A House Divided: Independent Counsel After Frank’s Casing

If a house is divided against itself, that house will not be able to stand.”

“No man can serve two masters.”

These two maxims underlie a central tenet of the attorney/client relationship: The client is the master and the attorney is the faithful, loyal servant. If the attorney owes duties to anyone else that loyalty is divided.

This straightforward arrangement becomes complicated in the insurance context. The carrier often chooses the defense counsel for the insured from a panel of attorneys who regularly do work for it, and provides billing guidelines that outline what fees and work it will agree to pay. It may closely monitor the defense. Defense counsel often strategize with adjusters because they are litigation savvy.

At the same time, the defense lawyer owes complete loyalty to the insured/defendant. The carrier is paying the bill, but the defendant is calling the shots. This relationship of carrier to insured to defense counsel is often referred to as the “tripartite” relationship. Seems clear, right?

Well, this arrangement was even murkier in the past. Until the 1970s there was not much guidance on the relationship of these three parties. In 1973, the Texas Supreme Court rocked Texas defense lawyers with the landmark decision in Employers Casualty Co. v. Tilley, 496 S.W.2d 552 (Tex. 1973) that crystallized the relative obligations. The Tilley Court found that an attorney hired to represent an insured “becomes the attorney of record and the legal representative of the insured” and, thus owes the insured a “same type of unqualified loyalty as if he had been originally employed by the insured.” Tilley laid the foundation for an insured’s right to independent counsel in the face of a reservation of rights by the carrier to potentially deny a duty to indemnify. After Tilley, there was no question as to whom defense counsel owed their first and foremost loyalty: the insured.

The Traver complication
Twenty-five years later the Texas Supreme Court clarified some of the boundaries of the tripartite relationship, and not in a way to make things easier for defense counsel, though many carriers gained some relief. In State Farm Mutual Automobile Insurance Co. v. Traver, 908 SW2d 624 (Tex. 1998), the Court not only reaffirmed that defense counsel owed its primary loyalty to the insured, but also established that, due to its ethical duty of unqualified loyalty, defense counsel must always protect the defendant’s interests, even if those interests would be compromised by a carrier’s billing guidelines or instructions. For example, where the carrier does not agree to a course of action that defense counsel thinks is necessary, defense counsel must follow the best interest of the defendant. But just as important, the Court held that a carrier is not liable for the defense counsel’s misconduct if it fails to handle the case properly. The defense attorney cannot use billing guidelines as an excuse for malpractice. And even though the insurance company is paying the defense counsel’s fees, it is not responsible, vicariously or otherwise, for the conduct of outside counsel. Simply, the insurance company has the obligation to pay the attorney’s fees, but is not responsible for the content or actions of the defense counsel.

Between Tilley and Traver, defense counsel are placed in the awkward position of being hired and paid by one entity, but having an unqualified obligation to another. At the same time, the carrier may not agree to pay certain defense fees, even if defense counsel believes the work is necessary to the defense. Conflict is inevitable. The carrier, though it must pay defense costs, is only responsible for “reasonable attorney’s fees”; it is not responsible for fees which are excessive or unreasonable. This creates significant tension between all three members of the tripartite relationship. To prevent unreasonable or excessive fees, insurers often issue guidelines to defense counsel explaining what they will and will not pay. In turn, defense counsel will often attempt to modify their defense of the case to fit within those defense counsel guidelines to ensure payment for their services. The defendant just wants an effective defense.

The problem, following Traver, is that if the defense counsel fails to take steps which were reasonable and appropriate for the defense of the case, the existence of the insurance company guidelines is no defense to the attorney. To the contrary, because the defense counsel owes a duty of unqualified loyalty to the insured, the attorney is required to take all reasonable steps, whether consistent or inconsistent, with the guidelines. Failure to do so, under Traver, is the attorney’s problem.

Defense counsel generally dislike this arrangement; it creates thousands of problems which vex, confuse and often infuriate them. Even so, defense counsel have been very flexible in adapting to this scheme and it generally works well. Now things have become yet more complicated.

Along comes Frank’s Casing
Every decade or so the Texas Supreme Court issues an opinion that fundamentally changes the landscape of Texas insurance law. In the 1990s, the case was State Farm Fire & Cas. Co. v. Gandy, 925 S.W.2d 696 (Tex. 1996). The case we remember from this decade may well be Excess Underwriters at Lloyd’s London v. Frank’s Casing Crew & Rental Tools, Inc., ___ S.W.3d ___, 2005 WL 125321 (Tex. May 27, 2005). This case is of fundamental importance to insurance professionals and attorneys for any number of reasons, some involving Stowers issues, others involving the right of reimbursement. Its impact is both direct and indirect on many areas of insurance practice. The significance of this particular case on the tripartite relationship appears to be indirect, but goes to the heart of the relationship.

The immediate issue in the case was how far the Court would prune back its prior decision to preclude a right of reimbursement in its decision in Texas Association of Counties v. Matagorda County, 52 S.W.3d 128 (Tex. 2000). In Matagorda County, the Court decided that a carrier could not seek a reimbursement of settlement proceeds from its insured because a claim was not covered, unless the insured expressly agreed to the settlement and to the carrier’s right to seek reimbursement (which never happens). As a practical matter, Matagorda County precluded reimbursement in almost all cases.

Frank’s Casing redraws those lines and allows carriers to seek reimbursement in circumstances where the insured has either asserted their right in a reservation of rights letter; has notified the policyholder that it intends to seek reimbursement; and either, (A) the policyholder agrees that the settlement is reasonable or (B) the policyholder demands that the carrier settle the case by accepting the underlying Plaintiffs’ settlement offer.

So what? How does that affect the independent standing of defense counsel? It puts defense counsel in the difficult position of evaluating or soliciting offers in a manner that protects the defendant from reimbursement, without preventing a proper and reasonable settlement. The defense attorney must carefully evaluate settlement offers, advise his client on how to respond to Stowers issues, and make other strategic decisions conscious that a false step could make the insured ultimately responsible for the settlement payment instead of the carrier.

While the insurance company may pay the defense counsel and indemnity payment up front, it may later seek reimbursement from the insured directly if the elements of Frank’s Casing are met. The defense counsel needs not only to protect the insured from the plaintiff’s claim, but to prevent the defendant from backing into a situation where the case is settled and the insured is forced to pay the claim itself. The new tension on the tripartite relationship is palpable. Like Gandy, which fundamentally changed how carriers approach declaratory judgment actions, Frank’s Casing will force carriers, insureds and defense counsel to re-evaluate how they address many settlement issues.

How far will this go to chill settlement discussions between carriers and the insured, defense counsel and carrier, etc., is hard to discern. But it will change things? Possibly dramatically.

Brian S. Martin, a partner in the Insurance and Coverage Section of the Houston office of Thompson, Coe, Cousins & Irons L.L.P., has extensive experience in insurance coverage and defense matters. Martin is a frequent author and CLE speaker on insurance topics, including coverage and bad faith issues.