Avoiding Blurred Lines: When Coverage Counsel Investigates Claim Facts

When insurance defense counsel undertakes additional duties, including acting in an investigative or claims-handling capacity, the attorney’s role can become blurred. The blurring of these lines can impact, among other things, traditional safeguards, such as attorney-client and work product privileges. Emerging case law takes a more critical approach to examining counsel’s actual role—a trend that potentially jeopardizes previous evidentiary and privilege safeguards.

At the Spring 2014 ABA National Legal Malpractice Conference, a panel of industry and defense counsel experts discussed strategies and tips to help clarify the scope of counsel’s role, protect confidential communications and minimize waiver of privileged information. They also took a close look at the ethical issues at play in related scenarios in order to better equip defense and coverage counsel to avoid blurred lines in their own practices.

Speakers included Elaine T. Lenahan of Thompson, Coe, Cousins & Irons LLP, Dallas; Terence J. Cullin of Forsberg & Umlauf, Seattle; William Freivogel of William Freivogel Consulting Services, Chicago; and Todd Hampton, vice president—claims of Monitor Liability Managers, Chicago.

The conference, presented by the ABA Standing Committee on Lawyers’ Professional Liability, was held April 30-May 2 in Boston.

Privilege Rules Called Into Question

Recent cases have called into question attorney-client privilege and/or confidentiality of communications between insurance companies and their outside counsel when the legal advisor takes part in claims investigation.

Cullen outlined recent Washington state case law—a jurisdiction not generally favorable towards insurance companies—indicating that once an insurance company asks outside counsel to investigate claims, even when they are hired to provide a coverage opinion, the attorney’s advice and communications with the insurer may become discoverable. Cedell v. Farmer’s Ins. Co. of Wash., 295 P.3d 239 (Wash. 2013), triggered this topic for discussion not only at the conference but also for claims professionals handling matters moving forward.

In Cedell, an insurer retained counsel to assist in making a coverage determination on a first-party fire loss case. The attorney examined the plaintiff-homeowner and his girlfriend under oath and sent a letter to the plaintiff stating that the origin of the fire was unknown and that Farmer’s might deny coverage based upon a delay in reporting and the inconsistent statements about the fire cause. Counsel’s letter also extended a onetime $30,000 offer set to expire within 10 days. During the 10-day period, counsel was out of town and did not return phone calls from plaintiff.

Cedell sued the insurer alleging, among other things, that it acted in bad faith in handling the claim. In response to discovery requests, the insurer produced a heavily redacted claims file asserting that the redacted information was not relevant or was privileged. The insurer also declined to answer some of Cedell’s interrogatories on the ground of attorney-client privilege, including the reason why the limited settlement period was imposed.

In reversing the interim appellate court decision decided upon then-established precedent, the Washington Supreme Court created new broader parameters for discovery of claims files and communications with counsel in cases where insurance companies hire counsel to investigate and advise on claim investigation and coverage issues.

The court reasoned that in a first-party claim, the insurance company has a quasi-fiduciary duty to its insured. Insurance contracts and practices are highly regulated and of substantial public interests. Therefore, “as a leading treatise notes, bad faith in this context ‘is not the equivalent of actual fraud’…. In the context of first-party insurance, bad faith may often be tantamount to civil fraud,” the court said.

The Cedell court started from the presumption that there is no attorney-client privilege relevant between the insured and the insurer in the claims adjusting process and that the attorney-client and work product privileges are generally not relevant to the claims handling process.

The insurer may overcome the presumption of discoverability by showing that its attorney was not engaged in the quasi-fiduciary tasks of investigating and evaluating or processing the claim but instead in providing the insurer with counsel as to its own potential liability.

However, unless those mental impressions are directly at issue in its quasi-fiduciary responsibilities to its insured, even if the insurer meets its burden to establish that the attorney provided advice outside the scope of its quasi-fiduciary claim investigation and evaluation responsibilities, the insured may still pierce the privilege if:

• the insured shows a reasonable person would have a reasonable belief that an act of bad faith has occurred, warranting an in camera inspection of the claimed privileged material; and

• after in camera review, there is a finding that a foundation exists to permit a claim of bad faith.

Summarizing the pre-Cedell procedure employed by the court in assessing the privilege between insurer and counselor, Cullen noted that the Cedell opinion suggests bad faith claims handling practices are tantamount to engaging in civil fraud.

Further, the Cedell court’s application of a “quasi-fiduciary duty” to insurance claim investigation and handling creates a brand new duty not previously identified elsewhere, according to Freivogel. He said that before Cedell he thought of the duty between insurers and insureds as mainly contractual. “With the formation of a quasi-fiduciary obligation, courts may be looking to create new ways to establish liability as against insurance companies,” he said.

Implications of Cedell

Hampton outlined the practical and substantive implications for coverage claim handling and investigation brought out by the Cedell opinion:

• significant burdens on trial courts in first-party bad faith cases where insurer retains a lawyer;

• expect in camera inspections by either or both parties and the concomitant burden and cost to show the privilege applies;

• additional file management burdens within the insurer and law firm;

• all communications between a lawyer and an insurer during claims handling process are presumed to be discoverable;

• providing a privilege log will no longer insulate communications from discovery;

• the burden is now on the insurer to show that the attorney was not engaged for the quasi-fiduciary task of evaluating or processing (adjusting) claims; and

• the insurer must show that the attorney was engaged to provide advice as to its own liability, i.e., whether or not coverage exists.

Hampton noted that the use of e-mail communications has created significant problems with respect to commingling and contaminating claim file contents and attorney communications: With the advent of e-mail, communications are sent before the content is fully analyzed. E-mail communications generally include quick responses with less time and effort put into editing down and taking out inappropriate nonfact editorial comments and opinions. E-mail becomes part and parcel of both the claim and attorney work files and thereby subject not only to potential discovery, but also to potential misinterpretation.

Practical Suggestions

The panel provided a number of practical suggestions for outside counsel and insurance company claim handling to minimize the risk of disclosure to adverse parties.

Where an attorney is arguably acting in more than one role, such as claim investigation and providing coverage advice, insurers may wish to set up and maintain separate files so as not to commingle different functions.

Both insurers and attorneys should keep legal advice opinions separate and apart from claim investigation work and be prepared to allow in camera inspection of the discreet communications that do not include legal advice to the carrier. The suggestion was made that any coverage advice communication be separately identified with the heading “Attorney-Client Communication pursuant to Cedell v. Farmers.”

Both attorneys and insurers ought to consider separation of normal claim handling activities from the provision of mental impressions by an attorney. Attorneys and claim handlers should limit claim file comments to facts and avoid personal characterizations.

Other Decisions on Privilege Waiver Claims

A 2013 federal district court case from Idaho applied Cedell to deny work product protection to documents created by an attorney in response to an insurer’s request for coverage advice.
Stewart Title Guar. v. Credit Suisse, 2013 BL 90020 (D. Idaho April 3, 2013).

The court ordered in camera review of asserted attorney-client privileged documents and ordered production of all documents regarding factual investigations by the attorney or claim adjusters. It placed the burden on the carrier to show which documents were not claim investigation related.

In Carolina Cas. Corp. v. Omeros, No. C12-287RAJ (W.D. Wash. April 12, 2013), the Cedell rule was applied to a third-party liability claim based upon the quasi-fiduciary duty of an insurer to its insured along with the public policy interest in regulating the business of insurance.

The court found that the public policy interest in regulating the business of insurance was just as important in a third-party claim as in a first party claim.

Palmer v. Sentinel Ins. Co. Ltd., No. C12-5444 BHS (W.D. Wash. July 9, 2013), looked at a first-party property case and held that, where an attorney acts in a dual capacity as between claim investigation and coverage advice, even the lawyer’s mental impressions are not protected when those impressions are directly at issue with respect to the insurer’s quasi-fiduciary duties to the insured. The Palmer court further concluded that the Cedell work-around of creating a split file was “not a workable alternative.”

Some courts have been critical of the Cedell approach. Phila. Indem. Ins. Co. v. Olympia Early Learning Ctr., No. C12-5759 RBL (W.D. Wash. July 2, 2013), concluded that Cedell “creates rather than alleviates confusion” and opined that if such a vast exception to attorney-client privilege was made based upon the litigant’s substantial need, the court did so “without explanation and without acknowledging that it was fundamentally altering a law.”

Ethical Issues

The quasi-fiduciary duty and expanded discovery outlined in Cedell implicates a number of ethical questions and challenges for attorneys, according to Freivogel.

Detailing the history of the attorney-client privilege, Freivogel noted it began with the premise that what the client told the lawyer would remain in confidence and was expanded to include what the lawyer told the client.

Sections 68, 70 and 86 of the Restatement (Third) of the Law Governing Lawyers (2000) cite the modern attorney-client privilege rule as running both ways to include client to attorney and attorney to client communications. Work product rules only apply when a client anticipates litigation. The general view is that once an insurance company hires an attorney to look into coverage, the attorney’s claim work and investigation is not privileged until such time as the insurance company makes a determination to deny coverage.

Attorneys need to educate themselves and their insurer-clients as to the possible Cedell and other privilege waiver rulings and to take appropriate steps to protect work file and insurance company communications as best they can from disclosure to first- and third-party claimants. Failure to do so may violate various Rules of Professional Conduct including Rule 1.1 (competence), 1.4 (communications with client), and 1.6 (preservation of confidential communications).

Insurance Company Perspective

Hampton provided an overview from the insurance company claim handling perspective. Insurers provide a defense on fraud claims in most states under reservation of rights. In making coverage determinations, insurers look at the dollars associated with the claim and assume that they will likely face an uphill battle convincing courts to deny coverage which often does not occur until an appellate ruling.

Insurance companies are generally sensitive to the need to split files between defense and coverage issues and expect that defense counsel will understand the need for segregation of claim investigation from coverage advice.

It is generally good practice for coverage counsel to review the policy in a manner that essentially first looks for coverage and clearly lays out in a coverage opinion the case where no coverage exists. If the investigating lawyer’s advice is that a claim is clearly not covered and the insurer denies the claim, that communication may not be protected in an in camera showing of bad faith.

Conclusion

If the Cedell opinion is adopted in other jurisdictions, insurers and outside coverage counsel should not expect that they will be able to protect attorney-client communications during claims investigations under attorney-client privilege and/or attorney work product claims and be guided accordingly in the form and content of their communications.