Applying Texas law, the U.S. Fifth Circuit Court of Appeals recently issued an opinion concerning an insured’s right to independent counsel when an insurer issues a reservation of rights letter. In Downhole Navigator, L.L.C. v. Nautilus Ins. Co., 686 F.3d 325 (5th Cir. 2012), the Court held that an insured is only entitled to independent counsel where the facts to be adjudicated in the underlying lawsuit against the insured are the same facts upon which coverage depends pursuant to the insurer’s reservation.
Does a reservation of rights create a conflict of interest?
The concern is that, with a reservation of rights, a conflict of interest arises that will prevent the insurer from properly conducting the defense. In other words, the outcome of the coverage issue can be controlled by counsel retained by the insurer who could “steer” the facts and evidence in the underlying lawsuit toward non-coverage.
However, citing the Texas Supreme Court in N. Cnty. Mut. Ins. Co. v. Davalos, 140 S.W. 3d 685, 588 (Tex. 2004), the Fifth Circuit held that a reservation of rights does not automatically create a disqualifying conflict; such a reservation only recognizes the possibility that a disqualifying conflict may arise in the future.
When a Reservation of Rights Leads to a Conflict of Interest
The Northern District of Texas explained, “In order for a disqualifying interest to exist, then, it must be apparent that facts upon which coverage depends will be ruled on judicially in the Underlying Suit.” Partain v. Mid-Continent Specialty Ins. Servs. Inc., No. 10-2580, 2012 WL 524130 (S.D. Tex. Feb. 15, 2012). “It is not until the facts to be adjudicated in the liability lawsuit are the same facts upon which coverage depends that a potential conflict becomes a disqualifying one, entitling an insured to select independent counsel.” Id.
Application of this rule is exemplified by Housing Authority of the City of Dallas (“DHA”) v. Northland Ins. Co., 333 F. Supp. 2d 595 (N.D. Tex. 2004). In that case, the insurer had reserved rights to disclaim coverage for a willful violation of a statute, and the plaintiff in the underlying lawsuit had alleged willful statutory violations on the part of the defendant-insured. Because the facts to be decided in the underlying lawsuit were the same facts that could defeat coverage, the insurer could not conduct the insured’s defense, and the insured properly refused the insurer’s qualified tender of defense.
Allen & Gooch is providing this legal update for informational purposes only. This article should not be construed as legal advice or a legal opinion as to any specific facts or circumstances. You should consult your own attorney concerning your particular situation and any specific legal questions you may have.