Insurers faced with the question whether a claim is covered under the insurance policy they issued often retain coverage counsel to assist in answering that question, and communicate with that counsel on the merits and weaknesses of the insurer's coverage position. Often, the issue of whether an insurer properly investigated and evaluated coverage turns on whether it sought and followed the advice of coverage counsel. Insurers generally engage in such communications with their coverage counsel under the assumption that the communications and the attorneys' work product are protected from discovery.
The Traditional Rules of Privilege
Both federal and state court law governing discovery in lawsuits have historically recognized that communications between attorneys and their clients created for the purpose of providing legal advice are privileged and exempt from disclosure.1
In addition, courts have historically recognized that an attorney's work product, when prepared in anticipation of litigation, is generally exempt from disclosure (absent extenuating circumstances, such as unavailability of the factual information contained in it from other sources).2 The attorney work product doctrine requires that there be a specific threat of litigation for the particular claim in issue, such as is created when an insured whose claim is denied retains counsel who threatens litigation if the denial of coverage is not withdrawn or the claim paid.
These traditional protections from discovery of attorney-client communications and attorney work product have often been applied when the client is an insurer and the attorney at issue is its coverage counsel providing legal advise to assist the insurer in determining whether a claim is covered.3 These protections, however, are not unlimited.
Exceptions to Privilege
Recent decisions by courts in several jurisdictions around the country give warning to insurers and their coverage counsel that they cannot always assume that their communications, and attorney investigations contained in insurers' files, will be protected from discovery by insureds whose claims have been denied or otherwise not handled as the insured deemed appropriate. Once a coverage issue turns into coverage litigation, particularly one including a bad faith claim, there are circumstances in which courts have ordered insurers and their coverage counsel to produce their communications and investigations. Such rulings have generally centered on circumstances in which (a) the insured and insurer have a "common interest"; (b) the insurer puts in issue the "advice of counsel" when defending a coverage or bad faith action; (c) the counsel acted as a claims-handler performing a business function rather than as legal advisor performing a legal function; (d) there is a bad faith claim and the attorney communications or work product documents are pertinent to whether the insurer's investigation and denial of a claim was proper; or (e) a combination of these prior factors is alleged. These exceptions to the traditional rules of privilege, as espoused in recent court decisions, are discussed below.
The Common Interest Exception
The common interest doctrine protects privileged communications between parties and their attorneys where a joint defense has been undertaken to bring about a common goal. When there is such a "common interest," disclosure of the otherwise privileged communication to either party is not considered to be a waiver of the client's privilege. This doctrine has been used by insureds to gain access to insurer communications with its counsel, under the theory that if the insurer and insured have a common interest in an issue, then when an insurer retains counsel to provide legal advice on that issue, both insurer and insured are entitled to access to the attorney's advice and investigation. Should a dispute develop between the insured and the insurer, the communications with counsel that occurred before the dispute developed are not protected from disclosure to the insured.4
Based on this principle, for example, an Illinois appellate court upheld the discovery by an insured of the communications between an insurer and its coverage counsel, who was retained to advise the insurer on the settlement of claims pending against its insured.5 After being advised by coverage counsel, the insurer settled some of the claims at issue, paying out its full policy limits. The insurer later retained separate counsel to defend the insured in further pending claims, and simultaneously filed its own suit against the insured seeking a declaration from the court that, because its policy limits had been exhausted, it had no further duty to defend or indemnify the insured. The court held that the insurer's communications with its coverage counsel as to the settlements were not privileged and should be disclosed to the insured in the coverage litigation. The court reasoned that coverage counsel gave advice on settling a claim asserted against the insured, a goal in which the insured and insurer shared a common interest, and thus the requested materials were prepared for the mutual benefit of the insured and insurer. Significantly, the court noted the lack by the insured of its own counsel at the time the coverage opinion in issue was obtained, indicating that a different result may have ensued if the insured had its own counsel advising it on the settlements. Moreover, the insured had raised the issue of whether the settlements were made in good faith.
The "common interest" can terminate during the course of a matter. A denial of coverage, and some (but not necessarily all) reservations of rights by an insurer, generally break the common interest between insurer and insured at least as to those issues on which a denial is based or reserved. Once the interests of the insured and insurer become adverse, the common interest doctrine no longer applies.6 Thus, an insurer seeking to defeat a request by an insured for its communications with coverage counsel on the grounds of common interest needs to demonstrate that a conflicting, rather than common, interest existed at the time of the communication or document at issue.
The Reliance on Advice of Counsel Exception
Privileges that protect a communication or document from discovery can be waived by the client. This waiver can occur when the client that has the privilege puts the protected information in issue through some affirmative act for its own benefit.
This situation can occur when an insurer engages in coverage litigation with its insured and justifies its denial of the insured's claim as being on the advice of coverage counsel – rather than based upon its own assessment of the claim. Having put the opinion of its coverage counsel in issue, the insurer may be faced with a court order to provide that coverage opinion and the work product on which it was based to the insured in the coverage action disputing the propriety of that denial of coverage.7 Some courts deem it unfair to allow the client (the insurer) to assert the advice of counsel to justify its actions, but then assert that its adversary (the insured) is not entitled to review that counsel's advice because it is privileged. Others recognize the principle, but will apply that exception to attorney-client privilege only when the contents of the legal advice is integral (and not merely relevant) to the outcome of the claim at issue.8
This does not mean that every coverage opinion will be discoverable whenever there is coverage litigation. The mere fact that there were communications between an insurer and its coverage counsel with regard to whether a claim is covered is not necessarily sufficient, without more, to support a demand by an insured that the communications or attorney work product be disclosed should the insurer deny the claim and coverage litigation ensue. Rather, the critical factor is whether the insured, in defending its coverage determination, places in issue the advice it received from its coverage counsel by relying on that advice as justification for its denial of coverage.
The Business Function Exception
Communications between client and counsel are generally accorded a privilege only if, and to the extent that, the communication is for the purpose of facilitating or providing legal advice. Should an attorney act in a business, rather than legal, role, the communications between the attorney and the insurer, and the attorney's work product, may not be granted the protections from discovery accorded documents created as part of the process of providing legal advice.9 Courts are often suspicious of perceived attempts by companies to try to shield from discovery documents that are actually prepared as part of the company's regular business function, by having that function performed by an attorney. Where the line is drawn between protected attorney communications and work product prepared for the purpose of providing legal advice, and communications and investigations that are for the ordinary business purpose of claim investigation and evaluation, can vary among different jurisdictions and depend on the specific document and circumstance in issue.
Assisting in the evaluation of a claim with coverage issues is often an important part of the services for which an insurer retains counsel. Insurers, however, should be aware that a court may scrutinize whether that attorney is acting not as counsel, but rather is performing the business function of a claims handler. As noted by a New York court,
whether material generated by counsel while investigating an insurance claim in the pre-litigation state is protected work product has been hotly contested …. However, the determination to pay (or, more often, not to pay) on an insurance claim has often been held to be a routine business function, even if performed by outside counsel …. When an investigation conducted by counsel crosses the line from business-centered (and un-protected) to litigation-centered [and protected] is a question of fact that must be determined on a case-by-case basis.10
In sum, if information regarding a factual investigation would be discoverable if conducted by the in-house claims handler, an insurer cannot shield it from discovery by using outside counsel to conduct the investigation.
Courts in Illinois consider whether documents created by coverage counsel were done so as part of the insurer's general course of business of investigation and payment of a claim – in effect created before there was any coverage position asserted by the insurer.11 If so, they tend to consider that a business document not entitled to protection.12 Moreover, when the issue is whether the attorney work product doctrine will apply to protect the document from disclosure, some courts look to the date the insurer denied coverage as the point when documents may be deemed to be created in anticipation of litigation and thus protected work product.
Thus, to minimize the risk of being directed to produce counsel communications and work product, insurers and their coverage counsel should make clear in their communications with each other that the counsel's role is to provide legal advice to the claims handler, rather than to function as a claims handler.
The Bad Faith Exception
Bad faith litigation is the forum in which an insurer's attorney-client communications and the work product of its counsel contained in the insurer's files appear to be most susceptible to discovery by the insured.
In Ohio, one of the jurisdictions most aggressive in recent years in ordering disclosure, the Ohio Supreme Court has stated that claim file materials showing an insurer's lack of good faith are "unworthy of protection" – including the insurer's communications with its coverage counsel in those files. In a series of decisions, Ohio courts limited the protection provided by the attorney-client privilege and work product doctrine in the context of bad faith actions, holding such documents to be pertinent to the issue of whether the insurer acted in good faith in handling its claims.13 In response to an insurer's argument that orders directing discovery of an insurer's communications with coverage counsel would discourage insurers from seeking legal advice, the Supreme Court of Ohio noted that "this argument is not well taken because it assumes that insurers will violate their duty to conduct a thorough investigation by failing, when necessary, to seek legal counsel regarding whether an insured's claim is covered under the policy of insurance, in order to avoid the insured late having access to such communications, through discovery."14
The Ohio Supreme Court, however, has distinguished between documents created during coverage investigation and prior to denial of the claim, which it directed be produced, from attorney documents prepared after coverage was denied, which were protected as created after a point in time when litigation with the insured was to be reasonably anticipated.15
An Ohio intermediate appellate court has extended discovery to include an insurer's files and its attorney communications with regard to claims in which the insurer did not deny coverage and ultimately paid the claim. The court noted that an insurer can exhibit bad faith in its claims handling and processing of the claim even when it does not deny a claim.16
Florida courts are also wrestling with the issue of an insured's ability to obtain an insurer's communications with its coverage counsel and that counsel's work product in the context of bad faith litigation. As in Ohio, the courts in Florida have noted that an insurer's entire claim file is evidence as to whether the insurer's handling of a claim was proper. In such cases, "the pertinent issue is the manner in which the company has handled the suit including its consideration of the advice of counsel so as to discharge its mandated duty of good faith…."17 However, while the Florida Supreme Court has upheld broad discovery of attorney work product (e.g., investigations) in bad faith actions, the issue of the discoverability of an insurer's communications with its counsel is still to be definitively addressed. In March 2007, the Florida Supreme Court heard argument on the issue, and a decision is pending.18
However, even courts upholding the propriety of insureds' broad demands for discovery of insurer files in bad faith actions have held that a court should not simply direct that entire files containing otherwise privileged information be turned over to an insured. Rather, the court should conduct an in camera review of the documents to determine the "critical issue" of whether the documents "may cast light on bad faith on the part of the insurer."19 Attorney-client communications and attorney work product contained in such files that do not reflect on that issue are not discoverable by the insured.20 Insurers faced with a demand for files that include attorney-client communications and attorney work product documents in litigation with their insured in jurisdictions that tend to uphold such discovery demands should press the court to at least review the documents for relevance before simply ordering them produced to the insured.
Thus, whether communications between an insurer and its coverage counsel, or that counsel's work product, are discoverable in a bad faith action will likely depend on the issue on which the allegation of bad faith is based, and the venue in which it is litigated.
Once coverage litigation ensues between an insurer and its insured, broad discovery demands from insureds are increasingly routine. Many insureds engaged in coverage litigation now attempt to obtain discovery not just of claims-handler evaluations, but also of the insurer's communications with its coverage counsel and that counsel's work product. Often insureds assert bad faith claims as a hook on which to hang their demand that all documents relating to a claim, including an insurer's communications with its coverage counsel, are relevant to whether the insurer acted properly in its denial or its handling of a claim. In recent years, some courts, particularly in jurisdictions such as California, Connecticut, Florida, Illinois, Ohio, and even the relatively pro-insurer New York, have scrutinized the issue of when insurer communications with their counsel and that counsel's work product are subject to production in a coverage action or bad faith action. Several courts have held at times that insurers must produce such documents, or at least show them to the court for review and consideration for production to the insured.
Retention of coverage counsel to provide legal advice on coverage issues is an important part of insurer evaluations of complex coverage issues, and can be a defense to subsequent claims by insureds that the insurer did not adequately investigate and evaluate the coverage issues. However, court decisions such as the ones discussed here demonstrate that insurers and their counsel should be careful to delineate the role of counsel as that of legal advisor, and to word their communications with an eye toward possible discovery down the road. Both insurers and their coverage counsel have to be cautious of assumptions of protection from disclosure of their communications and files, especially when those communications occur during the investigative stages of determining if a claim is covered.