This argument thus requires that the Court determine whether Cumis counsel represent or owe duties to the insurer such that Cumis counsel cannot represent the insured in coverage disputes with the insurer.

The starting point for determining to whom Cumis counsel owe what duties is the seminal California case Executive Aviation, Inc. v. National Ins. Underwriters, 16 Cal.App.3d 799, 94 Cal.Rptr. 347 (1971). In finding that an insurer was obligated to pay for the fees of independent counsel selected by the insured, the court followed the “reasonable solution” proposed in Prashker v. United States Guarantee Co., 1 N.Y.2d 584, 154 N.Y.S.2d 910, 136 N.E.2d 871 (1956), stating that:

[W]here a conflict of interest has arisen between an insurer and its insured, the attorney to defend the insured in the tort suit should be selected by the insured and the reasonable value of the professional services rendered assumed by the insurer. If the insured and the insurer are represented by two different attorneys, each of whom is pledged to promote and protect the prime interests of his client, adequate representation is guaranteed and the deleterious effect of *1156 the conflict of interest imposed on an attorney who attempts the difficult task of representing both parties is averted.

Executive Aviation, 16 Cal.App.3d at 809, 94 Cal.Rptr. 347. Like the New York Court of Appeals in Prashker; 8 the Executive Aviation court thus appears to have assumed that Cumis counsel would represent only the insured, and that the insurer would be entitled to counsel that would represent only the insurer.

Similarly, the Cumis court itself contemplated that being “the insureds’ independent counsel” meant representing the insureds, and being independent of the insurer. Cumis, 162 Cal.App.3d at 375, 208 Cal.Rptr. 494 (emphasis added). Thus, the court quoted with approval statements such as:

“Where a question exists as to whether an occurrence is within coverage, independent counsel representing the insured’s interests is required. The insurer is contractually obligated to pay for insured’s independent counsel.”

Id. at 374, 208 Cal.Rptr. 494 (quoting Dondanville, Defense Counsel Beware: The

Perils of Conflicts of Interest, 26 Trial Law.Guide 408, 415 (1982)) (emphasis added). Nor does the Cumis court appear to have believed that it is ethically possible to continue joint representation without consent once conflict has arisen. To take another example quoted by the court: “ ‘once the insurer decides to assert a coverage defense, the same attorney may not represent both the insured and the insurer.’ ” Id. (quoting Committee on Professional Responsibility of the State Bar of Louisiana Opinion No. 342, 22 La.B.J. 0-132 [within insert following page 46] (1974)). Indeed, it was precisely because “dual agency” representation is ethically impossible that the Cumis court required the insurer to pay for independent counsel for the insureds. Id. at 364-65 & n. 4, 374-75, 208 Cal.Rptr. 494. Since the attorney initially chosen by the insurer cannot ethically serve in both such capacities, the same logic requires the conclusion that the Cumis attorney for the insured may not either.

Other cases support the same conclusion. 9 For example, in Bogard, the court *1157 of appeal clearly recognized that Cumis counsel is hired to fulfill the insurer’s duty to provide “independent counsel to represent the insured’s interests” in order to avoid “the impossible ethical dilemma with which the attorney representing both insured and insurer in such a [conflict] situation is faced.” Bogara, 164 Cal.App.3d at 613, 210 Cal.Rptr. 578 (emphasis added); see also id. at 614, 210 Cal.Rptr. 578. Likewise in United Pacific Ins. Co. v. Hall, 199 Cal.App.3d 551, 245 Cal.Rptr. 99 (1988), the court had no doubt that “[t]he obligation of an insurer to provide independent Cumis counsel for an insured is premised on the ethical inability of an attorney to represent conflicting interests.” Id. at 556, 245 Cal. Rptr. 99 (citation omitted). Nor has the Court discovered any case holding that Cumis counsel are somehow exempted from the ethical rules that make it impossible to represent conflicting interests without consent.

Case law thus leaves little doubt that Cumis counsel represent solely the insured, and accordingly that there is no ethical requirement that prevents Cumis counsel from representing the insured in coverage actions adverse to the insurer as well as in liability matters. 10

The recent enactment of California Civil Code § 2860 is also strong support for the view that Cumis counsel do not represent the insurer. Most relevantly, section 2860(a) provides in pertinent part that:

“If the provisions of a policy of insurance impose a duty to defend upon an insurer and a conflict of interest arises which creates a duty on the part of the insurer to provide independent counsel to the insured, the insurer shall provide such counsel to represent the in sured____”

(Emphasis added.) Similarly, section 2860(f) provides in relevant part that such counsel have an “ethical and legal obligation to the insured.” (Emphasis added.) On the other hand, the statute says nothing about the kind of obligation Wausau alleges is owed to it as the insurer by Cumis counsel.

At least one other factor indicates that Wausau’s view of the role of Cumis counsel is unlikely to be accepted in California. The Cumis line of cases evolved out of express concern that counsel representing the insurer as well as the insured might prejudice the insured’s coverage and liability positions by favoring the insurer’s coverage position. See, e.g., Cumis, 162 Cal. App.3d at 364, 208 Cal.Rptr. 494 (“ ‘The [insurance] Carrier is required to hire independent counsel because an attorney in ac *1158 tual trial would be tempted to develop the facts to help his real client, the Carrier Company, as opposed to the Insured, for whom he will never likely work again---A lawyer who does not look out for the Carrier’s best interest might soon find himself out of work.’ ” (quoting trial court opinion)). Given the nature of this problem and the courts’ determination to alleviate it, it seems highly unlikely that the Cumis line of decisions or the legislature’s codification of it meant to allow the essential nature of the joint representation to remain the same, and merely to allow the insured rather than the insurer to make the initial selection of the counsel that would represent both of them. Rather, the Court believes that the Cumis decisions intended to eliminate the ethical dilemmas and temptations that arise along with conflict in joint representations, and that they accomplished this through mandating the insured’s right to Cumis counsel that represent only the insured.

This is not to say, however, that Cumis counsel necessarily owe no duties to the insurer. 11 The Court simply holds that any such duties do not as a matter of law create an attorney-client relationship between Cumis counsel and the insurer or otherwise make Cumis counsel vulnerable to disqualification at the instance of the insurer. The Court accordingly concludes that Cumis counsel do not as a matter of law have a relationship with the insurer that precludes such counsel from representing the insured in coverage disputes adverse to the insurer. Plaintiff has not shown that in law or fact the Archer firm has represented Wausau’s interests, and it therefore cannot be concluded that Archer has breached the ethical strictures against representation of adverse interests. Plaintiff’s first argument to disqualify the Archer firm is unavailing.

B. Seeno’s Motion to Disqualify the Robins Firm

Defendant’s motion to disqualify plaintiff’s counsel also hinges on the proper role of counsel in the Cumis context, but the foeus is now on the duties of counsel chosen by the insurer rather than on those of Cumis counsel chosen by the insured. The thrust of defendant’s motion is based on the Robins firm’s alleged double role as 1) counsel opposing coverage by Wausau, and 2) counsel opposing liability by Seeno. Defendant argues that in its second, disputed role Robins has been representing Seeno as well as Wausau, and that it is therefore an improper concurrent representation of adverse interests for Robins to represent Wausau in a coverage dispute such as this one, where Wausau’s interests are directly adverse to Seeno’s.

Defendant asserts that counsel selected by the insurer to assist in the handling of liability disputes necessarily have a dual agency status involving attorney-client duties to both the insurer and the insured. Defendant contends that such counsel’s primary duty is to the insured, and that Robins has breached this duty by its conflicting representation of Wausau in the adverse coverage disputes. Defendant further argues that Wausau has a duty to segregate its handling of coverage and liability disputes, and that the Robins firm has not done so. 12

*1159 As defendant vigorously asserts, it is of course true that counsel engaged by the insurer to defend claims against the insured in third-party actions 13 are normally representing the interests of the insured as well as the insurer. E.g., Purdy v. Pacific Automobile Ins. Co., 157 Cal.App.3d 59, 76, 203 Cal.Rptr. 524 (1984) (“We recognize that traditionally, where an insurance carrier is called upon to defend its insured, the attorney retained by the carrier for this purpose owes the same fiduciary duty to the insured as he or she would had the insured made the selection of counsel. The attorney’s primary duty has been said to be to further the best interests of the insured.” (citations omitted)). As discussed above, when an actual or potential conflict arises, it is also clear that the insured has the right to select Cumis counsel to represent solely the insured’s interests. By the same token however, the insurer may engage counsel to represent solely the insurer’s interests. This has long been the law, and developments in the Cumis area have not changed it.

Arguing to the contrary, defendant attempts to rely chiefly on Lysick v. Walcom, 258 Cal.App.2d 136, 65 Cal.Rptr. 406 (1968), which was decided before either Cumis or Executive Aviation. In Lysick, an attorney was retained by an insurer to defend against the liability of its insured in a wrongful death action and was thus representing both the insurer and the insured. However, after discovering a conflict between his clients and without fully disclosing the conflict or obtaining both his clients’ informed consent, the attorney engaged in settlement negotiations solely on behalf of the insurer. The court of appeal had no difficulty finding that as a matter of law the attorney had continued to represent the insured, 258 Cal.App.2d at 146-48, 65 Cal.Rptr. 406, and that in so doing he had “violated the legal and ethical concepts which delineated his duties to the [insured],” id. at 151, 65 Cal.Rptr. 406; see also id. at 153, 65 Cal.Rptr. 406.

Lysick goes on to clarify, however, that an attorney’s duties are “commensurate with the extent of his employment,” id. at 149, 65 Cal.Rptr. 406, and that it is perfectly permissible for the insurer to engage counsel to represent solely the insurer’s interests, id. at 149-50, 65 Cal.Rptr. 406. Moreover, Lysick recognized that such counsel have no ethical duties to the insured. Id. at 149-50, 65 Cal.Rptr. 406. Thus, citing Keeton, Liability Insurance and Responsibility for Settlement, 67 Harv.L.Rev. 1136,1167-71 (1954), the court observed that the insured and the insurer:

may create a relationship under which the attorney has no duty to the insured in the matter of settlement. In such a situation, ... the settlement decision has no significance between the insured and the attorney who is representing the defense in court. It is essential in such case, however, that the parties clearly understand that the client-attorney relationship does not extend to the matter of settlement, and if circumstances indicate that the insured may be misled, the attorney has the duty to make it clear to the insured that he represents only the [insurance] company with respect to settlement.

Lysick, 258 Cal.App.2d at 149-50, 65 Cal. Rptr. 406 (citation omitted). The attorney’s failure in Lysick was in failing to disclose that he intended to represent only the insurer in settlement and to obtain the insured’s consent to that representation; contrary to Seeno’s reading of the case, Lysick never suggests that the insurer was not entitled to counsel to represent solely its interests. Nor have subsequent cases changed this result.

*1160 As noted above, in Executive Aviation itself the court found that such representation was proper; indeed, the court clearly believed separate counsel for the insurer and the insured to be the best and most efficient model for ensuring adequate representation in the conflict situation:

If the insured and the insurer are represented by two different attorneys, each of whom is pledged to promote and protect the prime interests of his client, adequate representation is guaranteed and the deleterious effect of the conflict of interest imposed on an attorney who attempts the difficult task of representing both parties is averted.

Executive Aviation, 16 Cal.App.3d at 809, 94 Cal.Rptr. 347. The court also expressly contemplated that its “reasonable solution” would sometimes require “two attorneys for one action.” 14 16 Cal.App.3d at 810, 94 Cal.Rptr. 347.

More recently, in Bogard v. Employers Casualty Co., 164 Cal.App.3d 602, 210 Cal.Rptr. 578 (1985), the court of appeal again found it proper for an insurer to retain counsel to represent solely the insurer’s interests, and that such representation is consistent with Cumis law:

Based on Lysick, [the insurer] was free to hire counsel to represent it, and not [the insureds] at the settlement phase. However, that did not relieve [the insurer] of its duty to continue to defend [the insureds] either by retaining independent counsel for them itself, or by undertaking the payment of fees incurred by [the insureds] as a result of retaining cocounsel for the settlement negotiations.

Bogard, 164 Cal.App.3d at 614, 210 Cal.Rptr. 578.

Accordingly, it is clear that Robins does not, as a matter of law, represent defendant Seeno simply because it represents Wausau with respect to third-party *1161 eláims against Seeno. In light of defendant’s arguments, it is next necessary to determine whether Robins has represented Seeno as a matter of fact. If not, Robins cannot have breached any ethical duty to Seeno because Robins has no ethical duties to Seeno, and defendant’s motion to disqualify must be denied.

After a thorough review of the record in this proceeding, the Court cannot conclude that Robins has represented Seeno. First, no express evidence of a contract or letter indicating that Robins has ever been retained for such a representation has been offered. Second, Wausau maintains that it retained Robins solely to represent the insurer. E.g., Plaintiff’s Declaration of Paul N. Steinlage [hereinafter Steinlage Declaration] at 3. Third, the Robins firm has apparently always contended that it represents only Wausau. See, e.g., Plaintiff’s Declaration of John D. Shuff, filed October 14, 1987 [hereinafter Shuff