San Diego Navy Federal Credit Union v. Cumis Insurance Society
208 Cal. Rptr. 494, 162 Cal. App. 3d 358, 50 A.L.R. 4th 913 (1984)
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Rule of Law:
When an insurer provides a defense to its insured under a reservation of rights, and that reservation creates a conflict of interest, the insurer has a duty to pay the reasonable costs for independent counsel hired by the insured.
Facts:
- Magdaline S. Eisenmann sued the San Diego Navy Federal Credit Union and two of its officers, J. W. Jamieson and Larry R. Sharp (the insureds), for wrongful discharge and other torts, seeking both general and punitive damages.
- The insureds were covered by a policy from Cumis Insurance Society, Inc. (Cumis) and tendered the defense of the Eisenmann action to them.
- Cumis agreed to defend the insureds and retained the law firm of Goebel & Monaghan to represent them.
- However, Cumis sent the insureds a reservation of rights letter, stating it would defend them but might not provide coverage if liability arose from willful conduct or resulted in punitive damages.
- Concerned about this conflict, the Credit Union hired its own independent counsel, the firm of Saxon, Alt & Brewer, to protect its interests.
- Cumis initially paid for the independent counsel's services but later refused to pay any further invoices, asserting that no conflict of interest existed.
- During a settlement conference in the Eisenmann action, a demand was made within the Cumis policy limits, but the Cumis-retained counsel, Goebel & Monaghan, was authorized to offer a lower amount without consulting the insureds.
Procedural Posture:
- San Diego Navy Federal Credit Union, J. W. Jamieson, and Larry R. Sharp (the insureds) filed an action against Cumis Insurance Society, Inc. in the San Diego Superior Court (trial court) to compel payment for their independent counsel.
- The trial court entered a judgment in favor of the insureds, requiring Cumis to pay all reasonable expenses of their independent counsel.
- Cumis (appellant) appealed the trial court's judgment to the California Court of Appeal. The insureds are the appellees.
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Issue:
Is an insurer required to pay for independent counsel for an insured when the insurer provides its own counsel but defends under a reservation of rights that creates a conflict of interest?
Opinions:
Majority - Gamer, J.
Yes. When an insurer defends an insured under a reservation of rights based on potential noncoverage, a conflict of interest arises that entitles the insured to independent counsel at the insurer's expense. The normal tripartite relationship between insurer, insured, and counsel breaks down because the insurer's interest in proving non-covered conduct (e.g., intentional acts or conduct warranting punitive damages) diverges from the insured's interest in establishing liability based only on covered, non-intentional conduct. The counsel retained by the insurer is placed in an ethically untenable position of serving two clients with conflicting goals, as trial strategy, discovery, and settlement decisions could be manipulated to favor the insurer's coverage position at the insured's expense. Citing Tomerlin v. Canadian Indemnity Co., the court held that in such a conflict, the insurer cannot compel the insured to surrender control of the litigation, which implicitly requires the insurer to pay for the independent counsel selected by the insured to maintain that control.
Analysis:
This landmark decision established the right to what is now commonly known in California as 'Cumis counsel.' The ruling significantly shifted the balance of power in insurance defense litigation where coverage is disputed. It affirms that an insured's right to a conflict-free, loyal defense is paramount to the insurer's contractual right to control the defense. This precedent has had a major financial and strategic impact on the insurance industry, requiring insurers to fund a separate defense counsel when reserving rights, thereby increasing litigation costs but also protecting the ethical duties of lawyers and the rights of policyholders.
