(Article from Insurance Law Alert, January 2018)
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An Illinois appellate court affirmed a trial court decision holding that an insurer’s reservation of rights as to a punitive damage claim did not automatically create a conflict of interest entitling the policyholder to independent counsel at the insurer’s expense. Bean Products, Inc. v. Scottsdale Ins. Co., 2018 WL 522627 (Ill. App. Ct. Jan. 22, 2018).
A suit filed against Bean Products alleged that it marketed and sold home-gym products in violation of another entity’s copyright and trademark. Bean retained counsel, who provided notice of the suit to Scottsdale, Bean’s liability insurer. Scottsdale appointed counsel to defend the underlying suit and issued a limited reservation of rights with respect to the underlying claim for punitive and exemplary damages. Scottsdale further advised that it was not waiving “any additional defenses which further investigation will reveal.” Bean argued that the reservation of rights created a conflict of interest entitling Bean to retain independent counsel. After the underlying suit was settled, Bean sued Scottsdale seeking a declaration that Scottsdale was obligated to reimburse Bean for the fees incurred in paying for independent counsel. A trial court ruled in favor of Scottsdale, finding no conflict of interest and no right to independent counsel. The appellate court affirmed.
Under Illinois law, a conflict exists if “the insurer’s interests would be furthered by providing a less than vigorous defense to the [underlying] allegations.” Bean argued that Scottsdale had an interest in providing a less than vigorous defense to the punitive damages claim because any such damages would be outside the scope of coverage. The court disagreed, finding that the punitive damages issue created only an “attenuated, hypothetical conflict” rather than an actual one. The court distinguished precedent in which a reservation of the right to disclaim coverage for punitive damages gave rise to a conflict of interest where the underlying plaintiff had sought minimal compensatory damages and substantial punitive damages. Noting that the underlying complaint against Bean did not demand “a disproportionate ratio of compensatory to punitive damages,” the court emphasized that a reservation as to a punitive damage claim does not automatically give rise to a conflict under Illinois law.
The court also rejected Bean’s assertion that the “open ended” nature of Scottsdale’s reservation of rights created a conflict of interest. Bean contended that the reservation allowed Scottsdale to “lay the groundwork” for a later coverage denial while still controlling the defense of the underlying suit. Dismissing these contentions, the court held that Bean failed to show a divergence in the parties’ interests and, at best, demonstrated only a remote possibility that a conflict could develop.
A California federal district court reached the same conclusion in Tokio Marine Specialty Ins. Co. v. City of Laguna Beach, 2017 WL 6512226 (C.D. Cal. Dec. 18, 2017), ruling that a reservation of rights as to a “your insured location” policy exclusion did not create an actual conflict of interest between the parties even though the location of the cause of damage was at issue in the underlying dispute.
The City of Laguna Beach sought defense and indemnity from Tokio Marine for underlying claims arising out of a sewer backup. Tokio Marine agreed to defend under a reservation of rights. In its reservation, Tokio Marine cited several possible bases for non-coverage, including the contention that the contamination at issue did not satisfy the policy’s “your insured location” requirement. In response, the City demanded that Tokio Marine pay for independent counsel based on a conflict of interest. The City argued that a conflict existed because the precise location of the sewer blockage was a primary issue in dispute in both the underlying and coverage actions. The court disagreed and denied the City’s partial summary judgment motion.
Section 2860 of the California Civil Code requires an insurer to provide independent counsel to the insured if a conflict of interest exists. The court concluded that no such conflict existed here because the interests of the City and Tokio Marine were aligned in disputing the City’s liability. The court explained:
For an actual conflict to materialize, Tokio Marine’s appointed counsel would have to advocate that a blockage in the main line, rather than a trunk line, was the causal factor leading to the backup. Such a position would necessarily concede the City’s liability. The City provides no evidence to support why appointed counsel would take such a position when a defense that denies the City’s liability would both align with the interests of the City and Tokio Marine and fulfill counsel’s fiduciary duties to both clients.
The court also rejected the City’s contention that a conflict existed by virtue of the declaratory judgment action filed by Tokio Marine against the City to determine its rights and obligations, noting that “litigation alone does not, as a matter of law, create a conflict of interest that entitles the City to independent counsel.”