Courts debate if an insurer can bring a malpractice action against defense counsel it retained to defend its insured

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2019-09-10

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Liability insurers regularly retain defense counsel to defend their insureds against claims that potentially fall within coverage. Two state courts recently confronted the question of whether an insurer has standing to sue retained defense counsel for malpractice where counsel’s mishandling of the defense results in the insurer paying more than it otherwise could have to resolve a claim.

This debate originates from a commonly asked question; whether counsel retained by the insurer has an attorney-client relationship with both the insurer and the insured. Retained defense counsel often has an ongoing contractual relationship with the insurer pursuant to which the attorney is being compensated to defend multiple lawsuits. On the other hand, the attorney has a transitory relationship with the insured that is limited to providing a defense to a single lawsuit. This can call the loyalties of defense counsel into question. Additionally, the interests of the insurer and the insured may conflict with respect to how a claim is defended and settled. Given these dynamics, courts have scrutinized the role of attorneys in this type of tripartite relationship and, to varying degrees, have emphasized that the attorney must represent the insured with undivided loyalty.

If defense counsel represents the insured only, does the insurer have standing to seek recourse if the defense is mishandled? Courts have permitted insurers to pursue such malpractice actions in the majority of jurisdictions that have considered the question, but at least three state appellate courts—in Michigan, Texas, and Washington—have declined to permit insurers to bring direct legal malpractice actions against defense counsel. Two recent decisions deepen the debate.

Recent Decisions

A divided South Carolina Supreme Court recently followed the majority rule in allowing insurers to bring direct malpractice actions against defense counsel. See Sentry Select Ins. Co. v. Maybank Law Firm, LLC, 826 S.E.2d 270 (S.C. 2019). The case involved defense counsel that failed to answer requests for information on a timely basis. As a consequence of this failure, the insurer alleged that it was forced to pay $900,000 to settle the case, rather than the $75,000 to $125,000 that defense counsel had initially estimated as the settlement value of the case. The insurer brought a malpractice suit against the defense counsel in federal district court. The district court certified the following question to the South Carolina Supreme Court: “Whether an insurer may maintain a direct malpractice action against counsel hired to represent its insured where the insurance company has a duty to defend?”

In a 3-2 decision, the court ruled that the insurer could bring a direct malpractice action against defense counsel because of the tripartite relationship that exists between the insurer, the insured, and the attorney hired to defend the insured. The majority explained that “the insurer may recover only for the attorney’s breach of his duty to his client [i.e. breach of duty to the insured], when the insurer proves the breach is the proximate cause of damages to the insurer.” That said, the majority still emphasized that the insured is defense counsel’s only client and that counsel does not owe a separate fiduciary duty to the insurer.

The dissenting justices took issue with allowing an insurer to pursue a malpractice claim. Because defense counsel does not owe a duty to the insurer under South Carolina law, the dissenters suggested that the insurer should not be permitted to sue counsel for malpractice. The dissenters recognized that an insured would likely not bring a claim for malpractice against defense counsel when the allegedly negligent attorney resolved the claim within the policy limits. As a result, the defense counsel might avoid liability for malpractice entirely. While the dissenters found this result “troubling,” they concluded that their concerns about creating another exception to the privity rule under which attorneys are generally responsible only to their clients outweighed possible immunization of defense counsel.

Reaching a different outcome on the same question, a Florida appellate court recently ruled that an insurer cannot sue defense counsel for legal malpractice. See Arch Ins. Co. v. Kubicki Draper, LLP, 266 So. 3d 1210 (Fla. Dist. Ct. App. 2019). The insurer alleged that defense counsel committed malpractice by failing to raise the insured’s statute of limitations defense, thereby forcing the insurer to pay a larger settlement to resolve the underlying claim against the insured. The appellate court ruled that the insurer lacked standing to sue defense counsel because the insurer was not in privity with defense counsel, and that none of the recognized exceptions to the strict privity requirement applied to the facts. The court recognized that there were “public policy and common sense” arguments as to why an insurer should be able to pursue malpractice claims against defense counsel. However, the court found that existing Florida law did not allow it to depart from the privity requirement. The appellate court then granted a motion to certify the following question to the state’s highest Court: “Whether an insurer has standing to maintain a malpractice action against counsel hired to represent its insured where the insurance company has a duty to defend.” The Florida Supreme Court has accepted jurisdiction and is likely to issue a decision that further clarifies the issue under Florida law.

Comment

For an insurer contemplating a malpractice action against its appointed defense counsel, recent South Carolina and Florida decisions highlight the importance of evaluating the applicable law regarding tripartite relationships and the duties owed by the attorney in those relationships. In a jurisdiction that has not yet addressed the question of an insurer’s standing to bring a direct malpractice action, the recent South Carolina and Florida decisions provide a roadmap of case law and issues that may be instructive.

Read other items in Coverage Digest - September 2019