Of insurers, independent counsel and allegedly excessive fees

Originally published in The D&O Diary by Kevin M. LaCroix.

On Aug. 10, 2015, in an opinion that has already garnered a great deal of attention and commentary, the California Supreme Court ruled that an insurer that funded the payment for its insured of independent counsel (or “Cumis” counsel as independent counsel are known in California) in defense of a claim may seek to recover directly from the independent counsel law firm amounts the insurer paid that the insurer contends were excessive or unreasonable. Though the ruling represents a landmark of sorts, the California Supreme Court’s opinion is much narrower than many commentators have acknowledged, which will limit its applicability in other cases.

Background: Cumis Counsel

It has long been the law in California (as is also the case in a number of other jurisdictions) that where there is a conflict of interest between a liability insurer and its policyholder in connection with the defense of a claim – as, for example, where the insurer’s provision of a claim defense is subject to the insurer’s reservation of its rights to deny coverage for the claim depending on the outcome of the claim – then the policyholder is entitled to defense counsel independent of the insurer, paid for by the insurer. This type of counsel is known in California as Cumis counsel, by reference to the 1984 California intermediate appellate case of San Diego Federal Credit Union v. Cumis Insurance Society, Inc. (here) that recognized this policyholder right. The rights to Cumis counsel in California have been codified in statutory form in California Civil Code Section 2860.

Background: Underlying Claim

In September 2005, J.R. Marketing and several of their employees were sued in an action in Marin County Superior Court. The complaint asserted claims for intentional misrepresentation, breach of fiduciary duty, unfair competition, restraint of trade, defamation, interference with business relationships, mismanagement, and conspiracy. The defendants associated the Squire Sanders law firm in their defense. The Squire Sanders law firm also filed cross-complaints on the defendants’ behalf as well.

On Sept. 26, 2005, the companies tendered defense of the claims to their CGL insurer. The insurer disclaimed coverage, alleging, among other things, that the wrongful acts alleged predated the policies’ inception dates and that certain of the defendants were not covered insureds. The defendants filed a coverage lawsuit in the Marin County. The CGL carrier subsequently agreed to defend the defendants subject to a reservation of rights, but declined to pay fees incurred prior to the date of its agreement to defend.

In July 2006, the trial court in the coverage lawsuit entered a summary adjudication order finding that the CGL carrier had a duty to defend the underlying claim effective on the date the defense was first tendered. Because the defense was subject to a reservation of rights, the court ordered that the defendants must be provided Cumiscounsel at the insurer’s expense. The defendants retained the Squire Sanders law firm as Cumis counsel.

In September 2006, the trial court in the coverage lawsuit entered an enforcement order – that had been drafted by the Squire Sanders law firm and adopted by the court – directing the CGL carrier to pay all defense invoices that had been submitted and to pay all future defense invoices within 30 days of receipt. The order stated that defense fees had to be “reasonable and necessary,” and provided further that the “to the extent [the CGL carrier] seeks to challenge fees and costs as unreasonable and unnecessary, it may do so by way of reimbursement after resolution of [the underlying claim].”

In September 2009, the underlying claim was resolved. The coverage lawsuit, which had been stayed during the pendency of the underlying claim, resumed. The CGL carrier thereafter filed a cross-complaint seeking, among other things, to recoup $13.5 million it paid to Squire Sanders pursuant to the September 2006 enforcement order. The Squire Sanders law firm demurred to the cross-complaint’s claims against the firm, arguing that the insurer could assert no rights “against non-insureds, including an insured’s independent counsel.” The insurer’s claims and rights, if any, the law firm contended, pertained only to the party with whom it had a contractual relationship – that is, the policy insured.

In September 2011, the trial court sustained the law firm’s demurrer, concluding that the CGL carrier’s right to reimbursement, if any, was from the insureds, not directly from Cumis counsel. The CGL carrier appealed the trial court’s ruling. The intermediate appellate court affirmed the trial court. The CGL carrier filed a petition for review to the California Supreme Court, which the Supreme Court granted.

The Aug. 10 Opinion

In an Aug. 10, 2015, opinion written by Justice Mariano-Florentino Cuéllar for a unanimous court, the California Supreme Court reversed the intermediate court and remanded the case for further proceedings, ruling that “under the circumstances of this case,” the insurer may seek reimbursement directly from Cumis counsel.” The Court’s opinion was accompanied by a separate concurring opinion by Justice Goodwin Liu, which provide several important glosses on the majority opinion.

In reaching its conclusion, the Court reasoned that if Cumis counsel, “operating under a court order that expressly provided that the insurer would be able recover payments of excess fees,” Cumis counsel “have been unjustly enriched at the insurer’s expense.” The Court said that Cumis counsel “provide no convincing reason why they should be immune from liability for enriching themselves in this fashion.” The Court expressly rejected the law firm’s argument that any financial responsibility for excessive billing should fall first on their own clients – clients, the Court noted, who had “paid to receive a defense of potentially covered claims, not to face additional rounds of litigation and possible monetary exposure for the acts of their lawyers.”

In reaching this conclusion, the Court took pains to emphasize the limits of its ruling. In reversing the intermediate appellate court, the Supreme Court stressed that its conclusions about the CGL carrier’s right of reimbursement directly from defense counsel was made in reference to “the facts of this case and with the limits discussed,” adding in a footnote that given the September 2006 enforcement order authorizing the CGL carrier to seek reimbursement of excessive fees, “we need not and do not decide here whether, absent such an order, an insurer that breached its defense obligation hasany right to recover excessive fees it paid to Cumis counsel.”

The Court also took pains at several points in its analysis of the issues to stress “that our conclusion hinges on the particular facts and procedural history of this litigation,” adding that “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.”

The Court’s points of emphasis highlighted one particular aspect of the case that the Court clearly considered to be important, which is that the Squire Sanders law firm itself has drafted the September 2006 enforcement order. The Court said that “Squire Sanders’s own conduct in the course of this litigation further supports our conclusion,” noting that the firm “drafted the very order that expressly preserved [the CGL carrier’s] right to pursue reimbursement.” The Court’s conclusion that the insurer may seek reimbursement directly from the law firm “stems directly from – and is wholly consistent with – that order.” The Court added that the fact that the law firm “now attempts to avoid the effects of that order by encouraging us to foist all responsibility for reimbursement onto its erstwhile clients, but we see no reason to accept that invitation.”

The Concurring Opinion

In his concurring opinion, Justice Liu made a couple of interesting points, one of which helps cast some added light on the parties’ dispute, and the second of which foreshadows the difficulties the CGL carrier will have on remand actually trying to recover anything from the CGL carrier.

First, Justice Liu noted that while the majority opinion “foregrounds” the law firm’s behavior, there are other parts to the story; the CGL carrier “spent years attempting to avoid its duty to defend,” and while the law firm “was racking up disputed fees,” J.R. Marketing “was not exactly a helpless bystander.” Liu then recounts the long and tortured history of the parties’ disputes over the defense of the claim. These circumstances, Lie said, show “that the relationship among [the CGL carrier], J.R. Marketing and Squire Sanders was fraught in a way that fundamentally differs from the Cumis scenario,” adding that “given this background, it is not surprising that Squire Sanders’s fees led to a further dispute with [the CGL carrier], but it is not clear who, as between J.R. Marketing and Squire Sanders, should be directly accountable to [the CGL carrier] for any alleged overbilling.”

Liu then emphasized that the majority opinion “grounds its analysis in the September 2006 enforcement order,” but observed that the majority’s “narrow decision” did not address “how the trial court should determine which entity benefitted from the allegedly unreasonable fees.” He added that “I believe that [the CGL carrier] should have to overcome a presumption that any fees billed by Squire Sanders – even fees later found to be unreasonable – were incurred primarily for the benefit of J.R. Marketing,” adding that “an insurer seeking reimbursement from Cumis counsel for unreasonable fees should have to demonstrate that counsel misled the insured in the representation, acted without the insured’s express or implied authorization, contravened the insured’s instruction, or otherwise acted in a manner with little or no benefit to the insured.”

Discussion

I should emphasize that there were a number of important legal issue involved in this appeal, which I have not noted above and that I do not address below. For some analyses that address these important legal issues, I suggest referring to the Trout Lieberman’s law firm’s Insurance Law Blog’s August 11, 2015 post (here) or the post on the Sedgwick law firm’s Insurance Law Blog about the case (here). Without minimizing the importance of these legal issues, my interest in the case is more focused on its practical implications, as discussed below.

Following the issuance of the Supreme Court’s opinion, a number of sources issued commentaries that emphasized the California Supreme Court’s holding that an insurer may seek to recover directly from the Cumis counsel fees the insurer paid that the insurer contends are excessive or unreasonable. I even received message from senior claims representatives who wanted to make sure that I was aware of this important development.

The perceived significance of this decision, as I understand it, has to do with carriers’ long-standing gripe with the way the whole Cumis counsel system works. The point of Cumis counsel in the first place is that the policyholder has counsel that is independent of the carrier, so that the defense is independent of the carrier’s control. Once Cumiscounsel is put in place, the carrier is powerless do to anything, even if Cumis counsel racks up massive amounts of fees in ways the carrier contends are inconsistent with the merits of the case. If the carrier tries to raise a question about the fees, the carrier is open to the charge that it is interfering with counsel’s independence.

For those on the carrier side aggrieved by this, the California Supreme Court case represents, they hope, the possibility that they might be able to signal to the Cumiscounsel that if the counsel doesn’t get reasonable about its fees, then the insurer will, like the CGL carrier here, proceed at the conclusion of the underlying claim directly against the law firm to recover fees the insurer contends were excessive or unreasonable. An Aug. 11, 2015, memo from the Troutman Sanders law firm (here), that otherwise highlights how narrow the California Supreme Court’s decision in the case is, said that the case “provides a foothold for insurers to argue that reimbursement actions may be maintained directly against Cumis counsel generally.”

The problem for any carrier trying to rely on this decision in that way, in the hope that it might provide carriers a way to recoup fees from Cumis counsel or even provide some sort of restraining influence on Cumis counsel, is that the decision was expressly written so narrowly that it arguably has no precedential value outside of the narrow context of this case. The opinion expressly states that the court is not ruling whether, absent the September 2006 enforcement order, the CGL carrier here would have had the right to proceed directly against the law firm. It is going to be a very unusual set of circumstances that would suggest another carrier providing Cumis counsel in defense of another claim would have, based on this decision, the right to proceed directly against Cumis counsel to try to recover fees the carrier paid that the carrier contends were excessive. This case was highly unusual in the fact that the fees were being paid pursuant to a court order – and not just any court order, but one that itself expressly preserved the carrier’s right to seek recoupment. Indeed, given the narrowness of the Court’s holding and the very specific and peculiar facts that undergirded the court’s ruling, this holding may not only be of very limited precedential value, but it may even have very limited persuasive value.

This dispute has been going on since September 2005.  It is far from over; this coverage dispute will now go back to the trial court and will grind on for who knows how much longer. Moreover, even though Justice Liu’s comments about the proof requirements on remand appeared only in the concurring opinion and not in the majority opinion, the trial court will have to pay attention to them. Given the presumptions and proof requirements that the carrier will face, the possibility that the CGL carrier here ultimately will secure a significant recoupment from the law firm seems unlikely.

As for the law firm, well, because I have several friends who are partners at the Squire Sanders firm (or Squire Patton Boggs as it is now known), I will not comment further on what the majority opinion said about the firm or how the opinion characterized the firm’s arguments.

Suffice it to say that no one is ever going to “win” anything in this case.

I would like to thank a loyal reader for calling my attention to this decision and suggesting the decision’s significance to me. I should emphasize that the views I have expressed in this blog post are entirely my own.