New Conflict Of Interest
January 20, 2011
On Friday, the 7th U.S. Circuit Court of Appeals issued an opinion purporting to declare for the first time under Illinois law that a demand made by a tort plaintiff in excess of the insured's policy limit creates a conflict of interest between the defendant/insured and its insurer, requiring the insurer to notify the insured of its right to obtain independent counsel of its own choosing. R. G. Wegman Constr. Co. v. Admiral Ins. Co., No. 09-2022 (7th Cir. Jan. 14, 2011).
This opinion, if accepted as Illinois law, would create duties that have not heretofore existed and will be precedential in tort cases being defended under Illinois law in the federal district courts in Illinois.
Moreover, to the extent that it constitutes persuasive authority, the opinion may give rise to a proliferation of unwarranted bad faith actions against insurers arising out of tort litigation currently being defended in Illinois. There is no basis under Illinois law for the holding and the 7th Circuit should reconsider its decision.
Currently recognized conflicts do not turn on inflated demands
In a recent article in the March 2009 edition of the Illinois Bar Journal, the author identified four traditional circumstances where Illinois courts have found conflicts of interest between insurers and insureds entitling an insured to independent counsel of its own choosing. See Robert P. Vogt, "When Does an Insured Have a Right to Independent Counsel?" 97 Ill. B.J. 142 (2009). These four circumstances are:
- • complaints alleging both negligent and intentional acts;
- • acts that occur outside the policy period;
- • antagonistic insureds; and
- • punitive damage claims. Id. at 144-45.
With respect to the first, second and fourth circumstances, the courts have found a conflict of interest because "the defending insurer might be able to 'shift facts' or to 'lay the groundwork' for a claim to be pushed outside the policy's coverage." Id. at 144.
With respect to antagonistic insureds, such as an employee and employer where vicarious liability is disputed, an insurer cannot control both insureds' defenses because the two insureds would have diametrically opposed defense theories. Id. at 145.
The foregoing circumstances are markedly different from the common situation in tort litigation when plaintiffs make demands in excess of policy limits. Such demands by themselves do not suddenly create diverse interests among an insured, the insurer and retained defense counsel, since all three still have an aligned interest in vigorously conducting a defense to obtain either a defense verdict or a damages verdict under policy limits.
As a practical matter, tort plaintiffs routinely inflate their demands and no purpose is served by taking them too seriously. Some states, such as California, expressly recognize that tort plaintiffs frequently make inflated demands, which can exceed policy limits and that such demands alone do not create a conflict of interest, triggering the right to independent counsel. (Cal. Civ. Code §2860.)
The Wegman facts do not justify a new rule
Nothing about the Wegman facts should have prompted the 7th Circuit to create a new rule triggering the right to independent counsel whenever an inflated demand is made.
Wegman alleged in its complaint that it had a $1 million policy with Admiral and $10 million of excess coverage. Wegman was sued by a construction worker, Budrik, in 2003 and Admiral undertook Wegman's defense by retaining counsel for Wegman.
As early as May 2005 and no later than April 2007, Budrik demanded $6 million to settle the suit. Admiral failed to warn Wegman that the Budrik suit could exceed Admiral's policy limits and Wegman itself did not realize the possibility that the Budrik suit could exceed Admiral's limits until a few days before trial.
Wegman then promptly notified its excess insurer but the excess insurer refused coverage because of a failure to receive timely notice. Budrik prevailed at trial, recovering a $2 million judgment against Wegman. Wegman then sued Admiral to recover the judgment in excess of the policy limit.
The gist of Wegman's action, from the court's recitation of facts, appears to be that it lost its opportunity to obtain excess coverage because either Admiral's adjustor handling the claim, or retained counsel, did not keep Wegman fully informed of the lawsuit and counseled Wegman to put its excess carrier on notice. Certainly Wegman's attorney would have had a duty to keep Wegman properly apprised of its exposure and so too might Admiral in the adjustment of the claim.
The breach of these duties might well have been a way for the 7th Circuit to resolve the case. The facts, however, are not so remarkable that they should have led to a sweeping new rule not previously recognized in Illinois.
The Court's Reasoning Does Not Support Its Decision
In establishing the new rule the 7th Circuit stated:
The usual conflict of interest involves the insurance company's denying coverage, as in such cases as Royal Ins. Co. v. Process Design Associates, Inc., 582 N.E.2d 1234, 1239 (Ill. App. 1991), but the principle is the same when the conflict arises from the relation of the policy limit to the insured's potential liability, as in Mobil Oil Corp v. Maryland Casualty Co., 681 N.E.2d 552, 561-62 (Ill. App. 19997), and Hamilton v. State Farm Mutual Auto Ins. Co., 511 P.2d 1020, 1022-24 (Wash. App. 1973), aff'd. 523 P.2d 193 (Wash. 1974).
(Slip Op. 10.) The court's logic does not support the result reached.
First, it is black-letter law in Illinois that an insurer's interest in negating policy coverage does not in itself create a sufficient conflict of interest to excuse the insurer from conducting the defense. O'Bannon v. Northern Petro Chemical Co., 447 N.E.2d 985, 989 (Ill. Ct. App. 1983); Shelter Mutual Ins. Co. v. Bailey, 513 N.E.2d 490, 496 (Ill. Ct. App. 1987).
Accordingly, contrary to the 7th Circuit's decision, the "usual conflict of interest" does not arise simply from the insurance company's denial of coverage. That was made clear by one of the cases the 7th Circuit itself cited: Royal Ins. Co., wherein the court stated that "an insurer's interest in negating policy coverage does not in itself give rise to a conflict of interest." 582 N.E.2d at 1240.
The conflict of interest discussed in Royal Ins. Co., involved a Peppers type conflict where the insurer could "shift facts" that would have pushed the insured's claim out of coverage. That and the insurer's failure to properly reserve rights and file a timely declaratory judgment action resulted in a ruling for the insured.
Second, the Mobil Oil case cited by the court likewise does not support the creation of the new rule. Mobil Oil involved circumstances where the insurer initially undertook the defense without a reservation of rights, advising the insured there was $6 million in coverage.
After maintaining that position through 2? years of litigation, the insurer then asserted a reservation claiming only $250,000 in coverage. The court found that this "change in position" hampered the appointed defense counsel's settlement strategy and created the conflict of interest. Additionally, the Mobil Oil insured faced a large punitive damage claim and that created a conflict of interest recognized under Illinois law.
Third, the Hamilton case cited by the court involved a failure of the carrier to settle within policy limits when given an opportunity to do so. It thus has nothing whatever to do with the court's automatic conflict-of-interest rule.
Fourth, the 7th Circuit's new rule regarding conflicts of interest is contrary to its own jurisprudence. See Littlefield v. McGuffey, 979 F.2d 101, 108 (7th Cir. 1992). (The mere possibility of an excess verdict does not create a conflict of interest depriving an insurer of the right to control the defense.) Wegman does not even acknowledge the inconsistency.
The Need For Rehearing
We hope the 7th Circuit decides to rehear its decision in Wegman and correct its new automatic conflict rule triggering the right to independent counsel. This new rule will create delays in litigation and add to the cost of conducting the same and may create a proliferation of unwarranted bad-faith litigation.
It is understandable that the court may have been lead to the creation of this rule by statements made at oral argument by Admiral's counsel that "his client had been gambling on minimizing its liability at the expense, if necessary, of Wegman." (Slip Op. 9.) While such statements understandably would upset the court, there is no reason for the creation of a blanket rule not previously recognized by Illinois courts, especially given the well-recognized practice by which tort plaintiffs inflate their liability demands.
