Can an insurance-retained defense lawyer keep representing the insured when the carrier reserves coverage rights and intervenes in the same lawsuit?

Plain-English summary

The opinion addresses insurance-defense counsel where the insured has no separately retained coverage counsel and the carrier reserves coverage rights. It starts from the settled Kentucky premise, drawn from KBA E-368 and KBA E-410 and adopted by the Kentucky Supreme Court in American Insurance Association v. Kentucky Bar Association, that the insured (not the insurer) is the client, with the insurer a third-party payor governed by Rule 1.8(f).

The opinion answers four questions. A lawyer may be retained to defend an insured where the carrier has reserved rights (Question 1, yes), and may do so even where the carrier has filed a separate coverage action (Question 2, yes, following E-410). Where the carrier intervenes in the same civil action to determine coverage, the lawyer may continue only if the coverage issues are bifurcated from liability and stayed pending the liability determination (Question 3). Where the carrier intervenes and the coverage issues are not bifurcated but proceed collaterally with liability, the lawyer may continue only if the insured has separate counsel on coverage; if the insured remains unrepresented on coverage, the lawyer may not continue (Question 4).

The reasoning draws on E-410's holding that the lawyer may defend the insured but cannot represent the insured (or the insurer) in the declaration-of-rights action, because litigating coverage against the fee-paying insurer would violate Rule 1.7(b). The opinion explains that in combined, unbifurcated proceedings the defense lawyer would have to sit silent on coverage while the carrier's separate lawyer litigated non-coverage against the lawyer's own unrepresented client, an untenable position. It cites Travelers Indemnity Co. v. Dingwell for the principle that an insurer reserving rights cannot control the insured's defense, and concludes that if the insured has no separate coverage counsel and the court refuses to sever the issues, the defense lawyer should withdraw under SCR 3.130(1.16).

In practice

Under this opinion, insured-defense counsel in Kentucky may take and keep a reservation-of-rights defense, and may continue when coverage is litigated separately or when an intervened coverage claim is bifurcated and stayed. The opinion holds that, in a combined case where coverage is not bifurcated, continued representation turns on whether the insured has separate counsel for coverage: if so, the defense lawyer may confirm a limited scope under Rule 1.2(c) and continue; if not, the lawyer must withdraw under Rule 1.16. The opinion also states the lawyer cannot use Rule 1.2(c) to limit scope without separate counsel advising the insured, because obtaining informed consent from an unadvised insured in combined proceedings is not workable.

Common questions

Q: Can a lawyer take an insurance-defense case where the carrier has reserved coverage rights?

A: Yes. The opinion answers Question 1 yes, consistent with KBA E-410 (1999), and treats the insured as the client with the insurer as a third-party payor under Rule 1.8(f).

Q: What if the carrier files a separate action to decide coverage?

A: The lawyer may continue to defend the insured in the liability action. The opinion follows E-410: the lawyer cannot represent either the insured or the insurer in the separate declaration-of-rights action, but a separate coverage action ordinarily does not bar the defense.

Q: What if the carrier intervenes in the same lawsuit to decide coverage?

A: The lawyer may continue only if the coverage issues are bifurcated from liability and stayed pending the liability determination. The opinion frames the bifurcation-and-stay as what makes a limited-scope defense workable under Rule 1.2(c) and Rule 1.7(b).

Q: What if coverage and liability proceed together without bifurcation and the insured has no coverage counsel?

A: The opinion concludes the lawyer should withdraw under SCR 3.130(1.16). It reasons that the lawyer cannot defend liability while the lawyer's own client is left unrepresented on coverage being litigated in the same proceeding.

Background and rules framework

The opinion interprets Kentucky's conflict rules, SCR 3.130(1.7) (concurrent conflicts) and SCR 3.130(1.8(f)) (compensation from a third party), the limited-scope provision SCR 3.130(1.2(c)), and the withdrawal rule SCR 3.130(1.16). It builds on a line of KBA opinions on insurance defense (E-331, E-340, E-368, E-378, E-410, E-416) establishing that the insured is the client, and on the Kentucky Supreme Court's adoption of E-368 in American Insurance Association v. Kentucky Bar Association, 917 S.W.2d 568 (Ky. 1996).

Citations and references

Rules of Professional Conduct:

• MR 1.7 / SCR 3.130(1.7): concurrent conflicts of interest; consentability under 1.7(b).
• MR 1.8(f) / SCR 3.130(1.8(f)): compensation from one other than the client.
• MR 1.2(c) / SCR 3.130(1.2(c)): limiting the scope of representation.
• MR 1.16 / SCR 3.130(1.16): declining or terminating representation; withdrawal.

Statutes:

• KRS 304.12-230: Unfair Claims Settlement Practices Act (referenced re E-378).

Cases:

• American Insurance Association v. Kentucky Bar Association, 917 S.W.2d 568 (Ky. 1996), adopting KBA E-368.
• Travelers Indemnity Co. v. Dingwell, 884 F.2d 629 (1st Cir. 1989), insurer reserving rights cannot control the insured's defense.

Other opinions cited:

• KBA E-410 (1999): defense under reservation of rights and declaration-of-rights actions.
• KBA E-368 (1994) and E-378 (1995): the insured, not the insurer, is the client.

See also

• ABA Formal Op. 01-421: Insurer Litigation Guidelines
• ABA Formal Op. 03-430: Insurance Staff Counsel
• ABA Formal Op. 96-403: Insured Objecting to Settlement

Source

• Landing page: https://kybar.org/For-Members/Rules-Ethics-Information/Ethics-Opinions
• Original PDF: https://kybar.org/Portals/0/Admin/Ethics%20Opinions/KBA_E-452.pdf

Original opinion text

Reproduced from the official source for research purposes. The linked source is authoritative.

Formal Ethics Opinion
KENTUCKY BAR ASSOCIATION
Ethics Opinion KBA E-452
Issued: September 18, 2020

The Rules of Professional Conduct are amended periodically. Lawyers should consult the current version of the rule and comments, SCR 3.130 (available at http://www.kybar.org/237), before relying on this opinion.

SUBJECT: Ethical Duties of Lawyers Defending Insured Clients Without Separate Retained Counsel for the Client Where Insurance Carriers Have Reserved Rights to Coverage Defenses and Then Intervene to Determine Those Rights in the Same Litigation or in a Separately Filed Litigation.

QUESTIONS PRESENTED:

Question #1: May a lawyer be retained to defend an insured defendant where the retaining insurance carrier has reserved its rights to coverage defenses?

Answer: Yes. KBA Ethics Op. 410, Question #2 (1999).

Question #2: May a lawyer be retained to defend an insured defendant in litigation where the retaining insurance carrier has reserved its rights to coverage defenses and has commenced a separate civil action to determine the coverage questions?

Answer: Yes. KBA Ethics Op. 410, Question #4 (1999).

Question #3: May a lawyer defend an insured defendant in litigation where the retaining insurance carrier has reserved its rights to coverage defenses and has been permitted to intervene in the same civil action to determine the coverage questions?

Answer: Yes, if the insurance contract coverage issues are bifurcated from the liability issues and stayed pending the determination of the liability issues. See discussion below.

Question #4: May a lawyer defend an insured defendant in litigation where the retaining insurance carrier has reserved its rights to coverage defenses and has been permitted to intervene in the same civil action to determine the coverage questions, if the insurance contract coverage issues are not bifurcated from the liability issues and proceed through pre-trial practice collaterally with the determination of the liability issues?

Answer: Yes, if the insured defendant is represented by separate counsel with respect to the coverage questions in the combined liability and coverage proceedings. No, if the insured defendant is and remains unrepresented by separate counsel as to the coverage questions in the combined liability and coverage proceedings. See discussion below.

PREFACE:

This opinion assumes that the insured defendant is unrepresented by separately retained counsel of the insured's choice to advise and to represent the insured defendant in all coverage issues that may arise in connection with a particular lawsuit or claim. If the insured defendant has retained separate counsel, then that counsel will undertake to address the coverage issues as they arise, and the attorney retained by the insurance company would proceed to defend the underlying litigation. Counsel retained for defense of an insured should confirm through insured's separately retained counsel the limited scope of representation in the underlying litigation. SCR 3.130 (Rule 1.2).

The immediate ethical issues presented in this opinion arise where the insured defendant does not have separate counsel to advise and represent the defendant in a case in which the insurer has intervened in the underlying litigation and there are combined discovery and pre-trial proceedings conducted concerning the simultaneously litigated coverage and tort or other liability causes of action.

BACKGROUND:

The stepping off point for the analysis is the premise under Kentucky law that When an Insurer provides the defense to an Insured, the attorney represents the Insured but not the Insurer. See KBA E-368 (1994); KBA E-378 (1995). The Insurer is a third-party payor and the situation is governed by Kentucky Rules of Professional Conduct (KRPC) 1.8(f), . . . . KBA Ethics Op. 410, p.1 (1999). See also, KBA Ethics Op. 368, p.1 (1994) ("We reiterate our view that the insured is defense counsel's client, and not the insurer. See KBA E-331 and 340.") adopted, incorporated by reference in American Insurance Association v. Kentucky Bar Association, et al., 917 S.W.2d 568, 574 (Ky. 1999)("we find, as discussed above, that the language of E-368 is complete and articulate, and hold that the opinion clearly presents its stated purpose and rationale."); KBA Ethics Op. 416, p.5 ("when an insurance company engages a lawyer to defend an insured against a claim, the insured – not the insurer – is the lawyer's client.")

SCR 3.130(Rule 1.8). Conflict of interest: current clients: specific rules. (f) A lawyer shall not accept compensation for representing a client from one other than the client unless: (1) the client gives informed consent; (2) there is no interference with the lawyer's independence of professional judgment or with the client-lawyer relationship; and (3) information relating to representation of a client is protected as required by Rule 1.6.

This "one client, and the insured is the one" rule for counsel retained to defend an insured is established firmly at this point in time. Notwithstanding the clarity of this premise, from the number of formal ethics opinions arising out of a carrier's retention of legal counsel to fulfill the contracted duty to defend its insured, it is clear that significant conflict issues continue to arise.

DISCUSSION:

KBA Ethics Op. 410 (1999) is instructive in this analysis. In that opinion, the Board of Governors reviewed the specific question of whether a lawyer is permitted to defend an insured in the tort or other liability action when the carrier has issued a reservation of rights and has brought an action for declaration of rights to determine the policy coverage.

The opinion acknowledges that the insurance carrier retained lawyer is to act in the "best interests of the insured", which may well place the lawyer into a conflicting position as respects the carrier which has retained the lawyer:

When the reason for the reservation of rights is one involving the facts and theories to be developed in the matter in which the attorney defends the Insured, the Insurer's and the Insured's interests diverge more significantly and the attorney must always be vigilant to protect the client's rights and confidences and pursue the best defense for the client. This may require the attorney to be more adversarial in dealing with the Insurer because the Insurer may, consciously or unconsciously, desire to tilt the defense in a way to minimize its own liability. See Douglas Richmond, Lost in the Eternal Triangle of Insurance Defense Ethics, 9 Geo. J. Legal Ethics 475, 486 (1996) ("An insurer's reservation of rights presents a potential conflict of interest because the insurer may be more concerned with developing facts showing non-coverage than facts defeating liability."). The attorney, representing only the Insured, should seek to act in the best interest of the Insured, which usually means insuring that if there is a judgment, it will be covered by the Insurer. If the attorney also receives a significant percentage of his or her business from the Insurer, under 1.7(b), the attorney may have a conflict that cannot be waived by the client, the Insured.

KBA Ethics Op. 410, p.5 (Emphasis Added). The opinion is unequivocal that the lawyer may continue to defend the insured, but cannot simultaneously defend the insured in the declaration of rights action arising out of the underlying claim or litigation. The opinion contemplates that the lawyer would continue to represent the client in the tort or other liability action only.

But it is clear KBA Ethics Op. 410 assumes the declaration of rights or other coverage case is a separate civil action, or at the least, is stayed pending the outcome of the liability action proceedings:

If the Insurer files an action for Declaration of Rights, the attorney representing the Insured cannot participate as counsel for Insurer because to do so would be to take an action directly adverse to a present client in a matter intimately related to the present client. KRPC 1.7(a) states that an attorney "shall not represent a client if the representation of that client will be directly adverse to another client unless" the attorney reasonably believes that the representation will not adversely affect the representation and the client consents. Comment 4 to KRPC 1.7 states that the attorney should not request consent if a disinterested lawyer would conclude that the client should not consent. The Insured cannot be asked to consent to such representation of the Insurer in a Declaration of Rights action. Nor can the attorney represent the Insured in the Declaration of Rights action. Though the Insurer is not a client of the attorney, the position the attorney would find himself or herself in litigating the coverage question against the Insurer who is paying the attorneys fees in the underlying matter is not one permissible under 1.7(b). Assuming that both Insurer and Insured are represented by other counsel in the Declaration of Rights action, the attorney may continue to represent the Insured with the defense provided by the Insurer as long as the particular facts do not create a situation in which 1.7(b) would be violated. In the vast majority of situations, the fact that a Declaration of Rights action is ongoing should not affect adversely the attorney's representation of the Insured.

As noted above, if the insured is represented separately for the coverage issues, then the consent of the insured to a limited representation that would cover only the tort or other liability action is a relatively straightforward matter. SCR 3.130 (Rule 1.2(c)) would permit an attorney and client to limit the scope of the representation to the underlying liability litigation "if the limitation is reasonable under the circumstances and the client gives informed consent."

But a waiver or agreement by the otherwise insured defendant to a limited scope of representation excluding the coverage issues in a combined case (even if "informed consent" could be obtained without separate counsel for the insured to advise the "material risks" and "reasonably available alternatives") would leave the client without benefit of counsel as to the coverage case issues being simultaneously litigated. At the same time, in every deposition, discovery response, or pre-trial hearing, a separate lawyer retained by the carrier would be prosecuting the declarations action to establish the lack of coverage for the unrepresented, putative insured. All the while, retained defense counsel must sit idly by and cannot advise or assist his or her client across the table, or while standing before the bench, even though the lawyer is charged with the duty "to work in the best interests of the insured." This is an untenable position for any lawyer.

In evaluating the issues presented in combined litigation under Federal Rule 24(a), the court in Travelers Indemnity Company v. Dingwell, 884 F.2d 629 (1st Cir. 1989) made this observation:

. . . . There can be no dispute that an insurer has a direct interest in a lawsuit brought by an injured party against its insured when the insurer admits that the claim is covered by the policy in question. When the insurer offers to defend the insured but reserves the right to deny coverage, however, the insurer's interest in the liability phase of the proceeding is contingent on the resolution of the coverage issue. . . . Accordingly, the asserted interest is not cognizable for purposes of Rule 24(a)(2). We do not regard this conclusion as overly "legalistic" or "mechanical." Instead, we view it as reflecting the well-established policy that an insurer who reserves the right to deny coverage cannot control the defense of a lawsuit brought against its insured by an injured party. Allowing the insurer to intervene to protect its contingent interest would allow it to interfere with and in effect control the defense. Such intervention would unfairly restrict the insured, who faces the very real risk of an uninsured liability, and grant the insurer "a double bite at escaping liability." Morris, 741 P.2d at 251.

Id. at 638-39. [Emphasis added]. See, e.g., United States Fidelity & Guaranty Co. v. Adams, 485 So. 2d 720, 722 (Ala. 1986).

An agreement to limit the scope of the defense lawyer's representation in a combined liability and declaratory judgment coverage proceeding would require the insured to have separate counsel to advise the client on the merits of so doing. The retained defense counsel attempting to advise the insured client would do so from a position of conflict and could not do so without being subject to questioning the lawyer's impartiality. KBA Ethics Op. 378 (1995) addresses the question of a collateral defense in a tort action against the insured and a UCSPA claim against the insurer in the same action. The opinion rejects the idea that a limited scope and collateral defense of both the carrier and the insured would be possible in view of the conflicting duties that would arise in the litigation.

The same result would be present in the situation of the combined tort or other liability claims and defense of the declaratory judgment claim. It would be extraordinarily difficult to comply with SCR 3.130 (Rule 1.7(b)) and SCR 3.130 (Rule 1.0(e)) and consult with the insured client to obtain informed consent of a limited representation in the combined coverage and liability action. The insured client would have no way of determining during the combined proceedings when the insured's lawyer would be acting in the insured best interests for the underlying tort or other liability action or refraining from acting in the interests of the insured in the declaratory judgment action.

If the insured client retains separate counsel or is provided separate representation for the insurance policy coverage claims, the liability defense lawyer would not violate the Rules of Professional Conduct by continuing in this representation limited to the underlying tort or other liability claims. But the lawyer should confirm the limited role through the insured's personal counsel following SCR 3.130 (Rule 1.2(c)).

If in the combined litigation the parties and the court bifurcate the coverage issues and stay the litigation on those issues until determination of the liability issues, then the lawyer would be able to consult with the insured client and may be able to obtain the consent of the insured client to the limited scope of representation in the liability issues only under SCR 3.130 (Rule 1.2(c)). If such is obtained, the lawyer should make the judgment under SCR 3.130 (Rule 1.7(b)) as to whether "the lawyer reasonably believes that the lawyer will be able to provide competent and diligent representation to each affected client" in the liability claims alone.

If in the combined litigation the parties and the court do not bifurcate the coverage issues and stay the litigation on those issues until determination of the liability issues, then a lawyer may not represent the insured on the tort or other liability claim defense and leave the lawyer's client exposed and unrepresented on the policy claims. Without the putative insured having counsel to advise the insured in the combined policy and liability litigation, either personally retained or through additional counsel retained by the carrier for that purpose, the retained liability defense counsel is put in an untenable position. Under KBA Ethics Op. 410, a carrier retained defense lawyer may not represent the insured on the policy claims in either separate or combined proceedings. But at the same time a lawyer representing a client cannot act in the "best interests of the insured" during combined discovery, pretrial, and trial proceedings defending solely on the tort or other liability claims, leaving the lawyer's client without the advice of counsel and unrepresented on significant litigation issues that will be taking place right in front of the lawyer and are of significant importance to the client.

If the insured client does not have separate counsel to advise and represent the client on the insurance policy coverage claims, and the parties and the court determine the litigation will be combined and refuse to sever the matters for discovery, pretrial and trial proceedings, then the liability defense lawyer should withdraw from the client's representation. See SCR 3.130(1.16).

Note To Reader

This ethics opinion has been formally adopted by the Board of Governors of the Kentucky Bar Association under the provisions of Kentucky Supreme Court Rule 3.530. This Rule provides that formal opinions are advisory only.