Insurer Estopped From Raising Policy Exclusion After Relying On Information From Defense Counsel, Which Was Obtained From Client

A federal district court recently ruled that the insurer was estopped from raising a policy exclusion when it relied upon information from appointed defense counsel, which was obtained from the client/insured. The case has potential lessons for insurers and defense counsel in Hawai`i.

In Cosgrove v. National Fire & Marine Ins., Co.,2017 U.S.Dist. LEXIS 54479 (D. Ariz. April 10, 2017), a homeowner hired a contractor to remodel her house.  Plaintiff alleged that the contractor failed to remodel her house properly and filed a lawsuit against the contractor.   The contractor tendered the lawsuit to its liability insurer. The insurer agreed to defend under a reservation of rights and hired defense counsel to represent the contractor.

In its reservation of rights letter, the insurer advised the contractor that its policy contained Subcontractor Exclusion and stated that:

[t]o the extent that the damaged alleged in [the state-court Suit] arose out of operations performed for you by independent contractors or subcontractors and such independent contractors or subcontractors did not agree in writing to defend, indemnify and hold WTM harmless, failed to carry insurance with the provisions required by the Independent Contractors and Subcontractors Coverage Requirement Exclusion endorsement form(s) or otherwise failed to fulfill the requirements of the endorsement(s)  in any respect, the Policy does not provide coverage for the [state-court] Suit.

Id. at *2-3.

After interviewing his client and conducting an initial investigation, defense counsel advised the insurance adjustor that “[a]ll construction work was done by sub-contractors except for the framing” and that “[w]e have been unable to locate any sub-contract agreements.”Id.at *4.  Defense counsel said that he got the information from his client and “from a review of the job file.”  Id. at *5.

Defense counsel later wrote to the adjustor and said that it appeared that the contractor also did not perform the framing but that the framing was done by another company.  Defense counsel said that he probably got the information from his client or from additional materials which counsel found.

At some point, the adjustor concluded that the insurer had an 80% chance of defeating coverage based on the Subcontractor Exclusion.   This determination affected the insurer’s settlement position.  Defense counsel had recommended to the adjustor that the suit be settled for $110,000.  However, the adjustor only authorized $23,000.  The adjustor said that difference between defense counsel’s recommendation and what was actually authorized was based on the analysis of coverage. Id. at *8.  On another occasion, the homeowner made a $109,000 offer of judgment to settle the case.  Defense counsel requested authority up to $109,000, but the adjustor rejected the offer of judgment.

On the eve of trial, plaintiff and the contractor settled the case, which included the contractor’s stipulation to a $43,690 judgment and the contractor’s assignment to the homeowner of its claims against its insurer.

The homeowner then sued the insurer, alleging that the insurer breached its duty to indemnify and committed bad faith.  Among other defenses, the insurer asserted that it did not breach its duty to indemnify because no coverage existed under the policy.

The homeowner moved for partial summary judgment, arguing that the insurer was estopped from relying upon the Subcontractor Exclusion.  The homeowner argued that the insurer should be estopped because in raising the Subcontractor Exclusion, the insurer improperly relied upon information from defense counsel, which was obtained during the course of the attorney-client relationship. Id.  at *14-15.

The insurer argued that estoppel should not apply because the information provided by defense counsel was not confidential and privileged. The information obtained by defense counsel only involved the identity of the companies which performed work on the project and the fact that no subcontractor agreements existed. Moreover, the insurer noted that defense counsel stated that he might have gotten the information from a review of the job file and so it was not even clear that defense counsel got the information from his client.  Id. at *17-18.

The insurer also argued that the information about the subcontractors and the lack of subcontract agreements later became public knowledge when the contractor filed a third-party complaint against the subcontractors.

The Court was not persuaded by the insurer’s arguments.  The Court ruled that the information need not be confidential to invoke estoppel.  The key fact was that

Mr. Righi [defense counsel]used the attorney-client relationship with WTM [contractor] to gather information that he gave to defendant, which defendant then used to the detriment of WTM and now wants to use to deny coverage. At the point Mr. Righi disclosed the subcontractor information to defendant, he knew, or had reason to know, that WTM’s policy contained the Subcontractors Exclusion and that defendant may attempt to deny coverage based on this exclusion.[1]Yet despite this knowledge, Mr. Righi communicated to defendant the very information that defendant would need to deny coverage based on the Subcontractors Exclusion.

            Id. *19.

Regarding the argument based on the filing of the third-party complaint, the Court said that by the time that the third-party complaint was filed, defense counsel had already improperly disclosed the information to the insurer.  The insurer argued that the Court’s ruling would mean that the contractor would be barred from ever filing a third-party complaint.  The Court disagreed and stated that if defense counsel had first obtained the contractor’s/insured’s consent to disclose the information in the third-party complaint, there would have been no issue.  Id  at *20.

Because the insurer relied upon information obtained from defense counsel in the course of the attorney-client relationship, the Court granted the homeowner’s motion and ruled that the insurer was estopped from raising the Subcontractor Exclusion.  The Court specifically recognized that the result might seem “harsh.”  However, the Court noted that the insurer could have avoided the problem by conducting its own investigation instead of relying on information from defense counsel.  Id.  at 20-21.

Is Cosgrove An Outlier Or Is It Relevant To Attorneys In Hawai`i?

Initially, Cosgrove might be viewed as an aberration with little practical relevance to defense counsel and insurers in Hawai`i.  However, caution is warranted.

Finley v. The Home Ins. Company, 90 Haw. 25, 975 P.2d 1145 (Haw. 1998) is generally remembered as the case which rejected the Cumis doctrine in Hawai`i.  But sometimes forgotten are the principles which underlie the Finley holding.  One principle is that “[t]he [hired defense] attorney could not slant the outcome of the case to a theory of liability not covered by insurance without violating the duty of loyalty to his or her client, the insured. Finally, the attorney is precluded from sharing privileged information received in the representation with the insurer. See HRPC Rule 1.6.” 90 Haw. at 36, 975 P.2d at 1156.

Specifically relevant to the Cosgrove issue, the Finley Court stated, “[a]s a general rule, a defense attorney should never share with the insurer confidential information communicated by the insured. If defense counsel learns of information suggesting coverage defenses, such information must be kept confidential. Under no circumstances should appointed counsel attempt to uncover or develop coverage defenses.”Id., quoting, Douglas Richmond, Walking a Tightrope: The Tripartite Relationship Between Insurer, Insured and Insurance Defense Counsel, 73 Neb. L. Rev. 265, 270 (1994):

The first portion of the above quote suggests that defense counsel may share information with an adjustor, who later uses the information to deny coverage, as long as the information is not confidential. However, the last sentence is not necessarily limited to confidential information.  It is also unclear whether the last sentence refers only to attempts to uncover information, specifically knowing that the information can be used to develop coverage defenses or whether, as in Cosgrove, a “knew or should have known” standard applies.

Lastly, similar to Cosgrove, the Finley Court recognized that a breach of the principles for providing a defense under a reservation of rights can lead to the insurer’s being estopped from denying indemnification: “[T]he insurer’s conduct of the defense of the insured may be undertaken in such a manner that the insurer is equitably estopped from denying indemnification based on the result of the claim.”  90 Haw. at 37, 975 P.2d at 1157.

The lesson from Cosgrove and Finley is that appointed defense counsel must be careful in relaying to an insurance adjustor information obtained from the client/insured. Some defense counsel are reluctant to review a reservation of rights letter for fear of getting involved in potential coverage issues.  However, Cosgrove and Finley suggest that defense counsel should at least be aware of the coverage issues in order to avoid unwittingly conveying to the insurer information obtained from the client/insured which is later used to defeat coverage. HH

[1] The Court did not elaborate on why it felt that defense counsel knew or should have known that the policy contained the Subcontractor Exclusion.