Insurers navigating the sometimes unsettled waters regarding California’s independent counsel, or Cumis counsel, doctrine received helpful guidance this week from the Sixth Appellate District of the California Court of Appeal. Under California law, an insured may be entitled to independent counsel in the defense of an underlying claim when an insurer “reserves its rights on a given issue and the outcome of that coverage issue can be controlled by counsel first retained by the insurer for the defense of the claim[.]” Civ. Code § 2860(b). But, determining whether a given reservation of rights gives rise to independent counsel is not always an easy task. In Federal Insurance Company v. MBL, Inc. (2013) __ Cal.App.4th __ (Case Nos. H036296 & H036578), the Sixth District affirmed declaratory and money judgments in favor of multiple insurers in a dispute over whether the insured (“MBL”) was entitled to independent counsel in the defense of certain underlying environmental pollution cases against the insured. In reaching its conclusions, the Court found in favor of the insurers in several areas that had not been previously addressed by California appellate authority.

The Court rejected MBL’s theory that a “general” reservation of rights gives rise to a conflict of interest requiring independent counsel, holding general reservations “create a theoretical, potential conflict of interest—nothing more.” This holding confirms existing California law. Dynamic Concepts, Inc. v. Truck Ins. Exchange (1998) 61 Cal.App.4th 999. From this proposition, the Court went on to explain that MBL cannot “manufacture” conflicts of interest based on a “general” reservation where the insurer did not reserve specific rights. As a result, MBL could not claim a conflict of interest arose under the “qualified pollution exclusions” in the insurers’ policies or based on the “number of occurrences” when the insurers did not specifically reserve those rights in response to the insured’s tender.

From there, the Court of Appeal addressed several issues of first impression. The Court held that an insurer’s reservation of rights regarding its absolute pollution exclusion does not give rise to independent counsel because whether the underlying claim is the result of a governmental clean-up order or action is not a fact that defense counsel can control. “Either the loss arose out of a government claim to remediate pollution or it did not, and there is nothing which counsel, whether retained or independent, could do to change the answer to that question.” This is the first California decision addressing an absolute pollution exclusion in the independent counsel context.

Perhaps the most significant holding relates to the insurers’ reservation on whether there was “property damage during the policy period.” This is a common reservation for insurers, and MBL alleged that assigned defense counsel can control whether the alleged environmental property damage took place during the insurers’ policy periods, thereby shifting the insured’s liability to uncovered or self-insured periods. Relying on the rationale in Blanchard v. State Farm Fire & Casualty Co. (1991) 2 Cal.App.4th 345, the Court held that the timing of property damage is not something that defense counsel could control in the underlying case, and therefore, this reservation did not give rise to a conflict of interest. This is also the first time a California appellate decision has directly addressed this reservation.

In yet another first, the Court rejected MBL’s argument that insurers’ defense of other insureds in the same underlying action gave rise to a conflict of interest, holding that MBL “failed to present evidence below to show that the Insurers’ representation of other parties in the [underlying] action gave rise to a ‘significant, not merely theoretical, actual, not merely potential’ conflict of interest.” The court distinguished O’Morrow v. Borad (1946) 27 Cal.2d 794, a case involving two insureds of the same insurer suing each other for negligence arising out of an automobile accident. The Sixth District rejected MBL’s arguments based on O’Morrow, noting that California negligence law has significantly changed since 1946 and that this change in law eliminated the incentives of the insurer at issue in that case. In contrast, the insurers here had no incentive to shift liability from one insured to another because ultimately the insurers would potentially be obligated to indemnify all of their insureds. In the environmental context, it is common for insurers to have multiple insureds involved in the same underlying case, and the Court’s decision holds for the first time that an insurer can defend its multiple insureds without giving rise to a conflict of interest requiring independent counsel.

Finally, in addition to providing guidance for the first time on multiple reservations, the Court put teeth into the independent counsel doctrine by upholding an insurer’s money judgment. One of the insurers had paid independent counsel while the parties sought declaratory relief on whether MBL was entitled to independent counsel in the first place. The Court held that where an insured insists on independent counsel but is ultimately not entitled to it, a defending insurer can seek reimbursement for those fees from the insured. In other words, if an insured insists that a conflict of interest exists such that it has the right to independent counsel and it is later determined that no such conflict existed, a defending insurer that paid independent counsel’s fees can recover those fees from the insured. This may be one of the most important aspects of this decision because it puts insureds and their independent counsel on notice that being wrong on the independent counsel issue will have potentially significant financial consequences.

In sum, the Sixth District’s decision provides important guidance to insurers regarding the complexities of the independent counsel doctrine in California. And, by affirming a money judgment in favor of an insurer that paid independent counsel, the decision also creates a significant financial disincentive for insureds to try to manufacture conflicts of interest in the future.