For the most part, I think most policyholder lawyers would agree that, when an insurer defends an insured without a reservation of rights, the policyholder is not entitled to independent counsel. They certainly would say it’s an uphill battle. Policyholders may argue that there are exceptions, such as insufficient limits based on the insured’s possible liability or an allegation of punitive damages. But even this argument is often rejected. Indeed, California’s Cumis statute states that “no conflict of interest shall be deemed to exist as to allegations of punitive damages or be deemed to exist solely because an insured is sued for an amount in excess of the insurance policy limits.”

But this wasn’t the case in Med-Plus, Inc. v. American Casualty Company of Reading, No. 16-2985 (E.D.N.Y. Aug. 4, 2017), where the court held that the possibility of an award of punitive damages entitled the insured to independent counsel, despite the defense being provided without a reservation of rights.

Here’s the story. Med-Plus, a medical supply company, and others, were sued by Abbott Labs, a seller of medical equipment for diabetes patients, for alleged conspiracy to import international diabetes equipment for sale in the United States. Med-Plus’s insurer, American Casualty, initially disclaimed coverage. But then a second amended complaint was filed and American Casualty determined that, based on a now re-worded trade dress claim, a defense was owed.

At first American Casualty agreed to provide a defense under a reservation of rights. The insurer agreed that Med-Plus could use its own counsel and the insurer would pay 5/13 of the defense costs – based on 5 of 13 causes of action potentially alleging a trade dress infringement claim. [The insurer addressed the claim under New Jersey law and believed that payment of defense costs for solely covered claims was appropriate.]

Med-Plus rejected the terms and rates for this arrangement. After some back and forth, American Casualty agreed to defend Med-Plus, for all claims, without a reservation of rights. The insurer also informed Med-Plus that the punitive damages, and claims in excess of the policy limits -- both excluded – did not create a conflict of interest. American Casualty instructed Med-Plus to transfer the defense to the attorney selected by the insurer. But Med-Plus maintained that, on account of the demand for punitive damages, it was still entitled to be defended by counsel of its choice.

Putting aside the ins and outs of a choice of law issue, the court applied New York law to its analysis and found in favor of Med-Plus: “[U]nder the law of both states (New York and New Jersey], the possibility of punitive damages creates a conflict of interest that entitles policyholders to independent counsel.”

In reaching this decision, the court had concerns that the lawyer retained by the insurer may not be able to adequately represent Med-Plus: “A conflict of interest can insidiously infect professional decision making in myriad ways over the course of a lawyer’s representation, which is why lawyers are generally instructed either to decline conflicted representation or to obtain written informed consent from each affected client. See, e.g., N.Y. R. Prof’1 Conduct r. 1.8 cmt.11 . . . Conflicts of interest are best addressed prophylactically so as to avoid a challenging retrospective analysis of whether an attorney’s conflict of interest had a material effect on the representation. Plaintiff has offered sufficient support for its claim that punitive damages are a legitimate possibility in the Underlying Action. (Pl. Reply in Further Supp. of Pl. Cross-Mot. at 5-6 (noting that punitive damages have previously been awarded in similar actions, and also that Abbott’s success in securing preliminary injunctive relief is a sign of likely success on the merits).) That possibility means that Plaintiff and Defendant do not have complete unity of interests.”

The court then seemed to add some possible complexity as to how its decision could play out, holding that: “[t]his entitlement comes with the caveat that Plaintiff does not have a blanket right to counsel of its choosing for all purposes in the Underlying Action. Rather, the right is limited to issues that present a probable conflict of interest with the insurer. For example, should it become clear that certain claims in the Underlying Action are eligible for punitive damages while others are not, Plaintiff's right to independent counsel would be limited to the punitive-damage-eligible claims. Similarly, if Abbott agreed not to seek punitive damages, Plaintiff would no longer have a right to independent counsel on that basis.” (emphasis in original).

I struggle to understand this decision. The court didn’t explain, with any specifics, why the attorney retained by the insurer had a conflict. As I see it, the insurer is defending Med-Plus without a reservation of rights. Thus, the insurer will hire counsel who will work hard to defend Med-Plus, since any liability will be the responsibility of the insurer – the party that the lawyer may supposedly be more loyal to than Med-Plus. In doing so, the lawyer, by necessity, is also working to prevent liability in excess of the policy limits and punitive damages. The insurer and the insured have a common interest – defeat the plaintiff’s liability or limit the damages.

This is not a situation where one claim is covered and one is not and the attorney retained by the insurer may so-called “steer” the case toward the uncovered claims – a ludicrous notion, but one that some courts do use to justify independent counsel in a reservation of rights-defense situation.