The Insurance Company and Defense Firm Relationship

(written by Glenn Legge and Jerry Kimmitt )

TABLE OF CONTENTS

I. Defense Counsel's Relationship with the Insured and the Insurer in the Dim Light of Tilley.

A. The Insured is the Client, but What About the Insurer Paying the Bill?

B. Reservations of Rights and Coverage Conflicts

1) Dimming the Light of Tilley .

2) Communications With Insurers.

C. Irreconcilable Conflicts and Withdrawal

D. Practical Solutions to the Current Dilemma in Texas

II. The Role of Defense Counsel Appointed By an Insurer After State Farm Mutual Automobile Insurance Company v. Traver

III. The Duty of Defense Counsel Under Stowers

A. Historical Perspective

B. The Stowers Doctrine In the Eighties

C. Return to Normalcy in the 1990's

D. Recent Applications of the Stowers Doctrine

E. Valid Components of a Stowers Demand

IV. Insurance Company Guidelines and Billing Practices

A. Case Handling Guidelines

B. Submission of Legal Bills to Third Parties

SUMMARY

TABLE OF AUTHORITIES

Allstate Ins. Co. v. Kelly , 680 S.W. 2d 595, 598 (Tex. App.--Tyler 1984, writ ref'd n.r.e.)

American Physicians Ins. Exch. v. Garcia, 876 S.W.2d 842, 844 n.6 (Tex. 1994)

Bradt v. West , 892 S.W.2d 56, 77 (Tex. App.--Houston [1st Dist.] 1994, no writ)

Dynamic Concepts, Inc., v. Truck Ins. Exch., 61 Cal. App. 4th 999, 71 Ca. Rptr. 882 (Cal. Ct. App. 1998).

Employers Casualty Co. v. Tilley, 496 S.W.2d 552 (Tex. 1973).

G.A. Stowers Furniture Co. v. American Indem. Co. , 15 S.W.2d 544, 547 (Tex. Comm'n App. 1929, holding approved)

J.E.M. v. Fidelity and Casualty Co. of New York, 928 S.W.2d 668 (Tex. App.--Houston [1st Dist.] 1996, no writ).

Ranger County. Mut. Ins. Co. v. Guin, 723 S.W.2d 656 (Tex. 1987)

Rhodes v. Chicago Ins., a Div. Of Interstate Nat'l, 719 F.2d 116 (5th Cir 1983).

Rosell v. Farmers Texas County Mut. Ins. Co., 642 S.W.2d 278, 279-80 (Tex. App.--Texarkana 1982, no writ).

San Diego Navy Fed. Credit Union v. Cumis Ins. Soc'y, Inc., 208 Cal. Rptr. 494, 498 (Cal. App. 1984).

State Farm Mut. Auto. Ins. Co. v. Traver, 980 S.W.2d 625 (Tex. 1998).

State Farm Lloyds Ins. Co. v. Maldonado, 963 S.W.2d 38 (Tex. 1998).

Texas Farmers Ins. Co. v. Soriano, 881 S.W. 2d 312 (Tex. 1994).

United States v. Massachusetts Inst. of Technology, 129 F.3d 681 (1st Cir. 1997).

OTHER AUTHORITIES

Charles Silver, Does Insurance Defense Counsel Represent the Company or the Insured?, 72 Tex. L. Rev. 1538, 1597 (1994).

Christopher W. Martin and M. Jarrett Coleman, Independent Counsel Issues in Texas: 1998 Update, South Texas College of Law Texas Insurance Law Symposium, July 1998.

Douglas R. Richmond, Walking a Tightrope: the Tripartite Relationship Between the Insurer and Insured, and Insurance Defense Counsel , 73 Neb. L. Rev. 265 (1994).

Eric M Holmes, A Conflicts of Interest Roadmap for Insurance Defense Counsel: Walking an Ethical Tightrope Without A Net, 26 Willamette L. Rev. 1, 2-3 (1989).

Nelson Electrical Contracting Co., 1 No. 22 Mealeys Ins. L. Weekly at 15.

Robert B. Gilbreath, Caught in a Crossfire: Preventing and Handling Conflicts of Interest: Guidelines for Texas Insurance Defense Counsel, 27 Tex. Tech L. Rev. 139 (1996).

Restatement (Second) Of Agency § 385 cmt. a (1957).




THE INSURANCE COMPANY AND DEFENSE FIRM RELATIONSHIP

The relationship between an insurer and defense counsel is a fundamental element of any case which is handled by an attorney retained by an insurance company to defend the interests of the insured. Due to the complex nature of this relationship it can provide for hundreds of pages of analysis, comment and prognostication on a variety of topics from ethics to billing. Rather than engaging in a superficial review of a number of these worthy subjects, the purpose of this presentation is to provide a more substantive analysis of the insurance company and defense firm relationship in respect to the following areas of practice:

* Defense counsel's relationship with the insured and the insurer in the dim light of Employers Casualty Co. v. Tilley, 496 S.W.2d 552 (Tex. 1973).

* The relationship of defense counsel and the insurer in light of the recent Texas Supreme Court opinion in State Farm Mut. Auto. Ins. Co. v. Traver (Tex. 1998).

* The respective obligations of defense counsel and the insurer under the law set forth in G.A. Stowers Furniture Co. v. American Indem. Co., 15 S.W.2d 544 (Tex. Comm. App. 1929, holding approved) and its progeny.

* Insurance company guidelines and requirements to present defense counsel's legal bills to third party creditors.

* Defense Counsel's Relationship with the Insuredand the Insurer in the Dim Light of Tilley.

A. The Insured is the Client, but What About the Insurer Paying the Bill?

Most liability insurance policies obligate the insurer to defend the insured and pay for claims that fall within the terms and conditions of the insurance policy. Under this defense obligation the liability insurer will often select and compensate the attorneys that will defend the insured, thereby creating an attorney-client relationship with little or no input from the insured. Defense counsel appointed by an insurer owes a fiduciary duty to the insured to protect the insured's interests, whereas the relationship between defense counsel and the insurer is often regarded as a secondary or subordinate responsibility. This relationship may conflict with the commercial considerations of defense counsel, who often looks to the insurer as a source of business and often regards the insured as a one-off client. This tension between ethical and commercial considerations is the focus of most of the cases and treatises concerning the defense counsel relationship. Bradt v. West, 892 S.W.2d 56, 77 (Tex. App.--Houston [1st Dist.] 1994, no writ). Charles Silver, Does Insurance Defense Counsel Represent the Company or the Insured?, 72 Tex. L. Rev. 1538, 1597 (1994). In fact, the Texas Supreme Court has indicated that the only attorney-client relationship that arises out of an insurer's appointment of defense counsel, is that between the defense counsel and the insured. American Physicians Ins. Exch. v. Garcia, 876 S.W.2d 842, 844 n.6 (Tex. 1994). In situations where there are no qualifications of coverage by the insured, the peculiar nature of this tripartite relationship usually does not create any difficulties for defense counsel, as the interests of the insured and the insurer generally would be aligned.

B. Reservations of Rights and Coverage Conflicts

In some instances, however, the insurance company may appoint and pay for defense counsel for the insured while asserting a reservation of rights concerning the ultimate coverage of the claims against the insured. Under Texas Law an insurer's reservation of rights should:

* Identify the insurer;

* Inform the insured of the conflict of interest;

* Inform the insured that the insurer will provide a defense under the reservation of rights; and

* Inform the insured that it may secure independent counsel.

J.E.M. v. Fidelity and Casualty Co. of New York, 928 S.W.2d 668 (Tex. App.--Houston [1st Dist.] 1996, no writ).

When a reservation of rights is made the insured may properly refuse the appointment of defense counsel and pursue its own defense. In those instances, the insurer remains liable for reasonable attorney's fees incurred by the insured and may not insist on conducting the defense. Rhodes v. Chicago Ins., a Div. Of Interstate Nat'l, 719 F.2d 116 (5th Cir. 1983). In instances where defense counsel has been appointed under a reservation of rights it is foreseeable that the insured may have some questions covering the loyalty of the insured. The appointment of defense counsel by a liability insurer who has reserved rights to deny coverage to the insured may create a situation that puts into question the loyalty of defense counsel to the two other parties involved in this relationship, the insurer and the insured. Unfortunately, for defense counsel in Texas there is no general or predictable protocol for dealing with conflicts of interest that are inherent in the appointment of defense counsel under a reservation of rights or that may arise during the defense of the insured.

1.) Dimming the Light of Tilley.

More often than not, judicial consideration of the conflict of interests of appointed defense counsel is based upon the Texas Supreme Court's decision in Employers Casualty Co. v. Tilley, 496 S.W.2d 552 (Tex. 1973). In Tilley, the Court held that although defense counsel was paid by the insurance company, counsel owed a duty of unqualified loyalty to the insured, as if the counsel had been retained by the insured in the first instance. Further, the Court held that the moment any conflict arises between the interests of the insurance company and the insured, defense counsel must immediately inform the insured of the conflict.

The Tilley decision does clearly prohibit defense counsel from also serving as coverage counsel for the insurer. Unfortunately, the Tilley decision does not provide a great deal of practical advice or assistance to the defense counsel appointed by an insurer; perhaps this is why there are so many comments and treatises but very little substantive case law dealing with Tilley. The Tilley decision was decided more than twenty-five years ago and was the result of the Texas Supreme Court applying existing rules of professional conduct, that have been modified by the Texas Disciplinary Rules of Professional Conduct, and ABA Guiding Principles, which no longer exist. This has created a significant grey area for interpretation of the current Texas law concerning a defense counsel's obligation to the insured and the insurer.

The Court in Tilley opined that defense counsel must advise both the insured and the insurer of any coverage problems or conflicts. Tilley, 496 S.W.2d at 559. This admonition may not comply with the current Texas Disciplinary Rule of Professional Conduct 1.05, which prevents defense counsel from revealing confidential information to the disadvantage of the client without the client's consent. Rule 1.05 states, in part:

(a) 'Confidential information' includes both 'privileged information' and 'unprivileged client information.' 'Privileged information' refers to the information of a client protected by the lawyer-client privileges of Rule 503 of the Texas Rules of Evidence or of Rule 503 of the Texas Rules of Criminal Evidence or by the principles of the attorney-client privilege governed by Rule 501 of the Federal Rules of Evidence for the United States Courts and Magistrates.

(b) Except as permitted by paragraphs (c) and (d), or as required by paragraphs (e) and (f), a lawyer shall not knowingly:

(1) Reveal confidential information of a client or a former client to:

(i) a person that the client has instructed is not to receive the information; or

(ii) anyone else, other than the client, the client's representatives, or the members, associates, or employees of the lawyer's law firm.

(2) Use confidential information of a client to the disadvantage of the client unless the clients consents after consultation.

(4) Use privileged information of a client for the advantage of the lawyer or of a third person, unless the client consents after consultation.

(c) A lawyer may reveal confidential information:

(1) When the lawyer has been expressly authorized to do so in order to carry out the representation.

(2) When the client consents after consultation.

(3) To the client, the client's representatives, or the members, associates, and employees of the lawyer's firm, except when otherwise instructed by the client.

To make matters even more confusing, Texas Disciplinary Rule of Professional Conduct 1.06 can be interpreted as requiring that both the insurer and the insured should be advised of developments that may impact coverage. Rule 1.06 states, in part:(a) A lawyer shall not represent opposing parties to the same litigation.

(b) In other situations and except to the extent permitted by paragraph

(c) A lawyer shall not represent a person if the representation of that person:

(1) involves a substantially related matter in which that person's interests are materially and directly adverse to the interests of another client of the lawyer or the lawyer's firm; or

(2) reasonably appears to be or become adversely limited by the lawyer's or law firm's responsibilities to another client or to a third person or by the lawyer's or law firm's own interests.

(c) A lawyer may not represent a client in the circumstances described in (b) if:

(1) the lawyer reasonably believes the representation of each client will not be materially affected; and

(2) each affected or potentially affected client consents to such representation after full disclosure of the existence, nature, implications, and possible adverse consequences f the common representation and the advantages involved, if any.

(d) A lawyer who has represented multiple parties in a matter shall not thereafter represent any of such parties in a dispute among the parties arising out of the matter, unless prior consent is obtained from all such parties to the dispute.

(e) If a lawyer has accepted representation in violation of this Rule, or if multiple representation properly accepted becomes improper under this Rule, the lawyer shall promptly withdraw from one or more representations to the extent necessary for any remaining representation not to be in violation of these Rules.

(f) If a lawyer would be prohibited by this Rule from engaging in particular conduct, no other lawyer while a member or associated with that lawyer's firm may engage in that conduct.

In summary, the Tilley decision does not provide sufficiently clear instructions about how to deal with the difficulties that may arise when a defense counsel is defending the insured under a reservation of rights or a qualification of coverage, or in the event that a coverage conflict arises during representation of the insured.

2.) Communications With Insurers.

Due to the lack of any clear guidelines or definitive case law, defense counsel representing an insured under a reservation of rights should err on the side of conservatism concerning communications with the insurer concerning matters that could impact coverage. Unfortunately, this may not be an easy task as comments on the development of a case may have a tangential impact on coverage issues without intending to comment on coverage directly. For example, defense counsel's reports concerning date of loss, manifestation of injury, nature or cause of loss and/or damages could raise coverage issues with the insurer.

Communications with the insurance company are not the only conduct which may implicate a defense counsel's handling of a matter under a reservation of rights. The manner in which a case is defended, including the defensive strategies employed and the discovery conducted, can have a significant impact on whether the ultimate settlement or judgment is covered by the insurer's policy. The handling of a case can, in itself, create a conflict between the insured and the insurer if some theories of liability asserted by the claimant arguably fall within coverage while others are excluded. It is this no man's land of potential conflicts where the Tilley decision gives little or no assistance.

Perhaps the best practical advice is to provide regular and thorough reporting to both the insured and insurer, which contains recommendations concerning handling of discovery matters and updates on liability and exposure. See Eric M Holmes, A Conflicts of Interest Roadmap for Insurance Defense Counsel: Walking an Ethical Tightrope Without A Net, 26 Willamette L. Rev. 1, 2-3 (1989); Robert B. Gilbreath, Caught in a Crossfire: Preventing and Handling Conflicts of Interest: Guidelines for Texas Insurance Defense Counsel, 27 Tex. Tech L. Rev. 139 (1996). Defense counsel should try to avoid any comments about coverage or any references concerning developments in the case that could have a negative impact upon coverage. However, at times reports on substantive aspects of liability may be necessary to protect the interests of the insured and keep the insurer informed of significant developments, even though the reports may have a tangential effect on coverage. In most instances, where an insurer has issued a reservation of rights or has qualified coverage the insurer will have its own coverage counsel to review the developments in the case and determine if they impact coverage. If defense counsel's reports are insufficient or if defense counsel is required to provide further analysis, it is the role of the insurer or its own counsel to make such requests. Therefore, it is better to err on the side of conservatism when reporting, to avoid potential conflicts of interest.

C. Irreconcilable Conflicts and Withdrawal

In the event that an irreconcilable conflict arises during the pendency of a case, defense counsel may be faced with the prospect of withdrawing from the representation of the insured. Withdrawal of representation may create additional conflict issues in regard to defense counsel's communication to the insurer and the insured of the reasons necessitating withdrawal. Pursuant to Texas Disciplinary Rule of Professional Conduct 1.15, defense counsel may withdraw from representing the insured as long as the withdrawal can be accomplished without material adverse effect on the interests of the client. Rule 1.15 states, in part:

(a) A lawyer shall decline to represent a client, or where representation has commenced, shall withdraw, except as stated in paragraph (c), from the representation of a client, if:

(1) the representation will result in violation of Rule 3.08, other applicable rules of professional conduct or other law;

(2) the lawyer's physical, mental or psychological condition materially impairs the lawyer's fitness to represent the client; or

(3) the lawyer is discharged, with or without good cause.

(b) except as required by paragraph (a), a lawyer shall not withdraw from representing a client unless:

(1) withdrawal can be accomplished without material adverse effect on the interests of the client.

If the basis for withdrawal is a coverage conflict that has been discovered during the case than arguably Rule 1.15 could prohibit defense counsel from informing the insurer of this conflict. In that case, defense counsel should advise the insurer that an irreconcilable conflict has arisen without disclosing any development that would impact coverage.

Under current Texas law, a defense counsel must consider the requirements of the Texas Supreme Court in Tilley, the requirements of the Texas Disciplinary Rules of Professional Conduct and the interests of the insured when making determination as to whether to accept or continue with representation of an insured under a reservation of rights.

D. Practical Solutions to the Current Dilemma in Texas

The current uncertainties faced by defense counsel appointed under a reservation of rights from an insurer would largely be resolved if Texas were to adopt an approach similar to the majority of jurisdictions in the United States concerning conflicts between insurers, insureds and defense counsel. The first significant decision to deal with this issue was San Diego Navy Fed. Credit Union v. Cumis Ins. Soc'y, Inc., 208 Cal. Rptr. 494, 498 (Cal. App. 1984), wherein the California Court of Appeals held that:

* attorneys retained by an insurance company to defend an insured under a reservation of rights had to fully explain to the insured and the insurer the implications of the defense counsel's appointment;

* if the insured does not consent to the appointment of defense counsel by the insurer under a reservation of rights, the insured can hire independent counsel and the insurer will be responsible for the reasonable costs incurred by the independent counsel in defending the insured; and

* the insurer cannot compel the insured to surrender control of the litigation.

Subsequent to the Cumis decision, the California legislature codified the obligations of an insurer under a situation involving a conflict, or possible conflict, and placed limitations upon the conduct of the insurer, the insured and defense counsel in these situations. California Civil Code § 2860, provides, in part:

(a) If the provisions of a policy of insurance impose a duty to defend upon an insurer and a conflict of interest arises which creates a duty on the part of the insurer to provide independent counsel to the insured, the insurer shall provide independent counsel to represent the insured unless, at the time the insured is informed that a possible conflict may arise or does exist, the insured expressly waives, in writing, the right to independent counsel.

(b) For purposes of this section, a conflict of interest does not exist as to allegations or facts in the litigation for which the insurer denies coverage; however, when an insurer reserves its rights on a given issue and the outcome of that coverage issue can be controlled by counsel first retained by the insurer for the defense of the claim, a conflict of interest may exist.

(c) The insurer's obligation to pay fees to the independent counsel selected by the insured is limited to the rates which are actually paid by the insurer to attorneys retained by it in the ordinary course of business in the defense of similar actions in the community where the claim arose is being defended.

(d) When independent counsel has been selected by the insured, it shall be the duty of that counsel and the insured to disclose to the insurer all information concerning the actions except privileged materials relevant to coverage disputes, and timely to inform and consult with the insurer on all matters relating to the action.

(f) Where the insured selects independent counsel pursuant to the provisions of this section, both the counsel provided by the insurer and independent counsel selected by the insurer shall be allowed to participate in all aspects of the litigation. Counsel shall cooperate fully in the exchange of information that is consistent with each counsel's ethical and legal obligation to the insured. Nothing in this section shall relieve the insured of his or her duty to cooperate with the insurer under the terms of the insurance contract.

The majority of other jurisdictions in the United States have adopted similar statutory or common law positions concerning independent counsel. See Christopher W. Martin and M. Jarrett Coleman, Independent Counsel Issues in Texas: 1998 Update, South Texas College of Law Texas Insurance Law Symposium, July 1998. Obviously, for those who have defended an insured under a reservation of rights, definitive Texas law on this issue would be well received.

II. The Role of Defense Counsel Appointed By an Insurer After State Farm Mutual Automobile Insurance Company v. Traver.

In December 1998 the Texas Supreme Court issued the decision of State Farm Mut. Auto. Ins. Co. v. Traver, 980 S.W.2d 625 (Tex. 1998), which held that an insurer is not vicariously liable for the malpractice of an independent counsel selected by the insurer to defend the insured. The Court further reiterated that independent counsel appointed by an insurer owes unqualified loyalty to the insured and must at all times protect the interests of the insured if those interests would be compromised by the insurer's instructions.

In determining that an insurer is not vicariously liable for the wrongful acts of independent counsel appointed by the insurer, the Court's analysis focused on the insurer's right to control the attorney with respect to the details of his conduct. Focusing on the Restatement (Second) Of Agency § 385 cmt. a (1957), the Court found that "[a] defense attorney, as an independent contractor, has discretion regarding the day-to-day details of conducting the defense, and is not subject to the client's control regarding those details." Id. at 627. The Court's use of the word "client" is interesting as the part of the opinion immediately following this reference emphasizes the fact that the insured, not the insurer, is the defense counsel's client.

The Traver decision draws upon Tilley and opinions from other jurisdictions to support its finding that defense counsel has an unqualified loyalty to protect the interests of the insured and that these interests cannot be compromised by instructions from the insurer. The decision goes on to cite cases from outside Texas, which emphasize that defense counsel appointed by an insurer should be free from interference from the insurer.

The Court recognized that its holding in Ranger County. Mut. Ins. Co. v. Guin, 723 S.W.2d 656 (Tex. 1987) could be read as inconsistent with the holding in Traver. In Guin, the court held that an insurer was responsible to the insured for the acts of the appointed defense counsel. The Court in Traver went on to distinguish the facts of the Traver case, which involved claims for malpractice, from the facts of the Ranger case which were restricted to a Stowers' claim for negligent failure to settle. In addition, the Court emphasized that its broad language in Ranger concerning the scope of an insurer's responsibilities was dicta. The result of the Traver decision appears to be that an insurer is still responsible for the acts of appointed defense counsel for unreasonable failure to settle a matter but that this responsibility does not extend to counsel's negligent investigation or trial of a lawsuit.

The Traver decision reemphasizes that defense counsel's paramount loyalty is to the insured, not the insurer. In addition, it gives some guidance to defense counsel that some insurance company requirements may compromise the representation of the insured; therefore, defense counsel may be warranted in disregarding those requirements which impair counsel's ability to defend the insured. In summary, it provides additional support for erring on the side of the insured when faced with a judgment call on day to day case handling. Unfortunately, the Traver decision does not go far enough in providing a protocol by which defense counsel can be appointed nor does it provide defense counsel the degree of independence provided to Cumis counsel by statute.

Justice Gonzalez filed a concurring and dissenting opinion, joined by Justice Abbott, which analyzed the tripartite relationship between insurer, insured and defense counsel and recognized that an insurance company's interest is to provide a defense at the lowest possible cost. In particular, Justice Gonzalez questioned the ability of an insurance company's "captive law firm" to provide an insured with unqualified loyalty. The concurrence and dissent also expressed concerns that an insurer's desire to cut costs could compromise defense counsel's autonomy and independent judgment. Finally, Justice Gonzalez recommended that the Texas Legislature consider the problems inherent in the tripartite relationship and the conflicts that can arise between insurer, insured and defense counsel.

III. The Duty of Defense Counsel Under Stowers.

The tension inherent in the tripartite relationship of insurer, insured and defense counsel can become significant when faced with a Stowers settlement demand. Defense counsel must be aware of the potential Stowers exposure in cases where the settlement value exceeds, or is close to, the limits of insurance available to the insured. In those situations the relationship between the insurance company, the insured and defense counsel can be subjected to conflicts of interests between the parties. In addition, Stowers demands have been used frequently over the past two decades for the very purpose of driving a wedge between the insurer, the insured and defense counsel, therefore, counsel must be familiar with the evolution, and current application, of the Stowers doctrine.

A. Historical Perspective

In G.A. Stowers Furniture Co. v. American Indem. Co., 15 S.W.2d 544, 547 (Tex. Comm'n App. 1929, holding approved) the commission of appeals was faced with an issue of first impression in Texas: whether the insurer owes a duty to its insured to limit the insured's exposure to judgments in excess of policy limits and settle a third party claim if the demand is reasonable and within policy limits.

The underlying facts of the Stowers case involved a relatively simple auto accident in which an employee of the Stowers Furniture Company, driving a company van, collided with a vehicle on the shoulder of the road. The injured plaintiff filed suit against the company, alleging damages of $20,000. Stowers' insurer, American Indemnity Company, provided a defense and retained counsel for Stowers, pursuant to the terms of its insurance contract. The limits of the auto policy were $5,000.00. During the litigation, the plaintiff offered to settle the case for $4,000 but the carrier never offered more than $2,500. Following a jury trial, judgment was entered for $12,000 plus costs. After an unsuccessful appeal of the underlying case, Stowers satisfied the entire judgment and then brought suit against its insurer.

In the subsequent jury trial the insurer was found negligent for not settling the case. The commission reviewed the underlying insurance policy involved and noted that the contract gave the insurer the right to control all aspects of the litigation, including settlement. Consequently, the court held that when an insurer dictates the course of the litigation in which its insured is involved, then all actions taken by the insurer on behalf of the insured must be reasonable. The court therefore created a common law duty for all insurers to act "with that degree of care and diligence which an ordinarily prudent person would exercise in the management of his own business." Id at 547.

The commission held that, from the standpoint of the insured, if an ordinarily prudent person would have settled the case prior to trial, then the insurer which did not act in a prudent manner is responsible for all damages incurred by its insured.

B. The Stowers Doctrine In the Eighties

In the early eighties, Texas courts repeatedly confirmed that the Stowers Doctrine was a limited concept relating solely to the insurer's obligation to enter into reasonable settlement negotiations or accept reasonable settlement offers in order to protect its insured from an excess judgment. See Allstate Ins. Co. v. Kelly, 680 S.W. 2d 595, 598 (Tex.App.--Tyler 1984, writ ref'd n.r.e.), Rosell v. Farmers Texas County Mut. Ins. Co., 642 S.W.2d 278, 279-80 (Tex.App.--Texarkana 1982 , no writ). Defense counsel were usually in the middle of any conflicts between the insurer and the insured concerning settlement.

In 1987, the Texas Supreme Court appeared to supplement the Stowers remedy available by expanding the duty of the insurer with respect to all phases of the litigation. In Ranger County Mut. Ins. Co. v. Guin, 723 S.W.2d 656 (Tex. 1987), the court noted that the Stowers Doctrine was based upon an agency relationship between the insurer and the insured and therefore the insurer's duty to its insured should cover all activities carried on by the Underwriters pursuant to the insurance contract. The court thereby implied a duty of good faith dealing by the carrier not just with respect to settlement of the claims or litigation, but with respect to the investigation, preparation for defense of the suit, and the actual trial of the case. Id. at 659-60.

Taking Stowers where no man had gone before, the court also impliedly condoned a jury issue which seemed to place the burden on the insurer to make a settlement offer and begin settlement negotiations, even if no demand within limits had been made. Justice Gonzales, dissenting, noted that these principals were outside the scope of Stowers and created extra duties upon an insurer that were not envisioned by any previous court addressing Stowers. Justice Gonzales agreed the majority seemed to be applying the Stowers premise, that an unconditional offer to settle all claims within the policy limits must be made, but that the facts did not support the majority conclusion. The Texas Supreme Court, in State Farm Mut. Auto. Ins. v. Traver, supra, now appears to have backed off from its position in Guin, stating that its broad language pertaining to an insurer's responsibilities for defense counsel was dicta.

In the late 1980's and early 1990's, however, Stowers was a common component in any case in which damages could approach policy limits. Many lawyers automatically issued pro forma Stowers demand letters offering to settle within policy limits as a means of generating even more pressure upon the insured, insurers and their counsel, and as an attempt to drive a wedge between these parties.

C. Return to Normalcy in the 1990's

Following the public's "approval" of tort reform legislation and the election of a new Supreme Court, the expansion of remedies under the Stowers Doctrine ceased. While many may think the remedy originally created in 1929 no longer exists, in recent years the Texas Supreme Court has reaffirmed the basic principles of Stowers and strictly interpreted the procedures necessary to prove such a case.

APIE v. Garcia, 876 S.W. 2d 842 (Tex. 1994) is the landmark decision with respect to the elements necessary to prove a Stowers case, as well as the procedural matters required of the plaintiffs. The Court clarified and expressly stated the three elements of the test for successfully proving a Stowers claim:

Generally, a Stowers settlement demand must propose to release the insured fully in exchange for a stated sum but may substitute 'the policy limits' for a sum certain. The Stowers duty is not activated by a settlement demand unless three prerequisites are met: (1) the claim against the insured is within the scope of the insurance coverage; (2) the demand is within the policy limits; and (3) the terms of the demand are such that an ordinarily prudent insurer would accept it, considering the likelihood and degree of the insured's potential exposure to an excess judgment.

Id. at 848-49.

Justice Cornyn, writing for a five member majority, noted that initially the plaintiffs' pleadings did not allege any negligent conduct by the insured within the policy period and hence did not meet the first prong of the Stowers test. It was not until the day of trial that the plaintiffs' amended their petition and alleged a negligent act within the covered time period of the policy. The court then retreated from the dicta of Guin, which seemed to indicate the insurer had a duty to begin settlement negotiations. The court noted that although the insurer had always been involved in the case and was paying defense counsel fees, the insurer had no obligation to begin settlement negotiations, particularly when no negligent act of the insured within the policy terms and conditions was alleged. "Considering the negotiating incentives for each party, we conclude that the public interest favoring early dispute resolution supports our decision not to shift the burden of making settlement offers under Stowers onto insurers." Id. at 851.

The court observed that since the various policies which the insured possessed could not be stacked, the plaintiffs settlement demand of 1.6 million dollars was not within the single limits of the policy and hence the second prong of the Stowers test was never met. The court therefore reversed and rendered in favor of the insurer noting that the insurer could not be held liable for breaching the Stowers duty when no demand had ever been made within applicable policy limits.

D. Recent Applications of the Stowers Doctrine

In Texas Farmers Ins. Co. v. Soriano, 881 S.W. 2d 312 (Tex. 1994), the court considered the applicability of Stowers when multiple claimants are seeking recovery against one policy. Initially, the court reaffirmed the three prong test enunciated in Garcia. As a preliminary matter, the court noted the insurer had an obligation to act reasonably and protect the insured from all claimants. The Court went on to hold:

We conclude that when faced with a settlement demand arising out of multiple claims, and inadequate proceeds, an insurer may enter into a reasonable settlement with one of several claimants even though such settlement exhausts or diminishes the proceeds available to satisfy other claims.

Id. at 315.

E. Valid Components of a Stowers Demand

There are several lessons to be learned from the many recent cases applying the Stowers Doctrine. When evaluating or formulating a Stowers demand, the first issue to address is whether the demand is formal. No court has ever stated that a verbal Stowers demand is invalid, but it is obviously prudent to make sure that all demands which contemplate a Stowers claim following the resolution of the plaintiff's case, should be done in writing to ensure that all of the necessary elements can be proven in a simple, concise manner. Otherwise, counsel is left with attempting to prove that all the elements of a Stowers case have been met through the testimony of opposing counsel or claims handler. In addition, if such demands are made verbally at a mediation, the mediator would likely be prohibited from testifying at any subsequent trial and a swearing match may ensue between counsel on key points such as whether an offer was unconditional, released all claims, or otherwise complied with the Stowers requirements.

The Stowers demand therefore should be in writing, must offer to settle all claims unconditionally within policy limits, or for a sum certain within remaining limits, and must note that acceptance of the offered amount or remaining limits will result in a full and final release of all claims against the insured, at least as to the offering plaintiff(s). In addition, in light of the Texas Supreme Court's language in Maldonado, the insurer should be given a reasonable time within which to respond to the demand. While the courts have not specifically stated what is "reasonable", the greater amount of time would obviously enable the plaintiffs to argue that sufficient time was given. See State Farm Lloyds Ins. Co. v. Maldonado, 963 S.W.2d 38 (Tex. 1998). Generally speaking, thirty days in which to respond to a Stowers demand letter would seem to be sufficient and would likely negate any argument by the insurer that a reasonable amount of time was not given within which to respond to the demand.

The Stowers Doctrine has been heavily litigated and discussed in recent times. Where the courts have reversed many damage awards based on a violation of the Stowers duty owed to insureds, the remedy itself is still alive and well. All counsel when preparing and/or evaluating a Stowers demand must be aware of the technical nature of the claim and the reasons for the creation and evolution of the Stowers Doctrine. Further, defense counsel should be cognizant of the pressures that can be exerted on the tripartite relationship of insurer, insured and defense counsel when a Stowers demand is made.

IV. Insurance Company Guidelines and Billing Practices

In recent years insurance companies promulgated guidelines and billing practices to which outside counsel must adhere in order to continue working for the insurer. Justice Gonzalez, in his concurring and dissenting opinion in State Farm Mut. Auto. Ins. Co. v. Traver, acknowledged the last decade's evolving trends in modern insurance defense practice and stated his concern that insurance companies' cost control methods could compromise an attorney's autonomy and independent judgment. In addition, there are now concerns as to whether an insurer's requirement that defense counsel submit its legal bills to an outside auditor will waive the attorney-client privilege and protection afforded to work product. With these recent and ongoing developments in insurance company guidelines and requirements, defense counsel must be aware of the possible pitfalls that may exist in compliance.

A. Case Handling Guidelines

The purpose of most insurance company guidelines for defense counsel is to contain or reduce costs. Justice Gonzalez's comments in his concurrence and dissent in Traver focused on the possible negative effects of such guidelines:

Competition for insurance work weakens the defense lawyer's hand while it allows insurance companies to demand ever-stringent cost containment measures. In some insurance companies a case administrator, who may not even be a lawyer, decides legal strategy and tactics in the policy holder's defense. Some insurance companies impose billing restrictions and subject the lawyers to billing audits. These audits threaten the attorney-client privilege. Some companies even dictate whether an attorney or a paralegal does some of the work. . . . I do not mean to imply that all insureds are entitled to a 'Cadillac' defense when all they paid for is a 'Chevrolet.' My concern, however, is that because of recent market changes in insurance defense practice, some insureds who have paid for a 'Chevrolet' defense are getting a 'Yugo' defense.

Traver, 980 S.W.2d at 634.

In Traver, the Texas Supreme Court's majority opinion made various references to the importance of defense counsel's independent professional judgment and that defense counsel's duty to the insured should not be compromised by the insurer's instructions. These references were made in support of the Court's holding that a liability insurer is not vicariously liable for the acts of defense counsel retained to defend the insured.

Other than these comments by the Texas Supreme Court in Traver, there appear to be no Texas cases or State Bar ethics opinions on the issue of whether defense counsel's representation of the insured can be compromised by insurance company guidelines or billing practices. The California Court of Appeals has questioned the wisdom and propriety of "outside counsel guidelines" which limited or restricted the sort of work that could be performed by outside counsel retained to represent the insured. Dynamic Concepts, Inc., v. Truck Ins. Exch., 61 Cal. App. 4th 999, 71 Ca. Rptr. 882 (Cal. Ct. App. 1998).

Other commentators have questioned the ability of an insurance company to enforce guidelines that may be contrary to the desire of the insured. See, Douglas R. Richmond, Walking a Tightrope: the Tripartite Relationship Between the Insurer and Insured, and Insurance Defense Counsel, 73 Neb. L. Rev. 265 (1994); and one New York state court held that an insured's insistence on certain aspects of case handling was not a violation of the assistance and cooperation clause in the insurance policy. Nelson Electrical Contracting Co., 1 No. 22 Mealeys Ins. L. Weekly at 7.

In Texas, reference to the Texas Disciplinary Rules may provide some guidance concerning the ethical obligations of defense counsel when faced with unreasonable guidelines. Rule 5.04(c) of the Texas Disciplinary Rules of Professional Conduct states:

A lawyer shall not permit a person who recommend, employs, or pays the lawyer to render legal services for another to direct or regulate the lawyer's professional judgment in rendering such legal services.

In light of the Texas cases recognizing the insured as the client of defense counsel and the party to whom counsel owes "unqualified loyalty," it would appear that Rule 5.04 may prohibit an insurance company from enforcing guidelines that would inhibit defense counsel's professional judgment in defending the insured. See Traver, 980 S.W.2d at 628; Tilley 496 S.W.2d at 558. Certainly in cases where the insurer has issued a reservation of rights or a qualification of coverage, Rule 5.04 would certainly limit the effectiveness of an insurer's guidelines or case handling requirements.

B. Submission of Legal Bills to Third Parties

Insurance company requirements that defense counsel submit legal bills to third party auditors may result in a waiver of attorney-client privilege and protection afforded to work product. In United States v. Massachusetts Inst. of Technology, 129 F.3d 681 (1st Cir. 1997), the First Circuit held that a contractor's disclosure of documents, including billing statements, to the Defense Contract Audit Agency, forfeited any attorney-client privilege covering such documents. The court based its holding, in part, upon the fact that the client chose to share communications with a third party outside the "magic circle" of the attorney-client relationship, and therefore the attorney-client privilege was forfeited.

Applying the reasoning of the First Circuit to situations where the insurer could be considered a "secondary" client of defense counsel, the insurer's requirement that legal bills be submitted to third party auditors may result in a waiver of the attorney-client privilege. See Charles Silver, Does the Insurance Defense Counsel Represent the Company or the Insured?, 72 Tex. L. Rev. 1583 (1994). In situations where the insurer has issued a reservation of rights and/or the insured is the paramount, or only, client, a defense counsel's release of fee bills without the clients consent could be held to be an ethical violation. See Bradt v. West, 892 S.W.2d 56,77 (Tex. App.--Houston [1st Dist.] 1994, no writ); See Tex. Prof. Ethics Comm. Op. 464, 495, and 506.

When confronted with guidelines required by an insurer, defense counsel should make the insurer and the insured aware of the possible problems concerning waiver and disclosure of attorney-client privilege and work product, as well as any ethical difficulties that may be caused by guideline requirements concerning case handling and submission of legal bills to third parties.

SUMMARY

For the last 30 years, the law in Texas concerning the defense firm and insurance company relationship has not provided a great deal of practical guidance to attorneys or insurers. An indication of the unsettled nature of this area of law can be seen in the various attempts to drive wedges between the insurer, the insured and defense counsel through the use of the Stowers Doctrine. The absence of a predictable method by which to appoint defense counsel and deal adequately with apparent conflicts between insurers and the insured has created a significant grey area for appointed defense counsel. The Traver opinion is an indication of the Texas Supreme Court's awareness of the need for definitive law in this area and, hopefully, Texas lawmakers will recognize this as well.