Recently, once again, a California appeals court weighed in on the scope of the right to Cumis counsel and the meaning of Cal. Civil Code §2860. St. Paul Mercury Insurance Company v. McMillin Homes Construction, Inc., decision holds when a conflict of interest exists between an insurer and its insured arising out of possible non-coverage under the insurer’s policy, the insurer is obligated to offer independent counsel to the insured, which is to be paid for by the insurer.

The classic example of an asserted conflict of interest, giving rise to a demand by an insured for independent counsel, is a complaint alleging the insured’s liability results from intentional or negligent conduct. The expected or intentional acts exclusion, however, is not usually a bar to a defense obligation.[2] This conundrum is nothing new in California.

While the Cumis decision is from California and is a California principle, most states have their own rules, either codified by statute or case law, of when an insurer’s reservation of rights to contest insurance coverage triggers the insured’s right to independent counsel. At a minimum, Professional Rules of Conduct address conflicts of interest where an attorney has multiple clients or where a third party is paying the attorney to represent a client which is at the core of the reasoning for the insured’s right to independent counsel.

In the McMillin Homes matter, St. Paul sought a declaration that (1) St. Paul has the right to control the defense in the underlying construction defect action; (2) McMillin is not entitled to the appointment of independent counsel under Cal. Civil Code §2860; (3) McMillin breached the Policy by refusing to acknowledge St. Paul’s right to control the defense, including the selection of counsel, and (4) St. Paul has no obligation under the Policy to pay any fees or costs incurred by McMillin’s retained counsel.

In a district court opinion granting St. Paul’s motion for summary judgment, the court reiterated that “not every conflict of interest entitles an insured to insurer-paid independent counsel.” Id. at *5. Here, St. Paul accepted the tender of its additional insured, McMillian Homes, under its general liability policy issued to McMillian’s subcontractor, Executive Landscape, Inc. St. Paul assigned defense counsel; however, McMillian rejected appointed counsel and requested that St. Paul McMillian’s already-retained counsel continue as independent counsel under Civil Code §2860. McMillian argued that “ ‘St. Paul has every incentive to minimize Executive Landscape’s liability only, and it could do this through counsel it retained.’ ” Id. The court found that McMillian’s “theoretical incentives” against St. Paul to manipulate the litigation do not cause a conflict of interest requiring independent counsel under Cal. Civil Code §2860. The court noted that McMillian failed to present any evidence to support its contention and reiterated that the “conflict of interest must be ‘significant, not merely theoretical, actual, not merely potential’ ”. Id., citing James 3 Corp. v. Truck Ins. Exchange, 91 Cal.App.4th 1093, 1101 (2001).

The district court’s ruling in fact follows a prior published decision where the California Court of Appeal unanimously refused to hold that that the interests of the insurer and the subcontractor were “irreconcilably adverse” to each other so as to allow Centex the right to independent counsel.[3] Instead, California Courts have consistently held that an insurer that appoints counsel must prove that the appointed counsel could not impact the coverage by the manner in which the defense is handled. In contesting an insured’s request for independent counsel, the insurer must make a showing as to how the issues presented by its reservation of rights differ from or are extrinsic to those issues that develop in the underlying action.[4]

Under California law, the existence of a conflict of interest entitling the insured to independent counsel is a question of law.[5] California Civil Code §2860 specifically refers to the conflict of interest created by the carriers’ reservation of rights. There is no right to Cumis counsel in a vacuum. Accordingly, it is imperative that the insurer understand fully the facts of the loss and the case law that may control the insured’s right to independent counsel before issuing a reservation of rights. Alternatively, a carrier may also waive coverage defenses and avoid providing independent counsel. Caution should be undertaken in doing so, however, because the waiver of the coverage defense as to the insured (to avoid independent counsel) may also operate as a waiver of the right to assert that same coverage defense against the plaintiff in a subsequent direct action to recover a judgment.[6] However, where the reservation of rights letter only asserts, as a basis for non-coverage, damages or exclusions which cannot be controlled by defense counsel, there is no per se conflict of interest. See Centex Homes v. St. Paul Fire and Marine Ins. Co., supra 237 Cal.App.4th at 31.