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Insurance Law

Insured Entitled To Independent Counsel Even When Being Defended WITHOUT A Reservation Of Rights (Court Rejects ALI Draft Principle)

When it comes to an insured’s right to retain independent counsel, when being defended by its insurer under a reservation of rights, there are some general rules of the road. In a few states a defense provided under a reservation of rights automatically entitles the insured to independent counsel at the insurer’s expense. In a few others a reservation of rights defense never entitles the insured to independent counsel. And in most states that have considered the issue – it depends.

More specifically in the it-depends category, as one federal court put it: “If there is a reasonable possibility that the manner in which the insured is defended could affect the outcome of the insurer’s coverage dispute, then the conflict may be sufficient to require the insurer to pay for counsel of the insured’s choice. Evaluating that risk requires close attention to the details of the underlying litigation. The court must then make a reasonable judgment about whether there is a significant risk that the attorney selected by the insurance company will have the representation of the insureds significantly impaired by the attorney’s relationship with the insurer.” Armstrong Cleaners, Inc. v. Erie Ins. Exch., 364 F. Supp. 2d 797 (S.D. Ind. 2005), [enhanced version available to subscribers].

Here are some examples, courtesy of the Supreme Court of Alaska, where there is a significant risk that the representation of insureds by an attorney, selected by the insurance company, may be significantly impaired by the attorney’s relationship with the insurer: “First, if the insurer knows that it can later assert non-coverage, or if it thinks that the loss which it is defending will not be covered under the policy, it may only go through the motions of defending: it may offer only a token defense … . [I]t may not be motivated to achieve the lowest possible settlement or in other ways treat the interests of the insured as its own. Second, if there are several theories of recovery, at least one of which is not covered under the policy, the insurer might conduct the defense in such a manner as to make the likelihood of a plaintiff’s verdict greater under the uninsured theory. Third, the insurer might gain access to confidential or privileged information in the process of the defense which it might later use to its advantage in litigation concerning coverage.” CHI of Alaska, Inc. v. Employers Reinsurance Corp., 844 P.2d 1113, 1116 (Alaska 1993), [enhanced version available to subscribers].

In general, based on these standards, many courts do just as the Southern District of Indiana said in Armstrong Cleaners – they pay close attention to the details of the underlying litigation and then make a reasonable judgment whether there is a significant risk that the representation of the insured will be significantly impaired by the attorney’s relationship with the insurer. If so, the insured is entitled to independent counsel at the insurer’s expense.

As this general overview reveals, while there are various ways in which courts respond to an insured’s right to independent counsel, all of these scenarios share one thing in common–the potential for independent counsel never arises in the first place unless the insured is being defended under a reservation of rights.

This is what makes the Illinois federal court’s recent decision in Perma-Pipe, Inc. v. Liberty Surplus Insurance Co., No. 13-2898 (N.D. Ill. Apr. 21, 2014), [enhanced version available to subscribers], so potentially significant. Here the court concluded that the insured was entitled to independent counsel – despite the fact that it was being defended by its insurer WITHOUT a reservation of rights.

Then case went like this. The University of California told Perma–Pipe that pipes it had manufactured had suffered a “catastrophic failure” and the University would seek to hold Perma–Pipe liable for the resulting damage. Liberty had issued a general liability policy to Perma-Pipe with a per occurrence limit of $1 million and an aggregate limit of $2 million. On the basis that a Liberty reservation of rights issued to Perma-Pipe created a conflict of interest, Perma–Pipe selected independent counsel to defend it. Perma–Pipe was then named as a defendant in two lawsuits arising out of the pipe failure. In one, the University sought more than $35 million from Perma-Pipe. In another, a subrogated insurance carrier sought more than $5 million.

Liberty then sent Perma–Pipe a letter stating that Liberty was immediately withdrawing all bases on which it previously reserved its right to disclaim coverage and it would provide coverage up to the policy limits. As a result of Liberty’s withdrawal of all of its reservation of rights, it retained choice for Perma-Pipe and stated that it would no longer pay for counsel that Perma-Pipe had retained.

This seems like an appropriate right for Liberty to have exercised. However, Perma-Pipe responded as follows: “Although Liberty ... has waived any reservation of rights, under controlling Illinois law, a serious conflict still exists due to the real possibility of a judgment or settlement in excess of the Liberty policy limits, mandating that Perma–Pipe be allowed to continue to retain independent counsel at Liberty’s expense. Due to this conflict, Perma–Pipe requests that Liberty deactivate its retention of ... Archer Norris, and reappoint Laurie & Brennan as independent counsel.” (emphasis in orginal).

The court first looked at a choice of law issue and concluded that Illinois law applied and not California (explanation at the end why that was a disputed issue).

The Illinois federal court held that, despite Liberty’s withdrawal of its reservation of rights, Perma-Pipe was still entitled to be defended with counsel of its choice. The court noted that the “usual conflict of interest involves the insurance company’s denying coverage ..., but the principle is the same when the conflict arises from the relation of the policy limit to the insured’s potential liability.” The court further explained: “In other words, because an insurer’s exposure is capped by the policy limit, it may decide to try claims exceeding the limit, hoping that the resulting liability, if any, will be less, despite the risk that its insured could be found liable for an amount far greater than the limit. . . . [A] conflict exists when there is a nontrivial probability of an excess judgment in the underlying suit.” (citations and internal quotes omitted).

The court concluded that, because Perma–Pipe was being sued for more than $40 million, and the Liberty policy limit was $1 million per occurrence, there was a “nontrivial probability” that there would be an excess judgment in the underlying suit. Thus, despite Liberty’s withdrawal of its reservation of rights, Perma-Pipe was still entitled to be defended with counsel of its choice.

The court was not persuaded that a different outcome was dictated by the fact that Perma-Pipe had excess insurance (seemingly from different insurers). “Excess insurance applies only after primary coverage has been exhausted, its existence does not vitiate the conflict between the primary and the insured that arises from the likelihood of an excess judgment.”

Perma-Pipe’s significance is easy to appreciate. Insureds are routinely sued, especially in bodily injury cases, and there is an initial demand for more money than everyone, plaintiff included, knows that the case is worth. This amount will often exceed the typical limits of a primary policy. Further, many times such bodily injury cases do not involve coverage issues that create a reservation of rights scenario. Applying Perma-Pipe would entitle insureds to independent counsel in this not infrequent scenario. This would significantly increase the frequency in which insurers are obligated to provide independent counsel.

The Perma-Pipe court’s decision was a rejection of the majority rule on this issue. Further, it is worth noting that California’s Cumis statute (Cal. Civ. Code § 2860), [enhanced version available to subscribers], and draft ALI Principle of the Law of Liability Insurance §18 also specifically reject the Perma-Pipe conclusion. California’s Cumis statute states: “No conflict of interest shall be deemed to exist . . . solely because an insured is sued for an amount in excess of the insurance policy limits.” Section 18 of the draft ALI Principles states that because an insured is sued for an amount in excess of its policy limits “does not, in itself, oblige the insurer to provide an independent defense.”

Coverage Opinions is a bi-weekly (or more frequently) electronic newsletter reporting or providing commentary on just-issued decisions from courts nationally addressing insurance coverage disputes. Coverage Opinions focuses on decisions that concern numerous issues under commercial general liability and professional liability insurance policies. For more information visit

The views expressed herein are solely those of the author and not necessarily those of his firm or its clients. The information contained herein shall not be considered legal advice. You are advised to consult with an attorney concerning how any of the issues addressed herein may apply to your own situation. Coverage Opinions is gluten free but may contain peanut products.

    Randy Maniloff is Counsel at White and Williams, LLP in Philadelphia. He previously served as a firm Partner for seven years and transitioned to a Counsel position to pursue certain writing projects including Coverage Opinions . Nonetheless he still maintains a full-time practice at the firm. Randy concentrates his practice in the representation of insurers in coverage disputes over primary and excess obligations under a host of policies, including commercial general liability and various professional liability policies, such as public official’s, law enforcement, educator’s, media, computer technology, architects and engineers, lawyers, real estate agents, community associations, environmental contractors, Indian tribes and several others. Randy has significant experience in coverage for environmental damage and toxic torts, liquor liability and construction defect, including additional insured and contractual indemnity issues. Randy is co-author of “General Liability Insurance Coverage - Key Issues In Every State” (Oxford University Press, 2nd Edition, 2012). For the past twelve years Randy has published a year-end article that addresses the ten most significant insurance coverage decisions of the year completed.

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