GENERALLY

Defense counsel routinely represents the interests of both the insurer and insured.  This “three way” relationship was aptly described by a court in California in the following way:
 
In the insured-insurer relationship, the attorney characteristically  is engaged and paid by the carrier to defend the insured.  The insured and the insurer have certain obligations each to the other. . . arising from the insurance contract.  Both the insurer and the carrier have a common interest in defeating or settling the third-party’s claim.  As the matter reaches litigation, the attorney appears of  record for the insured and at all times represents him in terms measured by the extent of his employment.
 
In such a situation, the attorney has two clients whose primary, overlapping and common interest is the speedy and successful resolution of the claim and litigation.  Conceptually, each member of the trio, attorney, client-insured and client-insurer has corresponding rights and obligations founded largely on contract and as to the attorney, by the rules of professional conduct as well.  The three parties may be viewed as a loose partnership, coalition or alliance directed toward a common goal, sharing a common purpose which lasts during the pendency of the claim or litigation against the insured.
 
While the various States differ as to whether the insurer is a true client, at the very least there is a contractual relationship and counsel’s duties are defined therein. 
 
In New York, it is clear that no attorney/client relationship is created when the insurer retains counsel to represent its insured.  However, it is equally clear that there are obligations that run from counsel to the insurer and the selection of defense counsel for its insured does create the attorney/client relationship between counsel and the insured. 
 
Whatever the prevailing distinction is in a given state, the paramount consideration is that once retained, defense counsel owes the same unqualified loyalty to the insured as if he were personally retained.  After all, the client’s defense is the sole reason for the attorney’s representation.  While the insurer pays the judgment, the fact and legal consequence of liability remain upon the insured.  
 
THE ETHICAL DUTIES OF DEFENSE COUNSEL  
All attorneys in the United States are subject to ethical codes based on either the ABA Model Rules of Professional Conduct (Model Rules) or the predecessor ABA Model Code of Professional Responsibility (Model Code).  Both are similar in result.
 
Rule 1.7of the Model Rules states the general rule as follows: 
 
(a)        The lawyer should not represent the client if the representation of that client will be directly adverse to another client, unless: 
 
  (1) The lawyer reasonably believes the representation will not adversely affect the relationship with the other client; and
 
  (2) each client consents after consultation.
 
(b)        A lawyer shall not represent a client if the representation of that client may be materially limited by the lawyers responsibilities to another client or to a third person, or by the lawyers own interest, unless: 
 
  (1) The lawyer reasonably believes the representation will not be adversely affected; and
 
  (2) the client consents after consultation. When representation of multiple clients in a single matter is undertaken, the consultation shall include explanation of the implications of the common representation and the advantages and risks involved.  
 
Disciplinary Rule 5-105(a) of the Model Code requires a lawyer to:
 
Decline proffered employment if the exercise of his independent professional judgment on behalf of a client will be or is likely to be adversely affected by acceptance of the proffered employment. 
 
Disciplinary Rule 5-105(b) requires a lawyer to withdraw if a conflict affecting an existing representation arises out of another existing representation and Disciplinary Rule 5-101 requires withdrawal where the attorney’s professional judgment might be affected by his own personal interests. 
 
These Rules codify “the duty of undivided loyalty which an attorney owes to each of his clients”.  See Cinema Five, Ltd. v. Cinorama Inc., 528 F.2d 1384 (2^nd Circuit Court of Appeals, 1976). 

TERMINATION OF THE TRIPARTITE RELATIONSHIP

Usually the end of the relationship coincides with the completion of the defense of the insured.  Due to ethical considerations, however, defense counsel must recognize that there are circumstances which must bring about a termination of the relationship before the attorney representation is completed.
 
The primary reason for withdrawal by counsel is the existence of conflicts of interest where the client does not consent to continued joint representation.  Defense counsel must, therefore, be able to identify those conflicts which require withdrawal. 
 
Sometimes the end of the tripartite relationship is brought about by interference with the representation by the insureds personal attorney. Other occasions which necessitate withdrawal would be any time that the attorney favors the insurer to the detriment of the insured.
 
It bears repeating that the attorney’s first duty is to the insured.  Although a breach of the insurance contract provisions may justify a denial of coverage by the insurer, it would not warrant the withdrawal by defense counsel without consent of the insured or an application to the court.  So to, the attorney’s obligations to the insured do not end when the insurer becomes insolvent.  If the attorney were to abandon the insured under such circumstances he would be liable for malpractice.  
 
DIRECTING THE LITIGATION AND THE CODE OF PROFESSIONAL RESPONSIBILITY

Both Model Rules and Model Code have specific provisions concerning the affect of a third-party paying a client’s legal fees.  This is the normal method of doing business in the tripartite relationship, but neither rule specifically refers to the insurer-insured contract.  In the Model Rules, the provision appears in Rule 1.8:
 
(f) a lawyer shall not accept compensation for representing a client from one other than the client unless:
 
  (1) the client consents after consultation;
  (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.
 
The comparable provision under the Model Code is DR 5-107:
 
(A) except with the consent of his client after full disclosure, a lawyer shall not:
 
  (1) accept compensation for his legal services from one other than his client. 
  (2) Accept from one other than his client anything of value related to his representation of or his employment by his client. 
 
(B) A lawyer shall not permit a person who recommends, employs or pays him to render legal services for another to direct or regulate his professional judgment in rendering such legal services.
 
At first glance, portions of these two ethical rules seem to run afoul of the tripartite relationship because it, by definition, is predicated on the acceptance of payment from “one other than the client”.  However, in States where the insurer and the insured alike are recognized as “clients”, the attorney is receiving his fee from a “client” and the interests of the two clients coincide unless there is a coverage issue. 
 
However, in a State like New York where the insurer is not recognized to be a “client” then the section of Model Code DR 5-107(B) certainly warrants discussion.
 
INDEPENDENT COUNSEL

In 1984, the now famous case of San Diego Navy Federal Credit Union v. Cumis Insurance Society, Inc. (162 Cal. App. 3d 358), 208 Cal. Rptr. 494 (4^th District 1984) was decided.  With it, the concept of “independent counsel” came about.  The impact of Cumis was greatly increased because of the broad description it gave to a conflict requiring retention of independent counsel:
 
We conclude that the Canons of Ethics impose upon lawyers hired by the insurer an obligation to explain to the insured and the insurer the full implications of joint representation in situations where the insurer has reserved its rights to deny coverage.  If the insured does not give an informed consent to continued representation, counsel must cease to represent both.  Moreover, in the absence of such consent, where there are divergent interests of the insured and the insurer brought about by the insurer’s reservation of rights based on possible non-coverage under the insurance policy, the insurer must pay the reasonable cost for hiring independent counsel by the insured.  The insurer may not compel the insured to surrender control of the litigation.  Disregarding the common interests of both insured and the insurer in finding total non-liability in the third-party action, remaining interests of the two diverge to such an extent as to create an actual, ethical conflict of interest warranting payment for the insured’s independent counsel.
 
As you can see, Cumis seems to suggest that every coverage question creates a conflict and necessitates the hiring of independent counsel. While one of the cardinal rules for any insurance defense counsel is to refrain from involvement in coverage issues, this does not appear to be the corollary for the proposition that any coverage issue requires withdrawal of counsel. 
 
A more reasonable and recent approach in a conflict situation was presented in Nelson Electrical Contracting v. Transcontinental Insurance Company, 231 A.D.2d 207, 660 N.Y.S.2d 220 (3^rd Dept. 1997).  There, the court held that “where the interests of the insurer and insured are in conflict, the insured has the right to select independent counsel to conduct the defense so that tactical decisions will be in the hands of an attorney whose loyalty to the insured is unquestioned. 
 
In the underlying personal injury action that brought about the declaratory judgment action by Nelson v. Transcontinental, the insurer disclaimed coverage after defense counsel refused to oppose the third-party plaintiff’s motion for summary judgment on the common law and contractual indemnity claims.  Defense counsel was of the mind that the best approach to defending the action would be for the primary defendant and the third-party defendant to work together to defeat the injured party’s claims rather than trying to point fingers at each other.  The insurer disclaimed and would no longer pay the defense costs of its insured.  A declaratory judgment action was brought.  The Appellate Court affirmed the grant of the insured’s motion for summary judgment and found that “an insurer cannot be permitted to “direct or regulate” the exercise of the attorney’s “professional judgment in rendering” legal services.  The court cited to the code of professional responsibility DR 5-107(B) and went on to say that while the insured is contractually precluded from settling a case or assuming an obligation without the insurer’s consent, these limitations cannot be construed to prohibit counsel from making tactical decisions.  

WHEN IS THERE A CONFLICT?

When an insurer’s control over the litigation would provide the opportunity and incentive to sabotage the defense to the detriment of the insured, there is a conflict.
 
Coverage issues are frequently more theoretical than actual because they arise due to allegations of a complaint against the insured and such allegations may bear little relationship to reality.  Regardless of this, the insurer is compelled to inform the insured of its potential coverage defenses and reserve its rights if it wishes to protect itself should the allegations turn out to be supportable.
 
The most common situation in which a conflict may be presented is where the same facts are implicated in fixing both liability and in determining coverage.  The impact of any conflict may be avoided if the common issue need not be determined in the litigation.  However, if the case involves such a “pivotal fact” (see Mallen, “A New Definition of Insurance Defense Counsel”, 53 Ins. Coun. J. 108 (1986) and if the conflict on that issue cannot reliably be avoided by procedural means, than there will be an irreconcilable conflict.
 
The most common example of such a pivotal fact is the question of whether the insured injured the plaintiff intentionally or negligently.  Others include the insured’s compliance with applicable safety regulations relied upon in defining coverage and whether products liability results from a design defect or a manufacturing error. 
 
Another example of a case law conflict may be predicated on the insurer’s potential ability to manipulate the defense for its own benefit is one where the complaint alleges multiple acts of malpractice:  one of which was during the policy period and the others outside that period. 
 
A conflict can also be created by issues other than coverage.  One example is where two different insureds have inconsistent interests.  There, the defense of one insured will likely contribute to the prosecution of his claim against the other when the insurer is also obligated to defend and the insurer has an incentive to manipulate the defense with a view toward minimizing its own indemnity obligations by weakening the position of one or both.

ABA ETHICS OPINION 01-421

In February of 2001, the American Bar Association issued an Ethics Opinion concerning ethical obligations of a lawyer working under insurance company guidelines.  A number of States had addressed issues of the propriety of counsel following guidelines of various insurers, but the ABA is the most recent and the conclusion is drawn that counsel may not comply with guidelines that unreasonably interfere with the lawyer’s independent exercise of professional judgment in the defense of the policy holder. 
 
The ABA passes on some of the more recent questions concerning the tripartite relationship, among those whether a third-party legal auditor unnecessarily interferes with the relationship of the insurer/insured/counsel.
 
The opinion resolves the problem by suggesting that the lawyer disclose to the insured the fact of legal bill auditing so as to perfect a waiver of confidentiality.
 
The ABA recognizes the possible ethical problems posed by having to submit to company guidelines (see Model Code DR 5-107(B):  a lawyer shall not permit a person who . . . pays him. . . to direct or regulate his professional judgment in rendering such legal services).  However, they come to the conclusion that in the event that the attorney does believe that following certain guidelines would adversely effect his professional judgment, an attorney has the duty to withdraw.

CONCLUSION

Recently the Defense Research Institute (DRI) issued a set of “Recommended Case Handling Guidelines”.  It is submitted that those guidelines adequately protect the attorney/client while recognizing the needs of the three participants in the tripartite relationship.