On August 26, 2013, the California Court of Appeal, in Federal Insurance Co. v. MBL, Inc., H036296, H036578, 2013 WL 4506149 (Cal. Ct. App. Aug. 26, 2013) (MBL), upheld the trial court’s decision that the insurers did not have to pay for defense counsel of the policyholder’s choosing, in the absence of an actual conflict of interest.

In MBL, the policyholder tendered to its insurers the defense of third-party actions alleging groundwater contamination that was traced to a dry cleaning facility to which the policyholder supplied dry cleaning products.  Id. at *1.  The insurers accepted the tender of defense, subject to reservations of various rights and retained counsel to represent the policyholder.  Id. 

MBL refused to accept retained counsel, arguing that the insurers’ reservation of rights created a conflict of interest, and it demanded that the insurers instead pay for counsel of its choosing.  Id. at *1-*2.  The insurers denied that there was a conflict of interest and filed an action, seeking a declaration that they were not obligated to provide independent counsel to MBL.  Id. at *4.  The trial court granted summary judgment in favor of the insurers.  Id. at *5.  It held that neither the specific reservations of right, nor the general reservation of rights to deny coverage, presented a conflict of interest which would require the appointment of independent counsel.  Id.

On appeal, the court began its analysis by noting the general rule established in San Diego Navy Federal Credit Union v. Cumis Insurance Society, 162 Cal. App. 3d 358 (4th Dist. 1984), that if a conflict of interest exists between an insurer and its insured, based on possible noncoverage under the insurance policy, the insured is entitled to retain its own independent counsel at the insurer’s expense.  MBL, 2013 WL 4506149, at *6.  The court also discussed California Civil Code Section 2860, which “clarifies and limits” the rights and responsibilities of insurer and insured set forth in Cumis Id. (citations omitted).   The court noted that both statutory and case law make clear that not every conflict of interest triggers an obligation on the part of the insurer to provide the insured with independent counsel at the insurer’s expense.  Id. at *7.  For example, the mere fact that the insurer disputes coverage does not entitle the insured to Cumis counsel, nor does the fact that the complaint seeks punitive damages or damages in excess of policy limits.  Id.  Rather, the insured’s right to independent counsel depends on the nature of the coverage issue, as it relates to the issues in the underlying case.  Id.  Thus, “[w]here the reservation of rights is based on coverage issues which have nothing to do with the issues being litigated in the underlying action, there is no conflict of interest requiring independent counsel.”  Id. (citation omitted).  By contrast, independent counsel is required where there is a reservation of rights and the outcome of the coverage issue can be controlled by defense counsel.  Id.

The court then turned to the application of these general rules to the arguments raised by MBL.  MBL first argued that the existence of qualified pollution exclusions in some of the policies created a conflict of interest, since the insurers would have an interest in developing facts establishing that any discharge of pollutants was neither sudden nor accidental.  Id. at *8. The court rejected this argument, pointing out that the insurers did not raise a specific reservation of rights as to this exclusion.  Id.  It further rejected, as “unavailing,” MBL’s argument that the insurers, “by way of including a general reservation of rights in their letters, somehow incorporated specific reservations of rights on their respective qualified pollution exclusions.”  Id.  (emphasis in original).

The court also rejected the argument that the reservation of rights by one insurer based on the absolute pollution exclusion entitled MBL to independent counsel.  Id.  The court noted that whether the absolute pollution exclusion barred a claim arising out of MBL’s activities was not an issue that would be litigated in the underlying actions and was not an issue on which defense counsel could influence the outcome of the coverage issue.  Id.  It observed that “[e]ither 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.”  Id.

MBL next argued that independent counsel was justified because there was a conflict over whether its liability arose out of only one accident or occurrence.  Id. at *9.  However, the insurer whose policy contained the language cited by MBL had not reserved its rights concerning the number of occurrences.  Id.  Moreover, the number of occurrences was not at issue in the underlying action.  Id.  The court thus again held that “[w]ithout an express reservation of a right under the policy, there can be no conflict of interest based on the application of that exclusion or policy term during the pendency of the action.”  Id.

MBL also argued that it should be entitled to independent counsel because certain of the insurers defended and insured various third parties in the underlying action who were adverse to MBL.  Id.  The court, however, agreed with the insurers that MBL presented no evidence to show that the insurers’ representation of other parties gave rise to a “significant, not merely theoretical” or “actual, not merely potential” conflict of interest.  Id. at *10 (citation omitted).  The court noted that the insurers had retained different law firms to defend MBL and the other insureds.  Id.  It further noted that “[u]ltimately, the Insurers would potentially have to indemnify all of their respective insureds against any judgment that might be entered and thus would have no incentive to shift liability among them.”  Id. 

Regarding the insurers’ reservation of rights to deny coverage for damages occurring outside of their respective policy periods, the court concluded that, “where the coverage issue in question relates only to the timing of damages, there is no conflict under section 2860.”  Id. (citation omitted).  The court noted that defense counsel could not control the issue of when damages occurred, such as when MBL delivered solvents to the dry cleaning facility or when seepages and resulting environmental contamination occurred.  Id. at *11.  The court further noted that the timing of alleged damages would not be relevant to defense counsel jointly retained by multiple insurers, who together issued policies providing coverage to MBL over of period of approximately 20 years.  Id. 

Finally, the court rejected MBL’s contention that the insurers’ general reservation of rights gave rise to a conflict of interest, stating:  “General reservations are just that:  general reservations.  At most, they create a theoretical, potential conflict of interest – nothing more.”  Id. (citation omitted).   

On the basis of the above analysis, the appellate court found that MBL failed to present evidence demonstrating a triable issue of material fact on the question of whether there existed a conflict of interest under Section 2860.  Id.  It thus found that the trial court did not err in granting the insurers’ motions for summary judgment.  Id.

Regarding the one insurer that had agreed to pay the independent counsel’s fees, subject to a reservation of rights, the court dismissed, as moot, its motion for contribution from the other insurers.  Id. at *11.  However, the court noted that, because there was no obligation to pay those fees, that insurer could seek reimbursement from MBL.  Id.

The MBL ruling joins the long line of California cases that have set limitations on the general rule in Cumis, showing that policyholders do not have the right to select independent counsel at the insurer’s expense in every instance where an insurer has reserved its rights.  Rather, the parties’ respective interests must be analyzed to determine if there is a conflict of interest that puts appointed counsel in the position of “having to choose which master to serve.”  Id. at *7.  Specifically, the MBL ruling confirmed that the policyholder cannot use the insurers’ general reservation of rights to manufacture a conflict as to specific coverage defenses not specifically raised.  Id. at *8-*9.  It also confirmed that, where the coverage issue will not be litigated in the underlying action, or where defense counsel cannot control the outcome, independent counsel is not required.  Id.  In addition, this ruling shows that the fact that an insurer insures other parties in the underlying litigation does not per se entitle the policyholder to independent counsel of its choosing.  Id. at *9-*10.