Why it matters: Is California's Cumis rule applicable in Nevada? According to the Nevada Supreme Court, the answer is yes. The issue arose in the context of an insurer's refusal to provide independent counsel to an insured who allegedly injured other guests at a party. In the ensuing coverage litigation, a federal court judge in Nevada certified a question to the Nevada Supreme Court asking whether insurers must provide independent counsel for insureds à la San Diego Navy Federal Credit Union v. Cumis Insurance Society. The court answered in the affirmative: "We conclude that Nevada law requires an insurer to provide independent counsel for its insured when a conflict of interest arises between the insurer and the insured," the court wrote. "Nevada recognizes that the insurer and the insured are dual clients of insurer-appointed counsel. When the insured and the insurer have opposing legal interests, Nevada law requires insurers to fulfill their contractual duty to defend their insureds by allowing insureds to select their own independent counsel and paying for such representation." The rule is based in the state's ethics rules for attorneys, the court said, and a desire to avoid conflict of interest. Importantly, and worth noting, the unanimous court stated that insurers are obligated to provide independent counsel only when the legal interests of the insured and the insurer actually conflict and a reservation of rights letter does not create a per se conflict of interest.

Detailed discussion: Stephen Hansen was injured in an altercation with other guests while leaving a house party. As he was stopped at the gated exit of the residential subdivision, the car Hansen was riding in was rear-ended by Brad Aguilar. Hansen filed suit against Aguilar and other party guests in Nevada state court alleging negligence and various intentional torts.

Aguilar's insurer, State Farm Mutual Automobile Insurance Company, agreed to defend him under a reservation of rights. The letter specifically reserved the right to deny coverage for liability resulting from intentional acts and punitive damages.

The trial court granted summary judgment in favor of Hansen on the negligence claim after Aguilar admitted to negligently striking the other vehicle. Aguilar then agreed to a settlement with Hansen in which he assigned his rights against State Farm to Hansen.

Hansen sued State Farm in Nevada federal court, alleging that the insurer violated the state's Unfair Claims Practices Act, breached its contract with Aguilar, and breached the implied covenant of good faith and fair dealing. The federal court judge ruled that State Farm breached its contractual duty to defend Aguilar because it did not provide him with independent counsel of his choosing.

The insurance policy provided coverage only if Aguilar acted negligently, the judge noted, and did not cover intentional tortious acts. Therefore, the interests of Aguilar and State Farm were in conflict. Importing a California rule that originated in San Diego Navy Federal Credit Union v. Cumis Insurance Society, the judge said that an insurance company must provide independent counsel if its interests conflict with the insured's.

State Farm moved for reconsideration. The federal district court granted the motion and certified the issue to the Nevada Supreme Court.

The state's highest court began with Nevada's Rules of Professional Conduct for attorneys. RPC 1.7(a) states that "a lawyer shall not represent a client if the representation involves a concurrent conflict of interest." But when an insurer provides counsel to defend its insured, a conflict of interest may arise, the court said, "because the outcome of litigation may also decide the outcome of a coverage determination—a determination that may pit the insured's interests against the insurer's."

The result: the "insurer-provided lawyer will have a relationship with both the insured and the insurer, who each have legal interests opposing the other." California's Cumis rule solves this problem, requiring an insurer to satisfy its contractual duty to provide counsel by paying for counsel of the insured's choosing to avoid a conflict of interest resulting when an insurer reserves its rights to determine coverage.

What rule should apply in Nevada, the court wondered—the Cumis rule or some alternative?

Courts that have rejected the Cumis rule have not recognized the existence of a conflict of interest, instead reasoning that the sole client is the insured and counsel therefore owes a duty only to the insured, not the insurer. States that have adopted this line of thinking include Alaska, Connecticut, Hawaii, Tennessee, Virginia, and Washington.

"Nevada, in contrast, is a dual-representation state: Insurer-appointed counsel represents both the insurer and the insured," the Nevada Supreme Court said. "Because Nevada is a dual-representation state, counsel may not represent both the insurer and the insured when their interests conflict and no special exception applies. This suggests that theCumis rule, where the insurer must satisfy its contractual duty to provide counsel by paying for counsel of the insured's choosing, is appropriate for Nevada."

Several amici representing the insurance industry proposed two alternative approaches in lieu of the Cumis rule. One, the primary client model, would have counsel switch from dual-client to single-client representation as soon as a conflict arises. But this rule would be "unworkable" in a dual-representation jurisdiction, the court said, particularly in light of RPC 1.9(a), which prohibits a lawyer who has formerly represented a client in a matter from representing a client "in the same or a substantially related matter."

The second proposal, the contract model, also failed to persuade the court. With this rule, the insurer would select an insured's counsel and contractually instruct him or her that only the insured is a client. A "legitimate question whether counsel can be truly independent" existed, the court said, because the lawyer is selected by and receives compensation from someone with legal interests opposed to the lawyer's client, in violation of the spirit of RPC 1.8(f).

"In sum, Nevada, like California, recognizes that the insurer and the insured are dual clients of insurer-appointed counsel," the court wrote. "Where the clients' interests conflict, the rules of professional conduct prevent the same lawyer from representing both clients. California'sCumis rule is well-adapted to this scenario. It requires insurers to fulfill their duty to defend by allowing insureds to select their own counsel and paying the reasonable costs for the independent counsel's representation."

The court next turned to the effect of a reservation of rights and whether it creates a per se conflict of interest. Jurisdictions are divided on the issue, with some—Alaska, Arizona, Maine, and Massachusetts—applying a per se rule that a reservation of rights creates a conflict of interest between the insured and insurer-appointed counsel, while others (California, Connecticut, Maryland, Minnesota, and Oklahoma) look to the facts of the case to determine whether an actual conflict exists.

Again following the lead of California, the Nevada Supreme Court determined that a case-by-case inquiry into whether a conflict of interest exists was the best approach. The standard for trial courts when deciding whether a conflict of interest exists looks to the state's ethics rules for attorneys, and for independent counsel to be required, "the conflict of interest must be significant, not merely theoretical, actual, not merely potential."

"Therefore, even when (1) there is a reservation of rights and (2) insurer-provided counsel has control over an issue in the case that will also decide the coverage issue, courts must still determine whether there is an actual conflict of interest," the Nevada Supreme Court wrote. "This means that there is no conflict if the reservation of rights is based on coverage issues that are only extrinsic or ancillary to the issues actually litigated in the underlying action."

This approach is the most compatible with Nevada law, the court concluded. "We have held that dual-representation is appropriate as long as there is 'no actual conflict,'" the court wrote. "Moreover, because theCumis rule derives from rules of professional conduct, it follows that the appropriate standard is whether there is an actual conflict under RPC 1.7. Therefore, an insurer is obligated to provide independent counsel of the insured's choosing only when an actual conflict of interest exists. A reservation of rights does not create a per se interest."

To read the opinion in State Farm Mutual Automobile Insurance Co. v. Hansen, click here.