In a case of first impression, a California District Court has ruled that California law does not preclude an insured from retaining multiple law firms as independent or Cumis counsel where the insurer is defending under reservation of rights. The court’s ruling came in the case of Signal Products v. American Zurich Insurance Company, et al., U.S. District Court, Central District of California No. 2:13-cv-04581 – CAS-AJWx.

The Signal Products court was called upon to interpret California Civil Code §2860 in the context of cross-motions for summary judgment between American Zurich Insurance Company (Zurich) and its insured Signal Products, Inc. (Signal), the defendant in a trademark infringement action. Zurich had agreed to defend Signal under reservation of rights and consented to Signal’s retention of independent counsel.

Background

Exercising its right to independent counsel, Signal retained two firms to defend it with respect to the trademark litigation. Signal asserted that the two firms “divided up responsibilities” and in effect were “acting as one large law firm.” Zurich reimbursed the fees incurred by the first firm but for various reasons denied that it was obligated to reimburse the fees incurred by the second law firm. Signal brought suit alleging Zurich’s refusal to reimburse fees incurred by both firms breached its duty to defend, and cross-motions ensued.

Decision

No California court had previously addressed the question of whether an insured’s right to independent counsel is limited to a single law firm. The insured’s right to independent counsel at the insurer’s expense has its origin in the landmark case San Diego Navy Fed. Credit Union v. Cumis Ins. Society, Inc. (1984) 162 Cal.App.3d 358. In Cumis, the California Court of Appeal, citing California's Rules of Professional Conduct, held that where a potential conflict of interest arises, an insurer is contractually obligated to pay for independent counsel. In so ruling, the Cumis court reasoned as follows:

… A different situation is presented, however, when some or all of the allegations in the complaint do not fall within the scope of coverage under the policy. In such a case, the standard practice of an insurer is to defend under a reservation of rights where the insurer promises to defend but states it may not indemnify the insured if liability is found. In this situation, there may be little commonality of interest. Opposing poles of interest are represented on the one hand in the insurer's desire to establish in the third party suit the insured's ‘liability rested on intentional conduct’ (Gray, supra, 65 Cal. 2d 263, 279), and thus no coverage under the policy, and on the other hand in the insured's desire to ‘obtain a ruling … such liability emanated from the nonintentional conduct within his insurance coverage’ (ibid).”

The Cumis decision was subsequently codified by California Civil Code §2860, which provides, in pertinent part, that “If the provisions of a policy of insurance impose a duty to defend upon an insurer and a conflict of interest arises which creates a duty on the part of the insurer to provide independent counsel to the insured, the insurer shall provide independent counsel to represent the insured …” [Emphasis added]

In considering this provision here, the Signal Products Court noted that the text of §2860 does not define “independent counsel” and does not specify whether the insured is entitled to select multiple independent counsel. Nor does §2860 specify whether “independent counsel” refers to individual attorneys, a single law firm or multiple attorneys spread across multiple firms. The legislative history of §2860 is similarly silent on the issue.

Finding no help from the statutory language, the District Court turned to the case law, citing numerous reported decisions routinely finding that law firms comprising multiple attorneys may serve as Cumis counsel: “Having accepted that multiple attorneys may serve as Cumis counsel, there does not appear to be any principled grounds for requiring as a matter of law that all of those attorneys need to be employed by the same law firm. Certainly, §2860 does not impose such a requirement …” Accordingly, the Court held that §2860 did not, as a matter of law, preclude the use of two firms as Cumis counsel.

Significantly, however, the Court did not grant summary judgment to Signal. Instead, it ruled that an insured’s retention of a second law firm must be both “reasonable and necessary.” Reasonableness is generally a question of fact, not law; it was Signal’s burden to establish as undisputed fact that the retention of a second Cumis counsel was reasonable and necessary for the defense of the action – a burden it failed to carry on the record here.

The Court also stated that there was a question of fact as to whether Signal had notified Zurich that it had retained the second firm as Cumis counsel, suggesting that the insurer would not be responsible for fees incurred prior to being informed of counsel’s involvement. This is consistent with provisions of §2860 that give the insurer the right to demand that Cumis counsel meet certain minimum statutory requirements regarding professional experience and liability insurance. It appears that the Court left open the door for Zurich to argue that Signal’s alleged failure to give notice of the second law firm’s involvement precluded Zurich from exercising its rights under §2860 to consent to Cumis counsel.

Finally, the Signal Products Court held that Zurich’s “No Voluntary Payments” clause did not bar reimbursement of defense fees, reasoning that by reserving its right to contest coverage Zurich had created a conflict of interest with its insured and had thereby implicitly consented to Signal’s hiring independent counsel and therefore consented to the expense of independent counsel.

Practice Pointer

The holding in Signal Products that Civil Code §2860 does not preclude the retention of multiple firms as Cumis counsel is not particularly surprising for one simple reason: It is frequently necessary for the insured to retain counsel with specialized expertise to assist in the defense of complex litigation. The key “takeaway” from the Signal Products ruling is that the insured bears the burden of proving that the retention of a second firm and the fees charged by that firm were both “reasonable and necessary” to the defense. “The insurer’s obligation to defend extends to paying the reasonable value of the legal services and costs performed by independent counsel, selected by the insured.” Executive Aviation Inc. v. National Ins. Underwriters, 16 Cal. App, 3d 799, 810 (1971).

Among the factors a court will likely consider in determining whether the fees charged by a second firm acting as independent counsel were both “reasonable and necessary” are:

  • Whether the fees and costs were incurred subsequent to the tender of defense to the insurer
  • Whether the insurer was given notice of the second firm’s involvement as independent counsel before it incurred fees or costs for which the insured seeks reimbursement
  • Whether there is a demonstrable need for dividing the defense between multiple firms, including the magnitude of the litigation; the complexity and novelty of the legal issues presented; and whether the additional firm brings some specific capability or expertise to the table that may not be provided by the first independent counsel
  • Whether the multiple firms acting as independent counsel have implemented effective procedures to minimize duplication of efforts and redundant charges
  • Whether both firms have adequately documented their efforts through sufficiently detailed billings that demonstrate that the use of multiple law firms did not increase the overall costs of providing the insured’s defense.

This inquiry is inherently fact-sensitive and will need to be resolved on a case-by-case basis.