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When does an insurer have a duty to appoint independent counsel?

On Behalf of | Aug 3, 2022 | Insurance Recovery |

This was one issue decided in a recent ruling issued by the Central District of California. In this particular case, L.A. Terminals v. United National Insurance Company, there were a complex set of claims and cross-claims in both state and federal court. But the facts that supported an insured’s right to independent counsel were simple, as were the consequences of the insurer’s failure to do so.

A Brief Overview of The Facts

United National Insurance Company issued three successive commercial general liability policies to L.A. Terminals in the early 80’s. The City of Los Angeles was an additional insured under each of the policies.  Like most such policies, they each obligated United to defend its insureds in instances where they are sued for claims that at least potentially include alleged property damage. Each policy also included a Qualified Pollution Exclusion, which barred coverage for property damage caused by the “discharge, dispersal, release or escape” of “irritants, contaminants or pollution”.  There was an exception to each exclusion, however, for sudden and accidental “discharge, dispersal, release or escape”.

As noted, the underlying action was complex. It began when the City sued LA Terminals for alleged environmental contamination that occurred over decades at the City-owned Marine terminal and chemical storage facility operated by LA Terminals. In May 2018, LA Terminals asked United to defend it against the City’s lawsuit, but United denied coverage, citing the Qualified Pollution Exclusion.

LA Terminals cross-claimed against the City (and others). In September 2018, the City, as an additional insured under LA Terminals’ United policies, also asked United to defend the City against LA Terminals’ cross-suit.  Ironically, given its refusal to defend LA Terminals in the very same case, United agreed to defend the City.

At this point, the liability case spun outward, leading to the inclusion of multiple other parties, many of which cross-claimed against each other. Further, a federal court case was filed by LA Terminals against the City and others, asserting many of the same claims. Much like the state case, the federal case also led to the inclusion of a number of other parties, many of which filed cross-claims against each other.

About a year after United refused to defend its own insured, in February 2019, LA Terminals tendered the cross-claims against it in the federal case, as well as City’s recently amended complaint in the state case. In a total reversal of its earlier denial, United withdrew its denial of coverage in April 2019 and agreed to defend LA Terminals. However, United did not reimburse LA Terminals for any of its defense fees and costs incurred during the past year (which reportedly exceeded $3 million).

Prior to April of 2019, United assigned a single adjuster to handle the claims against LA Terminals (to which it had denied coverage) and the City (which it was defending). After agreeing to defend LA Terminals, United assigned separate adjusters for LA Terminals and the City. However, the “master claims file” was sent to both adjusters. LA Terminals asked United to appoint its existing defense counsel, but United refused. United denied that LA Terminals was entitled to independent counsel.

Was United Obligated to Provide Independent Counsel?

This was one of the issues that the court looked at in this case. It concluded that United was, in fact, required to provide independent counsel to LA Terminals. The court held that there were two separate reasons why.

First, United’s insured (LA Terminals) and additional insured (City) were litigation adversaries.  United was defending both, but both had claims and cross-claims against each other.  United began by defending the City against LA Terminals’ claims and was now defending LA Terminals against the City’s claims, all arising out of the same site contamination. The court noted that United “agreed to provide a defense to adversary-insureds in direct litigation conflict, each seeking to find the other liable for all or part of the alleged contamination.”. The court held that this alone was sufficient to compel United to appoint independent counsel.

United countered, however, arguing that its decision to split the claims file between separate adjusters eliminated this conflict and, therefore, avoided the need to appoint independent counsel. The court disagreed. The court was not persuaded. It noted that United waited six months after accepting the City’s defense before splitting the file. Indeed, it was not “until United agreed to defend [LA Terminals] as well that it finally split the claim file. Throughout this time, a single claims handler … handled the unified file and when the file was eventually split, [he] sent the “master files”—including an attorney’s claims assessment report—to both new adjusters.”

Second, United reserved rights on the Qualified Pollution Exclusion. The court held that this reliance triggered LA Terminals’ right to independent counsel. The court reasoned that the “claims and cross-claims put the nature of the alleged contamination at issue in the Underlying Actions, including whether and to what extent [LA Terminals] may be liable. Thus, by controlling [LA Terminals’] defense, United would have the ability to direct a more vigorous defense against a liability theory based on ongoing, deliberate pollution (which precludes … coverage) versus sudden, unexpected contamination (which [is] cover[ed]). Therefore, United’s appointed counsel could control the outcome of the very issue on which United has reserved the right to withdraw [LA Terminals’] defense. This conflict of interest warrants independent counsel.”

A Complex Conclusion

The underlying case is unquestionably complex. But the insured’s right to independent counsel was straightforward. United, its insurer, could not control the defense of two insureds who were each alleging that the other was responsible for the same contamination.

Further, by reserving rights on the Qualified Pollution Exclusion in its policies, United also created a conflict, because it would be motivated to use defense counsel to prove that the contamination was long-term, whereas the insured’s appointed counsel would want to prove that it was sudden and accidental. Such is the classic recipe for the trigger of an insured’s right to independent counsel.

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