SNR Denton, US, LLP on Downhole Navigator, LLC v. Nautilus Insurance Co.: Fifth Circuit Concludes That Texas No Longer Allows a Policyholder to Demand Independent Counsel Merely Because the Insurer Offers a Defense under Reservation of Rights

William Barker   By William T. Barker, Partner, SNR Denton

Older Texas cases had indicated that, whenever a liability insurer offered a defense under reservation of rights, the insured was entitled to demand defense by independent counsel, at the insurer's expense.  In Downhole Navigator, LLC v. Nautilus Insurance Co., the Fifth Circuit concluded that Texas has abandoned that rule.  This commentary argues that this was correct and follows the modern and better rule.

The commentary notes that the former Texas rule was an older and minority rule:

Courts have long had a concern that an insurer defending under reservation of rights might utilize its control of the defense to disadvantage the insured on coverage.  Some states authorize the policyholder to reject the insurer's defense whenever there is a reservation of the right to deny indemnification.  In jurisdictions which follow this rule, the policyholder is never obliged to accept a defense under reservation of the insurer's rights to deny indemnification for any judgment rendered.  Under this view, the policyholder's rejection of a defense under reservation may require the insurer either to affirm coverage unconditionally and defend or to disclaim coverage and refuse to defend, at the risk of breaching the policy if there actually was a duty to defend.  Some jurisdictions permit the insurer to avoid the latter risk by agreeing to pay for a defense conducted by counsel selected and controlled by the policyholder.  But none of the jurisdictions adhering to this rule permit the insurer, over the policyholder's objection, to control the defense when there is any question of coverage for the liabilities asserted in the action to be defended.  The insurer's role is limited to payment of counsel who represents and is directed by the policyholder alone.

Modern courts have developed a conflict-of-interest rule that deprives the insurer of control of the defense only where that control can be abused.  That rule also flows from and builds on the ordinary conflict-of-interest rules governing lawyers.  It is now the strong majority rule.  As the commentary explains, under the conflict-of-interest rule,

[t]he central question is whether a particular case involves any concrete prospect that defense counsel would have an opportunity to favor the insurer at the expense of the policyholder.  Only if the manner of handling the policyholder's defense could affect the determination of coverage or otherwise benefit the insurer at the policyholder's expense does a conflict exist, and many coverage questions are unrelated to the matters at issue in the tort action.  Ordinarily, actions reasonably calculated to minimize the expected loss in the liability action could only make both insurer and policyholder better off, regardless of any collateral dispute they may have regarding coverage.  The reason for this is that the coverage dispute will determine whether the insurer or the policyholder bears the loss, and the loser, whoever it turns out to be, will be better off if the loss is smaller rather than larger.

The commentary explains the majority rule in greater detail, explains how it adequately protects policyholders, examines the Texas case which adopted that rule, and examines the Fifth Circuit's application of that rule in Downhole Navigator.

William T. Barker is a member of SNR Denton's Insurance Litigation & Coverage Practice Group and practices in the firm's Chicago office.  He has a nationwide practice in the area of complex commercial insurance litigation, including coverage, claim practices, sales practices, risk classification and selection, agent relationships, and regulatory matters. He is the co-author, with Ronald D. Kent of THE NEW APPLEMAN INSURANCE BAD FAITH LITIGATION, SECOND EDITION and with Charles Silver of the forthcoming PROFESSIONAL RESPONSIBILITIES OF INSURANCE DEFENSE COUNSEL; he has written over 100 published articles on insurance and litigation subjects.  He has been described as "[t]he leading lawyer commentator" on the relationships between insurance and civil procedure.  Charles Silver & Kent Syverud, The Professional Responsibilities of Insurance Defense Lawyers, 45 Duke L.J. 255, 257 & n.4 (1995).  He is an Adviser to the American Law Institute project on Principles of the Law of Liability Insurance.  He is a member of the EDITORIAL BOARD OF THE NEW APPLEMAN ON INSURANCE LAW LIBRARY EDITION and THE NEW APPLEMAN INSURANCE LAW PRACTICE GUIDE.  He is Editorial Board Director and Senior Contributing Editor of INSURANCE LITIGATION REPORTER and a member of the Board of Editors of DEFENSE COUNSEL JOURNAL.

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Texas

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