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Silence is argument carried out by other means.

–Ernesto “Che” Guevara

As this blog has repeatedly documented, it can be hard for insurers to assert the attorney-client privilege in the context of bad faith litigation.  One difficulty arises in states that enforce a presumption against the privilege in bad faith suits.  In many cases, insurers need to waive the privilege, to assert a defense based on advice of counsel.  Last month, a federal court in South Carolina raised yet another problem.  In East Bridge Lofts Property Owners Assoc., Inc. v. Crum & Forster Spec. Ins. Co., No. 2:14-cv-2567 (D.S.C. June 3, 2015), the court ruled that by declaring in anaffirmative defense that it had a “reasonable basis” to deny coverage, an insurer puts attorney-client communications “at issue”and thereby waives its right to assert the privilege over correspondence with its own coverage counsel.

Unhealthy Development

In 2004, a group of developers undertook to convert rental units in 13 buildings in Mount Pleasant, South Carolina, into condominiums.  They sold the units as “fully renovated,” but the 200 residents of East Bridge Lofts claimed that the renovation left “many … building defects,” including water leaks, defective heating and air conditioning, structural issues with decks, balconies and walkways, unsuitable windows and holes hidden under exterior sidings.  The developers allegedly covered up their shoddy work by obtaining a property condition report from an unlicensed building inspector from Georgia.

An owners association sued the developers in December 2010.  One of the developers, Creekstone SC I, LLC, sought coverage from its liability insurer, Crum & Forster.  The insurer denied the claim in April 2014 and, the following month, it filed an action in state court in Texas, seeking a declaration that it had no duty to defend, indemnify or provide liability coverage.  That action was dismissed.  Thereafter, the insurer attended a mediation of the owners’ suit, but did not otherwise participate in its defense.  After trial, a jury awarded the owners association $55,000,000 in compensatory and punitive damages.

The parties to the underlying suit then brought a bad faith suit against the insurer in federal court in South Carolina.  In discovery in that case, the association subpoenaed the file of the attorney who had provided coverage advice about the underlying claim—and who also happened to be defense counsel in the bad faith suit.

Fighting Words

The insurer moved to quash the subpoena and sought a protective order, asserting that the requested materials were protected by both the attorney-client privilege and the attorney work product doctrine.  The privilege question turned on the doctrine of “at-issue” waiver.  As the court stated,

One way a party may implicitly waive the privilege is by placing a privileged communication ‘at issue’ in a case.

As this blog has shown, state laws differ over what kind of action on the part of an insurer is sufficient to put a communication “at issue.”  The court in East Bridge Lofts described that issue as “particularly nettlesome,” but it also found that South Carolina (whose law governed this issue) applies what is known as the “automatic waiverrule:

[W]here an insurer in a bad faith claim asserts as an affirmative defense that it acted reasonably and in good faith, the insurer puts at issue the evidence it had before it at the time it denied the claim, including communications with counsel relevant to its state of mind.

On that basis, the court held that the privilege as to all communications with coverage counsel that occurred before the date on which the claim was denied had been waived.

In reaching its conclusion, the court noted the “conflicting policies” between the “time honored attorney-client privilege” and the “duty of good faith and fair dealing an insurer owes to its insured.”  In this case, the court observed, the conflict was exacerbated by the fact that the insurer’s coverage counsel on the underlying claim was also its litigation counsel in the bad faith suit.

The work product issue was governed by federal law. The court declined to apply the work product doctrine on two grounds—one of which was closely related to its “at issue” analysis:

First, the documents prepared by [counsel] to aid Defendant’s coverage determination are likely not prepared in ‘anticipation of litigation.’  Further, because the insurer’s thoughts and knowledge are central to Plaintiffs’ bad faith claim, these documents are likely to be the only method by which Plaintiffs may prove their claim.

Don’t Accentuate The Affirmative

This case is a cautionary tale.  Boilerplate affirmative defenses are a staple of litigation—including bad faith litigation—and they are often asserted without much care.  But they can have serious consequences.

It has long been the rule that an insurer puts its communications with counsel at issue, thereby waiving the attorney-client privilege, when it asserts an advice of counsel defense.  Even in the absence of an advice of counsel defense, however, courts that apply the “automatic waiver” rule may find a waiver in a simple affirmation that the insurer had a “reasonable basis” for its actions.  There are sometimes valid reasons for presenting that assertion as an affirmative defense, but it is by no means necessary in every case.  East Bridge Lofts shows it should be handled with care.