The Supreme Court of Washington, in a 5-4 decision, resolved two issues in ways that will limit insurers’ right to invoke the attorney-client privilege “in the claims adjusting process.”

First, the court established a presumption that the privilege does not protect communications about claims from subsequent disclosure in a first-party bad faith suit. Under this ruling, the privilege could still apply where it did before–to communications in which the attorney provides “counsel as to [the insurer’s]own potential liability.” But insurers will now have to make an affirmative showing (sometimes by in camera review) that the lawyer was acting in this way, rather than functioning as a claims adjustor by investigating or processing the claim.

Second, the court ruled that the “fraud exception” to the attorney-client privilege does not require a showing of “actual fraud”: For purposes of the exception, a bad faith attempt to defeat a meritorious insurance claim is “tantamount to civil fraud.” Consequently, even where an insurer has rebutted the new presumption and established that the privilege applies, its attorney-client communications must be disclosed, if “a reasonable person would have a reasonable belief” that “an act of bad faith . . . has occurred.” The trial court will make this determination in an in camera review. In future bad faith cases, therefore, Washington courts will be making important determinations about the merits of the underlying claim whenever issues of privilege arise, and they will do so in a way that gives a significant advantage to insured plaintiffs.

Cedell v. Farmers

The facts of Cedell v. Farmers Ins. Co. of Washington, No. 85366-5 (Wash. Feb. 21, 2013), are straightforward. A fire destroyed a large part of the plaintiff’s home. Farmers, his insurer, did not immediately pay the claim, because the plaintiff and his girl friend allegedly made inconsistent statements about possible drug abuse. Farmers hired a lawyer, Ryan Hall, to help with the coverage decision. Among other things, Hall conducted examinations under oath, and he sent the plaintiff a letter, extending a one-time offer to settle the claim at a significant discount.

The plaintiff rejected the offer and sued Farmers for bad faith. In discovery in that suit, the plaintiff requested a copy of his claim file and propounded interrogatories. Farmers redacted certain portions of the file that reflected communications with Mr. Hall, and it objected to some of the interrogatories on grounds of privilege. The ensuing motion to compel made it all the way to the Washington Supreme Court.

Is There a Privilege at All?

In that court, the dispute sparked a controversy over the basic question of whether an insurer may invoke the attorney-client privilege in a first-party claim for bad faith. That issue split the five-Justice majority–which announced the presumption that there is no such privilege–from the dissent, in which three Justices concurred, and which asserted, even in the context of a bad faith claim, that insurers’ consultations with attorneys “should be protected.”

After staking out these opposing positions, though, the Justices seemed to be in basic agreement about what kinds of communications the law protects. Both sides started from the premise that an insurer stands in a “quasi-fiduciary relationship” to a first-party insured. The dissent elaborated: Unlike a true fiduciary, an insurer need not put the insured’s interests ahead of its own; it must only give them “equal consideration.” The duty to the insured must also be balanced against the duty an insurer owes to shareholders and other policyholders “not to dissipate its reserves” by paying meritless claims.

The dissent, by Justice Alexander, found this balance dispositive: “Given that an insurance company is entitled to give equal consideration to its own interests, it follows that it should be entitled to consult with counsel regarding its obligations under its policies”–and that those consultations should be privileged.

The majority’s opinion, by retiring Justice Tom Chambers, did not address these arguments directly, but focused instead on the degree to which lawyers’ advice is often entangled with the merits of a bad faith claim. The majority concluded: “[P]ermit[ting] a blanket privilege . . . because of the participation of lawyers . . . would unreasonably obstruct discovery of meritorious claims and conceal unwarranted practices.”

By Diverse Means We Arrive at the Same End

The dissent’s position was that communications between an insurer and its attorney “regarding [the insurer’s] obligations under its policies” are privileged. The majority ruled that those communications are presumed not to be privileged in a first-party bad faith claim. But the majority also held that that the presumption can be rebutted, if an in camera review establishes that

[the] attorney was not engaged in the quasi-fiduciary tasks of investigating and evaluating or processing the claim, but instead in providing the insurer with counsel as to its own potential liability; for example, whether or not coverage exists under the law.

It appears, therefore, that all of the Justices believe legal advice about the availability of coverage can be privileged, even in the context of a first-party bad faith action. Their disagreement is limited to how the privilege should be established.

What Now?

Prior Washington case law doesn’t provide much guidance on how to draw the line between “investigating and evaluating or processing” a claim and providing “counsel as to [the insurer’s] own liability,” and the Cedell decision shed no new light on that issue. Cedell presented a relatively easy case: The insurer’s attorney performed a number of services–conducting EUOs, negotiating with the insured–that are often provided by non-legal claims personnel. Thus, the court did not have to split hairs about whether an attorney who is asked to apply policy language to the facts of a case is providing the services of a “quasi-fiduciary” or of “counsel.” What about the attorney who is asked to assess the insurer’s liability in light of information in the insured’s financial records? Or opine about an insured’s potential credibility before a jury? Or recommend a negotiating strategy for an upcoming mediation? Or suggest how large a reserve to create? (Since the case was remanded for further review in accordance with the court’s rulings, those problems might still come up.)

And what if the lawyer gives both claims and legal advice? The Cedell opinion acknowledges (in a footnote) that an attorney can act “in more than one role”; when she does, the opinion suggests that “insurers may wish to set up and maintain separate files so as not to co-mingle different functions.” That’s good advice, but it doesn’t tell anything about which folder should hold the attorneys’ summaries of witness interviews.

The ruling in Cedell didn’t create, or even deepen, this uncertainty. But now that all attorney-client communications are presumed not to be privileged in the first-party, bad faith context, these border regions are likely to be explored extensively.

Wait. It Gets Worse.

Oh, and there’s something else. Both the majority and the dissent agreed that the attorney-client privilege is subject to exceptions, such as the “fraud exception.” And both opinions agreed that the exception applies to cases in which there has been no “actual fraud.” The dissent opined that “[e]ngaging an attorney . . . to further the bad faith denial of insurance coverage represents an abuse of the attorney-client privilege.” The majority went further, stating that “[i]f an insurer engages in bad faith in an attempt to defeat a meritorious claim, bad faith [is] tantamount to civil fraud.”

Consequently, where a plaintiff asserts that his insurers’ attorney-client communications are subject to the fraud exception, Washington courts must conduct an in camera review to determine whether “a reasonable person would have a reasonable belief that an act of bad faith has occurred.” If so, “the attorney-client privilege shall be deemed to be waived.”

If a coverage claim presents difficult questions, it’s usually a good idea to get an attorney involved. There’s always a risk that the attorney’s records might be discoverable in a subsequent bad faith case, but that only means they have to be created and maintained with the same care that applies to the rest of a claim file.

Cedell modifies these circumstances by giving every first-party, bad faith plaintiff a right to ask the court for an in camera review of the insurer’s file, to determine whether it supports the plaintiff’s claim on the merits. If the court upholds the insurer’s privilege, the plaintiff will usually not have lost ground, since her case probably does not depend on the contents of documents that have traditionally been privileged. But if the court orders the records produced, because it finds that “a reasonable person would have a reasonable belief that . . . bad faith has occurred,” it is hard to see (for example) how the court could later grant summary judgment to the insurer. At very little risk to her own position, the plaintiff will have gained significant leverage in dealing with the insured for the rest of the case.

In this way, Cedell gives insurers a reason to hesitate before consulting a lawyer about a problematic claim. Since the court’s majority’s opinion sought a balance between the need for liberal discovery with the right of a client “to fully inform their attorneys of all relevant facts without fear,” this is probably not the result they intended.