Possible Conflict of Interest Lets Insured Pick Counsel

By Don R. Sampen, published, Chicago Daily Law Bulletin June 3, 2019

The 1st District Appellate Court recently held that a complaint in which the plaintiff demands substantially more in punitive damages than compensatory damages can give rise to a conflict of interest between an insurer and the defendant insured, such that the insured is entitled to select independent defense counsel paid for by the insurer.

The insured in Xtreme Protection Services LLC v. Steadfast Insurance Co., 2019 IL (1st) 181501 (May 3), was represented by HeilizerLaw. Lewis Brisbois Bisgaard & Smith LLP represented the insurer, Steadfast.

The underlying plaintiff, David Israel, filed litigation against Xtreme and others in 2016. He alleged that the defendants placed listening devices in his office, attached GPS devices to his vehicles, sent threatening or harassing text messages and otherwise engaged in wiretapping, eavesdropping, intrusion upon seclusion, intentional infliction of emotional distress and other misdeeds.

The complaint went through several iterations. The third amended complaint, upon which the trial court ruled, generally sought compensatory damages in the amount “not less than $30,000” in each of four counts, and punitive damages of $1 million in each of two counts and $50,000 in each of two other counts.

Steadfast issued an “armed security services” liability policy to Xtreme, which covered Xtreme for bodily injury and property damage. The key provision of relevance here was an exclusion for punitive damages.

Xtreme tendered to Steadfast, which initially agreed to defend without asserting a reservation of rights. Thereafter, Xtreme’s counsel sought permission to choose a defense attorney to represent Xtreme, referencing a conflict of interest.

Correspondence ensued during which Steadfast ultimately denied Xtreme’s request for separate counsel, appointed counsel for Xtreme and continued to decline to raise any reservations except for the policy conditions and the exclusion for punitive damages.

Xtreme rejected Steadfast’s attorney and filed the instant declaratory judgment action in 2017. It sought a determination of its right to select its own counsel. Steadfast filed a counterclaim taking the position that it no longer had to honor its policy because Xtreme breached the policy’s cooperation clause in rejecting Steadfast’s appointed attorney.

On cross-motions for judgment on the pleadings, the trial court determined that Xtreme was entitled to select its own attorney due to Steadfast’s reservation on punitive damages. Following a Supreme Court Rule 304(a) finding, Steadfast took this appeal.

While the appeal was pending, Israel filed a fifth amended complaint, increasing his compensatory demand to $200,000 in each of four counts, and punitive demand to $1 million in each of four counts. Steadfast obtained leave to supplement the record with that complaint.

Analysis

In an opinion by Justice Sheldon A. Harris, the 1st District affirmed. He noted generally that an insurer has a right to control the defense of an insured to protect the insurer’s financial interest in the outcome of litigation. However, where the interests of the insurer and the insured are not aligned, an ethical issue may arise requiring that the insured be allowed to control the defense by selection of its own counsel.

Harris cited American Family Mutual Insurance Co. v. W.H. McNaughton Builders Inc., 363 Ill.App.3d 505 (2006), as an example of where a conflict arose. A conflict existed in that case because the insurer had an interest in showing that damage occurred prior to the policy’s effective date, while the insured had an interest in showing that the damage occurred after inception.

In the instant case, where Steadfast reserved on punitive damages, Harris turned to Nandorf Inc. v. CNA Insurance Cos., 134 Ill.App.3d 134 (1985), for guidance. In that case the underlying plaintiff sought $5,000 in compensatory damages and $100,000 in punitive damages.

The 1st District held that a conflict existed because, according to the court, CNA had an interest in providing a less than vigorous defense due to the minimal compensatory damages being sought.

The third amended complaint here, Harris said, sought no less than $120,000 in compensatory damages and no less than $2.1 million in punitive damages, if all the counts were aggregated. Since Steadfast denied coverage for punitive damages, it had little interest in defending against the claims for those damages.

Harris reasoned that Xtreme was “left with the greater interest and risk in the litigation,” and it therefore had a right to obtain independent counsel paid for by Steadfast.

Steadfast nonetheless pointed to the fifth amended complaint, which sought no less than $800,000 in compensatory damages among the various counts. Harris countered that this complaint also upped the punitive claim to more than $4 million. So, according to him, a conflict of interest still existed.

Steadfast raised one further argument going to Xtreme’s alleged breach of the cooperation clause in the policy, given Xtreme’s rejection of Steadfast’s appointed counsel. Harris said that the rejection was justified because Xtreme was entitled to select its own counsel. And, moreover, Steadfast never demonstrated how it was hampered in the defense.

The 1st District therefore affirmed in favor of Xtreme.

Key point

According to this court, a significant disparity between an underlying plaintiff’s claim for compensatory damages and its claim for punitive damages can give rise to a conflict of interest entitling the defendant insured to independent counsel.