Montana Weighs in on the Obligation to Provide Co-Counsel to Assist Another Insurer Defending Mutual Insureds

The insurance company’s duty to defend commonly requires the insurance company to hire legal counsel although that requirement may not be present in every case. The issue of dual representation recently came before the Montana Supreme Court in State Farm Fire and Cas. Co. v. Schwan, 371 Mont. 192, 308 P.3d 48 (2013).

In Schwan the decedent was a passenger in a vehicle driven by the Travis Turner (Travis). At the time, Travis was driving his mother’s vehicle and lost control of the vehicle. The vehicle left the highway and overturned ejecting both Whitney Schwan (Whitney) and Travis resulting in their tragic deaths. Travis’ parents, Marvin and Cheri Turner (Turners) had two State Farm insurance policies. The Turners had an automobile liability policy issued by State Farm Mutual Automobile Insurance Company (State Farm Auto) and a homeowners’ policy issued by State Farm Fire and Casualty Company (State Farm Fire).

Daryl and Patricia Schwan (Schwans) were the parents of decedent Whitney and sued both Travis’ estate and the Turners alleging negligence on the part of Travis and negligent entrustment on the part of the Turners. State Farm Auto retained Calvin Stacey (Stacey) to defend the Turners in the lawsuit. Several months later, Stacey notified State Farm Fire’s in-house legal counsel, David Bauer (Bauer), of the Underlying Action. At that time Stacey advised Bauer that the Schwans had demanded payment of policy limits under both the State Farm Auto and State Farm Fire policies. Although the homeowners’ policy excluded coverage for automobile accidents, the Schwans contended that the alleged facts triggered coverage under prior Montana case precedent.

After being notified of the lawsuit, Bauer, and representatives of State Farm Auto and State Farm Fire discussed the case with Stacey. State Farm Fire acknowledged a potential duty to defend the Turners under the homeowners’ policy and confirmed with Stacey that he was defending the Turners on all claims in the Underlying Action.Stacey advised State Farm Fire that additional counsel was not necessary to assist in defending the Turners. After receiving this information, State Farm Fire sent a letter to the Turners discussing the Schwan suit and Stacey’s representation of them. The letter went on to state that it was State Farm Fire’s understanding that the Turners were not tendering defense of the Schwan lawsuit to State Farm Fire and that if State Farm Fire did not hear from the Turners to the contrary, it was going to assume that it was acceptable for State Farm Fire to continue handling the case on the terms that Stacey would continue defending the Turners on behalf of State Farm Auto.

Throughout the duration of the underlying lawsuit, State Farm Fire maintained contact with State Farm Auto and Stacey. Stacey was advised by Bauer that if State Farm Auto’s defense of the Turners would terminate for any reason, State Farm Fire would assume responsibility for Stacey’s continued defense of the Turners. State Farm Auto agreed with that approach.

State Farm Fire filed a Declaratory Judgment Action seeking a declaration that it owed no duty to defend or indemnify the Turners under the homeowners’ policy. State Farm Fire then retained an attorney of the Turners’ choosing to defend the Turners in the Declaratory Action. The Turners selected attorney Michael Young (Young).

A court-ordered mediation for the Underlying Action was convened. Stacey attended with the Turners. Schwans’ counsel made a request to Stacey that Young also attend the mediation. Stacey then contacted Young on that request, and also requested a representative of State Farm Fire attend the mediation. Young attended the mediation as the Turners’ counsel in the Declaratory Judgment Action, and in-house counsel Bauer for State Farm Fire also attended. Notwithstanding State Farm Fire’s coverage position that the homeowners’ policy excluded all the Schwans’ claims based upon the auto exclusion, State Farm Fire participated in the mediation by offering “some money” in an unsuccessful attempt to settle the case.The mediation concluded with an alternative settlement that included a consent judgment against the Turners for $750,000 and assignment of all of Turners’ rights and claims under the homeowners’ policy to the Schwans. The Schwans gave the Turners a covenant not to execute.

The Schwans as assignees replaced the Turners in the Declaratory Judgment Action. At that time they filed a counterclaim alleging that State Farm Fire breached its duty to defend by not retaining counsel to “appear and defend” the Turners in the Underlying Action. Then the trial court granted summary judgment to the Schwans on that issue reasoning State Farm Fire had an obligation to defend and had breached that obligation by not retaining separate counsel for the Turners in the Underlying Action or contributing financially to payment of Stacey’s legal fees.

The Montana Supreme Court reversed the trial court’s ruling. The Court found that while the duty to defend commonly requires the hiring of legal counsel, the hiring of legal counsel was not required in every case. Reviewing the facts, the Montana Supreme Court in Schwan noted that State Farm Fire initiated discussions with both State Farm Auto and Stacey concerning the posture of the Underlying Action. State Farm Fire confirmed with Stacey that the Turners were being defended against all claims made against them in the litigation.Stacey assurance State Farm Fire that he did not need the assistance of additional counsel in defending the Turners. State Farm Fire corresponded with the Turners noting that Stacey’s representation of the Turners and the fact that the Turners had not tendered defense of the Underlying Action to State Farm Fire, and that State Farm Fire would proceed on the basis of allowing Stacey alone to defend unless they it heard from the Turners otherwise. State Farm Fire had agreed to undertake all responsibility for the defense in the event State Farm Auto discontinued its defense. Although not required to do so, State Farm Fire retained Young to represent the Turners in the Declaratory Judgment Action. State Farm Fire paid Young to participate in the settlement conference and to give coverage advice. At the mediation, State Farm Fire attempted to resolve the suit by offering some money for settlement despite believing there was no coverage.

After reviewing the facts, the Montana Supreme Court concluded that State Farm Fire had given the necessary substance to the duty to defend required by the policy and had fulfilled its contractual duty to the Turners under the policy. The Court stated:

It would make little sense for State Farm Fire to provide other legal counsel when such a need was not demonstrated. Although Schwans argue that State Farm Fire’s mere “participation” in Turners’ defense, without hiring separate counsel for them, fostered an “unavoidable conflict of interest,” we fail to see how Turners were left unprotected or were prejudiced by State Farm Fire’s actions.

The Montana Supreme Court found support for its finding in the decisions by courts in other jurisdictions on the same issue. Schwan, 371 Mont. at 199, 308 P.3d at 52-53 (citing Ceresino v. Fire Ins. Exch., 215 Cal.App.3d 814, 823, 264 Cal.Rptr. 30 (1989) (second lawyer not needed because insured was fully defended); … Horace Mann Ins. Co. v. Barbara B., 61 Cal.App.4th 158, 164, 71 Cal.Rptr.2d 350 (1998) (Horace Mann did not breach a duty because insured had been fully defended during the entirety of the lawsuit by his homeowner’s policy); Keene Corp. v. Ins. Co. of North America, 667 F.2d 1034, 1051 (D.C. Cir. 1981) (where Keene had multiple insurers, “only the insurer that Keene selects will defend Keene”); accord Allan D. Windt, Insurance Claims & Disputes: Representation of Insurance Companies & Insureds, § 4:10 at 322–23 (West, 4th ed., 2001) (“Although the insured, having already been provided a defense, cannot assert a claim against the nondefending insurer based on its defense obligation, the insurer that provides the defense should be able to assert a claim … [for] contribution or subrogation from such other insurer.”)).

The Montana Supreme Court held that State Farm’s failure to pay for Stacey’s fees did not constitute a breach of the duty to defend under the circumstances. First, that alleged failure did not affect the Turners because defense counsel and a full defense were being provided to them by State Farm Auto. Second, State Farm Fire had not received a request for payment of Stacey’s fees from the Turners or from State Farm Auto.The Court noted that payment of counsel in this context was a matter of contribution between insurers. Finally, the Court found that because the Turners were fully defended they could not complain about the situation. State Farm Fire had “ensured a full defense was provided to Turners, even though its decisions regarding counsel did not include hiring additional counsel.”

In a slightly different twist, insurers are faced with allegations of bad faith for not providing a simultaneous defense of their insureds under the same factual circumstance where the insureds are being defended by another insurance company. In that situation, the bad faith lawsuit oftentimes fails because the insureds or the insureds’ assignees cannot demonstrate damages flowing from the failure to provide a defense through the retention of co-counsel.