A federal district court in California has now sharply curtailed the application of that doctrine under California law, essentially holding that because insurance defense counsel has an obligation to the insured, any potential conflict of interest between the insurer and the insured cannot affect the defense.
Centex Home is a general contractor against whom several homeowners filed lawsuits alleging construction defects. Centex sought coverage for some of the claims as an additional insured on policies Travelers Property had issued to Centex's subcontractors. Travelers agreed to defend subject to a full reservation of rights. It agreed that the attorneys already retained by Centex could continue to represent it.
Nine months later Travelers informed Centex that it would hire new counsel of its own choosing, and retained two law firms to defend Centex. Centex refused to accept those firms unless Travelers showed that they could provide a conflict-free defense. It also claimed a right to independent counsel due to Travelers' reservation of rights.
Travelers stopped paying defense costs and filed a suit for declaratory judgment on the grounds that Centex breached its duty to cooperate.
In Travelers Property v. Centex Homes, The United States District Court for the Northern District of California noted that under California statute and case law:
[a] conflict exists "when an insurer reserves its rights on a given issue and the outcome of that coverage issue can be controlled by counsel . . . retained by the insurer for the defense of the claim." . . . However, if the coverage issue is "independent of, or extrinsic to, the issues in the underlying case," then independent counsel is not required. . . . Where the interest of the insured and insurer are aligned in defending against the underlying action, a conflict does not exist."
The court held that Travelers' reservation of rights did not give rise to a conflict of interest. One of the rights that Travelers reserved was the right to deny coverage if the damages alleged occurred outside the policy periods. Centex had asserted a statue of limitations defense in the underlying cases. It argued that Travelers would attempt to focus liability outside the policy periods, which would harm the statute of limitations defense.
The court rejected that argument because the conflict is a "merely potential" one.
[Centex] provides no evidence that [Travelers'] appointed counsel could shift the focus of liability outside of [Travelers'] policy periods. More importantly, whether damages occurred before, during, or after the policy period is a factual issue outside of counsel's control. . . . [Centex] and [Travelers] have the same interest in minimizing liability by establishing that any damages occurred at a time early enough for the statute of limitations defense to apply.
Furthermore, any counsel [Travelers] appoints also has legal and ethical obligations and a fiduciary duty to [Centex]. . . . Although [Travelers] might have an interest in continuing an investigation into its potential for coverage, this is irrelevant to the ability of [Travelers'] appointed counsel to control the issue of when any covered liability occurs.