When presented with a lawsuit potentially seeking covered damages, a liability insurer owes a duty to defend and is faced with three options:1) tender the defense unconditionally and therefore control the defense, including choice of counsel; 2) refuse to defend and risk breach of contract and bad faith liability; or 3) tender a defense under a reservation of rights. Truck Ins. Exch. v. Superior Court, 51 Cal. App. 4th 985, 993-994 (1996). If the reservation is based on the development of the facts in the underlying case, so as to create a conflict of interest, the insurer must inform the insured of its right to independent counsel. Id. at 994. Timely notice to its insured of independent counsel rights allows the insurer to exercise certain rights under Civil Code § 2860, most importantly the ability to cap attorneys’ fees to be paid to those rates that the insurer actually pays to attorneys retained by it to defend similar matters in the same community where the claim arose. This provision of law, § 2860, also provides for mandatory arbitration of any fee disputes. Civil Code §2860 is a provision of law the California Legislature passed under pressure from the insurance industry following the establishment of case law allowing insureds to use their choice of counsel at market rates where the insurer’s reservation created the conflict of interest inherent in option no. 3. See San Diego Fed. Credit Union v. Cumis Ins. Society, 162 Cal. App. 3d 358 (1984).
What happens if the insurer delays responding to the tender for a defense, and effectively takes option 2 by unreasonably delaying? If the insured brings a breach of contract and bad faith suit, can the insurer rely on § 2860? We have seen insurers boldly attempt to exercise rights under § 2860, including in particular the right to arbitrate fee disputes, even in the face of a breach of contract and bad faith lawsuit. Fortunately, the Courts have held that insurers cannot have it both ways. Intergulf Development v Superior Court, 183 Cal. App. 4th 16, 22 (2010) allowed a breach of contract and bad faith case to be tried before any “rate dispute” under §2860. Obviously if the insured prevails, the insurer will not be permitted to pursue an arbitration under § 2860. After all, the statute only applies to defending insurers, not those pretending to defend! Thus an insurer that unreasonably delays paying the defense bills or refuses to appoint defense counsel runs the risk inherent in option 2: being sued for breach of contract and bad faith. See Steelcase Inc. v. Nationwide Indemnity Co., No. 2:14-cv-06291-SVW-RZ, slip op. (C.D. Cal. Feb. 10, 2015). Selecting option no. 2 is a conscious act relinquishing a known right: in essence waiving any right to the provisions of §2860.