Conflicts of Interest: Hawaii Supreme Court Rejects Cumis Counsel Doctrine

HOLDING

The Hawaii Supreme Court recently held that a liability insurer retains its right to select defense counsel for its insured when it provides its insured with a defense under a reservation of rights letter and, barring the insurer appointed counsel's violation of the state's rules of professional conduct, the insurer is not required to reimburse the insured for its independent, personal counsel's fees. Accordingly, the Court rejected an insured's argument that a reservation of rights letter, without more, creates an inherent conflict of interest for the insurer appointed attorney that requires the insurer to reimburse its insured for its independent personal counsel's fees.

BACKGROUND

In Finley v. The Home Insurance Co., 1998 WL 905218 (Haw. Dec. 30, 1998), plaintiffs, James and Vanida Finley, sued their employers, Aaron Properties, Inc. and Aaron Properties Partners of Hilo, for wrongful termination. Aaron was covered under a workers' compensation insurance policy issued by now insolvent Hawaiian Insurance & Guaranty Co., Ltd. Pursuant to statute, Hawaii Insurance Guaranty Association ("HIGA") assumed the handling of the claim. Prior to tendering the defense of the wrongful termination action to HIGA, however, Aaron retained independent personal counsel to defend it in the action. HIGA accepted the tender under a reservation of rights letter and appointed its own counsel to defend Aaron in the action. Finley and Aaron settled the action. As part of the settlement, Aaron assigned to Finley its claim against HIGA to recover its counsel's fees, which HIGA refused to pay. Finley sued HIGA to recover those unreimbursed fees. The trial court granted HIGA's motion for summary judgment, dismissing Finley's claim. An appellate court vacated the trial court's decision. The Hawaii Supreme Court reversed the appellate court's vacatur and affirmed the trial court's decision in favor of HIGA.

DISCUSSION

Noting that this was a case of first impression, the Court began its analysis with an overview of the potential conflict of interest that is inherent in the tripartite relationship among an insurer, its insured, and insurance defense counsel. The Court pointed out that there are no other areas of law in which parties (insureds) are routinely represented by counsel selected and paid for by third parties (insurers) whose interests may diverge from those of the individual or entity the attorney was appointed to defend. Such divergence, the Court suggests, commences with a reservation of rights letter.

The Court explained that when an insurer provides its insured with an unconditional defense, both parties share a common objective: minimizing or eliminating liability; and no conflict of interest arises that would require the insured to retain independent counsel. But when the insurer provides its insured with a defense subject to a reservation of rights letter, a conflict exists because the insured's objectives - minimizing or eliminating liability and obtaining complete indemnification from its insurer - diverge from the insurer's objectives - minimizing or eliminating liability and avoiding some or all of its obligation to indemnify its insured. To remedy this conflict, the Court noted, some jurisdictions require the insurer to appoint independent counsel - commonly referred to as "Cumis Counsel" (from the California case that bears its name) - for the insured, paid for by the insurer.

In this case, the Finleys argued that HIGA had a duty to reimburse Aaron for its counsel's fees because "a conflict automatically arises whenever an insurer (1) accepts a defense under a reservation of rights; and (2) there are multiple claims in the complaint; and (3) the litigation of those claims has the potential of relieving the insurer of liability under its policy." Hence, the Finleys argued, the Court should follow other jurisdictions in requiring the appointment of Cumis Counsel and the Hawaii Rules of Professional Conduct ("HRPC") relating to conflicts of interest require HIGA to pay for the services rendered by "independent counsel."

The Court, relying on the protections that exist under the HRPC and on the integrity of the members of the bar appointed by the insurers to represent their insureds, rejected the Finleys' argument. The Court maintained that under the HRPC the insured's counsel owes a duty of loyalty solely to the insured, his only client under the tripartite relationship, and the insurer may not interfere with the attorney's professional judgment. Under this duty of loyalty, the counsel must: (1) consult with the insured regarding the means by which the objectives of the representation are to be pursued; (2) not allow the insurer to interfere with his or her independent professional judgment or with the attorney-client relationship; and (3) not allow the insurer to direct or regulate his or her professional judgment in rendering legal services to the insured. "Only if these requirements are met will the representation of an insured, paid for by an insurer with a conflicting interest in the outcome of the litigation, comport with the mandates of the HRPC."

The Court stated that if counsel appointed by the insurer scrupulously follows the mandates of the HRPC, the interests of the insured will be protected. In the event the Insurer's Counsel violates the HRPC, the insured has recourse to remedies against both the attorney and the insurer. For example, in the event counsel does not fulfill his or her duty to the insured, the insured can bring a malpractice claim. A malpractice claim could arise if counsel slants the defense to expose the insured to uncovered claims, conducts a "token defense", or shares confidential information with the insurer. Also, the insured may have an action against the insurer for bad faith or the insurer may be estopped from denying indemnification if the insured's actions caused counsel's breach of duty.

The Court also discussed the "enhanced" standard of good faith to which the insurer is held when it provides its insured with a defense under a reservation of rights letter. This requires the insurer to investigate thoroughly the cause of the insured's accident and injuries, retain competent counsel, inform the insured of the reservation of rights and of all coverage developments, and refrain from taking any action that favors the insurer's interest over the interest of the insured.

CONCLUSION

While noting that there is no general consensus among states concerning this issue, the Court held that the best result is to refrain from interfering with the insurer's contractual right to select counsel and leave the resolution of the conflict to the integrity of such counsel. In so doing, the Court rejected the Cumis Counsel approach to conflicts. "We believe that the remedies discussed above are an adequate deterrence against misconduct and safeguard the interests of the insured regardless of the fact that the attorney representing the insured is selected by the insurer." Accordingly, HIGA was not required to reimburse the Finleys for the fees of the insured's personal counsel.