Responding to Independent Counsel Arguments Based on R.G. Wegman Construction Co. v. Admiral Insurance Co.

Responding to Independent Counsel Arguments Based on R.G. Wegman Construction Co. v. Admiral Insurance Co.

  By William T. Barker, Partner, SNR Denton

Counsel for insureds are likely to use the Seventh Circuit’s opinion in R.G. Wegman Construction Co. v. Admiral Insurance Co., 2011 U.S. App. LEXIS 679 (Jan. 14, 2011), as a basis to argue for broader rights of independent counsel than formerly recognized.  In all contexts, insurer counsel should make arguments for narrow construction of Wegman.  Illinois state courts should be urged to hold that the Seventh Circuit  misconstrued Illinois law.[1]  In non-Illinois courts other than the Seventh Circuit and its district courts), insurer counsel should argue that Wegman should not be followed.

Wegman will present significant claim handling issues and it may be desirable to coordinate handling of claims presenting such issues.  Claim handling is not addressed here.

I.   The Wegman Opinion[2]

A.        Facts

R.C. Wegman Construction Co. (“Wegman”), a construction manager, was sued for injuries suffered by Brian Budrick (“Budrick”), an employee of Standard-Hayes Boiler & Tank, LLC (“Standard”), one of the contractors working at the site.  Standard’s $1 million policy with Admiral Insurance Co. (“Admiral”) named Wegman as an additional insured and Admiral defended.  Wegman was also an additional insured under a $10 million excess policy issued by American International Specialty Lines Insurance Co. (“AIG”).  AIG was not notified of the claim until just before the trial in September, 2007 and denied coverage for want of timely notice.  Judgment at trial was slightly more than $2 million, and Wegman brought this bad faith suit.

According to Wegman, Admiral learned at Budrick’s deposition in May 2005 that there was a realistic chance of an award exceeding its policy limits.  In April 2007, Budrick demanded $6 million to settle.  Admiral never told Wegman either of these things, so Wegman did not notify AIG until just before trial.  The primary claim was that Admiral should have notified Wegman of the risk of excess exposure. 

B.        District Court’s Dismissal

The district court concluded that Illinois recognizes a duty of good faith in managing the defense and settlement negotiations, which can be breached by failure to settle within limits or by picking an unduly risky defense strategy.  But, in its view, Wegman did not allege any breaches of that sort.[3]  (Wegman disputes that point, but the Seventh Circuit did not address the dispute.) 

Wegman argued that failure to notify the insured of possible excess exposure creates risks similar to refusing a within-limits settlement, so the duty of good faith should require such notice.  But Wegman did not claim that Admiral could have done anything to prevent the excess judgment.  Wegman claimed only that, with notice, it might have retained independent counsel and could have notified its excess insurer.  The district court conclude that that claim was “too attenuated to fit the [Illinois] courts’ circumscribed application of the duty of good faith.”[4]

Moreover, the court found that “the duty of the insure[r] to consider the interest of the insured at least equal to its own is rooted in the possibility that a conflict of interest [regarding settlement] may arise where the insured is a defendant in a suit in which potential recovery may exceed policy limits.”[5]  But here, no conflict arose because there were no within-limits demands and the only demand was clearly excessive, so there was no reasonable prospect that Wegman might have wanted to accept that (and Wegman did not allege that it would have been interested in doing so).[6]

The court further observed that Wegman had not cited any authority supporting a duty of the insurer to tell the insured what had occurred at a deposition or in anything other than settlement negotiations (which a single unreasonable demand did not constitute).  Defense counsel might have such a duty, but defense counsel were not sued and an Illinois insurer is not vicariously liable for defense counsel’s errors.[7]  Moreover, the very fact that the insurer had provided counsel who presumably did have a duty to keep Wegman informed counseled against imposing any duty to inform on the insurer itself.[8]

C.        Seventh Circuit’s Reversal

In an opinion by Judge Posner, the Seventh Circuit complained that “[n]either the briefs nor the complaint, nor for that matter the insurance policy, judicial opinions, or treatises on insurance law, tell us much about how situations of the sort presented by this case are handled by insurance companies.”[9]  So the court turned to “our own research.”[10]  That led it to the conclusion that “[t]he situation in question is the emergence of a potential conflict of interest between insurer and insured in the midst of a suit in which the insured is represented by a lawyer procured and paid for by the insurer.”[11]

In a normal case (and on the facts here), there is no reason at the outset to anticipate an excess judgment, and this leads the insurer to manage the case as if it were the sole defendant.  The court recognized that, under Illinois law,

"’the insurer's duty to defend includes the right to assume control of the litigation . . . to allow insurers to protect their financial interest in the outcome of litigation and to minimize unwarranted liability claims. Giving the insurer exclusive control over litigation against the insured safeguards the orderly and proper disbursement of large sums of money involved in the insurance business.’"[12]

“By virtue of that control, however, the insurer's duty to the insured includes not only ‘the hiring of competent counsel’ but also ‘keeping abreast of progress and status of litigation in order that it may act intelligently and in good faith on settlement offers.’”[13]  Thus, Admiral presumably knew, shortly after Budrick was deposed in May, 2005, of the facts indicating a genuine risk of excess liability.  (Admiral was hoping to avoid that by keeping Wegman’s share of the fault under 25%, which would have made Wegman liable only for its share of the fault, but the jury found that Wegman had 27% of the fault, making it jointly and severally liable.[14]  In these circumstances, the court said, “gambling with an insured’s money is a breach of fiduciary duty.”[15]

That brought the court to the independent counsel issue:

When a potential conflict of interest between insured and insurer arises, the insurance company's duty of good faith requires it to notify the insured. The usual conflict of interest involves the insurance company's denying coverage [citing cases], but the principle is the same when the conflict arises from the relation of the policy limit to the insured's potential liability…. Once notified by the insurer of the conflict, the insured has the option of hiring a new lawyer, one whose loyalty will be exclusively to him. If he exercises that option, the insurance company will be obligated to reimburse the reasonable expense of the new lawyer. Had Wegman hired a new lawyer upon being promptly informed of the conflict back in May 2005, that lawyer would have tried to negotiate a settlement with Budrik that would not exceed the policy limit; and if the settlement was reasonable given the risk of an excess judgment, Admiral would be obligated to pay. And since Wegman had excess insurance, notification to it of the risk of an excess judgment would have enabled it to notify its excess insurer promptly, in order to preserve the protection that the excess coverage provided.[16]

This appeared to assume that some unspecified conflict had created a right to independent counsel, with the power of such counsel to negotiate a settlement simply being a consequence of that right (and a basis for finding possible damage from failure to notify).  The Illinois Insurance Association, the American Insurance Association, and the National Association of Mutual Insurance Companies filed an amicus brief that tried to caution the court against assuming that independent counsel would have that power, but that brief concentrated on nonexistence of the supposed antecedent conflict and on alternate grounds that might have supported a duty to notify.

D.        The Supplemental Opinion

The Seventh Circuit denied leave to file the amicus brief and denied rehearing, filing a short supplemental opinion which clarified its reasoning as follows:

Admiral’s petition for rehearing contends that we held that “where there is a possibility of a verdict in excess of policy limits, there is a conflict of interest between the insurer and the insured.”  This characterization ignores the facts that led us to find a conflict (actually just alleged facts, since the complaint was dismissed by the district court).  We said that “the conflict in this case arose when Admiral learned that an excess judgment (and, therefore, a settlement in excess of policy limits, as judgment prospects guide settlement) was a nontrivial probability in Budrick’s suit.”  (emphasis added)  Among the facts supporting that characterization were (1) the nature and severity of the plaintiff’s injury, (2) the settlement demand in excess of policy limits, (3) the fact that the case had been slated for trial (and in fact tried), (4) the plaintiff’s securing at trial an award double the policy limit, (5) Admiral’s admission that its primary litigating strategy was to downplay Wegman’s responsibility rather than to deny liability, and (6) Admiral’s failure to warn Wegman that it had adopted a strategy that placed Wegman in jeopardy of an excess judgment.  Admiral’s attorney has admitted taking a gamble by proceeding to trial in hopes of a ruling that Wegman’s share of liability was below 25 percent, which would turn a $2 million damages award into a $500,000 award.  Rather than being warned by Admiral, Wegman discovered that the case was going to trial only through an accidental conversation just days before the trial began.

The case is thus like Nandorf, Inc. v. CNA Insurance Cos., which involved a compensatory damages claim and a punitive damages claim; the insured wanted to minimize its total liability while the insurer sought to minimize merely the compensatory damages claim because its insurance policy didn’t cover punitive damages.  Admiral made a similar strategic move when it faced a likelihood of an excess judgment; instead of notifying Wegman and allowing it to negotiate its own settlement, or at least notify its excess carrier, Admiral’s lawyer gambled on on obtaining a reduction in damages, on the basis of Illinois’ joint-and-several liability statute, that would bring the damages award against Wegman below Admiral’s policy limit.  Admiral’s gamble created a conflict of interest that entitled Wegman to choose its own attorney to represent its interests, yet Admiral failed to warn Wegman of what it was doing.  If Wegman can prove these allegations, it will have demonstrated a conflict of interest under Illinois law.[17]

Admiral’s rehearing petition made a major point of arguing that it had not taken any gamble.  Its defense strategy had not placed Wegman in jeopardy of an excess judgment: the facts of the case did that, and the defense strategy was the best chance of avoiding such a judgment.  (Wegman never argued otherwise, and the Seventh Circuit offers no basis to question Admiral on that point.)  Admiral was never presented with any opportunity to settle within its limits, so, it argued, the only thing it could do was try the case.

Of course, Wegman could have been protected against an excess judgment if notified of the risk and thereby warned of the need to place its excess insurer on notice.  But neither defense counsel nor Admiral had any interest in forestalling notice to the excess insurer.  There is no discussion in the opinion of whether Admiral and defense counsel knew of the existence of the excess insurance (as there are no allegations in the complaint about that).  But they must have been on notice of that.  (Budrick’s counsel almost surely propounded discovery about insurance.  And if Budrick’s counsel had thought that there was only $1 million in insurance, he’d almost surely have made a $1 million demand.)  Of course, Admiral and defense counsel probably did not know whether the excess insurer had been placed on notice.  Indeed, the most likely explanation for failure to keep Wegman informed was an assumption that the excess insurer had been put on notice, so that Wegman was in no real danger.  Danger or not, failure to notify Wegman may well have been a breach of duty.  But it involved no conflict of interest, because no one had any interest in preventing notice to the excess insurer.

But a conflict of interest on that point could be found had there been no excess insurance and if, as the Seventh Circuit clearly assumes, the risk of excess liability would have freed Wegman to settle for policy limits.  Because Admiral saw a possibility of holding the judgment to $500,000, its interest was to take the case to trial, even if there were a risk of an excess judgment.  That would look like the classic settlement conflict, which appears to be what the Seventh Circuit thought it saw.

Indeed, the original opinion explained the conflict in precisely those terms:

Suppose Admiral thought that if Budrik's case went to trial there was  a 90 percent chance of a judgment no greater than $500,000 and a 10 percent chance of a judgment of $2 million (to simplify, we ignore other possibilities). Then the maximum expected cost to Admiral of trial would have been $550,000 (.90 x $500,000 + .10 x $1,000,000, the policy limit), and so (ignoring litigation expenses) Admiral would not want to settle for any higher figure. But Wegman would be facing an expected cost of $100,000 (.10 x ($2,000,000 - $1,000,000)), and no benefit, from a trial.[18]

II. Responses to Wegman

A.        Narrow Construction

An important consideration in Wegman is that it arose on motion to dismiss.  If there were any plausible set of facts consistent with the allegations of the complaint on which Wegman might have been able to recover, dismissal would have been improper and reversal required.  While the Seventh Circuit suggested that reversal could be supported based on the possibility that a specified state of facts might be proven, the opinion was dictum to the extent that reversal would also have been required based on some narrower standard of liability consistent with the allegations in Wegman.

In particular, the court said that the conflict arose “when Admiral learned that an excess judgment (and, therefore, a settlement in excess of policy limits, as judgment prospects guide settlement) was a nontrivial probability in Budrick’s suit.”  But the facts described indicate a very substantial probability of an excess judgment.  There was no serious contest of liability and seemingly the only hope of keeping the judgment within limits was to have a finding that Wegman bore no more than 25% of the fault for the accident (making its liability several, rather than joint and several).  To the extent that the opinion suggests that some probability of excess liability less substantial that that evidently involved in Wegman might create a right to independent counsel, that suggestion is dictum, not binding on any other court.

The Seventh Circuit analogized the conflict that it saw as warranting independent counsel to the usual conflict created by the combination of excess exposure and an opportunity to settle within limits.  And the facts alleged are consistent with the possibility that Admiral would have been obliged to accept a $1 million demand had one been made (and Wegman so argued in its brief).  To be sure, no $1 million demand was made, and Admiral was not required to make an affirmative offer unless “the probability of an adverse finding on liability [were] considerable and the amount of probable damages would greatly exceed the insured’s coverage,”[19]  But even that might have been a plausible possibility under Wegman’s allegations.

If the probability of excess liability required to create the conflict perceived in Wegman were at the level necessary to create a duty to settle, the result would accord with that appropriate under traditional duty-to-settle analysis, coupled with the majority rule that the prospect of excess liability (without any other conflict) frees the insured to settle if the insurer has first breached its duty to settle.[20]  If Admiral were obliged to make a limits offer (or to tender its limits for settlement), that offer or tender would have provided the notice that the Seventh Circuit concluded was required.

On that basis, even the conclusion that Wegman was entitled to independent counsel was dictum.  The supposed right to independent counsel was only significant as a basis for holding that Wegman was entitled to notice.  Had Wegman gotten notice, it would have communicated that to its excess insurer and there would have been no need for independent defense counsel.  There was no conflict regarding the handling of the trial: Admiral had every incentive to minimize the verdict.  And there was no claim that independent defense counsel could have done anything different that might have improved the result.  The only issues were Admiral’s liability for failing to offer or tender its limits or for failure to notify Wegman of the risk of excess exposure.

An analysis based on the duty to settle, rather than on independent counsel would support the result in Wegman in another way.  While Illinois courts have not addressed the issue, it is generally agreed by courts and commentators that “[t]he insurer has a duty to provide the insured with certain basic information about settlement opportunities.”[21] To be sure, as the district court observed,[22] defense counsel has an independent duty to keep the insured informed of developments in the litigation.[23] But, if the insured is not properly informed, the insurer can be liable for an excess judgment that could have been avoided by providing such information.[24] In general, an insured should be informed of any settlement demand received from the plaintiff and to provide

the insured … sufficient information to make intelligent decisions to protect his own interests…. Furthermore, the insurer must inform the insured in a timely manner so that the insured will be able to use the information effectively. If the insured is unaware of the potential adverse liability to him and what steps the insured must take to protect his own interests, the insurer has not carried out its responsibilities to the policy holder.[25]

This duty to inform could have been triggered by the receipt of the $6 million demand or if it were found that Admiral ought to have offered its $1 million limit (or tendered that limit to Wegman for its use in settlement negotiations[26]). In either event, timely notice to Wegman would have enabled it to provide earlier notice to AIG. Requesting an excess insurer to contribute to a settlement in excess of primary limits is the sort of conduct the duty to notify is intended to enable. Because it was at least plausible, based on the allegations, that a duty to inform might have been triggered on this basis, dismissal was improper.

A noted commentator has argued that (as the district court appeared to hold) there is no duty to inform the insured of excessive demands.[27] The $6 million demand does appear to be excessive, so that rule might vindicate Admiral’s failure to notify, at least so long as Admiral did not have a duty to offer or tender its policy limit. But, even if an excessive demand would not trigger a duty of notice, there would remain the possibility that Admiral might have been obliged to offer or tender its limits.

B.        Wegman Incorrectly Interprets Illinois Law, Especially if Not Narrowly Construed

1.   In Illinois, the Right To Independent Counsel Is Determined by the Rules of Professional Conduct

As Wegman recognized, an insurer with the duty to defend ordinarily has the contractual right to control the defense of the case. Absent an actual conflict of interest precluding joint representation, both insurer and insured ordinarily are considered clients of defense counsel in Illinois.[28] But when there is a conflict of interest regarding the defense, the insurer cannot also be a client of defense counsel unless the insured gives informed consent to a conflicted representation.

a)  Maryland Casualty Co. v. Peppers.

The leading Illinois case on insurance defense conflicts is Maryland Casualty Co. v. Peppers.[29] Peppers was sued for both assault and negligent injury. St. Paul had an obligation to defend. This created a conflict of interest regarding the way the suit against Peppers would be defended. Peppers and St. Paul shared an interest in defeating the claim, but their interests diverged if Peppers were to be found liable:

if Peppers is held responsible, it would be to his interest to be found negligent, which, under the policy of insurance, would place the financial loss on St. Paul. On the other hand it would be to St. Paul's interest to have a determination that Peppers intentionally injured Mims, which, by the terms of the policy, would relieve St. Paul of the obligation to pay the judgment. [30]

The Supreme Court held that, as in any other case where there is a conflict between two prospective clients regarding the representation, professional conduct rules “prohibit an attorney from representing the interests of St. Paul and Peppers” unless Peppers were willing to waive the conflict or St. Paul were willing to withdraw its reservation of the right to disclaim coverage for intentional injury.”[31] “Absent the acceptance of the defense by [the insured] or the waiver [of its coverage defense] by [the insurer], [the insured] has the right to be defended in the personal injury case by an attorney of his own choice who shall have the right to control the conduct of the case.”[32] When the insured selects independent counsel, the insurer “must reimburse him for the reasonable cost of defending the action.”[33]

As Peppers holds, the standard for identifying a conflict of interest is the familiar one laid down in the Illinois Rules of Professional Conduct. They preclude representation where “the representation of one or more clients may be materially limited by the lawyer’s responsibilities to another client, a former client or a third person, or by a personal interest of the lawyer.”[34] A material limitation (as that term is used in the rule) exists when a lawyer “cannot consider, recommend or carry out an appropriate course of action for the client because of the lawyer’s other responsibilities or interests.”[35] In applying this standard to insurance representations, courts have special sensitivity to situations where the choices made by defense counsel could benefit the insurer at the insured’s expense.[36]

b)  Application of the Peppers Standard

Neither a coverage question nor the possibility that some portion of the judgment might be noncovered creates a conflict of interest if the insurer has no incentive to defend in a way contrary to the insured’s interests. Only if there is a substantial risk that the way in which the insured’s defense is handled could affect the determination of coverage does a conflict exist, and many coverage questions are unrelated to the matters at issue in the tort action.[37] As the Seventh Circuit held in National Casualty Co.v. Forge Industrial Staffing, Inc., if a vigorous defense of the covered claims will also defend the noncovered claims, there is no conflict.[38]  (One panel of the Seventh Circuit cannot overrule another without circulating the opinion to the full court,[39] which does not appear to have been done here.)

Where the noncovered portion of the exposure is purely the amount in excess of limits, the covered and the noncovered claims are the same claims, so a vigorous defense of the covered claims will also defend the noncovered claims. As the Mississipi Supreme Court explained (and as other courts hold), “a damage claim beyond policy limits in and of itself presents no ethical problem to the lawyer employed to defend the case, because his employment is for one of two purposes: either win the case or keep the damages as low as possible. Everything he does in fulfillment of either objective must of necessity benefit both [insurer and policyholder].” [40]

The Seventh Circuit so held in Littlefield v. McGuffey.[41]  Ordinarily, there is no right to independent counsel unless “’“the insurer's and the insured's interests in the conduct of the tort action are in serious conflict,”’ ” because the insurer and insured are “’complete adversaries on a crucial issue which would necessarily be decided either one way or the other if liability was [sic] imposed.’”[42] Littlefield also recognized that a conflict could exist where the insurer has “’an interest in providing a less than vigorous defense.’”[43]  Neither situation was present in Littlefield.  And this Court rejected the argument that excess exposure was sufficient to create a conflict: “State Farm seems to think that the possibility of liability exceeding coverage automatically triggered a conflict of interest. But …the one is not the conceptual equivalent of the other.”[44]

Nandorf, Inc. v. CNA Insurance Cos.[45] supports no different rule. The underlying tort action in Nandorf was brought against a store claiming false imprisonment and seeking compensatory damages of $5,000 and punitive damages of $100,000. The insurer affirmed coverage but stated that it would not indemnify for punitive damages because such indemnification would be contrary to public policy. The policyholder’s own counsel then demanded the right to control the defense and to have counsel fees paid by the insurer. During the pendency of the declaratory judgment action, the insurer apparently settled the underlying claim for a small sum, but the issue of liability for the policyholder’s counsel fees remained.

The Nandorf  court found a conflict of interest because, while both parties shared an interest in defeating liability, their interest diverged on damages. The insurer would be relatively well‑served by a minimal compensatory damage award combined with a large punitive damage award. In contrast, the policyholder cared little about the size of the compensatory award but was strongly interested in minimizing any punitive award. In particular, the policyholder would have desired a finding that the employees acted in good faith (even if their conduct was wrongful), thereby barring punitive damages.

However, the Nandorf court enunciated a narrow rule:

Our finding that a conflict of interest existed in the instant case is not meant to imply that an insured is entitled to independent counsel whenever punitive damages are sought in the underlying action. Under the peculiar facts and circumstances of this litigation, punitive damages formed a substantial portion of the potential liability in the [underlying] action and CNA’s disclaimer of liability for punitive damages left Nandorf with the greater interest and risk in the litigation. Notwithstanding the common interest of both insurer and insured in finding total non‑liability in the third party action, the remaining interests of the two conflicted to such an extent as to create an actual ethical conflict of interest warranting payment of the insured’s independent counsel by the insurer.[46]

Insofar as the fear might be that the insurer will not fund a sufficiently vigorous defense, that creates no conflict for defense counsel, who has every incentive to make maximum efforts for the insured. Nor (even apart from the likely inflation of compensatory damages by an inadequate defense of the punitive damage claim) would that make much sense for the insurer, which would be liable if it caused a less than adequate defense and that resulted in an inflated judgment.[47]  By analogy to the law governing an insurer’s duty to settle,[48] an adequate defense should be a defense that would be provided by an insurer liable for the entire claim.  And the reasonableness of defense expenditures and the causation of any large judgment would likely be questions for a jury unlikely to be sympathetic to an insurer charged with skimping on the defense.  (And, however that may be, Admiral had ample incentive to defend vigorously, because it had $1 million in coverage at stake and hoped to obtain a verdict well below that.)

The view that no conflict results from mere diminished incentive to defend claims without indemnify coverage is strikingly supported by Pekin Insurance Co. v. Home Insurance Co.,[49] a case decided a few days after Nandorf  by a different division of the same court which decided Nandorf. In Pekin, the policyholder demanded the right to control the defense because the automobile policy’s indemnity limit had already been exhausted by payment on behalf of another policyholder. The insurer declined to pay the policyholder’s chosen counsel and the Appellate Court upheld its right to refuse payment, despite the argument that a

conflict is created by the fact that Pekin is interested in keeping litigation costs to a minimum while the White Sox wish to obtain a full and vigorous defense. The Sox contend that, because of this conflict, they not only may choose their own defense attorneys, but also may require Pekin to pay any attorney fees incurred. Illinois, however, has only recognized two situations wherein the conflict of interest would be so great as to require the retention of outside counsel. These situations have involved either conflicts between two parties covered by the same insurer, or circumstances wherein proof of certain facts would move liability from the insurer to the insured. Since the facts here do not fit within either of these exceptions, the Sox cannot maintain their claims under a conflict of interest theory. [50]

While the mere existence of a large noncovered exposure should not be considered a conflict, the result in Nandorf was correct. The key to proper analysis is the nature of the underlying action there: a claim for false imprisonment by a storekeeper. In such a case, the detention would normally have been rather brief and any compensatory damages would be based almost entirely on emotional distress and would likely depend primarily on the jury’s outrage (or lack thereof) at the conduct of the defendant. As such, the separation of compensatory from punitive damages, while sharp in theory, is very indistinct in practice. It is not difficult to imagine that there might be ways of shaping the defense (including the argument to the jury) which might substantially affect the allocation between the two categories of the amount the jury decided to award.[51]

The only Illinois case finding a right to independent counsel based solely on the existence of excess exposure is Mobil Oil Corp. v. Maryland Casualty Co,[52] Maryland “vexatiously” disputed (for a time) the availability of a $10 million limit, claiming that only $250,000 was available. Mobil was almost certain to be liable for $250,000, which the court felt meant that Maryland’s interests could be “furthered by providing a less than vigorous defense.”  (The suggestion is that Maryland might have believed that its limits were effectively gone, so that no defense efforts would provide any benefit to it.)  Also, Mobil faced a large noncovered punitive damage exposure and would be in serious danger if the case were allowed to go to trial. For these reasons, the court concluded that Mobil had been entitled to independent counsel.[53] But, while Maryland had the conflicts that commonly accompany excess exposure (aggravated if it thought its limit gone), defense counsel had no such conflict. Mobil Oil is inconsistent with the governing rule laid down by the Illinois Supreme Court in Peppers: existence of a conflict is determined under the Rules of Professional Conduct and with Pekin. Other courts ought not to follow Mobil Oil on the independent counsel issue.

2.   Wegman Did Not Apply the Peppers Standard

Wegman did not identify any conflict of interest affecting the defense of the case, as would be necessary to trigger a right to independent counsel under Peppers.  It identified only a supposed conflict of interest between Admiral and Wegman regarding settlement.  Even that conflict would have existed only had there been no excess insurance.  Neither Admiral nor defense counsel had any interest in forestalling notice to the excess insurer, though they might well have breached duties to Wegman by failing to notify it..

To say that any conflict affected only Admiral and not defense counsel is not to say there was no remedy.  Rather, it is to say that Illinois law provides a different remedy.  Illinois law recognizes that, where claims involve a real risk of exposure in excess of limits, “[i]nsurers operate under a conflict of interest; the policy limit drives a wedge between what is good for insurers and what is good for clients.”[54]  Insofar as this duty relates to the making of settlement offers, it concerns a matter not within the control of defense counsel, who can only make offers that have been authorized by the party who will pay the amount offered. So, the remedy for this type of conflict is not a right to independent counsel: “Most states, of which Illinois is one, require insurers to …make settlement offers within the policy limits as if the insurer bore the full exposure.”[55] As this court put the matter, this is a duty “’not to gamble with the insured's money by forgoing reasonable opportunities to settle a claim on terms that will protect the insured against an excess judgment.’”[56]

The Seventh Circuit says that, had Wegman obtained independent counsel, (and had no excess insurance) that counsel could have attempted to make a reasonable settlement that Admiral would have been obliged to pay.  Of course, liability insurance policies ordinarily contain provisions restricting the insured’s right to settle without the insurer’s consent.[57]  Wegman’s policy presumably contained such provisions.  The Seventh Circuit relies on two Appellate Court cases.[58]  Those cases hold that where an insurer has reserved its right to deny coverage and relinquished control of the defense to independent counsel, that counsel may make a reasonable settlement, which the insurer must reimburse (to the extent of its coverage), despite such restrictions.

In Wegman, Admiral did not reserve its right to deny coverage, and that fact alone distinguishes the cases relied upon.[59]  Moreover, as already explained, Wegman never had any antecedent right to independent counsel, so those cases are inapplicable by their own terms.  Finally, even if they were applicable, they follow a minority rule, which has not been adopted by the Illinois Supreme Court.[60]  There are strong arguments against that rule.[61]  Other courts, if free to do so, ought to reject the rule relied upon in Wegman.

Moreover, the rule assumed by Wegman is even less sound than that adopted by the cases on which it relied.  That rule appears to allow the insured to settle, without the insurer’s consent, whenever there is some “nontrivial” probability of excess liability, even without some antecedent conflict regarding the defense or breach of the insurer’s duty to settle.  That would deprive the insurer of its contractually reserved control over settlement without good cause and contrary to the law virtually everywhere but in the Seventh Circuit.[62]

[1] See Traveler's Ins. Co. v. Eljer Mfg., Inc., 197 Ill. 2d 278 (2001), rejecting rule adopted in Eljer Mfg. Corp. v. Liberty Mutual Ins. Co., 972 F.2d 805 (7th Cir. 1982).

[2] Some of the facts stated are drawn from the briefs in the Seventh Circuit.  The district court granted a motion to dismiss, so Wegman’s allegations are taken as true.  Wegman supplemented its allegations with statements in its Seventh Circuit briefs, which the Seventh Circuit appears to have accepted as proper.

[3] R.C. Wegman Constr. Co v. Admiral Ins. Co., No. 08 C 6479, 2009 U.S. Dist. LEXIS 22546, at *6-9 (N.D. Ill. Mar. 20, 2009).

[4] Id. at *10.

[5] Id. at *10-11.

[6] Id. at *11-12.

[7] Id. at *13-14 n.3, relying on Brocato v. Prairie State Farmers Ins. Ass'n, 166 Ill. App. 3d 986, 990-91 (1988).  Even if Wegman’s defense counsel had limited their engagement to exclude insurance coverage issues, they would still have been obliged to “keep [Wegman] reasonably informed about the status of the matter.”  Ill. R. Prof. Cond. 1.4(a). 

[8] Id. at *14-15.

[9] 2011 U.S. App. LEXIS 679, at *7.

[10] Id. (citing a variety of articles).

[11] Id. at *8.

[12] Id. at *9-10, quoting Nandorf, Inc. v. CNA Ins. Cos., 134 Ill. App. 3d 134, ___ (1985)

[13] Id. at *10, quoting 4 Couch on Insurance § 202:17 (3d ed. 2007).

[14] Id. at *10-11.

[15] Id. at *11.

[16] Id. at *12-14 (emphasis added, citations omitted).

[17] Slip Op. at 1-2.

[18] 2011 U.S. App. LEXIS 679, at *10-11.

[19] Adducci v. Vigilant Ins. Co., 98 Ill. App. 3d 472, 478 (1981) (describing exception to general rule that insurer need only respond to demands, not make affirmative offers), cited with approval Haddick v. Valor Ins., 198 Ill. 2d 409, 417 (2002).

[20] William T. Barker & Ronald D. Kent, New Appleman Insurance Bad Faith Litigation, Second Edition, § 4.03[2][a].

[21] William T. Barker & Ronald D. Kent, New Appleman Insurance Bad Faith Litigation, Second Edition, § 2.03[4][a] (footnote omitted); see Stephen S. Ashley, Bad Faith Actions: Liability & Damages, §§ 3:09, 3:11 (2nd ed. 1997); 1 Allen D. Windt, Insurance Claims & Disputes, § 5:7 (5th ed. 2007).

[22] R.C. Wegman Constr. Co v. Admiral Ins. Co., No. 08 C 6479, 2009 U.S. Dist. LEXIS 22546, at *10 (N.D. Ill. Mar. 20, 2009).

[23] Roger v. Robson, Masters, Ryan, Brumand & Belom, 74 Ill. App. 3d 467, 474 (1979), aff’d on other issues, 81 Ill. 2d 201 (1980).

[24] William T. Barker & Ronald D. Kent, New Appleman Insurance Bad Faith Litigation, Second Edition, § 2.03[4][c]-[d].

[25] William T. Barker & Ronald D. Kent, New Appleman Insurance Bad Faith Litigation, Second Edition, § 2.03[4][a] (footnotes omitted).

[26] See Cent. Ill. Pub. Serv. Co. v. Agric. Ins. Co., 378 Ill. App. 3d 728, 737 (2008) (discussing claim that insurer which could not have settled claim within its own policy limit might have had duty to tender those limits to an excess insurer).

[27] 1 Allen D. Windt, Insurance Claims & Disputes, § 5:7, at 5-45 (5th ed. 2007).

[28] E.g. Rogers v. Robson, Masters, Ryan, Brumund & Belom, 74 Ill. App. 3d 467, 472 (1979) (collecting cases), aff’d 81 Ill. 2d 201 (1980).

[29] Maryland Cas. Co. v. Peppers, 64 Ill. 2d 187 (1976).

[30] Id. at 197.

[31] Id. at 198.

[32] Id. at 198-99.

[33] Id. at 199.

[34] Ill. R. Prof. Cond. 1.7(a)(2). This rule is newly adopted since Peppers, but is substantively identical to that in effect at the time of Peppers.

[35] Id., cmt. [8].

[36] See Jeffrey E. Thomas & Francis J. Mootz, III, The New Appleman on Insurance Law, Library Edition, § 16.04[4] (discussing insureds’ rights to independent counsel under the conflict of interest standard and under other standards applied in some jurisdictions).

[37] See Restatement (Third) of the Law Governing Lawyers § 123, cmt. c(iii) (perm. vol. 2000) (general antagonism between clients not conflict, so long as conflicting interests not implicated in particular representation).Mere filing of a declaratory judgment action as to coverage does not create a conflict if the coverage issues are entirely separate from the underlying issues. Allied Am. Ins. Co. v. Ayala, 247 Ill. App. 3d 538, 547-48 (1993); County of Massac v United States Fid. & Guar. Co., 113 Ill. App. 3d 35, 43-44 (1983).

[38] Nat’l Cas. Co.v. Forge Indust. Staffing, Inc., 567 F.3d 871, 876 (7th Cir. 2009) (no right to independent counsel: “In the event that the EEOC charges evolve into lawsuits, both punitive and compensatory damages would be tied to the same underlying conduct, namely Forge's alleged discrimination against its employees. Thus, in defending Forge's actions generally, NCC would necessarily be protecting Forge's interests with respect to both compensatory and punitive damages.”)

[39] Seventh Circuit Rule 40(f).

[40] Hartford Acc. & Indem. Co. v. Foster, 528 So.2d 255, 269 (Miss. 1988); N.Y. Mar. & Gen. Ins. Co. v. Lafarge N. Am., Inc., 593 F.3d 102, 125 (2nd Cir. 2010) (even excess exposure that threatened insured’s existence did not create conflict);Metlife Capital Corp. v. Water Quality Ins. Syndicate, 100 F. Supp. 2d 90, 94 (D.P.R. 2000); Allstate Ins. Co. v. Campbell, 334 Md. 381, 395-96 (Md. 1994) (insurer’s refusal to settle within limits does not create conflict); Johnson v. Cont’l Cas. Ins. Co., 57 Wn. App. 359, 363 (1990) (excess exposure, standing alone does not create conflict for defense counsel); Alaska Stat. § 21.89.100(b) & (c) (excess exposure not a conflict); Cal. Civ. Code § 2860(b).

[41] Littlefield v. McGuffey, 979 F.2d 101 (7th Cir. 1992).  See also Forge Indust. Staffing, 567 F.3d at 878 (“Simply put, if no fact issues appear on the face of the underlying complaint that can be conclusively resolved in such a way that insurance coverage is necessarily precluded under the policy, then appointment of independent counsel is not warranted”).

[42] Id. at 106 quoting Maneikis v. St. Paul Ins. Co., 655 F.2d 818, 825 (7th Cir.1981) (emphasis added and deleted).

[43] Id., quoting Nandorf, Inc. v. CNA Ins. Cos., 134 Ill. App. 3d 134, 139 (1985).

[44] Id. at 108.

[45] Nandorf, Inc. v. CNA Ins. Cos., 134 Ill. App. 3d 134 (1985).

[46]134 Ill. App. 3d at 140.

[47] See State Farm Mut. Auto. Ins. Co. v. Traver, 980 S.W.2d 625, 627-28 (Tex. 1998) (finding no vicarious liability of insurer for alleged errors of defense counsel, but remanding for consideration of possible direct liability for inadequacies in defense caused by the insurer).

[48] See William T. Barker & Ronald D. Kent, New Appleman Insurance Bad Faith Litigation, Second Edition, § 2.03[[2][d].

[49] Pekin Ins. Co. v. Home Ins. Co.,134 Ill. App. 3d 31 (1985).

[50] 134 Ill. App. 3d at 35 (citations omitted).

[51] Tews Funeral Home, Inc. v. Ohio Cas. Ins. Co., 832 F.2d 1037 (7th Cir. 1987) (IL law)

[52] Mobil Oil Corp. v. Md. Cas. Co., 288 Ill. App. 3d 743 (1997).

[53] 288 Ill. App. 3d at 756.

[54] Transport Ins. Co. v. Post Express Co., 138 F.3d 1189, 1192 (7th Cir.1998) (per Easterbrook, J.).

[55] Id. (emphasis added).

[56] Slip Op. at 2, 2011 U.S. App. LEXIS 679, at *2, quoting Twin City Fire Ins. Co. v. Country Mut. Ins. Co., 23 F.3d 1175, 1179 (7th Cir. 1994) (emphasis added). A later statement in this Court’s opinion (Slip. Op. at 9, 2011 U.S. App. LEXIS 679, at *12) suggests either that any gambling with the insured’s money would be improper (even though the law permits reasonable gambles) or that the facts here made this gamble improper (something which cannot be determined on the sparse allegations of the complaint). That suggestion should be removed. Whether any gambling was improper must be determined on remand, if relevant to resolution of this case.

[57] William T. Barker & Ronald D. Kent, New Appleman Insurance Bad Faith Litigation, Second Edition, § 2.02[3].

[58] Wegman, 2011 U.S. App. LEXIS 679, at *13-14, citing Myoda Computer Center, Inc. v. Am. Family Mut. Ins. Co., 389 Ill. App. 3d 419, 423-26 (2009), and Commonwealth Edison Co. v. Nat’l Union Fire Ins. Co., 323 Ill. App. 3d 970, 983-85 (2001).

[59] See Myoda, 389 Ill. App. 3d at 424 (distinguishing Alliance Syndicate, Inc. v. Parsec, Inc., 318 Ill. App. 3d 590, 600--01 (2000), which had enforced settlement restrictions, on the ground that there was no reservation of rights in Alliance).

[60] William T. Barker & Ronald D. Kent, New Appleman Insurance Bad Faith Litigation, Second Edition, § 4.05[1].

[61] Id.

[62] William T. Barker & Ronald D. Kent, New Appleman Insurance Bad Faith Litigation, Second Edition, §§ 4.02, 4.03, 4.05.

William Barker is the co- author of New Appleman Insurance Bad Faith Litigation, Second Edition. Mr. Barker will be presenting at the ABA Insurance Coverage Litigation Committee CLE Seminar on Saturday, March 5,

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