What has been called the “eternal triangle” in insurance defense practice is more aptly termed the “eternal conundrum.” Under certain circumstances, an insurer is obligated under a liability insurance policy to designate and compensate an attorney for defense of its insured. Unless otherwise specified by contract or agreement, a North Carolina insurance defense attorney has two clients, the insured and the insurer. To avoid any favoritism possibly engendered by the insurer’s long term relationship with the attorney or by the insurer paying the attorney’s bills, the insured is deemed the “primary” client, whose “best interest must be served at all times.” RPC 92
What does “primary” client mean in terms of a lawyer’s conduct? It appears the attorney at least owes the insured a heightened duty of communication and loyalty. See RPCs 92 and 118. The crux of dual client representation, however, is uncompromising allegiance to two clients. That is, absent a waiver, the attorney may advocate and pursue only courses of action that make both clients better off. Therefore, despite the insured’s “primary” designation, where the interests of the insured and insurer diverge, the attorney may not subordinate the interests of the insurer in favor of the insured.
Conflicts of interest in this dual client relationship can place an attorney in a particularly thorny situation. If the attorney’s representation of one client is either directly adverse to or will be materially limited by responsibilities to another client, there is a conflict under Rule 5.1. The question then becomes whether the clients can consent to representation despite the conflict, and if not, whether the attorney must withdraw from representation of one or both clients. This article is the first of several treating conflicts of interest in insurance defense practice. Its focus is appropriate attorney conduct when the insured reveals confidential information which would defeat his or her coverage under a standard liability policy. Consider the following hypothetical:
Suppose an insured is sued for damages based upon a negligence theory. The complaint only alleges occurrences covered by the insured’s policy. The insurer appoints defense counsel, in accordance with the policy, to defend in the name of the insured. During the course of the attorney-client relationship, the insured reveals that he and the claimant set up the whole incident to obtain insurance money under the policy. What should the attorney do?
In the first instance, the attorney is bound by Rule 4 of the Rules of Professional Conduct not to disclose confidential communications of the insured.i In addition, Rule 7.2 prohibits an attorney from assisting the client in conduct the attorney knows to be fraudulent. Most authorities agree that representation of the insured under these circumstances would violate an attorney’s duty not to assist client fraud. In light of these prohibitions, the attorney must counsel the insured to rectify the fraud, and upon the insured’s refusal, withdraw from representation pursuant to Rule 2.8.
Other authorities suggest that continued representation of the insurer, where the attorney has knowledge of the insured’s fraud, violates Rule 7.2 inasmuch as the attorney is acquiescing in such conduct. Even if we assume that representation of the insurer does not violate any ethical duty not to assist client fraud, the attorney is still faced with a conflict of interest under Rule 5.1. The attorney’s duty of confidentiality owed to the insured conflicts with the insurer’s interest in limiting its expenditures to those covered by the policy. Furthermore, the insurer cannot consent to representation because the confidentiality rules preclude the attorney from fully disclosing the reason for withdrawal. See Rule 5.1.
Many practitioners of insurance defense maintain that no conflict exists because the insurer has an absolute obligation to defend the insured so long as the complaint alleges facts which, if proven at trial, would be covered by the policy, whether or not such claims are baseless or fraudulent. Although recent case law indicates that under certain liability policies, the insurer’s duty to defend is governed by the four corners of the claimant’s complaint,ii North Carolina has not acknowledged a similar duty to defend on the part of insurance defense attorneys when faced with a conflict of interest or client fraud. See Rules 5.1 and 7.2, CPR 255 and RPC 103. Moreover, the insurer’s contractual duty to defend irrespective of the merits of the complaint, does not eliminate the conflict for an attorney with knowledge of collusion between the insured and the claimant because the attorney cannot act in the insurer’s best interest. If the attorney could divulge the insured’s fraudulent behavior, the insurer could choose either to defend under reservation of right, thereby preserving its right to contest coverage later, or to decline to defend, relying upon proof of fraud or collusion to absolve it from any subsequent breach of contract or bad faith claim by the insured. Because the attorney’s duty of confidentiality to the insured materially hinders representation of the insurer, the attorney must also advise the insurer to seek separate counsel. The theory is, where a fundamental conflict of interest exists, both the insured and insurer would be better off with separate counsel whose loyalty is not divided.
The preceding section discusses an insurance defense attorney’s professional duties under our Rules of Professional Conduct. Compliance with the letter and spirit of the rules, however, does not alleviate problems the rules were intended to address. First, some authorities point out that withdrawal from representation of the insured in the above situation, merely waives a red flag and is tantamount to revealing the essence, if not the substance, of the insured’s confidential communications. While it is true that even a purely non-communicative withdrawal is a signal to a savvy insurer to inquire about the circumstances of withdrawal, the rules nonetheless permit withdrawal under the above circumstances so long as the attorney reveals no confidential communications.
Second, the practical result of the attorney’s withdrawal from representation of the insured and the insurer is that another attorney may be faced with the same dilemma or conflict situation. In all likelihood, however, no conflict will exists because, upon recommendation of the withdrawing attorney, the insured will retain separate, independent counsel for his defense.iii Unless the insurer, by reason of attorney withdrawal, received a heads up as to a potential coverage dispute, however, it may be no better off than it was in the first instance.
Third, the confidentiality rules may actually facilitate client fraud. Having revealed the fraud to the first attorney, who has withdrawn, the insured now knows not to reveal the fraud to a second attorney, who will zealously represent the insured’s interests in defense of the claim.
Unfortunately, these inconsistencies plague insurance defense practitioners who strive to uphold the ethical requirements placed upon them. What’s more, the recently published Proposed Revised Rules of Professional Conduct do not appear to free attorneys from the ethical quagmire rooted in the “eternal triangle” of insurance defense. For discussions of other conflicts of interest dilemmas in insurance defense practice, look for the Ethics Page in subsequent issues of the State Bar Journal.
i Although RPC 153 appears to hold that where clients consent to joint representation by an attorney, communications are ordinarily not confidential as impliedly authorized under Rule 4, insurance defense cases have been universally distinguished because the joint representation is not undertaken by mutual consent, but by contractual obligation. ii See Waste Management of the Carolinas, Inc. v. Peerless Ins. Co., 315 N.C. 688, 692, 340 S.E.2d 374, 378, reh’g denied, 316 N.C. 386, 346 S.E.2d 134 (1986); Smith v. Nationwide Mut. Fire Ins. Co., 116 N.C. App. 134, 135, 446 S.E.2d 877, 878 (1994). iii Depending upon the circumstances of withdrawal and the terms of the policy, the insurer may be obligated to pay for the insured’s counsel.